Jenks Healthcare Business Report September 2001

In the September 2001 issue:

Will Health Care Lead The Economy Out Of Looming Recession?

With the economy almost certainly heading into a recession after the terrorist attack on September 11, the health care industry may benefit from a slowdown and is in a good position to lead the economy out of a recession.
P. 1

***

The Public Equity Markets
Other than Biotech IPOs, the rest of the health care IPO market fared well this year.
P. 3

***

The Venture Capital Market

More than $225 million was raised by health care companies in the venture capital market during the past month.
P. 7

***

Acquisition Market

Even though no new deals were announced during the rest of the week after the September 11 attack, M&A activity remains relatively brisk.
P. 8

***

Jenks Healthcare Business Report

Will Health Care Lead The Economy Out Of Looming Recession?

Without a doubt, the tragic events of September 11 will negatively impact the economy and most likely send the country into its first recession in 10 years. In the past few months alone, major publicly traded companies have laid off several hundred thousand employees, and the numbers continue to rise each day. While we know that the DOW is 30% off its peak and the NASDAQ is closer to 60% below its high, uncertainty remains as to how much lower the markets can go and, more importantly, how much worse the economy can get. The timing and nature of the nation’s military retaliation, as well as the potential for future terrorist attacks, do nothing to alleviate the heightened sense of anxiety which by itself can often propel an economy into a slowdown. With the negative prevailing sentiment and waning consumer confidence, spending by both consumers and businesses will continue on its downward path.

The question is, What sectors of the economy will be growing during the expected recession, other than defense contractors and related groups? The only obvious answer is health care. Although many view health care expenditures as sort of a tax on the economy, the reality is that it also is a major job generator, and those employees do spend their income. In fact, health care generated approximately 45% of all new jobs created during the past year. While most of the economy has seen the rate of job growth plummet from about 3% in the middle of 2000 to just above zero now, job growth in health care has risen from 1% to almost 2.5% during the same time period. This has been occurring in an economy already on the path towards a recession.

If we assume that a recession of unknown duration is upon us, health care will benefit in many ways. As unemployment increases, average wage rates in the labor-intensive health care services sector, while unlikely to decrease much, will at a minimum hold steady. More importantly, the supply of labor will increase as more nurses and other health care professionals return to work to not just replace the salary of a now unemployed spouse, but also to re-build the family "nest egg" which may have declined in value by 20% to 30% during the past year. In addition, thoughts of early retirement may be dissipating for some because of both of these reasons, which would also result in an increase in the labor force.

Stabilized labor costs and an expanding labor pool will benefit the senior care sector, and specifically nursing homes, the most, an area of the health care economy that has had the most difficult time controlling both the cost and quality of labor. In addition, since energy prices usually decline in a recession, facility-based businesses can expect to see a drop in this cost, even though some private pay only facilities, such as assisted living, have been able to bill residents an energy surcharge. A more stable labor market will also benefit the less labor-intensive assisted living segment. But if a recession implies lower housing prices, then the elderly that can postpone moving into an assisted living "lite" facility or any type of retirement housing may choose to do so, further exacerbating the slow fill-up rates experienced by many national providers.

The hospital industry continues to be the strongest segment of health care services, with most stocks trading at or near their 52-week highs. This sector will also benefit from a more stable labor market, but not to the same extent as the senior care market. Recently, Tenet Healthcare (NYSE: THC) led a surge in hospital stock prices after the company announced that its earnings for the first fiscal quarter ended August 31, 2001 would be 10% higher than consensus estimates and 35% to 45% above last year’s first fiscal quarter. These are strong numbers in any environment, but unusual in today’s market when most companies (outside of health care) are showing little or no growth in profits, and often declines.

The hospital industry is also benefiting from managed care losing the battle on patients’ rights. Because increasing health insurance premiums is the only way for health insurers to stay in business as health costs once again skyrocket, there has been little pressure on hospitals to contain costs or lower lengths of stay. And from an investment perspective, there are several hospital companies to choose from, many of which have very different strategies.

While the managed care industry suffered minimal direct financial impact from the events of September 11, with the exception of Aetna (NYSE: AET), which anticipates a $10 to $15 million pre-tax loss, the looming recession may have larger implications. Since every recession involves layoffs, the number of enrollees and, consequently, revenues, should decline. In addition, with back-to-back, double-digit premium increases, other enrollees may voluntarily drop out or corporations, already suffering from a slowing economy, may seek other solutions.

With the managed care industry already under attack for past cost containment policies coupled with a rising demand for more patients’ rights, the only way out has been large premium increases. Unfortunately, that alone may lead to more political backlash against managed care companies. With all of the issues, and failings, of managed care, we are probably in the beginning (very early) stages of reinventing the nature of health care insurance in this country, but the industry hasn’t quite grasped that yet. While other areas of health care may lead the economy out of recession, it will not be managed care.

The pharmaceutical industry, as well as most of health care, is seen as a defensive play from an investment perspective, and as the economy weakens this sector should not be impacted. In fact, generic drug makers may do even better if the unemployed or uninsured switch away from the more costly brand name drugs. Although biotechnology companies will be leading the next health care revolution, because they usually have little (if any) revenue and are always in need of cash, they do not have the same defensive characteristics as pharmaceutical or hospital stocks.

When trading resumed on the major stock exchanges, health care indexes mostly held their ground while the broader indexes lost 6% to 7% in value. In fact, the DJIA health care sector index dropped only 1.3% on that first Monday. Investors saw little reason to push health care stocks down, and will also realize that if the economy continues to worsen, those stocks will be the place to be invested in.

There is little need to mention the aging population and what that does for the growth in health care services because that is a long-term phenomenon and one that presumably will not be a major influence in what may be a short-term recession. Investors must also remember that recessions bring bad news to the health care industry, as well. Specifically, if state budget surpluses disappear, there will be pressure on Medicaid reimbursement for nursing homes. Since these rates are already below the cost of care in most states, and the majority of nursing home residents are funded by Medicaid, any increased shortfall will have a significant negative impact. Pressure on Medicare reimbursement, which has a larger impact on hospitals, could also put a dent into that sector’s high growth rates. These risks are small if the recession is short-term, which is the current prediction. With almost all areas of health care growing, and some at significant rates, there is strong evidence that this sector will be the engine that drives the economy out of the current slowdown. In a weak market, health care stocks are mostly up, and with the benefits of a recession, should go higher. Besides, what other choices are there, videos and popcorn?

Read the past headlines.