Blog: Paul and Brett’s Alpha September 2021

Paul Major, Brett Darke – Portfolio Manager

The monthly BBH factsheet and commentary is always thought provoking and elicits a wide range of responses and views, here at the Trust we thought it would be a good idea to make the portfolio management teams commentary available in form of  rolling 12 month blog, as always any comments and observations are welcome.

September 2021

Extraordinary Popular Delusions and the Madness of Crowds

What, ultimately, is the point of the BB Healthcare Trust? Prosaically, it exists primarily to enrich its shareholders, and seeks to do so in a manner that exceeds the returns alternative passive options in the same industry sector might offer. More thoughtfully, one might describe it as offering the opportunity for investors to participate in an inevitable and necessary change in the healthcare delivery paradigm, since that which is currently on offer demonstrably fails to meet society’s needs at an acceptable cost.

The fulfilment of these concurrent objectives necessitates an understanding of the nature of, and inter-relationship between, three key variables: 1. The bottlenecks in the current healthcare delivery system that create inefficiencies and sub-optimal outcomes; 2. The practical utility of proposed solutions to these problems and 3. The best way to gain exposure to these solutions vis-à-vis maximising risk/return for investors.

Sometimes, the perfect triangulation of these variables is not yet possible, typically because: 1. There are problems for which practical solutions still elude us; 2: There are proposed solutions that do not make sense to us and, more commonly, 3: There are solutions available that can only be gained through exposures that we do not consider attractive investments overall.

Regarding the third point, we usually reach this conclusion because of one or more factors that include valuation, management quality, irrational expectations on the part of investors (i.e. consensus forecasts seem too high) or because the solution lies buried within a larger conglomerate structure that dilutes the return potential to a point where it is no longer compelling.

The focus of this month’s missive is on those situations where it is our contention that the market either seems to misunderstand the likely solution to an issue, or has accorded it a valuation out of kilter with the realities of the marketplace it seeks to address. We find these two scenarios to be a frustratingly prevalent issue in the world of Healthcare IT in the post-pandemic world.

Everyone likes Tulips

One of your managers spent many years working as a sell-side analyst in the healthcare sector. Perhaps the most challenging aspect of this role relates to “selling” an investment idea to the preponderance of generalist investors who control the majority of investable capital.

There are always more ideas than bandwidth to assimilate them, and effectively transmitting one’s idea across the market relies upon the amplification of the proposal through various channels (email, Bloomberg, sales people, phone calls etc.). In a crowded market for ideas, an investment proposition (long or short) has got to capture people’s attention and imagination in order to gain the traction that will make it a success: it needs a punchy headline.

As any healthcare analyst who has fought for a prime slot in an investment bank’s morning sales meeting will attest, discussing a supermarket or an airline is much more relatable to the aforementioned generalist than the esoteric details of why a new drug that intervenes in a different molecular pathway than another one is going to be better at improving the symptomology of some disease (often one that no-one has heard of).
Even if an investor can wrap their head around the central premise, there are ‘p-values’, ‘approval pathways’, ‘secondary endpoints’ and all manner of technocratic nonsense that would not seem out of place at an EU summit. The idea thus needs to be repackaged in an easily digestible format. As any of you who have tried to read investment bank research notes on healthcare companies will appreciate, the necessary reductionist simplification is seldom done well.

Inasmuch as the details of a prospective healthcare investment may veer into the dry and arcane, the bigger picture investment case for healthcare solutions remains beguiling. By way of an example, one need only to look at the share price reaction of US large-cap biotech Biogen upon speculation that its now-approved Alzheimer’s therapy Aduhelm might reach the market.

Few diseases capture the public imagination as much as this fearful syndrome and, despite the disease having the worst historical probability of positive clinical outcomes of any area of medicine that we can recall, the Aduhelm developments became front page news across the globe; no matter that the data behind the drug could charitably be described as mediocre.

