Voters that initially opposed passage of the Affordable Care Act (ACA), or "Obamacare," are unlikely to see major changes in the program any time soon. Even if we see a Republican elected President in 2016, it makes little sense to expect that even a change in party leadership will result in significant repeals in healthcare legislation. The gears of government have simply been in motion for too long to start reversing now.
On the positive side, this creates a scenario where investors can capitalize on relatively predictable trends in certain market sectors as we head into next year. Investors buying stocks in areas like data-storage and medical technology will be well-positioned to benefit from these recent changes in America's healthcare system. But at the same time, there are sectors to be avoided and here we will look at some of the key differences in play.
Positives and Negatives for Insurers
Since the new laws require Americans to either buy health insurance or pay a fine, the number of people forced to take action could easily reach the tens of millions. This is enough of a shift to create ripple effect in financial markets, as those not already covered (typically low and middle income households) will be forced to increase spending in health insurance premiums where normally that money would have been spent on other discretionary goods and services. This is a negative for the economy as a whole but positive for insurance companies and this suggests a bullish resurgence in healthcare stocks.
Some of the best-positioned companies in this space include Centene (CNC), UnitedHealth Group (UNH), and Molina (MOH). For more conservative investors looking to diversify, the Health Care Select SPDR (XLV) is a solid ETF alternative that offers broader sector exposure. It should be understood that the fund offers less exposure to the insurance space, but recent government delays in the passage of structural reforms could create enrollment difficulties that might limit productivity and slow potential gains for insurers near-term.
Other potential problems have arisen from the fact that Healthcare.gov lacks sufficient back-end mechanisms needed for the government to pay insurers for subsidies and cost-sharing plans. This means insurance companies are forced to bill the government in estimated balance amounts for each individual case in order to cover these costs. The government has pledged to fix the payment gaps in these areas. But until that occurs, expect added strain in output potential for the central companies in this space.
Early System Problems
Problems like these echo the initial challenges seen in the system, as system glitches and error messages marked the first two months of its operation. As a result, program enrollment numbers were well below initial projections. The White House recently announced that less than 400,000 Americans have chosen plans in state and federal exchanges -- many of which have not even paid their first premium. Typically, health insurers will categorize a person as enrolled only after their first month's premium has been paid.
Prior reports from the Department of Health and Human Services (HHS) have shown lost enrollment applications for as many as 15,000 people trying to sign up for programs through Healthcare.gov in October and November. This means insurance companies never received these applications (and were never given the opportunity to bill for services). HHS contends the point that the transmission of enrollment records has improved in efficiency, with lost insurance applications "close to zero" since the beginning of December. But evidence of progress in these areas has been slow thus far and the results have been seen in Molina, UnitedHealth Group, and Centene coming off sharply from their October highs.
Clearly, there are significant problems that will need to be overcome -- and some of these issues will weigh disproportionately on health insurance stocks. Long-term, the Affordable Care Act is a positive for companies in this space. These early obstacles limit earnings prospects for key sector players in coming quarters, so until the government is able to iron out its initial deficiencies, we could see in some of these stocks near-term. For investors with broad time horizons and a conservative outlook, any declines could be used as a buying opportunity. But any stock buys here would need to be based on the assumption that the foundations of Obamacare are sound and that early difficulties will eventually be resolved.
New Taxes, Profit Limits, and Exits from State Exchanges
On the financial side, the Affordable Care Act could result in negatives that extend beyond simple productivity measures. New taxes and profit limits will be implemented as a means to pay coverage costs for what could be up to 30 million uninsured citizens in 2014. Reductions in funding for the privately-run version of Medicare (Medicare Advantage) will also be seen, and the likely outcome here is smaller profit margins for insurance companies. These added constraints have prompted several large insurers to exit participation agreements with state-run exchanges. Key examples here include Aetna, Anthem Blue Cross, Humana, and UnitedHealth Group. There are not many companies on this list but these are some of the biggest names in the business, so the impact for the industry will be substantial.
