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Whalebone Advisory provides investor relations and strategic advisory services to publicy-traded, pre-IPO, and development stage healthcare companies.
August 11, 2017

With Repeal Off The Table, Focus Shifts to Fixes;
Plus: FMS/NXTM, Soft Volumes & Drug Pricing Weigh on Earnings

Other than the standard-issue war of words between President Trump and Senate Majority Leader Mitch McConnell over the GOP’s failure to repeal the ACA (what else is new?), there are no new developments on the healthcare reform front. With no real hope for a legislative solution in the near-term, the focus now shifts to individual issues within the broader healthcare reform debate. For example, Anthem (ANTM) this week announced that it would pull out of individual exchange markets in half of Georgia’s counties and all of Nevada in 2018, sparking renewed emphasis on the need to strengthen the exchanges now that outright repeal is off the table.
As we have discussed before, the central conflict within the Republican party revolves around House and Senate members who may want to repeal the ACA but also have to face voters next year reliant on the exchanges for health insurance. Hence the increasingly vocal calls stabilize the exchange markets. The biggest risk to those markets, at this stage, is the Trump Administration’s ongoing game of chicken with the cost-sharing subsidies (CSR). The CSRs are fully funded through 2017, but there is uncertainty over whether the Administration will continue paying them in 2018, which is contributing to insurers’ decisions to pull out of numerous markets. This puts many individuals in the position of having either just one plan option in their market, or in many cases, none at all.
With growing bipartisan support for stabilizing the exchange markets, the prevailing questions are 1) whether the Administration is actually willing to let the exchanges fail, and 2) if the House and Senate can come together on a stabilization package more effectively than they could on repeal/replace. We should have more clarity on the fate of 2018 CSRs in the coming weeks.
The other main issue being considered now is the medical device excise tax, for which there is bipartisan support for repeal. With the ACA repeal/replace process no longer on the table, the question is how Congress may address the tax, whether through a standalone bill or as part of some other healthcare or tax reform package. At the Needham Med Tech 1x1 Conference in Boston this week, the President and CEO of AdvaMed, the industry’s trade association, estimates that there are at least 65 votes in the Senate for a repeal and that it is a key priority for Congress.

Fresenius Acquiring NxStage to Boost HHD, PD Businesses

Mondays, seemingly more often than not, bring significant M&A transactions, and this week was no different. Fresenius (FMS) announced that it has reached agreement to acquire NxStage Medical (NXTM) for $30/share, or roughly $2 billion. NXTM manufactures and sells dialysis systems and accessories for use in hospitals, dialysis clinics, or in the patient’s home. This price represents a roughly 5x multiple on NXTM’s expected 2017 EBITDA and came at a 30% premium to the stock’s close last Friday.
NXTM has a near monopoly on the home hemodialysis (HHD) market and is set to enter the peritoneal dialysis market in the next two years. FMS is already a customer of NXTM’s, having installed NXTM systems in many of its own clinics. Therefore, bringing this technology in-house makes strategic sense for FMS, which already treats approximately one-third of U.S. dialysis patients and a greater percentage in international markets. While FMS appears to be a logical partner for NXTM, some analysts believe that other bidders may emerge, include possibly Medtronic (MDT) or Baxter (BAX).
BAX, in particular, is an interesting candidate since Renal represents more than one-third of total revenue, it is developing its own PD system, and it has stated publicly its desire to become more active in M&A. Indeed, in meetings with analysts and investors this spring, management indicated that it is willing spend up to 20-25% of its market cap (or ~$8-$9 billion) on acquisitions. BAX appears set to begin clinical work on its PD product next year, with FDA approval likely in the late-2019/early 2020 timeframe. NXTM will beat BAX to market, but BAX management remains confident that its system will be competitive, and so the Street is not expected BAX to enter the bidding for NXTM.
Another wrinkle to this story is how relative newcomer Outset Medical will fit into the picture. The company is already to market with its Tablo system that can deliver dialysis treatments in a portable and more compact form factor with an onboard wireless informatics system to provide real-time data on how the patients is responding to the treatment. Tablo also contains its own integrated water treatment system that precludes the need for an entire water treatment room, making the system suitable for inpatient, outpatient, sub-acute, or home settings (although Tablo is not yet approved for home use). Outset is just beginning to ramp sales but could become a more meaningful player – and acquisition target – in the coming years.

