Healthcare Observer Oct 2013

Transcription

Healthcare
Observer Oct 2013
Med-Tech Multinationals Moving Toward Moats in China’s Burgeoning
Health-Care Market
As medical technology companies shift their attention to emerging markets, we think China’s
potential for growth in its health-care market—$1.7 trillion by 2022—is the key growth
opportunity spurring multinationals to set up shop there. China has already overtaken Japan
as the second-largest med-tech market, and we anticipate robust double-digit growth to
continue, especially considering the still-low penetration rates of common medical procedures
such as angioplasty, hip replacement, and cardiac resynchronization. We take a closer look at
how Abbott ABT (FVE: $40), Boston Scientific BSX (FVE: $9.50), General Electric GE (FVE:
$27), Medtronic MDT (FVE: $60), Stryker SYK (FVE: $70), and Zimmer ZMH (FVE: $80) have
created economic moats around their businesses in China. Of the med-tech companies, we
think Medtronic is relatively undervalued, and the best-positioned, to penetrate the Chinese
market with its wide-ranging product portfolio.
2
Potential to Tap Into Immense Growth by Digging
Med-Tech Moats in China
3
China’s Health-Care Spending Set to Triple by
2022 on Rising Incomes, Aging Population
20
Medical Technology Market in China: Awakening
Giant and Emerging Dragon
31
Chinese Challenges to Digging Moats in the
Stent Business
39
Orthopedics: Translating Wide Moats in China
45
General Electric’s Emerging-Market Strategy
Starts With Service Networks
47
Outlook for Industries in Health-Care
47
Healthcare Focus Lists
49
Healthcare Calendar
50
Coverage List
Debbie S. Wang, North America
Senior Analyst, Devices
1 312 384-3937
[email protected]
Daniel Rohr, CFA, North America
Strategist, Basic Materials
1 312 384-4836
[email protected]
Alex Morozov, CFA, North America
Director, Devices
1 312 696-6159
[email protected]
Damien Conover, CFA, North America
Director, Pharmaceuticals
1 312 696-6052
[email protected]
Contributing Morningstar Healthcare Observer Analysts
Daniel Holland, North America
Senior Analyst, Industrials
1 312 696-6589
[email protected]
Karen Andersen, CFA, North America
Senior Analyst, Biotechnology
1 312 384-4826
[email protected]
John Zecy, North America
Associate Analyst
1 312 384-3734
[email protected]
Vishnu Lekraj, North America
Senior Analyst, Healthcare Services
1 312 244-7021
[email protected]
Kai Bi, Asia-Pacific
Associate Analyst, Healthcare
86 755 3311-0000
[email protected]
Iris Tan, Asia-Pacific
Senior Analyst, Banks and Insurance
86 755 3311-0980
[email protected]
Healthcare Observer October 2013
2
Potential to Tap Into Immense Growth by
Digging Med-Tech Moats in China
by Debbie S. Wang
Executive Summary
A potent combination of GDP growth potential and a massive (and aging) population suggest
tremendous growth prospects for health-care demand in China. We attempt to gauge the magnitude
of the opportunity at 30,000 feet by assessing macroeconomic and national data on demographics.
Then, we focus more tightly on the medical-technology opportunities, challenges, and risks in China.
Finally, we take a close look at several key markets to see how well the multinational med-tech companies have replicated their economic moats in China, and the various strategies for doing so.
Key Takeaways
3 We size the Chinese health-care market at $1.7 trillion in 2022. Using international and Chinese
data sets on health spending, income, and demographics, we find the growth potential for Chinese health
spending is far greater than that for GDP. If China follows the “typical” path as it grows richer and older,
we would expect health care’s share of GDP to grow by 40% by 2022.
3 China’s med-tech market is already $21 billion—second in size only to the U.S.—and has been growing
in the high teens. We think there is plenty of room for further growth in cardiology, orthopedics, and
neurology thanks to rising demand through nearly universal health insurance, rising middle-class
expectations, and the shift in disease burden to chronic conditions. Simultaneously, supply is increasing
as more physicians are trained to use devices and more hospitals offer more sophisticated medical
services. Despite the real regulatory, reimbursement, price control, piracy, and corruption risks in China,
multinational med-tech firms have already put down stakes there in the hopes of capitalizing on
expected growth.
3 We think multinationals in the narrow-moat business of making drug-eluting stents will face major
challenges to digging moats in China. Abbott, Boston Scientific, and Medtronic rely heavily on efficient
scale as a source of economic moat in developed markets, where they operate as a rational oligopoly.
The competitive landscape in China includes formidable local competition that act as fast-followers and
have successfully innovated their way up the value chain.
3 We are confident the orthopedic multinationals can translate their wide moats in developed markets
to the burgeoning Chinese market. Unlike the stent makers, Johnson & Johnson, Stryker, Medtronic, and
Zimmer all benefit greatly from the high switching costs that characterize orthopedic products.
We think this dynamic will compensate for weaker intellectual property protection in China through the
midterm. Orthopedic multinationals have also bolstered this competitive advantage through savvy
acquisitions of local midtier competitors.
3
China’s Health-Care Spending Set
to Triple by 2022 on Rising Incomes,
Aging Population
by Daniel Rohr, CFA
We see tremendous growth prospects for health-care demand in China thanks to the combination
of GDP growth potential and a massive (and aging) population. We attempt to gauge the magnitude of
the opportunity using international and Chinese data sets on health spending, income, and demographics.
We find the growth potential for Chinese health spending is far greater than that for GDP. If China
follows the “typical” path as it grows richer and older, we would expect health spending to triple to $1.7
trillion (purchasing power parity) by 2022, as its share of GDP rises by 40%.
3 China spends roughly 5% of GDP on health care, far below the global average of 10%, but commensurate
with what we’d expect for its income level.
3 Rising incomes are strongly associated with a rising health-care share of GDP in the international
data set. A review of Chinese health spending since 1995 reveals no reason to believe China will break
from this global trend. We strongly expect health spending will grow faster than GDP as China climbs the
income ladder. We expect rising incomes to deliver a 1-percentage-point boost to the health-spending
share of GDP by 2022.
3 China’s rapidly aging population also will be a major driver behind the “GDP-plus” growth we expect
in health spending. By 2022, China will attain income levels Mexico and Turkey possess today, but will
be far older. We expect aging will add 1 percentage point to health spending’s share of GDP in China.
3 Continued urbanization also augurs rising health-care outlays, but the effect is largely subsumed in the
broader income-health spending linkage. Adjusted for income, urban and rural Chinese spend a roughly
identical amount on health care.
3 In total, tailwinds from income and aging suggest a tripling of the Chinese health-care market by 2022,
assuming the sort of 7% GDP growth embodied in consensus. Even under our more bearish “rebalancing”
GDP growth expectation of 5%, the health-care market would nonetheless more than double by 2022.
3 We expect public sources to foot a growing share of the bill for health spending. This trend is suggested
by the global data set, a multiyear trend in Chinese spending composition, and is explicitly targeted in its
12th Five-Year Plan.
4
Massive Economy, but a Fairly Modest Market for Health Care
China punches below its demographic and economic weight in terms of health-care spending.
China accounts for 19% of the global population. On a purchasing power parity, or PPP, basis, 14% of
global economic activity happens in China, close on the heels of the United States’ 18% share.1 But
China is only 7% of global health spending. Measured relative to the size of its economy, China spends
5.2% of its GDP on health care, well below the global average of 10.1%.
Measured in absolute terms, Chinese health spending clocks in at $583 billion (PPP) annually. That
ranks second globally, but it’s far behind the leader: the United States at $2.7 trillion. And it’s not much
more than the health spending of much smaller economies. Put in perspective, China’s market for
health products and services is roughly the same size as that of Germany ($357 billion) and France ($269
billion) combined, even though China’s economy is twice as large.
Exhibit 1: China Punches Below Its Demographic Weight in Heath Spending
Population
GDP (USD, PPP)
Health spending (USD, PPP)
Rank
Country
Millions
% share
Rank
Country
Billions
% share
Rank
Country
Billions
% share
1
China
1,344
19.3
1
United States
14,991
18.4
1
United States
2,677
32.7
2
India
1,221
17.5
2
China
11,301
13.9
2
China
583
7.1
3
United States
312
4.5
3
India
4,536
5.6
3
Japan
401
4.9
4
Indonesia
244
3.5
4
Japan
4,325
5.3
4
Germany
357
4.4
5
Brazil
197
2.8
5
Germany
3,227
4.0
5
France
269
3.3
6
Pakistan
176
2.5
6
Russia
3,204
3.9
6
United Kingdom
208
2.5
7
Nigeria
164
2.4
7
France
2,312
2.8
7
Brazil
204
2.5
8
Bangladesh
153
2.2
8
Brazil
2,291
2.8
8
Russia
199
2.4
9
Russia
143
2.1
9
United Kingdom
2,233
2.7
9
Italy
188
2.3
10
Japan
128
1.8
10
Italy
1,983
2.4
10
India
175
2.1
Source: United Nations Population Division, World Bank, World Health Organization, Morningstar analysis
Chinese Health Spending Will Grow Faster Than GDP in the Next Decade
China’s low health spending as a share of GDP is mainly a function of income level. As shown in the
exhibit below, which compares health spending’s share of GDP against GDP/capita, Chinese health
spending isn’t unusual after taking into account income. In fact, most middle income countries spend
a share of GDP on health care similar to what we see in China—around 4%–6%. Meanwhile, higher
income countries tend to spend a greater share of their incomes on health care—around 8%–12%.
The link between rising incomes and rising health-care share of GDP is rather robust. And with a few
notable exceptions, it’s very consistent.2
5
Exhibit 2: Health spending consumes a larger share of income as GDP rises
China
Other Countries
Health spending (% GDP)
20%
U.S.
Source: World Health Organization,
United Nations Population Division,
World Bank, Morningstar analysis
18
16
14
Note: Bubble size denotes population
12
10
8
6
4
2
0
10,000
GDP per capita, PPP (current international $)
20,000
30,000
40,000
0
50,000
Why do higher-income countries spend proportionately more on health care than their middle-income
counterparts? We’d suggest this is largely a function of the fact that richer countries have more income
available for discretionary consumption.3 And while a good deal of health care is decidedly nondiscretionary, past a certain point, health-care products and services are increasingly “elective” in nature: tied
more to “quality of life” than “quantity of life.” Indeed, the rising health spending share of GDP fits a
broader trend that accompanies economic growth: a rising services share of GDP.
Exhibit 3: Services Share of GDP Rises with Incomes Too
China
Other Countries
Services (% GDP)
80%
Source: United Nations Population
Division, World Bank, Morningstar
analysis
U.S.
70
60
50
40
30
20
10
0
10,000
20,000
30,000
40,000
50,000
Looking at how China’s health spending has evolved as incomes have risen suggests little reason to
believe China will break from the global trend as it scales the income ladder. As Chinese GDP has grown,
health care has claimed a bigger share of the pie. In 1995, the earliest year for which we have comparable figures on health spending, China was a decidedly lower middle-income country. Health spending
0
6
as a percentage of GDP was 3.2%. By 2011, the last year for which we have comparable figures on
health spending, Chinese GDP per capita had quadrupled to $8,408 on a PPP basis, placing China solidly in
upper-middle income territory. Health spending as a percentage of GDP has risen to 5.2%.
Exhibit 4: Chinese health spending has claimed rising share of GDP since 1995
China
Health spending (% GDP)
6.0
5.5
5.0
2011
4.5
4.0
3.5
3.0
2.5
1995
2.0
1.5
1.0
0.5
0
1,000
2,000
3,000
4,000
4,000
4,000
4,000
4,000
9,000
China’s Health-Care Market in 2022: Rising Incomes Suggest a Near-Tripling in Size
It therefore seems highly likely that Chinese health spending will claim a larger share of GDP as
incomes continue to rise, growing faster than the economy as a whole in the process. But how big
is the growth opportunity?
We can get a rough gauge of the China’s health-care market’s potential by overlaying a GDP growth
assumption against the “trend line” for health spending’s share of GDP implied by the international data
shown in Exhibit 2. In other words, we can simply push China along the trend line as incomes rise and
then work out how much it would spend on health care at any given point.
For example, 7% annual GDP growth (roughly equivalent to prevailing long-term consensus) in the 10
years to 2022 would boost Chinese GDP per capita to about $17,700 in current PPP terms. This would be
roughly double current levels. Assuming that the health spending share of GDP were to rise to slightly
above 6%, this implies health spending would reach $1.5 trillion in current PPP terms, about two and a
half times 2011 levels.4
0
7
Exhibit 5: Rising Incomes Imply Sharp Increase in Chinese Health Spending
Income effect
Health spending, USD billions PPP
3,000
2,500
2,000
1,500
1,000
500
United Kingdom
France
Germany
Japan
China
2011
China
2022
United States
0
Under more modest GDP growth assumptions incorporated in our rebalancing thesis5, which results in
a slightly lower point along the trend line (health spending grows to 5.7% of GDP), annual health
spending would nonetheless nearly double to about $1.2 trillion. The enormous growth China’s healthcare market would see even under this comparably bearish GDP outlook underlines the magnitude
of the opportunity. A doubling of China’s health spending would put its outlays on par with health-care
spending across the entire eurozone and about 3 times that of prevailing Japanese spending.
Owing to the rather strong relationship we observe between health spending and income levels
in the cross-country data set, we think this simple model for estimating future growth in Chinese health
spending is a reasonable one. But as with any long-term economic forecast, it’s clearly fraught with
uncertainty. At the most basic level, GDP growth is difficult to get right. And there are numerous factors
that could push Chinese health spending above or below the trend line for a given amount of GDP growth.
Will Demographic Tailwinds Drive Chinese Health Spending Higher Than “Normal”?
In fact, one might argue that big demographic trends could push China’s health spending above the trend
line in the decade to come. Over the next 10 years, China will grow older and more urban. Both developments are typically associated with strongly rising health spending.
But before we try to gauge the incremental impact of demographic change on China’s health spending,
a word of caution is warranted. While the foregoing exercise that focused on the linkage between
income and health spending did not directly address the impact of demographic change, in some ways it
did so indirectly.
That’s because rich countries tend to be older and more urban than poor countries. As a result,
movement along the trend line already accounts for a certain amount of aging and urbanization. It would
only be if China ages or urbanizes faster than normal for a country of its income level that these
demographic factors would push it above the trend line instead of merely along the trend line. (That’s
what we’ll evaluate next.)
