Friday, June 22, 2012

Health Care: Who Wins On Wall St.?

Content Section Jun 21, 2012 4:45 AM EDT

While campaign spin doctors and constitutional scholars prepare for one of the most significant Supreme Court decisions in a generation, Wall Street is moving quietly, making major bets and hedges on the case. The court’s ruling will shift billions across the healthcare industry and among its investors —not to mention the economy at large.

Most academics are bullish on the constitutionality of the individual mandate, the law’s cornerstone. There’s around a “10-to-1” chance of the provision’s survival, said Thomas Maguire, a professor of health economics at Harvard. But the market isn’t as optimistic.

“The market is pricing a 60% to 70% likelihood of the mandate being struck down,” said Michael Gregory, manager of two healthcare funds for an investment firm affiliated with Highland Capital Management LP.

According to six industry analysts and fund managers interviewed by The Daily Beast, Wall Street money believes that the individual mandate, if not the entire law, will be dumped.

Most major investment firms have already written up reports on the health-care law, screeds that read a lot like beltway punditry: “Justice Roberts may vote with Justice Kennedy,” muses RBC Capital Markets; “cynical observers see the Court as a political animal,” bemoans BMO. But though they may sound like op-eds, the bets have big money behind them.

In a case that will have very real consequences for the well-being of millions of people, it may seem a little crass to juggle shares. As Maguire said, it would be wrong to have the economic “tail wagging the health insurance dog.” But the traders descending on the health-care markets are giving us very real information on how the business world might react to different rulings. And the bottom line will affect top-level health care: patients covered, drugs supplied, hospital beds bought. That money talk is far from cheap.


Karen Bleier, AFP / Getty Images

So who could be Wall Street’s biggest winners and losers after the Court rules on the Affordable Care Act? There are three main, market-moving scenarios: the law is struck down in full, it is upheld in full, or the individual mandate component is struck down while the rest of the law is upheld.

SCENARIO 1: The entire law is invalidated.

This is the nightmare scenario for the White House, and bad news as well for hospitals, who will have to keep suffering with mountains of “bad debt” from uninsured patients. But it would be excellent news for most managed-care companies, who won’t have to eat new compliance costs. The health-care industry as a whole would be likely to see small gains as well, with the exception of Medicaid insurers, who were counting on the law’s new subsidies.

Should the law fall, drug and medical tech companies will see modest gains, said Chris Konstantinos, healthcare strategist at Riverfront Investment Group, and stocks will “rally hardest” for the big commercial insurance companies.

As BMO Capital Markets health analyst Dave Shove put it, “If the law gets struck down completely, all these stocks will go up on a short-term basis because there’s a belief that less regulation always leads to more profits.” Moreover, the law’s new taxes on medical technology— designed to offset its estimated $1.76 trillion cost—would disappear. “At the end of the day, money comes in that [the government] won’t get,” Shove said. “That’s pretty black and white.”

“The market is pricing a 60% to 70% likelihood of the mandate being struck down,” said one investment fund manager.

This effective tax cut would outweigh the extra market share from the millions of people that the mandate would have added, said Tom Carroll, analyst at Stifel Nicolaus.

In short, if you think the Court is going to toss the health-care law, buy Aetna, Cigna, and United— and short your favorite hospital or Medicaid provider.

SCENARIO 2: The entire law is upheld.

Now let’s say the professors are right: Justice Kennedy smiles on interstate commerce and the Affordable Care Act survives in full. Wall Street contrarians like Carroll and the team at RBC Capital Markets could make a killing, as they think the market’s misguided, and that there’s a 60%-plus chance that the mandate will stand.

The biggest industry winners in this scenario: hospitals. As Frank Morgan, RBC’s managing director of healthcare services, said, the “law will increase the number of insured Americans by 30 million; [that’s] more people with insurance, more people who utilize healthcare, more volume, and less bad debt expense.” The share prices of hospitals and Medicaid providers could jump around 20 percent, say Konstaninos, Gregory, and Morgan.

Medical devices and big pharma would have to face the taxes, but since these are anticipated losses, stocks would stay steady. As for the managed-care downside, analysts say it wouldn’t be that bad. Any ruling by the Supreme Court removes a major source of uncertainty from the whole industry. Moreover, most insurers have already been operating under the law’s regulations, which implies that their trading would stay flat in the short term, and may even rise in the next year.

The managed care upside: While the law’s guaranteed issue and community-rating rules would force insurers to take on costly patients at lower margins, their revenues would climb as the mandate covers more and more people.

“It may be an opportunity longer term,” said Konstaninos. “When the dust settles, you would have investors interested.”

For the first time in recent memory, the commercial insurers could become growth investments.

SCENARIO 3: The individual mandate is invalidated, but the rest of the law is upheld.

This baby-splitting could prove catastrophic for everyone—a “doom scenario” for hospitals, insurers, and investors, said Gregory. If the court finds the mandate severable from the rest of the bill—if they can “separate the egg from the batter,” as Konstantinos put it—things get a whole lot more complicated for a lot of health care companies.

Let’s say the Court throws out the individual mandate, but keeps community rating and guaranteed issue. That would be “bad for stocks across the board,” Carroll said. The decision would punt health-care reform back to Congress, which “isn’t doing anything this year” and thus create major uncertainty going into the November elections. Taxes on pharma and medical devices would remain, while managed-care and hospital companies would suffer big losses. As Shove said, “it sounds horrible for the big insurers,” who would be forced to take on sick patients without benefitting from the healthy ones who would have been enrolled under the mandate.

In this scenario, a lot of companies would simply cut their losses and leave the individual insurance market altogether; the law would essentially “run them out of business,” Shove said.

The rest of us would suffer with skyrocketing premiums. “Whoever’s left will be able to charge a lot of money,” said Les Funtleyder, a healthcare portfolio manager at Miller Tabak. “Healthcare insurance prices will go up significantly.” As for most hospitals, which can’t cut and run, they’ll be faced with mounting bad debt.

These three scenarios have been the main ones on investors’ minds. But how might a ruling on the health-care law affect the economic recovery? Since the market isn’t optimistic about its chances, it’s possible that the law’s full survival could prompt the best economic boost. Such a ruling would clear away a cloud that’s been hanging over the whole sector for months. As Morgan said, “the stocks look like they’re reflecting a lot of bad scenarios.”

And if there’s one thing the health-care industry hates, it’s uncertainty. With health expenditures now comprising 18% of the U.S. economy, a surprise shot in the arm could have positive macroeconomic implications. “It could help hiring,” said Funtleyder, as hospitals and exchanges would finally move to employ new workers.

Fund manager Michael Gregory is blunter. “At the core, we’re assuming that the Affordable Care Act will increase U.S. expenditures on health care by $2 trillion. Repeal of that law will deprive businesses of expansion opportunities.”

Of course, the Court could choose any of these three scenarios. But regardless of the ruling, smart investors stand to gain from newfound clarity. Moreover, if Wall Street gets a pleasant surprise, the rest of the economy could as well.

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