Now however, gravity has re-asserted itself. Doctors are sceptical to use a therapy with limited clinical utility and payors understandably reluctant to fund it. Prescription volumes are lacklustre relative to irrational market expectations. This is now reflected in Biogen’s share price, which stands 32%below the peak Aduhelm over-excitement; around $15bn of market value has evaporated.

As the pandemic has shown us, science is ever changing and often messy, with probabilities of outcomes dominating over certain conclusions in the vast majority of cases. The challenge of communicating complex medical ideas as simple investment cases, in a world where people are both time poor and prone to multitudinous distractions, often results in the loss of these subtleties. Consequentially, share prices can often end up reflecting not the optionality of future success, but the presumption of it. Clearly, this is a problem for any rational, valuation-sensitive investor.

The illusory truth effect

The often esoteric nature of the products and services can create a second-order problem for prospective investors. We all want healthcare to be better, since becoming ill during our lifetimes is almost a certainty. When someone comes to investors, say during a euphonious IPO pitch, with an argument as to why a new product or service has something to offer in addressing the issues faced by the industry, they are want to believe it is credible.

Moreover, when those same people are offering not a slice of the ~$1.3 trillion dollar market for drugs as tended to be the focus of yesteryear, but are rather seeking to capture a small percentage saving across the $10 trillion (and growing) total global healthcare spending pie, the temptation to conflate even the chance of modest success with certainty of value becomes quite compelling.

The artificer must always be asking what a new offer really brings and what, if anything, is genuinely differentiated about it. One must also remember that successful long-term investing is as much about the visibility of future profits as anything else; at some point you have to generate some cash. Yes, hot stocks can rise for a time, but gravity has proven a reliably consistent force throughout history.

At least you get a tulip

Many of our readers will have heard ad nauseam our summary of the healthcare patient continuum and our views on the attractive points within this for novel approaches to create significant value for society through lower costs or better outcomes. As regards the nature of the changes to come, many of you will also be familiar with our frequent prognostications, but some bear repeating:

1. The system is too reliant on skilled human capital, which is scarce; 2. The system is wasteful; 3. Due to the self-initiated nature of care, many interactions between patients and physicians are viewed as not medically necessary after they have taken place; 4. The intersection between the patient and physician is the single largest area of expenditure. 5. The administrative burden resulting from frontline patient interactions amounts to a very material proportion of caregivers’ worktime.

Could we see a mutational drift that leads to immunologically distinct variants as we have with influenza for example? Over time this is possible but that may not matter if we have a situation where vaccines must be given annually, as the vaccine can potentially be ‘tuned’ as necessary to the evolution of the pathogen as happens with influenza each year. As we have noted previously, there are many things about the vaccines that we worry about, but we do not think the virus is mutating fast enough at the moment for that to be a significant issue.

Having immersed oneself in studying this, it is not really difficult to conclude that one of the most impactful changes that could take place quickly is a move toward a system of electronic triage and case management (“ETCM”): your first interaction with the healthcare system is a digital one that enables your progress to be tracked and for you to be directed to the lowest acuity point of care along the way.

As a practical example, savings could come from re-direction: there is no point seeing the GP (cost to NHS - £150) if you have the flu. Isolate at home; go online and get some Lemsip and take it easy. On the other hand, if you have had flu-like symptoms for some days and are now struggling to catch your breath, you probably have pneumonia and you may need to bypass the GP and go to the hospital.

Incidentally, if you are wearing a recent generation smartwatch/fitness band, its pulse oximeter could even help confirm a diagnosis of pneumonia or COVID-related silent hypoxia remotely, but we are not quite there yet. Such rapid elucidation of a worsening prognosis could save lives and money.

Semper Augustus

It is easy to see how, at first glance, ETCM tools could bloom into that rarest of products: one that both improves outcomes and saves money. However, the next question is: in what form is this potential bonanza made manifest? The initial (and probably meretricious) view was that telemedicine was central to the answer. For a time, we thought this was the case too.

