Daniel Andres Jacome's Instablog Daniel Andres Jacome is currently a NYC-based equity research associate covering health care services. Daniel, who holds a BA from Tufts University, an MA from New York University, and an MBA from The Kelley School of Business at Indiana University, was most recently an associate covering health care services at FTN Equity Capital Markets in Boston. Before that, he was founder of Sestina Investment Research/Ceviche Fund Partners LP and also held full-time or internship positions at Maxim Group LLC, Oppenheimer & Co, and Wellington Management Company LLP. He is a CFA Level 2, CAIA Level 2, and CMT Level 1 candidate and his opinions have appeared on CNBC, TheStreet.com, and Yahoo! Finance. Daniel Andres Jacome http://seekingalpha.com Accretive Health IPO Is On the Way http://seekingalpha.com/instablog/27375-daniel-andres-jacome/68373-accretive-health-ipo-is-on-the-way?source=feed 68373
This IPO should be well-received, even with the weak macro backdrop and concerns that Europe is blowing itself with mountains of debt and a devalued currency. Rival MDAS and ECLP both floated stock in the last couple of years and both names shot up b/t +12% and +28% after their shares were offered to the Street.



One thing that could drag on Accretive is an overhang on shares given that Ascension wants to sell more stock within a year if the IPO goes well. That said, with acute care titan HCA also going public soon in a $4B+ deal, I'd imagine investors who were shunning other pockets of healthcare service stocks b/c of reform risk will take another look at these stories and drive up valuations beyond what has been printed on paper.

If I had my pick, I would go with the HCA flotation, as acute care is an obvious beneficiary from the Medicaid population pop in 2014 and greater number of insureds. Yes, reimbursement cuts to the industry will hurt like bamboo sticks on a bare back, but the industry is smart enough to shrink costs and preserve EBITDA margins, as well as roll up weaker players (non-profits especially), not unlike what we have seen in the retail pharmacy space (chains and systems get bigger, independents fold). THC and HCA recently reported poor commercial admissions, but pricing has not been nearly as horrendous and trends in volumes should normalize once the economy regains its footing (but I'll be the first to admit that this is a tailwind that is far out in my thinking).  

Important Disclosure: No long/short positions in any stocks cited. No formal coverage on any of stocks mentioned. Views of author are strictly his and do not reflect on that of his employer at any time whatsoever.]]> Wed, 12 May 2010 23:35:53 -0400
This IPO should be well-received, even with the weak macro backdrop and concerns that Europe is blowing itself with mountains of debt and a devalued currency. Rival MDAS and ECLP both floated stock in the last couple of years and both names shot up b/t +12% and +28% after their shares were offered to the Street.



One thing that could drag on Accretive is an overhang on shares given that Ascension wants to sell more stock within a year if the IPO goes well. That said, with acute care titan HCA also going public soon in a $4B+ deal, I'd imagine investors who were shunning other pockets of healthcare service stocks b/c of reform risk will take another look at these stories and drive up valuations beyond what has been printed on paper.

If I had my pick, I would go with the HCA flotation, as acute care is an obvious beneficiary from the Medicaid population pop in 2014 and greater number of insureds. Yes, reimbursement cuts to the industry will hurt like bamboo sticks on a bare back, but the industry is smart enough to shrink costs and preserve EBITDA margins, as well as roll up weaker players (non-profits especially), not unlike what we have seen in the retail pharmacy space (chains and systems get bigger, independents fold). THC and HCA recently reported poor commercial admissions, but pricing has not been nearly as horrendous and trends in volumes should normalize once the economy regains its footing (but I'll be the first to admit that this is a tailwind that is far out in my thinking).  

Important Disclosure: No long/short positions in any stocks cited. No formal coverage on any of stocks mentioned. Views of author are strictly his and do not reflect on that of his employer at any time whatsoever.]]> HCA Mulls IPO: Acute Care Space Should See More Momentum http://seekingalpha.com/instablog/27375-daniel-andres-jacome/62322-hca-mulls-ipo-acute-care-space-should-see-more-momentum?source=feed 62322 Leading hospital chain HCA is looking to raise ~$3B through an IPO in the near-future, reported Bloomberg late Wednesday. You will recall that HCA, which has over 160 inpatient facilities in the US, went private about four years ago. The price tag of the LBO was about $33B, but less than 15% of that was actual equity put up by the PE shops and fellow sponsors. If HCA floats stock, the capital will be used to pay down debt. HCA’ debt/EBITDA is roughly 5x, which would put it closer to the high end of hospital operators, like THC and CYH. Given the thawing credit markets, HCA, like other acute care operators, used 2009 and H1:10 to refinance and extend debt maturities.

