Investment Recommendations Across Healthcare, by Sub-Sector

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Richard Evans / Scott Hinds / Ryan Baum

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

203.901.1631 /.1632 / .1627

https://twitter.com/images/resources/twitter-bird-blue-on-white.png richard@ / hinds@ / baum@ssrllc.com

@SecSovHealth

February 11, 2013

Investment Recommendations Across Healthcare, by Sub-Sector

  • Key themes are new product flow, rising per-capita unit demand, direct and indirect effects of the Affordable Care Act (ACA), and mid-term pressures on US (small molecule) drug pricing
  • Overweight recommendations:
    • Select Specialty Pharmaceutical and Biotech names with pending new product flow
    • Commercial HMOs in early 2013 because of low valuations and the likelihood of rising enrollment; as 2014 draws closer we prefer Medicaid HMOs
    • Select Non-Rx Consumables names (e.g. CFN, OMI, BCR, BDX, COV) where revenue expectations fail to reflect likely near- (employment) and mid- (ACA) term drivers of demand
    • Hospitals, where revenue expectations also fail to reflect near- and mid-term demand; however as 2014 approaches we recommend reducing Hospital weights in favor of Non-Rx Consumables
    • Professional Services / IT, where evolving meaningful use standards and greater hospital / physician inter-connectedness accelerate IT-related capital spending. Companies with strong IT positions in larger hospitals (e.g. CERN) are preferred
    • Dental manufacturers and suppliers – these names benefit from rising per-capita volumes as employment improves; and, more than is the case in broader healthcare, we believe average product mix per-visit also improves with rising incomes and employment. XRAY and PDCO are preferred
  •  Underweight recommendations:
    • Large-cap Pharmaceuticals – US real pricing power accounts for an overwhelming percentage of global growth for most names (Roche is a particular exception); changes to benefit structure may dramatically reduce US pricing power in the middle-term
    • Drug Retail / Drug Wholesale / PBMs – States are likely to abandon the Average Wholesale Price (AWP) pricing benchmark this year; commercial plan sponsors should follow
    • Medical Equipment and Supplies – overall healthcare-related capital spending should flatten in 2013, and IT should take a rising share of the capital that is spent. Against this backdrop sellers of capital equipment in the Medical Equipment and Supplies sub-sector reflect expectations of double-digit sales growth
    • Research Tools & Services – expectations for revenue growth exceed sales expectations for commercial sponsors of research, despite the likelihood R&D as a percent of sales should actually fall. A federal budget sequester only makes matters worse by substantially reducing NIH research funding

Table of Contents

I. Overweights 4

A. Specialty Pharmaceuticals (Selective Overweight; emphasis on product flow) 4

B. Biotech (Selective Overweight; emphasis on product flow) 5

C. HMOs (Selective Overweight; reduce Commercial in favor of Medicaid closer to 2014) 7

D. Non-Rx Consumables (Selective Overweight) 8

E. Hospitals (Overweight; reduce in favor of Non-Rx Consumables closer to 2014) 9

F. Professional Services / IT (Overweight) 9

G. Dental (Selective Overweight; emphasis on US-focused businesses with higher mix products) 11

II. Underweights 12

A. Large-cap Pharmaceuticals (Underweight) 12

B. Drug Retail / Drug Wholesale (Underweight) 14

C. PBMs (Underweight) 14

D. Medical Equipment & Supplies (Underweight) 15

E. Research Tools & Services (Underweight) 16

III. Market Weights 17

A. Device Innovators [Med Tech] (Market Weight) 17

B. Diagnostic Labs (Market Weight) 17

IV. Appendix – List of Companies by Sub-Sector 19

Overweights

Specialty Pharmaceuticals (Selective Overweight; emphasis on product flow)

