Government run healthcare - effect on IB?

ibpotential's picture
Rank: Orangutan | 302

A lot of Democratic candidates are talking about making healthcare a public institution available for everyone.

Would this completely destroy the healthcare sector of IB? Should junior IB employees avoid being placed in the healthcare group? Interested to hear people's thoughts.

Comments (5)

Jul 10, 2019

Not interested in making this a political debate, just genuinely curious as to what effect this might have on deal flow for healthcare groups in IBD

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Jul 10, 2019

I hate to say that this is a serious case of wait and see, but it's a serious case of wait and see. Before I even get into my take on this, the question becomes what the final plan to be put in effect is. This covers everything from drug pricing to reimbursement rates to changes in the standard of care. We're talking a massive, complex overhaul of the system already in place. And don't forget, ICD-11 is in the early stages of rollout. That will have a huge effect on things come 2022. It will be a huge money sink, so things like that will need to be considered.

That said, let me get into my breakdown. First, from a care facility standpoint, if everything goes under a standardized reimbursement rate, I honestly expect to see a significant amount of industry consolidation to create fewer, larger, organized health systems, all purchased at a lower than expected pricing (relative to today's valuations) to gain economies of scale. Why the lower prices? Well, if everything is reimbursed on a CMS Basis, your reimbursement from insurance companies will decline by a significant percentage. If Medicare, on average, pays out a nickle on the dollar and insurance companies pay out 60 cents, you're losing 55 cents of revenue on every dollar spent. While I can't account for the impact of EMTALA/Non-Insured Illegal Immigrants, I assume some of the revenue that would, otherwise be a loss, will be paid out to offset th0e reduction.

The upside to this, however, is that consolidation would mean an increase in purchasing power for these health systems. But let's be real here, if the revenue from healthcare facilities is reduced, that means the cost of supplies across the board has to be reduced. Using HCA as an example, they make 46,667MM in 2018. 24,467MM of revenue came from managed care and other insurers while 19,089MM came from managed and non-managed medicare and medicaid programs. Since the managed care and other insurers portion of revenue is going to decline, the question is how big of a haircut will there be. For simplicity sake, let's call it 50%, which reduces that 24,467MM to 12,233.5MM. This reduces HCA's earnings by about 25% to 34,433.5MM. The only way that revenue doesn't fully tank is by adding back a portion of the uncompensated costs. I have a feeling that only the charity care costs will be added back in as a result. So we're tlaking another 8,600MM added back, which would bring the revenue up to 43,033.5MM. Based on the rest of their financials, they spent 41,342MM in operating expenses, with 21,425MM covering Salaries, 7,724MM covering Supplies, and 8,608MM in other expenses. That's 91% of their expenses right there. So what has to happen? They need to cut jobs, cut other expenses, and reduce the cost of supplies. That leaves ~1,800MM as your EBIT. My gut tells me that if HCA is going to experience a 25% decline, every hospital system will experience similar declines in revenue under a medicare-for-all system.

From a purchasing power perspective, if revenue is defined by the government's mandatory reimbursement rates and any and all legislative intent, the only real cost savings there is will come from layoffs, which will hurt an already strained system even more or acquisition. By buying more facilities, the larger parents will create some cost savings on the purchase of single-use goods. If I'm a hospital system, I'm going to reevaluate every single contract I have and reach out to competitors to eek out every single sent of cost savings I can on goods. Why spend money on BD Surgical Blades when I can buy from Cincinati Surgical at a cheaper rate? As a result, I see suppliers being forced to reduce prices in order to stay competative. I see some portions of Healthcare IT going the same way. I expect to see longer usage out of older systems to reduce IT spend and upgrade costs as well as extentions on the lease life of older machines that are still viable. I'm not sure how much of a decline in revenue this will produce, but it will produce a decline in revenue.

When it comes to medical devices, this is where it will get interesting. I see major consolidation of market share among the biggest names in the market. Not to say that they don't already have it, but we're talking hospitals pricing out brands they otherwise would have used regardless of the doctor preference. Medical device revenue is going to drop drastically. Instead of $10K for a pair of screws, the price will drop to $500 or $1000. Spacers, joints, hardware, etc. will all reimbursed at the government mandated rate. So how do you think that will affect Medical Device companies? If HCA saw a 25% drop in total revenue (before adding back charity care), how much do you expect J&J's Depuy Synthes, Zimmer Biomet, or Smith and Nephew to drop? It also will put a damper on some of the more expensive surgical cases. So expect medical device companies to experience a drop in revenue too. It doesn't mean there won't be activity in the space, but companies are going to be more careful when it comes to acquisitions of specialty technology unless it fits in their portfolio.

Healthcare IT, I honestly think, will be fine for the most part. I believe that it will survive because of the services provided are all long term and generally come with some sort of license component.

