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					January 10, 2011

Equity Research

Healthcare Industry 2011 Outlook



                                                                                                                 Health Care Team




                                                                                    Brian Abrahams, M.D., Senior Analyst
                                                                                                                     ( 21 2 ) 2 1 4 -8 0 6 0
                                                                                         b ri an . a b ra h a m s@ wa c ho vi a .co m
                                                                                           Larry Biegelsen, Senior Analyst
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                                                                                          l a r r y. b i e g e l s e n @ w a c ho v i a . c o m
                                                                                               Greg T. Bolan, Senior Analyst
                                                                                                                      ( 615 ) 5 25 - 24 18
                                                                                                   greg. b ol an@ w achovi a. co m
                                                                                                   Peter Costa, Senior Analyst
                                                                                                                     ( 617 ) 6 0 3 -4 2 2 2
                                                                                                  pe te r . co st a@ wa c ho vi a. co m
                                                                                     Gary Lieberman, CFA, Senior Analyst
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                                                                                          g a r y. l i e be r m a n @ w a c ho v i a . c o m
                                                                                   Michael Tong, CFA, PhD, Senior Analyst
                                                                                                                     ( 21 2 ) 2 1 4 -8 0 2 0
                                                                                              mi chae l.t o ng @wa c ho vi a. co m

Please see page 17 for rating definitions, important disclosures
and required analyst certifications
Wells Fargo Securities, LLC does and seeks to do business with companies
covered in its research reports. As a result, investors should be aware that the
firm may have a conflict of interest that could affect the objectivity of the
report and investors should consider this report as only a single factor in
making their investment decision.

HCTEAM011011-071134
                                                                                      WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                     EQUITY RESEARCH DEPARTMENT

Sector Highlights
▪   Biotechnology: Concerns over maturing revenue streams, pending patent cliffs, potential pricing
    contraction, and FDA unpredictability have weighed on the sector, particularly on some of the large-cap
    companies. However, we believe this creates opportunity, with certain large-cap companies trading at
    multiples that we do not believe appropriately reflect the growth prospects of their marketed products or
    pipelines. Despite the run-up in many midcap biotechs--perceived as occupying a “sweet spot” with higher
    growth and less risk--we believe some values remain. We believe the most attractive small-cap biotechs
    are those with platform technologies and underappreciated assets. Our favorite stocks are Gilead Sciences,
    Inc., Vertex Pharmaceuticals Inc., and Protalix BioTherapeutics, Inc (Outperform).
▪   Medical Devices: We expect the growth rate of the overall medical device industry to remain in the low
    single digits through 2011 given the (1) moderate economic growth and continued high unemployment
    forecast for 2011 by the Wells Fargo Economic Group; (2) continued pricing pressure; (3) a difficult
    regulatory environment; and (4) a limited number of major new product cycles. Our favorite stocks are
    Edwards Lifesciences Corporation ($79.05, Outperform) and The Cooper Companies, Inc.
▪   Healthcare Facilities: There will be a number of potential changing trends and catalysts for healthcare
    facilities in 2011. Investors are hopeful about higher utilization trends due to easy comparables and an
    improving economy (hopefully). On the other hand, the difficult position of state budgets and the potential
    expiration of increased funding for Medicaid could put pressure on reimbursement for providers. Our
    favorite stocks are DaVita Inc., Health Management Associates, Inc., and Universal Health Services, Inc.
▪   Managed Care: We believe 2011 is likely to be a rebasing year for managed care sector earnings before
    the group returns to earnings growth in 2012. We believe valuations in the group are already discounting
    medical loss ratio (MLR) minimums and the potential return of higher cost trends in 2011. State
    commercial rate reviews, the new exchange structures, Medicare audits, and state Medicaid budget
    pressure are some of the remaining headwinds for the group in 2011. Our favorite stock is UnitedHealth
    Group Inc.
▪   Pharmaceuticals: The much-awaited patent cliff for major pharmaceutical companies begins in 2011,
    and during the 2011-14 period, 22 of the top 50 top-selling small-molecule drugs are exposed to generic
    competition. Major pharmaceutical companies are likely to remain focused on cost reduction and right-
    sizing to prepare for growth beyond the patent cliff period. Specialty pharmaceutical companies likely will
    need to navigate a higher degree of price sensitivity. Our favorite stocks are TEVA Pharmaceutical
    Industries Ltd. and Watson Pharmaceuticals, Inc.
▪   Pharmaceutical Services: We believe an inflection point for early drug development activity is brewing
    and believe biopharma sponsors will begin refocusing resources on preclinical compounds in H2 2011. To
    that end, we believe investors should be overweight the two dominant preclinical players, Charles River
    Laboratories International, Inc. and Covance Inc. (CVD). Our favorite contract research organization
    (CRO) stock pick is Covance.
▪   Healthcare IT (HCIT): We believe 2011 will mark the onset of accelerating earnings momentum for
    clinical HCIT companies. Hospital and physicians will be eligible to receive substantial reimbursement
    incentives for adopting and meaningfully using certified electronic health records (EHRs), as dictated by
    the HITECH Act. We see the greatest earnings momentum potential for dominant ambulatory EHR
    vendors that comprise a significant level of sales from EHRs, like Quality Systems, Inc. Our favorite HCIT
    stock pick is Quality Systems.




                                   All stocks priced as of January 7, 2011.




                                                                                                                  3
                                                                                               WELLS FARGO SECURITIES, LLC
Health Care Team                                                                              EQUITY RESEARCH DEPARTMENT

HealthCare--An Economically Insensitive Group--Think Again!
Healthcare has historically been thought of as an economically insensitive group, but 2010 did a good job of
making investors rethink that premise. Healthcare utilization decreased for providers and, in return, those
providers continued to put pressure on medical device manufacturers’ prices in an attempt to make ends meet.
Medical technology companies saw pressure on capital spending as many not-for-profit providers continued to
struggle to get back on their feet following the financial crisis of the past two years.

Exhibit 1—Publicly Traded Hospital Company Admission Trends (Quarterly, 2000-10)
 10%                                                        Adjusted Admissions % growth SS
                                                            Admissions % growth SS
    8%


    6%


    4%


    2%


    0%
      00
      00
      01
      01
      02
      02
      03
      03
      04
      04
      05
      05
      06
      06
      07
      07
      08
      08
      09
      09
      10
      10
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
    1Q
    3Q
 -2%


 -4%


 -6%
Note: Aggregate same-facility admissions growth for CYH, HMA, LPNT, THC, UHS weighted by beds
Source: Company data, Wells Fargo Securities, LLC

Rising Job Growth Could Fuel Increased Utilization: We expect that utilization in 2011 is likely to pick
up from the weak levels in 2010 due to easy comparables and a continued, albeit moderate, improvement in
the economy. While the unemployment rate remains at historically high levels, it appears it has stopped
increasing, and job growth appears to be on the upswing.

Exhibit 2—Summary Hospital Company Unemployment Index Versus U.S. Average
(Monthly Percentages, 2005-Current--Seasonally Adjusted)
 12%                                                                                     5%
            Hospital Index Employment y/y %growth
                                                                                         4%
 11%
                                                                                         3%
 10%
                                                                                         2%

    9%                                                                                   1%
                                                                 Nat'l Unemployment
             National Employment y/y %growth                             rate            0%
    8%
                                                                                         -1%
    7%                                                                                   -2%
                  Hospital Index Unemployment rate
                                                                                         -3%
    6%
                                                                                         -4%
    5%
                                                                                         -5%

    4%                                                                                   -6%
08 05
11 05

02 05
05 06
08 06

11 06
02 6
05 07
08 7

11 07
02 07
05 8

08 08
11 8
02 08
05 9

08 09
11 09
02 09
05 10
08 10
11 10
       0
     00


     00




     00


     00


     00




     01
     0
     0
     0

     0
     0
     0


     0


     0

     0


     0


     0


     0

     0
     0
     0
     0
     0
  /2
  /2
  /2

  /2
  /2
  /2
  /2
  /2
  /2
  /2

  /2
  /2
  /2
  /2
  /2
  /2
  /2

   /2
   /2
  /2
   /2
  /2
  /2
05




Note: Unemployment rate includes data for (CYH, HMA, LPNT, THC, UHS) weighted by beds per county.
Source: Bureau of Labor Statistics, company data, Wells Fargo Securities, LLC




4
                                                                                          WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                         EQUITY RESEARCH DEPARTMENT