There is no doubt virtual consultations can improve productivity for physicians: people do not dilly-dally in the virtual world, they are seldom late for their appointments and they are more likely to attend. Even when they are late or absent, it is much easier for the doctor to quickly move along to some other work. Thus, if we think of the physician simply as a productive asset, we can sweat them harder in a virtual world.
However, there is still a cost. Diverting someone away from the “real GP” so they can waste cyber time is still a waste. Perhaps its £75 or £100 instead of£150, but it is not zero cost. Furthermore, there is still some paperwork that needs to be done and so the inefficiencies of the system are not really being addressed. One could of course try to shift the administrative burden onto the patient via pre-meeting form filling, but this is a double edged sword – ask them to do too much and they will vote with their feet.

Coming off the back of a bolus of artificially high utilisation driven by the pandemic, the challenge with the telemedicine stocks now is determining what a reasonable cadence for growth is and what, if anything defines a unique, market share winning advantage. Is it simply a network effect (more doctors available across a range of specialities)? Is it the interface itself?

If the pandemic taught us anything, it is that complex interfaces are really not necessary for the majority of routine interactions. If we take September 2020 as the baseline, (when Amwell listed on the back of its pandemic windfalls), the share price of SOC Telemed has declined 78%, Amwell 49% and Teladoc 34%.

The beginnings of the ‘return to normal’ has also confirmed that many people who switched from face-to-face to virtual did so from necessity rather than choice, leading us to conclude that, whilst the widespread adoption of virtual visits has been temporally accelerated versus our pre-pandemic base case, it has not proved durable to the extent that current consensus expectations imply.

Another question we keep asking ourselves relates to the barriers to entry. If we were to add up the invested capital consumed by this entire sector so far, it amounts to a sum that probably wouldn’t trouble say Optum Health, or anyone in ‘big tech’ who decided to make a move into this area and they could easily afford to hire the relevant medical expertise.

In other words, the field is still wide open, especially when it is not obvious to us that anyone has built a sustainable competitive advantage and made their tools a ‘must have’ for any insurance carrier or physician group/hospital. We have recently reviewed the telemedicine sector in detail (as we do for all sub-sectors on a regular basis), but are a long way from re-joining the fray.

Propagation and hybridisation

If telemedicine in and of itself is likely to become commoditised, how does one expand the offer to create that compelling value proposition that might actually save money and improve access to quality healthcare?

Some companies are experimenting with Artificial Intelligence and ‘Bots’ to do the triage component. This has gained some traction in China (where medical access is a huge problem for those outside major cities) and may well help with the Managed Medicaid market in the US where the consumer does not really have free choice and healthcare resources may be geographically sparse. Some of these systems are argued to be no worse than the average doctor (and thus better than all those below the median), but who recognises their doctor is one of the below average ones?

Moreover, the liability issues and risks around so-called edge cases (where something potentially serious presents as something benign, confounding accurate diagnosis) are likely to hamper consumer willingness to accept such care. One can only imagine what the print media could do with such a case; if you can manufacture panic from nothing over a few petrol stations being closed somewhere far away, what could you make of this situation?

We continue to monitor these sorts of tools but have yet to conclude that they amount to a compelling investment opportunity, even though valuations have come back quite a way from the pandemic peak. This leaves us with two remaining areas of interest within the wider Healthcare IT sub-sector. One relates to the proposition of value based care (“VBC”) and the other is a sub-set of case management that we call system navigation (not really relevant in the UK, but critical in America).

The nobility of profit

Value-based care is a delivery model where a provider (a hospital, physician group or Accountable Care Organisation (“ACO”), which is a multi-disciplinary collective setup to manage such models), are paid a capitation payment based on patient health outcomes. Under VBC contracts, outcomes are measured in detail and providers are rewarded for helping patients improve their health, especially regarding the incidence and management of chronic diseases.