8
China Isn’t “Old” Yet, but Will Age Rapidly
We begin by looking at age. At present, China isn’t very “old.” According to the 2010 census,
China has 113 million people aged 65 or older, a modest 8% of the country’s total population of 1.36
billion. But the size of that age group is set to swell significantly, to 187 million by 20256, pushing
the “senior share” of China’s population to 13%. Through 2022, China will add more seniors than will the
EU, U.S., Japan, Russia, and Brazil combined. China is at the vanguard of the broader global aging trend.
Exhibit 6: China’s Senior Population Will Double in Two Decades
Population (000s)
China’s senior population
250,000
Source: U.N. Population Division,
Morningstar analysis
200,000
150,000
100,000
50,000
1990
1995
2000
2005
2010
2015E
2020E
2025E
2030E
0
Exhibit 7: Top Seven Countries by Population 65+
2011
2022
Million persons
200
180
Source: U.N. Population Division,
160
140
120
100
80
60
40
20
China
EU
India
United
States
Japan
Russia
Brazil
0
9
China’s rapid aging unquestionably signals higher health spending in absolute terms, as health spending
is highest for individuals closer to end-of-life. But to determine whether this aging process will lift
health spending above what we typically observe for countries of China’s income level, we must assess
whether China is aging more rapidly than “normal” for its income level.
To answer that question, we’ll use a simple measure demographers call the old-age dependency ratio.7
The old-age dependency ratio tells us how many individuals past working age there are for each
person of working age. For international comparisons, working age is defined as 15–64. For the sake of
comparability, that’s the definition we’ll use here.
China’s old-age dependency ratio in 2011 was 11.6, meaning China had only 11.6 seniors per 100 workers.
As shown in Exhibit 8, that’s a fairly typical ratio for a country of China’s income level. This, in turn,
suggests we ought to observe a fairly “normal” health spending share of GDP—relative to countries of
similar income. And, of course, that’s exactly what we saw when we compared health spending and
GDP/capita.
Exhibit 8: Richer countries tend to be “older”
China
Other Countries
Old age dependency ratio
40
35
analysis
30
Note: Bubble size denotes population
25
U.S.
20
15
Turkey
10
Mexico
0
10,000
5
20,000
30,000
40,000
50,000
Fast forward to 2022 in the United Nations’ “medium fertility variant,” and China’s old-age dependency
ratio jumps to 17.8. By this measure of societal “age,” China would no longer be a spring chicken. And it
will have aged very quickly in a short period of time.
China’s rapidly rising old-age dependency ratio stems from both a low replenishment rate in the
working-age population (the denominator of the ratio) and a surge in the senior population (the numerator). The former effect is attributable to the One Child Policy, which, along with more “natural forces,”
sent Chinese fertility rates plummeting since 1980 and will mean far fewer individuals reaching working
age over the next decade than in the past decade. The result is a population age distribution with an
appearance some have described as akin to a “snake eating a water buffalo.”
0
10
Exhibit 9: A Snake Eating A Water Buffalo: China Population by Age Group
China’s population
Million persons
120
Source:National Bureau of Statistics,
100
80
60
40
20
0–4
5–9 10–14 15–19 20–24 25–29 30–34 35–39 40–44 45–49 50–54 55–59 60–64 65–69 70–74 75–79 80–84 85–89 90–94
95+
0
Getting Old Before it Gets Rich: China Will Be a “Gray” Middle-Income Country
To put the rather “dry” old-age dependency ratios in context, China’s current ratio is similar to that of
Japan in 1975 (11.6). By 2022, it will be slight above Japan’s in 1990 (17.1).8 Remarkably, China will have
covered as much demographic ground in 10 years as Japan did in 15 years.
Aging 33% faster than Japan did, it should come as little surprise that China would be aging far more
rapidly than countries of comparable income levels. Looking back at Exhibit 8, we can see that a 17.8
old-age dependency ratio would easily rank China the “oldest” of major middle-income countries.
Mexico, for example, has a GDP/capita of $16,013 (PPP) and a 9.5 old-age dependency ratio. Turkey,
another rung up the income ladder at $17,242/capita has a 10.8 old-age dependency ratio. Ten years from
now, China would be far older than these countries are today, but roughly just as rich.
Impact of Rapid Aging on China’s Health Spending
We think this strongly suggests China’s health spending share of GDP will exceed “typical” levels for a
middle-income country in the decade to come. In effect, this pushes China “above” the trend line
established in Exhibit 2. We estimate this would be worth about 1 percentage point of incremental GDP
share going to health care.
Adding this “aging” effect to the “income” effect on health spending and making no other adjustments
to our model would increase the estimated size of China’s 2022 health spending from $1.5 trillion to $1.7
trillion, assuming GDP growth approximates prevailing consensus.
11
Exhibit 10: Combined Income and Aging Effects Could Boost China’s Health Spending to $1.7 trillion
Aging effect
Income effect
Health spending, USD billions PPP
3,000
2,500
2,000
1,500
1,000
500
United Kingdom
France
Germany
Japan
China
2011
China
2022
United States
0
We arrive at that 1 percentage point estimate a couple ways. First, it seems reasonable in the
context of the international data set. A 1-percentage-point increase to the health spending share of GDP
at the $17,700/capita mark would push China’s health share of GDP from 6% to 7%. Although this
would put China at the higher end of health spending share of GDP at that income level, it wouldn’t be
“out of range.”
Second, we use morbidity statistics from China’s Ministry of Health to gauge how usage of the
health-care system varies with age. Morbidity in the context of Chinese public health statistics refers to
the number of health-care system users per 1,000 persons over a two-week period. A recent major
study conducted by the Ministry of Health, reproduced in Exhibit 11, found a two-week morbidity rate of
145 per 1,000 persons.
Looking at how morbidity changes with age gives us some sense of how health spending may change as
China ages. As expected, the morbidity rate among those aged 65 or older was the highest at 303,
equivalent to twice the average. More relevant to our discussion of the likely increase in Chinese health
spending over the next 10 years, the transition from the 55-64 bucket to the 65-plus bucket meant a 40%
increase in morbidity.
12
Exhibit 11: Seniors Use Healthcare System 40% More than 55–64 Year-Olds
Morbidity per 1,000 persons
(2 week period)
Morbidity rate
350
300
Source: China Ministry of Health,
250
200
150
100
50
Total Age
Group
0–4
5–14
15–24
25–34
35–44
45–54
55–64
0
65+
Overlaying these morbidity statistics against China’s age composition in 2022 ought to give us a
general sense of how health-care usage will change solely due to demographic effects. Exhibit 12 below
presents the results of this exercise. We estimate that Chinese health-care usage would rise 14.0%,
with a little more than two thirds of that increase attributable to aging of the population and a little less
than one third due to population growth.
Interestingly, while the increase in the 65 and older group has the single largest effect on health
usage (rising 34% to generate a 7.4 pp lift to the total), growing 45–54 and 55–64 groups are major
contributors too, delivering 3.5 pp and 6.0 pp lifts, respectively.
Exhibit 12: Population-Driven Healthcare Demand Growth: Contribution by Age Group
Contribution by age group
Percentage Points
8
Source: Morningstar analysis,
China Ministry of Health data
6
4
2
0
–2
0–4
5–14
15–24
25–34
35–44
45–54
55–64
65+
–4
13
Continued Urbanization Will Drive Health-Care Spending, but Not Beyond What Might Be Expected
for Income Level
Next, we look at another demographic mega-trend in China: the continued urbanization of the
population. With little more than half of its population technically classified as “urban,” China is roughly
as urbanized as we might expect given the typical relationship between urbanization and income level.
Exhibit 13: Richer countries tend to be more urban
China
Other Countries
Urban population (% total)
100
90
analysis
80
70
60
50
40
30
20
10
0
10,000
20,000
30,000
40,000
0
50,000
Setting aside the worthwhile debate on whether the official figure accurately reflects China’s “true”
level of urbanization as well as the question of causation, it seems reasonable to expect China
will continue to urbanize as its income levels rise.9 Not only is further urbanization strongly implied by the
global data set (richer countries tend to be more urban), but it’s also a stated policy of Beijing. The
government aims to add roughly 250 million people to the urban rolls by 2025, which would make China
roughly 68% urban by that time. This would be accomplished by a mix of migration, new births, and
reclassification. The U.N. Population Division’s medium fertility variant, reproduced below, expects a 65%
urban share by 2025.
Exhibit 14: China’s Urban Population Should Continue to Grow
Urban
Rural
Urban share (%)
Source: United Nations Population Division,
Million persons
% total population
1,600
70
1,400
60
1,200
50
1,000
40
800
30
600
20
400
10
200
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024
0
14
As tends to be the case in most countries, on average, China’s urban residents spend more on health
care than their rural counterparts. Data from China’s National Bureau of Statistics puts the urban-rural
health spending ratio at more than two-to-one: $231 versus $105 per capita (in PPP terms).10
But this does not mean urbanization should be considered a distinct health spending tailwind, above
and beyond income and aging. Although China’s urbanization is clearly a positive for health spending,
we suspect the boost to spending would come mainly from the fact that urban residents are richer than
rural residents.
That’s because, after we adjust for income, there seems to be little difference in health spending
between China’s city- and country-dwellers. If, instead of comparing the “average” rural resident (income
of $1,667/capita) to the “average” urban resident ($5,210/capita), we were to compare him with an urban
resident of comparable income, the difference in health spending almost vanishes. The typical urban
resident making as roughly the same money as the average rural resident (represented by the bottom
urban income decile with income of $1,643/capita) spends $116 annually on health care.
Exhibit 15: Adjusted for income, urban health spending is equivalent to rural health spending
Left axis
Disposable Income
USD,PPP
USD,PPP
500
15,000
Right axis
Cash expenditures on
health care
400
10,000
300
Source: National Bureau of Statistics,
200
5,000
100
0 Urban resident
(average)
Rural resident
(average)
Urban resident
(bottom income decile)
Urban resident
(top income decile)
0
This suggests urbanization is unlikely to provide any special lift to health spending above and beyond
that associated with rising incomes. Bringing it back to our basic framework, China’s continued urbanization implies movement along the trend line defined by the income-health spending relationship, as
opposed to movement above the trend line. As such, we make no additional adjustment to our estimate
to account for urbanization.
Public Outlays Likely to Drive Majority of China’s Health Spending Growth
Our forecast of a threefold increase in Chinese health spending by 2022 that would far outstrip
overall economic growth begs the question: who will pay for it? If China follows the path set by wealthier
countries, it’s highly likely public sources will largely foot the bill. As shown in Exhibit 16, private health
15
spending tends to be around 2%–4% of GDP regardless of income level.11 This implies private spending
on health care grows more-or-line with household incomes.12 By contrast, public health spending tends to
grow at a faster pace than incomes. It is public health spending that typically drives the “GDP-plus”
growth of overall health spending.
Exhibit 16: Private health spending tends to consume consistent share of GDP
China
Other Countries
Health spending, private (% GDP)
20
18
16
14
12
10
8
6
4
2
0
10,000
20,000
30,000
40,000
50,000
0
Exhibit 17: Growing public health spending drives overall increase in health spending
China
Other Countries
Health spending, public (% GDP)
20
18
16
14
12
10
8
6
4
2
0
10,000
20,000
30,000
40,000
50,000
For countries of China’s income level, public health spending accounts for about half of total health
spending.13 China is roughly in line with the average: public health spending is 56% of total health
spending. We might reasonably expect this share to grow to around 65% by 2022, assuming a doubling
of Chinese GDP per capita over this interval.
0
16
Exhibit 18: Public share of health spending rises with incomes
China
Other Countries
Health spending, public (% total)
100
90
80
70
60
50
40
30
20
10
0
10,000
20,000
30,000
40,000
50,000
60,000
0
A review of Chinese health spending reveals no reason to believe China will meaningfully deviate
from the global trend. As shown in Exhibit 19, since 1995, public health spending has steadily risen as a
share of GDP amid increasing GDP/capita: from 1.8% in 1995 to 2.9% in 2011. Meanwhile, private
spending on health care isn’t materially higher as a share of GDP than it was in 1995. Government policy
suggests this trend is likely to persist. In particular, the 12th Five-Year Plan makes strengthening
the public health-care system a policy priority and lays out the objective of limiting out-of-pocket
private spending.
Exhibit 19: Rising Public Outlays Have Led Overall Increase in China's Health Spending
Private
Public
Total
Health expenditure (% GDP)
6
5
World Bank, Morningstar
4
3
2
2011
1995
0
1,000
2,000
3,000
1
4,000
5,000
6,000
7,000
8,000
9,000
0
17
Private health spending’s falling share of GDP over the past decade—from 3.1% in 2002 to 2.3% in
2011—is noteworthy as it mirrored a broader trend in Chinese household consumption over the
period. As the boom in infrastructure and real estate came to dominate economic activity, household
consumption declined from 44% of GDP in 2002 to 34% in 2011. The declining household consumption
share reflected both a decline in the household income share of GDP and an increase in household
savings rates.
If, as we expect, Chinese households are likely to enjoy a rising share of GDP amid a rebalancing from
the investment-led growth that defined the past decade, the recent trend of falling private health
spending share of GDP seems likely to reverse. A transition from labor surpluses to labor deficits ought to
put upward pressure on wages, which, for the past decade, mostly lagged advances in worker productivity. Meanwhile, the expansion of China’s modestly sized service sector also augurs a higher household
income share of GDP, as the “labor content” of services is higher than that of industry.
Exhibit 20: Falling Private Health Spending Share of GDP Reflected Broader Decline of Consumption Share of GDP
Household consumption
Gross capital formation
% of GDP
60
Source: World Bank, Morningstar
50
1995
40
2011
30
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
20
Rising Incomes and Aging Population Will Make China a Top Growth Market for Health Care
Rising incomes and a rapidly aging population ought to generate rapid growth in China’s health spending
in the next decade. Not only do we expect health care will claim a larger share of China’s economic
pie, but Chinese health-care spending is likely to dramatically rise in relative importance for the global
health-care sector.
The opportunity is partly obscured by China’s comparably modest health-care market. While China is
the world’s second-largest health spender in purchasing power parity terms, it ranks far behind the U.S.
and doesn’t spend much more on health care than much smaller economies. Looking ahead, while
we do not expect China’s health spending to surpass that of the United States in the next 10 years, we
believe China will rank an increasingly dominant No. 2.
18
Just as important for investors, we also anticipate China will be, along with the United States, the
biggest growth market over this period—in terms of its incremental demand for health-care products and
services. Assuming prevailing consensus GDP forecasts, we anticipate China’s health-care market
would grow by about $1.1 trillion through 2022. This incremental demand would be roughly equivalent to
the total current spending of the next four largest health-care markets combined: Japan, Germany,
France, and the U.K.
