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NEWSLETTER OCTOBER 2016
1
TABLE OF CONTENTS
HEALTHCARE MARKET REVIEW AND OUTLOOK .... 1
INNOVATION: STILL STRONG ........................ 5
ABOUT SECTORAL ASSET MANAGEMENT ......... 12
HEALTHCARE MARKET REVIEW AND OUTLOOK
The post-Brexit sell off at the end of the second
quarter proved to be the best stock-buying
opportunity this past quarter. Macro issues faded
temporarily from the limelight, allowing equities to
run a bit, only to reappear late in the quarter in the
guise of interest-rate worries, re-emerging OPEC oil
price collusion (driven by Saudi Arabia’s new
“austerity”), and Hillary’s health scare, which
prompted a Trump election scare.
Over the quarter, the broad markets were up 5.3% (as
measured by the MSCI World AC Index), with
healthcare underperforming at +0.1%. Our
recommended positioning played out nicely this
quarter: both emerging-market and biotech equities
outperformed healthcare and the broad markets
generally. This quarter featured the beginning of the
long-awaited M&A resurgence, as well as some quite
unexpected clinical and regulatory events.
For much of the year, many market participants have
highlighted M&A as an important driver in healthcare,
given accumulating cash piles at many large
healthcare companies and depressed valuations for
many small ones. In Q3, deal making seemed to take
off in earnest, as we saw a significant number of
transactions. Having sold its Actavis generic business
to Teva at a pre-sell off valuation, cash-rich Allergan
went on a shopping spree, buying Vitae (for a 160%
premium) and Tobira (for an almost 500% premium
upfront plus milestones). Pfizer purchased Medivation
after a drawn out and competitive sale process.
Galenica acquired Relypsa for USD1.5bn, and Horizon
bought Raptor for USD0.8bn. In generics, Japan’s
ANNUALIZED VOLATILITY
1 MONTH 3 MONTH 6 MONTH 9 MONTH 12 MONTH 30 DAY 90 DAY
MSCI World Index (all country) 196.2 0.6% 5.3% 6.3% 6.6% 12.0% 11% 14%
MSCI World Index 4755.4 0.5% 4.9% 5.9% 5.6% 11.4% 11% 14%
MSCI World Healthcare Index 266.0 -0.1% 0.1% 5.7% -1.5% 5.3% 12% 13%
MSCI World Pharma 198.9 -1.0% -3.4% 3.1% -4.7% -0.1% 10% 12%
MSCI World Biotech 1261.2 0.2% 6.6% 6.8% -7.6% 3.2% 17% 19%
MSCI World Equip and Supplies 387.6 0.9% 3.2% 13.2% 13.7% 26.3% 13% 13%
MSCI World Healthcare Providers 457.7 0.2% -2.0% 3.1% 0.9% 5.3% 14% 13%
MSCI Emerging Market Healthcare 538.1 -1.1% 2.3% 2.7% 2.2% 4.5% 15% 14%
MSCI Emerging Markets 396.3 1.3% 9.0% 9.7% 16.0% 16.8% 15% 16%
CLOSE
9/30/2016INDEX
RETURN
NEWSLETTER THIRD QUARTER 2016
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Nichi-Iko picked up generic-injectable player Sagent.
Among medtechs, Zimmer, Globus, and Boston
Scientific each acquired smaller companies, while
Danaher bought Cepheid for a 50%+ premium. We
expect this M&A trend will continue.
The quarter offered a number of surprises. The most
significant clinical surprise completely changed the
near-to-mid-term fortunes of Merck (for the better)
and Bristol-Myers Squibb [(BMS), for the worse]. Both
companies reported Phase III findings of their
respective immune-oncology anti-PD-1 antibodies in
treatment-naive lung cancer. Merck reported positive
results, while BMS, to everyone’s surprise, announced
that its study had failed. Although the actual data will
not become available until a Q4 medical meeting,
many believe the different results stemmed from the
way the two companies defined the population
eligible for treatment (based on the degree of
expression of the PD-1 ligand, PD-L1). Merck, the top-
performing pharma this quarter, was up 9%, and BMS
was down 27% on the quarter.
Other clinical surprises included Seres Phase II failure
in C. difficile infection, Novavax’s Phase III failure of
its RSV vaccine in older adults, and the failure of
Intra-cellular Therapies’s second Phase III study in
schizophrenia. Topping off our Q2 surprise list was the
FDA’s unexpected approval of Exondys, Sarepta’s drug
for Duchenne Muscular Dystrophy, after a long and
public fight internally at the FDA.