HealthCare Reform--Just When You Thought It Was Safe To Go Back In The Water
The relief that some investors hoped for after healthcare reform legislation was passed at the beginning of
2010 was short-lived. Discussions of which regulations the U.S. Department of Health & Human Services
(HHS) would implement or waive, combined with court cases challenging the legality of the legislation, and a
newly empowered GOP threatening to repeal or defund various components of the legislation are likely to keep
the noise levels around health reform high in 2011. We expect that attempts at legislative repeal will be largely
for show, but that the GOP will attempt to use funding under the health reform legislation to pay for deficit
reduction or other, perhaps more popular, measures that may not be in healthcare at all. While the noise
around the constitutionality of the individual mandate and perhaps the Medicaid expansion are likely to draw
attention, a final decision is not likely until the cases reach the Supreme Court, which may take until late 2011
or early 2012. This could keep investors wondering if reform will happen at all for much of the year. Perhaps,
most importantly, we expect state and HHS-issued regulations around the structure of the exchanges, coverage
requirements, and the new taxes that affect many parts of the healthcare system to be discussed and issued
during the year. This uncertainty is likely to keep some level of macro attention on the group and fundamentals
may once again be second place to the macro picture regarding the potential upside for the group and its
subsectors.
Biotechnology Outlook
We expect drug pricing to continue to be in high focus during 2011, as the market looks to understand the
impact of the ongoing European economic crisis as well as the direction into which the United States heads--
regardless of whether or not the healthcare reform law is ultimately found constitutional, repealed, or
defunded. Unlike recent years, 2010 bore witness to large- and mid-cap biotech companies providing more
details on pricing negotiations with European socialist health systems and quantifying the financial impact of
these pricing cuts. A drug’s value proposition to these payers will continue to increase in importance as
healthcare budgets continue to be squeezed for the foreseeable future. Novel agents, which provide a clear
benefit over existing products, have increased odds of securing strong reimbursement, as has been
demonstrated by Celgene (CELG) in its negotiations with the United Kingdom’s National Institute of Clinical
Excellence (N.I.C.E.) in obtaining 26 months of coverage for Revlimid in the relapsed/refractory multiple
myeloma. In contrast, agents for much large diseases, such as Sanofi-Aventis’s Multaq for atrial fibrillation
have been more susceptible, where the French government indicated it would only pay for 65% of the drug’s
cost. For many of our covered companies with products sold overseas, we model a 5% or greater average
annual price decline, to account for the likely continued cost-containment efforts.
In the United States we have seen the debate over Dendreon’s (DNDN) pricing for prostate cancer drug
Provenge, and at some point an era could begin in which payers focus more heavily on pharmacoeconomics
and comparative effectiveness to determine reimbursement. However, we do not appear to have reached that
point yet, as regular price increases seem to be continuing as before (e.g., Celgene’s Revlimid 4.5% increase
effective December 10, 2010, and Genzyme/BioMarin’s Aldurazyme 5% increase effective January 3, 2011).
Still, we believe the expectations for pricing contraction--or at least limits on potential increases--will continue
to drive investors toward companies with drugs for orphan diseases, which have been the most insulated
globally. Many of these agents, such as Alexion’s Soliris and BioMarin’s Naglazyme, are unique, have no
competition, and serve an unmet need; as such, their value proposition is often relatively easy to define.
Additionally, most of these agents occupy a relatively small amount of each payer’s budget, making resistance
to their premium pricing not worth the potential political backlash. These factors have contributed to the
recent migration of increasing numbers of large pharma companies licensing with or acquiring orphan disease-
focused companies.
Regulatory Decisions--A Key Risk In Biotech: Regulatory risk from the U.S. Food and Drug
Administration (FDA) and the European Medicines Agency (EMA) is likely to remain an overhang on biotech
companies. Despite improvements in efficiency at the FDA since its nadir around 2008, the unpredictability of
approval decisions and outcomes of Advisory Committee meetings continue to cause significant volatility in
stock prices. The potential for the agency and its advisory committees to scrutinize a detail in a drug’s
preclinical package (roughly one-third of a New Drug Application or a Biologics Licensing Application), clinical
data previously thought to be irrelevant, or the revelation of previously unknown data in briefing documents,
at a panel meeting, or in a complete response letter, remain significant risks. Furthermore, due to the agency’s
heightened focus on product safety (partially resulting from increased congressional oversight and the
introduction of the Food and Drug Administration Amendments Act of 2007), a company’s new drug
application (NDA) or biologics license application (BLA) can be rejected or delayed as a result of its failure to
submit a Risk Evaluation and Mitigation Strategy (REMS), providing an additional risk for investors to
appreciate, consider, and analyze.




                                                                                                                       5
                                                                                                                    WELLS FARGO SECURITIES, LLC
Health Care Team                                                                                                   EQUITY RESEARCH DEPARTMENT

Easy-To-Find Values In Large-Cap Biotech: Large-cap biotech companies have seen significant multiple
compression over the past few years. The forward P/E multiple was roughly 19x in 2006 and is roughly 13x
currently (please see Exhibit 3). Gilead currently trades at a big pharma multiple of roughly 9.4x and at
roughly a 50% discount to its four large-cap biotech peers. Maturing product lines causing slower growth,
emerging worries over out-year patent cliffs, and concerns about the potential impact of global cost
containment measures have pressured several of the large caps. Although we believe these concerns may be
overdone, it is difficult to pinpoint a specific catalyst that would help turn the tide compared to the historical
views the market held on these names; even a potential merger and acquisition (M&A) event like the proposed
Sanofi-Aventis (SNY) acquisition of Genzyme (GENZ) was not enough to turn sentiment around in the sector
(with the possible exception of Biogen Idec [BIIB]). Instead, we believe it will likely take multiple events for
each company to begin to shift sentiment.
For Gilead, which has had its shares under the most pressure, our proprietary work speaking with managed
care providers indicates that payers will actually take a more “hands off” approach to HIV than the Street
believes. As such, the patent expiries over the next decade will likely be less disruptive than many expect. We
believe that as these concerns wane and developments (Quad data, B-tripla approval, and GS-7340 progress)
demonstrate the company’s ability to diversify its HIV pipeline, the company’s multiple will re-expand closer to
that of its peers.
For Celgene (Outperform), we expect continued global commercial execution, clarity on the European
Revlimid Marketing Authorization Application in front-line and maintenance multiple myeloma, and
additional data for Revlimid in non-Hodgkin’s lymphomas to provide catalysts to help sustain the company’s
best-in-class growth rate and lead to additional stock appreciation from current levels.
Exhibit 3. Compression Of Large-Cap Biotech Companies, P/E Ratios

    20x
    18x

    16x

    14x
    12x                                                                              x
                                                                                   (e cl uding G ENZ)




    10x

     8x

     6x

     4x
     2x

     0x
          E nd-    Mid-     End-    Mid-     End-     M id-      E nd-     Mid-       End-
          2006     2007     2007    2008     2008     2009       2009      2010       2010

Source: FactSet and Wells Fargo Securities, LLC

Exhibit 4a. Large-Cap Biotech Company Comparables
                                                                                                         '10-'14   Fwd            '10-'14        Sales multiple
Company           Ticker    Price   Shares (MM)   Mkt cap       Cash       Debt      EV                 EPS CAGR    P/E    PEG   Sales CAGR   2011   2012     2013
Amgen             AMGN     $56.55      944.8      $53,429     $13,442    $10,601   $50,588                 8%      10.7x   1.3       3%       3.5x   3.4x     3.2x
Biogen Idec        BIIB    $67.26      238.3      $16,028      $1,275     $1,100   $15,854                 7%      12.0x   1.8       2%       3.4x   3.4x     3.3x
Celgene            CELG    $58.99      470.6      $27,763     $2,997        $25    $24,791                20%      17.3x   0.9      14%       6.3x   5.5x     4.7x
Gilead             GILD    $37.51      811.9      $30,453      $1,657     $1,161   $29,957                13%       9.3x   0.7       8%       3.6x   3.3x     3.1x
Genzyme (1)       GENZ     $71.56      259.0      $18,533       $906       $171    $17,798                16%      17.4x   1.1       9%       3.7x   3.3x     3.0x
Mean                                                                                                      13%      13.3x   1.2       7%       4.1x   3.8x     3.5x
Source: FactSet and Wells Fargo Securities, LLC

Midcaps Have Been Favored By Market: Many midcap biotech companies substantially appreciated in
value during 2010, but we believe some values still remain. We believe the midcap biotechs have been
particularly attractive to investors recently, as they fit into a “sweet spot.” Many possess (or are expected to
soon have) the high growth lacking in the large-cap names, while being profitable or near-profitable.
Additionally, many of these companies do not have potentially binary clinical and regulatory risks inherent to
the smaller-cap names. Finally, some are perceived to be potential acquisition targets for larger biotechs and
big pharma companies looking to fill their pipelines. While we do not necessarily expect a dramatic increase in
M&A activity within the biotechnology sector, we believe the perception that many midcap names are potential
targets likely places a floor in the valuation of these stocks.