Aetna's annual revenues for 2012 came in above $34 billion, and the company has already announced plans to withdraw participation for exchanges in three states. This includes Connecticut (its corporate home state), in a decision that was made after state legislators told Aetna to reduce its rates. Aetna refused, and now only three companies offer insurance plans to Connecticut residents. Humana, UnitedHealth, and Anthem Blue Cross have made similar decisions, as these companies are now unable to collect premiums that are sufficient to cover the costs of its individual insurance programs. But this does not change the fact that state exchanges will continue to be the only way to buy health insurance with taxpayer subsidies. The trends here are clear, and not exactly encouraging: As the major insurance companies decline participation in state exchanges, options for consumers will be reduced drastically.
Healthcare's Tech Beneficiaries
One area that stands to benefit most can be seen in healthcare's tech space. Under the Obamacare system, many companies will be required to digitize their records and make them available electronically -- offering clear advantage for company that provide data-storage systems. Well-positioned names in this space include Omnicell (OMCL), which offers automated systems for hospital supply management, healthcare analytics, and medication records. Similar names can be seen in Quality Systems (QSII) and Computer Programs and Systems, Inc. (CPSI), which have the added attraction of enhanced dividend payouts. When looking at the tech and IT space, stocks will be aided not only by the Obamacare programs but by the 2009 HITECH Act, as well. This legislation was designed to improve on the accuracy of medical records -- requiring hospitals, pharmacies, and caregivers to digitize their records and make them more easily accessible.
Given the factors listed above, Obamacare will undoubtedly complicate the process of finding suitable insurance programs and health care providers. This creates a larger need for tech companies to step in and simplify the process. Increased demand for these data services sets the stage for strong performances in future corporate earnings. So next, we look at some of the medical technology and data storage companies that are best positioned to benefit from these programs.
One of the companies seeing massive gains as a result of operating an emerging alternative marketplace is eHealth (EHTH). The company is best positioned to capitalize from the ACA, given some of its recent developments. Since May of this year, the stock has gone from trading at approximately $20 to more than $45 as of 1/2/14. This is largely due to their ability to profit from the new influx of business coming into the marketplace as a result of the ACA. However, it should be noted that it hasn't all been roses, they have recently been vocal regarding their struggles with the completion of the back-end integration with HHS, placing the blame on the government organization that is responsible for Healthcare.gov and the back-end processing system.
eHealth is primarily an online insurance brokerage, the company claims to be the oldest online health insurance company, effectively pioneering the online enrollment process. The issue that is holding them back and could possibly affect their earnings, is the continued struggles that HHS is having with completing their back-end enrollment integration for brokers like eHealth. Company CEO Gary Lauer recently sent out a press release critical of continued struggles, specifically asking department Secretary Kathleen Sebelius to make these continued struggles a priority.
One thing to note is that there are some private companies that could make attractive acquisition opportunities for many of the companies mentioned in this analysis. The industry is well known for its active involvement on the M&A side and you should certainly pay close attention to not only some of the potential acquisition targets, but some of the companies outside of the health insurance space that are forming partnerships with some of these companies.
For example, Walgreens has announced a partnership with GoHealth, a private company that runs a marketplace where consumers can compare pricing on healthcare plans. Walgreens is hoping to win-over the consumers who will be entering into the health care marketplace (and, in the future, filling prescriptions) by providing informational services to make the process of enrolling in an ACA approved plan somewhat easier. It's not a bad strategy and it is certainly one that is being used by others outside of the space who also might see some opportunities as a result of Obamacare.
Other examples include Blucora (BCOR) - owner of the tax preparation services company TaxAct - which has decided to put some effort into leveraging the ACA opportunity. This is also true for both Intuit (INTU) - which owns TurboTax and H&R Block (HRB). Intuit recently announced that it has partnered with online health insurance marketplace pioneer eHealth to help simplify the enrollment process for any individuals who might be eligible. Despite these efforts, it might not reap as much reward as competitor H&R Block could see from its partnership with GoHealth, LLC. The private company provides an online insurance platform for consumers to compare pricing plans and sign up. The partnership will provide consumers with the ability to shop for a plan and H&R Block CEO Bill Cobb said recently that one third of their clients are eligible for a subsidy. How many of those clients end up enrolling through this partnership with GoHealth remains to be seen.