In Other News: MDRX ACE Takeaways, PODD Adds Heft to Its Board

Allscripts Healthcare (MDRX) hosted its annual Allscripts Client Experience (ACE) conference in Chicago on Tuesday combining a gathering of MDRX clients with an investor day. Management was upbeat and expressed confidence in the company’s progress in executing on its five-year plan, citing its solid earnings results through the first half of the year. Value-based care (VBC) remains a top priority, and with the ongoing political uncertainty causing unquantifiable levels disruption for hospital capital spending plans, many hospitals understand the importance of making this difficult transition. While many health systems may struggle with various aspects of the transition, MDRX reiterated its commitment to helping these networks develop systems to measure performance metrics and how these changes in care delivery may impact financial performance.
MDRX also provided color on its recent acquisition of McKesson’s (MCK) Enterprise Information Solutions business. The Street generally views this addition as complementary to MDRX’s existing Sunrise platform, now giving the company offerings at all ends of the value spectrum and enabling it to gain market share. Management expects the deal to add 200 basis points of EBITDA margin by 2019, largely through cross-selling opportunities and SG&A leverage.

Insulet (PODD) added two respected veteran executives to its Board of Directors this week. The company appointed Michael Minogue, President, CEO, and Chairman of Abiomed (ABMD), and James Mullen, currently the CEO of Patheon (PTHN), which has agreed to be acquired by Thermo Fisher (TMO), and the former President and CEO of Biogen (BIIB). Minogue and Mullen replace the retiring Regina Sommer and Joseph Zakrzewski and are coming on board at a time of increasing interest in the diabetes space as large players (ABT and MDT) and newcomers (Bigfoot Biomedical) are entering the space with new sensors, pumps, and fully integrated closed-loop systems. Therefore, fortifying the Board with executives accustomed to operating in ultra-competitive markets would seem to make sense for PODD.

Earnings Review: Utilization Headwinds Pressure Providers, Drug Pricing Declines Weighing on Generics and Specialty Pharmacies

The last full week of the June quarter earnings season brought many of the same trends we saw in the previous three weeks. We saw continued outperformance from managed care companies on improved medical loss ratio (MLR) despite uncertainty over the fate of the exchanges next year and ongoing utilization headwinds from inpatient, outpatient, and sub-acute providers that may or may not be part of a longer-term trend. Biopharma and pharmacy results were also largely positive, although drug pricing, particularly on the generic side, remains a headwind that is expected to persist for the foreseeable future. Medtech, for the most part, has proved to be relatively stable, although the dental market continues to experience global challenges that is hampering both consumable and equipment sales growth. We look forward to the upcoming fall conference season, which should perhaps shed additional light on expectations for the second half of the year and an early look at 2018.
We review key results below (in the order of conference call):