6
                                                                                                     WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                                    EQUITY RESEARCH DEPARTMENT

Interestingly, the run-up in the midcaps appears to be concentrated more among the profitable companies;
case in point, BioMarin (BMRN) and Alexion (ALXN) are up 42% and 68%, respectively, since the beginning of
2010, versus the S&P, up 19%. In contrast, we have seen investor skittishness around companies with pending
approvals/launches, such as Vertex (VRTX) and Human Genome Sciences (HGSI). In the case of Vertex, which
we cover, we believe this creates a buying opportunity ahead of what we expect to be a relatively smooth
telaprevir approval process and strong launch (although we acknowledge that there could be some share
volatility around the potential FDA Advisory Committee meeting). We believe telaprevir will dominate the
market over competitor boceprevir in the first few years, and that the revenue tail is at less risk than many
perceive.
Exhibit 4b. Midcap Biotech Company Comparables
                                                                                              '10-'14     Fwd               '10-'14         Sales multiple
Company                 Ticker    Price   Shares (MM)   Mkt cap    Cash     Debt      EV     EPS CAGR     P/E      PEG    Sales CAGR   2011     2012     2013
Alexion                  ALXN    $82.56       90.5      $7,471     $176      $11    $7,306      31%      34.6x      1.1       23%      10.5x     8.3x     6.7x
Amylin                  AMLN     $14.68      144.0      $2,114     $668     $738    $2,184        -         -        -        23%       3.5x     3.3x     2.5x
BioMarin                BMRN     $26.94      102.5      $2,761     $301     $497    $2,958     -16%     1371.9x   -87.0       17%       6.0x     5.3x     4.5x
Cephalon                 CEPH    $60.46      75.2       $4,549    $1,648   $1,183   $4,084      -7%       7.4x     -1.0       -4%       1.5x     1.7x     1.7x
Cubist                   CBST    $22.53       59.3      $1,336     $319     $245    $1,262      8%       13.4x      1.8       8%        1.9x     1.8x     1.6x
Dendreon                DNDN     $35.42      144.3      $5,112     $577      $69    $4,604        -         -        -        67%      13.7x     6.0x     3.9x
Human Genome Sciences    HGSI    $24.82      188.7      $4,685     $719     $598    $4,564        -         -        -       105%      24.9x     8.2x     4.4x
Onyx                    ONXX     $36.87       62.7      $2,313     $578     $144    $1,879      35%      143.9x     4.1       28%       7.8x     6.2x     4.9x
Regeneron               REGN     $34.31       80.1      $2,749     $341     $109    $2,516        -         -        -        23%       5.7x     4.8x     3.6x
United Therapeutics     UTHR     $66.26       56.9      $3,771     $229     $251    $3,792      21%      21.3x      1.0       12%       5.0x     4.4x     3.9x
Vertex                   VRTX    $36.20      203.2      $7,356    $1,285    $154    $6,225        -         -        -        64%      11.7x     3.5x     2.7x
Mean                                                                                           12%      265.4x    -13.3      33%       8.4x      4.8x     3.7x
Source: FactSet and Wells Fargo Securities, LLC

Small-Caps: Opportunity In Platform Technologies And Underappreciated Assets: Among the
small-cap biotech companies, which trade more on the merits of the clinical data than on macro forces, we
believe the best values often come from companies with solid platform technologies or data catalysts far
enough away that they are under the radar. Protalix (PLX), our favorite small-cap company, has a unique
profile for a sub-$1 billion market cap biotech, with the potential for sustainable profitability near term from
taliglucerase sales, and an underlying platform capable of producing other successful protein drugs longer
term. Data for Rigel’s (RIGL, $7.74, Ouperform) rheumatoid arthritis drug fostamatinib is not expected until
late 2012, but we believe the company represents an attractive value for longer-term investors. This is based on
our expectations for the emergence of oral agents in this space and the good probability of phase III success,
which we anticipate for fostamatinib.


Top Picks

Gilead Sciences, Inc. (GILD) ▪ Rating: Outperform ▪ Market Cap $30.5 billion
Stock Price: $36.34 ▪ Valuation Range: $48.00-52.00
2011 Estimates—EPS: Q1 NE | Q2 NE | Q3 NE | Q4 NE | FY2011 $4.12 diluted
▪   Central to our thesis is our belief that U.S. managed care providers will continue to take a “hands-off”
    approach to managing HIV-related costs, enabling Gilead to preserve more revenue long term than the
    Street expects.
▪   While we are more cautious on the prospects for Gilead’s TMC278-based fixed-dose combination (FDC:
    Truvada plus TMC 278), we believe the Quad FDC (Truvada, cobicistat, and elvitegravir) will help Gilead
    remain well positioned over the long term in the evolving HIV treatment landscape.
▪   We blend several methodologies: applying the mean forward PEG for other large-cap biotechs (1.2x) to
    our 2011E EPS of $4.12 and 16% growth rate, and a DCF analysis from 2011E-2022E using a 10% discount
    rate and a (2%) terminal growth rate. Key risks include lower-than-expected B-tripla uptake, growing cost-
    consciousness among payers, and failure of Quad in phase III.
Recent Research: “GILD: We Have Resumed Coverage With An Outperform Rating,” 12/9/10

Vertex Pharmaceuticals, Inc.(VRTX) ▪ Rating Outperform ▪ Market Cap $7.4 billion
Stock Price: $35.11 ▪ Valuation Range: $44.00-48.00
2011 Estimates—EPS: Q1 NE | Q2 NE | Q3 NE | Q4 NE | FY2011 ($1.80) diluted
▪   We believe telaprevir’s launch will meet high Street expectations, based on our survey of hepatitis C
    physicians following the 2010 AASLD Meeting (late October 2010). A key contributor to our thesis is
    based on physicians’ beliefs that their current practices will be able to accommodate a meaningful increase
    in patient load, suggesting that capacity will not limit the launch trajectory.




                                                                                                                                                            7
                                                                                         WELLS FARGO SECURITIES, LLC
Health Care Team                                                                        EQUITY RESEARCH DEPARTMENT

▪    Our survey indicated physicians’ strong preference for telaprevir over boceprevir--nearly 3 to 1 (in naives
     and prior failures)--based on telaprevir’s efficacy, perceived lower rates of anemia, shorter dosing, higher
     potential for shorter peg-interferon/ribavirin dosing, and potential for b.i.d. dosing. We believe this will
     help enable Vertex dominate the Hepatitis C virus (HCV) market for the first several years after launch.
▪    We expect the revenue tail for telaprevir to be more prolonged than some expect, given the high bar it sets
     for second-generation agents and the recent setbacks faced by interferon-free combinations.
▪   We blend several valuation methods including, applying the mean 2014E P/E multiple for high-growth
    mid-cap biotechs (14x) to our out-year VRTX EPS estimate, applying the mean 2012-14E comparable sales
    multiples (4-8x) to our out-year revenue estimate, and a DCF analysis. Risks include failure of VRTX to
    obtain telaprevir approval, and a slower-than-expected launch.
Recent Research: “VRTX: Physician Survey Supports High Telaprevir Uptake,” 12/9/10


Healthcare Facilities 2011 Outlook
2011 Pricing: With healthcare utilization notably weak during 2010, pricing for facilities was generally a
bright spot for operators. As noted at the beginning of this report, we expect utilization to rebound, albeit
perhaps modestly, in 2011; pricing, on the other hand, could prove to be somewhat more challenging in 2011.
Medicaid reimbursement is most at risk in 2011 due to the expiration of increased federal matching rates at
the middle of 2011. It would appear that an extension of these higher rates may be less likely with a
Republican-controlled House. State governors will likely be an important constituency pushing for an
extension, as state budgets remain difficult. The number of individuals on Medicaid grew significantly in 2009
and probably again 2010. This trend could continue in 2011 as more individuals qualify for the benefit.
Therefore, even if price per unit for Medicaid is less than in 2010, overall spending could continue to increase
due to high enrollments.
Exhibit 5. Medicaid Enrollment 2000-09
                      9.3%
                                                                                       8.4%

            7.5%



                               5.6%

                                        4.3%

    3.2%                                         3.2%                        3.1%




                                                           0.2%
                                                                   -0.7%

   2000      2001      2002    2003     2004      2005     2006     2007     2008      2009
Source: Kaiser Foundation

Dialysis Sector To Experience Biggest Reimbursement Change: The dialysis industry is to experience
the biggest change to reimbursement in more than 20 years as Medicare begins to pay the industry a single
bundled rate for both dialysis treatments and any pharmaceuticals administered during treatment. Currently,
facilities are reimbursed at average selling price (ASP) plus 6% for pharmaceuticals. Contracts with
commercial payers are similarly expected to change. We believe that the change will be extremely favorable to
dialysis providers as there should be ample opportunity for operators to reduce costs to a greater extent than
the decrease to reimbursement. While we are optimistic that dialysis companies will be able to implement
savings relatively quickly under the bundle, the assumptions in our financial models take a more-conservative
view that the savings will be implemented steadily over the course of 2011 with the full benefit felt in 2012. A
significant portion of the savings is expected to come from reductions in cost of the drug Epogen. One risk to
cost reductions is the contract terms providers have for drug, which could impact how much of the drug
providers use.