China’s Health-Care Demand Growth Trajectory Puts That of Fellow BRICs in the Shade
In our view, the potential far exceeds that of China’s fellow BRICs, a differential tied to China’s
unmatched mix of demographic heft, aging population, and income level. While India’s population is just
as large (and would surpass China by 2028 in the U.N.’s medium fertility population forecast), it’s far
younger and far poorer. Russia and Brazil are both wealthier on a per capita basis, but their combined
populations are only 25% of China’s. And while both are older than China, they’re not aging as rapidly,
with more modest increases to the old-age dependency ratio.
Using the same income-aging model to extrapolate health spending for India, Russia, and Brazil and
making what we believe to be fairly non-contentious GDP growth assumptions14, we estimate the
collective incremental spending growth of these three countries to be 50% that of China’s incremental
growth. As far as the health-care opportunity is concerned, only one BRIC truly merits its capital letter. K
Endnotes:
1 PPP measures somewhat flatter the size of China’s economy. Using market exchange rates, China’s economy is 10% of the world total versus the United States at 21%.
2 Exceptions to the usual relationship are instructive. The United States spends 18% of GDP on health care, considerably more than what
we might expect given the usual relationship between health spending and income. African countries with high incidence of HIV also spend
substantially more on health than might otherwise be expected given their income level.
3 Some might be attributable to the higher prevalence of non-communicable diseases in wealthier countries: diabetes and heart disease,
for instance.
4 Countries with incomes between $15,000 and $20,000 spend a weighted average of 6.1% of GDP on health care.
5 See “China’s Rebalancing Act,” Morningstar Basic Materials Observer, August 2013.
6 On its way past 300 million in the late 2030s according to the U.N.’s Population Division. The U.N. Population Division produces multiple sets of population forecasts that make different assumptions pertaining to fertility, mortality, and immigration. For the purposes of our analysis, we’ve used the “medium fertility” variant. But through 2025, there is no difference in old age dependency ratio among the scenarios as all individuals of working age population by 2025 have already been born.
7 We’re excluding children from the discussion mainly because 1) they don’t work and 2) other than the very young, they don’t consume as much health care.
8 And like Japan of 1990, China of 2022 will be sitting on the verge of major additional societal aging. But China will be quite a bit poorer than Japan of 1990.
9 Because there’s no standard definition of what constitutes “urban,” cross-country analysis needs to be conducted with an abundance of caution. We’ve previously argued that China’s official figure seriously understates the percentage of the population living in urban areas owing to an
unusually strict population density hurdle to achieve urban classification. Additionally, many suggest large swaths of China’s hard-to-measure urban migrant population continue to be misclassified as “rural” despite living more than half the year in urban areas. The underestimated figure has been pegged as high as 100 million, which would add 7 percentage points to China’s official figure.
10 These figures refer to private outlays on health care and would not include government-paid health care, for example.
11 Private health expenditure includes direct household (out-of-pocket) spending, private insurance, charitable donations, and direct service payments by private corporations.
12 Once again, the United States is a notable exception, with private health spending consuming nearly 10% of GDP.
13 Public health expenditure consists of recurrent and capital spending from government (central and local) budgets, external borrowings and grants (including donations from international agencies and nongovernmental organizations), and social (or compulsory) health insurance funds.
14 We assume 6.5% for India, 3.5% for Russia, and 4% for Brazil. The IMF’s World Economic Outlook assumes average growth rates of 6.5%, 3.6%, and 4%, respectively, through 2018.
19
Exhibit 21: Population, Economy, and Health Spending Statistics
Year
China
Brazil
Russia
India
United States
2012
1,351
199
144
1,237
314
2022
1,383
214
139
1,379
340
2012
699
169
106
392
259
2022
868
186
106
494
288
2012
651
30
37
845
55
2022
516
27
34
886
52
2012
243
49
22
364
62
2022
247
44
24
359
65
2012
991
135
103
808
209
2022
964
148
93
928
216
2012
117
15
19
64
43
Population (millions)
Total
Urban population
Rural population
Ages 0–14
Ages 15–64
Ages 65+
Total dependency ratio
Old age dependency ratio
Child dependency ratio
Fertility rate
2022
172
22
22
92
59
2012
36.4
46.8
39.7
53.0
49.8
2022
43.5
44.3
48.9
48.6
57.4
2012
11.8
10.7
18.1
7.9
20.4
2022
17.8
14.8
23.2
9.9
27.3
2012
24.5
36.1
21.6
45.0
29.4
2022
25.6
29.4
25.8
38.7
30.0
2011
1.58
1.81
1.54
2.59
1.89
2022
1.53
1.66
1.67
2.26
2.08
2012
12,471
2,366
3,373
4,793
15,685
2022
24,532
3,502
4,758
8,998
20,473
Economy
GDP ($PPP, billions)
GDP/capita ($PPP)
CAGR
7.0%
4.0%
3.5%
6.5%
2.7%
2012
9,233
11,909
23,501
3,876
49,965
2022
17,732
16,390
34,185
6,523
60,238
2011
583
204
199
175
2,677
2022
1,732
333
357
450
4,121
2011
432
1,026
1,384
142
8,527
2022
1,252
1,557
2,564
326
12,124
2011
5.2%
8.9%
6.2%
3.9%
17.9%
2022
7.1%
9.5%
7.5%
5.0%
20.1%
Healthcare
Health spending ($PPP billions)
Health spending per capita ($PPP)
Health spending as % GDP
Source: World Bank, Morningstar estimates
20
Medical Technology Market in China:
Awakening Giant and Emerging Dragon
by Debbie S. Wang
Against the backdrop of growing health-care spending in China, we take a closer look at the $21 billion
Chinese medical technology market—already the second-largest after the United States. As many moaty
multinational med-tech companies venture into the Chinese market, we think investors should appreciate
both the immense potential of the market, as well as the challenges and risks that med-tech moats face.
Large, Fragmented Field
There are an estimated 11,000–12,000 domestic medical technology companies in China, fueling
15%–20% annual growth in this med-tech market. Up until recently, local med-tech companies
have concentrated on manufacturing low-tech and disposable devices, but we now see them making
inroads with more technologically advanced and higher-risk implantable devices. We expect Chinese
companies to continue moving up the value chain thanks to government emphasis on the development
of the native med-tech industry. The central government has specifically called out med-tech as a key
area for increased expertise and growth. Consistent with this mandate, China has made substantial
progress in the last decade toward reaching global manufacturing standards for medical devices. More
and more facilities are ISO 13485-certified, which means they have demonstrated the ability to produce
medical devices that consistently meet customer and regulatory requirements. By no means have all the
quality issues been resolved, but China is on the path toward global standards. We think this will be
helped along as more Chinese device makers set their sights on exporting these higher-value products
outside of China, and Western-trained ethnic Chinese return to China to set up shop.
We anticipate there will be robust growth in cardiology, orthopedics, and neurology. Historically
infectious disease and infant mortality were the largest public health concerns. Thanks to the aging
population, high smoking rates, lifestyles that are more sedentary, and pollution, we have seen a shift in
the disease burden in China. Cardiovascular disease and cancer have grown more prominent.
Exhibit 22: Disease Burden in China
Cause of Death %
Cerebrovascular disease
18
Chronic obstructive pulmonary disease
14
Ischemic heart disease
8
Stomach cancer
5
Liver cancer
4
Lung cancer
4
Perinatal conditions
3
Tuberculosis
3
Lower repiratory infections
3
Source: Ministry of Health, Centers for Disease Control 2010
21
Moreover, there is pent-up demand for these treatment options and devices because the technology was
not accessible until relatively recently. First, there were few physicians and hospitals with the training
and expertise to do large joint replacements or implant coronary stents. Second, there were few patients
who could afford these interventions on an out-of-pocket basis. China has now reached a point where we
see a window that is extremely favorable for the spread of med-tech. On the demand side, we think
patients are increasingly interested in spending on health now that insurance has spread to cover more
people, rising incomes can better absorb out-of-pocket expenses, and there are heightened consumer
expectations for quality. On the supply side, more doctors have been trained to perform these procedures
and more hospitals now offer them.
Exhibit 23: Spread of Angioplasty in China
Number of Hospitals offering PCI
Number of Angioplasty procedures
1996
2001
2007
2010
51
200
1078
870
6,200
16,345
147,300
290,000
Source: Chinese Society of Cardiology
Angioplasty and the use of coronary stents remained extremely small for the first decade after
the procedure was made available in China (1986–96). However, it has grown tremendously in the last
decade, especially after the introduction of drug-eluting stents in 2003. We think there is still plenty
of runway left for drug-eluting stents in China--an estimated 230 million Chinese suffer from cardiovascular disease.
Regulation Remains More Uncertain in China
While the Chinese regulatory process for medical devices is similar to that in the U.S., the regulatory
landscape still changes with some frequency as the Chinese Food and Drug Administration (or CFDA,
formerly known as the State Food and Drug Administration, or SFDA) makes modifications along the way
to address new dynamics in the growing medical technology industry.
Fortunately, there is some consistency in how the CFDA and the U.S. Food and Drug Administration
classify medical devices. Both agencies put them into Class I, II, and III buckets, depending on how
invasive and risky the device is. Lower-tech, disposable devices (for example, thermometers, eyeglass
frames, and tongue depressors) that are not intended to support or sustain life are subject to the lightest
regulation. Chinese medical device companies have mainly focused on manufacturing these types of
products in the past. Class II devices, which include infusion pumps, ceramic dental restorations, and
trocars, are subject to mandatory performance requirements, but typically do not need to submit clinical
trial data before approval. Class III devices encompass implantable pacemakers, heart valve replacements, and coronary stents and are the most tightly regulated.
Unfortunately, China’s regulatory process is not completely centralized, and manufacturers may need to
apply to other governmental bodies for clearance. Lower-risk lower-tech products may need to seek
22
provincial or municipal approval, resulting in the need for additional resources to gain approval
through a patchwork of geographies. So far, Class III devices have not run into any particular pitfalls with
the CFDA. We think this is because most of these higher-risk, sophisticated products are produced by
multinationals that have already met developed-world regulatory standards.
However, the main complaint by multinationals is that the CFDA approval process is very slow.
The current state of events was driven by the exposure of flagrant corruption at the SFDA in 2007. That is
when it was discovered that Zheng Xiaoyu, former head of the SFDA, had taken $850,000 in bribes
from eight large companies to approve drugs, including six that were fake. In the wake of this scandal
(and Zheng’s execution), the level of regulation and scrutiny of applications has risen significantly,
slowing down the process. Even though the CFDA regulations state that the approval time frame
for clinical studies is 60–90 days, it usually takes about 12 months to secure approval before moving
into trials.
Another difference between the CFDA and the FDA is the former’s emphasis on clinical trial stage.
The biggest hurdle at the CFDA is getting approval for the clinical trial. It is at this stage that the CFDA
does a very slow and detailed examination of the application. Once trial approval is secured, regulation
becomes much lighter, and product marketing approval and production can happen faster and with
less scrutiny. This stands in direct contrast with the FDA, where it is relatively easy to gain approval on
the trial design, but much tougher to withstand the closer examination of the product’s safety and
efficacy to determine marketing approval.
We do not see any shifts on the horizon that would cut down this waiting time for multinational companies. If anything, we think new proposals at the CFDA could leave multinationals at a disadvantage when
it comes to the time frame for trial approval. The CFDA is drafting guidelines to create an accelerated
review process for domestic device companies. This change is in keeping with the central government’s
goal of developing national competency in medical technology, according to the current Five-Year Plan.
Multinational device companies and their investors should be prepared for more political changes of this
ilk that will further tilt the playing field in favor of local Chinese device firms.
Nevertheless, the sheer size of this market, along with its robust growth potential, has led most of the
multinational med-tech firms to set up shop in China, though the level of investment has varied. Some
firms, including Medtronic, Abbott, and General Electric, see China as a strategic priority and invested
heavily to put down roots there. On the other hand, Edwards EW and CR Bard BCR have invested far less
extensively in China and do not seem to view penetration of this market as a corporate priority.
Overall, we think greater presence and investment in China translates into greater familiarity with
regulatory agencies, distributors, and customers that can pay off in many ways. For example, if a foreign
firm has already made it through the lengthy regulatory gauntlet at the CFDA to commercialize a product
in China, it becomes far easier to go through that process again with additional products (even unrelated
ones) because the firm has established a track record with the government.
23
Exhibit 24: Multinational Med-Tech Companies in China
Medical Equipment/ Device
Firms in China
Key Products in China
Sophistication of Timing of
Technology
China Entry
Local Partners
Investments in China
Abbott
Coronary and
endovascular
High
Very early
None in medical devices
Device training center in Shanghai; Manufacturing facility for
vision care products (for export)
>$650mm
Becton Dickinson
Safety sharps,
diabetes care
Low-Mid
Very early
None
Manufacturing and R&D
facility in Suzhou since 1995,
3000 employees
<$800mm
Boston Scientific
Drug-eluting stents,
endscopy, cardiac
rhythm management
High
Late
None
R&D center in Shanghai
>$200mm
CR Bard
Vascular, urology,
oncology
Mid-High
Late
None
None
Coloplast
Ostomy, wound care
Mid-High
Early
None
Major manufacturing facility in
Zhuhai (for export); Training center
in Shanghai
Covidien
Endomechanical,
Mid-High
energy, vascular, airway
& vent, pulse oximetry
Mid
None* (looking aggressively into
local distributors)
R&D and Technology center
in Shanghai
Edwards Lifesciences
Surgical heart valves
Mid
None
None
Johnson & Johnson
Orthopedics, neurovas- Mid-High
cular surgery, vision
care, diabetes care,
infection prevention,
diagnostics, cardiovascular disease, sports
medicine, and aesthetics
Early
Acquired Guangzhou Bioseal
Biotech
R&D center in Suzhou
Medtronic
Spine, trauma,
Mid-High
cardiac rhythm management, vascular
Early
Acquired China Kanghui; prior
minority investments in Shandong
Weigao, and previous distribution
JV with Shandong Weigao
R&D center in Shanghai; Patient
Care Center in Beijing; Pacemaker manufacturing facilities in
Shanghai
$664mm
Mindray
Patient monitoring and Mid-tier
life support, in-vitro
diagnostics, ultrasound
systems (black/white
and color), digital
radiography, orthopedics,
endoscope devices
Early
Acquired Dragonbio, Shenke,
Hyssen
Global HQ in Shenzhen, R&D centers in Beijing, Chengdu, Nanjing,
Shangahi, Xi'an
$473mm
St. Jude Medical
Surgical heart valves,
High
cardiac rhythm management
Late
None
Training center in Beijing
Smith & Nephew
Coronary and
endovascular
High
Early
None
Wound management manufacturing facility in Suzhou (for export)
$150mm
Stryker
Trauma, spine,
reconstructive
Mid-tier
Late
Acquired Trauson
Manufacturing facility in Suzhou
$279mm
Zimmer
Reconstructive, surgical Mid-tier
instruments
Late
Acquired Beijing Montagne
R&D and manufacturing center
in Beijing
$120mm
Source: Company filings. Morningstar estimates
*Medical device/equipment revenue only
High
2012 Estimated
China Revenue*
>$90mm
$72mm
$300mm
$70mm
>$450mm
> $115mm
24
For those multinationals that would like to create a footprint on the ground, setting up a training center is
a natural first step. This allows the firm to begin building relationships with the practitioners, which is
part of what creates a med-tech moat. It also helps the firm influence the supply side of the health-care
equation by increasing the number of physicians and nurses who are trained to use their products. Some
multinationals go a step further by locating R&D centers in China, thereby taking advantage of the robust
pool of talented scientists in the country. This also means these firms can tap into local market knowledge to help tailor and innovate the products to address local needs.