I think the HCA IPO would be well-received. Looking at HCA’s Q409 numbers, bad debt and same-store admissions seemed within the neighborhood of industry peers. EBITDA climbed +8% and outpatient admits were also strong. HCA is at a $31B revenue run-rate for 2010E, approximately.  More notably, I believe acute care should see an interest among investors, even as many of the names that are publicly traded have soared to 52 week highs. The health-reform risk overhang is past us and the group should benefit from the lower number of uninsured entering the system beginning in 2014E. Arbitrarily using an example of an operator that was opearting in parts of the US that were hard hit by the economic downturn (HMA, which operates in Florida, for example), I highlight how nasty bad debt got in the back half of '09. Thankfully, HMA, like others, was able to axe op ex aggressively to help the botom-line.

 

Estimates on the Street are about 32 million more people getting insurance. Roughly half of that 32 million will fall into Medicaid and the others will likely become part of the state exchanges. The first bucket of that 16 to 17 million or so will represent the number of uninsured adults living under the 133% federal poverty level threshold. These are the poorest of the poor and the bucket that ends up in the ER incurring significant hospital bills that they cannot pay (you will often hear that hospitals “overcharge” uninsured, making them pay more than commercial admissions pay – while this may occur, collection rates on the uninsured are quite low). Getting more people in the US covered should help acute care operators lower their uncompensated care levels, as well as lower volatility in their earnings streams – investors like visibility and this may help hospital EBITDA multiples over the long-term.

In the last downturn, the group lost roughly 3-4 turns on its historic EBITDA multiple. I also expect the acute care group to benefit from restrictions on physician-owned hospitals as this gradually wipes out another level of competition from the playing field. This last data-point is not being discussed much on Wall Street, but it is a trend to consider.If the HCA IPO is well-received by the buy-side, the group as a whole should generate more retail interest. I believe institutions have long played the space and were smart in doing so as the stocks tend to move sharp and hard, usually before bad debt peaks and admissions normalize.

Disclosure: Author holds no position in securities mentioned and the author's firm does not cover the securities mentioned. Authors views are STRICTLY his and do not reflect that of his employer whatsoever.]]> Wed, 07 Apr 2010 20:11:02 -0400 Leading hospital chain HCA is looking to raise ~$3B through an IPO in the near-future, reported Bloomberg late Wednesday. You will recall that HCA, which has over 160 inpatient facilities in the US, went private about four years ago. The price tag of the LBO was about $33B, but less than 15% of that was actual equity put up by the PE shops and fellow sponsors. If HCA floats stock, the capital will be used to pay down debt. HCA’ debt/EBITDA is roughly 5x, which would put it closer to the high end of hospital operators, like THC and CYH. Given the thawing credit markets, HCA, like other acute care operators, used 2009 and H1:10 to refinance and extend debt maturities.

I think the HCA IPO would be well-received. Looking at HCA’s Q409 numbers, bad debt and same-store admissions seemed within the neighborhood of industry peers. EBITDA climbed +8% and outpatient admits were also strong. HCA is at a $31B revenue run-rate for 2010E, approximately.  More notably, I believe acute care should see an interest among investors, even as many of the names that are publicly traded have soared to 52 week highs. The health-reform risk overhang is past us and the group should benefit from the lower number of uninsured entering the system beginning in 2014E. Arbitrarily using an example of an operator that was opearting in parts of the US that were hard hit by the economic downturn (HMA, which operates in Florida, for example), I highlight how nasty bad debt got in the back half of '09. Thankfully, HMA, like others, was able to axe op ex aggressively to help the botom-line.

 

Estimates on the Street are about 32 million more people getting insurance. Roughly half of that 32 million will fall into Medicaid and the others will likely become part of the state exchanges. The first bucket of that 16 to 17 million or so will represent the number of uninsured adults living under the 133% federal poverty level threshold. These are the poorest of the poor and the bucket that ends up in the ER incurring significant hospital bills that they cannot pay (you will often hear that hospitals “overcharge” uninsured, making them pay more than commercial admissions pay – while this may occur, collection rates on the uninsured are quite low). Getting more people in the US covered should help acute care operators lower their uncompensated care levels, as well as lower volatility in their earnings streams – investors like visibility and this may help hospital EBITDA multiples over the long-term.

In the last downturn, the group lost roughly 3-4 turns on its historic EBITDA multiple. I also expect the acute care group to benefit from restrictions on physician-owned hospitals as this gradually wipes out another level of competition from the playing field. This last data-point is not being discussed much on Wall Street, but it is a trend to consider.If the HCA IPO is well-received by the buy-side, the group as a whole should generate more retail interest. I believe institutions have long played the space and were smart in doing so as the stocks tend to move sharp and hard, usually before bad debt peaks and admissions normalize.

Disclosure: Author holds no position in securities mentioned and the author's firm does not cover the securities mentioned. Authors views are STRICTLY his and do not reflect that of his employer whatsoever.]]> hospitals Acute Care and Obamacare: Now What? http://seekingalpha.com/instablog/27375-daniel-andres-jacome/61856-acute-care-and-obamacare-now-what?source=feed 61856 On March 25, private equity giant Cerberus announced a deal to acquire Catholic non-profit health system Caritas Christi for $830 million. The deal would turn Caritas into a for-profit, unload its pension liabilities onto Cerberus, and enable the struggling non-profit to keep its staff levels intact. More importantly, I think the deal could be seen as a canary in the coal mine that suggests more non-profits will pursue consolidation opportunities with larger players who are less vulnerable to the major changes that will befall the acute care industry now that health reform has been passed.