Two-year forward expectations for Specialty Pharmaceutical sales growth of +/- 12 pct are substantially above probable developed world healthcare demand growth (5.2 pct, Exhibit 1) over the same period, implying some combination of new product flow, share gains, and/or real pricing power. Revenue growth expectations (+/- 5 pct) for the predominantly generic spec pharma companies are well below the cap-weighted revenue growth outlook for the sub-sector as a whole, and on par with developed world demand growth; this implies average growth expectations for the broader sub-sector cannot be explained by per-capita unit demand alone, and so must be driven by some combination of new product flow and/or pricing power among the brand-oriented spec pharma companies. Growth expectations across the brand-oriented names are highly varied, further implying that product flow expectations are the driving force behind revenue growth estimates (real pricing gains for brands tend to be spread more or less evenly across companies)

Concentrating portfolios around new product flow is one of our major themes, and we recommend overweighting Specialty Pharmaceuticals as a sub-sector by selectively overweighting names that have pending new products. Elsewhere we’ve demonstrated that stocks with pending major product approvals follow reasonably predictable patterns of share price performance, and we’ve constructed a series of trading rules to exploit these patterns[1]. The spec pharma names listed in Exhibit 2 are included in the broader portfolio of companies we recommend because of pending (or recent) regulatory actions. Importantly, our rules for trading around regulatory actions produce relatively frequent adjustments to these recommendations; updates to these recommendations are available from us on a daily, weekly, or monthly basis

Biotech (Selective Overweight; emphasis on product flow)

As with Specialty Pharmaceuticals, two year forward revenue growth expectations (+/- 15 pct) for Biotech are well in excess of probable developed world growth in health demand, and these growth estimates are almost certainly a consequence of expectations for product flow. Here too, our recommendation is to overweight Biotech as a sub-sector by selectively overweighting those names with pending major regulatory approvals (Exhibit 3)

Importantly, our concerns with respect to US pricing power for Major Pharmaceuticals (see later) do not extend to Biotech. Large pharma pricing power comes from periodic increases to US selling prices for existing products; in contrast, biotech products tend to launch at high price levels, with little or no real gain in effective pricing after product launch. Absent direct price intervention by government, payors (government and private) will have to deny coverage of higher priced biotech products in order to lower prices, and we don’t see these types of policy changes as likely in the near-term

IPAB is a narrow but important exception to our argument of continued US pricing freedom for biotechs. We do expect IPAB to intervene in biotech (and drug and device) pricing, though only in Medicare (predominantly if not exclusively Parts A and B). And, we believe IPAB is more likely to apply uniform percentage discounts to prevailing prices across all products than to specify new (lower) prices for individual products[2]

Exhibit 4 lists biotech names according to their degree of exposure[3] to IPAB pricing pressure. Any IPAB pricing actions will not be known before 2014, or applied before 2015 – thus for the time being IPAB exposure has no effect on whether we include biotech stocks with pending (or recent) regulatory approvals in our portfolios

HMOs (Selective Overweight; reduce Commercial in favor of Medicaid closer to 2014)

Two-year forward revenue growth estimates (+/- 12 pct) for the predominantly commercial HMOs are well above the likely rate of growth in US healthcare demand, and generally above revenue growth expectations for US-listed healthcare stocks. In light of gross profit margin caps (i.e. MLR floors), this level of revenue growth cannot come from per-member pricing gains in excess of rates of medical cost growth, thus estimates imply a sell-side expectation of enrollment growth. This is rational in the near-term, as even slight employment growth should have the effect of raising commercial enrollment. In the middle to longer-term (specifically, after the health insurance exchanges begin operating), we have concerns that commercial enrollment among the larger publicly traded HMOs (UNH, WLP, CI, AET) could actually fall, and that average plan values purchased by commercial beneficiaries may also fall[4]

Valuations (in particular P/E ratios) for the commercially-oriented HMOs are the lowest in healthcare; this implies the buy-side either does not believe sell-side growth expectations in the near- to middle-term, and/or is heavily discounting estimates in light of disintermediation risks in the middle- to longer-term