Small and mid-cap stocks (biotech, medtech, pharma,
and services) were strong this quarter, and the Russell
2000 HC was up 13.5%. Aside from the previously
mentioned M&A dynamic in this space, which
certainly drove performance, many positive events
also contributed to the strong smid-cap rally. Most
notably, Clovis was up 162% on positive data with
rucaparib in ovarian cancer, and Aerie was up 114% on
positive Phase III data with Roclatan in glaucoma. In
medtech, ophthalmology company STAAR Surgical
(+70%) and vascular surgery company LeMaitre (+40%)
led the pack following solid beats. Among services,
Healthways (+129%) headed the group after
announcing strong quarterly results and a
restructuring that saw the sale of two
underperforming segments. Among smid-caps, we
continue to be most attracted to biotech names,
which trade at about 5.4x forward 12m price/sales
(range 4-10x).
The emerging markets (+9.0%) also had a stellar
quarter, outpacing the broad markets, while
healthcare in emerging markets (+2.3%) topped
developed-market healthcare. Chinese, South Korean,
and Indian names led the performance, while
Taiwanese, Hong Kong, and Thailand stocks were
weak. In China, Fosun Pharma, the top performer at
+28%, acquired Indian Gland Pharma and signed an
innovative deal with medtech Intuitive Surgical for
the development of products targeting the early
diagnosis and cost-effective treatment of lung cancer
via robotic-assisted catheter-based medical devices.
The CFDA also laid out a number of policy changes;
these included prioritized review of first-to-market
generics, specific requirements for bioequivalence
filings, and the establishment of US-style advisory
committees to support application reviews. Indian
names exhibiting strength this quarter included
Piramal Enterprises (+29%), Cadilla (+20%, on progress
with remediation), and Cipla (+18%, on a CEO
transition and a strategy change in Europe). In Korea,
Celltrion (+16%) was strong due to legal progress in
bringing J&J’s Remicade to the US market, while
Hanmi (-25%) fell on the last day of the quarter
following Boehringer Ingelheim’s termination of a co-
development program. In Thailand, hospital stocks
were weak following multiple terror-related bomb
blasts that threaten to dampen medical tourism
volumes.
On an industry basis, biotech had the strongest
performance (+6.6%), thanks to its attractive
valuation (as we have highlighted), good clinical-
development news, and M&A. Pharma was the
weakest performer, at -3.4% for the quarter, pulled
down by a number of key players. As noted, BMS (-
28%) was a big drag on the sector, falling dramatically
on its self-imposed misfortunes in immune-oncology.
Novo-Nordisk (-21%) followed closely, after a reset of
growth expectations for its long-acting insulin
NEWSLETTER THIRD QUARTER 2016
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franchise after the approval of Eli Lilly’s biosimilar
Basaglar. The new product gives the Indiana player
increased bargaining power with PBMs and managed
care. Finally, Pfizer (-3%) was weak after its second
quarter earnings when management hinted (and later
in the quarter confirmed) that it was not going to split
its business into two as had been speculated for many
years.
Following a number of solid quarters, healthcare
services (-2.0%) reversed course and were negative
this time around. McKesson (-10.5%) led the pack
downhill following commentary on generic deflation.
United Health (-0.4%), one of the year’s best
performing managed-care stocks given its lack of M&A
involvement and Optum segment growth, finally
paused and retreated a bit. Acute-care provider
results were disappointing, as 2016 had fewer
catalysts and incremental ACA benefits. Finally,
medtech continued its ascent, up +3.2% for the
quarter. Most companies reported above
expectations, including Intuitive Surgical, Edwards,
Boston Scientific, Dexcom, and Abiomed. However,
not all were strong; notable exceptions included
Medtronic (which had a slight revenue miss and is
facing headwinds in TAVR and ICDs) and orthos. Key
approvals for the quarter included Boston’s Lotus
Edge (in Europe), Edwards Sapien 3 in intermediate-
risk patients, and Abiomed’s Impella 2.5 and 5.0 heart
pumps for the treatment of drug resistant acute
hypertension in Japan. Dexcom won a significant
victory at the FDA as an Advisory Committee voted in
favor of non-inferiority of their continuous blood-
glucose monitor versus finger-prick glucose
measurement. However, the approval of Medtronic’s
“artificial pancreas” closed loop cBGM and insulin-
pump system later in the quarter, will likely cause
Dexcom to experience an earlier-than-expected
headwind.
