A big-time patent settlement betweenMerck & Co.(NYSE: MRK) andBristol-Myers Squibb(NYSE: BMY),Johnson & Johnson's (NYSE: JNJ) fourth quarter earnings report, andAetna(NYSE: AET) andHumana's (NYSE: HUM) $37 billion merger bust were among the top stories in healthcare last week. Should you buy any of these stocks?
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In this episode of The Motley Fool's Industry Focus: Healthcare podcast, Kristine Harjes and Todd Campbell to explain how these market-moving stories impact your portfolio.
A full transcript follows the video.
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This podcast was recorded on Jan. 25, 2017.
Kristine Harjes:Welcome to Industry Focus, thepodcast that dives into a different sector of the stock market every day. I'm your host, Kristine Harjes, and it's January 25th. Healthcare investorextraordinaire Todd Campbell is skyping in to Foolheadquarters. Todd, did you see the big DOW news this morning?
Todd Campbell: Unbelievable. Who would have thought 20 years ago we'd be where we are today, at DOW 20,000?
Harjes: 20,000as of this morning.I think, if you've been watching it lately,you probably could have seen this coming. The DOW has been rising since the election of Donald Trumpto the presidency of the United States. There's beenlots of business people appointed to the cabinet,such as the CEO ofExxonMobil, for example. Even this morning, the DOW opened at 19,994. We all know it's just a matter of time.
Campbell: Right,the concept of deregulation and potentially lower corporate tax ratesproviding some additional tailwinds. But again, like anything,it's the power of compounding. Over time, if the market grows at a 4-6%annual rate, you're going to eclipse thesemilestones decade after decadeafter decade. It's a great reminder to investors wholook back on the Great Recession and wereextremely nervous that the next time we go throughone of those hiccups to just take a deep breath andkeep focusing on that long-term plan.
Harjes: Absolutely. Inhonor of the event, I wanted to sharea little bit of history about the Dow JonesIndustrial Average. What it is, is a price-weightedaverage of 30 large American publicly traded companies. It is the most well-known index of the United Statesstock market. Itactually dates all the way back to 1896, whena guy named Charles Dow was involvedin the creation of it. Todd, here's a little bit of trivia for you. Do you knowthe only one of the original 12 companiesto still be on the index today?
Campbell: Oh, god ...General Electric?
Harjes: Yeah, that's it.
Campbell: (laughs) Oh! Yay!
Harjes: (laughs)I was going to give you the hint that it was theIndustrialAverage, to see ifmaybe that would help, but yeah, you got it on your own.
Campbell: That was really tough,I had to really go back in time. I'm old, but I'm not that old.
Harjes: (laughs) Yeah, 1896, not quite. Actually, of the fivecompanies that we plan on talking about today, two of them areactually on this index. We'll betalking a little bit aboutMerckandBristol-Myers Squibband somepatent infringement lawsuit business that has gone on with the two of them. We'llalso be talking aboutJohnson & Johnson, touching on their earnings,because we gave you a preview last week, so why not check back in this week? Then,toward the end of the show, we will also talk about two health insurers,AetnaandHumana. So, of those five, the two that are in the index are Merck and, as I'm sure is not surprising, Johnson & Johnson. But, let's kick it off with Merck, and also Bristol-Myers.
Campbell: Somevery interesting news here this week, Kristine. Wouldn't you like to be able to add nine figures in revenue with just the stroke of a pen?
Harjes: Yeah, that would be nice. My bank account would love it.
Campbell: That'sessentially what's happened here with Bristol-Myers and Merck. Essentially, these twocompanies have settleda patent dispute,Bristol-Myers coming out on top. Merck has now agreed to give them a pile of money up-front tomake up for royalties that they hadn't been paying for infringing on the patent. And,according to the settlement, Merck is going to giveBristol-Myers a healthy 6.5% dividend from here until 2023, and then another 2.5% from 2024 to 2026.
Harjes: And that'sspecifically on one drug named Opdivo and Keytruda.
Campbell: Yes. Both these drugs work inthe same way, theytarget a protein called the PD-1, which is expressed on T-cells, in which cancer cells sneakily use to evade the immune system's detection.