Pharma... yeah... I think that this one is the biggest boondoggle simply because you have to balance R&D costs with the new reimbursement costs in place. While I expect that Pharma will continue to have M&A activity, I think that most of it will be driven by acquisition of biotech and higher-risk startups who have a product that fits the existing portfolio. I don't think that much will change with regard to M&A activity, but this is the one that has me most unsure. I'm unsure simply because I don't know what happens with this one. Moreso than any area in healthcare, Pharma reimbursement rates are going to drive everything. So while we won't have a Mylan fucking over people who need epipens, who knows what will happen for on-patent drug pricing which is where most pharma companies derive their revenue from anyway.

Finally, we get to the providers. This is the one area where I'm truly not sure what will happen. I don't know what will happen here. Does this mean the death of private practice and a shift to a pure hospitalist system? Does this mean that private practice will continue given the decline in revenues theat everyone will face without any reductions in offsetting costs? What kind of an effect will it have on the number of doctors currently in practice? From a deal perspective, this is the hardest to gauge because there is no guarantee of anything.

For those that want the TL;DR, here's the short and simple. No clear plan means there's no clue as to what will happen. Dealmaking will continue, but at a reduced price because of structural changes. HCIT/HC Services will end up being the most stable area for healthcare banking, while there will be an initial uptick in HC Facilities M&A activity in the first few years post-rollout, followed by a decline in that space. Medical Devices will end up consolidating. Pharma is up in the air because of too many unknowns on where reimbursement goes, but expect it to continue. HC Providers is a total clusterfuck.

Jul 10, 2019

wow, thank you

Jul 10, 2019

You asked for apolitical, so that's apolitical. Here's the thing you need to remember about analysis. There are key linkage points in any industry that you need to understand to make any decent prediction. For Healthcare, reimbursement rates are one of those key linkage points. It happens to be the biggest driver of revenue across the board. If we move to a Medicare-for-all (MFA)/universal healthcare system(UHS), the obvious question is how does that change revenue in healthcare. From there, everything else falls into place. If you make a change to a single linkage point, how does everything else change? It's a ripple effect. If a procedure can be billed for $10,000 and your non-Medicare reimbursement rate drops from 75 cents on the dollar to 5 cents on the dollar under an MFA/UHS for a given procedure, you are losing ~93% of your income from that one procedure. You're going from seeing $7,500 to $500. Multiply that out by your volume and there's your massive cut in revenue. That means whoever is earning the reimbursement now has 93% less income derived from the volume of work they do for that procedure. So if you have declining revenue, you need to offset it somehow. So it goes back to looking at spend across labor, service specific purchases (such as those surgical sharps, gowns, gloves, and single use foam scrubbers covered in Chlorahexidine Gluconate, Parachlorometaxylenol and Povidone-Iodine used for scrubbing in), operating costs, and IT. The question becomes how do you reduce those costs to generate a large enough EBIT to cover any other added expense, interest and taxes. And there are cerain things, the cost of medical malpractice insurance, that won't change even with an MFA/UHS in place. Depending on how providers fare after the implementation of an MFA/UHS, we could see these these necessary expenses continue to rise. So once you start to understand how everything links together, everything else can just fall right into place.

Now, I keep harping on reimbursements simply because it is the biggest driver of revenue. It ties the entire analysis together. Just look at the Zimmer Biomet 10K. In the Forward-looking statement, it clearly states:

These risks, uncertainties, and changes in circumstances include, but are not limited to: ... challenges relating to changes in and compliance with governmental laws and regulations affecting our U.S. and international businesses, including regulations of the U.S. Food and Drug Administration and foreign government regulators, such as more stringent requirements for regulatory clearance of products... the impact of healthcare reform measures... reductions in reimbursement levels by third-party payors and cost containment efforts of healthcare purchasing organizations...

If you read the Risk Factors - there is a specific risk factor entitled "If third-party payors decline to reimburse our customers for our products or reduce reimbursement levels, the demand for our products may decline and our ability to sell
our products profitably may be harmed."

There's also a risk factor for "Business Outside the US", which one of the key drivers there is "Foreign Reimbursement Rates".

If you look at Merck's 10-K, "reimbursements" pops up multiple times in the risk factors section. From right out of the 10-K, under additional risks and adverse conditions: "changes in medical reimbursement policies and programs and pricing restrictions in key markets".

So yeah... reimursements... they are a total bitch. Legitimately, they suck even without trying to balance the potential structural issues that switching brings with it.

I'll add one more thought, which slipped my mind earlier. There is one issue which I didn't discuss when it comes to revenue for Care Facilities and Med Device Manufacturers, and that's volume. This one really is plan specific and heavily relies on the structure of a Medicare-for-all/Universal healthcare plan. Depending on how they structure things, necessity may drive a decline in volume across the board for hospital utilization, medical device volume, and pharma sales. I think that declines in volume will really spur on a high degree of M&A to help offset some of the loss of revenue.

Jul 11, 2019
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