It is probable the next three months will not be as
calm as the previous three. The macro side may prove
more challenging. Contributing factors include a US
presidential election hosting the most controversial
cast of characters in some time, a likely rate hike
from the US Federal Reserve, an Italian referendum,
and the continued rise of German populist parties
ahead of next year’s election.
Healthcare industry news flow, though, should be
robust this quarter. In pharma, we will get a glimpse
at Merck’s and BMS’ first-line lung cancer anti-PD1
studies, which should shed some light on BMS’
disastrous outcome. We will also get data from Eli
Lilly’s solanezumab in the long-awaited Phase III study
in mild Alzheimer’s patients. Roche will report data
from the APHINITY study, which may go a long way in
helping to protect its HER-2 franchise. Pharma-
industry valuation contracted almost one full point (to
15.1x ntm P/E) this last quarter, with BMS’ collapse
the major driver of the contraction.
In biotech news, we will see a number of gene-
therapy companies report clinical data (Avexis,
Biomarin, Bluebird and Spark Therapeutics).
Ophthotech’s Phase III results in wet age related
macular degeneration will settle whether Regeneron’s
late Q3 setback was a drug or class effect (and good
or bad for the former company). Biogen and Eisai will
release additional Alzheimer’s data, and, finally,
more data on migraine prevention from CRGP
antibodies will be announced.
Despite the modest run-up this quarter, valuations in
healthcare remain attractive (P/E 13.8x ntm
earnings), and the outlook is solid (see our feature
piece, “Innovation: Still Strong”). This being said, the
M&A premiums now baked into the valuation of
several smid-cap biotech names should be expected
to fade away over time.
In the medtech industry, the momentum from the
solid roll out of new launches should continue. The
issue that we have with the industry is its valuation –
at 20.6x ntm P/E, it is the healthcare’s most
expensive major industry. Thus, we are much more
SALES EPS PE17E EV/SALES17E COGS
MSCI World Pharma 4% 8% 15x 3.7x 27%
MSCI World Biotech 8% 11% 13x 5.4x 16%
MSCI World Equip and Supplies 6% 11% 19x 3.8x 37%
MSCI World Healthcare Providers 6% 12% 14x 0.5x 83%
GROWTH P.A. 2016-2018E
NEWSLETTER THIRD QUARTER 2016
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selective. In managed care, little progress in the
ANTM/CI and AET/HUM deals should occur before the US election. Hospital volumes show no sign of turning
around and are likely to remain soft. In services, we
prefer to focus on smaller, more innovative, players
in the space. Valuations stand at 14.5x ntm PE.
Overall, the areas we continue to be most excited
about are biotech and emerging-market healthcare.
These industries have solid fundamentals and quite
attractive valuations despite their strong recent
performance. Indeed, with biotech at 13.8x ntm
earnings and 5.4x ntm sales, and emerging-market
healthcare equities at 23x ntm earnings, both have
further upside potential, given expected bottom-line
growth rates of 15-20% and 15%, respectively.
Stephan Patten, CFA
Managing Director & Deputy Chief Investment Officer
NEWSLETTER THIRD QUARTER 2016
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INNOVATION: STILL STRONG
INTRODUCTION
During the 2009-15 biotech rally, numerous
commentators speculated on its cause and concluded
that, at least in part, an improvement in R&D
productivity was responsible. With the correction over
the last twelve months, the question is now: has R&D
productivity subsided and the stream of innovative
products ground to a halt? Over time, additional
analyses of R&D trends have been possible and many
have pointed in an encouraging direction.
In this report, we explore some of the evidence, using
four vignettes of recent R&D success as practical
illustrations of transformative innovation. We also
highlight that innovation is not limited to biotech and
pharma players; indeed, as shown in two of our
vignettes, medtech and healthcare service companies
are capable of creating exciting new products. In light
of ongoing concerns about unsustainable healthcare
spending and growing scrutiny of drug pricing in the
US, the importance of strong innovation over the long
term cannot be overstated as breakthrough products
are well appreciated by both public and private
payers.
Figure 1: US FDA approvals of new molecular entities.
Source: Fda.gov. As at December 2015.
Figure 2: Cumulate success from Phase I to launch;
percentage likelihood of moving from Phase I to launch.
Source: Pharmaprojects 2015, McKinsey analysis.