As a reminder, the biggest changes to acute care coming from Obamacare, on the downside, will be roughly $155B in Medicare cuts, which includes roughly a $35B haircut in DSH payments to hospitals that see a disproportionate share of indigent patients. On the plus side, beginning in 2014, the insured pool in the US will significantly expand. Estimates on the Street are about 32 million more people getting insurance. Roughly half of that 32 million will fall into Medicaid and the others will likely become part of the state exchanges. Getting more people in the US covered should help acute care operators lower their uncompensated care (and help collection rates), as well as lower volatility in EPS. You will recall that uncompensated care for a hospital is essentially bad debt (funds the hospital planned to collect but did not) + charity care (care it provided but never expected to get paid for). As you can see, it’s essentially a major trade-off for the group and its essential that those insurance expansion projections materialize over the next decade, since the market basket cuts in reform will hurt and have no offset if the insured pool doesn’t materialize. 
 
I also expect the acute care group to benefit from restrictions on physician-owned hospitals as this gradually wipes out another level of competition from the playing field.  Since the insurance pool doesn’t widen until 2014E – but the cuts begin right away – I expect non-profits that operate on low margins and are overexposed to one geographic region to look for exits.



To sum it up, expect more consolidation in the acute care industry and expect the larger (publicly traded and private) health systems to benefit since they have more scale, diversity, and better access to capital. One thing is for certain: every hospital system in the US will have to find ways to creatively work around the challenges health reform will usher in beginning now. The names have run up ahead of reform so it's up to readers to pick apart the street models and see what a realistic earnings power run rate will be now that health reform is in the rear-view mirror. One name I prefer, at least from a viewpoint of expsosure to crowded ERs and levels of uncompensated care, is THC. Further, THC is deleveraging nicely and commercial admissions should pick up once the economy can start adding jobs at a sustainable level.
 
Stocks impacted: LPNT HMA THC CYH UHS KND PSYS

Disclosure: Author holds no position in securities mentioned and the author's firm does not cover the securities mentioned. Authors views are STRICTLY his and do not reflect that of his employer whatsoever.  ]]> Mon, 05 Apr 2010 00:28:03 -0400 On March 25, private equity giant Cerberus announced a deal to acquire Catholic non-profit health system Caritas Christi for $830 million. The deal would turn Caritas into a for-profit, unload its pension liabilities onto Cerberus, and enable the struggling non-profit to keep its staff levels intact. More importantly, I think the deal could be seen as a canary in the coal mine that suggests more non-profits will pursue consolidation opportunities with larger players who are less vulnerable to the major changes that will befall the acute care industry now that health reform has been passed.

As a reminder, the biggest changes to acute care coming from Obamacare, on the downside, will be roughly $155B in Medicare cuts, which includes roughly a $35B haircut in DSH payments to hospitals that see a disproportionate share of indigent patients. On the plus side, beginning in 2014, the insured pool in the US will significantly expand. Estimates on the Street are about 32 million more people getting insurance. Roughly half of that 32 million will fall into Medicaid and the others will likely become part of the state exchanges. Getting more people in the US covered should help acute care operators lower their uncompensated care (and help collection rates), as well as lower volatility in EPS. You will recall that uncompensated care for a hospital is essentially bad debt (funds the hospital planned to collect but did not) + charity care (care it provided but never expected to get paid for). As you can see, it’s essentially a major trade-off for the group and its essential that those insurance expansion projections materialize over the next decade, since the market basket cuts in reform will hurt and have no offset if the insured pool doesn’t materialize. 
 
I also expect the acute care group to benefit from restrictions on physician-owned hospitals as this gradually wipes out another level of competition from the playing field.  Since the insurance pool doesn’t widen until 2014E – but the cuts begin right away – I expect non-profits that operate on low margins and are overexposed to one geographic region to look for exits.



To sum it up, expect more consolidation in the acute care industry and expect the larger (publicly traded and private) health systems to benefit since they have more scale, diversity, and better access to capital. One thing is for certain: every hospital system in the US will have to find ways to creatively work around the challenges health reform will usher in beginning now. The names have run up ahead of reform so it's up to readers to pick apart the street models and see what a realistic earnings power run rate will be now that health reform is in the rear-view mirror. One name I prefer, at least from a viewpoint of expsosure to crowded ERs and levels of uncompensated care, is THC. Further, THC is deleveraging nicely and commercial admissions should pick up once the economy can start adding jobs at a sustainable level.
 
