After health reform failure, industry builds corporate giants

[Guest guest]

Overhaul's Failure Will Ignite U.S. Health Mergers (Update2)

February 08, 2010, By Nussbaum and Meg Tirrell

Feb. 8 (Bloomberg) -- Insurers, drugmakers and hospitals will likely slash costs

and merge companies to maneuver through a U.S. health-care landscape marked by

rising medical expenses and the loss of millions of potential paying customers.

With Congress' sweeping overhaul of the health system stalled, industry will

seek its own answers to a push by government and the private sector to rein in

costs, said Curtis Lane, senior managing director at MTS Health Partners, a New

York-based equity fund. An aging U.S. population will spur demand for services

and, at the same time, boost pressure to control spending, he said.

One solution will be increased consolidation, with companies led by WellPoint

Inc., the biggest U.S. insurer by enrollment, and Community Health Systems Inc.,

the largest publicly traded hospital chain, scooping up rivals unable to " spread

rising costs across fewer customers, " said Keckley, of the Deloitte Center

for Health Solutions.

The health-care market " certainly seems to favor bigger, innovative, scalable

companies, " said Keckley, executive director of the Washington-based center, in

a phone interview. Drugmakers facing the loss of patent protection on

top-selling medicines " were looking at decelerating revenues, with or without

reform, " he said.

President Barack Obama's plan to expand insurance coverage to more than 30

million Americans and impose more regulations on the medical industry was

upended Jan. 19, when Republican Brown won the Massachusetts U.S. Senate

seat held for 47 years by the late Kennedy, a Democrat and one of

Congress' staunchest supporters of widening coverage.

Political Dynamic

Brown's victory deprived congressional Democrats of their 60-vote,

filibuster-proof majority in the Senate needed to win passage of the health-care

measure. The Standard and Poor's 500 Managed Health Care Index has fallen 9.5

percent and the S & P 500 Pharmaceutical Index has dropped 7.6 percent since then,

compared with the S & P 500's 8.1 percent decline. That follows a six-month period

in which health stocks outperformed the S & P.

The drop is partly the result of uncertainty, said Les Funtleyder, a

Tabak & Co. health-care analyst in New York. Democrats have talked of passing

stripped-down legislation that would ban insurers from denying coverage to

people based on their health, while dropping a mandate in the current bills that

more Americans buy their products.

Targets for Cuts

Pharmaceutical companies and hospitals negotiated deals with the Obama

administration to forgo revenue to help pay the cost of expanded coverage. The

companies may be targets for bigger cuts now by Democrats who said the

agreements hadn't cost industry enough, said Hacker, a Yale University

political science professor who supports Democrats' plans for a comprehensive

overhaul.

" Absent reform, fewer and fewer Americans are going to be able to afford their

services and products, " Hacker said by e- mail. " And there is no prospect they

will get the sweet deals they struck with the White House if a broad bill is not

on the table. "

Obama said he won't abandon the overhaul at a Feb. 2 town- hall meeting in

Nashua, New Hampshire, and repeated that vow four days later at the Democratic

National Committee's winter meeting in Washington.

" We've got to punch it through, " Obama said of the legislation during the Nashua

meeting. The House and Senate passed separate bills and were negotiating a final

plan when Brown won in Massachusetts.

In an interview yesterday with " CBS Evening News " anchor Couric, Obama

invited Republican and Democratic lawmakers from the House and the Senate to a

Feb. 25 meeting to discuss ways to get a health-care overhaul through Congress.

One-in-Five

One in five working-age Americans lacked health coverage during the first half

of 2009, the highest in six years, the U.S. Centers for Disease Control and

Prevention said in a Dec. 16 report. Health-care spending last year reached an

estimated $2.5 trillion, rising 6 percent from 2008, analysts with the U.S.

Centers for Medicare and Medicaid Services said in another paper, released Feb.

4 in the journal " Health Affairs. "

The U.S. government faces pressure to slow the rise in health spending as it

tries to plug a budget deficit projected to reach $1.6 trillion this year, said

Deloitte's Keckley. The overhaul bills included cuts of more than $120 billion

over a decade to Medicare Advantage, a program that pays private insurers to

provide benefits to the elderly. Obama also proposed a $20 billion increase in

discounts drugmakers must give Medicaid, the joint U.S.-state health program for

the poor.

" Entitlement programs are going to be on the front- burner, " if lawmakers want

to reduce the deficit, Keckley said.

Insurer Expense Limits

The overhaul's death may spare insurers from limits on their administrative

expenses, regulations forcing them to accept even the costliest patients and $70

billion in additional taxes on industry premiums. It would also deprive

companies of millions of new, taxpayer-subsidized customers at a time when

commercial enrollments are dropping.

Among the nation's 1,300 health plans, larger companies with a national reach

led by Minnetonka, Minnesota-based UnitedHealth Group Inc., and

Indianapolis-based WellPoint, will have the advantage, Keckley said.

The companies have the size to negotiate better rates with hospitals and the

capital to fund technological upgrades to better track patient costs and doctor

quality, he said. Smaller plans with fewer than 200,000 customers are the most

likely to go under or be bought, he said.