Empirical evidence of R&D’s improvement generally
begins with FDA drug-approval rates and gradually
moves in more esoteric directions. The recent trends
in FDA approvals of “new molecular entities” show no
evidence that the pace of new drugs approvals is
slowing. The previous two years have been among the
highest on record (see figure 1), and this year, 17
approvals have already been announced. A greater
understanding of the underlying mechanisms of
disease and an improved ability to produce
informative early “test” models have been offered as
qualitative reasons for this improvement in R&D
success. Are they correct? Hard measures of these
factors are difficult to assess. A recent McKinsey
analysis concluded that the cumulative rates of
success in drug development have improved in recent
years, after hitting a nadir a number of years ago (see
figure 2). Also, a recently published review from
Boston Consulting Group tried to disentangle R&D
success factors by analyzing 18 different attributes of
842 molecules created by 419 companies over the
past 10 years. The analysis concluded that company
size, location of the company headquarters, market
size, or the drug target’s family contributed little,
while attributes associated with scientific creativity
NEWSLETTER THIRD QUARTER 2016
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and good judgment generally contributed to success1.
At present, more than 7000 unique new medicines are
in development, with cancer drugs (1919),
neurological drugs (1308) and infectious-disease drugs
(1261) leading the pack. Remarkably, it is estimated
that 70% of the projects in development are
potentially “first-in-class,” meaning that, if
successful, these products would be novel approaches
to disease treatment.
Innovative medical products – be they drugs or
devices – will be able to continue to command price
premiums, even in our current environment. Truly
innovative companies have generally been spared -
and should continue to be spared - consumer and
political wrath. Remember that last year’s political
uproar over Turing Pharma’s Daraprim, Valeant’s
Nitropress, Isuprel and other products, and, more
recently, Mylan’s EpiPen, was about very old drugs,
and not breakthroughs. This distinction is consistent
with our view and reflects current political thinking.
For instance, Hillary Clinton’s Drug Plan differentiates
between old and new therapies:
“Our pharmaceutical and biotech industries are an
incredible source of American innovation and
revolutionary treatments for debilitating diseases. But
it’s wrong when drug companies put profits ahead of
patients, with unjustified price increases not for new
innovations, but for long available and generic
treatments……” (Emphasis added)
The resistance to price pressure generally comes from
two sources: the tremendous medical benefit of
innovative drugs and pharmaco-economics.
Revolutionary treatments usually have far reaching
effects. For example, the advent of Highly Active
Antiretroviral Therapy (HAART) in the late 1990s
1 Scientific creativity was measured crudely by the number of publications and patents per dollar of R&D spend and citation frequency. Good judgment was measured by attributes such as the company’s having a long-tenured R&D leader and having a high kill-rate in pre-clinical and Phase I products.
Figure 3: Actual vs projected death rates for HIV/AIDS in
the US. Source: Truven Health Analytics, 2014.
dramatically changed the projected course of HIV
outcomes. Companies such as GlaxoSmithKline,
Gilead, and Merck contributed to changing the course
of the disease from a death sentence into a largely
chronic condition, avoiding an estimated 862,000
premature deaths. More recently, Gilead’s
introduction of the costly hepatitis C therapy
sofosbuvir (USD 1000/pill) was accompanied by much
anger. These direct antiviral drugs radically altered
the outcome for patients, reducing the treatment
course from 12 to 3 months and boasting a cure rate
of nearly 100% (vs 40% for older therapies), with a
marked improvement in side effect profile. When
Congress requested justification for Gilead’s price
point, the company readily complied and provided
thousands of pages of pharmaco-economic studies.
New products – such as those that will be discussed
later – are generally launched at a price that has been
firmly vetted with extensive pharmaco-economic
research. These studies, conducted in parallel to
Phase I, II, and III safety and efficacy studies, aim to
answer questions regarding the broad financial
benefit (ie, quality of life, reduction in
hospitalization, and other indirect costs) the product
will bring to society.
What follows are four illustrations of the remarkable
state of healthcare innovation today across various
industries. We will first look at gene therapy, a
technology that suffered serious setbacks in the past
NEWSLETTER THIRD QUARTER 2016
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but is emerging as an exciting area of clinical
research with the potential to truly revolutionize
multiple therapeutic areas. Then, we will revisit
immune-oncology, popular among biotechs and
pharmas, for this year’s developments. Third, we
shall leave the drug-development sector to
investigate Edwards Lifesciences, which has pioneered
the catheter-based delivery of replacement aortic
heart valves. We will conclude with a healthcare
service company that is successfully offering new
modalities of healthcare delivery.
