Winston Kotzan's Instablog Winston Kotzan is an alum of the Indiana University Kelley School of Business. He has experience as an associate performing equity research for the healthcare-focused investment bank Leerink Swann in New York. Prior to Wall Street, he created a student organization at Indiana University called the Mad Money Club which became successful in bringing Jim Cramer's Mad Money Back to School Tour to Bloomington (www.iumadmoney.com). Winston also has extensive experience in software development and holds an Information Technology degree from Purdue University. Winston has appeared on CNBC and The Today Show. Visit his website www.winstonkotzan.com for his latest news and developments. Winston Kotzan http://seekingalpha.com The Give-and-Take Reality of Healthcare Reform http://seekingalpha.com/instablog/64425-winston-kotzan/23268-the-give-and-take-reality-of-healthcare-reform?source=feed 23268 This past weekend, for the first time the Obama administration hinted that it would be willing to sacrifice the publicly funded insurance portion of the Affordable Health Choices Act in order to make a bipartisan concession.  Investors reacted positively to this news, sparking a rally in managed care stocks Monday as fear was assuaged that this government insurance option would over the long run hurt the industry.

Despite growing signals that this congress is willing to loosen some of its more controversial measures to fix healthcare, there are still plenty of reasons to worry.  I contend that Affordable Health Choices Act will not achieve its laudable goals if it is passed in current form.  Here are some of the key reasons that I believe this bill will accelerate the unsustainable trend of costs and national debt over the long term:

1. The Affordable Health Choices Act will fail to curb healthcare inflation

A lack of individual accountability for the costs associated with treatments is a major cause of healthcare’s spiraling financial burden.  Yet, the proposed reform ineffectively addresses this problem.  In Senator Daschle’s book Critical, he writes:

 “…doctors and hospitals had little reason to care about costs.  Hospitals considered doctors to be their clients, and doctors made the decisions about how to care for patients.   They decided whom to admit to the hospital, how long to keep them there, and which tests to run.  Doctors, bound by the Hippocratic Oath, had no reason to know or care about the cost of what they ordered.  Hospitals were happy to earn as much money as possible by performing every test and procedure imaginable.  Patients with insurance didn’t pay much attention either, since they weren’t paying the bills, and their main concern was getting well.”

In later pages, he cites examples of how even after the advent of managed care, the misguided use of expensive tests and procedures leads to poor cost containment. 

The bill calls for all Americans to have some form of health insurance.  Unfortunately, this “Shared Responsibility for Healthcare” does little to encourage personal responsibility towards cost containment – the moral hazard of patients and doctors liberally using expensive treatments on the tab of other insurance payers still abounds.

2. A reduction in subsidies to private industry will not cover the cost of expansions

In town hall meetings, President Obama has suggested that the overpayments made in the Medicare Advantage program could be redirected to insure more people.  However, the savings of a cutback in Medicare Advantage would appear to be insufficient.  According to a June 28, 2007 CBO testimony, leveling Medicare Advantage payments with the traditional fee-for-service arrangement would save $149 billion over 10 years.  However, according to CMS figures, Medicare in total spent $431 billion in 2007 alone to insure its approximately 44 million members.  Diverting any extracted savings from Medicare Advantage to help cover the 47 million uninsured citizens would be a drop in the bucket.  Additionally, many Medicare Advantage programs provide supplemental benefits on top of traditional Medicare so it would naturally be more expensive.

3. The prevention and wellness components are inefficient

A major cost containment component of the bill involves a strategy for curbing costs through numerous expensive public programs which include the establishment and expansion of government entities directed towards wellness and prevention.  However, the CBO recently released a report stating that preventive care measures tend to increase net healthcare costs, and the benefits of wellness programs are tenuous at best.  The CBO report states:

“Although different types of preventive care have different effects on spending, the evidence suggests that for most preventive services, expanded utilization leads to higher, not lower, medical spending overall. …a new government policy to encourage prevention could end up paying for preventive services that many individuals are already receiving—which would add to federal costs but not reduce total future spending on health care.”

On wellness programs, the CBO commented:

“…designing government policies that are effective at inducing people to be healthier is challenging. Even successful efforts might take many years to bear fruit and could involve significant costs. Moreover, many employers already support some wellness services for their employees, and new government efforts to encourage such services could end up paying for services that some individuals are already receiving—which would add to federal costs but not reduce total future spending on health care.”

Along with these programs, Congress vows to increase insurance coverage via mandates and the use of federally funded credits to make plans more affordable. If the prevention and wellness efforts are ineffective at lowering costs, then how could this bill reasonably expect to achieve both goals of expanded national coverage without adding a significant burden on top of our already insurmountable government debt? 