WellPoint, the largest health plan by enrollment, owns 14 state Blue Cross

plans. It sees " a unique opportunity " to consolidate more of them once the

health-care debate is settled, Chief Executive Officer Braly said by

telephone.

Expanding Services

UnitedHealth, the second biggest insurer, has expanded beyond traditional

insurance to include a drug-benefits manager, a health-care consulting firm and

a bank to finance medical transactions. CEO Hemsley also bought the

northeast unit of rival Health Net Inc. of Woodland Hills, California, last year

in a deal worth up to $610 million.

" We wouldn't change it at all, " Hemsley said of the company's strategy absent an

overhaul, in a Jan. 21 conference call with analysts. Looking at " the core

fundamental market needs, that's what we're responding to. They align with

reform because of the same issues and challenges. "

Hospitals, too, may consolidate as Community Health Systems, Health Management

Associates Inc. and LifePoint Hospitals Inc. intensify their pursuit of

competitors hurt by the recession, said Sanford Steever, editor of " The Health

Care M & A Report, " a Norwalk, Connecticut-based newsletter.

Hospital Losses

A third of the nation's community hospitals had operating losses in 2008,

according to the American Hospital Association. Health Management of Naples,

Florida, the second-largest publicly traded chain, is " seeing increased

opportunities " to buy centers, said Senior Vice President Farnham. Prices

have dropped as much as 50 percent over three years, he said.

LifePoint, of Brentwood, Tennessee, may buy three more hospitals this year, said

CEO Carpenter.

MTS Health's Lane said his firm is hearing more since the Massachusetts election

from individual investors looking for health-care buys and companies interested

in help financing deals. He declined to give details.

Health industry stocks may not return to the mid-2000s premiums they traded at

over the broader market, said Lane, a former head of health-care investment

banking at Bear Stearns Cos. While the aging population makes growth almost a

certainty, the Washington debate has shown investors the power the government

has over industry incomes through Medicare and Medicaid, he said.

With that vulnerability laid bare, " that could have a chilling effect on

multiples for a long period of time, " Lane said. MTS had more than $200 million

in assets under management as of November, with investments in home health-care,

diagnostics and hospital companies.

More Efficient

" Consolidation allows you to operate more efficiently, and at the end of the

day, whether reform is imposed by the government or driven by market forces,

these companies are going to have to get better at being more cost effective and

providing higher quality, " he said.

Pharmaceutical companies may see sales suffer as more Medicare patients hit the

so-called donut hole, a gap in coverage that forces some elderly recipients to

pay thousands of dollars extra for their prescriptions and leads some to use

fewer medications.

The legislation would fill all or part of that hole by making pharmaceutical

makers offer cheaper drugs. Customers would have done " less pill-cutting, less

eliminating the prescriptions totally and perhaps less switching to generic

alternatives, " said Tony , an analyst with Barclays Capital in New York,

in a telephone interview Feb. 1.

Donut-Hole Discounts

" Seniors lose out " without the legislation, said. " Longer term, maybe the

pharmaceutical industry loses out. "

Pharmaceutical companies led by New York-based Pfizer Inc., the world's biggest

drugmaker, also stood to gain millions of customers, said Sullivan,

director of research at Leerink Swann & Co., a Boston-based health-care

investment bank. The industry had agreed to spend $80 billion over 10 years as

part of the overhaul, partly in donut-hole discounts.

The industry " did a good job of managing its risk in health-care reform, "

Sullivan said by telephone Feb. 3. " The death of health-care reform is probably

a neutral for them, if even a slight negative. "

With patents on some of their largest medicines scheduled to expire, the

companies will need to cut expenses as cheaper generic copies flood the market,

Sullivan said.

" Whether or not a comprehensive version of health-care reform passes into law,

drug companies have to be in the business of controlling their costs better, " he

said.

For drugmakers, " the major risk is that there is some future plan that's more

onerous than the current plan, " Barclays' said, citing the threat of

price controls.

Biotechnology Policies

Biotechnology companies Amgen Inc., of Thousand Oaks, California, and Genzyme

Corp., of Cambridge, Massachusetts, may win friendlier policies on generic

competition if Congress drops the broader health bill and takes up the issue

separately, said Mike King, a Merriman Curhan Ford & Co. analyst in New York.

The House and Senate measures would give biotech drugs 12 years of exclusivity

before rivals could introduce generic versions, less than the time urged by the

industry.

The bill " was going to be all industry-unfriendly, " King said Feb. 1 in a

telephone interview.

Medical-device makers, Medtronic Inc. of Minneapolis and & of

New Brunswick, New Jersey, among them, may avoid $20 billion in added fees if

the overhaul stalls. The sum for device companies " looked particularly onerous

given the size of the industry, " Sullivan said.

Greater Transparency

Medtronic, while it doesn't support the tax, would like to see parts of the

legislation passed, said Steve Cragle, a company spokesman, in a Feb. 3

telephone interview. He cited greater transparency in payments doctors get from

industry and money to explore which medical procedures are more effective.

J & J referred questions to industry groups AdvaMed, for devices, and PhRMA, for

drugmakers. AdvaMed declined to speculate on the legislation. In a Feb. 1

statement, PhRMA, without being specific, said that it supports a comprehensive

health-care bill " if done in a smart way and a fair way. "

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