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Whalebone Advisory provides investor relations and strategic advisory services to publicy-traded, pre-IPO, and development stage healthcare companies.
August 18, 2017

What Becomes of CSRs, ACA With Trump Increasingly Isolated?
Plus: CMS Proposes Scaling Back Bundled Payment Model

Street Smarts is taking a one-week hiatus next week and will be back on schedule in two weeks.
The CBO, in conjunction with the Joint Committee on Taxation (JCT) this week published a score of the effects of the Trump Administration’s proposed elimination of cost-sharing reductions (CSRs), or the subsidies provided by the Department of Health and Human Services to enable insurers to offer affordable plans through the ACA’s exchange markets. Assuming HHS Secretary Tom Price follows through on his threat to cut off CSRs after December 2017, the joint report estimates that insurance premiums on plans purchased through the exchanges would increase by an average of 20%. In addition, the CBO sees a $194 million increase to budget deficits over the next 10 years as the higher premiums would result in more tax credits during that period.
The Trump Administration has committed to continue paying CSRs through the end of the year, but while there is no official stance yet for 2018, President Trump has repeatedly called for letting the ACA collapse before Congress takes up healthcare reform again. As we have discussed in the past, this is an untenable position for lawmakers in both parties. Setting aside the particulars of which policy prescription actually makes the most sense, all House members and one-third of Senators are running for re-election next year. So, after making the abstract promise to “repeal Obamacare,” Republicans would instead have to face constituents who live in states that did not expand Medicaid and in which the local exchange market has collapsed. Hence the bipartisan effort to strengthen the ACA rather than let it die.
Undoubtedly complicating matters this week is the latest controversy engulfing Trump, this time his tone-deaf and unfortunately illuminating responses to the tragic and horrifying events in Charlottesville last weekend. While there is no direct link between his comments and the healthcare reform effort, the broader implication is a further widening of the gulf between the President and Republicans in both the House and Senate. That gulf has grown in recent months, evidenced most notably by the Senate’s rejection multiple repeal/replace bills and by the GOP-crafted Russia sanctions legislation that Trump had no choice but to sign. But it appeared to reach new heights this weekend as countless Republicans, including Paul Ryan, Mitch McConnell, John McCain, Marco Rubio, Lindsey Graham, Mitt Romney, and both former Presidents Bush, specifically denounced both white supremacist groups and Trump’s initial response.
Cynics could argue that savvy politicians will always seize opportunities like this to say the right thing and elevate themselves in the process. And none of these figures was ever a Trump supporter in the first place, so what does it really matter?
To that, we have two responses. First, Trump still hopes to pass meaningful legislation, so if GOP leadership intends to freeze him out entirely and move forward without him, he will be forced to either sign legislation of which he does not approve or spend his entire term without fulfilling a single promise. Now, he can chalk that up to the same old “swamp” that he has been unable to drain. But as he publicly attacks members of his own party, including Senators Lindsey Graham and Jeff Flake (both of whom voted for the skinny repeal, by the way), he kills his own ability to win back the support of his own party.
However, Trump’s bigger potential problem is that, as the “businessman president,” he has now lost the support of many of the most influential business leaders in the country. CEOs such as Bob Iger (Disney) and Elon Musk (Tesla) previously resigned from the Strategy and Policy Forum after Trump’s decision to withdraw from the Paris Accords, but several more followed suit this week in protest. Ken Frazier (Merck) was the first to resign in protest from the Manufacturing Jobs Initiative, followed closely by the CEOs of Intel, Campbell Soup, 3M, and Under Armour. Trump finally dissolved both councils on Wednesday after more leaders, including vocal Trump supporter Steve Schwarzman (Blackstone), made initial plans to disband them. Several healthcare leaders, including Alex Gorsky (JNJ), Mark Bertolini (Aetna), and Toby Cosgrove (Cleveland Clinic), were also among those publicly distancing themselves from Trump.
It is not yet clear what the broader impact of this will be, but the overarching concern, in our view, is what an increasingly isolated Trump might be inclined to do. With dwindling support in both Congress and in the business community, he is likely to resort to more unilateral decisions, such as cutting off CSRs and letting the ACA collapse without a replacement in place. He has thus far proven to be unwilling to compromise, and his default response is to insult critics rather than to try to find common ground. It appears, therefore, that we are in store for more instability going forward, which could drive more insurers to abandon the exchanges (as many have already done).

Medtech News: CMS Proposes Weakening CJR Model,
A Posts Beat/Raise Quarter, ALGN Faces New Competition

CMS this week issued a proposed rule calling for a reduction in the number of geographic areas from 67 to 34 in its Comprehensive Care for Joint Replacement Model (CJR). CMS also proposes to eliminate certain other models, including Episode Payment Models and Cardiac Rehabilitation incentive payment models. These programs established three bundled payment models in an effort to shift financial accountability to hospitals and physicians in terms of quality and cost of care. The idea was to make providers consider more carefully which patients they were selecting for care and the types of acute and post-acute care they were recommending.
The proposal to drastically scale back these programs comes as no surprise to the Street, as Secretary Price has long been a vocal opponent of the CJR. While eliminating bundled payments altogether would seem to be difficult to achieve, this proposal significantly weakens these programs, making voluntary for roughly half of participants and creating an expected $90 million of savings to CMS over the remaining three years of the program. In terms of the impact on orthopedic implant makers, this is a modest positive, since a bundled payment system places downward pressure on pricing. The impact since the beginning of the CJR has not had a noticeable impact on implant pricing thus far, but this proposal does remove an overhang for orthopedic stocks like Stryker (SYK) and Zimmer Biomet (ZBH).
The main questions going forward will the extent to which this proposed rule changes before being finalized and how many hospitals continue to participate on a voluntary basis. We expect more color to emerge during the upcoming fall conference season and then again during the next earnings season in late October.
Agilent (A) on Tuesday reported above-consensus revenue and EPS for its fiscal 3Q ending July 31, while management raised fiscal 2017 revenue, EPS, and free cash flow guidance and set fiscal 4Q revenue and EPS guidance slightly ahead of the Street. Among the key drivers were better-than-expected core growth, led by upside in Life Sciences and Diagnostics/Genomics, and the company appears to be gaining market share from its other Tools competitors. Management also noted that biopharma end market demand remained strong, a trend that appears to be sustainable going forward.