Another way of looking at this would be to say that an accredited organisation is in effect bidding to manage the medical risk of a particular group of patients (usually in a geographical location). If they do not meet performance goals then they are penalised financially. If they manage to deliver over and above (i.e. better outcomes) they are rewarded and, most importantly, the link between reimbursement and activity (the so-called fee-for-service model in the US that drives so much over-treatment) is broken. In this way, both sides (the ultimate payor, usually the State or Federal government, and the provider organisation) share the financial benefits of successful innovations.

The most surprising thing about this marketplace in the US is that it is not already much larger, given that one of the key objectives of the 2010 Affordable Care Act (“Obamacare”) was to promote VBC approaches (and the related value based payments, where hospital reimbursement levels for procedures paid for by Medicare and Medicaid varies with longer-term outcomes).

Part of the problem has been developing the IT systems to identify and manage patient needs better and thus meet the quality requirements and gain the opportunity to earn the upside; many physician groups and hospitals lacked the software tools to analyse how to intervene to change the cost/benefit ratio.

The big players in the market are beginning to build their own systems to do this (e.g. Anthem’s EPHC initiative, with its Co-operative Care program), but the provider networks in the US remain highly fragmented and smaller players need the help of specialist IT companies to build the necessary capabilities. It is here that we see opportunities for investment returns in line with both the thematic and financial objectives of the Trust and there remains room in this marketplace for the smaller software vendors to compete with larger players.

The moral maze

Imagine being a middle class employed American with a chronic medical condition. You are resigned to spending a significant amount of money managing your condition through recurrent physician appointments and your out of pocket drug costs. There may be other services that you might need as well, such as routine scans or tests. How do you navigate the landscape of providers and services to optimise cost, convenience and disease management?Even assuming that you had all of the relevant data to hand, how can a layperson weigh up the various trade-offs to get the best overall package for their personal needs?

There are innumerable surveys showing that employees do not really understand, or make full use of many of the benefits available to them from their carrier and others show they often get sub-optimal or over-treatment because they do not have access to second opinions. When we look to the individual health plan market (the so-called insurance exchanges created by Obamacare), the larger states also offer lots of choice (e.g. California had 11 plans on offer in recent years, New York 12 plans).

One could devote pages to criticisms of this fragmented and complex network, but for now it is what it is. Until that changes, consumers and employers will benefit greatly from benefit navigation software that enables them to select the best care for themselves or their plan members and then make best use of that care in order to stay as healthy as possible without incurring unexpected costs. Similar algorithms applied in the VBC segment can help to flag up people who are likely to incur certain issues ahead of time, which is another way to save them and their insurance carrier money.

Benefit navigation and optimisation is another area of the Healthcare IT landscape that we currently find attractive. It suits independent players as they can avoid perceived conflicts of interest and it is a growing niche as data builds up showing that employees who have access to these sorts of “care assistance” packages are happier and healthier, which makes them both more productive and cheaper for their employer.

Shoots or Leaves?

In summary then, the challenge for the longer-term investor is balancing the obvious central role that technology and software-enabled solutions will play in transforming the healthcare system with the realistic proposition for monetisation and investor value creation. Many of the ideas currently on offer are, like a beautiful flower, superficially attractive.

However, they are not immune from wilting and dying. How does one find a hardy perennial or identify that special tulip when the seed will not become a bloom for several years? As far as we can tell, there is no magic answer to this and, frankly, if we did have one, we would not be articulating it in our factsheet for all to read. The only way to navigate through this topic is to remain grounded in the numbers.

We are, at heart, GARP investors and will only pay up for growth that we can see within a reasonable timeframe and that reflects a base case scenario with appropriate levels of competitive risk baked in. Information technology undoubtedly has an outsized role to play in the re-shaping of the healthcare delivery paradigm, but that does not mean that every opportunity is worthy.

We always appreciate the opportunity to interact with our investors directly and you can submit questions regarding the Trust at any time via: shareholder_questions@bbhealthcaretrust.co.uk

As ever, we will endeavour to respond in a timely fashion. We thank you for your support of BB Healthcare Trust.

Paul Major and Brett Darke