4. The public plan is an unnecessary use of public funds

The Affordable Health Choices Act aims to increase competition in the insurance market by establishing a public plan.  Even a wholly nonprofit-driven insurance organization is unlikely to offer an incremental benefit significantly better than what is currently delivered in the private market.

In 2008, Wellpoint paid 83.6% of its $51 billion in premium revenue to cover the medical payments of its clientele.  After subtracting administrative costs of running the business, the company was left with a measly 4% profit margin ($2.5 billion) for its shareholders.  Removing this profit would only lead to a slight discount on premiums for customers.

Even President Obama admits that it would be difficult for a public plan to remain competitive with private industry.  As he stated during a town hall meeting, “If you think about it, UPS and FedEx are doing just fine, right? No, they are. It's the Post Office that's always having problems.”

An alternative idea now being floated is the establishment of state founded insurance co-ops, a type of independent company owned by its constituents.  Depending on its implementation, a network of co-ops could be more or less efficient than a public plan.  Incrementally, I don’t believe it would provide any more marketplace competition than the original idea of a single competing government entity.  However, the conflict of government ownership may be abated.  The good news from this analysis is that public plan, co-op, or not, managed care companies like Wellpoint, UnitedHealth, and Humana likely here to stay.

A Proposed Alternative

A big government solution with the high potential for waste is not the answer to our healthcare issues.  In fact, government regulations are an impediment to competition within the insurance industry.  Because each state has its own requirements for what should be included in an insurance plan, insurance providers must devise separate systems for performing business in each state.  This leads to a great deal of administrative waste and prevents risk pools from being effectively spread across populations.

I believe the following ideas would be more effective in accomplishing healthcare reform goals:

1. Promote the use and accessibility of Health Savings Accounts (HSAs)

HSAs put some responsibility of lowering healthcare costs on the patient.  With standard insurance, patients have no incentive to seek quality care at a more affordable price because copays are standard.  With a finite flexible spending account such as an HSA, the incentives are aligned for patients to shop around for non-emergency healthcare.

Flexible spending accounts could be installed as an option in a program like Medicare by offering monthly allotments toward the individual’s account combined with higher deductibles or percentage-based copays.  A proportional cost sharing system driven by flexible spending accounts could have wider implications beyond simple episodes of primary care.  Rather than having the government make a decision on whether a patient receives certain diagnostic tests, the economics of financial scarcity will lead to more personalized choices between the patient and the doctor.  Patients will be more likely to seek tests such as MRIs at the least expensive venues and competitive forces will lower prices over the long run. 

2. Deregulate the insurance market to allow interstate competition

Rather than rely on a solitary incremental choice provided by a public plan that is likely to operate in the red, the government could open a firestorm of free market competition and innovation by just allowing plans to compete across state lines.  According to a February 2005 study by The Commonwealth Fund (Insuring the Healthy or Insuring the Sick? The Dilemma of Regulating the Individual Health Insurance Market), a large disparity exists in the individual market insurance premiums between states.  This is primarily due to state regulations about what benefits should be covered by insurance.  A tradeoff occurs between coverage and benefits.  By allowing interstate competition through the American Health Benefit Gateway, a wider variety of choices will be available to purchasers and local public policy makers could use a trial-and-error based approach to determine the best balance of benefits and affordability.

3. Allow a tax deduction for individual market insurance premiums

It is widely believed that the bane of our insurance system stems from employers’ World War II era tax break for healthcare expenses.  Our employer-driven healthcare system engendered a dependency of employees on their workplace for healthcare.  Today this system presents a significant obstacle to entrepreneurship and burdens our domestic businesses competing against foreign enterprises that do not have an obligation to pay for healthcare costs.  Rather than further impose healthcare costs on our businesses with a pay-or-play provision, a reform should work to nudge us away from this system by establishing a stronger independent insurance market.

Conclusion

Once this proposal is signed into law, any mistakes will be nearly impossible to repeal.  For an industry so important to America morally and economically, such sweeping untested changes could have disastrous consequences.  We have already seen similar reforms fail in states such as Massachusetts.  The state achieved a remarkably low uninsured population rate of ~2.7%, but at a cost.  Rationing now exists via wait lists, insurance is still unaffordable for many families, and the state’s budget is threatened by cost overruns.

Rather than allow the government to flex its “bully pulpit” and exercise unprecedented market manipulations over one of our key industries, I believe it would be more productive to minimize the existing governmental interferences that have led to obstructions in the marketplace.  An effective reform would inspire true competition for insurers, providers, and the regulators within different geographic localities.

