Eclipsys: Uncertainty Eclipses an Optimistic Outlook

Investors have been looking for a seat on the healthcare information technology gravy train. Ever since the American Recovery and Reinvestment Act of 2009 was passed in February, the healthcare IT sector has rallied and outperformed the broader market (See Figure 1). Contained within the ARRA is the HITECH Act, a piece of legislation designed to incent medical providers to install and use IT systems for the delivery of better care. The legislation sets forth an estimated $19B in publicly funded grant & loan programs and Medicare/Medicaid incentive payments which will be distributed to medical providers who are “meaningful users” of healthcare information technology.



The HITECH Act supports an excellent cause that will help modernize our healthcare infrastructure. With the big bucks to be gained by medical software vendors as hospitals and physicians upgrade their IT systems, it is no surprise that the healthcare IT sector has taken center stage on Wall Street. However, no one should enter an investment without a dose of healthy skepticism. While I expect the rising tide in the healthcare IT transformation to lift all boats, investors should be careful to avoid missteps.

One stock I believe at risk is a favorite among buy-siders: Eclipsys (ECLP). Eclipsys is a leader in the area of electronic medical records (EMR) and financial analytics software for hospitals. The company has a rich history since it began in 1995, with origins in Computerized Physician Order Entry (CPOE) systems. A CPOE system processes and helps coordinate doctors’ requests for medications, lab tests, and other diagnostic procedures within a hospital. Eclipsys has a highly regarded product built on the Microsoft .NET platform, and now offers a broad range of medical management software products. Today, Eclipsys is a strong contender in the hospital market. Its major competitors include healthcare IT giant Cerner (CERN), McKesson Provider Technologies (MCK), and Epic Systems (privately held).

Don’t Throw Caution to the Wind

I believe Eclipsys could benefit greatly from the HITECH Act over the next several years. Hospitals are eager to capitalize on the Medicare incentive payments, and certainly want to avoid the reimbursement penalties beginning in 2016. However, good opportunities for business do not always translate to good investment opportunities in the stock market. Here are my fundamentals-based reasons on why Eclipsys may not be the best way to play the healthcare IT frenzy:

1. No HITECH-related deals have been signed. Management presented its Q1 2009 earnings conference call with an optimistic forward-looking tone. However, they were clear to acknowledge that the impacts of HITECH-related spending have not yet been felt. This is an excerpt from the May 6th conference call:

Andy Eckert, CEO:

I can’t point to a single contract that happened during that period [Q1] that was purely a result of that activity [HITECH-related]…

Later in the call Andy Eckert states:

…while the stimulus is a wonderful thing, our clients are still hurting financially. That’s the reality. They are hurting financially and so we’ve seen projects slow down. We’ve seen some projects get delayed for months, and that is something that, again, gives us some level of balance in our world. This is not up, up, and away, by any means.

Although I am rooting for the HITECH spending to begin pulling through soon, this tough economic environment and uncertain reimbursement outlook has hospital administrators still cautious about capital spending. In fact, it may be a very long time before hospitals begin making major capital spending decisions to get their incentive payments. A recent survey by Hospitals & Health Networks shows that hospitals have not been very gung ho lately about IT spending.

While long-term investors may contend that now is the time to invest because the money will come rolling in sooner or later, my next few points are more specific to Eclipsys and may be the harbinger of a black swan coming around the corner.

2. Headcount reductions could cause a bottleneck. Early this year, Eclipsys preannounced Q4 2008 earnings results with an unexpected shortfall due to a rapid deterioration in the economy. In response, Eclipsys significantly trimmed its staff in the professional services group.

While this move seems to have cut unnecessary expenses for the time being, it could come back to bite them when business picks up. Although management may believe that headcount could quickly be inflated upon a surge in bookings, I would beg to differ. With a smaller number of consultants, there will undoubtedly be some costs to ramping up again as the company seeks to hire and train new employees. It may even be more costly than normal operating environments. If the economy upturns and a sudden spending glut forms as hospitals rush to upgrade in time for the 2011 incentive payments, trained healthcare IT professionals may come at a premium. I believe this makes Eclipsys vulnerable to strained implementation capacity once the ball gets rolling.

3. Eclipsys’ customer base is already saturated with CPOE; organic growth opportunities may be limited. From current information, the “meaningful use” criteria required to qualify for government incentive payments are likely to include CPOE as a central component. Since Eclipsys has the highest CPOE penetration rate in the industry (~60%, I estimate), this may limit some of the cross selling opportunity within its customer base. Other healthcare IT vendors such as Cerner (CERN) or Computer Programs & Systems (CPSI) may stand to benefit more from the installation of CPOE within their respective customer bases.

In January, an analyst at Thomas Weisel Partners was inadvertently copied on an email from CEO Andy Eckert to CFO Robert Colletti. In the email, Eckert acknowledged that the company is struggling with its organic growth rate, and has accelerated acquisitions as a remedy. In December of 2008, the company acquired Premise, a maker of patient flow software. Several months before that, it purchased MediNotes, a vendor of small physician practice EMR software. In early 2008, Eclipsys purchased EPSi for its revenue cycle analytics offering. Perhaps the organic growth issue indicates that Eclipsys is a victim of its own success.

