We expect nominal pricing to decelerate 50 bps, from 1.9% to 1.4%; this is a direct consequence of the 2% decline in Medicare payment rates brought about by the ‘fiscal cliff’ sequester. Dental services are significantly less affected by the sequester, and appear able to maintain steady price growth of roughly 3.7%

Independent of our quarterly growth rate models, we handicap the odds of a trend break, i.e. a significant acceleration or deceleration in demand. The trend-break model indicates near zero probability – <2% – of accelerating demand in 2Q13

Our models correctly anticipated that the downward trend in unit demand would persist during 1Q13 – however the fall was even more dramatic than our pessimistic view. This is directionally consistent with company reported results from the quarter – where surprises to the downside of sell-side analyst revenue consensus estimates far exceeded positive surprises

We believe demand is weak primarily because of low employment, which translates into a smaller percentage of households having the benefit of the most generous source (employer-sponsored) of health coverage. Employment gains, expansion of Medicaid eligibility, and the initiation of state health insurance exchanges all are likely to expand the availability of health coverage in the relatively near-term

We recommend a pro-US / pro-cyclical tilt to healthcare portfolios; this translates into overweight positions for Hospitals, select Non-Rx Consumables (especially more US-focused names such as CFN and OMI), and select Dental names (emphasize more US-focused names with product lines that include higher-mix items, such as XRAY and PDCO). We recommend underweight positions in Large-cap Pharmaceuticals (on US real pricing power concerns), drug trades (Retail, Wholesale, PBM)(on the loss of AWP pricing, and risks of PBM disintermediation), and Research Tools / Services (implied revenue growth exceeds R&D spending growth)

For our full research notes, please visit our published research site

-          Unlike last year’s Jelly Bean intro, Nexus 7 launch and Glass skydiving extravaganza, Google I/O 13 had no single OMG moment and introduced no major new product categories.

-          The 3 ½ hour key note reeled off more than 100 enhancements to core franchises – Search/Now, Maps, Google+, Chrome, Play, Wallet, and the Android developer kit all got major upgrades.

-          The All Access music service, the pure Android Galaxy S4, and new photo editing/sharing tools lead the headlines, but integrated functionality across apps and platforms is the big step forward.

-          Google’s mastery of the cloud is a powerful weapon as platform differentiation and monetization shifts from the device to the web-based services that will increasingly define the user experience.

Last year, Google closed the opening keynote of its I/O developers conference, with a team of extreme athletes skydiving onto the roof of the San Francisco Moscone convention center and performing a series of mountain bike half-pipe stunts, before rappelling down to street level and bursting into the auditorium, all broadcasted to the audience via the first Google Glass units ever seen in the wild. This “Dire Wolf and Unicorn Show” (dog and pony seems too pedestrian), launched a year of Google Glass mania in nerd world and nearly over shadowed the Android 4.0 Jelly Bean and Nexus 7 tablet launches that had come earlier in the program. A second keynote on day two of the conference more quietly launched Google’s Compute Engine cloud hosting program aimed squarely at Amazon Web Services. That was a lot of “all new” for a single conference.

Google I/O 13 took a very different tack. No new hardware was announced – the pure Android version of the Samsung Galaxy S4 is a nice bone to throw to the true believers, but it is still the same hardware as the standard skinned version and will likely sell in de minimus quantities. Instead, Google went systematically through its application portfolio and offered a panoply of thoughtful improvements to almost all of them. Moreover, Google also offered Android Studio – a completely revamped development suite for the operating system that earned rapturous applause from the thousands of developers in attendance. Android Studio will make it much easier to develop for the platform, adding powerful tools for writing and testing apps, easing the burden of supporting the multiple versions of the OS in the market, and facilitating pathways to broader monetization. Management bragged that Android app installs had surpassed 48 billion, up 2 ½ times from a year ago on a trajectory to surpass Apple and its 50 billion+ apps within the next few months. All of this goes to make Android a much more attractive market for independent developers, enticing them to write for Android first and iOS second, rather than the other way around.