Full Disclosure: Winston is long shares of HUM
]]> Tue, 18 Aug 2009 01:44:16 -0400 This past weekend, for the first time the Obama administration hinted that it would be willing to sacrifice the publicly funded insurance portion of the Affordable Health Choices Act in order to make a bipartisan concession.  Investors reacted positively to this news, sparking a rally in managed care stocks Monday as fear was assuaged that this government insurance option would over the long run hurt the industry.

Despite growing signals that this congress is willing to loosen some of its more controversial measures to fix healthcare, there are still plenty of reasons to worry.  I contend that Affordable Health Choices Act will not achieve its laudable goals if it is passed in current form.  Here are some of the key reasons that I believe this bill will accelerate the unsustainable trend of costs and national debt over the long term:

1. The Affordable Health Choices Act will fail to curb healthcare inflation

A lack of individual accountability for the costs associated with treatments is a major cause of healthcare’s spiraling financial burden.  Yet, the proposed reform ineffectively addresses this problem.  In Senator Daschle’s book Critical, he writes:

 “…doctors and hospitals had little reason to care about costs.  Hospitals considered doctors to be their clients, and doctors made the decisions about how to care for patients.   They decided whom to admit to the hospital, how long to keep them there, and which tests to run.  Doctors, bound by the Hippocratic Oath, had no reason to know or care about the cost of what they ordered.  Hospitals were happy to earn as much money as possible by performing every test and procedure imaginable.  Patients with insurance didn’t pay much attention either, since they weren’t paying the bills, and their main concern was getting well.”

In later pages, he cites examples of how even after the advent of managed care, the misguided use of expensive tests and procedures leads to poor cost containment. 

The bill calls for all Americans to have some form of health insurance.  Unfortunately, this “Shared Responsibility for Healthcare” does little to encourage personal responsibility towards cost containment – the moral hazard of patients and doctors liberally using expensive treatments on the tab of other insurance payers still abounds.

2. A reduction in subsidies to private industry will not cover the cost of expansions

In town hall meetings, President Obama has suggested that the overpayments made in the Medicare Advantage program could be redirected to insure more people.  However, the savings of a cutback in Medicare Advantage would appear to be insufficient.  According to a June 28, 2007 CBO testimony, leveling Medicare Advantage payments with the traditional fee-for-service arrangement would save $149 billion over 10 years.  However, according to CMS figures, Medicare in total spent $431 billion in 2007 alone to insure its approximately 44 million members.  Diverting any extracted savings from Medicare Advantage to help cover the 47 million uninsured citizens would be a drop in the bucket.  Additionally, many Medicare Advantage programs provide supplemental benefits on top of traditional Medicare so it would naturally be more expensive.

3. The prevention and wellness components are inefficient

A major cost containment component of the bill involves a strategy for curbing costs through numerous expensive public programs which include the establishment and expansion of government entities directed towards wellness and prevention.  However, the CBO recently released a report stating that preventive care measures tend to increase net healthcare costs, and the benefits of wellness programs are tenuous at best.  The CBO report states:

“Although different types of preventive care have different effects on spending, the evidence suggests that for most preventive services, expanded utilization leads to higher, not lower, medical spending overall. …a new government policy to encourage prevention could end up paying for preventive services that many individuals are already receiving—which would add to federal costs but not reduce total future spending on health care.”

On wellness programs, the CBO commented:

“…designing government policies that are effective at inducing people to be healthier is challenging. Even successful efforts might take many years to bear fruit and could involve significant costs. Moreover, many employers already support some wellness services for their employees, and new government efforts to encourage such services could end up paying for services that some individuals are already receiving—which would add to federal costs but not reduce total future spending on health care.”

Along with these programs, Congress vows to increase insurance coverage via mandates and the use of federally funded credits to make plans more affordable. If the prevention and wellness efforts are ineffective at lowering costs, then how could this bill reasonably expect to achieve both goals of expanded national coverage without adding a significant burden on top of our already insurmountable government debt? 

4. The public plan is an unnecessary use of public funds

The Affordable Health Choices Act aims to increase competition in the insurance market by establishing a public plan.  Even a wholly nonprofit-driven insurance organization is unlikely to offer an incremental benefit significantly better than what is currently delivered in the private market.

In 2008, Wellpoint paid 83.6% of its $51 billion in premium revenue to cover the medical payments of its clientele.  After subtracting administrative costs of running the business, the company was left with a measly 4% profit margin ($2.5 billion) for its shareholders.  Removing this profit would only lead to a slight discount on premiums for customers.