Stocks impacted: LPNT HMA THC CYH UHS KND PSYS

Disclosure: Author holds no position in securities mentioned and the author's firm does not cover the securities mentioned. Authors views are STRICTLY his and do not reflect that of his employer whatsoever.  ]]> One Flew Over The Cuckoo's Nest: Private Equity Goes After Psychiatric Solutions http://seekingalpha.com/instablog/27375-daniel-andres-jacome/58240-one-flew-over-the-cuckoo-s-nest-private-equity-goes-after-psychiatric-solutions?source=feed 58240 Shares of inpatient psychiatric facility provider Psychiatric Solutions rocketed +24% intraday Wednesday after the WSJ reported  that the Tennessee-based provider was in talks to be acquired by private-equity firm Bain Capital. According to the article, PSYS was asking for a +25% premium to its current market price. This would imply at least a $30 price tag - and a ~1.7x EV/sales multiple - which makes sense given that $30 is roughly the stock’s 52 week high. The stock closed under that price, so there may be a merger arbitrage play here. I think this deal is gonna get done one way or the other.  Several operators and PE shops looked at the name and my own industry research has found that buyers are lurking for the sort of business PSYS operates.

 

PSYS, which operates roughly 90 psychiatric hospitals and treatment centers in 32 states, is at $1.9B 2010E run-rate and is the prime beneficiary of a regulatory ruling that passed in 2008. The legislation, THE MENTAL HEALTH PARITY ACT, outlaws health insurance practices that set lower limits on treatment or higher co-payments for mental health services than for other medical care. Typical annual limits in the past have included 30 visits to a doctor or 30 days of hospital care for treatment of a mental disorder. Otherwise stated, the new playing field mandates that plans require equivalence, or parity, in coverage of mental and physical ailments. This means managed care plans have to redesign benefits to better accommodate mentally ill people. I believe this should lead to an uptick in PSYS admissions over the long-term.

Further, reimbursements to psychiatric care providers from government payors have improved over the last decade and mental illness has been “de-stigmatized” in the US over the same time period – these are two drivers to think about. Further, PSYS has long had shorts hounding the stock (current short interest to float ratio was 15%) and had a relatively leveraged balance sheet (ample debt was taken on as PSYS did a number of roll-ups over the last few years). Shorts have focused on several quality issue allegations at PSYS facilities, often pounding the stock off incisive media reports and rumor-mongering. I think Bain believes this has put a transitory lid on PSYS’ upside and is targeting its underlying growth potential away from the scrutiny of Wall Street.

Although one could play the arb game here, I think another safer way to play this is via Universal Health Services, an operator of acute as well as psychiatric care facilities. UHS’ behavioral segment reflects 25% sales, but 50% of EBITDA, underscoring the better reimbursements and profitability of the psychiatric business. I also think UHS is cheap relative to the acute care peer group, likely stemming from its exposure to the Las Vegas market – as a reminder, Nevada is suffering from a record number of foreclosures and unemployment there was 13% in February, +330 bps over the national rate. That said, UHS has a solid balance sheet, is well-run, and generates strong returns on capital. I would think that buy-siders who missed the pop and shorts who just got torched on PSYS will take a closer look at the closest comparable to PSYS out in the marketplace, and potentially recalibrate how they think about the psych business now that Bain and others have flown over the cuckoo's nest.

 Disclosure: No position in securities mentioned and author's firm does not cover PSYS. Authors views are STRICTLY his and do not reflect that of his employer

]]> Wed, 10 Mar 2010 19:21:00 -0500 Shares of inpatient psychiatric facility provider Psychiatric Solutions rocketed +24% intraday Wednesday after the WSJ reported  that the Tennessee-based provider was in talks to be acquired by private-equity firm Bain Capital. According to the article, PSYS was asking for a +25% premium to its current market price. This would imply at least a $30 price tag - and a ~1.7x EV/sales multiple - which makes sense given that $30 is roughly the stock’s 52 week high. The stock closed under that price, so there may be a merger arbitrage play here. I think this deal is gonna get done one way or the other.  Several operators and PE shops looked at the name and my own industry research has found that buyers are lurking for the sort of business PSYS operates.

 

PSYS, which operates roughly 90 psychiatric hospitals and treatment centers in 32 states, is at $1.9B 2010E run-rate and is the prime beneficiary of a regulatory ruling that passed in 2008. The legislation, THE MENTAL HEALTH PARITY ACT, outlaws health insurance practices that set lower limits on treatment or higher co-payments for mental health services than for other medical care. Typical annual limits in the past have included 30 visits to a doctor or 30 days of hospital care for treatment of a mental disorder. Otherwise stated, the new playing field mandates that plans require equivalence, or parity, in coverage of mental and physical ailments. This means managed care plans have to redesign benefits to better accommodate mentally ill people. I believe this should lead to an uptick in PSYS admissions over the long-term.