8
                                                                                        WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                       EQUITY RESEARCH DEPARTMENT

Hospitals: With the recent unsolicited bid of Community Health Systems (CYH) for Tenet, acquisitions have
taken center stage in the hospital sector. CYH’s willingness to pay a 40% premium for shares of THC and its
rejection of the offer as being “grossly [undervalued]” has the companies “putting their money where their
mouth is” with regard to valuations for the group being too low.
While the operating environment for hospitals is expected to improve (at least slightly)--if for no other reason,
than the volume comparables being easy--the visibility into results remains murky for 2011 due primarily to
the uncertainty of the economy. One favorable development for for-profit hospitals is that acquisition prices of
not-for-profit hospitals appear to be at their lowest in at least ten years. The combination of the uncertain
operating environment with the attractive acquisition environment has made this a strategy companies appear
to be increasingly pursuing.


Top Picks

DaVita Inc. (DVA) ▪ Rating: Outperform ▪ Market Cap.: $7.3 billion
Stock Price: $73.40 ▪ Valuation Range: $77.00-$82.00
2011 Estimates—EPS: Q1 $1.00 | Q2 $1.01 | Q3 $1.19 | Q4 $1.29 | FY2011: $4.49
▪   We believe the transition to a bundled payment scheme is a long-term positive for the dialysis services
    industry. DaVita’s opportunity to reduce costs significantly outweighs any temporary reductions in
    revenue per treatment; this should generate margin expansion over the next couple of years. An automatic
    update to Medicare pricing will also be an incremental positive under the bundled payment methodology.
    Financial flexibility offers DVA the option to allocate capital to grow through acquisitions and de novo
    expansion or buyback shares with its current authorization, at $800 million. The company currently has
    more than $1.0 billion of cash on its balance sheet.
▪   Our valuation range of $77.00-$82.00 assigns an 8.2x EV/EBITDA multiple to our 2012 EBITDA
    estimate, which we then discount back one year, at 12%. We use our 2012 estimate as the basis for our
    valuation to remove what could be a noisy transition to bundled reimbursement in 2011. We believe 8.2x
    is conservative, given the company’s three-year average EV/EBITDA multiple of 7.8x and our expectation
    for accelerating EBITDA over the next two years. Key risk factors to our valuation range include payer mix
    shift away from commercial, regulatory risk, inability to reduce costs under the bundled reimbursement,
    and a slowdown in the approval process for new facilities.
Recent Research: “DVA: Reports Strong 3Q10 Results—Repurchases $400 million Stock,” 11/05/10

Universal Health Services, Inc. (UHS) ▪ Rating: Outperform ▪ Market Cap.: $4.0 billion
Stock Price: $41.12 ▪ Valuation Range: $43.00-47.00
2011 Estimates—EPS: Q1 $0.87 | Q2 $ 0.92 | Q3 $ 0.77 | Q4 $ 0.78 | FY2011 $3.35
▪   We expect that the acquisition of Psychiatric Solutions (PSYS), which closed in November, will be about
    $0.67 accretive to EPS in 2011. We believe that this estimate could prove conservative if UHS is able to
    improve the PSYS assets more quickly than currently expected.
▪   UHS, which generates the least amount of its revenue and EBITDA from acute care facilities, compared
    with its peers, could benefit from a more favorable business mix due to continued weakness in acute care
    volumes.
▪   Our valuation range is $43.00-47.00. We expect 2011 EBITDA of $1.092 billion and believe that a 7.8-8.1x
    target EV/EBITDA multiple is appropriate, given our estimated EBITDA growth of about 55% in 2011.
    Risks to the company include weak state budgets from which its behavioral hospitals derive a significant
    portion of their revenue and a concentration of its acute care business in the Las Vegas market, which has
    been particularly sensitive to the weak economy.
Recent Research: “UHS: In-Line Q3—Adjusting Ests.—Preliminary Approval of PSYS Deal,” 10/29/10

Health Management Associates, Inc. (HMA) ▪ Rating: Outperform ▪ Mkt. Cap.: $2.4 billion
Stock Price: $9.25 ▪ Valuation Range: $9.00-$11.00
2011 Estimates—EPS: Q1 $0.19 | Q2 $0.17 | Q3 $0.18 | Q4 $0.20 | FY2011 $0.75
▪   One company, in particular, that we think is in an excellent position to benefit from this dynamic for the
    next several years is Health Management due to its size; it is relatively small, so 3-5 acquisitions could
    make a meaningful difference to revenue and EBITDA growth. New management has had enough time to
    address any issues at its core hospitals to allow it to pursue acquisitions without significant risk of a
    negative impact to its core operations.




                                                                                                                    9
                                                                                         WELLS FARGO SECURITIES, LLC
Health Care Team                                                                        EQUITY RESEARCH DEPARTMENT

▪    We estimate that the acquisitions that HMA has made over the past 12 months could add approximately
     $0.25 to EPS over 3-4 years. This assumes average EBITDA margin improves to 16% from about 0% on
     the $650 million of acquired revenue (16% x $650 million = $104 million of incremental EBITDA), or
     $0.25 of EPS. This compares favorably with our current EBITDA and EPS estimate of $0.75 for 2011.
▪    As for the acquisitions completed this year, HMA feels comfortable with the progress made toward
     achieving its target of midsingle-digit margin in the first year. Management highlighted potential margin
     opportunity of approximately 400-500 basis points (bps) of margin expansion through supply cost by
     adding the hospital onto its GPO HealthTrust.
▪   Our valuation range is $9.00-11.00. The midpoint of our valuation range is 7.0x our 2011 EBITDA
    estimate. We believe this is appropriate given that we estimate the company’s five-year average
    EV/EBITDA multiple at 7.2x. Risks include weak state budgets and the potential that a weak economy
    could keep hospital volumes from recovering and/or put pressure on bad debts.
Recent Research: “HMA: Meetings with Management; Back to the Future:…” 12/09/10

Post-Acute Care: Volumes for the post-acute group were essentially in line with those of acute-care
operators in 2010, and we expect that they are likely to similarly recover to some extent in 2011. Post-acute
operators tend to have a greater percentage of their costs derived from fixed and semi-fixed sources, and
therefore, when revenue growth is negatively affected, they experience a correspondingly bigger negative
impact on EBITDA and EPS. This was the case for some of the operators during 2010, and if volumes rebound
in 2011 they could experience a bigger benefit on the upside.
Nursing homes face the greatest uncertainty due to Resource Utilization Group (RUG) refinement, which is
expected to be implemented fully, retroactive to October 1. The for-profit operators, such as Sun Healthcare
(SUNH) and Kindred Healthcare (KND) both seem to be confident that they will be able to navigate the change
with few (if any) negative financial consequences. Our view had been more pessimistic due to the fact that for-
profit operators had a disproportionate percentage of patients in the highest reimbursement categories.
Assuming that the companies are right and are able to avoid the negative impact from the change, our
estimates for 2011 may prove to be conservative.
Medical Device Outlook: We expect the growth rate of the overall medical device industry to remain in the
low single digits through 2011 given the (1) moderate economic growth in the United States and continued high
unemployment forecast for 2011 by the Wells Fargo Economic Group; (2) continued pricing pressure in the
United States and Europe; (3) a difficult regulatory environment; and (4) a limited number of major new
product cycles. We do, however, believe that 510(k) reform will be less negative for the industry than many
investors fear. FDA plans to publish its work plan for 510(k) reform in late December 2010 or early January
2011, and we believe that it may drop its proposed Class IIb distinction. This would be positive for the industry
because the new Class IIb category would increase the data required for approval of many new devices and
this, in turn, would increase costs and extend development timelines. We also expect a few other aspects of
510(k) reform to potentially help the medical device industry, such as streamlining the de novo device process.
We expect M&A activity to remain high as growth-challenged but cash-rich large-cap medical device
companies, such as Medtronic, Inc. and Johnson & Johnson look to acquire growth and innovation. This
should help support the valuation of small- to mid-cap names in the sector. In this slow-growth environment,
we favor companies with significant new product stories that can drive top-tier revenue growth and generate
operating leverage. The companies in our coverage universe that best exemplify this are: Edwards Lifesciences,
HeartWare International, Inc. ($85.88, Outperform), Cooper Companies, and Allergan, Inc. ($69.56,
Outperform).


