Is Buying Big Pharma The Perfect Health Care Hedge?

This past week a successful investor friend and I were discussing the future and where we might see both stock market strength and growth in jobs.   His answer surprised me: pharmaceuticals and health care.

When I questioned him about specifics he waved his hand in the air and merely said: "what other industry do you know of that's about to add 30 to 40 million new customers."

A simple and elegant point.

While the uninsured may have access to emergency care and basic medication, what they often lack is the ability to get the kind of brand name prescription pharmaceuticals similar to those who have health insurance.   The kind of drugs many Americans take for years on end and which drive profits in the industry.   A health care bill may change that for the benefit of the drug companies.

A plan that requires all Americans to have some form of health insurance will likely be a bonanza for the pharmaceutical industry.  It is why, as former labor secretary Robert Reich points out, 'big pharma' not only doesn't have a problem with universal insurance, it actually is spending hundreds of millions of dollars in support of the idea.   More consumers with insurance, more money for them.

We are a prescription drug nation.   According to the Kaiser Family Foundation, scripts rose 68% from 1994 to 2004 while the overall population only grew 12%.   Prices also went up an average of 8.3% in that time.    Drugs are a moneymaker.

Many gave kudos to the White House for cutting that 10 year, $80 billion dollar deal with big pharma back in August, but its becoming clear it was a master-stroke by the drug industry.   The deals terms state that the drug industry agrees to cost savings of up to $80 billion over ten years, but no more.   It also received an 8% increase in Medicaid repayments and an agreement on opposition to the importation of brand name drugs.

$80 billion over ten years.   $8 billion per year.   Let's do some numbers.

The best selling drug in America, Pfizer's Lipitor, does more than $8 billion per year in sales.   The top 10 prescription drugs in America do around $40 billion per year in sales.    It is estimated that 30-40 million Americans (taking out the estimated millions of undocumented immigrants) lack insurance, or about 20% of the population.   These 30-40 million new 'customers' will have greater access to doctors and prescriptions.  Assuming this group has similar aggregate medical conditions as the overall population (and there is no reason to believe they don't, in fact they may have more given that the poor tend to have greater issues with obesity, diabetes and other treatable conditions), this could add another 20% to sales of just the top 10 drugs alone.    20% of $40 billion is - bingo - $8 billion per year.  And remember that only factors in the top 10 drugs.   There are hundreds more in the market.  It is clear that $8 billion in cost cuts will be made up in multiples over the years.

Generics may also benefit, but not to the level of the brand name drugs, mostly because of choice.   Consumer choice is a huge part of the drug industry.   It is why drug advertising is one of the few growth areas in the media, and why it's impossible to watch more than 15 minutes of television without seeing an ad for some kind of prescription medication.   Consumers are more aware than ever of choices, and the ads hope to convince us to ask our doctor for a specific - and often non-generic, drug.  Furthering the market share gain of the brand names over the generics may be increased competition of health insurers across state lines.   Competition may lower costs for the insurers, but it may also force them to offer greater access to the brand name drugs their customers will demand to sign up.

Medical devices are likely to follow the same path.  While the Baucus legislation includes an excise tax on this industry, once again the numbers are clear that any additional tax hit will be more than made up for with growth in sales by adding another 20% of the population to the customer base.

Whatever health insurance (remember when it was actually called health care reform?) bill passes, it will be a tax on all working Americans.    Congressional speeches aside, it is impossible to add 40 million of anything and not increase costs.    Former CBO director Douglas Holtz-Eakin estimates it could add a few thousand dollars per year in costs to middle class families.   And while there is little most Americans can do to get away from the long, aggressive tax arm of Uncle Sam, it might be a smart hedge to invest in the very industry to which taxpayers are going to add customers.   A loss in taxes may mean a capital gain.