Jenks Healthcare Business Report February 2003

In the February 2003 issue:

Earnings Problems? Not in Health Care

Earnings results in health care were impressive in 2002, if early reports continue to hold. Double-digit growth was not uncommon. We discuss the news by sector, and portents for 2003. See page 1

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Public Equity Market

Regardless of earnings, investors are still extremely cautious, with few results triggering any enthusiasm. No health care IPOs were filed; two secondaries priced, with differing results. See page 3

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Venture Capital Market

The pace of venture investment had been too hot not to cool down, but 35 companies still managed to raise $320.6 million this month. Biotech and Medical Devices made two-thirds of the deals, leading LPs to worry about a “biotech bubble.” See page 5

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Feature Stories

PIPE Dreams. With the chill in the public markets, seven publicly traded companies turned to private equity this month, raising $121 million. Charts on page 4. See page 5

Profile: Elixir Pharmaceuticals. The next in our series of closer looks at firms successfully attracting VC. This one managed a merger at the same time. See page 10

Jenks Healthcare Business Report

Earnings Problems? Not in Health Care

With the nation’s attention directed toward the impending war and nerves rattled by threatened terrorist attacks in our major metropolitan areas, it is difficult to focus on earnings results for fourth quarter 2002, but focus we must. Now that the Internet bubble is a thing of the past, when earnings did not appear to matter, investors are paying attention to earnings trends, and health care has been surprisingly resilient. Just as the health care industry led the merger and acquisition market in 2002, we would not be surprised to see health care revenue and profit growth lead all sectors of the economy for last year as well.

Although all companies have not reported fourth quarter and year-end results yet, our sampling of about 50 companies across all major segments has yielded some impressive results. However, we excluded companies (such as small biotechnology firms) that have no revenues. In addition, several of the companies that posted losses were expected to do so, but saw a reduction in the loss compared to the previous year’s fourth quarter loss. Compared with the fourth quarter in 2001, nearly 70% of the companies surveyed had double-digit revenue growth in the 2002 fourth quarter, and more than one-third of those were over 20%.

When looking at earnings per share (excluding one-time charges), a similar pattern emerges, with more than 65% of the companies posting double-digit growth and the majority of those above 20%. This is one of the reasons why so many people are bullish on the health care sector even as the Dow drops below 8000 again. Even many of the large pharmaceutical companies, which as a sector is supposed to be faltering as blockbuster drugs come off patent and generics cut into profits, fared reasonably well, the notable exception being Merck (NYSE: MCK), which had flat earnings.

While investors concentrated on the problems of the pharmaceutical industry in 2002, managed care companies may well be the focus of investor attention, as well as the government’s, in 2003 as the health care economy grapples with out-of-control costs. So far, all of the major health care insurers have been reporting solid earnings growth, except Oxford Health Plans (NYSE: OHP), which reported a 16% decline in net earnings on an 18% rise in revenues in the fourth quarter. Investors may have questioned some of the components of its latest earnings report, driving its share price to a 52-week low of $27.89 on February 12.

The largest health insurer, UnitedHealth Group (NYSE: UNH), reported a 58% surge in earnings per share on an 11% increase in revenues in the fourth quarter. The earnings beat Wall Street’s estimates by $0.04 per share, and the company, with more than 17 million enrollees, expects to increase premiums by 13% while medical costs are estimated to rise by 11% to 12%. Despite this news, UNH’s shares have dropped to their lowest level since early December.

The second largest health insurer, Aetna (NYSE: AET), posted a healthy fourth quarter profit compared with a loss in the year-ago quarter, on a revenue decline of 22%. The revenue decline was mostly the result of shedding several unprofitable accounts, and sequential quarterly revenues are not expected to turn upwards until mid-2003. Most importantly, AET’s commercial HMO medical loss ratio (MLR) dropped to 80.4% in the fourth quarter, compared with 81.4% in the third quarter and 89.7% in the fourth quarter of 2001. With 15% premium increases in 2003 and medical costs expected to rise by 12% to 13% at the company, earnings may rise by 15% this year. Management has estimated 2003 earnings per share to be in the range of $3.30 to $3.40, significantly higher than original analyst estimates of $3.08 per share. A $275 million reduction in SG&A in 2003 will also contribute to the higher earnings. The stock price has done little since the earnings results were released, and with a 12x PE ratio based on 2003 earnings, investors may not be entirely convinced, or else the shorts are keeping a lid on any price increase.