Further, reimbursements to psychiatric care providers from government payors have improved over the last decade and mental illness has been “de-stigmatized” in the US over the same time period – these are two drivers to think about. Further, PSYS has long had shorts hounding the stock (current short interest to float ratio was 15%) and had a relatively leveraged balance sheet (ample debt was taken on as PSYS did a number of roll-ups over the last few years). Shorts have focused on several quality issue allegations at PSYS facilities, often pounding the stock off incisive media reports and rumor-mongering. I think Bain believes this has put a transitory lid on PSYS’ upside and is targeting its underlying growth potential away from the scrutiny of Wall Street.

Although one could play the arb game here, I think another safer way to play this is via Universal Health Services, an operator of acute as well as psychiatric care facilities. UHS’ behavioral segment reflects 25% sales, but 50% of EBITDA, underscoring the better reimbursements and profitability of the psychiatric business. I also think UHS is cheap relative to the acute care peer group, likely stemming from its exposure to the Las Vegas market – as a reminder, Nevada is suffering from a record number of foreclosures and unemployment there was 13% in February, +330 bps over the national rate. That said, UHS has a solid balance sheet, is well-run, and generates strong returns on capital. I would think that buy-siders who missed the pop and shorts who just got torched on PSYS will take a closer look at the closest comparable to PSYS out in the marketplace, and potentially recalibrate how they think about the psych business now that Bain and others have flown over the cuckoo's nest.

 Disclosure: No position in securities mentioned and author's firm does not cover PSYS. Authors views are STRICTLY his and do not reflect that of his employer

]]> SXCI: Hidden Gem of the PBM Ecosystem http://seekingalpha.com/instablog/27375-daniel-andres-jacome/57584-sxci-hidden-gem-of-the-pbm-ecosystem?source=feed 57584

SXCI Catches a Big Fish! Shares of pharmacy benefit manager SXC Health Solutions spiked 23% over the last two days after the company reported a very solid Q4:09 a well as signing a large PBM deal with Medicare-driven managed care company Healthspring to manage the prescription drug benefit for 500,000 HS lives with roughly $1B in annual drug spend. At a 2% pre-tax margin and 34% tax rate, the contract could be worth as much as +$0.42 to EPS (over the life of the contract); at a more conservative 1% pre- tax margin, it’s worth roughly +$0.22 bump to the bottom-line. Recall that managed care contracts are less profitable than employer wins for most PBMS. The HS contract begins 1/1/2011. Back of the enveloping it, I suspect the HS impact to 2011E EPS could be in the ballpark of +$0.08. Meanwhile, 2010 EPS will be dragged modestly by implementation costs going into the contract (this is typical of PBM contracts' year 1, wherein start up costs are the highest). Strikingly, the big 3 PBMs all bid for this contract (~15MM claims) and lost out to SXCI.

I believe that SXCI is an under the radar story not familiar to many investors. As a small cap stock ($1.5B market cap), many on the buy side focus more on PBM giants like ESRX and MHS, which also generated solid returns in 2009 (SXCI shares tripled) after severe scrip erosion trends that many assumed out of the recession did not materialize. Even after such a strong move this week, I feel SXCI has plenty of upside left and should handsomely reward investors with a 3-5 year outlook



Q409 Was a Blowout For Q409, SXCI reported adjusted EPS of $.052 (+85%) versus consensus of $0.44. Mail penetration increased + 150 bps y/y to 11%. Full-year operating cash flow increased +105% y/y and adjusted EBITDA/adjusted claim was $2.74. Adjusted claims were up +12% in Q409. 2009 EBITDA doubled y/y and EBITDA as a percentage of gross profit (48% Q409 versus 32% Q208) growing nicely, reflecting scalability across the model and hence strong operating leverage. Client retention is at 98%, in line with peers. Two uncertainties were cleaned up as well – SXCI renewed the state of Hawaii contract as well as its $150MM contract (worth I estimate ~$0.03 annually to EPS) with Boston Medical Center. Generic fill rate came in at an industry leading 72%. Notably, SXCI has a very active sales pipeline for 2010. I suspect there is as much as $3-5B in SXCI’s pipe. SXCI issued cash EPS guidance of $1.92 to $2.00 for 2010. Without the HS deal, that number would have been materially higher.


Investment Highlights

** The PBM industry is morphing into a more integrated supply chain model than a pure “top-down buyer/sponsor decides” model. Technology is more important than ever, and using it to bend the health care cost curve is where I think the industry is ultimately headed. SXCI is a technology-driven PBM and I do believe there transparency and fee-based model is one reason they are winning a lot of new business. SXCI does a lot of state Medicaid FFS (fee for service) business, an area that has come under a lot of scrutiny given cost over-runs and squandered state budgets. States are trying to save money wherever possible, and SXCI is helping them do just that. Like most PBMs, the business is “cap ex lite,” so the opportunity to generate free cash is large. SXCI is running at a $2.5MM/qtr cap ex run-rate. Further, Health IT is roughly 7-8% of SXCI’s business. The cross-selling opportunity is large and SXCI is already transforming its 70 different technology clients to its PBM side (7-10 were converted in 2009), whose top-line grew +54% in 2009 versus the HCIT segment, whose revenues increased +17%.SXCI estimates that 1-in-4 PBM transactions in the US interface with its technology.

