12 July 2016
Following her now famous tweet, in which she accused pharmaceutical companies of “price gouging”, Hillary Clinton has been credited with having triggered a major sell-off in healthcare stocks in September last year. However, with the sector outperforming the broader market in each of the previous five calendar years, the current consolidation phase is a healthy development for investors.
US election weighs on sentiment
The polls suggest that Hillary Clinton and Donald Trump will remain head-to-head in the race for president. This begs the question of what the election campaign means for the healthcare sector. Clearly, the debate over tighter regulation of drug pricing has weighed on investor sentiment, especially as generalists focus more on macro headlines rather than product pipelines, and have exited the space. This risk-off behaviour has led investors to shun the more volatile biotech space in favour of more economically-sensitive areas, such as medical devices and life science tools. The drug pricing discussion has been a recurring topic on the campaign trail, but we believe that this issue will die down as candidates concentrate on larger topics in the run-up to the November election. In the near term, we see little appetite for widespread bipartisan reform given the political set-up of a Republican-dominated Congress.
In the second half we expect investors to turn their attention back to fundamentals as we are entering a newsflow-rich period with many catalysts, including regulatory decisions, scientific conferences and pivotal clinical read-outs in immuno-oncology, cardiovascular, multiple sclerosis and Alzheimer’s disease.
A busy M&A calendar ahead
Looking at structural drivers, we are seeing scope for a pick-up in M&A activity off a quiet first half 2016. This outlook is based on a number of interesting observations in the market place. Large companies are disposing of certain assets, freeing up huge amounts of cash to invest elsewhere. For example, Allergan is selling its generics business to Teva, and is now looking for opportunities to redeploy more than USD 30 billion. Also, the unexpected collapse of the Pfizer / Allergan merger triggered a paradoxical reinvigoration of the M&A landscape as both companies are on the hunt for fresh targets, in turn giving a boost to biotech shares. And indeed, in May Pfizer announced its first acquisition post Allergan: the purchase of Anacor Pharmaceuticals for a total consideration of USD 5 billion. The loss of patent protection and market exclusivity for many blockbusters over the period from 2021 to 2030 will lead to further market consolidation and brisk M&A activity. Finally, we expect the deal making process to be facilitated by large cash balances and sellers more open to the prices that acquirers are willing to pay.
Valuation does not reflect innovation potential
Today’s valuation of about 17x one-year forward earnings and a 2% discount to the broader market is the most attractive in more than three years. We believe these multiples do not reflect the strong innovation potential of the sector. The typical expansion phase within a product cycle is around 10 years. We estimate that we are about four years into the expansion phase of the current product cycle, powered by breakthrough scientific discoveries that will continue to fuel revenue growth and provide high visibility into future cash flows.
For the remainder of this year we will continue to see the innovative pace within healthcare upheld, with many disruptive innovations and technologies advancing their path to becoming approved therapies. We anticipate that positive newsflow coupled with a recovery in valuations will translate into positive investment returns. Further, we expect headwinds from the US election to abate as November draws nearer and a new president is finally elected.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.