Top Picks

The Cooper Companies, Inc. (COO) ▪ Rating: Outperform ▪ Mkt. Cap.: $2.7 billion
Stock Price: $55.98 ▪ Valuation Range: $61-$63
2011 (Oct) Estimates—EPS: Q1 $0.68 | Q2 $0.84 | Q3 $0.94 | Q4 $1.00 | FY2011 $3.47
▪    We believe COO can continue to grow its contact lens (CL) business faster than the contact lens market
     because the company is benefiting from the conversion of its older lenses to its new, higher-priced silicone
     hydrogel (SiH) lenses. While SiH lenses account for 41% of the overall CL market today, they represent
     only 28% of COO’s sales. As the percentage of SiH lenses sold by COO moves toward the industry average,
     COO’s top-line growth should continue to outpace that of the market because of the mix benefit it derives
     from the higher-priced SiH lenses.
▪   Our 12-month valuation assumes approximately 16x our CY2012 EPS estimate of $3.92. Risks to our
    valuation range are slowing market growth, increased competition, and manufacturing delays.
Recent Research: “COO: 4Q Beat and Good FY11 Guidance Still Seems Conservative,” 12/8/10




10
                                                                                             WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                            EQUITY RESEARCH DEPARTMENT

Managed Care Outlook
We expect fewer and lower-magnitude upside earnings surprises in 2011 than in 2010. However, we believe the
upside should be viewed as more sustainable than 2010’s larger upside, which was prior to medical loss ratio
(MLR) minimums taking affect. We believe the fear of the most negative aspects of healthcare reform will
begin to die down as the year progresses, freeing the shares in the group to advance further. We believe the
state rate review, MLR minimums, Medicare audits, cost of compliance with the new regulations, and state
budgetary shortfalls will pressure the group to consolidate more as underwriting skill, scale, and efficiency
become even more important in determining performance in 2011 and beyond. The relatively low valuation
multiples compared to the rest of the market could provide for some further upside potential in 2011. Overall,
we believe 2011 will be a rebasing year for the group as health care reform begins to alter the landscape.
Medicare: Over the long term, we continue to favor Medicare Advantage providers, despite the negative
climate from Washington over this product and the threat of Medicare audit results. We believe that the
Medicare Advantage insurers have already weathered some of the worst rate pressure that would occur as a
result of healthcare reform, since the government had already lowered rate increases below what was the likely
trend in 2010 and 2011, and that difference is likely to be added back into the rates in the future, somewhat
offsetting the future reform-driven cuts. In addition, with the concept of controlling medical costs becoming
increasingly important, we believe the Medicare Advantage insurers should be seen as the best at controlling
costs. We believe Humana Inc. (HUM, $54.84, Outperform,) and UnitedHealth Group, Inc. (UNH, $35.18,
Outperform) are best positioned to grow due to their significant positions in the Medicare Advantage sector.

Exhibit 6. Baby Boomers Fuel Medicare Growth In Years Ahead

                                        2000          2010      2020     2030     2040     2050


 US Population Over Age 65 ('000s)     35,061        40,243     54,632   71,453   80,049   86,705

  % Change                                            15%        36%      31%      12%      8%

   % of US population                   12%           13%        16%      20%      20%      21%



                         No. of People Turning Age 65 ('000s)
    4,500
    4,000
    3,500
    3,000
    2,500
    2,000
    1,500
    1,000
      500
        0
       20 0
       20 1
       20 2
       20 3
       20 4
       20 5
       20 6
          07

       20 8
       20 9
       20 0
       20 1
       20 2
       20 3
       20 4
       20 5
          16

       20 7
       20 8
       20 9
          20

       20 1
          22
          23
          0
          0
          0
          0
          0
          0
          0

          0
          0
          1
          1
          1
          1
          1
          1

          1
          1
          1

          2
       20




       20




       20




       20

       20




Source for both charts: Wells Fargo Securities, LLC and U.S. Census Bureau

Medicaid: The significant reform-driven Medicaid market expansion is not due to occur until 2014. In the
interim, increased medical cost trends, strained state budgets, and an improving economy may provide some
headwinds for the sector. We believe AMERIGROUP Corp. (AGP, $45.91, Outperform) is best positioned to
benefit from the approximate $40 billion in new Medicaid contracts likely to be assigned over the next three
years due to its strength with the aged, blind, and disabled population.




                                                                                                                      11
                                                                                                                                   WELLS FARGO SECURITIES, LLC
Health Care Team                                                                                                                  EQUITY RESEARCH DEPARTMENT

Exhibit 7. Medicaid Market Expansion

                                       2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Total


Pre-reform Medicaid & CHIP (MM)          40         39         39        38        35       34       35       35       35       35

Effect of Reform (MM)                     *         -1         -2        -3        10       15       17       16       16       16

    Total Enrollees (MM)                 40         38         37        35        45       49       52       51       51       51

Change in Coverage Related               $0     -$1        -$2       -$4       $29      $56      $81      $87      $91      $97       $434
 Federal Spending: ($ in Billions)

Additional State Spending:              N/A     N/A        N/A       N/A       N/A      N/A      N/A      N/A      N/A          N/A       $20
($ in Billions)

    Total New Spending                                                                                                                $454
     ($ in Billions)

Source: Congressional Budget Office

Commercial: We believe the commercial segment’s low utilization in 2010 will return to more “normal
levels” in 2011. This increased trend is likely to be caused by increased costs from healthcare reform, the
improvement in the economy, and the start of easier cost trend comparison quarters. However, we believe
most plans priced for this rise in trend. We believe companies that have higher-than-average exposure to both
the individual and small group markets may face greater pressure as the MLR minimums begin in 2011 and
continued rate review pressures premium rate increases. We believe UnitedHealth has the size, scale, and
diversified product offering to gain commercial membership and grow revenue, and is therefore best
positioned to weather the challenges in the commercial sector.

Exhibit 8. Exchange-Based Premium-Supported Market

                                         2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Total


Pre-reform:                                    0          0         0         0         0        0        0        0        0         0

Subsidized Exchange Members (MM)                0          0      0         0         7       11       17       18       19        19
Unsubsidized Exchange members (MM)              0          0      0         0         1        2        4        5        5         5
                                              ___        ___    ___       ___       ___      ___      ___      ___      ___       ___
    Total Enrollees (MM)                        0          0      0         0         8       13       21       23       24        24

Subsidies & Tax Credits for Exchange          $0          $0        $0        $0    $19      $43      $77      $97     $106      $114      $456
 Premiums: ($ in Billions)


    Total New Spending or Credits                                                                                                          $456
     ($ in Billions)

Source: Congressional Budget Office


Top Pick
UnitedHealth Group Inc. (UNH) ▪ Rating: Outperform ▪ Market Cap.: $38.7 billion
Stock Price: $35.18 ▪ Valuation Range: $42.00-$46.00
2011 Estimates—EPS: Q1 $1.03 | Q2 $0.99 | Q3 $0.97 | Q4 $0.81 | FY2011 $3.80
▪       We believe UnitedHealth, as the leader in Medicare Advantage, will see continued growth as this
        program’s market growth accelerates with baby boomers first starting to turn 65 in 2011.
▪       Furthermore, we believe UnitedHealth’s diversified commercial product offering and differentiated and
        higher-margin health care services business will allow it to adapt to healthcare reform better than its peers.
▪       UnitedHealth should also benefit from its strong balance sheet, better systems, strong network, and solid
        management team.
▪   Our valuation range of $42.00-46.00 is based on an 11-12x multiple of our FY2011 EPS estimate of $3.80.
    Risks include margin contraction and continued valuation pressure from healthcare reform, margin
    pressure from medical cost growth above premium growth, further enrollment or mix changes due to the
    weak economy, and further regulatory pressure on premium rate increases.
Recent Research: “UNH: Signaling Caution In 2011; Raising Estimates” 10/19/10




12
                                                                                        WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                       EQUITY RESEARCH DEPARTMENT

Pharmaceuticals Outlook: In our view, the major theme in pharmaceuticals for 2011-14 is the patent cliff.
Branded pharmaceutical manufacturers should face U.S. generic competition on many of the blockbuster
drugs of the past decade, drugs such as BMY’s Plavix (IMS October 2010 trailing 12-month U.S. sales: $6.1
billion), PFE’s Lipitor ($7.3 billion), GSK’s Advair Diskus ($4.7 billion), AZN’s Seroquel ($4.3 billion), and
MRK’s Singulair ($4.0 billion). As such, we think large-cap pharmaceutical manufacturers are more focused on
right-sizing and cost management through initiatives such as facilities rationalization and head count
reductions than on near-term growth. With expected near-term revenue declines, recent investor focus has
primarily been on dividend yield. We view the glut of patent expiries as a boon for generic manufacturers and
expect significant earnings growth for the first two years of the cliff (2011-12) and sustained earnings strength
through 2015.
Among specialty pharmaceutical companies for 2011, we continue to like companies with a niche therapeutic
focus early in the product cycle. We expect those with established products to continue to focus on new product
commercialization and lifecycle management.
A continuing theme in pharmaceuticals is the debate on biosimilars. Currently, there is no approval avenue for
generic versions of biologic (large molecules, proteins) medicines and we do not expect a near-term resolution.
The impossibility of replicating biologic materials identically remains a hurdle to an abbreviated FDA approval
process. Given the complexities and expense of producing biosimilars, we think that even if a path does
emerge, it is unlikely that smaller generic players could compete. Biosimilar development could be the next
frontier of generic growth beyond projected 2011-14 earnings. An alternative path toward biosimilars is full
clinical development, a venture we think only larger manufacturers could pursue.