  • Cigna (CI). CI posted a strong beat-and-raise 2Q with upside in all business segments and both commercial and government MLRs that came in better than expectations. The company continues to see strong Medicare Advantage enrollment growth and retains ample capacity for share repurchases and/or M&A while it continues to try to collect its breakup fee from ANTM.
  • Wellcare (WCG). Similar to CI, WCG also posted a beat-and-raise quarter as enrollment growth exceeded expectations and Medicaid MLR performed well. Management continues to explore M&A opportunities in both Medicare and Medicaid but less so in the individual market.
  • Horizon Pharma (HZNP). 2Q revenue, adjusted EBITDA, and EPS were all well ahead of consensus, and management raised guidance to reflect strength among Rare Disease drugs and unexpected upside from the Primary Care business.
  • Luminex (LMNX). Solid growth in ARIES and Verigene drove a slight revenue beat, while EPS was ahead of consensus. Management reiterated 2017 revenue guidance but set 3Q guidance below the Street, raising concerns about licensing headwinds despite continued solid assay sales.
  • Nevro (NVRO). 2Q results were in line with those pre-announced in July, while 2017 guidance was reaffirmed. The company continues to add sales reps aggressively and is now forecasting 2017 operating expenses to be at the high end of its previously-guided range. While this spend likely pushes back net income breakeven until late 2017/early 2018, increased salesforce headcount has been a reliable driver of top-line growth, and management is confident it can achieve gross margin of 70%+ exiting 2017.
  • PRA Health Sciences (PRAH). PRAH posted a solid top- and bottom-line beat, driven largely by stronger-than-expected bookings, and management raised 2017 revenue and EPS guidance. Guidance does not yet include the impact of the company’s recent acquisition of Symphony Health Solutions for $530 million, which is expected to be immediately accretive to adjusted EPS, and which the Street views as a deal analogous to the Quintiles-IMS merger.
  • Diplomat Pharmacy (DPLO). While 2Q revenue was roughly in line with the Street, EBITDA and EPS came in well ahead, and management raised 2017 EPS guidance as a result. Driving the top line were price increases on existing drugs and several new drug launches, offset somewhat by lost contracts and declines in Hep C. The company also announced the departure of President Paul Ulrick, who will be replaced by Joel Saban, who recently served as EVP of Pharmacy Operations for Catamaran.
  • Envision Healthcare (EVHC). Slight upside in Physician Services offset continued weakness in Ambulatory Surgery, while Emergency Department volumes remained under pressure. EBITDA and EPS did beat analyst estimates, but management lowered 2017 revenue and EPS guidance to reflect this volume pressure. The company also agreed to sell its AMR business to KKR for $2.4 billion in a deal that will combine it with Air Medical Holdings.
  • Tenet Healthcare (THC). 2Q revenue, adjusted EBITDA (excluding a non-recurring gain), and EPS all missed consensus, and management lowered 2017 guidance across the board to account for recent asset divestitures, lower volume projections, and greater expected uncompensated care expense. The question for THC and other hospital stocks is the extent to which this lower-volume environment is already priced into shares.
  • Valeant Pharmaceuticals (VRX). 2Q revenue was in line with the Street, but adjusted EBITDA and net income came in well ahead, and management reiterated 2017 adjusted EBITDA guidance despite asset divestiture plans (revenue guidance was reduced on expectations of completed sales). VRX also now expects to pay down more than the $5 billion of debt it had previously committed to by February 2018. Despite the deleveraging efforts, questions still remain about how the company intends to reaccelerate revenue growth, particularly in light of softness in Dermatology.
  • CVS Health (CVS). CVS beat on the top and bottom lines for 2Q and raised the bottom end of the 2017 EPS guidance range (although it lowered operating profit guidance). Retail drove the upside as PBM revenue was in line despite slowing growth in the specialty pharmacy business (notably from Hep C). Management did acknowledge the looming threat from Amazon (AMZN) but noted the high barriers to entry in the pharmacy market and the increasing emphasis on providing clinical capabilities.
  • Endo International (ENDP). Posted a top- and bottom-line beat in 2Q, driven largely by strength in the generics business, which the Street believes can make ENDP a potential acquisition target from larger pharma companies seeking to augment their generics units. Management lowered 2017 EPS guidance to reflect the market withdrawal of Opana ER and the planned closing of a manufacturing facility.
  • Mallinckrodt (MNK). Relative softness in Specialty Brands (specifically Acthar, INOMax, and Therakos) offset upside in Specialty Generics, while adjusted EPS came in ahead of consensus, and management reiterated 2017 guidance. While the company has a promising pipeline, the Street’s chief concern remain the ongoing debate about drug pricing and the opioid epidemic, which the President has now labeled “a national emergency.”