BIOTECHS: GENE THERAPY – COMING OF AGE
The concept of gene therapy is relatively
straightforward: diseases caused by defective genes,
such as cystic fibrosis, hemophilia and many others,
could be treated or even cured by introducing
functional genes into the patient’s cells. However, in
practice, a large number of challenges arose, and
these had to be addressed before the promise of gene
therapy could be realized.
Viruses were the first mechanism used to deliver
genes to cells, capitalizing on their ability to target
specific cell types and generate the expression of new
genetic material. However, the types of viruses used
in early trials caused complications, including
mortality, and led to significant caution in the field.
In a highly public case in 1999, four days after
receiving an experimental gene therapy for a rare
metabolic disorder, Jesse Gelsinger died as a result of
Figure 4: Basic mechanism of gene therapy. Source:
http://biol1020-20121.blogspot.ca/2012/09/gene-
therapy-for-duchenne-muscular.html.
Accessed September 2016.
a severe immune reaction to the modified cold virus.
Further, some trials used retroviruses, which
integrated or became inserted in the patient’s
genome; viral integration can lead to mutations or the
activation of genes that promote the development of
cancer, and several cases of leukemia were observed.
Recent and ongoing innovation has led to the
development of novel viral vectors that have
overcome these problems. The new vectors are less
immunogenic and do not insert into the patient’s
genome or are not associated with harmful mutations
at sites of integration.
More than 25 years after the first human received
gene therapy, the field is finally coming of age. Two
gene therapies have been approved in the EU,
Strimvelis (GSK) for the treatment of a severe
combined immunodeficiency (ADA-SCID or 'bubble-boy'
disease), and Glybera (Uniqure) for a rare metabolic
disorder called lipoprotein lipase deficiency (LPLD).
Hundreds of other gene-therapy trials are ongoing or
planned in a wide range of diseases, and early data
have shown remarkable clinical benefit. One of the
more dramatic examples is a treatment being
developed by Avexis for spinal muscular atrophy
(SMA). SMA is caused by a mutation in a single gene,
the survival motor neuron gene 1 (SMN1), which
affects motor nerve cells in the spinal cord. SMA
affects about 1 in 10,000 babies and is the leading
genetic cause of death for infants. In its most severe
form, babies cannot sit unsupported or walk, and the
median age of survival without permanent ventilation
is less than one year. Ninety percent of patients do
not reach their second birthday. Interim results from
Avexis’ Phase I/II trial showed marked improvement
in functional scores, with 11 out of 12 (92%) patients
treated with a therapeutic dose achieving levels of
function almost unheard of in SMA type-1 patients,
and 25% achieving scores in the normal range. No
deaths have been observed to date. The magnitude of
the benefit of this treatment for SMA patients will
become clearer over the coming months, as data to
be presented at upcoming medical meetings will show
patients’ achievement of major motor milestones,
NEWSLETTER THIRD QUARTER 2016
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Figure 5: Hypothetical overall survival Kaplan Meier
curves. Source: Roche Q3 2014 presentation.
including walking, and will reflect a longer duration of
follow-up.
While the promise is clear, some challenges still
remain. Unanswered questions relate to optimising
gene therapies across different organs and
indications, as well as to the potential duration of
clinical benefit and the possibility of re-dosing.
However, a key question concerns the business model.
Many gene therapies may result in a long-term benefit
after a single administration, possibly even in a cure.
In order to recoup the R&D investment in very rare
diseases, the cost per patient is likely to be extremely
high: Glybera is priced at USD1.4 million in the EU2.
The payment model for potentially curative
treatments may evolve alongside the development of
such therapies. Single-payer systems in Europe and
elsewhere may favour annuity models, whereby the
cost is amortized over the expected duration of
clinical benefit. Due to customer mobility, the
willingness of US commercial payers to reimburse
such costly treatments remains to be seen, and
reimbursement upfront or via annuities may vary,
2 Glybera has not garnered significant use, even considering the rarity of the condition. While the hefty price tag may play a role, most of the reason for the commercial failure lies with the setting and the available data. Glybera was never shown to produce a durable clinical benefit; rather, some evidence was generated showing reduction in episodes of pancreatitis, the painful complication of the disease. In contrast, many of the promising ongoing gene therapy programs are showing dramatic clinical benefits that could better justify a 7-figure price tag.
depending on whether the gene therapy has a
pronounced impact on existing treatment costs. While
various aspects of the commercial model need to be
worked out, we are convinced that life-saving or life-
altering gene therapies will drive economic as well as
medical value.