** Roughly $290B is spent on pharmacy benefits annually, comprising approximately 3.7 transactions a year. The major industry value drivers are well-known by now:

1. Mail delivery  - roughly 22% penetration in the industry while the Big 3 average penetration of ~30% -  SXCI is at 11%, so there is a long run way for them. Recall that PBMs make more money delivering scripts through mail and typically offer sponsors 500 bps more off a drugs wholesale price. Mail is essentially a win-win for both PBMs and customers since mail is cheaper for patients (lower copays) and yet more profitable for benefit managers. It is the fastest growing channel. PBMs will not be slow to point out that EBITDA/claim (profit metric the street focuses on) growth is correlated to mail penetration. 

2. Specialty pharmaceuticals are growing roughly ~15% versus low single digits for overall prescription drug spending in the US – specialty drugs are, as a reminder, exhorbitantly expensive, tough to handle, often injectable drugs. These drugs are patient-specific and PBMs have an opportunity to come in and handle these complex claims. I estimate the specialty drug mkt is worth about $80-$85B at year end 2009. I've seen numbers out there that think it could be as high as $100B by 2012. 

3. Generic drug penetration - roughly $80-$100B worth off brand drugs go off patent in the next five years – the US is at roughly 70% penetration and 2011-2012, “the Lipitor cliff years,” will be monster years for generics. Generics delivered through mail are wildly profitable, but I don't know how large the delta is here - Ive heard somewhere around 5-10x more profitable on an absolute dollar basis.

** The Baby Boomer bolus (# of people over the age of 65 is expected to double by 2040) we face longer-term also bodes well for prescription drug utilization. SXCI, like most PBMs, will leverage this opportunity. Lastly, the Part D business, although not sticky, is relatively profitable for PBMs, even though PBMs play a passive role in claim processing. The HS win is showing that SXCI can cut the mustard just as well if not better than the Big 3 pharmacy benefit managers who also bid. Whether MA-PD or standalone PDP plans [Part D plans are approved and regulated by the Medicare program, but are actually designed and administered by health plans - Part D coverage is not standardized & plans choose which drugs they wish to cover, and at what tier they wish to cover them], seniors in Part D plans utilize an above average # of scripts annually so this is another leg of LT growth for the group.

Valuation Concerns SXCI fetches 32x 2010E street estimates of $2.01 (adjusted EPS). The Big 3 PBMs go for 18x, roughly, so investors are clearly paying up for growth and there is no room for error here. Accordingly, I would welcome a pullback and feel more comfortable grabbing shares at a 22-25x multiple. 22x is about where the other PBMs have traded on a peak basis recently. I do believe that if SXCI continues to win more high-level business at the clip that it is currently doing - and increases its mail penetration significantly - it may one day be acquired. After doing an oversubscribed secondary that raised $200MM in Q4, SXCI sits on $10/share in cash and no debt. Nearer-term however, I believe SXCI will be an acquisitor, not a seller. SXCI has a proprietary platform for claims adjudication and its hard for me to tell if it will integrate smoothly with another PBMs. As far as M&A, SXCI management has said repeatedly that they will only pursue EBITDA-positive targets and accretive deals. Assuming SXCI uses all of its cash on deal flow, it’d likely be taking out a smaller PBM with an annual $20-30MM EBITDA run-rate.

Risks Worth Thinking About A) irrational industry pricing - I do NOT think this is the case but CVS' blowup last year and bleeding book of business has some concerned B) pernicious health care reform, centered on PBM's opaque business model and Democrats fighting for more transparency on pricing & rebates (10-20% probability that something insidious passes, in my view - Id argue SXCI actually has an advantage here relative to other PBMs given its "see-through" model) C) the ABC wholesaler contract is up for renewal this year. Poor terms on that contract could pressure shares and D) there is a lack of clarity among some regarding what SXCIs gross margins will be in 2010. I believe a ~150 bps degradation is in order and is baked into expectations. Anything worse than that would raise questions and likely trigger PE compression.

Disclosure: No position in securities mentioned and author's firm does not cover SXCI. Authors views are STRICTLY his and do not reflect that of his employer.
]]> Sat, 06 Mar 2010 14:17:30 -0500

SXCI Catches a Big Fish! Shares of pharmacy benefit manager SXC Health Solutions spiked 23% over the last two days after the company reported a very solid Q4:09 a well as signing a large PBM deal with Medicare-driven managed care company Healthspring to manage the prescription drug benefit for 500,000 HS lives with roughly $1B in annual drug spend. At a 2% pre-tax margin and 34% tax rate, the contract could be worth as much as +$0.42 to EPS (over the life of the contract); at a more conservative 1% pre- tax margin, it’s worth roughly +$0.22 bump to the bottom-line. Recall that managed care contracts are less profitable than employer wins for most PBMS. The HS contract begins 1/1/2011. Back of the enveloping it, I suspect the HS impact to 2011E EPS could be in the ballpark of +$0.08. Meanwhile, 2010 EPS will be dragged modestly by implementation costs going into the contract (this is typical of PBM contracts' year 1, wherein start up costs are the highest). Strikingly, the big 3 PBMs all bid for this contract (~15MM claims) and lost out to SXCI.