  • Henry Schein (HSIC). 2Q revenue was slightly above consensus, led in part by Dental, but key aspects of the segment, namely US consumables and international equipment showed weakening trends and decelerating growth. The Street will look to how the business improves with the beginning of the XRAY equipment distribution agreement, but broader macro headwinds continue to weigh on the sector.
  • Myriad Genetics (MYGN). Fiscal 4Q revenue and EPS topped consensus, but management set fiscal 2018 revenue and EPS guidance below consensus on continued expected headwinds in Hereditary Cancer revenue. The company did see sequential growth across all of its major molecular diagnostic tests during the quarter, but the Street’s main concern about the company longer term centers around the continued challenges in hereditary.
  • Penumbra (PEN). Strong Neuro sales, most notably Ischemic Stroke and Neuro Embolization, drove a 2Q top-line beat, and while 2017 revenue guidance was reiterated, management suggested that the full-year number could come in at the high end or slightly above the stated range. One possible headwind is a difficult second half year-over-year comparison due to inventory stock in Japan from the launch in 2Q 2016 of PEN’s Smart Coil. However, the Street is fairly confident that continued uptake could be sufficient to drive upside in the second half.
  • Surgery Partners (SGRY). 2Q revenue, adjusted EBITDA, and EPS all came in well below consensus, and management lowered all 2017 guidance meaningfully. Increased pressure on procedure volumes and payor mix drove the weakness, and management believes that the preponderance of high-deductible plans has more patients delaying procedures likes knee replacements. Subsequent to the call, multiple analysts downgraded the stock citing further expected pressure on the top line.
  • Charles River Laboratories (CRL). CRL beat the Street on revenue, gross and operating margins, and EPS, and management raised 2017 revenue growth guidance (largely on a smaller expected FX headwind) while maintaining EPS guidance. The company noted continued strong demand from biotech customers, and further deleveraging leads the Street to expect possible M&A opportunities down the road.
  • Dentsply Sirona (XRAY). 2Q revenue missed the Street and EPS was in line, but management lowered 2017 EPS guidance due to Patterson’s CEREC inventory destocking ahead of the distribution transition and to ongoing operational execution challenges. The Street remains concerned about the company’s ability to generate the synergies that were expected when the merger was completed last year, and the global dental market remains constrained. There is, however, potential upside from the new distribution arrangement with HSIC in the US.
  • Mylan (MYL). 2Q revenue and EPS came in below expectations as the pricing environment created increased headwinds, and management lowered 2017 revenue and EPS guidance significantly, citing ongoing pricing and regulatory challenges. The company is also pushing out US product launches, including generic Advair and Copaxone, to 2018. The Street expects pricing headwinds to continue to weigh on the company despite likely future upside from those product launches.
  • Perrigo (PRGO). Strong performance in all business segments and geographies drove a top- and bottom-line beat, and management raised 2017 EPS guidance, even including the removal of the divested API business. The company is emerging from an extended period of uncertainty and appears poised to return to sustainable growth, with questions remaining about capital deployment strategy going forward.

The Week Ahead: Focus on Corporate Access with Earnings Done

With earnings season effectively over, the Street’s attention now shifts to a number of bank-hosted corporate access events before things largely shut down during the last two weeks of August. There is one investor conference next week – Wedbush PacGrow’s Annual Healthcare Conference in New York on Tuesday and Wednesday.
Next week also features three analyst-hosted bus tours. Leerink on Tuesday and Wednesday is bringing investors to Nashville on Tuesday and Wednesday for its Heart of Healthcare Facilities bus tour of hospital and provider companies. The Barclays medical device and life science tools/diagnostics teams are hosting a three-day MedTools bus tour in both southern and northern California from Tuesday through Thursday. Finally, Mizuho is touring specialty pharmaceuticals companies in New Jersey on Wednesday.
Please see the calendar below for a comprehensive look at key events in healthcare through the end of September. As always, we welcome all feedback, and have a great weekend!


Jeremy Feffer
Managing Member
Whalebone Advisory, LLC
T: 646.580.5583 | M: 917.749.1494
Copyright © 2017 Whalebone Advisory LLC, All rights reserved.

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