4. Two top executives abruptly left the company. Finally, a glaring red flag is the abrupt departure of Eclipsys’ CEO and CFO. In January, CFO Robert Colletti mysteriously resigned. Then in May, only days after the Q1 results were reported, CEO Andy Eckert left his post, citing family ties in California and the accomplishment of operational goals. Eckert has been with Eclipsys since 2005 and is credited for transforming company’s strategy and expanding its product line beyond CPOE. His successor is a board member who joined the company in February. While the proximate departure of these executives may be a mere coincidence, history has shown us that such management shakeups could also be a leading indicator of more systemic problems within the company.

Valuation

Eclipsys tends to trade at premium multiples compared to other stocks in the healthcare IT sector. I believe that money managers are drawn to its small market cap and strong presence in the industry. At its current multiples, I would hardly consider it a value buy. My aforementioned reasons to be cautious point out the likelihood of troubling news in the future, which would make ECLP shares susceptible to a sudden drop in value.

Despite my hesitation to take a long position, I would not have the conviction to short ECLP either. With the momentum of HITECH on the way, any positive news on deals signed due to the legislation could rocket the shares. Such good news may appear near the company’s Q2 earnings release on August 6th.

Finally, Eclipsys would make an attractive buyout target for bigger fish. With giants such as Microsoft, Oracle, and Johnson & Johnson expressing interest in healthcare technology, Eclipsys may be ripe for picking.

The Meaningful Use Conundrum

Although I am certain that the HITECH Act will bring meaningful changes within the healthcare field, how soon is difficult to tell. Currently, I believe the “meaningful use” definition is still too ambiguous for budget planners to comfortably make IT purchase decisions. The HITECH Act refers to a “meaningful use” definition to determine whether a medical provider’s IT system is sufficient to deserve the Medicare and Medicaid incentive payments. Until now, the committee responsible for defining “meaningful use” is still refining the criteria.

On June 16th, the committee released its first draft of “meaningful use.” Already, there has been some pushback from industry. Criticism has centered on its vagueness and the feasibility of meeting the definition by 2011.

• CIO Group Comments on Meaningful Use
• Docs to Feds: Go Slow on Meaningful Use
  
• HIMSS: Clarity Needed on Meaningful Use
  
• Premier Comments on Meaningful Use
  

It may be later on in the year by the time we get more clarity on “meaningful use”. The committee is set to meet again on July 16th. Personally, I believe that some of the 2011 goals would be hard to achieve, especially for struggling hospitals that are entrenched with legacy systems. It will likely be later in the year by the time the ambiguities in “meaningful use” are ironed out. By then, hospitals will have a brief time window to upgrade their systems to meet the 2011 criteria. Implementations of these systems take many months, and in some cases up to two years for a complex rollout. Given the human capital quagmire of training the number of professionals necessary to get so many systems installed in such a short time, the industry may face a capacity constraint. To be fair, the committee will either have to lower the bar on the 2011 criteria or many hospitals will miss the opportunity to capitalize on the incentive payments in the early years.

I believe that the HITECH incentive plan is likely to encounter the same industry pushback as the ICD-10 coding conundrum. Originally, the department of Health and Human Services had an October 1, 2011 deadline for medical providers to begin reporting health statistics using the ICD-10 code system, replacing the current ICD-9 set of codes. Due to a strong industry pushback on the costs of changing systems to comply, HHS was forced to postpone the deadline by two years to October 2013.

Final Word on the Healthcare IT Market

I believe the healthcare IT market will be a great place to be for the next few years. For anyone looking to consider a career path, healthcare IT is certain to provide some fun challenges and prosperous times. However, investors should remain cautious because the timing is everything. While I do not believe Eclipsys is a suitable place to park money at the moment, some better opportunities may lie in the ambulatory market vendors such as Allscripts (MDRX) and Quality Systems (QSII).

The implementation of systems for small physician offices (the ambulatory market) is less complex than a hospital. In many cases the software can be remotely hosted, alleviating the burden of hardware installation difficulties for the physician. I believe Software-as-a-Service (SaaS) will become a key strategic tool for the ambulatory software vendors. athenahealth (ATHN) is one of the leading, if not the premiere, providers of SaaS-based financial and EMR software for small physician offices. However, I believe ATHN’s stock valuation makes it less attractive as an investment. For Allscripts and Quality Systems, I believe the opportunity is huge, but investors should wait for attractive entry points before building a position.

Full Disclosure: At the time of this writing, Winston does not hold a position in any of the above mentioned stocks.

Comments

[tresspass:]

Though not a new contract, this upgrade for the largest non-profit hospital in the US is significant, imo, for ECLP:

finance.yahoo.com/news...

i believe the author is onto something when he more than suggests that firms not in the burgeoning HIS arena will want and need to. ECLP is an excellent pathway.

Jul 09 11:38 AM