The headline grabber of the session was Google’s new All Access streaming music service, offering unlimited access to tracks from all three major labels for a $9.99 monthly fee. All Access gets users up and running immediately, with millions of tracks and well-designed functions for organizing queues and playlists, and tools for discovering new music. The service fills a major hole in the Android experience – Google had little success in enticing iTunes users to upload their music files to Google’s Drive service or to build a download business within Google Play. Assuming they are willing to foot the monthly fee, Android users can bypass most of the pain of switching from Apple. Given the 900 million Android devices that have been activated to date, odds are that All Access will find a reasonable market.

All Access was not the only change to Google Play. The store had already received a recent revamp, making it easier to find and download popular or recommended apps and content. Today’s announcements included a new games API that will enable users to save game status synched across different devices, along supporting multiplayer play, with tools to make it easier for developers to include multiplayer functionality in their games.

Google Search will soon show statistics graphically, and try to anticipate subsequent questions and add that data to the graphs. It has added conversational search, whereby the service interprets questions in context without requiring specific keywords. Conversational search can be initiated by voice, with the activation phrase “OK Google”. Google Now has been updated with six new types of notification cards, including information about books, music, TV shows and video games that may be of interest given time and location.

Maps received a substantial upgrade. Location maps will no longer be populated with generic landmarks, but will be customized to the user and context. Places a user has recently searched for or visited will be identified. Directions offer significantly more detail, with options, including alternative driving routes, public transit, biking paths and/or pedestrian routes,  graphically noted and estimated transit times offered based on existing conditions. Public transit directions will also include times for the next train or bus departure. Google Earth is now integrated allowing one click to satellite images. Navigation functions will soon include real-time incident alerts and dynamic re-routing. Flight schedules have also been integrated into Maps, allowing more extensive trip planning. All of this comes in an interface that is cleaner, with less screen real-estate devoted to extraneous menus and functions.

Google+ has been completely redesigned, with 41 new features. The splashiest of these is a set of photo editing and sharing tools. For example Google+ will automatically improve the tonal balance, sharpen details, remove noise and soften skin textures in photos uploaded to it. The service will also analyze photo sets, culling out blurry and poorly exposed images and proposing best choices from duplicate photos. It can also recognize and identify people and landmarks. The service will connect series of photos into animated GIFs. Google has also increased the free storage available to its users to 15GB, with unlimited free auto-backup for photos of less than 2048px. The redesigned Google+ now streams in three columns, in contrast to the single column feeds offered by Facebook and Twitter. Items in the streams are presented as interactive “cards” similar to those employed by Google Now. New posts will automatically be given a hashtag, which will make it easier for your posts to be discovered and for you to find content similar to what you have posted.

Google+ also becomes the lynchpin for a new unified cross-platform messaging system. Users can send text, photo and video messages using the Google+ Hangout facility, integrated within Gmail as well and available on desktop, Android and iOS. The service is intended to allow users to maintain conversations as they move across platforms with friends who may be on dissimilar devices. To date, Hangout’s main calling card has been its ad hoc video conferencing ability, and Google added a number of bells and whistles to the flagship service as well. Gmail got a few minor tweeks, including the ability to use Google Wallet to send money via an email attachment and buttons that will show with message notifications, allowing actions without opening the message. The latter capability is open to developers, who could streamline e-commerce e-mail authentications or offer one-click renewals.

YouTube was on the back burner during the keynote, but Google did announce an expansion of its Live Access program to any channel with more than 1,000 subscribers. This broadly increases the access to the live streaming service and should drive a dramatic increase in the availability of live content on the site.

Taken as a whole, the enhancements presented at Google I/O extend the company’s lead in delivering a comprehensive cloud-based experience that bridges devices and venues. Most of the new functions offered lever Google’s extraordinary web-scale distributed data center, supporting device operating systems with seemingly limitless computing and storage muscle provided from the cloud. As wireless networks grow ever faster and more ubiquitous and as users demand consistent experiences across device categories, I believe these cloud-based services will become the primary point of competitive differentiation and the key monetization lever in the battle for the hearts and pocketbooks of consumers. In this, the war is shifting onto terrain where Google has no real peers.