The German dental company Straumann on Thursday made a significant move into the orthodontic space via its $150 million acquisition of privately-held ClearCorrect. This deal makes Straumann a significant player in the clear aligner space and providing Align Technology (ALGN) with its first major competitor. ClearCorrect presently possesses roughly 5% market share in the US, but Straumann already has an established salesforce here and should be able to boost that share via cross-selling with its implants and other products. Straumann also sells a digital intraoral scanner that can compete with ALGN’s iTero, so Straumann also presents as a meaningful competitor in CAD/CAM and 3D printing. ALGN is the unquestioned leader in the clear aligner space, which is still a growing and underpenetrated market, particularly in international markets, so the presence of a stronger competitor is unlikely to create a major challenge for ALGN. However, this is certainly a development to monitor for ALGN analysts and investors in the coming quarters and years.

Major Management Changes at UNH, NUVA

There were two significant management changes this week. UnitedHealthcare (UNH) announced that CEO Stephen Hemsley will transition to Executive Chairman and that President David Wichmann will assume the role of CEO effective September 1. Hemsley is expected to retain an operational role to aid in the transition. While this move came as somewhat of a surprise to the Street, the general consensus among analysts and investors is that this change should not have a material impact on operations or results. Wichmann has been with the company for 20 years, and with Hemsley still in the fold, this is expected to be a seamless transition, and some have applauded UNH for promoting continuity and minimizing disruption.
NuVasive (NUVA) on Tuesday moved quickly to fill the CFO role vacated by Quentin Blackford, who left to assume the CFO role at DexCom (DXCM). NUVA has hired Raj Asarpota, who has previous public-company experience as CFO of Questcor Pharmaceuticals (sold to Mallinckrodt) and of Life Technologies (sold to Thermo Fisher). This hire does not necessarily suggest that NUVA is preparing to sell itself, but it is notable that NUVA CEO Greg Lucier was CEO of Life Technologies when Asarpota was CFO, so the two have a long history of working together. The Street also noted Asarpota’s extensive operating experience, which analysts expect to help advance NUVA’s margin expansion initiatives.

The Weeks Ahead: Bus Tours and Several Key Earning Reports

The traditional earnings season is over, but there are a handful of significant earnings reports over the next two weeks that the healthcare world will focus on fairly closely. These are companies that are either reporting their fiscal fourth quarters (and thus have additional time to release result) or whose fiscal quarters do not line up with calendar quarters. Since we will not be publishing Street Smarts next week, we preview all of the key earnings releases through the end of August.

Earnings Release/Conf. Call Quarterly Consensus Revenue/EPS FY Consensus Revenue/EPS What to Look for On the Call
Premier Inc. (PINC) Monday AMC, 5:00pm ET FY 4Q17:
$400.2 million /
FY 2018:
$1.64 billion /
Additional color into 2018 guidance beyond what management discussed at May Investor Day and practical impact of inability to pass repeal/replace
Medtronic (MDT) Tuesday BMO, 8:00am ET FY 1Q18:
$7.46 billion /
FY 2018:
$30.86 billion /
Updated 2018 guidance to reflect current FX rates and Medical Supplies divestiture to Cardinal Health; also new color on impact from June computer crash and delayed MiniMed 670G launch
Accuray (ARAY) Tuesday AMC, 4:30pm ET FY 4Q17:
$111.7 million / $0.00
FY 2018:
$398.6 million / ($0.15)
Pre-announced results were in line and debt restructuring pushed out maturities, so key will be management color on gross order guidance and backlog conversions
Patterson Companies (PDCO) Thursday BMO,
10:00am ET
FY 1Q18:
$1.34 billion /
FY 2018:
$5.74 billion / $2.33
Commentary on global dental market trends and the company’s dental equipment prospects following the end of the XRAY distribution partnership
Catalent (CTLT) Monday, 8/28 AMC, 4:45pm ET FY 4Q17:
$547.5 million / $0.57
FY 2018:
$2.12 billion / $1.57
Key puts and takes behind FY 2018 guidance and management thoughts on M&A in light of recent TMO/PTHN and Lonza/Capsugel deals
Cooper Companies (COO) Thursday, 8/31 AMC, 5:00pm ET FY 3Q17:
$552.6 million / $2.57
FY 2017:
$2.13 billion / $9.62
Color on market share position and opportunities in Vision and sales force expansion plans

In addition to these earnings report, the Piper Jaffray medical device and diagnostics team is hosting its 10th annual Medtech and Diagnostics Bus Tour through California. The three-day tour running Monday through Wednesday will visit medical device and diagnostic companies in northern and southern California.
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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