Healthcare Memo: Most Favored Nation

Welcome to Rebound Capital. Here we conduct deep research into beaten-down stocks and study companies that made a successful comeback. Subscribe for free and join 5,100 other investors to make sure you don’t miss our next briefing:

A quick update before we jump in — The Trade Desk ($TTD), which was up 30% after our buy call in June, just reported its earnings and is down 28% in pre-market. We will be covering the earnings and its long-term impact in detail tomorrow (available only for paid subscribers).

U.S. healthcare and pharmaceutical stocks are experiencing their worst performance in decades. Healthcare’s valuation discount to the S&P 500 is now nearly at its widest in 30 years, and most companies are trading at half the P/E of the S&P 500.

Drawdown figures on some of these household names are astonishing:

Healthcare ETFs have now seen 12 consecutive months of net outflows, and the outflow in July was more than any other sector, according to State Street. To put the drawdown in perspective,

This has naturally attracted a lot of value investors who believe that the bad news is priced in and the market is due for a pullback.

While we agree with the overall sentiment (as we highlighted with our GLP-1 investment basket), there is something that could turn these bargains into value traps.

Trump’s Most Favored Nation (MFN) proposal would force Medicare to pay no more than the lowest price that peer nations pay for the same drugs. U.S. drug prices for many medications are 4–5 times those in peer-developed markets.

While the proposal is logical, if it’s enforced in its current form, it will be catastrophic for most of these companies. Given the compressed valuations, deep drawdowns, and constant regulatory overhang, let’s dig into:

It started with this May 12th executive order from President Trump. It directs the U.S. to secure a most-favored-nation (MFN) price on prescription drugs. Simply put, the aim is that Americans should pay no more than the lowest price in comparable developed countries.

Just focusing on the key aspects,

After the administration engaged with manufacturers on MFN pricing, the proposals fell short. Last week, on July 31st, the White House sent letters to 17 pharma companies laying out specific MFN paths.

The letter had four demands:

September 29th will be the deadline for companies to update to MFN pricing. If not, Trump has said that he would "deploy every tool in our arsenal to protect American families from continued abusive drug pricing."

Till now, none of the companies has responded to the letter. It makes sense, as it’s still very early in the 60-day window, and pricing teams will likely drag their feet until the White House makes its next move.

The 17 companies that received the letters were

While all these companies have something to lose by the MFN implementation, there are a few firms that will be hit the hardest.

Merck was already in a deep drawdown before MFN. They are very reliant on U.S. sales of Keytruda (a top-selling cancer immunotherapy). Keytruda’s price in the U.S. is substantially higher than abroad, and it currently has no biosimilar competition (making it an ideal target for MFN). Merck gets an estimated ~45-50% of its revenue from the U.S., but a larger share of profit (due to price differentials).

Both are part of our GLP-1 portfolio and are among the leading GLP-1 drugs for diabetes and obesity. U.S. insulin prices have been notoriously high compared to those in the rest of the world. Even their weight loss drugs, Ozempic and Wegovy, are both considerably cheaper in Europe. Both firms derive roughly ~50% or more of sales from the U.S. market and stand to lose significant revenue if forced to sell at MFN prices.

These partners co-market Eliquis, a blockbuster blood thinner with no generic due until 2028. Eliquis has been a significant cash cow in the U.S. Any mandate to sell at the lowest global price would substantially reduce its U.S. profit.

p.s. — This is just a preliminary list based on a glance at their product mix. Deeper due diligence coming soon.

This is not the first time the Trump administration has attempted to implement most-favored-nation pricing. Back in November 2020, it was announced that Medicare drugs would come under the MFN model starting in January 2021.

But just next month, it was blocked by a Judge for skipping APA notice, followed by a nationwide preliminary injunction. After this, the new Biden administration did not try to salvage a model that was legally vulnerable and operationally disruptive.

The concerns are overblown and may have created a buying opportunity.

JP Morgan had an interesting finding where on average, the S&P 500 returned only 4% in the next 12 months if you invested when the consumer sentiment was at its peak, whereas if you invested when the consumer sentiment was at its lowest, over the next 12 months, your average return was 24.9%!

A 6x increase in returns just by investing when everyone else was skeptical to do so.

Healthcare is going through a similar situation where consumer sentiment is now at the lowest it has ever been. While its tough to invest in a situation like this given the uncertainties, it’s exactly these setups that will provide the most return if we can stomach the volatility.

Next week, we will be building (and investing our own capital) into a healthcare basket. The report will be exclusive to Rebound Capital paid subscribers.

Upgrade now to receive it (plus a lot more) the moment we post:

Thank you so much for reading till the end. If you found it useful, the only thing I ask you in return is to share it with a friend. See you next time :)