For our full research notes, please visit our published research site.

Assuming households that do purchase coverage do so optimally, +/- 80 pct of households would buy the cheapest (Bronze) coverage and the remainder (+/- 20 pct) the most expensive (Platinum) coverage. By purchasing the cheapest plan, healthy households (the 80 pct on Bronze) minimize their payment of excess premiums (premiums above their costs of care), and thus minimize the extent to which they subsidize households (the 20 pct on Platinum) whose medical costs exceed premiums paid

Small employers with younger and healthier employees can almost certainly save by self-funding, i.e. by avoiding the exchanges entirely. Stop-loss policies to self-funding employers can be priced to reflect a specific employer’s health risks, where fully-insured policies on the public exchanges cannot. This is likely to result in small group exchanges consisting of significantly worse-than-average health risks

We believe that the Affordable Care Act’s (ACA’s) provisions for limiting adverse selection are too weak (e.g. penalties for being uninsured are too low), or even counter-productive (higher effective premiums for younger than for older subsidy-eligible beneficiaries at a given level of income). The Act’s provisions for risk sharing are relatively strong; however these only serve to ensure equivalent relative exposure to unsustainably high absolute risks

Conclusion: Enrollment in individual and small group exchanges will be much less than originally (and perhaps even currently) expected; sellers of alternatives to full risk policies (ASO services, medical stop-loss insurance) in the small group markets will see accelerating demand; and, additional legislation and/or regulatory rule-making (i.e. further reforms) may be necessary soon after the exchanges begin operating

Cigna (CI) is a notable beneficiary of rising demand for ASO services and medical stop-loss in the small group market. Health Net (HNT) and Aetna (AET) are relatively exposed to small group risk, and stand to lose from a shift by employers (with healthier workers) to self-funding. AET’s acquisition of Coventry, completed last week, increases their exposure

Risks to other insurers have less to do with adverse selection (you can see it coming and price for it; and, the ACA ensures the risks are more or less equally shared), and more to do with the high likelihood that adverse selection forces new – and potentially adverse – legislation and/or rule-making

For our full research notes, please visit our published research site.

Only two subsectors are staying ahead of the market this year – Transports and Packaging.  Transports was expensive to start with, so what we see is investors continuing to favor the consolidation and market structure story here – pushing many stocks to new highs.  The Packaging story is more of a value play, with stocks that looked cheap reacting to more positive expectations.  The Packaging sector has also seen significant consolidation, but these moves are quite recent and we have yet to see any return on capital improvement at the sector level, of the type that has propelled the Transports sector.   Both of these groups are consumers of energy – fuel and plastics/glass/aluminum – and as we see oil prices moderate this might also be a boost.  See our recent research note for more analysis of what is and is not working.

We are seeing some extremes in valuation – companies with below trend returns on capital where valuations are expecting returns to fall further and companies with above trend returns on capital, pricing in a further gain.  The most extreme examples are summarized in the exhibit.

Viagra is a perennial favorite of drug counterfeiters. The National Association of Boards of Pharmacy (NABP) counts more than 10,000 online pharmacies dispensing to US customers but operating outside of state and/or federal regulatory compliance; more than 8,000 of these will either issue prescriptions or dispense prescription products without one. Thus patients too embarrassed to ask for a prescription, and/or those with off-label plans, can avoid physicians

Beyond being shy and/or misbehaving, men are cheap. Years ago when Levitra and Cialis ended Viagra’s ED monopoly, we asked men to ‘build’ an optimal ED drug by allocating 100 points among their preferred drug attributes, with more points given to the more important features. Men gave as many points to low price as to speed of onset, and twice as many points to low price as to duration of effect. Price matters – a lot

