With the recently announced acquisitions of Nordion by U.S.-based Sterigenics, Patheon by private equity firm JLL Partners and Paladin by Endo Pharmaceuticals, the unwinding of the Canadian health care industry, which began in earnest in the second half of the 2000s, seems to have largely come to its conclusion. This once promising growth sector has not found a way to revive itself, and Canadian investors find themselves with few domestic choices when looking for exposure to an important and fundamentally attractive industry. As significant holders of Patheon and Nordion, we appreciated the recognition of the underlying value (finally) of these two businesses, but somewhat lament the lack of opportunities to redeploy capital domestically.
So how did we get here, and what does the future hold for Canadian health care? Having had a front-row seat for much of the rise and fall of the sector in Canada over the course of my career, I am unfortunately unenthusiastic regarding its future prospects. At Signature, we expect to look outside of Canada to get our health care fix.
As a biochemistry graduate in the mid-1990s, I hitched my career wagon to the Canadian healthcare star, first getting a PhD and then working at a start-up biotechnology company. This was in the era of some of the great Canadian success stories – Biochem Pharma, QLT, ID Biomedical – when the promise of the industry seemed limitless and Canada appeared poised to take a leadership role on the back of high-quality science and a healthy dose of entrepreneurship. Moving over to the finance industry, I watched a second wave of Canadian companies ascend, with firms like AnorMED, Cardiome and Angiotech rapidly developing promising new products and companies like MDS, Patheon and Biovail taking their place as global leaders in their respective fields. It was, for a short window, a good time to be a Canadian health care investor (or analyst).
Things changed fairly rapidly for the sector however, and the promise of an enduring industry in Canada faded. With a decline or disappearance of the incumbents through acquisition (ID Biomedical, AnorMED, Axcan Pharma), operational issues (MDS, Patheon, Biovail) or a lack of ability to come up with their next great product (Angiotech, QLT), the sector faced the challenge of reinventing itself. While a boom and bust cycle is not unusual for an industry built on innovation, there were unfortunately no new companies ready to fill the void. This was due to a rather sudden lack of available risk capital from the emergence of the commodities super cycle, which functionally sucked all of the oxygen out of the room. Coupled with an absence of a commitment from the federal and provincial governments to the industry, bench strength was lacking and over the next 5-7 years, the sector dramatically hollowed out in Canada. When I left Canada to work for the United States (prospects seemed equally dim for a Canadian health care analyst as they were for Canadian health care investors), there were few strong or emerging companies, and the aggregate market cap of health care companies in the TSX index had shriveled to around $5 billion, representing less than 50 basis points of the total index.
The situation is very different outside Canada however, as investment in the sector has continued at a rapid pace. In 2013 alone, there was approximately $100 billion raised by health care companies globally, with more than 50 IPOs. During my time in the U.S., where capital for innovation and institutional support for the industry doesn’t appear to be lacking, it seemed apparent that significant new advances across biotechnology, medical devices and even health care services would continue to drive growth of the sector globally. With strong underlying fundamentals it is not difficult to see why the sector continues to attract attention.
Upon my return to Canada a few years ago, it was disappointing to see that little had changed. Although the market cap ($60 billion) and relative weight (3%) of health care companies in the TSX index have technically never been higher than they are now, they are still low relative to global markets. Further, the index is entirely comprised of firms that have Canadian listings but are functionally U.S. companies (e.g. Valeant, Catamaran and Extendicare). While we continue to watch for select domestic opportunities (there is still good science being done in Canada), it seems clear that the prospects for the Canadian sector remain underwhelming.
We maintain an overweight position in health care equities across our funds as we see significant long-term tailwinds for the sector, with demographic and emerging market wealth effects driving strong demand for providers of health care. We are focused on companies with strong research and development capabilities, such as Roche and Novartis, as ultimately top-line growth will be driven by pipeline success and the ability to deliver novel drugs to the health care system. We hope that someday a Canadian firm can rejoin the ranks of the global health care leaders, but until then, we will continue to look elsewhere around the globe for opportunities.