PHARMA: IMMUNE-ONCOLOGY
Immune-oncology (IO) has changed the landscape of
cancer therapy. While standard chemotherapeutic
and targeted therapy regimens can shrink tumours
and improve short-term survival, IO offers the
possibility of a durable response. With the advent of
immunotherapies, researchers have observed a novel
phenomenon - “long-term remissions” in a meaningful
proportion of patients (see figure 5).
Although researchers have long believed that the
immune system (fighter of ‘non-self’ in our bodies)
should be well suited to fight cancer (‘non-self’),
scientists have found it difficult to realize the
potential of leukocytes, macrophages, and other
immune cells to destroy tumours. Years ago, small
biotech companies tried to prime the immune system
to recognize and fight cancers through initial
attempts at cancer vaccines. Curiously, these
techniques failed to extend survival, despite the fact
that some immunologic effects were reported.
However, the recent discovery of a class of
molecules, known as ‘immune checkpoints,’ which
are expressed on tumour cells and block the action of
certain immune cells offered drug developers a way
to bring those cells back into play. Releasing the
brakes using novel immune-checkpoint inhibitors
enabled a huge leap forward in the field of immune-
oncology.
This year has seen an expansion of the tumour types
in which immune-oncology drugs are licensed for use,
including head and neck cancer, squamous cell lung
cancer, and renal cell carcinoma. The most significant
development came in lung cancer, when Merck
announced that first-line Keytruda showed a
statistically significant improvement in progression-
free and overall survival, while Bristol-Myers Squibb
NEWSLETTER THIRD QUARTER 2016
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reported that their comparable drug Opdivo failed in
a different frontline-therapy trial. (Both drugs are
approved as second-line therapies in non-small-cell
lung cancer.) Although the full data are not yet
available the speculation is that the choice of
biomarker cutoffs (ie, what proportion of tumour cells
express the checkpoint inhibitors’ ligand), with Merck
at 50% and Bristol-Myers at 5%, led to the different
outcomes. Another strategy, chemo-sensitization of
tumours that seem to be non-responsive to
immunological attack, is showing signs of success. A
second group at Merck has reported evidence that
chemotherapy can augment the effects of immune-
checkpoint inhibitors in lung cancer.
Much more can be expected from this fertile field, as
new drug targets are discovered, new IO combinations
are paired, and new immunotherapies are combined
with standard chemotherapies and targeted
therapies. In the years to come, expect to see long-
term remission rates continue to climb in many
cancer types, with the goal of increasing rates far
north of the currently observed 18% in melanoma.
MEDTECH: EDWARDS LIFE SCIENCES
Moving to other areas of healthcare, one of this year’s
best performers (+53%) has been Edward’s
Lifesciences, thanks to the very meaningful market-
opportunity expansion of their novel transcatheter
heart valve. The rise of minimally invasive solutions
has largely replaced legacy surgical counterparts.
These new options have allowed thousands of patients
to forgo treatments of highly variable efficacy with
significant toxicity. Many others, who heretofore
would have been untreatable, have now been able to
receive a functional valve. In coronary artery
diseases, stents delivered over a catheter in a
minimally invasive fashion to occluded vessel sites
have for the most part cannibalized coronary artery
bypasses. In a similar fashion, transcatheter aortic
valve replacement (TAVR), first approved in Europe in
2007 and in the United States in 2011, has rapidly
established itself as the treatment of choice for
stenotic aortic valves. Keep in mind that patients with
severe aortic stenosis have a limited life expectancy,
with survival rates as low as 50% at 2 years without
the replacement of their natural aortic valve.
Although heart valves have been surgically implanted
in patients for years, the development of valves that
could be implanted in a minimally invasive manner via
a catheter required substantial engineering ingenuity.
First, the replacement aortic valve must be flexible
enough to fit into a catheter that is narrow enough to
pass through major blood vessels. As correct
placement of the replacement valve is important,
deployment needs to be exact. Finally, this heart
valve needs to have long-term durability, 10 years or
more. The genius that allowed the optimizing of these
divergent variables (flexibility and durability) led to
the successful development of transcatheter heart
valves.
Figure 6: Edwards Lifesciences SAPIEN 3. Source:
Edwards.com. Accessed September 2016.
Through a phased process, the rapid development of
new generations of transcatheter valve initially
opened up the market to surgically inoperable
patients. Later, patients traditionally deemed as high
surgical risk were treated. Today, these two
indications represent a worldwide market exceeding
USD3bn annually (source: Sectoral). Two leaders,
Edwards Lifesciences and Medtronic, share the bulk of
it. The balance of the market is held by a handful of
other competitors.