A few very determined multinationals have actually built manufacturing facilities in China, despite the
risk of intellectual property leaking out. Thus far, most of these facilities manufacture lower-tech
products, such as Coloplast COLO.B and Smith & Nephew’s SNN wound management items. Medtronic
was one of the earliest when it opened a pacemaker manufacturing line in Shanghai back in 1996. As
multinationals contemplate the real risk of protecting intellectual property and trade secrets against the
prospect of lower manufacturing costs and more opportunities to penetrate the Chinese market, we
expect more firms will migrate more resources to China over time. If China can demonstrate that it is
strengthening its protection of IP, this shift could happen more quickly. We note that some med-tech firms
have taken a slightly different approach to putting down roots in China through joint ventures or outright
acquisition. In the past, Medtronic had formed a joint venture with Shandong Weigao Medical Group,
which makes trauma and spinal products. Singapore-based Biosensors did the same with Shandong
Weigao to make drug-eluting stents. For various reasons, both Medtronic and Biosensors have ended
those JV arrangements. Acquisition of Chinese orthopedic firms seems to be in vogue now, with
Medtronic, Stryker, and Zimmer all making purchases in the last three years. We think this model holds
more potential (we discuss this in detail starting on Page 40 ).
The Reimbursement Picture is Mixed
Accessibility to health care in China has improved greatly over the last few years. Thanks to historic
and comprehensive health care reform that was rolled out in 2009, nearly 95% of Chinese citizens now
have basic medical coverage under some sort of health insurance scheme (and many receive subsidies
to pay for coverage). One major goal of the reform was to lessen the disparity between urban and rural
residents’ access to care. The introduction of these new schemes has helped address that gap.
Exhibit 25: Population Covered by Insurance
2003
2011
Urban residents
55%
89%
Rural residents
21%
98%
Source: Ministry of Health
25
This new coverage whetted patient appetites for more and better health care services. It has
allowed them to receive care for ailments that they might have simply ignored in the past. Nonetheless,
we note that the coverage is many miles wide, but only an inch deep, at this point. For example,
the New Rural Cooperative Medical Scheme that covers the rural population provides reimbursement
only for 20 selected diseases at this point, including lung and stomach cancer, heart attack, and cleft
palate. The government’s goal is to gradually evolve to more comprehensive coverage, and has launched
a number of disease “pilots” to investigate the cost and benefits of reimbursement for breast cancer,
end-stage renal failure, and HIV/AIDS. Capitation on reimbursement remains fairly low at CNY 200, which
translates into $48 in purchasing power parity. We note that coverage provided to urban employees and
government workers through long-standing insurance programs tends to offer more expansive and
generous benefits. We think China has definitely made considerable progress toward spreading a wide
insurance net and reducing the gap between urban and rural residents. But, it will likely be a number of
years before the depth of coverage for rural residents is comparable with what urban employees enjoy,
and benefits are beefed up to provide a real safety net.
Another change in reimbursement that we view positively for med-tech companies is the government’s
intention to keep the proportion of out-of-pocket spending at roughly 30% of total health-care outlays
over the longer run. This is a marked change from 10 years ago when out-of-pocket spending accounted
for more than 50% of total health-care spending. Meeting this objective will necessitate increasing
government-funded health care spending through the midterm. Even as health-care inflation may cause
total spending to rise faster than GDP, targeting out-of-pocket outlays at 30% should help the accessibility and affordability issue for Chinese patients. Private insurance remains an option for more affluent
consumers to plug the gaps that go beyond basic medical insurance.
While we think growth in demand is a favorable harbinger for med-tech, we are less optimistic about
government reimbursement policies, which can change at the drop of a hat. In particular, we anticipate
the government’s concern about holding down total health-care spending will result in reimbursement
and procurement policies that are disadvantageous to multinational firms. We have already seen some of
these policies take shape. For example, hospitals are now limited to two suppliers for any type of
device—one domestic, and the other can be foreign. Multinational device makers are now subject to
tendering processes for virtually all types of products. Even winning the tender may not necessarily be
positive. If actual volume used falls below the units outlined in the original bid, the supplier has very little
recourse and must provide fewer units than expected at the cited price, which can hurt profitability. In
some cases, the government has instituted price ceilings on certain procedures that make it more
economically attractive for hospitals to use products from local suppliers. This means multinationals
must often rely on affluent patients to cover the excess device cost through out-of-pocket payment.
In 2005, the government also implemented a purchasing review process for large-ticket equipment,
including robotic surgical systems and gamma knives. This process is similar to what the U.K.’s National
Institute for Health and Care Excellence, or NICE, does when it reviews new technologies for its costs
and benefits. This amounts to another hurdle that multinationals face as they attempt to penetrate China
with innovative med-tech. As long as multinational firms offer devices at a substantial premium to local
26
competitors, we think the government will pull any available levers to apply pricing pressure and slow
the growth of health-care spending.
Health-Care Provider System: On Balance, Favorable for Med-Tech
The provider system in China remains motivated to use more med-tech, which bodes well for the
multinationals. On the whole, we think the tangled factors that have created this incentive system will be
quite difficult to unwind and may require a wholesale reinvention of the financing of health care,
which is unlikely in the midterm.
As China made its move to a market economy over the last 30 years, the former state-supported provider
system, which focused on primary care and geographical reach, withered. As a result most of China’s
provider resources are concentrated in hospitals and in the urban areas, though health-care reform
efforts have managed to redirect some resources to less urban areas most recently. The critical turning
point came when public hospitals were expected to be economically self-sufficient. This, coupled with a
fee-for-service framework, greased the skids for the current incentive system where most procedures and
services are reimbursed at low levels. To compensate, hospitals and doctors rely on selling high-margin
drugs and medical devices. This activity enhances both hospital profitability, as well as doctors’ incomes.
This has led to documented overprescription of antibiotics, injections, and corticosteroids in China. The
government has countered with its Essential Drug List, which puts price controls on key commonly used
or high-health benefit drugs to keep them affordable to the general public. There is the distinct possibility
that the government might institute similar measures for medical devices in the future. In the meantime,
physicians continue to press the use of certain drugs and devices for economic gain. These financial
incentives are also conducive to crossing the line into corruption, including kickbacks and bribes by
multinational firms. Please see page 27 for our perspective on recent Chinese crackdowns on corruption
by multinational pharma companies and the implications for med-tech.
China’s current provider system remains heavily based in state-funded public hospitals, though we expect
some care to migrate into lower-acuity settings—more health clinics, more primary care on an
outpatient basis, more care outside large urban areas. The best-funded and best-staffed institutions
remain the Class III hospitals, which are located in the largest urban areas. These hospitals attracted the
better-trained physicians, allow them to practice more sophisticated medicine, have the leading-edge
technology available, and are more prestigious partly because they tend to be more research-oriented.
Not surprisingly, patients have a strong preference for the Class III hospitals based on perceptions
of high-quality care. Class II hospitals are located in less-urban markets, tend to be smaller, have fewer
resources, and less access to technology and highly trained staff. Class I hospitals in the rural areas lag
even farther behind.
27
Exhibit 26: Growth in Hospitals
2005
2006
2007
2008
2009
2010
2011
June 2013
1,692
Class III
946
1,045
1,182
1,192
1,233
1,284
1,399
Class II
5,156
5,151
6,608
6,780
6,523
6,472
6,468
6,626
Class I
2,714
2,738
4,685
4,989
5,110
5,271
5,636
6,173
Source: Ministry of Health
Through reform efforts, the state has attempted to shift both supply and demand to Class II and I
hospitals. Despite some success in moving supply to these hospitals, patients continue to prefer the
Class III hospitals, especially now that most Chinese have some health insurance coverage. Changing
patient perceptions and behavior will take time. The government has indicated it would like to see
private hospitals increase in order to help the provider system meet growing demand. However, we are
somewhat skeptical that this can happen in the absence of changes to reimbursement policies. Currently,
close to 90% of patient volume is handled through public hospitals. Private hospitals exist in a smaller
niche where one segment specializes in traditional Chinese medicine, another segment mainly cater to
the Western ex-patriate community, or provide specialty care. One key obstacle that keeps the private
hospitals from expanding is current reimbursement policy that prevents state reimbursement to private
hospitals for any procedures or services. This would be the equivalent of withholding all Medicare
reimbursement from private hospitals in the U.S. Thus, most Chinese private hospitals rely on patients
with private insurance or sufficient wealth to cover charges out-of-pocket. Even as the government lifts
restrictions that limit foreign ownership and streamlines the approval process for foreign-funded
hospitals, we think the current reimbursement issue will slow down the development of this segment.
Nonetheless, the existing number of public hospitals and the volume of patients they care for still offer
very attractive growth prospects for med-tech firms as physicians and patients seek to access technologies that have, until recently, been unavailable to most Chinese people.
by Damien Conover &
John Zecy
Risk of Corruption in China: Lessons From Pharmaceuticals
While investors should remain cognizant of the potential for corruption allegations in China’s medical
device market, we do not believe these issues will have a structural impact on the market’s long-term
opportunities.
Fair warning to investors
Before taking a position in China’s medical device market, we think investors should take notice
of corruption allegations in China’s pharmaceutical market that are gradually shedding light on similar
practices in medical devices, namely bribery. The nation’s large network of state-run hospitals must
survive on skimpy reimbursement for medical services, and salaried doctors are not compensated well
compared with their Western peers. Salaries are set to the pay scale of government work, and even
doctors with 10 years of experience earn around CNY 10,000 a month (about $20,000 a year) in Beijing15.
To compensate for the bare-bones reimbursement on services, hospitals, and doctors rely on selling drugs
28
and medical devices, which are typically acquired at wholesale prices and then marked up substantially
to patients. Although these practices are legal and aboveboard, they also have cultivated an environment
that is conducive to kickbacks and outright bribery. Bribery has consequently become a means of survival
for state-backed physicians and hospitals that must contend with the government’s suppression of
medical costs for its citizens. Furthermore, competition among pharmaceutical and device firms makes
the ground for corruption even more fertile as companies try to penetrate the market through acts
of paid education that borderline on bribery, including direct payments and travel vouchers. In some
cases, firms tap their regional sales networks to pay kickbacks to doctors for using and prescribing their
products. This also typically involves some sort of price fixing, giving the firm an upper hand and inflating
prices for consumers.
China’s current regulatory framework is also partly to blame. The purchasing process for pharmaceuticals and devices can prove cumbersome given the restrictive list of medicines covered by the
national insurance system and provincial red tape for market introduction. While the process for essential
medicine in primary care facilities is centralized, the tendering process for medicine outside this scope is
fragmented and can leave room for illicit markups despite government regulated prices. Oversight
of these transactions is not as formalized and creates hurdles for the tendering process, particularly in
medical devices with regulation occurring at different bureaucratic levels and standards.16
Regulatory issues in China’s health-care industry first surfaced in 2008 in the nutritional
market. Six infants fell victim to tainted domestic baby formula and spurred consumer preference for
foreign brands that were viewed as safer. As foreign formula began to consequently dominate the
market, the National Development and Reform Commission, or NDRC, accused foreign manufacturers of
gouging prices and issued fines to six firms (Mead Johnson, Danone, Biostime, Abbott, FrieslandCampina,
and Fonterra) totaling $108 million for anti-competitive pricing tactics. When coupled with detected
corruption in China’s pharmaceutical industry, increased price scrutiny in the nation’s health-care system
has become increasingly warranted, and the government’s crosshairs seem to be set on foreign firms.
Patterns emerging in Chinese regulatory oversight as markets grow. As the need for
health care in China expands and specific industries grow in size, government oversight seems to follow
as issues of pricing and illicit trade practices come to light. China’s burgeoning market for pharmaceuticals (valued at more than $60 billion) serves as the greatest example where at least five cases have
been brought against industry titans including Eli Lilly LLY, GlaxoSmithKline GSK, Novartis NVS, Pfizer
PFE, and Sanofi SNY, all within a two-month timeframe (July–August 2013). As noted in Figure 1, most
cases involved forms of bribery or kickbacks where sales representatives where directed to make
payments to hospitals or doctors to influence drug prescriptions, often resulting in higher prices. Chinese
authorities seem to be on a warpath to crack down on such practices, and medical device firms are
starting to feel the heat.
29
Exhibit 27: Big Pharma Brushes with Corruption Investigations
Company
2012 Chinese Manufacturing
Sales ($million)
Facilities
R&D
Facilities
Corruption Allegations
Date
Eli Lilly
Does not
disclose
2
2
Allegedly used about $5 million to bribe doctors in China, offering kickbacks
to ensure doctors used its drugs, including its insulin brand.
August 2013
GlaxoSmithKline
1,150
6
1
Accused of bribing doctors, hospitals and government officials in an effort
to sell more drugs at higher prices.
July 2013
Novartis AG
Does not
disclose
3
1
An employee offered money to doctors to boost sales of its drugs, a practice that
led to higher pharmaceutical prices for consumers.
August 2013
Pfizer
Does not
disclose
4
2
Bribed doctors employed by Chinese government healthcare institutions
to influence the prescription of Pfizer products between 2003 and 2007.