Top Picks
TEVA Pharmaceutical Industries Ltd. (TEVA) ▪ Rating: Outperform ▪ Market Cap.: $49.7 billion
Stock Price: $49.11 ▪ Valuation Range: $64.00-$67.00
2011 Estimates—EPS: Q1 NE | Q2 NE | Q3 NE | Q4 NE | FY2011 $5.36
▪   In our view, TEVA is best positioned overall to capitalize on the patent expiration cycle, with 12 disclosed
    ANDA filings including four first-to-file opportunities among the current 50 top-selling drugs.
▪   Positioning in branded products and biosimilars should yield growth beyond 2012.
▪   Global presence should drive long-term growth as generic penetration grows in markets outside the U.S.
▪   Our valuation range of $64.00 to $67.00 is based on a P/E multiple of 12.0-12.5x our 2011 cash EPS
    estimate of $5.36. Risks to the stock trading to our valuation range include Copaxone
    deceleration/adverse litigation outcome, and significant generic price erosion.
Recent Research: “TEVA: CRL For Copaxone sNDA--Maintain Outperform” 12/23/2010

Watson Pharmaceuticals, Inc. (WPI) ▪ Rating: Outperform ▪ Market Cap.: $6.5 billion
Stock Price: $50.36/ Valuation Range: $54.00-58.00
2011 Estimates—EPS: Q1 NE | Q2 NE | Q3 NE | Q4 NE | FY2011 $4.03
▪   WPI is potentially the best-positioned generic manufacturer for 2011, with exclusive agreements to launch
    authorized generic versions of Concerta and Lipitor (aggregate U.S. revenue: $8.6 billion)
▪   Emerging biologics capabilities and growing brand portfolio could position WPI for growth beyond 2012.
▪   Global supply chain initiative improving margins for the long-term and cautious pursuit of a
    transformational business development move could drive growth and improve tax rate.
▪   Our valuation range of $54.00 to $58.00 is based on a P/E multiple of 13.5x-14.5x our 2011 cash EPS
    estimate of $4.03. Risks to the stock trading to our valuation range include deceleration in Rapaflo and
    Gelnique, delay in generic Ferrlecit approval, and earlier than expected Micro-K competition.
Recent Research: “WPI: Prochieve 8% Met Phase-III Primary Endpoint In PTB Study” 12/6/2010

Pharmaceutical Services Outlook: As seen in Exhibit 9, shares of CROs have fared quite well relative to
the S&P 500 over the past ten years.




                                                                                                                    13
                                                                                                                                                              WELLS FARGO SECURITIES, LLC
Health Care Team                                                                                                                                             EQUITY RESEARCH DEPARTMENT

Exhibit 9. Relative NTM P/E Ratio Of CROs Versus S&P 500
                                  110%


                                  90%
  Premium / Discount to S&P 500




                                  70%
                                                                                               Average =
                                                                                              25% Premium
                                  50%


                                  30%


                                  10%


                                  -10%


                                  -30%


                                  -50%


                                  -70%
                                     Jan-99   Jan-00             Jan-01     Jan-02     Jan-03     Jan-04        Jan-05    Jan-06       Jan-07       Jan-08       Jan-09    Jan-10
Source: FactSet and Wells Fargo Securities, LLC

Given our belief that biopharma companies will increasingly utilize outsourcing as a means to “bend” the drug
development cost curve and shorten time to market for novel molecular entities, we see the outsourced drug
development market growing 6-8% yr/yr over the next three years.

Exhibit 10. Our Projection For The Outsourced Drug Development Market
                                                            $30.0

                                                            $25.0

                                                            $20.0
                                               $ billions




                                                            $15.0

                                                            $10.0

                                                             $5.0

                                                            $-
                                                                      2005          2006      2007       2008      2009     2010E 2011E 2012E 2013E

                                                                          Growth at 100 bps            Growth at 200 bps       Growth at 300 bps


                                                                           2005      2006      2007      2008     2009    2010E    2011E            2012E     2013E
 Penetration                                                                                                                                                              CAGR '10E - '13E
 in billions                                      $ outsourced        $      11.9    $ 13.6   $ 15.3    $ 17.4   $ 18.3   $ 19.3   $    20.3    $     21.4   $    22.6
 Growth at 100 bps                                                                    14.2%    12.8%     13.9%     5.1%     5.3%        5.4%          5.4%        5.5%          5%
                                                  $ outsourced        $      11.9    $ 13.6   $ 15.3    $ 17.4   $ 18.3   $ 19.8   $    21.3    $     22.9   $    24.6
 Growth at 200 bps                                                                    14.2%    12.8%     13.9%     5.1%     8.0%        7.8%          7.6%        7.4%          8%
                                                  $ outsourced        $      11.9    $ 13.6 $ 15.3 $ 17.4 $ 18.3 $ 20.3 $ 22.3 $                      24.5 $      26.7
 Growth at 300 bps                                                                    14.2%  12.8%  13.9%   5.1%  10.7%   10.1%                       9.6%        9.1%         10%
                                                                                                                                                             Average            8%
Source: Wells Fargo Securities, LLC

For those CROs with a dominant presence along the drug development spectrum, possessing broad global
scale and deep therapeutic expertise, we think sales growth could easily exceed our estimate for industry
growth. Possessing all of the aforementioned characteristics, we believe Covance is primed to post low-double-
digit sales growth and given its highly fixed cost structure, we believe resurgence in sales growth will produce
midteens earnings growth.




14
                                                                                         WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                        EQUITY RESEARCH DEPARTMENT

Top Pick
Covance (CVD) ▪ Rating: Outperform ▪ Mkt. Cap.: $3.4 billion
Stock Price: $52.06 ▪ Valuation Range: $58.00-59.00
2011 Estimates—EPS: Q1 $0.68 | Q2 $0.69 | Q3 $0.74 | Q4 $0.75 | FY2011 $2.85
    Covance has a dominant presence in the full spectrum of drug development service offerings, which
    should bolster the company’s ability to win mega-strategic alliances with large pharma companies.
    CVD is significantly levered to resurgence in preclinical activity and given our belief that this subsegment
    will begin to recover in H2 2011, we see significant upside to our 2011 and 2012 EPS estimates
    Our valuation range represents 19x our 2011 EPS estimate. Risks to our valuation range include: (1)
    intense competition and excess capacity in the preclinical market, and (2) late-stage cancellations.
Recent Research: “CVD: Delivery Above Our Expectations: Reiterate Outperform” 11/05/2010

In our view, consumers will ultimately benefit from an increase in drug development outsourcing. It is well
documented that the use of CROs can decrease the time it takes to develop a drug as well as lower the overall
cost of drug development. As a result, consumers should see a reduction in the time it takes to bring a drug to
market and perhaps a decrease in the price of new drug therapies.
Health Care IT Outlook: Under the The American Recovery and Reinvestment Act (ARRA), the Health
Information Technology for Economic and Clinical Health Act (HITECH) provides nearly $30 billion in
government funding to physicians and hospitals that adopt and demonstrate “meaningful use” of government-
“certified” electronic health records (EHRs) between government fiscal year (GFY) 2011 and GFY2015.
For the companies that develop and sell EHRs, the opportunity is likely one of historic proportions. Current
adoption rates for EHRs among healthcare providers have been documented in the midteens, mainly a
function of cost and uncertainty around return on investment. In our view, the $30 billion in funding will
undoubtedly lower these barriers. Indeed, the Congressional Budget Office estimates that the passage of the
HITECH Act will ultimately drive the EHR adoption rate among physicians and hospitals to 90%. Our
proprietary model is not quite as optimistic (see Exhibit 11, but we still estimate that roughly $12 billion is up
for grabs through CY2015. To put this in perspective, we believe that the size of the current EHR market is
around $2.9 billion. Needless to say, the addressable market for well-established EHR vendors is significant.
Comprising nearly tw0-thirds of our addressable market size estimates, we favor dominant vendors of EHRs to
the ambulatory space. With around 15% share of the ambulatory clinical IT market and approximately 40% of
sales derived from EHRs, we think Quality Systems (QSII) is best positioned to benefit from a surge in EHR
adoption among physician practices.