NEWSLETTER THIRD QUARTER 2016
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Figure 7: Penetration of valve replacement in the US.
Source: Edwards.com, 2015 Analyst presentation.
Although some are making inroads, their success has
been limited to approximately 20% of the market
outside the US. (Source: Sectoral estimates). Most
important, the field of aortic stenosis remains large
and underpenetrated. As a result, valve developers
must steadily innovate to stay at the forefront of the
field.
The latest advance came in August 2016, when
Edwards Lifesciences received US approval to treat
patients characterized as intermediate risk to
surgery. (Prior to this announcement, Medtronic had
been granted a similar approval in Europe.) This
indication is estimated to represent an opportunity
exceeding USD3bn, more than doubling the current
market (source: Sectoral estimates). Furthermore, as
awareness rises on the back of positive clinical
results, more patients are likely to become
incrementally disposed to seek TAVR therapy. The
better outcomes should help overcome their fears of
undergoing a risky and invasive surgical procedure.
Finally, Edwards’ low-risk trial (targeting a USD5bn
market) in the US is under way, but approval for this
indication is not anticipated for several more years.
SERVICES: INNOVATION IN HC PROVISION
In years past, the sound of cold-and-flu season was
the sniffling and coughing of patients waiting in
overcrowded clinics, physician offices, and emergency
departments. For many, the wait could last several
hours. More recently, some patients have benefitted
from a cost-effective and convenient alternative:
telemedicine.
In Lewisville, TX, the operation hub of Teladoc
(Bloomberg ticker: TDOC), the cold-and-flu season
plays a very different tune. Similar to a control room,
Teladoc can track in real-time an uptick in cold-and-
flu-related physician consultations or visits. With their
first-mover advantage, Teladoc has built a highly
scalable technology platform; via a mobile app, online
portal, or simply over the phone, patient requests are
answered in a matter of seconds and connected to a
physician in minutes. If needed, a physician can e-
prescribe a treatment and have it ready for pick up at
the patient’s preferred pharmacy.
The cold-and-flu season is just one timely example of
telehealth’s ability to bridge the patient-physician
gap in a cost- and time-effective manner. Today,
more than fifteen million Americans have access to
Teladoc services in general medicine, pediatrics,
behavioural and mental health, dermatology, smoking
cessation, and sexual health. Members can rely on
Teladoc twenty-four hours a day, seven days a week.
Indeed, access to care is becoming a growing concern
in healthcare delivery. Changing demographics,
coupled with a growing number of American’s with
health insurance coverage have created bottlenecks
in traditional brick-and-mortar facilities. Based on
CDC data, Teladoc believes that 9 of its top 10 most
common diagnoses are responsible for roughly 100
million annual office visits.
A number of forces have come together to make
telemedicine an attractive service for patients. First,
the rise of high-deductible health plans shifts a
meaningful share of the medical liability onto
NEWSLETTER THIRD QUARTER 2016
11
employees. Consequently, healthcare consumers have
become more sensitive to price. In feedback surveys,
25-30% of Teladoc users would have visited an
emergency department, while roughly 50% would have
gone to an urgent care center or physician office.
Compared with a USD1,500 emergency department
visit or a USD200-300 physician office visit, Teladoc’s
USD45 charge offers significant value to both patients
and their employers/health plans.
Second, as payment models move away from fee-for-
service to quality outcomes, the efficiency gains from
telehealth in patient time, productivity, satisfaction,
and overall medical cost will become increasingly
important. Current technologies enable Teladoc to
offer a sophisticated call-in center for efficient co-
ordination of patients and physicians; as a
consequence, highly regarded provider groups,
including Mount Sinai and HealthPartners, now use
the Teladoc platform. Finally, Teladoc’s special
business model, in which clients are charged modest
subscription fees (in addition to usage fees), has also
helped ensure the company’s success: promoting
patient/consumer engagement through the delivery of
prompt (and profitable) telemedicine services.
Figure 8: Teladoc’s differentiation. Source: teladoc.com.
Accessed September 2016.
The value proposition of telehealth seems well
accepted by Teladoc’s long list of marquee health
plans, employers, and provider-group clients. The
company also has a notable partnership with CVS.
From a government standpoint, most states now
require insurers to reimburse telehealth visits.
