December Special Situations Investment Trends

JT Taylor, Managing Director and Senior Analyst
December 1, 2014

Taxes Need Fixing:  The annual fiasco over tax “extenders” is on display once again, and a deal lasting two years may be off the table. And, the likely solution — a one-year extension, retroactive to Jan. 1, 2014 — satisfies no one.  It’s still another reminder that the U.S. tax code is broken, so we’ll go out on a limb and predict serious action on corporate reform (under the moniker of business tax reform), potentially raising revenues that could pay for the Highway Trust Fund and other infrastructure projects.

Individual tax reform may be coming, but not next year — President Obama all but removed that possibility today with his insistence on moving corporate reform first.  Encouragingly however, his proposal to use repatriated funds for infrastructure may yet represent common ground with incoming House Ways and Means Chairman Paul Ryan.

December Energy Policy Investment Trends

Joe McMonigle, Senior Energy Analyst
December 1, 2014

Wind, Solar & Biodiesel Energy Tax Extenders: House and Senate congressional leaders are negotiating a potential tax extenders deal for consideration in early December. It’s unclear whether a general tax deal can get across the finish line but at least two energy provisions are in play. First, the easy one: renewal of the biodiesel tax credit will make it into the deal and probably retroactive to 2014. It has wide-spread support, and most importantly, no big opponents. The Production Tax Credit (PTC), on the other hand, is very expensive and lots of enemies. Press reports last week indicated that negotiators had agreed to a phased-out PTC extension at 100% for 2014 & 2015 followed by 80% in 2016 and 60% in 2017 after which the PTC is terminated. PTC supporters in the Senate hope that instead of a simple two year extension, the phase-out plan will mitigate strong opposition in the House. The House leadership seems in favor of a PTC extension as bargaining chip for permanent business tax provisions, such as the R&D tax credit. But it faces major opposition from the tea party, oil industry and big nuclear utilities. We think the phase-out plan, which is essentially a four-year extension, will be non-starter in the House. Meanwhile, the solar industry would like the ITC which expires in two years to get an early renewal but that seems highly unlikely.

Export-Import Bank Financing of Overseas Coal Plants: As part of President Obama’s climate change push last year, he issued an executive order directing Export-Import Bank, OPIC and other financing agencies to exclude projects involving coal plants. However, House Republicans and Senator Joe Manchin (D-WV) rolled back the executive order in the current Continuing Resolution which expires on December 11. We expect similar coal-friendly language to be included in the next continuing resolution or omnibus bill in December.

House Hearing to Push Crude Exports: Republicans are wasting no time in pushing crude exports as the House scheduled a hearing on December 11. Lifting the ban on crude exports will see significant action in 2015 with Republicans also now in control of the Senate. Its biggest proponent is Senator Lisa Murkowski (R-Alaska) who is slated to become Chairman of the Senate Energy Committee with Republicans in the majority. On a separate track, the White House may take some incremental steps early next year to allow condensate exports and blunt momentum for lifting the ban. While we don’t think the White House will take executive action to lift the ban, we believe the President would sign a bill if it can pass through Congress.

NRC Nomination in Lame Duck: If you think Majority Leader Harry Reid’s biggest priority is keeping the government operating with a spending bill, you would be wrong.  Instead, Senator Reid’s is more concerned about the Senate confirming a new nominee to the Nuclear Regulatory Commission (NRC). In October, the NRC’s current chairperson announced she was leaving to take a job in academia. The development created a crisis situation for Senator Reid, the long-time Yucca Mountain foe. Reid has been able to keep Yucca stalled with friendly NRC appointments and cutting appropriations. In November the White House nominated current commissioner & Reid ally Jeffrey Baran to a new five-year term. If Reid can’t get Baran confirmed in the Lame Duck session, the nomination will surely run into trouble when Senate Republicans take over in January.

December Health Policy Investment Trends

Paul Heldman, Senior Health Policy Analyst & Sarah Mills, Analyst
December 1, 2014

Inpatient rehab facilities remain a top potential source of Medicare legislative savings to finance congressional initiatives in 2015, including for a likely bill in late March to delay a 21% Medicare physician pay cut scheduled to take effect April 1. MedPAC, a congressional advisory panel on Medicare, will likely at its Dec. 18-19 meetings consider a recommendation to more closely align inpatient rehab hospital payments with those of lower paid skilled nursing facilities. Inpatient rehab providers: HLS, KND; skilled nursing facilities: ENSG, SKH, KND.