After being extremely pessimistic last October, with two cuts in its earnings forecast, Cigna (NYSE: CI) beat revised estimates for the fourth quarter by seven cents, causing the company’s share price to jump by 12% in early February. But one-half of that increase was lost in the following days, and the stock, at $41.75 per share, is a far cry from its 52-week high of $111 per share. Just like Aetna, CI has shed unprofitable accounts and is slashing costs, including the elimination of up to 3,900 jobs. Unlike most of the other insurers, however, CI’s commercial HMO MLR in the fourth quarter increased to 86.4% from 85.5% a year ago. The company will have to increase premiums by larger percentages than the rest of the market and will lose some business in 2003 as a result.

Two of the largest operators of Blue Cross and Blue Shield plans, WellPoint Health Networks (NYSE: WLP) and Anthem (NYSE: ATH), posted earnings per share gains of 42% and 40%, respectively, in the fourth quarter. But these results did nothing for their shares. In the case of Anthem, which raised its earnings per share forecast for 2003 by $0.10 per share, its share price tumbled to a new 52-week low of $53.00 per share. Revenues are expected to be up 23% this year, and the integration of its acquisition of Trigon Healthcare is on track with expected savings of $50 million in 2003 alone. Management may be asking what else it can do to satisfy investors.

Perhaps the problem has something to do with "Medicare reform," as briefly outlined in the recent State of the Union address, which may involve a private-sector drug benefits plan. Unfortunately, it’s beginning to sound like the existing Medicare+Choice plans, which have not been popular, or profitable, with insurers. The other potential problem is whether managed care plans will get the math right if they have to redesign benefit plans to implement benefit buydowns by large corporate customers.

Meanwhile, hospital costs account for almost 50% of total medical costs incurred by HMOs, and other than some fallout from Tenet Healthcare’s (NYSE: THC) Medicare problems, hospitals are quite happy with increasing rates. As we have said before, something has got to change, and with change comes miscalculation, which often results in volatile earnings. It may be looking good for managed care companies today, but investors apparently are not willing to buy into the long term.

The earnings front has not been all good news, and often that has been related to 2003 forecasts. An example of this is Accredo Health (NASDAQ: ACDO), which provides pharmacy services to patients with chronic diseases. Earnings for the company’s second quarter ended December 31, 2002 doubled on a 127% jump in revenues from an acquisition, but because of slower sales for some of its products, revenues for the year ending June 30, 2003 will be about 3% below previous forecasts, and earnings per share for fiscal 2003 and 2004 will be slightly below estimates. This news sent the share price down more than 25%, ultimately hitting a 52-week low of $24.17.

Last March, MedSource Technologies (NASDAQ: MEDT), a medical device manufacturer, went public at $12.00 per share, hit a high of $15.11 within a few weeks, and then slowly descended over several months to about $6.00 per share. But when MEDT announced in late January a cut in its 2003 profit forecast because of lower sales, the stock plunged by 50% and recently hit a new low of $2.38 per share. No wonder there’s no IPO market.

If you think things are bad, it is always worse somewhere else. IntraBiotics Pharmaceuticals (NASDAQ: IBPI), which is engaged in the development of novel antibiotics but which has no revenues, reported a net loss of $10.3 million in the fourth quarter. It also announced that the number of employees had declined from 37 to 11 during the quarter, but that the number had dropped to just five by January. The good news? It has $13.3 million of cash ($0.35 per share) and perhaps a viable product for the prevention of ventilator-associated pneumonia. The bad news? The current share price is just $0.18, down 96% from last April.

Read the past headlines.