Even President Obama admits that it would be difficult for a public plan to remain competitive with private industry.  As he stated during a town hall meeting, “If you think about it, UPS and FedEx are doing just fine, right? No, they are. It's the Post Office that's always having problems.”

An alternative idea now being floated is the establishment of state founded insurance co-ops, a type of independent company owned by its constituents.  Depending on its implementation, a network of co-ops could be more or less efficient than a public plan.  Incrementally, I don’t believe it would provide any more marketplace competition than the original idea of a single competing government entity.  However, the conflict of government ownership may be abated.  The good news from this analysis is that public plan, co-op, or not, managed care companies like Wellpoint, UnitedHealth, and Humana likely here to stay.

A Proposed Alternative

A big government solution with the high potential for waste is not the answer to our healthcare issues.  In fact, government regulations are an impediment to competition within the insurance industry.  Because each state has its own requirements for what should be included in an insurance plan, insurance providers must devise separate systems for performing business in each state.  This leads to a great deal of administrative waste and prevents risk pools from being effectively spread across populations.

I believe the following ideas would be more effective in accomplishing healthcare reform goals:

1. Promote the use and accessibility of Health Savings Accounts (HSAs)

HSAs put some responsibility of lowering healthcare costs on the patient.  With standard insurance, patients have no incentive to seek quality care at a more affordable price because copays are standard.  With a finite flexible spending account such as an HSA, the incentives are aligned for patients to shop around for non-emergency healthcare.

Flexible spending accounts could be installed as an option in a program like Medicare by offering monthly allotments toward the individual’s account combined with higher deductibles or percentage-based copays.  A proportional cost sharing system driven by flexible spending accounts could have wider implications beyond simple episodes of primary care.  Rather than having the government make a decision on whether a patient receives certain diagnostic tests, the economics of financial scarcity will lead to more personalized choices between the patient and the doctor.  Patients will be more likely to seek tests such as MRIs at the least expensive venues and competitive forces will lower prices over the long run. 

2. Deregulate the insurance market to allow interstate competition

Rather than rely on a solitary incremental choice provided by a public plan that is likely to operate in the red, the government could open a firestorm of free market competition and innovation by just allowing plans to compete across state lines.  According to a February 2005 study by The Commonwealth Fund (Insuring the Healthy or Insuring the Sick? The Dilemma of Regulating the Individual Health Insurance Market), a large disparity exists in the individual market insurance premiums between states.  This is primarily due to state regulations about what benefits should be covered by insurance.  A tradeoff occurs between coverage and benefits.  By allowing interstate competition through the American Health Benefit Gateway, a wider variety of choices will be available to purchasers and local public policy makers could use a trial-and-error based approach to determine the best balance of benefits and affordability.

3. Allow a tax deduction for individual market insurance premiums

It is widely believed that the bane of our insurance system stems from employers’ World War II era tax break for healthcare expenses.  Our employer-driven healthcare system engendered a dependency of employees on their workplace for healthcare.  Today this system presents a significant obstacle to entrepreneurship and burdens our domestic businesses competing against foreign enterprises that do not have an obligation to pay for healthcare costs.  Rather than further impose healthcare costs on our businesses with a pay-or-play provision, a reform should work to nudge us away from this system by establishing a stronger independent insurance market.

Conclusion

Once this proposal is signed into law, any mistakes will be nearly impossible to repeal.  For an industry so important to America morally and economically, such sweeping untested changes could have disastrous consequences.  We have already seen similar reforms fail in states such as Massachusetts.  The state achieved a remarkably low uninsured population rate of ~2.7%, but at a cost.  Rationing now exists via wait lists, insurance is still unaffordable for many families, and the state’s budget is threatened by cost overruns.

Rather than allow the government to flex its “bully pulpit” and exercise unprecedented market manipulations over one of our key industries, I believe it would be more productive to minimize the existing governmental interferences that have led to obstructions in the marketplace.  An effective reform would inspire true competition for insurers, providers, and the regulators within different geographic localities.

Full Disclosure: Winston is long shares of HUM
]]> wlp unh hum ci aet cvh Healthcare reform Managed care Health Care REIT Keeps a Strong Pulse http://seekingalpha.com/instablog/64425-winston-kotzan/20703-health-care-reit-keeps-a-strong-pulse?source=feed 20703 As the financial calamity of 2008 unfolded, REIT shares have fallen along side the broader market, pushing dividend yields to highs not seen for several years. The industry is now rife with fears stemming from the beleaguered commercial real estate market. For many REITs caught with overleveraged balance sheets, the perfect storm of impending debt maturity and the frozen credit market will not bode well.