As 2014 and the eventual start date(s) for state-based exchanges approach, the commercially-oriented HMOs become less attractive. Being convinced that even modest US employment would lead to earnings upside in 2013[5], and further believing that current low multiples account for most if not all of the disintermediation risks we would expect in the early months or even years of the post-exchange period, we continue to recommend an overweight position in the commercially-oriented HMOs, the logic being that pre-2014 job growth remains a reasonable likelihood. The risk to this recommendation is that 2013 unfolds without any meaningful job growth, and that the stocks enter 2014 with few fundamental catalysts but with growing headline risks

Where the commercially-oriented HMOs face increasing disintermediation risks beyond 2014, the Medicaid HMOs (e.g. MOH, CNC, MGLN, WCG) become increasingly relevant. We believe Medicaid enrollment eventually expands as states raise eligibility levels to 100FPL over a period of years, and expands further as demonstration projects for dual-eligibles run their course, leading to HMO enrollment of the remaining duals. These fundamentals are vastly preferable to those facing the commercially-oriented HMOs in the middle- to longer-term; however we believe consensus expectations for the Medicaid HMOs still lean toward an unrealistically large (> 100FPL) and/or all-at-once expansion of Medicaid in 2014. As 2013 runs its course we believe it will become increasingly clear that the expansion will be smaller and slower[6]; accordingly we recommend rotating into Medicaid HMOs at the expense of commercially-oriented HMOs in late 2013 / early 2014

MOH, CNC, MGLN, and WCG are preferred on the basis of their higher levels of exposure to an eventual Medicaid expansion (Exhibit 5)

Non-Rx Consumables (Selective Overweight)

Across the sub-sector, average 2-year forward revenue growth expectations of +/- 5.5 pct are on par with global healthcare demand growth; however growth expectations are diverse across the individual names in the group. The most purely US and commodity focused names (CFN, OMI) carry average 3 year revenue growth estimates of just +/- 2.4 pct. These forecasts appear to ignore any prospect of improving per-capita demand as a result of either improving employment (as early as this year) or ACA-related coverage expansions in and beyond 2014. The largely (but not purely) commodity oriented multi-national suppliers (e.g. COV, BDX, BCR) carry average revenue estimates of just +/- 4.5 pct, which are at least somewhat below our estimate of global healthcare demand growth. Our recommendation is to overweight Non-Rx Consumables on the belief that rising (particularly US) per-capita unit demand will lead to revenue growth ahead of estimates. As more US-focused names CFN and OMI would be preferred, followed by COV, BDX, and BCR

Hospitals (Overweight; reduce in favor of Non-Rx Consumables closer to 2014)

Two-year forward revenue growth estimates for the ‘general hospital’ oriented Hospital names (HCA, UHS, CYH, THC, LPNT, HMA) average +/- 4.7 pct, marginally less than our 4.9 pct estimate of US demand growth for the same period. We believe these names will at least meet revenue expectations despite the likelihood of further Medicare rate reductions in the context of a budget sequester[7], and that job-cycle and ACA-related gains in per-capita unit demand should result in revenues exceeding these estimates

However because the Hospital names have performed so well recently (Exhibit 6), and because we see reform-related risks[8] to middle- and longer-term Hospital expectations, we recommend reducing Hospitals and increasing Non-Rx Consumable exposure as 2014 approaches

Professional Services / IT (Overweight)

Meaningful use payments have catalyzed adoption of electronic health records (EHRs) by hospitals and physicians; and, continued evolution of the meaningful use standards should drive continued demand for software updates and associated services