August 2012
Sanofi SA
1,280
6
1
Paid bribes of about $276,000 to a number of doctors and hospitals in Beijing,
Shanghai, Guangzhou and Hangzhou in late 2007.
August 2013
Source: Wall Street Journal, Company Filings
According to media reports, the Commerce Ministry’s anti-monopoly bureau is probing China’s medical
device market (valued at $20 billion) with unusually extensive surveys, the questions of which, industry
executives report, target all aspects of the device trade such as the value of imported goods, pricing
strategies, sales techniques, volume, and workforce size. Two prior cases serve as examples to follow
when detecting illicit trading, one involving a bribery charge against AGA Medical (now owned by
St. Jude Medical STJ) in 2008 and the other pertaining to the 2012 prosecution of Biomet for delivering
cash to surgeons upon completion of surgery and sponsoring questionable travel. While China’s medical
device market has historically attracted less scrutiny because of less direct competition between foreign
and domestic firms, we expect further incidences could arise as the industry garners more attention.
Short-term fines and pushback from Chinese authorities don’t diminish our outlook
for health care in China. Despite the potential for these incidents, we think investors would do well to
develop a thick skin for short-term noise that we do not believe will structurally affect the long-term
opportunities available in China’s medical device market. Using the pharmaceutical companies in Figure 1
as a model, it is apparent that devoted health-care firms are continually allocating capital toward
manufacturing plants and R&D facilities to leverage industry tailwinds. As select companies are tried for
illicit trading practices, we think the medical device firms with heavy investments in China will remain
committed to servicing the nation’s evolving health-care system.
The resulting fines are also a concern, but we anticipate that firms will be able to bear the brunt
with litigation reserves and that the penalties will be more of a slap on the wrist compared with the size
of market opportunities. The $108 million charged to six formula manufacturers in August mark historically significant fines by Chinese authorities. However, the penalties represent only about 3%
of the firm’ 2012 sales with the exception of Mead Johnson and Biostime, which were charged 4% for a
lack of investigative cooperation and 6% due to the magnitude of the violation, respectively. Four of
the firms lowered their prices upward of 20% during the summer investigation, but some expect market
30
share to increase as a result. In the case of AGA Medical and Biomet, both firms’ penalties summed to
about 1% of total sales, a cut that we believe does little to discourage them or other incumbents.
What comes as more of a shock is the potential $3 billion fine that GlaxoSmithKline may incur with its
corruption case, which would represent 3 times its 2012 sales in China. This may stand as a lone outlier
and we believe will be re-negotiated with recent rumors pointing to Glaxo’s exit from the Chinese market
if the penalty is not tapered. Regardless of the amount, Glaxo has openly responded by dispelling such a
move and has reaffirmed its commitment to servicing China, which we would expect given the firm’s
robust capital investments in the country and the market’s growth potential. Further, as with the case of
lowering nutritional prices, Glaxo also mentioned that it will likely reduce drug prices in China as a result
of shifting to a more simplified operating model in China, but we believe the price cuts are largely
intended to appease the Chinese government over potentially corrupt practices by Glaxo.
As China’s middle class expands and the mainland continues to urbanize, we believe firms will remain
eager to capture lucrative opportunities in the medical device market. Oversight can only increase as the
nation overhauls its health-care system and adopts the precedents set among foreign governments.
Following the example of formula manufacturers and pharmaceutical firms, we think medical device
manufacturers should adapt similarly to shifts in the competitive and regulatory landscape. K
Endnotes:
15 Oasis International Hospital
16 Professor Lizheng Shi, Tulane University
31
Chinese Challenges to Digging Moats in
the Stent Business
by Debbie S. Wang
Although U.S.-based manufacturers have enjoyed the benefits of economic moats in drug-eluting
stents, or DES, as they have branched off into distribution in the developed world, we note that digging a
comparable moat in China will be difficult. If anything, the evolution of the drug-eluting coronary stent
market in China offers an interesting case study that highlights just how quickly business can be won and
lost when multinational companies enter the market. We think the competitive dynamics in the Chinese
DES market offer cautionary lessons to medical device makers seeking to penetrate the Middle Kingdom.
Ingredients for Stent Moats
In general, we view coronary stents as a narrow-moat business. That is, drug-eluting stents are likely to
generate economic profits over the next 10 years and allow manufacturers to exert some pricing power.
This makes the DES business far more attractive compared with no-moat markets where competitors may
simply earn their cost of capital. On the other hand, DES companies do not enjoy the stronger competitive
advantages that wide-moat firms possess. We see the cardiac rhythm management and orthopedic
segments as wide-moat businesses and less vulnerable to encroaching competitors.
In the developed world, DES makers have relied on a few key elements to dig moats around
their businesses, and we anticipate these factors may not directly translate in China. First, intellectual
property is one major factor underlying DES moats. Boston Scientific, Medtronic, and Abbott (and
Johnson & Johnson previously) all possess extensive patents that surround their DES products, and have
historically defended this property aggressively. The major stent rivals are typically embroiled in lawsuits
and counter-lawsuits involving patent infringement on stents that may have already been rendered
obsolete by the introduction of newer, next-generation technology. While the legal costs of dragging
these issues out in court over years may seem wasteful, we think the main benefit of all this litigation is
to keep potential new competitors from entering the fray. In the grand scheme, it is not particularly
financially harmful for large players like Johnson & Johnson and Boston Scientific to fund ongoing
litigation over intellectual property—both firms generate plenty of cash and have deep pockets. However,
if a small, emerging competitor were to find itself the target of patent litigation by Medtronic or
Abbott, the burden of defending itself could hold dire financial implications.
Second, DES manufacturers have protected their businesses, to some extent, by building strong relationships between sales reps and physicians, who continue to make the brand choice for these types of
implanted devices. This access to the practitioner translates into opportunities to influence the brand
choice and introduce new products and technology.
32
Third, and perhaps most important, DES makers in the developed markets benefit from efficient
scale. In other words, a highly consolidated set of stent manufacturers can serve a market of limited size
in a manner that allows all participants to reap economic profits. In the developed markets, there
have historically been three or four major stent makers at any given time, and they operate as a rational
oligopoly. We note that this oligopoly is strongest and pricing is most stable with three competitors in the
mix; in contrast, price declines tended to be slightly greater with four rivals present. This might have
played a part in J&J’s decision to withdraw from the DES market in 2011.
Chinese Challenges
We contend that it will be substantially more difficult for multinational DES makers to construct narrow
moats in China, primarily because the business environment is less conducive to moat-digging.
Nonetheless, the considerable potential for profitable growth in China remains a huge attraction that
many medical device companies have decided they cannot pass up. First and foremost, the intellectual
property protection that the developed markets offer is severely diminished in China. This partly reflects
the nation’s millennia-long Confucian-influenced culture of defined hierarchy in which copying was
viewed as a form of respect and flattery. As a result, Chinese legal and political culture put little
importance on notions of proprietary intellectual property, and the nation was ill-equipped to deal with
foreigners who placed emphasis on the issue. That Confucian legacy also means China did not cultivate
strong rule-of-law standards and systems that are far more developed in Western countries.
It has only been in the last 30 years that China has begun to tackle the slow process of developing
legislation to protect intellectual property. We note that China has gradually revised its IP laws to more
closely hew to global standards, as the country seeks to play a bigger role in global trade. Although over
time China has made some progress, the country remains a hotbed of piracy, and enforcement of recent
legislation remains lax. Unfortunately, we think these conditions are unlikely to change in the near term
because the government has specifically designated medical technology as an industry that it wishes to
develop in China. The quickest way to develop expertise in an industry has been for China to allow
multinational firms to enter its market, and then tacitly encourage local firms to reverse-engineer those
products and set up shop. But, there is some light on the horizon that we think could change the IP
environment in China over the longer run.
33
Exhibit 28: Number of Patents Filed Over Time
China
US
Japan
European Patent Office
500,000
Source: WIPO Statistics Database 2013
300,000
450,000
400,000
350,000
250,000
200,000
150,000
100,000
50,000
1980
1985
1990
1995
2000
2005
2010 ‘11
0
Over the last decade, China has significantly ramped up its own patent filing activity, and now
leads the U.S. in direct patent applications. While there are some legitimate criticisms about the quality
of patents that China has granted, we think the massive volume of patents surely also contains highquality patents, too. Over time, China will find that it is beneficial to have a strong legal system to
enforce intellectual property rights, especially when it helps native companies. We think that during this
interim as China evolves toward stronger IP protection there will be more opportunities for enforcement.
But, the burden of enforcement will lie with the multinational companies. If multinationals pour resources
into protecting patents in China, there will be more cases of enforcement going forward. Nevertheless,
this additional cost of doing business there and the real risk of losing proprietary technology continue to
weigh on multinationals in the meantime.
We think the relationship-building aspect of stent moats will translate fairly well in China, which remains
an environment where personal relationships are critical to gaining access and opportunities to sell to
hospitals. However, this also means that multinationals will need to engage in substantial local hiring in
order to assemble a team that already has or can build out the network of relationships. Some stent
makers have already embraced this strategy. Two years ago, Boston Scientific shifted its focus and set
out to hire 1,000 employees in China. Medtronic aims to double its employees in China to 2,000 by
2015. Though we believe conditions in China are conducive to these relationships, we are cautious about
the durability of these relationships as it is not uncommon for employees to switch to competitive
companies. Retaining employees will become a more important endeavor in China, especially as the
demographic loss of working-age adults grows more pronounced over time.
Finally, we are pessimistic that the DES market in China will reach efficient scale anytime soon.
By definition, this source of economic moat involves a limited market. For better or worse, China’s DES
market will be large, relative to the volume in developed markets. For example, drug-eluting stent volume
34
in China was more than 630,000 last year, which is within striking distance of the estimated 900,000 units
used annually in the U.S., making the Chinese stent market roughly $515 million. Notably, while percutaneous coronary procedures have been declining in the low-single digits in the U.S. thanks to concerns
about overuse, angioplasty in China has been growing in the high teens over the last nine years as more
practitioners were trained to do these procedures and more hospitals began to offer them, in conjunction
with increased health insurance coverage and income growth.
Exhibit 29: Burden of Coronary Heart Disease
(mm)
China
U.S.
Patients with cardiovascular disease
230
26.5
Patients with hypertension
200
67
Number of heart attacks/year
2
0.715
Number of strokes/year
7
0.795
Sources: National Center for Cardiovascular Disease 2010, Beijing; Centers for Disease Control 2011
We expect sizable growth for years to come thanks to the size of the Chinese population, widespread
smoking, changing lifestyles and diet, as well as growth of the elderly. Approximately 230 million Chinese
suffer from coronary heart disease, compared with 26.5 million in the U.S.
Exhibit 30: Drug-Eluting Stent Volume in China
2012
2013E
2014E
2015E
2016E
2017E
Continued 10% Growth
633,000
696,300
765,930
Bull Case 14% Growth
633,000
727,950
837,143
842,523
926,775
1,019,453
962,714
1,107,121
Bear Case 5% Growth
633,000
664,650
697,883
1,273,189
732,777
769,415
807,886
Source: Huidian Research, Morningstar estimates
If Chinese percutaneous coronary volume continues to grow at the robust pace we project at
10% (significantly lower than the 20%-plus rates seen since 2003), then the stent market could reach
more than 1 million units in five years, making China the largest DES market in the world. It is this
prospect that has lured multinational DES makers into China and spurred domestic device makers to
compete for a piece of the pie.
Strategies for Stent Makers in this Evolving Market
Over the last decade, since Johnson & Johnson first entered China with its Cypher drug-eluting
stent in 2003, we have seen the Chinese coronary stent market evolve very quickly. This has forced
35
multinationals to remain flexible about strategy and its tactics on the ground, and remains an instructive
case for any med-tech company that is contemplating entry into China. In the early days of the DES
market (as illustrated by the timeline below), J&J and Boston Scientific pioneered and dominated the
market in China with an emphasis on its high-quality, premium stents that were not available locally.
Exhibit 31: Chinese Drug-Eluting Stent Timeline
Boston Scientific
Liberte
J&J
Cypher Select
Multinationals
J&J
Cypher
Boston Scientific
Taxus
Domestic
2003
2004
2005
MicroPort
Firebird
Lepu
Partner
Boston Scientific
Promus Element
Medtronic
Endeavor
2006
2007
J&J
Cypher Select
Abbott
Xience
Medtronic
Resolute
Abbott
Xience Prime
2008
2009
2010
2011
MicroPort
Firebird2
JW Medical Systems*
Excel (Bioabsorbable polymer)
Lepu
Nano
(Polymer-free)
2012
2013
MicroPort
Firehawk
Awaiting
approval
(Bioabsorbable
Polymer)
* JW Medical was originally a joint venture between Singapore-based Biosensors and Shandong Weigao. Biosensors bought out its partner in 2011
Source: Company filings
However, it did not take long for local competition to spring up. MicroPort, Lepu, and JW Medical
Systems flocked to launch their own drug-eluting stents in short order. Most of these local competitors
had only come into existence in the late 1990s, and were often led by Western-educated and trained
founders who saw an opportunity in the emerging Chinese DES market. As fast-followers, these
local rivals could produce products that were of “good enough” quality, which allowed them to develop
the nascent midtier market. Local stent makers also flexed their muscle in other ways and have proven
themselves formidable competitors. In particular, the local DES makers were manufacturing in China,
whereas Boston and J&J were commonly manufacturing in Ireland, the Netherlands, and Puerto Rico, all
tax-advantaged locations but not necessarily competitive in terms of cost relative to China. This
translates into compelling domestic stent prices for hospitals, especially those that are in Class I and II
outside the major urban areas. By focusing on the non-urban markets, domestic stent makers were able
to leverage their ability to build relationships, establish solid brand reputations, and work with hospitals
that were new to percutaneous coronary intervention. All the while, the multinationals concentrated on
selling premium products in the sophisticated, urban Class III hospitals.
We note that this cost advantage is a key reason new local entrants have been drawn into the market.
MicroPort, the leading domestic DES maker with an estimated 22% market share, enjoys gross margin
around 85%, which is comparable with the gross margin multinationals can garner for its drug-eluting
stents in the U.S. market. MicroPort can achieve those attractive margins even though it typically prices
its stents at a 30%–40% discount to Abbott’s Xience or Boston’s Promus. Taking advantage of this
two-tiered approach to the Chinese hospitals and working to expand the stent market, local DES makers
36
were able to take substantial share from the multinationals in dramatic fashion. The prospect of these
hefty profits will only attract more local competitors to the field, which leaves the significant consolidation necessary to reach efficient scale very far off in the future.