However, with crisis comes opportunity. As rationality returns to the markets and investors once again look to fundamentals, REITs with the most robust balance sheets will emerge in an even stronger position. One such sector that I believe will thrive over the long run is health care REITs. In this article, I will explore Health Care REIT (HCN), a company which I believe is poised to outperform in what is likely to be a slow and arduous recovery.

Investment Thesis

Health Care REIT leases real estate to the operators of medical facilities that cater to the elderly. I believe that this company’s relatively non-cyclical business will appeal to investors, particularly those seeking the support of a reliable dividend. Key strengths include:

High quality cash flows supported by a strong core business. Healthcare is a generally secular industry and thus is less susceptible to economic downturns. I believe that the geriatrics specialty would have even more stable business trends given that nearly all elderly individuals are covered by some form of Medicare. Despite some recent pressure on tenant occupancy in the entrance fee based CRCC developments, the shortfall appears to be inconsequential.

Favorable demographic trends should prove beneficial. Regardless of the economic climate over the next several years, Health Care REIT stands to benefit from an aging US population. As the bolus of baby boomers develops growing medical needs, the facilities owned by Health Care REIT are perfectly aligned to capitalize on this trend.

A steady dividend supported by a strong balance sheet and cash flow. Unlike many other REITs that made the blunder of egregiously using leverage and off-balance sheet joint ventures, Health Care REIT has used leverage conservatively and does not hold a stake in any joint ventures. There is little reason to believe the company will have any difficulty fulfilling its debt obligations. The company’s dividend is well supported by cash flow, in line with historical levels.

Health Care REIT is set to outshine its competitors. When liquidity returns to the debt and real estate markets, I believe this company will be in an advantageous strategic position. Its solid financial footing should enable it to continue working on new developments going forward while many of its rivals are constrained by the capital markets.

Investment Risks

A prolonged period of economic turmoil can still weigh on results. Although Health Care REIT has held together pretty well so far, the adverse effects of the economy on its tenants could eventually hurt the bottom line. For example, an operator of medical office buildings could go bankrupt if its consumers are unable to pay. Thus far, management seems to have had success in monitoring and replacing the most at-risk operators.

The success of entrance fee based communities is somewhat levered to the housing market. The independent living/CCRC developments may fall short of occupancy expectations if the economy worsens enough to make it difficult for seniors to foot the large entrance fees. In other cases, seniors may hesitate moving into independent living/CCRCs if they are bogged down with financial obligations at a prior residence. Management has noted some sluggishness in the entrance fee based communities, which they attribute to the housing crisis. Since these communities are an integral aspect of Health Care REIT’s new developments, occupancy rates should be monitored closely.

Reimbursement risk from Medicare and Medicaid threaten certain revenue streams. Obama's administration is on a crusade to curb rising healthcare costs, and reimbursement is one lever the government can pull. The impacts could be felt through lackluster annual Medicare market basket adjustments, or outright payment cuts to some services. Of Health Care REIT’s 2008 results:
  • 30% of skilled nursing facilities revenue was from Medicare

  • 43% within specialty care facilities revenue was from Medicare

  • 51% with skilled nursing facilities revenue was from Medicaid

  • 19% at specialty care facilities revenue was from Medicaid

The full fury of government intervention was experienced by the industry with the Balanced Budget Act of 1997. The bill radically changed reimbursement schedules, and inadvertently resulted in severe financial stress for skilled nursing facilities. Many nursing homes went bankrupt. The only good outcome of this program was a critical learning experience for government officials as to the impacts of such cavalier cost cutting measures.

Sector rotation can broadly hurt the stock prices of REITs. During times of strong economic growth, buy side investors tend to favor high growth stocks. If the economy begins to move forward with great momentum, such a rotation in investment habits could occur and money could roll away from the stable, but low growth REITs.

Company Overview

Health Care REIT manages a portfolio of properties aimed at providing health care to the elderly. As of June 30, 2009, the company owned 620 properties fairly disbursed geographically among 39 states. Each property belongs to one of five categories:


Independent Living / Continuing Care Retirement Communities (CCRC) are large, multifamily residential developments are designed to meet the changing medical needs of retired individuals as they age. Most are exclusive to people age 55 and up. Many of these developments are designed to be located near recreational venues such as golf courses, which cater to the demographic. But importantly, medical facilities including assisted living and physician office buildings are also nearby or on the campus. The goal is to offer various levels of medical service without requiring the individual to change into an unfamiliar setting as he or she ages.