The dominant IT providers in the hospital and physician settings are relatively distinct (Exhibits 7, 8), and this presumably reflects the historic differences in use of IT by hospitals and physicians[9]. However because we believe hospital-centered accountable care organizations (ACOs) will form at an increasing rate, and because this requires hospitals and physicians’ offices to move not only to common EHRs, but to more compatible enterprise software platforms, we believe hospital and physician office IT platforms will become more similar. We also believe that hospitals are more likely to drive the formation of – and manage – ACOs; accordingly we expect hospitals to steadily begin projecting their IT standards into the physician’s office. This implies that the dominant providers in the hospital IT space have the strategic high ground and are preferred as investments to more physician-oriented IT providers, aside from the obvious risk that physician-oriented providers are acquired at a premium by hospital-oriented providers

CERN and MCK have been recent share gainers in hospital EHR installs (Exhibit 9); MDRX, GE and MCK have been recent share gainers in physicians’ offices (Exhibit 10). Healthcare IT sales are a relatively modest part of both MCK and (especially) GE; this effectively leaves only CERN and MDRX as investment choices with relatively large market shares and stable positions in their respective segments. Of the two we prefer CERN, because its home market (hospitals) is to our minds the strategic high ground, and because of high client dissatisfaction rates in the physician market for MDRX

Dental (Selective Overweight; emphasis on US-focused businesses with higher mix products)

At +/- 5.9 pct, 2-year forward revenue growth expectations for Dental suppliers are marginally higher than those of Non-Rx Consumables (+/- 5.5 pct). However we believe Dental suppliers have two potential advantages over manufacturers / suppliers of Non-Rx Consumables:

  1. Dental suppliers have more channel power (Dental suppliers are more likely to influence products stocked and used by dentists than Non-Rx Consumable names are to influence products used by physicians, particularly in hospitals); and,
  2. We believe that both product mix and per-capita unit demand improve in dentists’ offices as employment levels rises, but that product mix in doctors’ offices and hospitals is less affected by employment levels

Accordingly we favor Dental names with more US-focused product lines that include at least higher mix / discretionary products, e.g. PDCO and XRAY

Underweights

Large-cap Pharmaceuticals (Underweight)

Revenue estimates imply slow but stable growth of +/- 1 pct through 2014, well below our 5.2 pct growth expectation for developed-world healthcare demand. Slow revenue growth estimates imply (we believe correctly) an expectation of continued product mix erosion, but still fail to account for medium-term risks to US real pricing power[10]. Because US pricing power accounts for an enormous percentage of current revenue and earnings growth (Exhibit 11), a decline in rates of US real price growth – which we believe is more likely than not over a +/- 3 year timeframe – would result in an outright decline in global revenue and earnings

As concerned as we are with risks to pricing power over the +/- 3 year timeframe, we do not expect serious pressure on US list pricing this year. List pricing gains thus far in 2013 are very strong (Exhibit 12); and, the eventual changes to drug benefit design[11] that we believe lead to reduced real pricing power are not yet in place. Because much of the industry’s total list price change occurs each January, and because benefit designs change more or less annually (and are largely fixed for 2013), current-year risks to US pricing power are limited

We recommend increasing Device Innovator (e.g. Cardio, Ortho) weights at the expense of Large-cap Pharmaceuticals during 2013. Trading at similar multiples to large-cap pharmaceuticals, device innovators are likely to see revenue acceleration (secondary to employment-related increases in utilization) in the same timeframe that large-cap pharmaceuticals see revenue deceleration secondary to lost US pricing power

Within a reduced weighting for Large-cap Pharmaceuticals, our approach to stock selection within the group is to:

  1. Minimize exposure to stocks with heavy reliance on US real pricing gains;
  2. Minimize exposure to stocks with heavy exposure to likely pricing pressure from the Independent Payment Advisory Board (IPAB)[12];
  3. Maximize exposure to stocks with undervalued pipelines[13]; and
  4. Maximize exposure to stocks with pending significant product flow[14]

Exhibit 13 ranks the large-caps on each of these measures; BMY and Roche are most preferred

Drug Retail / Drug Wholesale (Underweight)