Exhibit 32: Chinese DES Market Share
2004
2009
2010
2011
2012
Multinationals %
80
Local Manufacturers %
20
34
30
35
40
66
70
65
60
Source: In Vivo
As we have discussed in the past, low switching costs are another reason why drug-eluting stents
are a narrow-moat business. With stents and delivery systems that are fairly interchangeable and a
relatively shallow learning curve, it is very easy for interventional cardiologists to move from one brand
to another. As a result, stent share is vulnerable to significant change in the space of a few quarters
when competitors launch products.
Local Stent Makers Up Ante
While locally made stents hold the price advantage, we are particularly impressed with the R&D
capabilities of MicroPort and Lepu Medical. Even though it is not necessarily difficult to reverse-engineer
a middling drug-coated stent, these local competitors have stepped on the gas to rev up innovation.
Staffed up with plenty of engineers and scientists, the local companies have not stinted on R&D
spending. These dollars were wisely spent in two areas. First, Chinese DES makers invested in clinical
studies to demonstrate the comparability of their products when stacked against Boston and J&J’s
stents. This data helped to diminish perceptions that the local stents lagged on quality. Second, aggressive R&D efforts have allowed the local DES makers to leapfrog ahead the multinationals on the
technology front. While the multinationals have been working on bioabsorbable polymers, polymer-free,
and resorbable stents, none has commercialized these technologies yet (the only exception is Abbott’s
ABSORB stent that is approved for marketing in Europe). On the other hand, Lepu and JW Medical have
already rolled out a bioabsorbable polymer and polymer-free stent in China. MicroPort is awaiting CFDA
approval on its Firehawk stent with a bioabsorbable polymer.
37
Exhibit 33: Chinese Drug-Elating Stent Market Strategies
Premium Quality
Abbott
Medtronic
Boston Scientific
Lepu
JW Medical
Lower Tech
MicroPort
Sophisticated Tech
Value-tier
Efforts by these local DES makers to establish themselves as creators of leading-edge technology may
leave multinationals wary and concerned about China. Indeed, these competitive dynamics have forced
the multinationals to be nimble about shifting strategy. We suspect it took the dramatic share decline for
the multinationals to realize they had lost the edge on technology, and to prod them into lowering their
prices and narrowing the gap with domestic products. While these pricing shifts may have helped the
multinationals regain some market share in recent years, we think the formidable wave of local competition has fundamentally pushed Abbott, Boston, and Medtronic into defensive mode. In order to compete
and maintain pricing, the multinationals will need to out-innovate the domestic competitors and
potentially do a better job of tailoring their DES products for the Chinese market. Another strategic option
would be to lower their cost structure by moving manufacturing to China. However, we think the
multinationals are reluctant to do this because it would leave them vulnerable to piracy, with little
recourse in the legal system. If China were to beef up its enforcement of intellectual property rights, then
we might see some relocation of manufacturing.
A Narrow Moat Becomes Narrower Still in China
Overall, we think it will be considerably more difficult for the multinationals to replicate the narrow DES
moats they enjoy in developed markets. The scale of the DES market in China and the proliferation in
local competitors means that any rational oligopoly is very far off indeed. In the meantime, weak
protection of intellectual property and low switching costs will leave the multinationals vulnerable to
pricing pressure. Currently, these firms still gain some mileage as foreign “brands” which Chinese
consumers tend to prefer. However, we are not entirely confident that this will sustain the multinationals
over the longer run, especially since there are some policies in place that tilt the advantage to domestic
stent makers. The tendering process limits hospitals to one domestic and one foreign supplier.
Additionally, reimbursement favors domestic stents by tying them to higher rates (local stents are
reimbursed at 70% of the price versus 50% for imported stents), or by capping reimbursement at a level
where the domestic stent is covered but the patient would need to pay out of pocket for the difference on
an imported stent. It is not clear how long the multinationals can hold out in the face of this consistent
38
pressure on price, or whether the opportunity to gain a slice of such a large market is too tempting
to pass up.
Either way, we believe the multinationals will, over the longer term, find themselves competing with the
Chinese DES makers outside China. Even though the Chinese companies may not penetrate the U.S.
market in the near- or midterm, other markets seem to be fair game, particularly other emerging markets
such as Brazil and India. Currently, sales outside of China account for approximately 20% of Lepu
Medical’s total revenue, and one of MicroPort’s key strategies is to expand into new geographies. We
suspect it is this eventuality that could raise alarm at the multinationals. K
39
Orthopedics: Translating Wide Moats
in China
by Debbie S. Wang
The orthopedic industry in China as followed a similar progression as the drug-eluting stent market, but
there are a few distinctions that give us confidence that the orthopedic multinationals can dig wide
moats in this geographic area. Like the DES makers, multinational orthopedic firms entered the Chinese
market by staking out the premium, high-end portion of the market by focusing on Class III hospitals. This
allowed local competitors, such as Shandong Weigao and Trauson, to design and manufacture lesssophisticated and lower-priced orthopedic implants. As a result, domestic manufacturers could establish
a foothold with Class II and I hospitals in smaller cities, thereby pioneering the value-segment of the
orthopedic market. If it feels like you’ve seen this movie before, you have. But, there are a couple of
different twists that lead us to believe the orthopedic multinationals will end up in a stronger competitive
position than the DES multinationals.
These wide-moat companies are similar to DES makers in that intangibles such as intellectual property
and relationships with practitioners are both important sources of competitive advantage. This
means that orthopedic multinationals will also find themselves vulnerable to weaker IP protection in
China. As noted before in the stent discussion, we think there has been progress on this front as China
evolves its laws surrounding intellectual property. However, enforcement remains lax and inconsistent.
Though we expect enforcement will improve over the longer term as China seeks to protect its own
growing cache of patents, it will take time and multinationals are wise to be wary.
Digging Moats on High Switching Costs
It’s important to note that orthopedic companies’ wide moats are rooted in high switching costs and we
think this aspect of the moat will translate well in China. Unlike drug-eluting stents, reconstructive
joint replacements involve using extensive sets of instrumentation that are specific to each competitor.
Moreover, surgeon skill and experience are major factors in the clinical outcome. In the developed
markets, surgeons stick with their preferred implant vendor and sales rep for 5–15 years, and tend to use
that favored vendor for more than 90% of their procedures. We expect similar dynamics should play
out in China when it comes to joint reconstruction, which we anticipate will experience major growth
thanks to the size of the aging and arthritic Chinese population.
40
Exhibit 34: Patients with Arthritis (mm)
China
124.6
U.S.
48.6
India
24.3
U.K.
9.6
Italy
Canada
5
4.8
Source: Trauson 2008
In contrast, low switching costs for DES mean that products can be used interchangeably and interventional cardiologists can still reliably reach success rates of more than 95%. Orthopedic surgeons
are not in the same position—the learning curve is much longer and steeper, in order to reach optimal
clinical outcomes.
Unfortunately, high switching costs can be a double-edged sword. On one hand, this means surgeons
tend to be very loyal and companies can expect most surgeons trained on their systems to stay put. On
the other hand, this dynamic also makes it very difficult to pull orthopedic surgeons away once they
are committed to competitive brands. Unlike the significant DES market share shifts that can happen in
the space of two quarters, share shifts for orthopedic companies are measured in 100 to 200 basis points
over the period of 5–10 years. Historically, orthopedic companies have relied on acquisitions as the
primary mode of boosting market share.
Lessons Learned That Have Led to New Strategies for China
We think the orthopedic companies are well-situated to replicate their wide moats in China by relying on
the high switching costs central to orthopedic surgery in the near- and midterm. This will allow some
time for the intellectual property environment to evolve, which will strengthen moats over the long run.
The orthopedic history of “market share by acquisition” has resulted in the current land grab in China for
local orthopedic companies. We think this strategy of co-opting the strongest local competitors is a savvy
approach—one that the DES device makers missed and probably now regret. Over the last three years,
Medtronic purchased Kanghui Medical for roughly $755 million; Stryker acquired Trauson for $764 million;
and Zimmer bought Beijing Montagne for an estimated $57 million. With the various segments of the
orthopedic market growing nearly 20% annually, there is more upside to be had.
41
Exhibit 35: China's Orthopedic Implant Market (Rmb bn)
Other
Spine
Joint
Trauma
12
10
8
Source: Frost & Sullivan
6
4
2
2006
2007
2008
2009
2010
2011
2012
0
We think the orthopedic multinationals learned a valuable lesson from how the DES market evolved in
China. While J&J, Boston Scientific, Abbott, and Medtronic were focused on organically penetrating
the advanced Class III hospitals with sophisticated technology, this left the vast middle market of Class II
and I hospitals receptive to overtures and attention from new local suppliers such as MicroPort and Lepu
Medical. Now the DES multinationals lack the product depth to appeal to the middle market, and also lag
behind the local rivals in terms of building out relationships with hospitals and practitioners outside the
large urban areas.
From a strategic and portfolio perspective, we think the orthopedic acquisitions make sense. The
trauma segment continues to account for approximately 35% of China’s orthopedic market, and most
Chinese orthopedic surgeons start out doing trauma before specializing in spine, large joint reconstruction, or extremities. The local orthopedic device makers tend to hold extensive portfolios of trauma and
spine products, while they lack the higher-tech, more sophisticated large joint implants. The multinationals offer a mirror image—smaller trauma offerings and a robust portfolio of hip and knee replacements. Melding the product portfolios together makes for a complementary fit. In the case of Medtronic
which does not have hip and knee implants, the acquisition of Kanghui means Medtronic now has a
strong trauma offering when it had none before. Additionally, Kanghui has rolled out its own hip and knee
systems recently, and also has licensed joint replacement designs from Consensus Orthopedics. Now
Kanghui can strengthen its spinal portfolio with Medtronic’s expertise in that segment.
In general, the trauma segment—with its lower-tech nails, plates, and rods—is dominated by local
companies. On the other hand, the spinal and joint implant markets are still weighted primarily toward
multinational firms. We expect the multinationals to approach the trauma market in China mainly through
their acquisitions on the ground. This is partly because these less highly engineered products are more
prone to generic competition (and thus, margin pressure), and partly because the cost structure of locally
manufactured products will be more competitive. We think Stryker and Zimmer will be selective about
42
which foreign-produced trauma products it imports to China, at least through the midterm. We anticipate
the growing middle-class demand for joint replacement will be a boon to orthopedic multinationals,
both with its high-end premium products, as well as with the possibility of engineering lower-cost, more
basic implants (manufactured in China) for the widening swath of the middle market.
We also note that the acquisition strategy has helped the multinational companies avoid the key
strategic pitfall that DES makers ran into. Similar to the local DES manufacturers, the main local
orthopedic firms have primarily concentrated their efforts on penetrating the middle-market through
Class III hospitals in smaller cities, and Class II hospitals outside urban areas. By acquiring these local
competitors, the multinationals can continue to focus on offering high-end products at the Class III
hospitals in the premier cities, but they will also reap the benefits of a presence (albeit with different
brands) in the non-urban middle market. As a result of this acquisition spree, we think the market
share split between locals and foreigners has shifted.
Exhibit 36: Local vs. Foreign Share of China Orthopedic Market
Multinational Companies
Local Orthopedic Companies
Source: Frost & Sullivan, Morningstar
estimates
49%
51%
2009
36%
64%
2013
Three Additional Strengths of Acquisition Strategy: Distribution, R&D/Manufacturing, and
Tailored Products
First, medical device distributors in China exercise considerably more influence than in developed
markets, and it can be difficult for multinational companies to grow their own distribution network in the
vast and fragmented Chinese system of approximately 22,000 hospitals (the U.S. has about 5,700
hospitals, for perspective). Aside from complementary product portfolios, local competitors’ distribution
networks are extremely valuable to multinationals.
43
Exhibit 37: Local Orthopedic Distribution Networks
Distributors
Hospital Customers
Kang-Hui Medical (MDT)
335
2,969
Trauson (SYK)
663
3,840
Shandong Weigao
995
2,963
Source: Comapany filings
We think this could be the most valuable aspect of what the multinationals have purchased. By law,
foreign device makers must go through Chinese distributors. The time, effort, and man hours necessary to
replicate these distribution networks are sizable for multinational companies. Now Medtronic, Stryker,
and Zimmer will be able to funnel their high-end products through these distribution networks that will
reach much further into the group of Class II hospitals.
Second, these purchases also give the multinationals R&D and manufacturing facilities in China
to produce those middle-market products at an advantageous cost structure, while they still retain the
flexibility to keep manufacturing of their premium products elsewhere, and lessen the risk of piracy.
Currently, multinationals can mark up their large joint implants to roughly 3 times the local device price.
However, we think these prices may come under pressure as joint reconstruction volume grows through
the mid-term in developed markets. Having facilities on the ground will give multinationals an opportunity to test out the manufacturing waters, in the event that they eventually move some manufacturing of
premium products over to China.
Finally, these newly acquired Chinese facilities mean the multinationals will be better able to tailor
their products to the local market. Orthopedic surgeons and regulators have raised concerns about the
differences in skeletal structure between Chinese people and Western people for whom premium
orthopedic products have been designed. The more multinationals can demonstrate that their products
are tailored for Chinese physiology, the better reception they will receive.
Market Potential Outweighs Reimbursement and Regulatory Risks
Overall, we contend the orthopedic multinationals, compared with DES multinationals, will have an
easier time of translating their wide moats to China thanks to the high-switching costs of their products
and timely strategies to purchase the largest local competitors. However, we recognize that the
Chinese orthopedic market will be subject to many of the same governmental and regulatory policies that
favor local med-tech firms over multinationals. Furthermore, we would not be surprised to see more
local competitors attempt to penetrate the premium segments that are currently dominated by multinational companies. MicroPort, the native DES company that has given Abbott, Boston, and Medtronic a
real run for its money in the Chinese stent market, has purchased Wright Medical’s reconstructive
orthopedic business. This gives MicroPort a strong reconstructive technology platform relative to other
local competitors (and importantly, it also provides MicroPort with entry into the U.S. orthopedic market).
All of this should be a wake-up call to all med-tech companies. Even those with the widest moats will
44
need to continually enhance their innovation in order to compete. But, considering the sheer size of the
Chinese market, this seems to be an opportunity that orthopedic multinationals cannot pass up.