Some IL/CCRCs generate revenue through monthly rental income, but it is becoming more commonplace for communities to charge a one-time entrance fee. This entrance fee could range from $20,000 to $400,000. However, the majority of fees seem to be above $100,000. Upon the resident’s death or departure from the community, 60%-90% of the entrance fee is usually refunded (to the estate in the event of death). Of Health Care REIT’s properties, 60% of the unit mix is entrance fee based.

Assisted Living facilities bridge the gap between independent living and skilled nursing facilities. These properties are state regulated, rental based housing units that allow the individual to live semi-independently, but with the assistance of trained staff. Services include assistance with bathing, dressing, toileting, eating, and management of medication. Some of these centers are qualified to take care of patients afflicted with Alzheimer’s disease or dementia.

Skilled Nursing facilities, synonymous with nursing homes, provide short term acute care for the elderly. These properties can charge by rental or daily rates, and are staffed by professionals 24 hours.

Specialty Care consists of long term acute care hospitals. These facilities offer a variety of inpatient and outpatient services.

Medical Office Buildings contain clinics, physician offices, laboratories and other outpatient-related facilities. They are often located near hospitals and other medical properties.





Management runs a perpetual process of evaluating the strategic value of its properties. The company routinely divests of assets that no longer have the same long-term appeal in light of senior housing trends. Lately the company has been disposing of its smaller medical office buildings and standalone senior housing properties. Entrance fee based communities seem to have the construction limelight, with 10 of 15 such developments opening recently. New investment is focused on combination facilities and more modern medical office buildings.

Industry Overview

I believe Health Care REIT is well positioned to benefit from the large, graying baby boomer population. The Census Bureau, which considers “boomers” to be individuals born in 1946 through 1964, estimated this demographic to be 78.2 million in 2005. According to the Census Bureau’s 2008 statistics, the 65 and over population is anticipated to grow by about 6.6 million, or 16% from 2010 through 2015.

According to current statistics, just 5% of the United States population accounts for 49% of total healthcare costs. Furthermore, about 30% of all healthcare spending involves patients in their last year of life. Given such data, it is not unreasonable to infer that a large elderly population would increase demand for the kinds of facilities owned by Health Care REIT.



Balance Sheet Analysis

Health Care REIT appears to be well capitalized with a solid balance sheet. Management has kept a conservative mix of debt and capital. A debt-to-capital ratio above 0.60 is typically considered onerous. As far as I could tell from the financials, the company appears to be comfortably in line with its covenants.



According to company reports, the only off-balance sheet vehicles are letters of credit. Unlike many other REITs, the company is not hampered by off-balance sheet joint ventures. Furthermore, the bulk of debt maturities appear to be several years out. Due to management's well-maintained financial discipline, I do not foresee any capital access issues for this company should it decide to roll over any of its near-term maturing debt.



On a final note, the majority of the debt is also unsecured, which frees Health Care REIT’s properties from the burden of encumbrances.

Dividend Analysis

The company in the past has consistently raised its dividend, and there is little reason to believe that it would stall future increases. Dividend coverage appears to have remained stable for the past several years.




Valuation

Health Care REIT’s Price/FFO multiple appears to trade at the midpoint of its peers. Its historic median multiple appears to be approximately 12.2X, making Monday’s close of 40.78 appear expensive. Despite its recent price, I still believe that HCN is a strong portfolio holding and could trade at a premium to its historic multiple as investors seek stability in a precarious economy. Assigning a multiple of 13X to the consensus 2010 estimate would bring HCN to a price of 42.90, a gain of 11.9% including one year of dividends. However, my suggestion would be to buy aggressively if the stock pulls back into the 30s.






Full Disclosure: At the time of this writing, Winston does not hold a position in HCN.
]]> Tue, 04 Aug 2009 03:30:10 -0400 As the financial calamity of 2008 unfolded, REIT shares have fallen along side the broader market, pushing dividend yields to highs not seen for several years. The industry is now rife with fears stemming from the beleaguered commercial real estate market. For many REITs caught with overleveraged balance sheets, the perfect storm of impending debt maturity and the frozen credit market will not bode well.

However, with crisis comes opportunity. As rationality returns to the markets and investors once again look to fundamentals, REITs with the most robust balance sheets will emerge in an even stronger position. One such sector that I believe will thrive over the long run is health care REITs. In this article, I will explore Health Care REIT (HCN), a company which I believe is poised to outperform in what is likely to be a slow and arduous recovery.