Revenue growth expectations (+/- 3.8 pct) for drug retailers and wholesalers generally parallel growth expectations for US pharmaceutical sales; however EPS growth expectations (mid-teens) imply considerable productivity gains. Looking deeper, productivity gains appear tied to expectations of expanding gross margins; this in turn implies a general belief that the drug trades’ gross margins will continue expanding as generics grow as a percentage of total prescriptions

In contrast, we believe generic dispensing margins eventually come under pressure for a number of reasons, key among these being the replacement of the Average Wholesale Price (AWP) pricing benchmark by National Average Drug Acquisition Cost (NADAC) and/or Average Manufacturer Price (AMP)

Various regulatory, legislative, and budgeting steps at the federal and state levels should provide mounting evidence that AWP will be replaced as the prevailing Medicaid drug pricing benchmark by 2014[15]. Once federal and state governments adopt alternatives to AWP, we believe larger commercial plan sponsors (e.g. GE, Ford, John Deere, AT&T, Verizon, etc.) will follow, and that medium to smaller employers then follow the larger plan sponsors. Despite what we believe will be mounting evidence of AWP’s displacement, we acknowledge that most commercial drug benefit contracts will still be benchmarked to AWP in 2014[16], and that gross margin pressures from the replacement of AWP should not be significant before 2015. The key risk to our underweight position is that the stocks do not respond to the loss of AWP until the margin compression actually impacts earnings, in which case we’re simply too early

We note that MCK is less exposed to generic margin compression than its Drug Wholesale peers by virtue of its more diverse business mix; and, that some of its non-wholesale business lines (e.g. Oncology Therapeutics Network and McKesson Technology Solutions) are in areas we view as strategically attractive

PBMs (Underweight)

We continue to have a generally bearish view of the PBMs[17], for the following reasons:

  • The loss-of-AWP associated compression of generic margin affects PBMs (particularly ESRX)[18] even more than Drug Retail / Drug Wholesale
  • As retail dispensing mix shifts further away from brands (to generics), the relevance of rebates on retail brands as a source of client savings declines
  • As brand mix shifts further away from traditional retail brands (to more complex specialty brands), drug benefits are more likely to be managed in coordination with medical benefits (e.g. UNH’s OptumRx)
  • As employer-sponsored beneficiaries move to (state or private) exchanges, they are more likely to buy combined medical and prescription coverage, reducing the percentage of beneficiaries in ‘carve-out’ PBM contracts negotiated directly with employers[19]

As the most traditionally-configured (large reliance on retail brand rebates, mail-order generic dispensing margins, and direct-to-employer contracts) ESRX is by some margin the least well positioned of the PBMs. CVS is somewhat less at risk by virtue of its more limited reliance on mail-order and the diversity of its combined PBM/retail operations, though CVS’ retail operations also are exposed to AWP-related generic margin compression. We believe CTRX is the best positioned, being less reliant on brand rebates to deliver cost savings, and being better able to grow revenues through market share gains than either ESRX or CVS

Medical Equipment & Supplies (Underweight)

Two-year forward sales growth estimates average +/- 10.5 pct, and premium valuations (+/- 1.5x cap weighted healthcare on forward EPS) imply market expectations of even faster and/or longer growth. US medical equipment spending growth generally parallels US GDP growth across longer time periods (Exhibit 14); this suggests overall revenue growth expectations for the sub-sector may be aggressive. Recent purchasing surveys (e.g. Premier) indicate a leveling off of capital spending by hospitals in 2013; and, an intention to direct an increasing percentage of capital spending to information technology. Accordingly we recommend an underweight position in Medical Equipment & Supplies, preferring healthcare IT companies as beneficiaries of healthcare related capital spending

Research Tools & Services (Underweight)

