Industry stays on track, upward trajectory with some timeframe adjustments

As we approach the end of the third calendar quarter of 2021, we look forward by revisiting some of our predictions for Healthcare in 2021 and what nuances are influencing our outlook for the future.

At the start of the year, MUFG worked with our partners at the Fitch Group to host the 2021 Annual Healthcare Symposium. The panel of MUFG and Fitch analysts along with industry experts focused on:

• COVID-19 Sector and Rating Impact
• M&A Capital Markets
• Opportunities and Innovation Given the New Normal

We are pleased that our three major takeaways that were the consensus of the panel of experts feel as applicable at the end of the third quarter as they did at the start of the year.

• Performance: Healthcare is a highly resilient sector—while the Delta Variant may have extended the timeframe for our views that the healthcare sector would “return to normal” over the course of 2021, it has not derailed or reversed the overall recovery.
• Politics: While the Biden administration continues a relatively aggressive domestic agenda (infrastructure spending being the current focus) – we continue to believe that change for the healthcare sector will continue to be evolutionary rather than revolutionary. BidenCare = Obamacare 2.0
• M&A: 2021 has been a year of relatively healthy M&A activity in healthcare and is following our predictions of a high number of transactions but more bolt-ons and mid-sized deals vs. mega-deals.

Healthcare is in a favorable [credit ratings] position… in large part a reflection that the sector was resilient during the pandemic

— Megan Neuburger, Fitch Ratings

Performance
Megan Neuburger’s characterization remains spot on. Given the traditional drivers of strong global demographics, the prevalence of chronic diseases and relatively inelastic demand, healthcare is traditionally seen as a relatively stable and predictable industry. Going forward, our conviction in this thesis is only strengthened by the performance of the sector in the face of a global pandemic. Certainly, there was some variability in terms of the impact of COVID-19 on the sector, but in aggregate (and certainly relatively to many, if not most, other industries), healthcare showed continuing solid financial performance.

A combination of the Delta Variant and the unexpectedly high vaccine resistance has led to higher absolute case, hospitalization, and mortality numbers than our outlook would have predicted. Having said that, we continue to view our predicted “return to normal” for the healthcare sector as a whole as still on track. Delta may have elongated the recovery period more into the end of 2021 than our original view of mid-2021 but does not seem to have derailed the recovery or reversed progress made.

Looking at the typical subsectors of Healthcare:

• Pharma/Biotech: We have seen negative impact restricted to early impacts on (i) short term supply chain disruptions and (ii) “timing differentials” from patients accelerating scripts going into lockdowns and working down those stocks over time.
• MedTech: We have observed more variable impact dependent on a company’s percentage of revenue coming from elective procedures. Here the impact of the Delta Wave is most felt as delays of elective procedures (and even rationing of care) have extended the healthcare sector’s recovery period. However, given the required nature of the underlying procedures, quick and strong sector recovery following easing of infection rates and lockdowns has been the norm since last summer. Many healthcare systems have begun to segregate facilities into COVID/non-COVID meaning elective procedures can often continue even in the face of higher local infection rates.
• Services: Clearly the most directly impacted by the pandemic as most healthcare services require physical interaction between provider and patients. The geographically concentrated nature of the current Delta Wave has meant that impact has been blunted. Anything associated with Telemedicine and Staffing continues to have a strong tailwind given the elongated recovery curve.

Politics
Once again, our panelists’ views that the Biden administration and most centrist Democrats see Obamacare as an ongoing framework for healthcare public policy appears to have been realized. The few changes to date have been evolutionary rather than revolutionary. BidenCare = Obamacare 2.0. The razor-thin margin in the Senate has proven to be the expected circuit breaker to significant healthcare public policy changes. In terms of predictions of likely changes, we see continued expansion of Medicaid eligibility continuing to be at the forefront of that list. The concerns around the addition of a “Public Option” (for example lowering the Medicare eligibility age or making Medicare an option for all) appears to have been put on the back burner. We continue to view a Single Payor System as essentially impossible given the current political climate.

Actions under the Biden administration are likely to be incremental, for example focus on coverage expansion and CMMI payment models. We also anticipate increased regulatory flexibility in R&D.

— Sun Hee Choe, FasterCures

Focus on pharma pricing and an overall push for healthcare pricing transparency remain the political focus and a reality. Pharma pricing pressure is here to stay, although we view it being driven more by “moral suasion” rather than direct government price controls. Speculation about an inclusion of Medicare price negotiations as a “pay for” in the Infrastructure Bill appears to have come and gone. The President and Congress are likely to keep up public pressure in order to influence pharma pricing – which has been the main mechanism used over the past decade. In addition, we see continued bipartisan support for transparency measures like the Surprise Billing restrictions in the COVID relief package. Overall, we see government trying to get the Healthcare industry to come up with solutions rather than impose controls at the Federal level.

M&A
There is no doubt that 2021 has had a healthy level of Healthcare M&A activity with transactions ranging from Medicaid Managed Care Providers to MedTech and Pharma companies acquiring products and platforms to private equity sponsors making additions to existing companies and acquiring new platforms for growth.

This supports our panel’s consensus that 2021 would be a year of quite good M&A activity in the healthcare sector. A combination of relatively strong operating and financial performance despite the pandemic, a low interest rate environment, and highly liquid capital markets proved to be strong drivers of a high level of activity.

In addition, the pandemic itself is serving as a driver as companies undertake full and detailed reviews of their product portfolios and service offerings to determine what is core and noncore in the current environment. We find that companies seem to be using these reviews as the impetus to deal with various “orphan” and “stub” businesses that typically were acquired as part of a strategic acquisition.

Capital issuance was extraordinary during the pandemic and as we see interest rates remain low, points to a positive viewpoint for financing events in 2021.

— Andreas Dirnagl, MUFG

We see this clearly continuing into the final quarter of 2021 and likely well into 2022. The healthcare sector is vast and the impact of this sort of fundamental review is likely to be measured in quarters and years rather than weeks and months. This is another way of saying that large transformative “mega” (>$50B) transactions in Healthcare remain on the back burner as the “tailwinds of COVID” and the positive impacts of deals done to date remove much of the motivation for such deals (especially in Pharma). Provided rates remain low and markets remain liquid, this healthcare M&A “wave” is likely to continue well into 2022. We would also note that given the underlying demographic and operating strength of the healthcare sector—it typically remains relatively shielded from most major capital markets volatility.