Harjes: Right. This is a completely novel way oftreating cancer, which is whyyou have Bristol-Myers saying here, "Hey, wait,you have infringed upon the patent that we have." So, this willeffectually endall of the patent infringement litigationagainst Merck's Keytruda, andas you mentioned, Bristol will get a whole pile of money to make up for the past, and then they'll get royalties going forwards. Thepayments will actually be split 75% toBristol-Myers and 25% to a company calledOno Pharmaceutical, it's aJapanese partner on the drug. This is still a very hefty sum forBristol-Myers.
Campbell: Right. They're getting $625 million right up front. Merry Christmas, here's $625 million! Then,if you look at the potential market opportunity for these checkpoint inhibitors, these PD-1 drugs, it'stremendous, it's huge. These are billions and billions dollar drugs. Justout of the gate,assuming no additional growth on Keytruda, you'd belooking at right around $100 million in royalties stream heading toward Bristol.
Harjes: Right,so this is huge news. Most likely, the drug will continueto expand, making it even bigger and bigger newsgoing forward. And that 6.5% royalty will lastall the way through the end of 2023.
Campbell: Right. Youjust mentioned to the ability to expand. A lot of cancers use this PD-1 toescape detection. What they're finding is,as they do more and more trials indifferent types of cancer, that these drugs are very effective, very high response rates in patients. This was especiallyinteresting, to see them come to this agreement, becausein the last year or so,both drugs, Opdivo and Keytruda, they've diverged in what'shappened in their clinical trials, with Merck havinga lot of success and Bristol-Myers mostly,in my view, because of the way they designed their trials, having less success,especially in lung cancer.
Harjes: Right. This issomething we have talked about on a previous episode of Industry Focus, so our long-timelisteners will hopefully remember. Itbasically had to do, as you mentioned, with the trial design, where Opdivo failed its trailin which it was looking at pretty much all levels of PD-1expression 5% or above as opposed to,when they did the Keytruda study, it was 50% PD-1 expression and above. Of course, it's a drug that works on PD-1, so if you'retargeting patients that have a higher expression of it, you'retilting the odds in your favor.
Campbell: Yeah, it's almost like Merck went the safe route, andBristol-Myers tried to jump the shark.
Harjes: Right,and it backfired.
Campbell: Bygoing the safe route, Merck was able to nab an FDA approval for the use of Keytruda in the first line setting for high-expressing PDL patients. What's really interesting is that they also have recently filed for first line use of Keytruda pluschemotherapy in patients who don't express PD-1,after seeing some pretty solid trials. So,if Bristol-Myers had eitherdesigned the trials so that was only high-expressing patients initially, or had combined it withchemotherapy, who knows if Keytruda would have theadvantage in lung cancer heading into 2017 versus Opdivo. Obviously,I think that probably made Bristol-Myers a bit more willing to agree to that royalty stream, because they looked at it and said, "Well,if we can't get the first line, and the first line could be worth up to $1 billion, at least maybe we can share in some of Keytruda's success."
Harjes: Absolutely. It isnot a bad consolation prize.
Campbell: No,and it's all high-margin money. They're not actually producing anything, they already produced the IP for it.
Harjes: Yep, that'smoney in the pocket. Let's move on andtouch back on Johnson & Johnson earnings, which we did a preview of last week. Todd, what was the report like?
Campbell: Last week, we had talked about a couple different things. One of the things that had jumped out to us, or,one of the things we wanted to make sure everyone was aware ofwas the potential threat to Johnson & Johnson's best-selling drugRemicade, which is used to treatrheumatoid arthritis. That drug has lostpatent protection, and it's now facing a biosimilar that workssimilarly to it that launched in November. So, we were very curious to seewhat's going to happen with Remicade's sales. And,sure enough, Johnson & Johnson went from growing almost 10%year over year in the U.S. for Remicadein the third quarter to actually losing ground on Remicade year over year in the fourth quarter. Sales fell 1.7% in the U.S. for Remicade to $1.17 billion, where in Q3, they rose 9.4% to $1.22 billion.