Investment Thesis

Health Care REIT leases real estate to the operators of medical facilities that cater to the elderly. I believe that this company’s relatively non-cyclical business will appeal to investors, particularly those seeking the support of a reliable dividend. Key strengths include:

High quality cash flows supported by a strong core business. Healthcare is a generally secular industry and thus is less susceptible to economic downturns. I believe that the geriatrics specialty would have even more stable business trends given that nearly all elderly individuals are covered by some form of Medicare. Despite some recent pressure on tenant occupancy in the entrance fee based CRCC developments, the shortfall appears to be inconsequential.

Favorable demographic trends should prove beneficial. Regardless of the economic climate over the next several years, Health Care REIT stands to benefit from an aging US population. As the bolus of baby boomers develops growing medical needs, the facilities owned by Health Care REIT are perfectly aligned to capitalize on this trend.

A steady dividend supported by a strong balance sheet and cash flow. Unlike many other REITs that made the blunder of egregiously using leverage and off-balance sheet joint ventures, Health Care REIT has used leverage conservatively and does not hold a stake in any joint ventures. There is little reason to believe the company will have any difficulty fulfilling its debt obligations. The company’s dividend is well supported by cash flow, in line with historical levels.

Health Care REIT is set to outshine its competitors. When liquidity returns to the debt and real estate markets, I believe this company will be in an advantageous strategic position. Its solid financial footing should enable it to continue working on new developments going forward while many of its rivals are constrained by the capital markets.

Investment Risks

A prolonged period of economic turmoil can still weigh on results. Although Health Care REIT has held together pretty well so far, the adverse effects of the economy on its tenants could eventually hurt the bottom line. For example, an operator of medical office buildings could go bankrupt if its consumers are unable to pay. Thus far, management seems to have had success in monitoring and replacing the most at-risk operators.

The success of entrance fee based communities is somewhat levered to the housing market. The independent living/CCRC developments may fall short of occupancy expectations if the economy worsens enough to make it difficult for seniors to foot the large entrance fees. In other cases, seniors may hesitate moving into independent living/CCRCs if they are bogged down with financial obligations at a prior residence. Management has noted some sluggishness in the entrance fee based communities, which they attribute to the housing crisis. Since these communities are an integral aspect of Health Care REIT’s new developments, occupancy rates should be monitored closely.

Reimbursement risk from Medicare and Medicaid threaten certain revenue streams. Obama's administration is on a crusade to curb rising healthcare costs, and reimbursement is one lever the government can pull. The impacts could be felt through lackluster annual Medicare market basket adjustments, or outright payment cuts to some services. Of Health Care REIT’s 2008 results:
  • 30% of skilled nursing facilities revenue was from Medicare

  • 43% within specialty care facilities revenue was from Medicare

  • 51% with skilled nursing facilities revenue was from Medicaid

  • 19% at specialty care facilities revenue was from Medicaid

The full fury of government intervention was experienced by the industry with the Balanced Budget Act of 1997. The bill radically changed reimbursement schedules, and inadvertently resulted in severe financial stress for skilled nursing facilities. Many nursing homes went bankrupt. The only good outcome of this program was a critical learning experience for government officials as to the impacts of such cavalier cost cutting measures.

Sector rotation can broadly hurt the stock prices of REITs. During times of strong economic growth, buy side investors tend to favor high growth stocks. If the economy begins to move forward with great momentum, such a rotation in investment habits could occur and money could roll away from the stable, but low growth REITs.

Company Overview

Health Care REIT manages a portfolio of properties aimed at providing health care to the elderly. As of June 30, 2009, the company owned 620 properties fairly disbursed geographically among 39 states. Each property belongs to one of five categories:


Independent Living / Continuing Care Retirement Communities (CCRC) are large, multifamily residential developments are designed to meet the changing medical needs of retired individuals as they age. Most are exclusive to people age 55 and up. Many of these developments are designed to be located near recreational venues such as golf courses, which cater to the demographic. But importantly, medical facilities including assisted living and physician office buildings are also nearby or on the campus. The goal is to offer various levels of medical service without requiring the individual to change into an unfamiliar setting as he or she ages.

Some IL/CCRCs generate revenue through monthly rental income, but it is becoming more commonplace for communities to charge a one-time entrance fee. This entrance fee could range from $20,000 to $400,000. However, the majority of fees seem to be above $100,000. Upon the resident’s death or departure from the community, 60%-90% of the entrance fee is usually refunded (to the estate in the event of death). Of Health Care REIT’s properties, 60% of the unit mix is entrance fee based.