Hospitals and the Supreme Court: We caution investors in hospitals from being too optimistic about the continuation of federal subsidies to help 4.5 million people buy health coverage now that the Supreme Court has accepted a challenge to the government assistance to working class Americans in 35 states.  We reiterate the subsidies will most likely continue to flow, but we think the issue could get snagged and tangled in the politics of the 2016 presidential and congressional elections. Oral arguments are likely in early March, followed by a high court ruling in late June. Hospitals: HCA, LPNT, THC, UHS, CYH.

Device Tax, Insurance Risk Corridors: We reiterate a 65% chance that the new Republican-controlled Congress early next year will eliminate the 2.3% tax on medical device sales by capitalizing on opposition to the levy from Democrats representing states with a heavy concentration of device manufacturers. Government assistance to health insurers known as risk corridors is also in play for moderation or repeal by Republicans who describe it as an industry bailout. However, we think the Obama administration and industry will most likely successfully push back against repeal of this mechanism for helping insurers to contain premium increases.

Biosimilars:  The Food and Drug Administration (FDA) is moving under a new abbreviated process toward approval of the first lower cost biosimilar competitor to a brand-name biotech drug.

The first product approval may come as early as May for a biosimilar version of Neupogen being produced by Sandoz, the generic manufacturing division of Novartis (NVS), in our view.  The maker of the innovator version of the drug is Amgen.

Progress by the FDA includes likely issuance by the agency of guidance by year end on labeling and interchangeability requirements for  biosimilars. We are unsure whether the FDA will also address biosimilar naming in its labeling guidance, but we expect a guidance on naming will be be available within the first half of 2015. We reiterate the FDA will most likely resolve the contentious biosimilar naming issue in a way most favorable to makers of biosimilars by requiring these products to have a modifier attached to the generic drug name that is traditionally shared by innovator and generic drug companies for products with the same active ingredients.Generic Drug Pricing:  We believe the new Republican-controlled Congress is unlikely to take legislative steps to control rising generic drug prices. The greater threat may be from the Justice Department, which is investigating generic drug price increases.  Medicare and Medicaid data showed an average 448% increase from July 2013 to July 2014 for half of all generic drugs, according to Sen. Bernie Sanders of Vermont, a liberal independent who caucuses with the Democrats. Sanders recently held a subcommittee hearing on rising generic drug prices.

December Telecom-Media Policy Trends

Paul Glenchur, Senior Telecom-Cable Analyst
December 1, 2014

Comcast-Time Warner Cable: The Justice Department and the FCC continue to review the proposed combination of the country’s largest cable operators.  We continue to believe a DOJ challenge would be a tough case for the government.  Still, regulators are concerned that the merged operator could leverage its broadband customer scale to disadvantage online video providers or raise broadband network interconnection costs.  We think the deal will likely be approved with significant conditions by the end of the first quarter next year.  If the FCC majority begins to settle on common carrier regulation of broadband services in its net neutrality rules, the contemplated imposition of such rules could actually enhance prospects for deal approval.

Net Neutrality: President Obama has endorsed public utility regulation of broadband networks, escalating the risk that the FCC’s Democratic majority will go along despite its role as an independent regulator. The push for common carrier regulation under Title II of the Communications Act requires a careful analysis and disposition of associated legal issues, pushing the FCC’s target for final rules well into next year.  The threat of such regulation is a major overhang on cable and telco operators and they are scrambling to avoid a Title II outcome.

Over-the-Top Video: The FCC will likely propose treating pure over-the-top broadband video providers as cable competitors entitled to regulatory benefits like program access and retransmission consent rights.  The classifications would apply to linear content providers, not on-demand services like Netflix.  The FCC proposal could boost emerging OTT offerings from Dish Network and Sony. But there is an under-appreciated risk to cable operators.  The FCC could gain greater latitude to regulate cable broadband network management practices independent of net neutrality rules.

December Defense Policy Investment Trends

LtGen Emerson “Emo” Gardner, Senior Defense Adviser
December 1, 2014

Congress is on track to pass a baseline Pentagon budget of $496B for FY 2015 that will increase procurement spending by a net $1.8B (+2%) above the President’s baseline request. The increase to the procurement account will be accomplished within the previously agreed topline by means of minor reductions to the President’s proposals for R&D, Operations and Maintenance and Manpower. HII‘s carrier and LPD shipbuilding programs and BA‘s F-18 line will be the big winners. Total Pentagon procurement spending in FY 2015 will now be down only 1.7% from FY 2014.

Pentagon spending will increase in FY 2016.  The Administration is finalizing a Pentagon budget proposal of $535B for FY 2016, $36B above the sequestration cap imposed by the Budget Control Act which it assumes will be amended next year.  We think this is a good assumption.  It is difficult to believe that the new, Republican-led Congress will underbid this President on defense going into an election year. We expect to see a deal in 2015 that will raise the discretionary budget caps for defense spending in FY 2016 and 2017.