Three-year forward sales growth expectations for Research Tools & Services average +/- 5.4 pct, well ahead of the combined 3.6 pct revenue growth expectation for an aggregate of Large Pharmaceuticals, Specialty Pharmaceuticals, and Biotech. Given increased awareness of negative R&D returns, and increasing conservatism with respect to R&D spending, R&D as a percentage of sales for these companies is more likely to decline than to remain constant. Accordingly, R&D spending growth from commercial sources of R&D funding is likely to be somewhat below these companies’ 3.6 pct rate of revenue growth

US federally funded research spending may flatten or even decline in 2013 if the budget sequester goes into effect. The National Institutes of Health (NIH) carry an FY2013 budget authorization of $34B, of which $2.5B (just over 7 pct) is subject to sequester. If the NIH FY2013 budget remains intact, it will have grown by roughly 10 pct over FY2012 ($30.9B); however if the sequester takes place NIH spending growth year on year will be reduced to roughly 1.9 pct. Because research spending is relatively more variable and discretionary than spending on personnel and facilities, actual research spending could slow more than NIH spending overall, and might even fall relative to FY2012. We estimate that NIH spending is roughly one-quarter of total annual US R&D spending

The best case scenario for R&D spending is for commercial research-based companies to keep R&D spending constant as a percentage of sales, and for NIH to avoid the sequester, in which case we would expect +/- 5.5 pct R&D spending growth in 2013 only, on par with three-year revenue expectations for the Research Tools & Services sub-sector. However if the NIH is subject to sequester, we would expect at most 3.1 pct R&D spending growth, and actual growth could be below this figure if commercial R&D as a percentage of sales falls further in 2013, and/or if NIH prioritizes facilities / personnel spending over research grants in the event of a sequester

Our view is that estimates and valuations (with the exception of TMO all trade at a premium to Healthcare) do not account for risks to near-term R&D spending, thus our recommendation to underweight Research Tools & Services

Market Weights

Device Innovators [Med Tech] (Market Weight)

Device Innovators’ two year forward revenue growth expectations of +/- 4 pct are below expectations for developed world demand growth; we believe this reflects (correct) expectations of continued US and ROW pricing pressures, and (incorrect) extrapolation of current low levels of per-capita procedure demand

On a sub-sector to sub-sector basis, we prefer Device Innovators (e.g. ABT, MDT, SYK, STJ, ZMH, SNN, BSX) to Large-cap Pharmaceuticals. Valuations are similar; however we believe Device Innovators have much more stable pricing[20], and are more beneficially levered to an eventual (job recovery-driven) increase in US per-capita unit demand

In the near term, we generally prefer the predominantly orthopedic names (e.g. SYK, ZMH, SNN) to the predominantly cardiovascular names, as the ortho names tend to be more beneficially levered to rising per-capita unit demand, and less exposed to eventual IPAB pricing pressures (Exhibit 15)

Diagnostic Labs (Market Weight)

Revenue growth expectations of +/- 1 pct are well below realistic expectations for US healthcare demand growth, and valuations (fP/E’s) are at a discount to broader healthcare. We see a realistic likelihood that revenues and earnings will exceed expectations, however we see preferable opportunities to buy volume-sensitive names with low revenue expectations elsewhere (e.g. CFN, OMI). We see some disintermediation risks for the labs as hospitals increasingly formalize relationships with providers along the lines of accountable care organizations (ACOs) and/or integrated health networks (IHNs). And, we believe that average prices for products / services sold to Medicare cannot remain higher than average commercial prices indefinitely

Appendix – List of Companies by Sub-Sector

Specialty Pharmaceuticals

Biotech

HMOs

Non-Rx Consumables

Hospitals

Professional Services / IT

Dental

Large-cap Pharmaceuticals

Drug Retail / Drug Wholesales

PBMs

Medical Equipment & Supplies

Research Tools & Services

Device Innovators [Med Tech]