I believe that SXCI is an under the radar story not familiar to many investors. As a small cap stock ($1.5B market cap), many on the buy side focus more on PBM giants like ESRX and MHS, which also generated solid returns in 2009 (SXCI shares tripled) after severe scrip erosion trends that many assumed out of the recession did not materialize. Even after such a strong move this week, I feel SXCI has plenty of upside left and should handsomely reward investors with a 3-5 year outlook



Q409 Was a Blowout For Q409, SXCI reported adjusted EPS of $.052 (+85%) versus consensus of $0.44. Mail penetration increased + 150 bps y/y to 11%. Full-year operating cash flow increased +105% y/y and adjusted EBITDA/adjusted claim was $2.74. Adjusted claims were up +12% in Q409. 2009 EBITDA doubled y/y and EBITDA as a percentage of gross profit (48% Q409 versus 32% Q208) growing nicely, reflecting scalability across the model and hence strong operating leverage. Client retention is at 98%, in line with peers. Two uncertainties were cleaned up as well – SXCI renewed the state of Hawaii contract as well as its $150MM contract (worth I estimate ~$0.03 annually to EPS) with Boston Medical Center. Generic fill rate came in at an industry leading 72%. Notably, SXCI has a very active sales pipeline for 2010. I suspect there is as much as $3-5B in SXCI’s pipe. SXCI issued cash EPS guidance of $1.92 to $2.00 for 2010. Without the HS deal, that number would have been materially higher.


Investment Highlights

** The PBM industry is morphing into a more integrated supply chain model than a pure “top-down buyer/sponsor decides” model. Technology is more important than ever, and using it to bend the health care cost curve is where I think the industry is ultimately headed. SXCI is a technology-driven PBM and I do believe there transparency and fee-based model is one reason they are winning a lot of new business. SXCI does a lot of state Medicaid FFS (fee for service) business, an area that has come under a lot of scrutiny given cost over-runs and squandered state budgets. States are trying to save money wherever possible, and SXCI is helping them do just that. Like most PBMs, the business is “cap ex lite,” so the opportunity to generate free cash is large. SXCI is running at a $2.5MM/qtr cap ex run-rate. Further, Health IT is roughly 7-8% of SXCI’s business. The cross-selling opportunity is large and SXCI is already transforming its 70 different technology clients to its PBM side (7-10 were converted in 2009), whose top-line grew +54% in 2009 versus the HCIT segment, whose revenues increased +17%.SXCI estimates that 1-in-4 PBM transactions in the US interface with its technology.

** Roughly $290B is spent on pharmacy benefits annually, comprising approximately 3.7 transactions a year. The major industry value drivers are well-known by now:

1. Mail delivery  - roughly 22% penetration in the industry while the Big 3 average penetration of ~30% -  SXCI is at 11%, so there is a long run way for them. Recall that PBMs make more money delivering scripts through mail and typically offer sponsors 500 bps more off a drugs wholesale price. Mail is essentially a win-win for both PBMs and customers since mail is cheaper for patients (lower copays) and yet more profitable for benefit managers. It is the fastest growing channel. PBMs will not be slow to point out that EBITDA/claim (profit metric the street focuses on) growth is correlated to mail penetration. 

2. Specialty pharmaceuticals are growing roughly ~15% versus low single digits for overall prescription drug spending in the US – specialty drugs are, as a reminder, exhorbitantly expensive, tough to handle, often injectable drugs. These drugs are patient-specific and PBMs have an opportunity to come in and handle these complex claims. I estimate the specialty drug mkt is worth about $80-$85B at year end 2009. I've seen numbers out there that think it could be as high as $100B by 2012. 

3. Generic drug penetration - roughly $80-$100B worth off brand drugs go off patent in the next five years – the US is at roughly 70% penetration and 2011-2012, “the Lipitor cliff years,” will be monster years for generics. Generics delivered through mail are wildly profitable, but I don't know how large the delta is here - Ive heard somewhere around 5-10x more profitable on an absolute dollar basis.

** The Baby Boomer bolus (# of people over the age of 65 is expected to double by 2040) we face longer-term also bodes well for prescription drug utilization. SXCI, like most PBMs, will leverage this opportunity. Lastly, the Part D business, although not sticky, is relatively profitable for PBMs, even though PBMs play a passive role in claim processing. The HS win is showing that SXCI can cut the mustard just as well if not better than the Big 3 pharmacy benefit managers who also bid. Whether MA-PD or standalone PDP plans [Part D plans are approved and regulated by the Medicare program, but are actually designed and administered by health plans - Part D coverage is not standardized & plans choose which drugs they wish to cover, and at what tier they wish to cover them], seniors in Part D plans utilize an above average # of scripts annually so this is another leg of LT growth for the group.

