In the first seven months of 2015 the healthcare market came to the rescue of the event-driven strategy. Reports indicate:
- The gains for event-driven hedge funds in this period have been quite modest, just 1.7%
- These funds lost ground in July, with a bottom line of -0.6% in contrast to +0.7% for all strategies;
- Exposure to the commodity sector was the big problem, and
- Healthcare has been the solution, keeping this sector in the black YTD.
The rippling effects of the Affordable Care Act of 2010, a/k/a Obamacare, in the United States, have a lot to do with the volatility of related markets, and the subsequent “events” or “special situations” on which the strategy thrives.
All of this raises the question: why is a bill that was signed into law five years ago having such an impact just now?
Three Challenges
In part, its impact on the investment world has been mitigated until very recently by the protracted and complicated litigation that the new law immediately generated. There was no clarity about how much of the law would survive the various challenges.
Since then, three big challenges to the law, framed in different ways, have gotten as far as the Supreme Court, and the administration has won two of them. In June 2012, SCOTUS upheld the constitutionality of the individual mandate.
Two years later, the court allowed closely held for-profit corporations to opt out of the contraceptive mandate, a regulation adopted by the Health and Human Services Department pursuant to the ACA. Despite the furor this created, in retrospect this looks like a detail in the operation of the law, not a significant set-back to the over-all scheme. Meanwhile, in January 2014, most major provisions of the law had come into effect, although some remain to be phased in.
Finally, in June 2015, the court decided King v. Burwell, a challenge that took the form of a dispute over the interpretation of the statute. SCOTUS found that the law means what its sponsors thought it means, thus upholding the use of federal subsidies to pay for health insurance in every state, not merely in states that have set up state-sponsored exchanges. Any remaining hope that SCOTUS would restore something like status quo ante must by now have disappeared.
With that hope gone, and with implementation taking hold, the law seems to have inspired a good deal of consolidation in the healthcare world, in physicians’ practices, in hospitals, in medical devices, and in pharmaceuticals.
Looking at Pharmaceuticals
Thus, Teva decides to buy Allergan for $40.5 billion, and hedge funds reap rewards for long positions in them both.
Even leaving Obamacare aside, there are two factors in the pharmaceutical business in particular that make it peculiarly susceptible to the urge to merge just now. First, the profits in the generics end of the business have been on a diet, they’ve been getting more slender over at least a decade. That process seems to have reached a tipping point. Second, the drugs which were scheduled to go off patent have gone off patent. What has been a loss for some (the patent holders) has been a boon for others. Yet such boons are slowing, and the companies that might once have pitched their planning around drugs held by other (and proprietary) manufacturers and that were nearing the end of their patent life, now have to look elsewhere: such as, the M&A market.
Obamacare is giving us a new world, and in the transition to that new world, and whatever equilibrium it will entail, there will be inefficiencies. The typical event-driven merger arb play is the ‘easy way’ to make money on this situation. There are other ways.
For example, do the sorts of closely held corporations referenced in Hobby Lobby get an advantage or a disadvantage by opting out of contraception coverage? If they either get an advantage or suffer a disadvantage from their decision, in comparison to, say, publicly owned competitors, then it ought to be possible to bet on that outcome in the one or the other direction. Surely someone will figure it out, and will do so ahead of the market at large, before the logic of discounting and of equilibrium closes this window.