Diagnostic Labs

  1. Please see “A Simple Formula for Drug (and Biotech and Spec Pharma) Stock Selection – Updated” SSR, LLC December 4, 2012 for details on our approach to selecting stocks with pending new products
  2. Please see “US Healthcare Demand Part 3: Reform Effects – ACA Looks Like a Headwind” SSR, LLC October 1, 2012 for a more thorough discussion of IPAB
  3. Estimated percentage of global sales to Medicare Parts A & B
  4. We believe employers will transfer a significant percentage of employees to health insurance exchanges – both public (i.e. state-based) and private. One effect is that employees on exchanges have a broader range of plan choices – including local providers as an alternative to national underwriters, and lower-priced (and less generous) plans as an alternative to the relative generous (and relatively expensive) coverage standards offered by employers through the national underwriters. The likely result is some combination of market share losses and falling average plan values for the larger publicly traded HMOs. For more details, please see “US Healthcare Demand Part 3: Reform Effects – ACA Looks Like a Headwind” SSR, LLC, October 1, 2012
  5. Please see “The Mechanics of Commercial HMOs’ Gross Profits…” SSR, LLC, June 14, 2012 for more details on the link between the employment cycle and commercial HMO profit growth
  6. Please see “Why Medicaid Eligibility Will (Still) Level Off at 100FPL” SSR, LLC, December 17, 2012 for our detailed view on the likely timing and magnitude of the Medicaid expansion called for by the Affordable Care Act
  7. Please see “Hospitals’ Stable to Improving Net Pricing Power” SSR, LLC, January 24, 2012 for a more detailed discussion of Hospital pricing power
  8. These include in particular a smaller and more gradual expansion of Medicaid than expected; and, an eventual reduction in average levels of medical benefit generosity for employer-sponsored beneficiaries
  9. Hospitals’ enterprise IT systems tend to be very billing oriented. Where practically all hospitals have some type of enterprise software, many physicians’ offices still do not. And, enterprise software for physicians’ offices (i.e. physician practice management or PPM modules) is configured very differently than hospitals’ enterprise software
  10. Please see “Large Cap Pharma’s Dependence on US List Price Growth is Unsustainable” SSR, LLC, February 26, 2012 for a more detailed discussion of pressures to large cap pharmaceutical pricing power
  11. Widespread use of percentage co-insurance in place of fixed dollar co-payments, particularly for non-preferred ‘tier 3’ products dispensed at retail in the US
  12. Ibid 2
  13. Please see “An Index of the Value in Large Cap PharmaCos’ Midto Early-Stage Pipelines” SSR, LLC November 8, 2012 for a more thorough discussion of how we estimate relative values for pharmaceutical pipelines
  14. Ibid 1
  15. Please see “The Incredibly Slow (But Very Nearly Certain) Death of AWP” SSR, LLC, January 15, 2013 for details on steps being taken at the federal and state levels to replace AWP
  16. The majority of commercial 2014 benefit contracts will be signed (3Q2013) before the majority of states are likely to have taken formal steps to replace AWP (3Q – 4Q2013)
  17. Please see “PBM Pricing Post-AWP – An Estimate of Sustainable Earnings Power” SSR, LLC, November 14, 2011; “ESRX, HMS, and the PBM Bear Case” SSR, LLC, July 25, 2011; “The Thread Holding Generic Dispensing Margins” SSR, LLC, May 5, 2011 for a thorough review of the PBM bear case
  18. Mail order generic dispensing margins tend to be higher than either retail generic dispensing margins, or PBMs’ fees per generic prescription dispensed in their retail networks
  19. Direct-to-employer contracts are more profitable than contracts in which PBMs function as third party administrators of drug benefits offered by HMOs as part of comprehensive coverage
  20. We recognize that Large Pharmaceuticals pricing is growing (in the US) at very high single digit rates, where Device Innovators’ US prices are steadily declining. The Device Innovators are able to produce slightly positive revenue despite slow erosion of US pricing; however if Large Pharmaceuticals lose their real pricing power as we predict, the result would be an outright decline in Large Pharmaceuticals revenue
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