However, the Texas Medical Board (TMB) passed anti-
telemedicine legislation that it wishes to enforce. In a
friend-of-the-court brief, the Federal Trade
Commission commented on the ongoing litigation
between the TMB and Teladoc, and its remarks may
serve as the best endorsement for telehealth yet:
"There is no evidence that any disinterested state
official reviewed the TMB rules at issue to determine
whether they promote state regulatory policy rather
than TMB doctors’ private interests in excluding
telehealth—and its lower prices—from the Texas
market."
CONCLUSIONS
During the past year, biotech equities – especially
small and mid-caps – have corrected dramatically.
Given the overall robust quality of R&D trends, we are
confident that strong innovation should continue.
Thus, we see this pullback in biotech as a buying
opportunity. As we have seen, innovation is also
present in other healthcare industries and, among
service names, we are quite interested in innovative
business models. Immune-oncology should continue to
provide many investment opportunities, as novel
mechanisms are fully investigated in the near-term
and established therapies expand their range of
indications. Finally, our sweet spot among medtech
stocks includes those companies, such as Edwards,
that have come to market with very innovative
technologies that address a significant market in a
revolutionary way.
The Sectoral Investment Team
NEWSLETTER THIRD QUARTER 2016
12
ABOUT SECTORAL ASSET MANAGEMENT
Sectoral Asset Management is an investment advisor whose focus is managing global healthcare equity portfolios. Sectoral has one of the world’s longest track records in managing biotech equities and is a
sub-advisor of numerous healthcare and biotech funds offered by partners in Europe, North America, and Asia.
Investment Professionals
Jérôme Pfund, CFA - Chief Executive Officer Marco Cianflone – Financial Analyst
Michael Sjöström, CFA - Chief Investment Officer Anna Fan, Ph.D., CFA - Financial Analyst
Stephan Patten, CFA – Deputy Chief Investment Officer Adrian Lam – Financial Analyst
Marc-André Marcotte, CFA – Head of Research François Beaubien, Ph.D. - Associate
Mina Marmor, Ph.D., CFA – Portfolio Manager Olivier Brosseau, MBA - Associate
Maha Katabi, Ph.D., CFA – Partner, Private Equity Vasilios Tsimiklis, CFA – Economist
Howard Riback, CPA, CA - Director, Private Equity Pierre Gauthier, CFA - Senior Trader
Christopher Lui - Senior Financial Analyst
Sectoral Advisory Network
Under the supervision of Marc-André Marcotte,
Sectoral has established a proprietary network of
talented professionals, researchers and clinicians in
complementary disciplines worldwide.
The Sectoral Advisory Network (SAN) is designed to
support Sectoral with scientific due diligence in its
investment process. SAN’s members include:
Amanda Adler, MD, Ph.D. Epidemiology / Diabetes Addenbrooke's Hospital, Cambridge, UK
Michel Aguet, MD Oncology Swiss Federal Institute of Technology, Switzerland
Henry I. Miller, MS, MD Health Policy / Regulation Hoover Institution, Stanford, CA, USA
Jeffrey P. Somers, JD Law Morse, Barnes-Brown & Pendleton, Waltham, MA, USA
Angus C. Russell Pharmaceuticals Industry Retired CEO of Shire plc
William N. Starling Medical Technologies Synergy Life Science Partners
Magdalena Leszczyniecka, Ph.D. Biosimilars STC Biologics, Cambridge, MA, USA
Frank Ma, Ph.D. Pharmaceuticals Industry i-MD, Shanghai, China
Vishar Vasudevan Emerging Markets Former CFO of Dr. Reddy’s
Contact Information Phone: +1 514 849 8777 ext. 223 Fax: +1 514 849 6777 1010 Sherbrooke St. West, Suite 1610, Montreal QC H3A 2R7, Canada
www.sectoral.com
The Sectoral Asset Management newsletter is published quarterly by Sectoral Asset Management (“Sectoral”). It is provided solely for purposes of evaluating Sectoral's advisory services. This newsletter is not an offer, recommendation or solicitation to buy or sell securities or units of any Fund. Any commentary within the report is for informational purposes only and is general in nature. This document contains certain statements that may be deemed forward-looking statements. They are based on certain assumptions, analyses of historical trends, current conditions, expected future developments and other factors. Certain information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. Past performance is no guarantee of future results. Investing in healthcare companies involves a high degree of risk, and prices of these companies' stocks may be very volatile. Sectoral may hold securities of issuers referred to in this report in portfolios under management. You may request performance updates by emailing Jérôme Pfund at [email protected]. SECTORAL372