- Money from heavy selling in growth stocks is piling up on the sidelines and looking for new leaders.
- The Affordable Care Act (Obamacare) is creating unusually large opportunities for preventive diagnostics.
- The changeover from ICD-9 to extremely complex ICD-10 billing codes creates lost income, higher expenses and sleepless nights for doctors, but enormous potential growth for healthcare companies.
- Healthcare companies that align best with The Affordable Care Act are already showing signs of outperforming their peers.
Healthcare makes up close to 20% of the economy, and for the past few decades, healthcare companies providing office support to physicians have been enjoying rapid growth and high-flying share prices. The required billing codes are complex and must be submitted properly, or the doctors may be paid less than they bill; or even worse, they may not get paid at all. The current ICD-9 code uses more than 14,000 different codes, and has created a large need for help to process claims.
Unfortunately, healthcare company valuations and PE ratios have risen so fast, they have become unsustainable and are now being revalued by a major correction. When this revaluation is over, the landscape will look different. With Obamacare taking root this year and the radical changeover from ICD-9 to ICD-10 happening next year, the companies that align themselves best will rise and become the new leaders, while those that do not will either remain flat or even decline further.
One reason to be optimistic about the long-term outlook for healthcare companies is that a new and even more complex set of codes that is emerging as a nightmare for physicians is turning out to be a boon for the companies providing coding and billing services. The highly complex ICD-9 codes are being switched over to an even more complex ICD-10 code that has over 80,000 billing codes. The changeover to ICD-10 was recently delayed by Congress, and is scheduled to become effective October 1, 2015. Nachisom Advisors estimates the cost to implement the changeover from ICD-9 to ICD-10 to be from $56,000 to $226,000 just for a small practice, and from $2 million to $8 million for a large practice.
The Affordable Care Act that became effective at the beginning of this year makes things even more interesting. Obamacare provides that all diagnostics considered to be preventive shall be fully paid by Medicare and private insurance companies. This means that preventive tests will be free to the patient, because Medicare and private insurance carriers will pay the doctor in full without charging the patient's deductible. Therefore, healthcare companies that can deliver appealing and effective preventive diagnostics can create substantial additional revenue for the physicians at a time when they really need it.
If healthcare companies offer life-saving and money-making preventive diagnostics to physicians with no large upfront capital cost, doctors will be standing in line to sign up. Instead of a large upfront cost, the healthcare company can charge on a per procedure basis, and the income to the doctor and the healthcare company can be surprisingly large. This model is a big win for the patient, the doctor, the healthcare company providing the preventive diagnostics, and the government by spending less overall due to diagnosing serious illness earlier.
If You Were A Physician, Which Healthcare Company Would You Choose?
Knowing that doctors face a 24% pay cut in Medicare and Medicaid reimbursements, they will be driven to find new sources of revenue. The first thing they can do is to be certain they are well-versed in the new ICD-10 billing and coding procedures, so that their income will be maximized. On its website, Athenahealth claims it can boost a physician's practice net income by $41,800 per year. The big question is, just how motivating is $41,800 per year in bottom line results?
What if a healthcare company offered your practice the same back-office support for ICD-10 as you are getting now, but also offered early detection cardiovascular and cancer diagnostics that would increase your annual revenue by $500,000 compared to $41,800? That is precisely what is beginning to happen in the healthcare industry, and it is worth the time to look for those healthcare companies that will leap ahead of the pack, because they are seizing the opportunities made possible by Obamacare.
Athenahealth is a high-flyer that just had its wings clipped in the current sell-off, when it fell from $206 to $136. Athenahealth provides cloud-based medical billing services and support, electronic medical record services, communications and healthcare business services to help over 50,000 physicians worldwide to help them manage their practice and maximize income from complicated billings.
Athenahealth has been growing rapidly, and reported 2013 year-end sales of $595 million that were over 30% higher than 2012. Gross margins have been healthy at over 50%, but heavy G&A has been killing the bottom line, with a very disappointing PE ratio over 1,900. With the markets sobering up in the current sell-off, Athenahealth is likely to remain under pressure until it can demonstrate significantly lower G&A results or a PE ratio that is much better than 1,900. The fact that it has shown over 30% growth for the past few years will not be enough to overcome its present over-valuation.
There is no mention of Athenahealth offering physicians preventive diagnostics or diversifying with other profit centers, but Athenahealth may be able to continue its impressive growth with the ICD-10 changeover. It is difficult to justify buying or holding Athenahealth shares until revenues spike or until G&A is reduced dramatically, but once either happens, shares will rocket again.
Castlight Health (NYSE:CSLT)
More evidence that healthcare companies are hot is Castlight's entrance as an IPO. The shares were sold in the IPO for $16, and traded on their first day at a sparkling $41.95. Since then, the shares have given almost everything back in the recent market correction by sliding to $17.00.
Castlight provides cloud-based software for enterprises in the United States. Its software enables enterprises to control their healthcare costs, and enables employers to provide actionable information to their employees, introduce advanced benefit designs and manage adjacent areas of healthcare benefit spending.
