Some investors love to parrot the thesis that the aging of America will be a boon to health care companies of all stripes. What these investors aren't always able to explain, though, is who is going to pay for all of that growth. That's a key issue with home oxygen therapy provider Lincare (LNCR). While efforts to diversify the business are pressuring margins and cash flow in the near-term, long-term investors should support these as moves towards better long-term sustainability.
First Quarter Results Not Bad On Balance
Revenue growth of 16% looks pretty flashy, but organic growth was a more modest 6%. Lincare saw a 1% negative impact from Medicare rate changes, with about 11% growth coming from various acquisitions. Interestingly, patient growth was the slowest it has been in some time (up about 2%), while revenue per patient rose by double-digits.
Lincare is spending a lot of money in building out its non-oxygen businesses and is swallowing poor margin leverage in the meantime. COGS jumped almost 32% this quarter and EBTIDA rose just 4% for the quarter.
Acquisitions Still A Good Idea
Roughly 40-50% of the oxygen therapy industry is made up of small companies that find it increasingly difficult to compete in the tougher Medicare rate environment. This is giving Lincare a great low-cost growth lever. While Lincare has used acquisitions to compensate for losing bids in certain geographies, the company's recent acquisitions seem more financially motivated. It sounds as though Lincare paid about 1x revenue for six deals with relatively low revenue levels, but the incremental margins from incorporating them suggest that Lincare may have only paid 2x or 3x EBITDA.
As is the case for skilled service providers like Amedisys (AMED) and Ensign Group (ENSG), acquisitions are going to dominate Lincare's future growth. While the government wants spirited competition as a means of controlling costs, the reality is that ongoing reimbursement cuts make more and more businesses commercially nonviable. So long as Lincare can pay lower multiples for these deals than its own stock carries, it's a reasonable supplemental growth option.
Lincare now has about 20,000 patients in anti-coagulation testing business and continues to build out its pulmonary therapy and drug businesses. These are important avenues for diversifying away from the oxygen therapy business and taking advantage of incrementally better economics. The downside is that these efforts are costing money today and Wall Street seldom looks past the next quarter.
Risks Keep The Multiples Down
Although Lincare management has a proven track record of navigating tough reimbursement changes, Wall Street is still worried about the next round of cuts. Some on the Street apparently believe that competitive bidding could cut rates by 20-30% in the back half of 2012, even though government officials believe that competitive bidding is going to lead to much more modest (10-15%) savings.
It's not discussed much with Lincare, but I also wonder if there are assumed risks from improving COPD drugs. Existing drugs from Forest Labs (FRX) and pipeline drugs from Forest, Novartis (NVS), and GlaxoSmithKline (GSK) are not cures, but perhaps there is a built-in fear that better drugs will someday reduce the need for oxygen therapy.
Last and not least, I think the Street is worried that the company is going to commit more assets to speed up its diversification process. While a lot of analysts and investors seem to want a bigger dividend (despite a 3% yield) or buybacks, these don't build long-term value. Assuming that the company can identify synergistic service opportunities (ideally those reimbursed by private insurers), that really ought to be the priority. Again, it's a question of timing and Wall Street isn't interested in the long-term at Lincare.
The Bottom Line
While lower-than-expected cuts would definitely be a much-needed piece of good news, I wouldn't count on it. Quite frankly, an investment in Lincare is a bet on management's ability to diversify the business, manage the rate cuts, and continue to find ways to squeeze more profits out of the business. Investors who can't get comfortable with the Medicare risk are probably better off with stocks like AmSurg (AMSG) where private-pay is a much bigger factor. That said, Lincare's fair value in the low $30s and decent dividend may make the cut for some investors today.