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As suspected by Citron Research in its initial report, the problems at Arthrocare (NASDAQ:ARTC) had to be more systemic than first described. Ergo, a note from one of their main “cheerleaders” — Lazard Capital Markets, who slipped out a piece of research Friday after the close. Lowering their price target for Arthrocare, Lazard cited 3 concerns:

  1. Reimbursement issues (exactly as identified in the Citron report).
  2. Arthrocare losing market share in the Opus shoulder division, mainly due to increased competition and pricing.
  3. Arthrocare’s response – a claimed share buyback, according to Lazard, “seemed aggressive” (“given the company’s current cash balance and free cashflow run-rate” – as pointed out by Citron) — while still, in Lazard’s words, is at best an “indirect” response to the reimbursement concerns at issue.

It remains Citron’s belief that Arthrocare has been losing market share and margins in its mainline divisions, which would be the motivation for the aggressive billing procedures in their spinal division.

Most importantly, this note makes it clear that now everyone, including the sell-side analysts, are finding the Discocare/Arthrocare relationship too close for comfort. Both Susquehanna and Lazard have now highlighted these concerns.

Citron notes what the analysts have not mentioned. Concerns about Discocare pricing the Arthrocare products goes beyond just “discomfort”. Upcoding is the biggest problem with insurance fraud today. It is the opinion of Citron, through reliable information received and through conversations with doctors, that Discocare is coaching, advocating and incenting doctors to use the code 63056 for a procedure that should have the code 62287.

Going beyond conventional “marketing” activities, Discocare is absorbing the financial risk that any doctor might be exposed to in performing what is otherwise a non-reimbursable procedure. It is now time for the sell-side analysts to look beyond the superficial research and ask themselves the hard question: Is Arthrocare helping to facilitate upcoding and taking on financial risks for doctors — a serious no-no in the healthcare supply market? If in fact Arthrocare decides to either back away from Discocare or recognize it as a related party, then a declining stock price might become the smallest of their concerns.

Source: Lazard Capital Markets Confirms Concerns About Arthrocare