CardioNet: A Market-Beater Or A Value Trap?

| About: BioTelemetry, Inc. (BEAT)

CardioNet (NASDAQ:BEAT) is a cash-rich health care provider of a cash-flow-positive business. Is there an opportunity in the common shares to outperform the broader market over the next few years? Let's look at the current status of the business to find out.

Existing State of the CardioNet Business

CardioNet services patients by diagnosing and monitoring heart rhythm disorders. According to a press release by competitor CardioComm Solutions, there are currently over 4 million people in the U.S. currently receiving care for recurring arrhythmia, and between 2000 and 2030 the number of people over age 65 will double, greatly expanding the number of those who will need heart diagnostics and monitoring services.

The vast majority of the CardioNet business comes from the MCOT device (Mobile Cardiac Outpatient Telemetry). Over the last three years ended 2010, revenues of BEAT have ranged from $120 million - $140 million per year. According to the most recent quarterly financial statement, filed November 8, 2011, the composition of patient revenue in the third quarter of 2011 was 39% Medicare and 61% commercial. Patient volumes were 51% medicare related and 49% commercial.

In the most recent 10-Q, filed 11/9/2011, the company stated it is paid by a contract provider for the Centers of Medicare and Medicaid Services - Highmark Medicare Services. The reason why CardioNet has had such fluctuations in operating results is half of its patient volume comes from Medicare, and HMS reduced reimbursement rates by 33% on July 10, 2009. The company estimates the reduction cost it $25.4 million for the year ended 12/31/2010. On November 2, 2010, CMS reduced the rate by 2%, applicable starting 1/1/2011.

Based on the 2009 reduction, commercial payers responded by wanting to renegotiate their reimbursement rates, which then saw pressure in the first half of 2009 and also the second half of 2010. In the most recent 9 months of 2011, CardioNet experienced an increase in the average commercial reimbursement rate. Over time, the company expects stable or declining commercial reimbursement rates.

For the 9 month period ending 9/30/2011, revenues were essentially flat, increasing 1.8% from the same period in 2010 ($92,238 from $91,241). The growth was aided by the acquisition of a company, Biotel.

The net loss for the nine month results was ($0.48) per share on a GAAP basis ($11.6 million), and ($0.28) on and adjusted GAAP basis ($6.8 million), because of one time restructuring and integration charges of ($0.20) per share ($4.8 million) related to the Biotel purchase.

Looking at the most recent quarter, revenues declined 3.2% year over year to $26.6 million from $27.5 million in the same period of 2010. The net loss was ($0.29) per share on a GAAP basis ($7.1 million) and ($0.21) on an adjusted GAAP basis ($5.1 million). The company stated reduced patient visits because of the stagnant economy helped contribute to the revenue decline.

Cost Reduction Initiatives

CardioNet released an update to it's primary MCOT product on a limited basis in the 4th quarter of 2011. According to the press release dated December 14, 2011, the recent product release is expected to reduce the cost of the product by up to 33% and allow physicians to make it available to patients in the physicians offices and also deploy it much quicker. The company also engaged in restructuring and integration initiatives in 2010 and 2011, taking total charges of $2.0 million in the 3rd quarter of 2011 and $1.4 million in the same period of 2010.

Growth Prospects

CardioNet acquired Biotel in December of 2010, paying $11.6 million. Buying Biotel gave the company an ability to develop, manufacture, test, and market medical devices and software to medical companies. It provided new customers and entry into clinical trial services and diversification to the existing business. The acquisition provided $12.3 million of revenue through the most recent 9 months of 2011, (10.2 from Biotel and 2.1 from a Braemer subsidiary, Holter).

In the third quarter of 2011, CardioNet secured 13 new payer contracts, bringing the total number of payer contracts it has to 341, up 12% from December 31, 2010.


Based on 24.4 million common shares outstanding, the current market capitalization of BEAT is 24.4 * 3.10= 75.64 million. Current operating cash flow for the most recent nine month period was 490K, or on an annualized basis 700K. The valuation using these figures would be 75.64/.7=100X OCF, which is not such a great bargain.

However, if we look at the valuation, adjusting for restructuring and integration charges, and back out current net cash on the balance sheet, the valuation changes dramatically. Total net cash on the balance sheet is $43 million, and we get an Enterprise value of 75.64-43=32.64. Adjusted EBITDA for the most recent nine month period is $2.3 million, and annualized that would come to 2.3*4/3= 3.06. The valuation figures now are 32.64/3.06=10.666 X EBITDA. The key figure here is how much cash gets generated as more people enter the over 65 category and BEAT services more customers (that is the plan, anyway).

Legal Issues

A potentially material liability for the company exists because of a Civil Investigation Demand issued by the U.S. Department of Justice on August 25, 2011. The investigation concerns allegations CardioNet may have used inappropriate diagnosis codes when submitting claims for payment to Medicare for it's real time outpatient cardiac monitoring services. The time period involved is from January 1, 2007 through August 25, 2011, which is almost 4 years of payments. No accrual has been set aside for contingent liabilities, and the company is unable to predict what action or impact the outcome of the matter may have on the company's business.

If we take average revenue over those four years of $100 million and 40% of total revenue is medicare business, the fees involved are 40% * 400 million = 160 million. A very serious situation indeed and one any investor in CardioNet should diligently research to come to their own conclusion on the magnitude of the potential fines.

Recent Legal Settlement

The company announced on December 15, 2011, it reached a preliminary agreement with the West Palm Beach Police Pension Fund to settle litigation for $7.25 million, $6 million of which is paid by insurance coverage. Management believes removing the uncertainty of the potential litigation and expense allows it to concentrate on growing the business without further distraction.


The company currently carries $49 million of goodwill related to acquisitions on the balance sheet. If the stock price stays at the current low levels for an extended period, the goodwill must be tested to see if a charge should be taken against the carrying value. Management must look at this on an annual basis, and currently does not believe a charge is mandatory.

Obama Health Care Law

The Obama Administration passed a huge health care mandate through Congress, and there could be major implications regarding Medicare reimbursement rates in an attempt to drive down health care costs. Any reduction close to what the company experienced in 2009 would again have a material affect on the business. Any investor should research what the implementation of the new law might mean for CardioNet in the future.

Decision Time

A cash rich balance sheet, an expanding target market, and a cash flow positive business with expanding potential insurance coverage are all positives for CardioNet. Potentially large legal liability, lower reimbursement rates, and reduced patient visits are all negatives for possible buyers. How you compare one to the other determines whether you are a buyer or not.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.