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Matt Brice, The Sova Group (20 clicks)
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The point of a business is to make money for its owners. If cash comes in the door in the form of operating cash and its managers quickly shuffle that money out the back door through failed acquisitions or capital expenditures that do not produce results in the form of increased profits, the owners are left with only pieces of paper, resting all their hopes on the greater fool theory of investing--hoping one day to sell those worthless pieces of paper to someone else for more than what they originally paid. Granted, this can at times be a fruitful endeavor, but be weary that you may be the last one standing without a chair when the music stops.

Amedisys (AMED) is a business that fits the bill for the description above. Money comes in the front door and goes out the back without ever benefiting its rightful owners, the shareholders. Over the past 10 years, since 2003, the company has garnered over $10.2B in revenues. On these revenues, the company has earned negative ($113m) in net profits. Operating cash flow comes in at approximately $990m. However, between capital expenditures and acquisitions, Amedisys has spent a collective $1.33B, resulting in a negative ($343m) available to the owners of the business. In other words, the shareholders are getting nothing. No stock buybacks, no dividends. Left holding the bag, waiting to sell to the greater fool.

Amedisys Key Figures

10 Year Total (since 2003)

Revenue

$10,193B

Net Income

($143m)

Operating Cash Flow

$989m

Capex and Acquisitions

$1,332B outflows

FCF Available to Owners

($343m)

In this period of time, the Founder, CEO and Chairman of the Board has collected approximately $25m in salary, restricted stock, option grants and other compensation. These figures are taken from the proxy statements over the past ten years and adjusted for forfeitures when required (as indicated in the footnotes of each subsequent year). As a side note, adjusting for such forfeitures is what media outlets typically forget to do when lambasting CEO compensation. I digress. Shareholders, on the other hand, have received no dividends or share repurchases during this period.

Business Model Problems with Home Health:

The unspoken problem with home health is that revenue and costs are hard to determine prospectively. The nurse doesn't visit a patient and charge Medicare $200 for the visit (and the company in turn pays her $100). Instead, the Prospective Payment System requires an indication of the category of patient illness and a payment is set for the next 60 days. Here is where the rubber meets the road--in those 60 days a lot can happen. The patient may pull out his catheter and need it to be replaced on a Sunday (time and a half overtime). A patient may experience chest pains and want the nurse to visit to reassure him/her. All of the extra visits are not added on to the payment. Instead, the Prospective Payment System is meant to average these extra visits with other patients who require less visits than projected. With enough experience and data, these costs should average out and companies should be able to manage to earn a profit.

However, another very unspoken truth is that the frontline healthcare providers generally have no concern for the bottom line. This is built into the healthcare mind. It must be a pledge that nurses and doctors take when they enter the medical profession ("I will never read or even try to understand the P&L statement for my medical practice"). I say this in a factual not damaging matter (my wife is a doctor). Some doctors are able to do this when they own their own practice, but I have never seen a frontline therapist or nurse take any interest in wanting to know the impacts of their actions on the bottom line of the company. The result is easy to predict. The patient may need to be seen 3-5x per week following release from the hospital. Without fail, the nurse will set up the schedule to visit the patient 5x per week. More visits, better treatment, the nurse or therapist reasons. However, the Medicare payments will be the same regardless of whether the patient is seen 3x or 5x per week. Home health care operators have tried to solve this problem by adjusting the pay arrangements with its staff. When they pay staff on a salary or hourly basis, visits decrease significantly. The nurse reasons, why should I make 5 visits a day when I get paid the same for making 4 per day? This results in a lower overall visit count, but higher average visit cost. The managers respond by paying the staff on a per visit basis. However, self-interest rules again and the staff frequently increase their visits, resulting in higher overall visit costs. Amedisys, and the other public operators, have gone back and forth over the years switching models in order to try effectively manage their costs without success. I recently spoke with a member of Amedisys' management who indicated that the latest change in their compensation system is to shift admission nurses to salary as their visits can be longer and therefore the pay-per-visit model is difficult because they have a "lumpy" number of visits.

Frontline healthcare workers productivity is fairly easily managed in a hospital or other medical facilities setting, however, when the nurses and therapists are going into the homes of the patients, the time spent on each case can vary widely due to the autonomy of being aware from a facility. These variable employee costs are difficult to manage and will continue to affect the gross margins of Amedisys and other home health care providers.

Amedisys thinks it can manage these costs through its technology spend, however, its financial results do not bear this out. Despite spending 2x the industry average on capital expenditures over the past 10 years (mostly on information technology), gross margins continue to decline from 56% in 2007 to a paltry 42.8% on a trailing 12-month basis. Although Amedisys is the worst of the bunch in this regard, their task appears sisyphian as they try to efficiently manage frontline healthcare workers whose require a lot of discretion in treating patients, but do not want to ever be seen as actively managing the bottom line when it comes to treating patients.