Medtronic Well-Situated to Ride China’s Rise
Of the medical device multinationals, we think Medtronic is best positioned to benefit from the
rise of Chinese spending on med-tech. Even though it may be hampered by competitive forces behind its
control in the stent market, Medtronic faces far more upside than other device manufacturers because
of its extensive product portfolio. With the addition of Kanghui’s strong distribution network, Medtronic
now has an avenue through which to move all of its devices into Chinese hospitals, including pacemakers, implantable cardioverter defibrillators, insulin pumps, and heart valves. Medtronic will be there
with products just as access is improving, and demand is growing among previously untreated or
undertreated patients. For example, the Ministry of Health has just included type I diabetes as a
condition that will be covered under the insurance schemes; the insulin pump market is dominated by
type I diabetic patients. In our universe of med-tech companies, Medtronic remains relatively undervalued with shares trading roughly 10% below our fair value estimate of $60 per share. K
45
An Informative Case:General Electric’s
Emerging-Market Strategy Starts With
Service Networks
by Daniel Holland
Having entered the China market decades earlier, General Electric moved forward in the health- care
market with fresh strategies that have paid off. GE laid out a two-pronged strategy that involved a
grassroots “made for China” focus and relied on its proprietary data collection and high-touch service
to lay the groundwork for an economic moat.
Creating Indigenous Products for China
First, it did not take long for GE to realize that its initial strategy—relabeling stripped-down versions of
American products for China—would not work because the working conditions in China were fundamentally different from those in developed markets. For example, American hospitals can count on having
reliable, consistent power available. However, installing a magnetic resonance imaging machine in
a remote area of China comes with the risk of intermittent power, and consequently, poor utilization of
the equipment.
These types of issues required GE to re-think and re-engineer how to design products especially for the
region. GE elected to make significant capital investments in the region, with the objective of locally
engineered, locally manufactured, and locally consumed products. Approaching the market in this way
allowed the firm to create indigenous products that met a specific local need. Additionally, this strategy
allowed GE to control more of its intellectual property, controlling the introduction of technology to the
market and the pace of innovation (instead of contracting with local manufacturers).
Enhancing Service amd Proprietary Features
Second, GE elected to focus on not only the product, but also on establishing a regional network of
service centers addressing clinics and smaller hospitals, which are generally less interested in pricier
medical equipment. This segment of the market lacks both financing and often the expertise to take
advantage of the equipment, and instead opts for more basic tools that are easier to use and can address
a broad audience. As a result, large multinational equipment makers expended little effort on penetrating
this part of the market. GE’s service centers provide remote diagnostics and monitoring services, which
help the users become more proficient, mitigating a key hindrance to higher-equipment utilization.
It’s also important to note that GE has found a way to lessen the threat of technology infringement, by
focusing on the moatier software element. The value of GE’s equipment is less dependent on the
hardware solution, and more concentrated in the software embedded within the product. Similar to how
GE approaches remote monitoring and diagnostics in its jet engines and gas turbines businesses, the
company collects and retains proprietary data on all units in the field that can be used to engage
46
customers after the initial point of purchase. The rise of digital imaging, in particular, has enhanced the
value of software in medical equipment. While counterfeiters can copy the physical likeness of the
medical equipment, it is far more difficult to replicate the requisite software backbone or the service
network built by General Electric. As a result, competitors aiming to replicate particular features of the
device will be unlikely to deliver the same level of value to the end user as the GE solution. The
portable ultrasound machine, launched in 2009 is one example of GE’s approach to building a product
designed for local market needs and then using service and software to make the equipment more
valuable. This product has been successful in China, so much so that it has also been exported to rural
settings in developed regions.
GE’s Success Has Left Philips and Siemens Struggling in China
GE’s successes with its novel strategies stand in large contrast to the struggles of its competitors.
Whereas GE has reported double-digit order growth in the region and profitability consistent with the
global business, both Siemens SI and Philips PHIA have taken impairment charges on their health-
care businesses in the last two years as growth lagged managements’ expectations. Despite stated
intentions to focus on lower-cost middle-market products, Philips and Siemens have yet to expand
beyond their key large, technologically advanced cities. We view the next couple of years as critical in
determining whether either of these firms can regain their footing in the Chinese markets or will concede
the region and return to their core competency in big-ticket equipment sales in Western regions.
In our opinion, GE’s key challenge is to retain the customers that they have invested in and educated,
even as the market evolves and matures. Among multinational firms selling any type of capital equipment, service attachment rates in China tend to be lower than in Western markets. Once local customers
understand the product well enough, the tendency has been for them to perform their own maintenance
and develop their own innovations around the existing technology, allowing them to avoid longer-term
service contracts that have been a mainstay in capital equipment sales. To the extent that the customers
view GE’s altruism as their opportunity to walk up the learning curve without bearing the full cost,
customers may decide to abandon GE for a competing technology. We still view this as a more mediumto long-term threat as there is a significant runway for growth in the second- and third-tier cities, and
GE’s head start in building out its service network has helped to establish a commanding lead in its
respective markets. K
47
Outlook for Industries in Healthcare
Five-Star
Four-Star
Three-Star
Two-Star
One-Star
100%
Data as of August, 2013
50
Services
Medical
Medical
Instruments Devices
Pharma
Managed
Biotech
Care/PBMs
0
26
24
30
6
Number of
Companies
14
26
The biotechnology industry now represents the only
industry with 5-star stocks. Including both 4-star and 5-star
stocks, the managed-care and PBM industry is at the
top along with the biotech and pharmaceutical industries.
The industries with the worst rankings are services and
medical instruments. Looking at the entire health-care sector, the number of 5-star stocks is at a very low level with
only two stocks with 5-star ratings.
Healthcare Large Cap Focus List
Company Name
Moat
Uncertainty
Price to
Fair Value Star Rating
Analyst
Express Scripts ESRX
Wide
Medium
0.70
QQQQ
Lekraj
Sanofi SNY
Wide
Medium
0.74
QQQQ
Conover
Teva TEVA
Narrow
Medium
0.78
QQQQ
Waterhouse
WellPoint WLP
Narrow
Medium
0.83
QQQQ
Lekraj
Valeant Pharmaceuticals VRX Narrow
Medium
0.85
QQQQ
Krempa
Medtronic MDT
Wide
Low
0.90
QQQQ
Wang
Gilead GILD
Narrow
Medium
0.91
QQQQ
Andersen
Covidien COV
Narrow
Medium
0.93
QQQQ
Morozov
Quest Diagnostics DGX
Narrow
Medium
0.95
QQQ
Wang
Amgen AMGN
Wide
Medium
0.98
QQQ
Andersen
Data as of September 20, 2013
Since the August 2008 inception, our focus list has
outperformed the iShares Dow Jones U.S. Healthcare ETF
Index IYH by 59% and the S&P 500 by 91%. On an
absolute basis, the focus list has returned 127% since the
initial launch. We measure our performance by equally
weighting each holding and rebalancing at the end of each
month. This month, we are not making any changes to our
large-cap list.
48
Healthcare SMID Focus List
Company Name
Moat
Uncertainty
Price to
Fair Value Star Rating
Nordion NDZ
Narrow
High
0.79
QQQQ
Krempa
Myriad Genetics MYGN
Narrow
High
0.83
QQQQ
Morningstar
Analysts
Edwards Lifesciences EW
Narrow
High
0.91
QQQ
Wang
Charles Rivers Labs CRL
Narrow
Medium
0.93
QQQ
Morningstar
Analysts
LabCorp LH
Narrow
Medium
0.94
QQQ
Wang
VCA Antech WOOF
Narrow
Medium
0.95
QQQ
Wang
Varian VAR
Narrow
Medium
0.97
QQQ
Morningstar
Analysts
Paladin Labs PLB
Narrow
High
0.98
QQQ
Krempa
Smith & Nephew SNN
Narrow
Medium
1.00
QQQ
Wang
Given Imaging GIVN
Narrow
High
1.03
QQQ
Wang
Data as of September 20, 2013
Analyst
Since our recent launch at the beginning of September
2010, our focus list has outperformed the iShares Dow
Jones U.S. Healthcare ETF Index IYH by 11% and the
Russell Mid Cap Index by 27%. On an absolute basis, the
focus list has returned 100% since the initial launch.
We measure our performance by equally weighting each
holding and rebalancing at the end of each month.
This month, we are not making any changes to our
SMID-cap list.
49
Healthcare Calendar
October 2013
Event
Date
Location
Oct. 2–5
Copenhagen
6
7
8
9
10
11
12
European and Americas Committee for MS (ECTRIMS/
ACTRIMS)
13
14
15
16
17
18
19
American College of Gastroenterology (ACG)
Oct. 11–16
San Diego
20
21
22
23
24
25
26
FDA Panel on JNJ's simeprevir for hepatitis C
Oct. 24
—
27
28
29
30
31
1
FDA Panel on GILD's sofosbuvir for hepatitis C
Oct. 25
—
American College of Rheumatology (ACR)
Oct. 26–30
San Diego
Transcatheter Cardio Therapeutics (TCT)
Oct. 27–
Nov. 1
San Francisco
Event
Date
Location
American Association for the Study of Liver Disease
(AASLD)
Nov. 1–5
Washington
DC
1
2
3
4
5
November 2013
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
FDA Panel on MRK's ATI drug for allergy
Nov. 5–6
—
17
18
19
20
21
22
23
American Society of Nephrology (ASN)
Nov. 5–10
Atlanta
24
25
26
27
28
29
30
Society of Immunotherapy of Cancer (SITC)
Nov. 6–10
National
Harbor, MD
American Heart Association (AHA)
Nov. 16–20 Dallas
50
Biotechnology Companies
Company
Ticker
Analyst
Star Rating
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
Actelion Ltd.
ATLN
Karen Andersen
QQ
7,734
64.30
49
1.31
None
High
15.6
Alexion Pharmaceuticals, Inc.
ALXN
Lauren Migliore
QQQ
22,299
114.03
115
0.99
Narrow
High
37.0
Alnylam Pharmaceuticals, Inc.
ALNY
Karen Andersen
QQ
3,627
57.61
42
1.37
None
Very High
NM
Amgen Inc
AMGN Karen Andersen
QQQ
88,280
117.18
119
0.98
Wide
Medium
14.3
Biogen Idec Inc
BIIB
Biomarin Pharmaceutical, Inc.
BMRN Karen Andersen
QQ
58,938
247.98
210
1.18
Wide
Medium
34.4
QQQ
10,983
78.38
71
1.10
Narrow
Medium
NM
Celgene Corporation
CELG
Karen Andersen
QQ
61,083
148.52
123
1.21
Narrow
High
20.6
Cubist Pharmaceuticals, Inc.
CBST
Dendreon Corp
DNDN Karen Andersen
David Krempa
QQQ
QQQQ
4,259
64.44
60
1.07
None
High
24.8
506
3.21
3.8
0.84
None
High
NM
Elan Corp PLC
ELN
Karen Andersen
QQQ
7,981
15.60
14
1.11
None
High
NM
Exelixis, Inc.
EXEL
Lauren Migliore
QQQQQ
1,033
5.61
11
0.51
None
Very High
NM
Gilead Sciences Inc
GILD
Karen Andersen
QQQQ
98,450
64.32
71
0.91
Narrow
Medium
21.5
Grifols SA
GRFS
Karen Andersen
QQQ
11,025
32.07
30
1.07
Narrow
Medium
16.8
Incyte Corp Ltd
INCY
David Krempa
QQ
5,535
36.16
24
1.51
None
Very High
116.3
InterMune, Inc.
ITMN
Lauren Migliore
QQQQ
1,261
15.39
25
0.62
None
Very High
NM
Lexicon Pharmaceuticals, Inc.
LXRX
Karen Andersen
QQQQ
1,173
2.28
3.5
0.65
None
Very High
NM
MannKind Corporation
MNKD Karen Andersen
QQQ
1,796
5.95
6.5
0.92
None
Very High
NM
Novo Nordisk A/S
NVO
Karen Andersen
QQQQ
95,040
172.80
209
0.83
Wide
Medium
17.5
Onyx Pharmaceuticals, Inc.
ONXX
Karen Andersen
QQQ
9,144
124.53
125
1.00
None
High
QLT, Inc.
QLTI
Michael Waterhouse
QQQ
231
4.52
4.5
1.00
None
Very High
Regeneron Pharmaceuticals, Inc.
REGN
Stefan Quenneville
QQQ
30,327
307.11
291
1.06
Narrow
High
Roche Holding AG
RHHBY Karen Andersen
QQQ
227,855
66.04
68
0.97
Wide
Low
4.3
Seattle Genetics, Inc.
SGEN
Lauren Migliore
QQ
5,816
47.73
30
1.59
None
Very High
NM
Shire PLC
SHPG
Karen Andersen
Q
23,040
122.80
81
1.52
Narrow
Medium
33.6
Vanda Pharmaceuticals, Inc.
VNDA
Karen Andersen
QQ
369
12.94
10
1.29
None
High
NM
Vertex Pharmaceuticals
VRTX
Stefan Quenneville
QQQ
17,761
76.29
88
0.87
None
High
NM
ViroPharma, Inc.
VPHM Lauren Migliore
2,618
39.96
25
1.60
None
Very High
Karen Andersen
QQ
Fwd P/E
138.9
NM
36.9
38.5
51
Diagnostics & Research Companies
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
QQQ
16,864
50.98
46
1.11
Narrow
Medium
15.2
Morningstar Analysts
QQQ
2,600
31.80
28
1.14
None
High
14.8
BIM
QQQ
2,864
CRL
Lauren Migliore
QQQ
2,288
72.60
72
1.01
Narrow
Medium
15.7
46.64
50
0.93
Narrow
Medium
14.8
Covance, Inc.
CVD
Lauren Migliore
QQ
4,783
85.56
71
1.21
Narrow
Medium
21.6
Icon PLC
ICLR
Lauren Migliore
Idexx Laboratories
IDXX
Debbie Wang
QQQ
2,374
39.00
36
1.08
Narrow
High
19.8
QQ
5,153
98.08
88
1.11
Narrow
Medium
23.8
Laboratory Corporation of America
Holdings
LH
Debbie Wang
QQQ
8,988
99.76
106
0.94
Narrow
Medium
12.6
Life Technologies Corp
Lonza Group AG
LIFE
QQQ
12,927
74.87
76
0.99
Narrow
Medium
15.9
LONN
QQ
3,904
75.20
63
1.19
None
High
14.9
Mettler-Toledo International, Inc.
MTD
Alex Morozov
Q
7,215
240.95
167
1.44
Narrow
Medium
19.2
Myriad Genetics, Inc.
MYGN Morningstar Analysts
QQQQ
2,067
25.69
31
0.83
Narrow
High
12.4
Nordion, Inc.