Harjes: Yeah. Before you specified in the U.S.,I was actually going to ask youfor that clarification,just because there is a good amount of difference here regarding this drug betweenwhat's going on internationally versus in theUnited States. Internationally, the biosimilar has beenon the markets in Europe for a while, a long enough time that,as they put it in the earnings report itself,they are continuing to see the impact of biosimilar competition. But, it's in the U.S. that we just recently,at the end of last year, saw the biosimilar come to be approved by the FDA. It wasinteresting to me, the discrepancy betweenthe numbers that you just reported, where you saw that decline, versus the quote from theearnings call where management said, "We have notobserved any significant impact to date," and that was referring to the impact of the biosimilar, Inflectra, on Remicade.
Campbell: Right. AndI think they can probably make that argument by saying, "Wehaven't necessarily lost any market share." But,remember, in order to protect their market share, they'rehaving to cut the price and offer greater discounts, which, of course,is going to weigh on their ability togenerate out sales growth. Andeven with competing heavily onprice,if you go in and listen to that conference call andget all the way to the question and answer section,management did sort of tip their hand and say they could perhaps lose 10-15% in the first year of market share. So,Remicade being Johnson & Johnson's biggest drug,a drug with $4.4 billion run ratein the United States alone, losing market share is going to create a headwind that could keep its sales depressed in 2017. It's not adisaster by any sort. I still think they can grow sales and profit by 3% this year. But,3% is probably not going to get too many people overly excited about this company.
Harjes: Right. Andinterestingly, the pharmaceutical segment has historically been what drives this company forward,but in this past quarter, the consumer products segment, that's yourListerine and Band-Aids and things you would buy atCVS, thatactually led the way. Their sales were up3.4%, particularly when you lookdomestically, sales were up 13% in that unit.
Campbell: I look at it over the course of a trailing 12-month period forconsumer goods, because you just don't know what's happening withpeople building up wholesale inventories and that type of thing. If you'relooking for the full year, sales have declined 1.5% from 2015. So,I think what we'll need to do is watch and see how thatplays out over the course of the next few quarters, andsee if they're still delivering that kind of growth. If they are, great,that's awesome news. But I think, again,as we talked about,they get the majority of their revenue from the pharmaceutical area. And while they havesome intriguing stuff that could help offset some of those headwinds toRemicade, this isgoing to be an evolving story for 2017, no question.
Harjes: For sure. Anything else that you want to touch on with J&J earnings before we move on to our last story of the day?
Campbell: There was one bright spot that I want to call out, thatI think investors should be aware of,and that was the performance of Darzalex,which is their new multiple myeloma drug. That launched back in late 2015 for use in the fourth line setting. So,pretty far back in patient treatment. But,as we moved in toward the end of the year, that's wonapproval now for use alongside Revlimid in the second line setting. Revlimid, of course,is the granddaddy in multiple myeloma with $8 billion inprojected sales this year. Darzalex sales in the fourth quarter were $200 million. That gives it an $800 million run rate. That'snot bad for a drug that only launched a year and a couple months ago. Itcertainly could indicate that this is their next billion-dollar blockbuster drug.
Harjes: This drugdefinitely has somemomentum. Overall, Johnson & Johnson did deliverright around expectations. The one area they fella little bit short was in their 2017 guidance. Right now, we're looking atanticipated sales of $74.1-74.8 billion, which,I believe you mentioned a little bit earlier,is about 4-5% growth. They had been expecting $75.1 billiongoing into the report. But there's still a lot to shake out in 2017, and that's not a huge miss right there. Lots tokeep your eye on still with Johnson & Johnson.
Laststory of the day was something that just came out earlier this week,which is that the Humana Aetna merger was blocked by aDistrict Court. This was a $37 billionmerger within the health insurance industry thata lot of people had their eye on.
Campbell: Wetalked earlier about how the Dow Jones was eclipsing 20,000partly because of deregulation. Apparently, the Department of Justice,the district court judge didn't get that memo. TheDepartment of Justice basically has cried foul on this deal, they cried foul a while back,saying that by combining these two very large players inMedicare Advantage,it would cause a big problem topricing and access to health insurancewithin markets where they overlap. Thesetwo companies, Aetna and Humana,attempted to try and assuage the judge byagreeing to sell some assets toanother company calledMolina Health. However, whenpush came to shove and the judgelooked at all the different puts and takes, hedetermined that the risk was justfar too great in that Medicare Advantage segmentto go ahead and approve the combination of these two big companies.