Think about it like the owner-operator franchise model. Fast food restaurants and hotel chains realized long ago that giving away extra ketchup packages or [insert your own hotel cost-saving measure] was going to quickly make it a money-losing proposition. However, with an owner-operator on-site keeping a close eye over his own profits, there was hope to watch these details like a hawk. The home health care model faces the same challenge. The large home health care companies have claimed that by growing large they are able to create efficiencies that the mom and pop operators do not have. However, in a low-margin business with absolutely no pricing power, the profits evaporate as the business-oriented managers move further away from each branch. They are instead competing with local operators who watch their costs feverishly because whatever falls to the bottom line is theirs to keep. The local providers know each time a nurse makes an extra visit or when an extra supply kit is given to an older patient by a kind nurse "just in case" she needs it. Amedisys has tried to solve this problem by heavily investing in its own software system (in contrast to the other 3 major home health providers that have used off-the-shelf software products), but as I mentioned above, their gross margins have continued to worsen.

Revenue and Demographic Trends

Amedisys (and other home health operators, GTIV, LHCG, AFAM) have a slogan, "Favorable Demographic Trends." It has become gospel for them. Repeat it enough times and maybe someone will believe it. You hear it so many times from the operators, especially after each consecutive money losing quarter--But, we have "Favorable Demographic Trends." I almost expect to see a prime-time TV commercial from Amedisys closing with said tagline. The issue, however, isn't that there is any dispute over the demographic trends, but instead whether home health care operators can or will ever make a profit from such trends.

Another key statistics the home health care industry likes to trot out is a slide with various figures regarding the average cost of patient care in various settings, i.e. hospitals, skilled nursing facility and home health care.

 

Inpatient Hospital

Skilled Nursing

Home Health

Avg. Cost

$11,700

$11,728

$5,257

Avg. Per Diem Cost

$2,388

$431

$44

The average per diem cost for the patients is significantly lower in a home health care setting. The conclusion that the industry would like you to draw is that when it comes to cutting payments to providers, those cuts should come from the hospital industry and/or we should through regulatory power encourage the shift of patient care out of the institution (hospital or SNF) and into the home. The problem with this reasoning is that the hospital industry is using its size and power to lobby those lawmakers to bring the cuts anywhere but the hospital industry. In the latest statistics available, 2009, the hospital industry revenue vs home health care came in as follows:

Hospital Industry: $781B

Home Health and Hospice: $55B

The hospital industry is literally the $800B gorilla in the room, approximately 14x bigger than the home health industry. Revenue cuts continue to come from the home health side and regulations continue to encourage less usage of home health. One illustrative example: before 2011, doctors could re-authorize an additional 60-day period of home health visits by merely sending another order to the home health care company. As of January 1, 2011, new regulation, Face-to-Face Encounter, require that doctors see the patients before re-authorizing continued home health visits. This nudge has decreased overall demand for home health and taken away some of the most profitable patients. The most profitable patients were the ones that continued to be re-authorized every 60 days for home health, but were not sick enough to see the doctor within that 60-day time period--this is the type of patient that needs to be seen only 1x per week, but is worth the same as the patient that is seen 3-5x per week.

KKR and The Greater Fool:

Shareholders have little hope of seeing any value from Amedisys under the current management. (The executive officers have turned over multiple times since 2003, but Bill Borne has been the only one left standing.) They have wasted considerable cash flow on capital expenditures that have not improved their business or acquisitions that have been subsequently written-off or shut down. Goodwill and Intangibles have been written down by approximately $750m since 2010. Approximately $1B in operating cash flow has come in the front door over the past ten years, but $1.3B has gone out the back door without shareholders ever being rewarded.

Enter KKR.

Since August, KKR Asset Management has acquired a roughly 14.9% stake in Amedisys. It is important to note that KKR Asset Management is an arm of the traditional KKR & Co. whose bread and butter business is buyouts. However KKR Asset Management arm is relatively new to the firm KKR & Co. as KKR & Co. has become a public company and diversified into different roles as an overall asset manager and not a pure-play buyout firm. The KKR Asset Management arm has not in its short history taken a stake in a company that was subsequently sold to its buyout-side partners at KKR & Co. This could happen or KKR Asset Management could seek to replace the current management team and prevent the cash flow from continuing to fly out the back door. Either of these scenarios is plausible, but you are investing with the hopes of a management shake-up or a buyout, not that the underlying business will perform.

In conclusion, Amedisys is a company whose only value lies in hoping that another buyer will come to purchase your stake at a greater price. Intrinsically speaking, Amedisys has been unable in its past 10 years to provide a single cent to investors in the form of actual returns.

Source: Amedisys And Greater Fool Theory Of Investing