NDZ
David Krempa
QQQQ
535
8.64
11
0.79
Narrow
High
13.6
Parexel International Corporation
PRXL
Lauren Migliore
QQ
2,809
49.96
38
1.31
Narrow
High
23.2
Company
Ticker
Analyst
Star Rating
Agilent Technologies Inc
A
Alere Inc
ALR
BioMerieux SA
Charles River Laboratories
International Inc
Fwd P/E
PerkinElmer Inc
PKI
Alex Morozov
QQ
4,322
38.58
31
1.24
Narrow
Medium
16.0
Qiagen NV
QGEN
QQQ
4,987
21.28
22
0.97
None
Medium
18.4
Quest Diagnostics Inc
DGX
Debbie Wang
QQQ
9,388
61.81
65
0.95
Narrow
Medium
12.4
Quintiles Transnational Holdings Inc Q
Lauren Migliore
QQQQ
5,673
44.00
50
0.88
Narrow
Medium
18.8
Thermo Fisher Scientific Inc
TMO
Alex Morozov
QQ
33,975
94.24
80
1.18
Narrow
Medium
15.3
Waters Corporation
WAT
Alex Morozov
QQQ
9,071
106.44
105
1.01
Wide
Medium
17.2
WuXi PharmaTech (Cayman), Inc.
WX
Lauren Migliore
QQ
1,920
27.02
20
1.35
None
High
14.8
Company
Ticker
Analyst
Star Rating
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
AbbVie Inc
ABBV
Damien Conover
QQ
75,149
47.40
41
1.16
Narrow
Medium
14.6
AstraZeneca PLC
AZN
Damien Conover
QQQ
64,883
51.82
56
0.93
Wide
Medium
9.9
Bayer AG
BAYRY Damien Conover
QQ
96,877
117.15
99
1.18
Narrow
Medium
13.6
Bristol-Myers Squibb Company
BMY
Damien Conover
QQ
78,250
47.53
39
1.22
Wide
Medium
22.4
Eli Lilly and Company
LLY
Damien Conover
QQQ
60,681
53.86
52
1.04
Wide
Medium
16.4
GlaxoSmithKline PLC
GSK
Damien Conover
QQQ
123,023
50.27
56
0.90
Wide
Medium
19.0
Johnson & Johnson
JNJ
Damien Conover
QQQ
253,824
90.07
90
1.00
Wide
Low
15.0
Merck & Co Inc
MRK
Damien Conover
QQQ
141,212
48.25
52
0.93
Wide
Medium
13.3
Novartis AG
NVS
Damien Conover
QQQ
186,241
76.11
78
0.98
Wide
Low
13.6
Pfizer Inc
PFE
Damien Conover
QQQ
190,929
28.84
30
0.96
Wide
Medium
12.1
Sanofi
SNY
Damien Conover
QQQQ
135,447
50.84
65
0.78
Wide
Medium
7.7
Major Drug Manufacturers
Fwd P/E
52
Specialty & Generic Drug Manufacturers
Market
Cap
Price
Fair Value
Price/FV
QQQ
18,430
138.40
127
Michael Waterhouse
QQQ
27,073
91.20
RDY
Michael Waterhouse
QQQ
6,388
ENDP
Lauren Migliore
QQ
5,056
Forest Laboratories, Inc.
FRX
Damien Conover
QQQ
11,921
H.Lundbeck A/S
LUN
David Krempa
QQ
23,140
Hikma Pharmaceuticals PLC
HIK
Michael Waterhouse
QQQ
2,062
Hospira, Inc.
HSP
Michael Waterhouse
QQQ
Mallinckrodt PLC
MNK
David Krempa
QQQ
Merck KGaA
MKGAY David Krempa
QQ
Momenta Pharmaceuticals, Inc.
MNTA Michael Waterhouse
QQQ
Mylan Inc
MYL
Michael Waterhouse
QQ
Paladin Labs, Inc.
PLB
David Krempa
QQQ
Perrigo Company
PRGO
Michael Waterhouse
Teva Pharmaceutical Industries Ltd
TEVA
Michael Waterhouse
UCB SA
UCB
Lauren Migliore
QQ
Valeant Pharmaceuticals International Inc
VRX
David Krempa
QQQQ
Warner Chilcott PLC
WCRX David Krempa
QQQ
Zoetis Inc
ZTS
David Krempa
Q
Company
Ticker
Analyst
Star Rating
Aetna Inc
AET
Vishnu Lekraj
Catamaran Corp
CTRX
Vishnu Lekraj
Cigna Corp
CI
Express Scripts
ESRX
Humana
Company
Ticker
Analyst
Star Rating
Actavis Inc
ACT
Michael Waterhouse
Allergan, Inc.
AGN
Dr. Reddy Laboratories, Ltd.
Endo Health Solutions Inc
Moat
Uncertainty
Rating
1.09
Narrow
High
13.6
100
0.91
Wide
Medium
16.4
37.56
34
1.10
Narrow
High
17.5
44.27
33
1.34
Narrow
High
14.3
44.41
40
1.11
Narrow
High
43.3
118.00
100
1.18
Narrow
High
26.5
1043.00
1000
1.04
Narrow
High
17.7
6,803
41.07
37
1.11
Narrow
High
17.9
2,463
42.68
42
1.02
None
Medium
17.0
33,394
51.20
42
1.22
Narrow
Medium
4.3
Fwd P/E
819
15.67
16
0.98
None
Very High
50.5
14,635
38.33
25
1.53
Narrow
High
11.4
1,214
58.77
60
0.98
Narrow
High
21.0
QQ
11,810
125.33
102
1.23
Narrow
Medium
18.9
QQQQ
31,628
37.43
48
0.78
Narrow
Medium
7.3
8,317
45.34
37
1.23
None
High
19.8
35,324
106.12
125
0.85
Narrow
Medium
12.0
5,536
22.04
20
1.10
Narrow
High
16,255
32.51
24
1.35
Wide
Medium
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
QQQ
24,127
64.84
65
1.00
Narrow
Medium
10.2
QQQ
10,727
52.04
57
0.91
Narrow
Medium
19.7
Vishnu Lekraj
QQ
21,982
77.72
62
1.25
None
High
10.2
Vishnu Lekraj
QQQQ
50,431
61.94
89
0.70
Wide
Medium
12.1
HUM
Vishnu Lekraj
QQ
14,819
94.71
82
1.15
None
High
10.1
UnitedHealth Group Inc
UNH
Vishnu Lekraj
QQQ
72,023
70.84
76
0.93
Narrow
Medium
11.5
WellPoint Inc
WLP
Vishnu Lekraj
QQQQ
24,673
82.53
100
0.83
Narrow
Medium
9.0
Company
Ticker
Analyst
Star Rating
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
Fwd P/E
Kindred Healthcare, Inc.
KND
Michael Waterhouse
QQQ
728
13.44
13
1.03
None
Very High
8.0
7.2
20.2
Health Care Plans
Fwd P/E
Long-Term Care Facilities
53
Medical Care Companies
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
644
14.01
13
1.08
Narrow
High
17.8
QQ
12,443
58.53
50
1.17
Narrow
Medium
11.5
Michael Waterhouse
QQQ
19,894
32.72
32
1.02
Narrow
Medium
9.8
HCA
Michael Waterhouse
QQQ
18,934
42.34
35
1.21
None
Very High
10.7
Select Medical Holdings Corporation SEM
Michael Waterhouse
QQQ
1,151
8.24
9
0.92
None
Very High
7.0
Tenet Healthcare Corp
THC
Michael Waterhouse
VCA Antech, Inc.
WOOF Debbie Wang
QQQ
4,346
42.77
36
1.19
None
Very High
11.9
QQQ
2,515
28.38
30
0.95
Narrow
Medium
15.0
Tenet Healthcare Corp
THC
QQQ
4,084
40.19
36
1.12
None
Very High
14.4
VCA Antech, Inc.
WOOF Debbie Wang
QQQ
2,516
28.39
30
0.95
Narrow
Medium
17.3
Company
Ticker
Analyst
Star Rating
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
Abbott Laboratories
ABT
Debbie Wang
QQQQ
54,923
35.34
40
0.88
Narrow
Low
13.5
Abiomed, Inc.
ABMD Julie Stralow
QQ
866
22.04
17
1.30
None
High
50.5
Boston Scientific, Inc.
BSX
Debbie Wang
QQ
15,765
11.74
8
1.47
Narrow
High
22.9
Edwards Lifesciences Corporation
EW
Debbie Wang
QQQ
7,939
70.71
78
0.91
Narrow
High
18.8
Given Imaging, Ltd.
GIVN
Debbie Wang
QQQ
586
18.50
18
1.03
Narrow
High
20.8
Medtronic, Inc.
MDT
Debbie Wang
QQQQ
53,863
54.00
60
0.90
Wide
Medium
13.3
Nobel Biocare Holding AG
NOBN Michael Waterhouse
QQQ
1,708
13.80
13
1.06
Narrow
Medium
25.1
Smith & Nephew PLC
SNN
Debbie Wang
QQQ
11,190
62.33
61
1.02
Narrow
Medium
42.2
Sonova Holding AG
SOON
Alex Morozov
QQQ
7,699
114.70
109
1.05
Narrow
Medium
21.6
St Jude Medical, Inc.
STJ
Debbie Wang
QQQ
15,477
53.89
49
1.10
Wide
Medium
13.3
Stryker Corporation
SYK
Debbie Wang
QQQ
27,086
71.63
70
1.02
Wide
Medium
15.3
Thoratec Corporation
THOR
Julie Stralow
QQQ
2,152
37.40
34
1.10
None
High
19.1
William Demant Holding A/S
WDH
Alex Morozov
QQQ
30,138
516.50
466
1.11
Narrow
Medium
19.8
Zimmer Holdings Inc
ZMH
Debbie Wang
QQQ
14,159
83.51
80
1.04
Wide
Medium
13.0
Thoratec Corporation
THOR
Julie Stralow
QQQ
2,076
36.09
34
1.06
None
High
20.8
William Demant Holding A/S
WDH
Alex Morozov
QQQ
29,204
500.50
466
1.07
Narrow
Medium
20.6
Zimmer Holdings Inc
ZMH
Debbie Wang
QQQ
13,538
79.85
80
1.00
Wide
Medium
13.9
Company
Ticker
Analyst
Star Rating
AMN Healthcare Services, Inc.
AHS
Vishnu Lekraj
QQQ
DaVita HealthCare Partners Inc
DVA
Michael Waterhouse
Fresenius Medical Care AG & Co.
KGaA
FMS
HCA Holdings Inc
Michael Waterhouse
Fwd P/E
Medical Device Companies
Fwd P/E
54
Medical Distribution Companies
Market
Cap
Price
Fair Value
Price/FV
QQ
14,369
62.23
47
QQ
18,144
53.45
HSIC
Michael Waterhouse
QQQ
MCK
QQ
Owens & Minor, Inc.
OMI
Patterson Companies, Inc.
PDCO
Michael Waterhouse
Company
Ticker
Analyst
Star Rating
AmerisourceBergen Corp
ABC
Cardinal Health Inc
CAH
Henry Schein, Inc.
McKesson, Inc.
Moat
Uncertainty
Rating
1.32
Narrow
Medium
16.7
40
1.34
Narrow
Medium
13.3
Fwd P/E
9,120
105.44
99
1.07
Wide
Medium
18.4
30,181
132.01
100
1.32
Narrow
Medium
15.6
Q
2,223
35.12
27
1.30
None
Low
15.3
QQQ
4,338
41.20
39
1.06
Wide
Medium
17.9
Moat
Uncertainty
Rating
Medical Instruments & Supplies Companies
Company
Ticker
Analyst
Star Rating
Market
Cap
Price
Fair Value
Price/FV
Baxter International Inc.
BAX
Karen Andersen
QQQQ
39,189
72.20
80
0.90
Wide
Low
13.5
Becton Dickinson & Co
BDX
Alex Morozov
QQQ
19,979
102.87
103
1.00
Narrow
Low
15.5
C.R. Bard, Inc.
BCR
Debbie Wang
QQ
9,506
120.10
107
1.12
Narrow
Medium
16.5
CareFusion Corp
CFN
Michael Waterhouse
QQQ
8,140
37.97
37
1.03
Narrow
Medium
15.3
Coloplast
COLOB Debbie Wang
QQ
63,347
329.50
294
1.12
Narrow
Medium
23.5
Cooper Companies
COO
Michael Waterhouse
QQ
6,461
131.99
99
1.33
None
High
17.8
Covidien PLC
COV
Alex Morozov
QQQ
29,067
63.19
68
0.93
Wide
Medium
14.8
DENTSPLY International, Inc.
XRAY
Michael Waterhouse
QQ
6,305
44.31
39
1.14
Narrow
Medium
16.4
Essilor International SA
EI
Michael Waterhouse
QQ
17,835
83.06
67
1.24
Wide
Medium
23.9
Hologic Inc
HOLX
QQQQ
5,444
20.13
26
0.77
Narrow
Medium
15.6
Illumina, Inc.
ILMN
QQ
10,219
81.67
65
1.26
None
High
37.7
Insulet Corporation
PODD
Debbie Wang
QQ
2,054
37.75
27
1.40
None
High
Intuitive Surgical, Inc.
ISRG
Alex Morozov
QQQ
14,692
369.98
400
0.92
Wide
High
19.5
Mindray Medical
International Limited
MR
QQQ
4,994
42.53
42
1.01
None
High
17.9
Varian Medical Systems, Inc.
VAR
QQQ
8,138
75.59
78
0.97
Narrow
Medium
16.2
Fwd P/E
55
Pharmaceutical Retailers
Market
Cap
Price
Fair Value
Price/FV
QQQ
73,456
59.80
62
Vishnu Lekraj
QQQ
11,797
58.97
WAG
Q
52,911
Company
Ticker
Analyst
Star Rating
Sigma-Aldrich Corporation
SIAL
QQQ
Company
Ticker
Analyst
Star Rating
CVS Caremark Corp
CVS
Vishnu Lekraj
Shoppers Drug Mart Corporation
SC
Walgreen Company
Moat
Uncertainty
Rating
0.96
Wide
Medium
13.4
61.54
0.96
None
Medium
19.0
55.99
35
1.60
Narrow
Medium
16.8
Market
Cap
Price
Fair Value
Price/FV
Moat
Uncertainty
Rating
10,581
88.00
81
1.09
Narrow
Medium
Fwd P/E
Specialty Chemical Retailers
Fwd P/E
18.9

Healthcare Observer Oct 2013

Transcription

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