The typical Viagra Rx is $160 – $190 at retail (6 to 7 pills at about $27 each). Viagra is not covered by Part D, so not many men over 65 have coverage. A little more than two-thirds of commercial plans cover ED treatments, but most require co-payments well above the prevailing tier-2 $30 for ‘preferred’ brands. Counterfeits are available for $1 to $3 / pill – cheaper than the best co-pay

For all of these reasons ‘online pharmacies’ will remain attractive to men who are cheap, shy, or misbehaving. PFE’s online service can only cater to men with legitimate prescriptions that are willing to pay either retail, or their applicable co-pay. Notably, most commercial drug benefits will not pay for drugs received by mail, unless the prescription is filled by the payor’s own mail order operation. Thus outside of CVS (who administers PFE’s program) there may be many men with drug benefits that cover Viagra, but that will not cover prescriptions sourced from Viagra.com

Thus on net, the marginal utility of Viagra.com is that it serves men who are: 1) sufficiently self-confident to talk to their doctors (and thus get legitimate US prescriptions); 2) willing to pay either retail or their share of retail; 3) if covered, belong to a commercial plan that will cover a mail Rx dispensed out of network; AND, either: 4) too shy to have the Rx filled at retail; and/or who prefer the convenience of Viagra.com over any mail alternative their plan may offer. The initiative makes total sense – but offers very little answer to men’s motives for buying counterfeits – so the counterfeits will continue

For our full research notes, please visit our published research site

Consensus expects Qualcomm’s sales and earnings growth to sharply decelerate, with investors even more skeptical, worried that the company’s lucrative IPR licensing business will slow with cheaper phones and royalty rate challenges. We disagree. QCOM’s addressable market will grow with the global migration from 2G GSM, with adoption of cellular in tablets, with the rise of machine-to-machine networking, and with adoption of 4G LTE for residential broadband. We also believe that royalty rates will prove far more stable than many fear. QCOM is the largest IPR holder for LTE, with particularly profound contributions in the technologies most critical for 4G devices, with a peerless R&D program continually adding to the portfolio. We also note that Qualcomm’s innovative licensing approach has established a long-standing legal precedent for the value of its IPR, and that, as a chip maker, it has asymmetrical negotiating leverage over device makers. Finally, we believe Qualcomm’s strength in semiconductors is underappreciated – its modem and ARM-based processor designs are best-in-class, it leads in system-on-a-chip integration, and it recently announced a potentially game changing 40 band RF chip that could be integrated into a single package, turn-key solution. This technical mastery is driving market share gains, while opening more of the device bill-of-materials to Qualcomm.

Expectations for Qualcomm are extremely cautious. Despite 25% sales growth and 18% EPS growth over the past 4 quarters, consensus projects QCOM’s FY14 sales and EPS growth to slip to 11% and 8% respectively. The current share price projects an even gloomier scenario – QCOM’s iso-curve shows implicit assumptions for single digit long term sales growth with deteriorating margins. This pessimism seems to be driven by a belief that the company’s lucrative IPR licensing royalty stream could be in jeopardy. We strongly disagree.

Qualcomm’s addressed market will continue strong growth. QCOM has benefited from a long transition from 2G GSM, where it has no IPR claims and no semiconductor sales, to 3G WCDMA and 4G LTE, where it commands substantial royalties and dominates both modem and processor chips. This transition is still playing out in emerging markets, with 45% of mobile phones sold in 2012 still 2G only. While the increasing prominence of emerging market smartphones will drive average prices lower, the existence of contractual caps on the device price subject to royalty mitigates this somewhat. We also note that the large majority of tablets are currently shipped with WiFi only, but as 4G prices fall with time and competition, the percentage using QCOM IPR should rise, perhaps precipitously, also opening opportunities for semiconductors. We also believe that 4G LTE advanced will successfully compete for residential broadband before 2020, opening another new market for QCOM.

