15 December 2016
Donald J. Trump’s accession to the White House, together with a comfortable republican majority in Congress, should alleviate investor trepidation about drug price legislation. On the same day, voters in California rejected “The California Drug Price Relief Act”, a deceptively simple proposal aimed at reducing drug prices paid by state entities. Clearly, these outcomes are a boon for investors in the beaten-down biopharmaceutical sector. While the immediate market reaction was overwhelmingly positive, the question is how much comfort do these outcomes provide investors with for a sustained comeback in 2017 and beyond?
Sure enough, discussions on drug prices will continue to grab the headlines every now and then, but we expect the fierce polemic that has so negatively impacted investor sentiment to die down. We cannot rule out any policy wildcards from a Trump administration, especially as Obamacare gets repealed and replaced, but democratic-style healthcare reforms are off the table. And so, undoubtedly, the results of the US elections set the stage for a re-rating of the sector.
Increased competition in therapeutic areas such as diabetes and higher reimbursement hurdles set by commercial payors will continue to put downward pressure on prices, especially in areas that lack innovation. But it is important to emphasise that efforts to contain drug prices have been the norm over the last 25 years and will continue to be in effect in the future. For example, we expect more price transparency and new pay-for-performance reimbursement models with a greater emphasis on the value of medicines.
Looking ahead into 2017, we expect side-lined investors to move back into the sector as the investment case for healthcare remains very compelling, and even more so now in a postelection world…
One of the cornerstones of President-elect Trump’s policy is comprehensive corporate tax reform, including a one-time tax repatriation holiday and possibly a permanent research and development (R&D) tax credit as part of the incentivisation of innovation. We believe such a tax overhaul plan should face low hurdles in Congress as there is growing consensus on the need for tax reform to make American enterprises more competitive. Healthcare appears set to become one of the major beneficiaries. Based on limited market and corporate data we estimate that companies in the healthcare sector hold about USD150bn in cash and USD450bn in profits overseas.
While it is difficult to predict how and to what extent tax reform will affect corporate strategies, it has been well telegraphed that, besides returning cash to shareholders, companies have a strong interest in external business development. New tax incentives will increase their financial flexibility substantially and make potential company breakups (Pfizer, Johnson & Johnson) more attractive. On the supply side, years of successful product development have created a pool of attractive takeout candidates to choose from.
We therefore feel that the foundations have been laid for a broadly-based increase in merger and acquisition (M&A) activity during the period ahead. In this respect, it is worth noting that during the recent quarters in which M&A volumes have peaked, activity has typically been driven by larger deals rather than an uptrend in the number of individual transactions. For example, the second quarter of 2016 was dominated by the USD35.2 billion acquisition of Baxalta by Shire. Similarly, when healthcare M&A volumes eclipsed those of all other sector in the first quarter of 2015, AbbVie’s bid for Pharmacyclics took centre stage.
In terms of valuation, healthcare trades at the highest discount in five years and biotechnology stocks can be bought at record low multiples. Consequently, while investors give little credit to the fundamentals of the sector today, we believe that this anticipated pickup in M&A transactions - together with positive product-pipeline news flow and a reset in earnings expectations for 2017 - is all that is needed to bring investors back into healthcare, sooner rather than later.
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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.