Valuation Concerns SXCI fetches 32x 2010E street estimates of $2.01 (adjusted EPS). The Big 3 PBMs go for 18x, roughly, so investors are clearly paying up for growth and there is no room for error here. Accordingly, I would welcome a pullback and feel more comfortable grabbing shares at a 22-25x multiple. 22x is about where the other PBMs have traded on a peak basis recently. I do believe that if SXCI continues to win more high-level business at the clip that it is currently doing - and increases its mail penetration significantly - it may one day be acquired. After doing an oversubscribed secondary that raised $200MM in Q4, SXCI sits on $10/share in cash and no debt. Nearer-term however, I believe SXCI will be an acquisitor, not a seller. SXCI has a proprietary platform for claims adjudication and its hard for me to tell if it will integrate smoothly with another PBMs. As far as M&A, SXCI management has said repeatedly that they will only pursue EBITDA-positive targets and accretive deals. Assuming SXCI uses all of its cash on deal flow, it’d likely be taking out a smaller PBM with an annual $20-30MM EBITDA run-rate.

Risks Worth Thinking About A) irrational industry pricing - I do NOT think this is the case but CVS' blowup last year and bleeding book of business has some concerned B) pernicious health care reform, centered on PBM's opaque business model and Democrats fighting for more transparency on pricing & rebates (10-20% probability that something insidious passes, in my view - Id argue SXCI actually has an advantage here relative to other PBMs given its "see-through" model) C) the ABC wholesaler contract is up for renewal this year. Poor terms on that contract could pressure shares and D) there is a lack of clarity among some regarding what SXCIs gross margins will be in 2010. I believe a ~150 bps degradation is in order and is baked into expectations. Anything worse than that would raise questions and likely trigger PE compression.

Disclosure: No position in securities mentioned and author's firm does not cover SXCI. Authors views are STRICTLY his and do not reflect that of his employer.
]]> WAG Reports Modestly Better February Same-Store Sales http://seekingalpha.com/instablog/27375-daniel-andres-jacome/57108-wag-reports-modestly-better-february-same-store-sales?source=feed 57108 WAG is +1.65% today, ahead of the general market, after reporting February same-store sales. Although not glaringly solid on first look, WAG’ front end comps did notably improve over the last 2 months. On average, WAG front-end same store sales are down 1-6% over the last three months. Front-end same store sales declined -.6% in Feb versus -1% in January and -3.1 % in December. December and January suffered from calendar shifts, but more notably, weaker flu activity and a one-time merchandising blip that resulted in WAG stocking shelves with less seasonal items than competitors.



Longer-term investors may want to look at WAG given the potential for $1B in operating income savings by FY11. Nevertheless, no one will doubt that WAG has its work cut out for it, and most recently made yet another round of management changes as it rolls out its customer centric retailing initiatives. For those not familiar with CCR, this is WAGs store revitalization project, which will cover over 3000 unit stores by the Fall of this year. AT roughly $40K/store cost, I estimate this will eat $0.08 of EPS near-term but drive long term traffic building in stores. As a reminder, traffic potentially leads to higher basket size, which is critical to the bottom-line. WAG has itself said at investor conference that one extra front end item per customer annually is a +$1 to EPS.

 

Keep in mind WAG as well as RAD and CVS are facing easy y/y H1:09 comps so the coming months will have to show materially better same-store sales to keep the recovery theme intact amongst drugstore stocks.

 



Disclosure: none ]]> Wed, 03 Mar 2010 12:48:23 -0500 WAG is +1.65% today, ahead of the general market, after reporting February same-store sales. Although not glaringly solid on first look, WAG’ front end comps did notably improve over the last 2 months. On average, WAG front-end same store sales are down 1-6% over the last three months. Front-end same store sales declined -.6% in Feb versus -1% in January and -3.1 % in December. December and January suffered from calendar shifts, but more notably, weaker flu activity and a one-time merchandising blip that resulted in WAG stocking shelves with less seasonal items than competitors.



Longer-term investors may want to look at WAG given the potential for $1B in operating income savings by FY11. Nevertheless, no one will doubt that WAG has its work cut out for it, and most recently made yet another round of management changes as it rolls out its customer centric retailing initiatives. For those not familiar with CCR, this is WAGs store revitalization project, which will cover over 3000 unit stores by the Fall of this year. AT roughly $40K/store cost, I estimate this will eat $0.08 of EPS near-term but drive long term traffic building in stores. As a reminder, traffic potentially leads to higher basket size, which is critical to the bottom-line. WAG has itself said at investor conference that one extra front end item per customer annually is a +$1 to EPS.

 

Keep in mind WAG as well as RAD and CVS are facing easy y/y H1:09 comps so the coming months will have to show materially better same-store sales to keep the recovery theme intact amongst drugstore stocks.

 



Disclosure: none ]]>