Top Pick
Quality Systems , Inc. (QSII) ▪ Rating: Outperform ▪ Market Cap.: $2.1 billion
Stock Price: $71.30 ▪ Valuation Range: $77.00-78.00
2012 (Mar) Estimates—EPS: Q1 $0.64 | Q2 $0.68 | Q3 $0.74 | Q4 $0.85 | FY2012 $2.92
    Quality Systems has significant mind share within the physician practice arena, which should bode well
    for the company’s ability to capture a large percentage of physicians adopting EHRs
    Given our belief that the incremental EHR sales opportunity is approximately $2.6 billion in 2011 and
    that QSII’s clinical IT applications carry 15% market share within the physician practice segment, we
    believe that more than 40% upside to our CY2011 EPS estimate of $2.73 could exist.
    Our valuation range is driven by our DCF model. The range implies 28x our CY2011 EPS estimate and
    16.5x our CY2011 EBITDA estimate. Major risks include (1)trajectory of EHR adoption is considerably
    more shallow than our projections, and (2)increasingly competitive EHR pricing, especially in the small
    physician practice market.
Recent Research: “QSII: Analyst Day Offers Plenty of Reasons to Remain Positive,” 11/17/2010




                                                                                                                     15
                                                                                                                         WELLS FARGO SECURITIES, LLC
Health Care Team                                                                                                        EQUITY RESEARCH DEPARTMENT

To better illustrate QSII’s potential earnings power as EHR adoption increases, we offer the following scenario.
Our above-consensus estimates for QSII may prove to be conservative. For CY2011 EPS, we are at $2.73, which
compares to consensus of $2.67. We provide a hypothetical scenario in which our EPS estimate appears quite
conservative. We rely heavily on our addressable-market-size model, which calls for $8+ billion incremental
ambulatory EHR sales through 2015. MDRX believes the ambulatory opportunity is $10 billion through 2014.
Now, assuming Quality Systems has about 10% of the ambulatory EHR market and this share holds constant
over the foreseeable future, using our addressable-market-size model, we come up with nearly 40% upside
potential to our $2.73 estimate.
For CY2011, we assume QSII’s revenue grow 25% yr/yr, or to $84 million. We believe about 40% of this delta
will come from new EHR sales, or $34 million. Our addressable EHR market-size model projects that new
ambulatory EHR sales will hit $2.2 billion in 2011. Applying QSII’s 10% share, gets $220 million incremental
sales to QSII. If we assume 70% of those sales come from software license sales (other 30% from SaaS-based
EHRs), we arrive at $154 million incremental EHR sales in 2011. We then subtract the $34 million of
incremental EHR sales already assumed in our model and arrive at $120 million. To be conservative, we
assume these incremental software sales carry a 40% incremental operating margin, which yields $48 million
of operating income (.4 * $120 million). Tax effect at 37% and divide by 29.5 million shares out produces $1.03
EPS above our $2.73 estimate, or 38% upside potential.

Exhibit 11. Addressable Market Size For Electronic Health Records
                                                                                                                                                                Incremental Revenue
                                                            10/01/2010 -            10/01/2011 -        10/01/2012 -        10/01/2013 -        10/01/2014 -     Opportunity for EHR
                                                             09/30/2011              09/30/2012          09/30/2013          09/30/2014          09/30/2015           Vendors
                                        Present             GFY 2011E               GFY 2012E           GFY 2013E           GFY 2014E           GFY 2015E       GFY 2011E - GFY 2015E
Physician Office Setting
# of Physicians                              77,400                167,700                270,900             322,500             335,400             340,560
adoption rate                                     15%                   33%                   53%                 63%                 65%                 66%
Addressable Market (Δ physicians)            77,400                  90,300               103,200              51,600              12,900               5,160

Delivery methods
Software/IT
License and Implementation Fees     $ 2,058,840,000     $     1,871,016,000     $ 1,820,448,000     $     884,940,000   $     214,914,000   $      83,437,200
Penetration of Software delivery                  95%                   93%                   90%                 88%                 85%                 83%
Maintenance                         $   220,590,000     $      250,582,500      $     529,222,500   $     664,672,500   $     697,567,500   $     710,338,500

SaaS                                $    32,461,560     $        56,807,730     $     143,371,890   $     197,474,490   $     213,705,270   $     221,279,634
Penetration of SaaS delivery                       5%                      8%                 10%                 13%                 15%                 18%

Physician Market                    $ 2,311,891,560     $   2,178,406,230       $2,493,042,390      $1,747,086,990      $1,126,186,770      $1,015,055,334      $      8,559,777,714


Hospital Setting
# of Hospitals                                    400                 1,000                 1,800               2,200               2,400               2,600
adoption rate                                     10%                   25%                   45%                 55%                 60%                 65%
Addressable Market (Δ hospitals)                  400                   600                   800                 400                 200                 200

Software/IT
License and Implementation Fees     $   450,000,000     $      540,000,000      $     630,000,000   $     315,000,000   $     157,500,000   $     157,500,000
Maintenance                         $    90,000,000     $      135,000,000      $     315,000,000   $     405,000,000   $     450,000,000   $     495,000,000

Hospital Market                     $   540,000,000     $     675,000,000       $ 945,000,000       $ 720,000,000       $ 607,500,000       $ 652,500,000       $      3,600,000,000


Hospitals and Physicians            $ 2,851,891,560     $   2,853,406,230       $3,438,042,390      $2,467,086,990      $1,733,686,770      $1,667,555,334      $     12,159,777,714
Source: Wells Fargo Securities, LLC estimates




16
                                                                                         WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                        EQUITY RESEARCH DEPARTMENT


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                                                                                                                                      17
                                                                                           WELLS FARGO SECURITIES, LLC
Health Care Team                                                                          EQUITY RESEARCH DEPARTMENT

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AGN: Risks include further deterioration in the economy, new competition in the neurotoxin markets, and failure of
clinical trials for late-stage pipeline products and regulatory delays.
AGP: Key risks include strained state budgets possibly causing Medicaid rate increases to be below medical cost trend,
continued valuation pressure on the group from health care reform, and higher than anticipated medical costs from
the increasing medical complexity of the enrollees that AMERIGROUP covers.
CELG: Key risks are generic versions of Revlimid, setbacks to front-line/maintenance approvals, and reimbursement
challenges.
COO: Risks include prolonged inefficiencies in SiH production and slowdown in contact lens market.
CRL: Risks to our valuation range include: 1) continued study-start slippage 2) excess industry toxicology capacity
causing further pricing pressure 3) increasing financial leverage.
CVD: Risks to our valuation range include: 1) intense competition and excess capacity in the preclinical market, and 2)
late-stage cancellations.
DVA: Company risks include: potential payer mix away from commercial, which typically pays 3-4x more than
Medicare; a history of active regulation and investigation of the dialysis industry; an inability to reduce total costs of
treatment through a combination of lower prices paid and utilization of drugs.
EW: Key risks include the PARTNER trials, product delays, and uptake of Sapien.
GILD: Key risks include lower-than-expected B-tripla uptake, growing cost-consciousness among payers, and failure
of Quad in phase III.
HMA: Risks to our valuation include: concentrated revenue with about 33% of its revenue in Florida; higher bad debt
trends at its hospitals due to negative employment trends; and potentially significant reimbursement changes




18
                                                                                       WELLS FARGO SECURITIES, LLC
Healthcare Industry 2011 Outlook                                                      EQUITY RESEARCH DEPARTMENT

associated with healthcare reform.
HTWR: Risks to our thesis include slower-than-expected growth of the LVAD market and/or negative clinical data for
the HVAD.
HUM: Key risks include rate pressure and other changes in Medicare Advantage, margin contraction and continued
valuation pressure from health care reform, potential loss of its TRICARE program, and to a lesser extent margin
pressure from medical cost growth above commercial pricing, and regulatory pressure on commercial MLRs and
premium rate increases.
PLX: Risks include FDA and/or EMA failure to approve taliglucerase, emergence of an immunogenicity signal, and
market competition.
QSII: Major risks include (1)trajectory of EHR adoption is considerably more shallow than our projections, and
(2)increasingly competitive EHR pricing, especially in the small physician practice market.
RIGL: Key risks include failure of fostamatinib in ph. III, emergence of a new safety signal, and poor market uptake.
TEVA: Risks to the stock trading to our valuation range include Copaxone deceleration/adverse litigation outcome,
and significant generic price erosion.
UHS: Risks to our valuation include: Concentrated revenue with 14% of net income coming from the Las Vegas
market which has been negatively impacted by the weak economy. Higher uncompensated care trends due to negative
employment trends. Potentially significant reimbursement changes associated with healthcare reform.
UNH: Key risks include margin contraction and continued valuation pressure from health care reform, margin
pressure from medical cost growth above premium growth, further enrollment or mix changes due to the weak
economy, Risk Adjustment Data Validation audit results, and further regulatory pressure on premium rate increases.
VRTX: Risks include failure of VRTX to obtain telaprevir approval, and a slower-than-expected launch.
WPI: Risks to the stock trading to our valuation range include deceleration in Rapaflo and Gelnique, delay in generic Ferrlecit
approval, and earlier than expected Micro-K competition.