Investors worry that Qualcomm’s royalty rate could fall. Investors have long fretted over QCOM’s royalty rate, first concerned that rates on 3G would be much lower than on 2G, and now again, that they will be lower on 4G LTE. Royalty rates calculated as a strict percentage of total device sales have declined, but this is largely driven by the rise of smartphones and tablets, where royalty payments on expensive models are subject to negotiated caps, and by Apple, which contends that its partner Foxconn’s license allows it to pay royalties on its manufactured costs rather than the wholesale price. QCOM disputes this contention.

We are unconcerned about royalty rates for 5 main reasons. First, LTE has been sporadically deployed and will depend on 3G for seamless coverage for many years, meaning that 4G devices will be subject to 3G royalty rates. Second, QCOM’s patent holdings in LTE are the strongest in the industry and particularly skewed toward technologies required in devices rather than base stations. QCOM’s prodigious R&D spending and leadership in technologies core to the future roadmap of LTE, such as MIMO, position it to add to its dominance. Fourth, since QCOM does not produce devices, it gains considerable negotiating leverage vs. licensees that do, since it typically does not need a cross-license. Finally, QCOM’s 20 year program of licensing its entire portfolio of both standards essential and implementation patents at a fixed percentage royalty to 261 signed licensees is a powerful precedent in negotiations and at court. We note that QCOM has already negotiated 4G renewals with Samsung, LG, HTC, Nokia, Huawei, and Foxconn (Apple) without legal action or obvious effect on collection rates.

Qualcomm’s chip business is taking share and expanding its addressable market. Historically, QCOM has dominated the 3G baseband modem market, an advantage that it has extended into 4G LTE and enhanced with the 2011 acquisition of WiFi chip leader Atheros, and that will serve it well as 2G markets transition to 3G. QCOM has also established leadership in smartphone application processors, benefitting from Android’s share gains vs. Apple, from the design superiority of its proprietary ARM implementation, and from its head start in integrating modems and processors into a single system-on-a-chip (SoS). We expect QCOM’s newest Snapdragon SoS chips to continue gaining share, with the potential for share gains in tablets where it has been historically weaker. Finally, the recently announced 40-band RF chip could position QCOM to take meaningful share in a new segment of mobile semiconductors, with future potential from power management, sensors and displays.

We believe sales and earnings will be meaningfully higher than consensus for FY14. While the prodigious growth in the market for smartphones will slow, the proportion of devices subject to QCOM royalties and addressable by its semiconductor solutions will expand. Even taking investor caution over royalty rates seriously, it is difficult to build the case for the sharp deceleration from the 27% sales growth expected for FY13 and the 11% growth built into FY14 consensus. Given our belief that licensing revenue growth will remain on trajectory, we are also optimistic that overall margins can be sustained near current levels. We believe that the combination of likely upside surprises and revisions with a valuation that appears to be pricing in considerable downside, for a company that is at the technological center of the sector wide paradigm shift underway, is an exceptional opportunity.

For our full research notes, please visit our published research site.

The ACA provisions driving the premium increase for smaller employers (e.g. community rating, minimum essential benefits, excise tax on premiums) can be entirely avoided by shifting from fully-insured coverage to self-funding – self-funded plans are exempt from these ACA provisions.

We show that because of ACA, the average small employers’ cost of self-funding is on par with, or cheaper than, continuing with fully-insured coverage. For employers with healthier than average employees, self-funding may be far cheaper than fully-insured coverage; stop-loss premiums paid by self-funding employers can still vary according to the health of employees, where fully-insured premiums cannot

As an added motive, employers no longer face the risk of sharp increases in stop-loss premiums in a year following large self-funded claims – because they now have the option of reverting to the exchange for fully-insured, community-rated coverage if and when their employees’ claims rise

Roughly 40 pct of fully-insured commercial lives are sponsored by employers with ≤ 100 employees (Exhibit 4, pg. 4); we expect many of these lives will shift to self-funded plans. CVH is most negatively affected with more than 10 pct of members in small group risk plans; CI is least negatively affected with less than 0.1 pct of members in small group risk (Exhibit 5, pg. 5)
CI and UNH are best positioned to benefit from expansion of self-funding among smaller employers; both have relatively large shares of the ASO (administrative services only) service market for smaller employers (Exhibit 6, pg. 6), as well as the market for medical stop-loss insurance (Exhibit 7, pg. 7)