Harjes: Right.When you look at the Medicare Advantage market,these are two of the three largest players, withUnitedHealthcarebeing the other one. This is a huge market. 31% ofpeople on Medicare are enrolled in Medicare Advantage. And it's growing,the number of people enrolled in these private plans has tripledbetween 2004 and 2016. So, the thinking is,with these companies combining, there'snothing that could happen, no newcompetitors, no divestitures,nothing that would avoid the competitive issues that would come up. Essentially,the verdict came down to,no matter what happens here,they should have just completed independently to win more customers rather than try to get togetherto have that bigger negotiating power and win that way.
Campbell: Right. Kristine,it's not like we're talking about a product that you can buyonAmazon,regardless of what county you live in or what state or what town or whatever. Theseinsurance programs do not offerplans the same in every community. They can be very different,and different companies can participatein those different communities. So,you have very different competitive marketplaceswithin each specific county or town throughout the nation. AndI think the big risk was, OK, youconsolidate power, but these two very large players turning itinto the biggest player in Medicare Advantage,what happens in those communities that, say, are under-served? Where,maybe, UnitedHealthcare isn't currently participating in,or there aren't any other options. If you havethat kind of a situation and give that much pricing power oversomething as important as health insurance to these insurers, who's to say that they'regoing to act in the best interest of the patient, and compete and drive those prices down?
Harjes: Exactly. Moving forward with these companies, Aetna will owe Humana a $1 billion breakup fee. Interestingly, neither stock really moved a ton. WhatI think will be the key thing to watch here,after we've already seen this news report, iswhat happens with the merger betweenCignaandAnthem? There will be a ruling on that one soon. These areanother two health insurance companies. It's an even bigger deal, it's $48 billion. Andthey have even more national overlap. So,you definitely want to keep your eyes on that one.
Campbell: Yeah.I don't think there's a very good shot of that deal going through. I think Cigna and Anthemhaven't even put forward as good a united front as Humana and Aetna did.I'll be surprised if they go ahead and approve this. Listen, theMedicare Advantage Market specifically is growingand it's big. It's growing by about a million new subscribers annually. So,this is a lucrative business that is still attractive for these companies independently. Obviously, Humana is the most pure play of all four of these insurers, they get the majority of their salesfrom their Medicare Advantage business. So,if you're interested in a stock ideathat would allow you to benefit from the fact thatyou have aging Baby Boomers who are going to beincreasingly going into the marketplaceand looking at their different Medicare options,maybe Humana is a name that should be back on your radar.
Harjes: Lookingmore broadly at the healthcare insuranceindustry, do you think that Humanaand the Medicare Advantage market would be the way to play this? If you couldonly buy one health insurer, is that what it would be?
Campbell: Well,the thing that's nice about that isyou don't have the risk of what's going on with the ACA. Yes, Humana hassome participation in the ACA programs. But it gets the bulk of its sales throughMedicare Advantage. Medicare Advantage is not impacted by the reform that's the repeal and replace ofObamacare or the ACA. So,you could look at it and say, the demographics support it, it's not asexposed to the risk ofwhat could come in the future of this industry. So,it's definitely one of the more intriguing playsnow that it's going to be on its own.
Harjes: All right. Thanks so much, Todd! As always,people on the show may have interests in the stocks that they talk about, andThe Motley Fool may have formal recommendationsfor or against these stocks,so don't buy or sell based solely on what you hear. That's a wrap for today's show. Until next time, Fool on!
Kristine Harjes owns shares of Johnson and Johnson. Todd Campbell owns shares of Amazon.com and General Electric. The Motley Fool owns shares of and recommends Amazon.com. The Motley Fool owns shares of ExxonMobil and General Electric. The Motley Fool recommends Anthem, CVS Health, Johnson and Johnson, and UnitedHealth Group. The Motley Fool has a disclosure policy.