Is Patient Health Being Mortgaged via Derivatives as Homes Were During the Financial Crisis?

    Senator McConnell’s Dilemma:   To Serve Patients or Investors?

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When evaluating health care investments it is important to analyze the structure of leading drug and medical equipment companies.  A close look indeed reveals a derivative driven system in which private equity and hedge funds increase demand for drug payments by purchasing the rights to the cash flows from key drugs.  Patients are indeed unaware that many of the drugs they consume are now owned in part by private equity investors.

Large drug companies’s royalty cash flows are sold to private equity investors and then these private equity firms slice and dice the cash flows into fixed income products and sell them to investors.  Not unlike the sale of mortgage backed bonds issued prior to the housing crisis.   While the collateral for mortgages was homes, the collateral for these bonds is patient health.

Imagine the profits for the private equity and hedge funds in that they not only get a management fee yet also carried interest incentive profits.  In addition, they also earn other fees on the fixed income products sold to an added layer of investors.  Meanwhile, patients try to explain rising drug prices.

Two leading purchasers of drug cash flows from major drug firms are Royalty Pharma and DRI Capital.  These firms do not discover, develop or manufacture products. Instead they purchase drug cash flows from patients.

Each boasts of having high quality diversified drug portfolios,  better diversified that most big drug firms.  This claim is true, see following NY Times story.


See complete New York Times story here:

The Private Equity Firm That Quietly Profits on Top-Selling Drugs – The New York Times

If given an opportunity to be an equity investor in Royalty Pharma, Merck or Pfizer, I would choose Royalty Pharma.  They have essentially cherry picked the medical system and are better diversified.  The problem is that Royalty Pharma is not publicly traded but rather an insider’s game.

Royalty Pharma will, however, issue  “equity interests” to sellers of royalties.  It is not clear whether this is straight stock or non-qualified stock options.   Either would of course provide a powerful incentive to “market the heck out of these products.”   This is exactly what happened with mortgages.   Rather than “liar loans” regarding mortgages the new mantra is “ask your doctor about.”

Remarkably, while most of the firms that purchase drug royalties and package them into these investment products are registered with the SEC as investment advisors, Royalty Pharma is not.  See exemption letter granted from SEC in 2010 based upon Royalty Pharma’s  logic that they are not an investment firm.

Royalty Pharma’s Exemption From Filing ADV Form with the SEC


Not only does Royalty Pharma get significant investment dollars from public pensions and other tax exempts, it also now has a subsidiary credit firm that has done an IPO on the European exchange. This means teachers, firemen, and many others are invested in Royalty Pharma via their pensions. See NYT story.

One would also think Royalty Pharma would be mentioned in the SEC 10Q and 10K filings of major drug firms with whom they do business, including Merck and Pfizer, yet it isn’t.  Failure to disclose such a “material” relationship violates the most basic nature of SEC disclosure.

In addition, while some US based drug and medical equipment firms have done tax inversions to present themselves as UK or Canada based to avoid domestic taxation, others have gotten more specific and done what one could call “product specific inversions.”

Of course a tax evasion backlash is a key risk to any inversion in the event of successful reform. Royalty Pharma is indeed an “Irish Unit Trust” per its correspondence with the SEC, a fact it used to further legitimize why is should not be required to register with the SEC.

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It is somewhat ironic that Caterpillar is being sued by the IRS for falsely classifying US based sales as European, exposing it to a $2 billion judgement and enforcement actions by the IRS, while Royalty Pharma, with more than 1.5 billion in revenue, reclassifies U.S. based sales of key drugs it takes royalty payments on as European sales, essentially doing the same thing.

This should be President Trump’s focus, fairness first prior to discussing rates.  Job producing American industries have been handicapped too long by these tax inequities that only serve to inspire foreign firms to buy US companies and eliminate all taxes via creative accounting.

Basic Steps Used by Drug Companies Who Sell Royalty Cash Flows, Example Royalty Pharma:

1.  Royalty Pharma and other leading purchasers of drug cash flows, firms primarily based in the UK and Canada, solicit investment funds and form partnerships with large investors, mostly tax exempt public pensions, foundations and endowments.  For this they earn a management fee and carried interest incentive fees.

2.  Merck, Pfizer, Johnson and Johnson, Eli Lilly and other large drug companies then sell future drug royalty cash flows on specific drugs to these firms in one of three ways: Patent and exclusive Purchase Agreement, Exclusive License Purchase Agreement or a Royalty Payment Conveyance agreement.  They might for example sell the right to a drug for $300 million to Royalty Pharma who in turn gets  a 5 percent royalty on all future sales.

3.  Royalty Pharma creates fixed income products that are sold to investors in order to generate funds necessary for the next drug royalty purchase.  These bonds are generally highly rated by the bond rating agencies.  A key assumption being that the underlying drug prices are sustainable.

Royalty Pharma CEO Pablo Legorreta’s Presentation to Institutional Investors Further Explaining Its Business Model

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List of Royalty Pharma’s Top 30 Purchased Royalties:

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Conclusion:  Royalty Pharma has a great inside game, one that investors should pay attention to in the event it opens up.

President Trump should also be paying attention because this is where the real patient care debate lies, that is drug costs, rather than wasting so much time and energy on the insurance coverage side, whether Obamacare or TrumpCare. Drug costs can and should come down substantially.