Taking all moving parts into account (decline in fully-insured, rise in ASO and stop-loss) CI is by far the best positioned and is a clear beneficiary (no meaningful small group risk exposure; strong presence in ASO and stop-loss); CVH is by far the least well positioned and stands to be negatively affected (relatively large exposure in small group risk; little or no exposure in ASO or medical stop-loss)

For our full research notes, please visit our published research site.

-          Current sentiment for Apple’s FY 2Q13 is horrible – consensus EPS is down 15% over the last 90 days and Cirrus’s warning drove shares back below $400, off nearly 25% over the same time frame.

-          Consensus says Apple is cheap – 5.8x estimated FY13 EPS and 5.2x FY14, adjusting for $137B in cash and investments – but consensus assumes double digit sales growth and rising gross margins.

-          2Q13 estimates for 8.4% YoY sales growth and 38.5% GMs are tenuous, yet analysts are backend loading 4Q at 20% sales growth and 39% GM, with 12% FY14 growth on stable 39% GMs.

-          Consensus forecasts of reaccelerating growth and rising margins are not credible. Apple may be cheap, but it is unlikely to perform until the megabulls have capitulated and estimates are reasonable.

“Apple under $400 has GOT to be cheap enough, right? It has $137B in cash and investments on the balance sheet and is projected to generate another $51.5B in cash from operations this fiscal year. It trades for just 9 times consensus EPS for FY2013, only 5.8x if you adjust for all of that cash. Sure the company has hit a competitive bump, but a low cost iPhone is on the way, just in time to dominate in China once China Mobile signs that inevitable megadeal to carry it. Furthermore, a new, larger screen iPhone and a major iOS upgrade are also coming to put Samsung and Google in their place. By the way, don’t forget about the Apple Television – Asian manufacturers are working on prototypes as we speak – and the iWatch wrist-based peripheral. That’s two more legs for the Apple stool. Once the big increase in the dividend is announced, watch out! Reiterating strong Buy, with a price target of a ba-jillion dollars.”

It must have been tough being an Apple Bull this past quarter – publishing that same call for the umpteenth time and subjecting yourself to yet another perp walk performance on CNBC. Still, at some point, the national nightmare will have to end, Apple will hit bottom and the bulls will be right again. However, no amount of cheerleading is going to hasten the coming of that day, and in fact, the cheerleaders may, in fact, be their own worst enemies. Buy-side sentiment is indeed bad, but sell side estimates are nowhere near bad enough.

The market has baked in an Apple miss for the 2^nd fiscal quarter, to be announced after the close tomorrow. After notable March quarter slip-ups and dire forward predictions from Apple partners Foxconn, Cirrus logic, and LG Displays, and surprisingly low iPhone numbers from Verizon, no one believes Apple will hit the 40 million iPhone unit mark that had been bandied about earlier in the quarter, with flat YoY shipments of 35 million the psychological Mendoza Line for many investors. Apple shares are off nearly 25% since the beginning of the quarter, dropping more than 7% just in the past 4 trading sessions.

Meanwhile, sell-side analysts are holding out hope. While consensus EPS has come down 15% over the course of the quarter, the sell side still hews to the high end of the company’s guidance for 2Q13 – $41-43B in sales with gross margins between 37.5 and 38.5% – even after management’s admonishment that it was getting serious about offering realistic guidance and despite the bearish data points that have been inconveniently cropping up (Exhibits 1-2). Moreover, many analysts are just pushing their recovery projections out a quarter or two. Consensus YoY sales growth for 2Q13 is just 8.2%, but expectations for 4Q13 project a robust recovery to 20.6% growth rolling into 12% growth for the full 2014 fiscal year.. Gross margins, which fell 880bp from 47.4% in 1Q12 to 38.6% just a year later, are projected to bottom out at 38.5% and begin rising, reaching 39% in 4Q13 and holding the line there for 2014.

