Market confidence in the medical device sector declined, at least in the short term, in response to the Obama administration's fiscal 2010 budget proposal in late February, but analysts say investors are overreacting to very abstract risks to the industry.

Device stocks, along with pharmaceutical offerings, have declined at a distinctly quicker rate compared to the overall market since Feb. 26, when the budget overview came out.

An ¹ index of about 150 medical instruments and supplies stocks tracked on Yahoo Finance, for instance, fell 9.3% from the close of market on Feb. 25 through the end of that week. The Dow Jones Industrial Average dropped by less than 3% over the same period.

"The fallout from the White House budget proposal was far-reaching, but in our view way overstated and largely misplaced," writes J.P. Morgan device analyst Michael Weinstein in a March 2 note.

Only One Device-Specific Proposal

The budget includes proposals designed to raise about $634 billion for a reserve fund to help pay for a yet-unspecified health care reform plan. Half of the money would come from increasing tax revenue and the other half from health policy reforms.

In the latter category, the largest chunks of savings would be generated from payment cuts to private insurers that contract with CMS to service Medicare managed-care beneficiaries; better alignment of hospital payments with quality measures such as reduced readmission rates; and reform of home health Medicare payments.

The administration also proposes to increase rebates that drug makers have to pay the government under Medicaid, and to create a pathway for FDA approval of generic biologics. The only proposal directly targeting the device sector is a requirement for prior authorization by radiology benefit managers for Medicare imaging scans (² Also see "Obama Budget Seeks Prior Authorization For Medicare Imaging" - Medtech Insight, 2 March, 2009., p. 3).

Overall, "There is not much in this budget proposal that directly impacts the medtech sector," notes Kim Monk, managing director with Capital Alpha Partners.

The proposed hospital cuts, totaling about $38 billion, have some carryover to the device industry, primarily in capital equipment, a subsector already suffering from the global credit crisis (³ Also see "Diagnostics Imaging Sector Hit By Hospitals’ Dwindling Access To Capital" - Medtech Insight, 2 February, 2009., p. 9). But the hospital cuts "shouldn't mean some big negative hit" to implantable device firms, J.P. Morgan's Weinstein says.

Morgan Stanley's David Lewis says in a March 3 note that the stock underperformance is "being driven more by abstract fears of increased government scrutiny of health care costs and associated pricing pressures."

Investors are right to consider the general prospects for health reform beyond the specific provisions of the budget proposal, Lewis concedes. But much of the device sector is more insulated from the types of proposals under consideration than, for instance, the drug and insurance industries, he stresses.

"Medical devices do not face the same type of pricing pressure stemming from government intervention as other sectors, as device pricing is not directly regulated, and is based on competitive innovation and is negotiated between supplier and hospital," Lewis writes.

"Any attempt to more directly regulate device pricing would require an overhaul of the [inpatient diagnosis-related group] system, which we view as unlikely, and certainly not contemplated by the Obama administration's plan."

In any case, the health fund provisions in the Obama budget are still very much in the proposal stage. Later in the year Congress will use the budget as a starting point to produce a non-binding budget resolution, establishing an upper spending limit. For the specific policies to be enacted, lawmakers would need to complete the optional budget reconciliation process.

"We probably won't have reconciliation, but that remains to be seen," Capital Alpha's Monk said. If not, specific pieces of legislation would be needed in order to make these and other changes.

- David Filmore (d.filmore@elsevier.com)

Despite Stock Drop, Obama Budget Not Expected To Tangibly Impact Medtech

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