Take-Over Possibilities: Newer Companies to Watch
Other companies that you should pay close attention to include doctor scheduling and review service ZocDoc. The company has made incredible inroads since it was founded in 2007 and it has been reported that the company declined a $300 million acquisition attempt by Aetna in 2011. Shortly after, Aetna announced that they had acquired ZocDoc competitor Healthagen which made a similar scheduling app called iTriage. ZocDoc has grown by massive leaps since the acquisition attempt and is even more of a desirable acquisition target for other carriers that make up Aetna's main competition.
One company that has received a little attention and is worth watching is Health.Verticalize.net, which is started to establish itself as one of the leaders within the healthcare marketing services industry, specifically with a focus on developments generated by Obamacare. Those working closely within the sales and marketing side of the healthcare industry have noted that the private company which has kept a very low profile until recently, has quietly amassed what some are speculating to be the largest audience of Obamacare eligible consumers of any one individual company. For these reasons, it will be critical to watch for developments in this space. Should any of these private companies announce plans to form a partnership with one of the public companies in the health space (especially those already seeing a lift in their stock price) you should carefully review what that could mean to its bottom line.
Obamacare's Stock Winners
Already however, we have started to see some of the winners in the new system. One of the largest and most stable stocks in the medical technology sector is Cerner (CERN), which has a market cap of $18.8 billion and a strong history of reliable growth rates in both earnings and revenue. From a price-to-earnings (P/E) perspective, valuations are somewhat high at 43 but the stock has pulled back from its October highs and is a solid buy in the lower $50s. Cerner's relative size advantage is one of its most attractive elements, as this means the company is well-positioned to enter into new markets.
Another good selection has been HMS Holdings (HMSY), which is essentially a government watchdog that is likely a good deal of billing management business once measures in the Affordable Care Act are fully implemented. Most of the revenues at HMS are driven by its relationships with Medicare and Medicaid. The company's essential function is to catch billing mistakes before they filter through the system. Both Medicare and Medicaid are on pace to increase in function and complexity in the coming months, and this creates a greater likelihood for errors in reimbursement and outright fraudulent claims.
These problems fall right in the HMS wheelhouse, and this will create significant opportunities for the company to grow its bottom line as Obamacare gains traction. Estimates from the Department of Health and Human Services suggest that $65 billion in inaccurate Medicaid/Medicare payments have already been made, with only $4.2 billion identified and corrected. There is a tremendous amount of opportunity here for companies like HMS, and at the moment this sector has only scratched the surface in terms of potential revenue growth.
Last, we look at Accretive Health (AH), which works in one of the most difficult areas of the medical billing space. Accretive Health is the largest healthcare debt collector in the US. Those with insurance are much more likely to seek out medical care than those without it, so Obamacare should result in drastic increases not only in total hospital visits but in the amount of unpaid billing debt as well. A large part of the attraction in Accretive Health comes from its data systems, which are able to categorize patient needs in ways that can prevent needless visits to the emergency room. Accretive is also capable of handling billing and other tasks in medical record keeping, which makes the company an efficient all-in-one option for hospitals looking to manage the rising patient intakes that are expected in the next few years.
So, while there have been some clear deficiencies early on, Obamacare stands to benefit key sectors of the healthcare environment. For the health insurers, the process has been slow. But with expectations for drastic increases in hospital intakes, pharmaceuticals purchases, and generalized doctor visits there is bullish potential there as well. Positive stock performance in all these sectors will depend on the success or failure of any proposed changes in the Affordable Care Act, so investors with exposure to health care stocks will need to monitor these developments in order to assess which sectors are most likely to benefit.