These expectations for 4Q13 and 2014 pipe dreams. Apple’s highest margin product, the iPhone is under assault by companies with arguably superior products at lower prices, while carriers begin to push back on Apple device subsidies that have been 40% higher than those for its competitors. Apple’s unit volumes have stagnated, with even bullish projections targeting 5% YoY unit growth. At the same time, the mix of iPhones, which drive nearly 60% of Apple’s overall profits, is shifting toward the cheaper and less profitable older models. Apple may fight back by introducing new models, such as the widely rumored low-end iPhone, but while these products may buttress the company’s market share as the industry growth turns increasingly toward emerging markets, it is very unlikely that they will have a positive effect on overall margins. The growth story is better in the iPad business, where Apple is losing share but in a much faster growing market segment. Still, growth in tablets comes at a cost, as iPads sport much lower margins than the carrier subsidized iPhone. Moreover, competition is spoiling the tablet party too – Amazon and Google are willing to sell their devices at cost and make it up on e-commerce and advertising, leaving Apple’s relatively profitable products at a 40-60% premium price that is increasingly hard to justify.

These trends aren’t stopping just because analysts want them to. If Apple manages to stem its sharp margin erosion, it will come at the expense of market share and growth, and if it looks to reaccelerate its top line, then margins will continue to fall. Nor will the introduction of an Apple iTelevision or iWatch save the day. The sales of iPhones and iPads are simply too big for these wish list products to make a difference to Apple, particularly given the product launch costs and slow ramp that would be associated with either gambit.

The reality is that Apple consensus numbers have still got to come down … A LOT … before the stock can work. While the idea that it is cheap relative to its real long term cash flow power has merit, it is very difficult for a stock to perform well during a protracted period of difficult news flow, earnings misses and sharp downward revisions. It is never “all in the stock” and only with capitulation will it be safe to get back in the water. Ironically, the only way for the biggest Apple bulls to be right is to stop being so bullish.

For our full research notes, please visit our published research site.

Pricing also remains suppressed – 1Q13 will be the ninth straight quarter of price growth below 2%, more than twice as long as the last such period in 1997-1998

We estimate that flu effects drove a +/- 1% unit demand increase in 4Q12, and raised health services unit demand by +/- 1.5% in 1Q13. Large apparent flu effects continue to indicate that underlying ‘non-flu’ unit demand growth is well below the 1.5% demographic rate

We believe demand is weak primarily because of low employment, which translates into a smaller percentage of households having the benefit of the most generous source (employer-sponsored) of health coverage. Employment gains, expansion of Medicaid eligibility, and the initiation of state health insurance exchanges all are likely to expand the availability of health coverage in the relatively near-term

We recommend a pro-US / pro-cyclical tilt to healthcare portfolios; this translates into overweight positions for Hospitals, select Non-Rx Consumables (especially more US-focused names such as CFN and OMI), and select Dental names (emphasize more US-focused names with product lines that include higher-mix items, such as XRAY and PDCO). We recommend underweight positions in Large-cap Pharmaceuticals (on US real pricing power concerns), drug trades (Retail, Wholesale, PBM)(on the loss of AWP pricing, and risks of PBM disintermediation), and Research Tools / Services (implied revenue growth exceeds R&D spending growth)

Independent of our quarterly growth rate model, we handicap the odds of a trend break, i.e. a significant acceleration or deceleration in demand. The trend-break model indicates a very low probability – 11% – of accelerating demand in 1Q13

For our full research notes, please visit our published research site.