Even at $18, Castlight is selling at 120 times sales and is losing money. Castlight has a lot of catch-up to do to justify even $18 per share. There is no mention of Castlight offering its physicians preventive diagnostics, but perhaps it will be able to garner a large share of companies where employees are searching for the best medical deal. So far, the revenues are not showing up, and only time will tell if they will materialize or not. Meanwhile, Castlight shares still appear overpriced, unless it pulls a rabbit out of the hat.
Cerner Corp. (NASDAQ:CERN)
Cerner Corporation is a global supplier of healthcare information technology solutions, services, devices and hardware. Cerner solutions optimize processes, such as billing and coding, communications, medical records and more for healthcare organizations. Cerner has been around for over 35 years, and is a highly respected name. A 25-year chart of Cerner paints a beautiful line of growth steadily going Northeast, but with all the new competition in this space, the company may be challenged to maintain this growth rate. Cerner has a reasonable PE ratio of 43, a price-to-sales ratio of about 6, and only gave up about 6 points in the recent growth stock sell-off.
In search of new growth, Cerner offers what it calls the "Smart Room" for patients, nurses, doctors and even family to use during hospitalization. With increasing competition expected in billing and coding, the Smart Room may be a very smart move to increase revenues.
Cerner and Claritas Genomics are collaborating to develop a rapid, scalable laboratory solution for molecular diagnostics that may eventually add significant revenues to the top line.
Cerner is one of the few healthcare companies looking beyond back-office solutions for physicians, and will be rewarded with additional growing revenues and profits. Cerner appears to be fairly priced, and is a buy in this sell-off, based on expected increasing revenues and profits from ICD-10 and the Smart Room.
IMS Health Holdings (NYSE:IMS)
IMS is one of two healthcare stocks that have been bucking the trend in the last month's meltdown. IMS shares were sold at $20 in an IPO on April 4th, and closed at $23 the same day. So far, IMS is one of the few healthcare stocks to escape the brutal sell-off in healthcare and high-growth stocks.
By applying cutting-edge analytics and proprietary application suites hosted on the IMS One intelligent cloud, the company connects more than 10 petabytes of complex healthcare data on diseases, treatments, costs and outcomes to enable its clients to run their operations more efficiently.
Customers include pharmaceutical, medical device and consumer health manufacturers and distributors, providers, payers, government agencies, policymakers, researchers and the financial community.
IMS reported $2.54 billion in 2013 revenues and $82 million in net income.
The annual growth has been disappointing at about 4%. IMS has a market cap of $7.9 billion, a PE ratio of 92 and a price-to-sales ratio of 3.1.
Some troublesome numbers are the low growth rate of 4% and the high PE ratio of about 92. Also concerning is the $8 billion listed in assets, where $6 billion of the 8 is in "goodwill" and "other".
IMS offers analytic tools for diagnostics, but does not offer any diagnostic devices to doctors. The company could see a higher growth rate now that ICD-10 codes will be mandatory by October 1, 2015.
IMS appears to be adequately priced, and will be valued on performance.
Millennium Healthcare (OTCQB:MHCC)
Rising since January this year, Millennium Healthcare has also been bucking the downtrend in healthcare stocks. Like the pack, Millennium is capitalizing on a business model built around The Affordable Care Act. It offers cloud-based ICD-10 coding and billing services, electronic records, communications and other support to help doctors run their practices; however, it is set apart through its offering of innovative medical devices that utilize cutting-edge technology, and are cost-effective and approved by the FDA.
Millennium has tied up exclusive marketing agreements for state-of-the-art, early detection, preventive diagnostics for cardiovascular disease and cancer. Certain diagnostics are 100% free to the patients, as Medicare and private insurance reimburses the doctors. Millennium offers these easy-to-use preventative diagnostics without significant up-front costs, making it easy for physicians to adopt. These diagnostics could add about $500,000 per year in income to each doctor's office. The devices currently being offered include VasoScan, a highly accurate, non-invasive device that assesses cardiovascular risk following a three-minute evaluation via finger probe sensor. The company also offers OralCDx and DermCDx, patented and proprietary oral and skin swab diagnostics that accurately diagnose oral cancers and skin cancers without invasive chunk biopsies.
Millennium recently announced the signing of an additional 400 physician offices, that now brings their total to over 700. With a deal this attractive, doctors are standing in line to sign up, and there are already over another 1,000 offices pending. The company projects that with the full rollout of devices to these first clients, it could be in a position to generate over $200 million annually.
Millennium has created a business model built around The Affordable Care Act that is very appealing to doctors, because it greatly increases their ability to improve patient care by diagnosing life-threatening heart disease and cancer, while significantly improving their revenues. Millennium is expected to save Medicare and insurance companies billions by diagnosing serious illnesses before they require expensive treatments or hospitalizations.
Like many emerging growth companies, Millennium shares the risk of being able to raise adequate capital to be an ongoing concern, but with its strong story and remarkable projected growth from actual signed contracts, Millennium is likely to be able to raise all the cash it needs to execute its contracts and complete their rollout. Based on current outstanding shares of 67 million, and signed agreements with 700 offices, with 1,000 more in the legal department, if Millennium executes on its rollout, $8 appears to be a reasonable target for Millennium shares. It's likely the company will have to dilute with additional shares to meet its cash requirements, but this target looks reasonable and achievable.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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