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STOCK RATING
1=Outperform: The stock appears attractively valued, and we believe the stock's total return will exceed that of the market over the
next 12 months. BUY
2=Market Perform: The stock appears appropriately valued, and we believe the stock's total return will be in line with the market
over the next 12 months. HOLD
3=Underperform: The stock appears overvalued, and we believe the stock's total return will be below the market over the next 12
months. SELL
SECTOR RATING
O=Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months.
M=Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months.
U=Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months.
VOLATILITY RATING
V = A stock is defined as volatile if the stock price has fluctuated by +/-20% or greater in at least 8 of the past 24 months or if the
analyst expects significant volatility. All IPO stocks are automatically rated volatile within the first 24 months of trading.

As of: January 10, 2011
45% of companies covered by Wells Fargo Securities, LLC         Wells Fargo Securities, LLC has provided investment banking
Equity Research are rated Outperform.                           services for 43% of its Equity Research Outperform-rated
                                                                companies.
53% of companies covered by Wells Fargo Securities, LLC         Wells Fargo Securities, LLC has provided investment banking
Equity Research are rated Market Perform.                       services for 45% of its Equity Research Market Perform-rated
                                                                companies.
3% of companies covered by Wells Fargo Securities, LLC          Wells Fargo Securities, LLC has provided investment banking
Equity Research are rated Underperform.                         services for 45% of its Equity Research Underperform-rated
                                                                companies.




                                                                                                                                   19
                                                                                           WELLS FARGO SECURITIES, LLC
Health Care Team                                                                          EQUITY RESEARCH DEPARTMENT

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20
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                                                                    EQUITY RESEARCH DEPARTMENT



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sam.pearlstein@wachovia.com                                                                           todd.wickwire@wachovia.com



CONSUMER                                           HEALTH CARE                                          REAL ESTATE, GAMING & LODGING
Food                                               Biotechnology                                        Gaming
   Eric Serotta, CFA             (212) 214-8035      Brian Abrahams, M.D.           (212) 214-8060         Carlo Santarelli                  (212) 214-5029
      Dennis Geiger              (212) 214-5028         Matthew J. Andrews          (617) 603-4218           Kelly Knybel                    (212) 214-8065
Homebuilding/Building Products                     Healthcare Facilities                                Healthcare/Manufactured Housing & Self Storage
   Carl Reichardt                (415) 396-3054      Gary Lieberman, CFA            (212) 214-8013         Todd Stender                   (212) 214-8067
     Adam Rudiger, CFA           (415) 396-3194        Ryan Halsted                 (212) 214-8022           Philip DeFelice, CFA        (443) 263-6442
Leisure                                            Managed Care                                         Lodging/Multifamily & Retail
   Timothy Conder, CPA           (314) 955-5743       Peter Costa                   (617) 603-4222        Jeffrey J. Donnelly, CFA      (617) 603-4262
     Joe Lachky                  (314) 955-2061    Medical Technology                                        Dori Kesten                (617) 603-4233
     Michael Walsh, CFA, CPA     (314) 955-6277       Larry Biegelsen               (212) 214-8015           Robert LaQuaglia, CFA, CMT (617) 603-4263
Restaurants                                             Narendra Nayak              (212) 214-8038      Office/Industrial & Infrastructure
   Jeffrey F. Omohundro, CFA     (804) 697-7354         Lei Huang                   (212) 214-8039        Brendan Maiorana, CFA          (443) 263-6516
      Katie H. Willett           (804) 697-7356    Pharma Services                                          Young Ku, CFA                (443) 263-6564
      Jason Belcher              (804) 697-7352       Greg T. Bolan                 (615) 525-2418
Retail Hardlines                                        Tim Evans                   (615) 525-2426
   Matt Nemer                    (415) 396-3938    Pharmaceuticals
     Trisha Dill, CFA            (312)-920-3594      Michael K. Tong, CFA, PhD      (212) 214-8020
Specialty Retailing                                    Brian E. Jeep                (212) 214-8069
   Evren Kopelman, CFA           (212) 214-8024        David Gu                     (212) 214-8057
     Maren Kasper                 (212) 214-5016


                                                                                                        TECHNOLOGY & SERVICES
                                                                                                        Data Networking & Wireline Equipment
                                                                                                           Jess Lubert, CFA                  (212) 214-5013
ENERGY                                                                                                        Michael Kerlan                 (212) 214-8052
Alternative Energy                                                                                      Information Technology (IT) Services
   Sam Dubinsky                  (212) 214-5043                                                           Edward S. Caso, Jr., CFA       (443) 263-6524
Exploration & Production                           INDUSTRIAL                                                Suman Kaba                  (443) 263-6540
   David R. Tameron               (303) 863-6891                                                             Richard Eskelsen             (410) 625-6381
     Gord0n Douthat              (303) 863-6920    Aerospace & Defense
                                                                                                          Eric Boyer                     (443) 263-6559
     Trevor Seelye               (303) 863-6880       Sam J. Pearlstein             (212) 214-5054
                                                      Gary S. Liebowitz, CFA        (212) 214-5055      Semiconductors/Computer Hardware
   Michael A. Hall, CFA          (303) 863-6894                                                           David Wong, CFA, PhD               (212) 214-5007
                                                        Michael D. Conlon           (212) 214-5056
Midstream Energy/Master Limited Partnerships                                                                Amit Chanda                      (314) 955-3326
                                                   Automotive/Industrial and Electrical Products
   Michael Blum                  (212) 214-5037                                                         Software
                                                     Rich Kwas, CFA                 (410) 625-6370
   Sharon Lui, CPA               (212) 214-5035                                                           Philip Rueppel                 (617) 603-4260
                                                        David H. Lim                (443) 263-6565
     Eric Shiu                   (212) 214-5038                                                             Priya Parasuraman            (617) 603-4269
     Praneeth Satish             (212) 214-8056    Diversified Industrials
                                                      Allison Poliniak-Cusic, CFA   (212) 214-5062      Technology
     Hays Mabry                  (212) 214-8021                                                           Jason Maynard                      (310) 597-4081
   Ronald Londe                  (314) 955-3829    Machinery
                                                                                                             Karen Russillo                  (415) 396-3505
     Jeff Morgan, CFA            (314) 955-6558      Andrew Casey                   (617) 603-4265
                                                                                                             Aron Honig                      (212) 214-8029
                                                        Justin Ward                 (617) 603-4268
Utilities                                                                                               Transaction Processing
                                                     Sara Magers, CFA               (617) 603-4270
   Michael Bolte                 (212) 214-8061                                                           Timothy Willi                      (314) 955-4404
   Jonathan Lefebvre             (212) 214-8026    Ocean Shipping
                                                                                                            Robert Hammel                    (314) 955-4638
   Neil Kalton, CFA              (314) 955-5239       Michael Webber, CFA           (212) 214-8019
                                                                                                            Daniel Moisio                    (314) 955-0646
     Sarah Akers, CFA            (314) 955-6209         Ross Briggs                 (212) 214-8040
     Jonathan Reeder             (314) 955-2462    Transportation
Oilfield Services and Drilling                        Anthony P. Gallo, CFA         (410) 625-6319
   Matthew D. Conlan, CFA        (212) 214-5044         Michael Busche              (443) 263-6579
     Christopher W. Wicklund     (212) 214-8028
   Tom Curran, CFA               (212) 214-5048



                                                                                                        EQUITY STRATEGY
FINANCIAL SERVICES                                                                                      Equity Strategy
                                                                                                          Gina Martin Adams, CFA, CMT         (212) 214-8043
Insurance                                                                                                    Howard Park                      (212) 214-8063
   John Hall                     (212) 214-8032    MEDIA & TELECOMMUNICATIONS
   Sean R. Dargan                (212) 214-8023    Broadcasting & Cable
     Vincent Caintic, CFA        (212) 214-8034       Marci Ryvicker, CFA, CPA    (212) 214-5010
     Elyse Greenspan, CFA         (212) 214-8031        Timothy Schlock, CFA, CPA (212) 214-5011
     Susan Ross                  (212) 214-8030         Stephen Bisson           (212) 214-8033
Specialty Finance                                  Interactive Entertainment
   James P. Shanahan             (314) 955-1026       Jess Lubert, CFA              (212) 214-5013
   Christopher Harris, CFA       (443) 263-6513          Michael Kerlan             (212) 214-8052
     Nathan Burk, CFA            (314) 955-2083    Telecommunication Services - Wireless/Wireline
U.S. Banks                                           Jennifer M. Fritzsche          (312) 920-3548      RETAIL RESEARCH MARKETING
   Matt Burnell                  (212) 214-5030      Gray Powell, CFA               (212) 214-8048      Retail Research Marketing
     Herman Chan                 (212) 214-8037        Andrew Spinola                (212) 214-5012       Colleen Hansen                      (410) 625-6378



                                                                                                                                                    January 5, 2011

				
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