The TMT IPO market has been dead since the 2008 financial crisis. Facebook was supposed to make it safe for the dozens of increasingly valuable private TMT companies to come public, but botched execution made the FB IPO an impediment rather than a catalyst. Now there are dozens of TMT companies that could come public in the next 12-18 months. We have identified 35 that have likely valuations above $500, and evaluated them on the attractiveness of both the opportunity that they address and their competitive positions. The universe includes 9 e-commerce startups, 8 enterprise SaaS providers, 4 cloud service providers, 4 social networkers, 3 each of cloud infrastructure, enterprise hardware and on-line media, and 1 internet advertising network. We are most intrigued by Alibaba, Twitter, Hulu, Square, Atlassian and Pinterest, and have the most skepticism about subscale e-commerce players and enterprise IT plays. In this light, we are adding Workday to our large cap model portfolio and Marin Software to our small cap portfolio, both of which are recent IPOs.

A 5 year IPO drought has left dozens of interesting TMT companies private. The 2008 financial crisis killed new issues for many months. Facebook’s highly anticipated 1Q12 issue was supposed to break the log jam, but instead compounded the problem with the stock still more than 25% below its offering price. Still, industry scuttlebutt and recent S1 filings suggest that many IPOs that have been in a holding pattern could look to land in 2013.

Our list of 35 potential TMT IPO candidates contains intriguing companies. We identified 35 private TMT companies that we believe would command market caps in excess of $500 million, were they to come public. Rating these companies on the size of the market that they could address and on the strength of their competitive position, we have established a rough assessment of their likely attractiveness to investors. Of course, attractiveness must be tempered by the aggressiveness of the eventual offering price, a consideration obvious to investors and bankers alike in the wake of the Facebook debacle.

Acquisitions from the list by big cap players are likely. Over the last 3 years, Google has done 62 acquisitions for an estimated $16.3B, Intel has done 19 for $9.5B, Microsoft – 12 for $10.6B, IBM – 29 for $5.6B, Oracle –26 for $8.7B, HP – 13 for $20.2B, and so on. Many of the companies our IPO candidate list have been rumored as targets in the past, and some may choose to be bought rather than to pursue a private listing. Their value to would be acquirers is largely commensurate with our ratings, although some companies would significantly improve their competitive positioning in combination with a synergistic buyer.

Our favored candidates are Alibaba, Twitter, Hulu Square and Atlassian. E-commerce companies are the largest group, but other than Alibaba and Craigslist, the companies lack for scale and barriers to competition from the likes of Amazon. SaaS Applications is the second largest category, with many opportunities for start-ups, some of which will hit while others miss. We like Atlassian best from this group. Cloud infrastructure software and social networks have fewer candidates, but carry the highest ratings – Twitter is most favored from these groups, followed by Pinterest and Tableau. Cloud services, on-line media and on-line advertising are a mixed bag, with Hulu and Square stand-out candidates. We are not optimistic about overall spending on enterprise data centers, and view enterprise hardware makers skeptically – Violin Memory is the best of a risky lot.

Our large cap model portfolio performance has been strong. The large cap portfolio outperformed the S&P500 tech components by 280bp since our last update in late December, delivering 1.2% absolute performance over that time. We are removing Akamai – which is off 19% after poor numbers and guidance in February, Nuance – which moves in sympathy with Apple, and Skyworks – which we believe to be threatened by a new RF product from Qualcomm. In their place, we are adding Workday – a SaaS ERP vendor which recently IPOd, Netflix – which has built considerable business momentum with the success of its original programming, and JDS Uniphase – which could benefit from growing wireless data in both its network test and optical components businesses.

Our small cap model portfolio performance has been weak. The small cap portfolio underperformed the tech components of the S&P600 by 200bp, dropping 2.9% in absolute terms, since it was updated on January 7. Brightcove, Fusion IO and Allot were the primary culprits, and we are removing Brightcove and Allot, along with Triquint, which, like Skyworks, we believe is threatened by Qualcomm’s innovative 40-band RF chip. In their place, we are adding Marin Software – a recent IPO which sells SaaS tools to manage on-line ad campaigns, Ixia – a network test equipment supplier that is well positioned for expected wireless data build outs, and AMCC – which has traction on ARM based server processor chips.

For our full research notes, please visit our published research site.