Assisted Living facilities bridge the gap between independent living and skilled nursing facilities. These properties are state regulated, rental based housing units that allow the individual to live semi-independently, but with the assistance of trained staff. Services include assistance with bathing, dressing, toileting, eating, and management of medication. Some of these centers are qualified to take care of patients afflicted with Alzheimer’s disease or dementia.

Skilled Nursing facilities, synonymous with nursing homes, provide short term acute care for the elderly. These properties can charge by rental or daily rates, and are staffed by professionals 24 hours.

Specialty Care consists of long term acute care hospitals. These facilities offer a variety of inpatient and outpatient services.

Medical Office Buildings contain clinics, physician offices, laboratories and other outpatient-related facilities. They are often located near hospitals and other medical properties.





Management runs a perpetual process of evaluating the strategic value of its properties. The company routinely divests of assets that no longer have the same long-term appeal in light of senior housing trends. Lately the company has been disposing of its smaller medical office buildings and standalone senior housing properties. Entrance fee based communities seem to have the construction limelight, with 10 of 15 such developments opening recently. New investment is focused on combination facilities and more modern medical office buildings.

Industry Overview

I believe Health Care REIT is well positioned to benefit from the large, graying baby boomer population. The Census Bureau, which considers “boomers” to be individuals born in 1946 through 1964, estimated this demographic to be 78.2 million in 2005. According to the Census Bureau’s 2008 statistics, the 65 and over population is anticipated to grow by about 6.6 million, or 16% from 2010 through 2015.

According to current statistics, just 5% of the United States population accounts for 49% of total healthcare costs. Furthermore, about 30% of all healthcare spending involves patients in their last year of life. Given such data, it is not unreasonable to infer that a large elderly population would increase demand for the kinds of facilities owned by Health Care REIT.



Balance Sheet Analysis

Health Care REIT appears to be well capitalized with a solid balance sheet. Management has kept a conservative mix of debt and capital. A debt-to-capital ratio above 0.60 is typically considered onerous. As far as I could tell from the financials, the company appears to be comfortably in line with its covenants.



According to company reports, the only off-balance sheet vehicles are letters of credit. Unlike many other REITs, the company is not hampered by off-balance sheet joint ventures. Furthermore, the bulk of debt maturities appear to be several years out. Due to management's well-maintained financial discipline, I do not foresee any capital access issues for this company should it decide to roll over any of its near-term maturing debt.



On a final note, the majority of the debt is also unsecured, which frees Health Care REIT’s properties from the burden of encumbrances.

Dividend Analysis

The company in the past has consistently raised its dividend, and there is little reason to believe that it would stall future increases. Dividend coverage appears to have remained stable for the past several years.




Valuation

Health Care REIT’s Price/FFO multiple appears to trade at the midpoint of its peers. Its historic median multiple appears to be approximately 12.2X, making Monday’s close of 40.78 appear expensive. Despite its recent price, I still believe that HCN is a strong portfolio holding and could trade at a premium to its historic multiple as investors seek stability in a precarious economy. Assigning a multiple of 13X to the consensus 2010 estimate would bring HCN to a price of 42.90, a gain of 11.9% including one year of dividends. However, my suggestion would be to buy aggressively if the stock pulls back into the 30s.






Full Disclosure: At the time of this writing, Winston does not hold a position in HCN.
]]> hcn REITs Healthcare ECLP: Uncertainty Eclipses an Optimistic Outlook http://seekingalpha.com/instablog/64425-winston-kotzan/12449-eclp-uncertainty-eclipses-an-optimistic-outlook?source=feed 12449 Investors have been looking for a seat on the healthcare information technology gravy train. Ever since the American Recovery and Reinvestment Act of 2009 was passed in February, the healthcare IT sector has rallied and outperformed the broader market (See Figure 1). Contained within the ARRA is the HITECH Act, a piece of legislation designed to incent medical providers to install and use IT systems for the delivery of better care. The legislation sets forth an estimated $19B in publicly funded grant & loan programs and Medicare/Medicaid incentive payments which will be distributed to medical providers who are “meaningful users” of healthcare information technology.



The HITECH Act supports an excellent cause that will help modernize our healthcare infrastructure. With the big bucks to be gained by medical software vendors as hospitals and physicians upgrade their IT systems, it is no surprise that the healthcare IT sector has taken center stage on Wall Street. However, no one should enter an investment without a dose of healthy skepticism. While I expect the rising tide in the healthcare IT transformation to lift all boats, investors should be careful to avoid missteps.

One stock I believe at risk is a favorite among buy-siders: Eclipsys (ECLP). Eclipsys is a leader in the area of electronic medical records (EMR) and financial analytics software for hospitals. The company has a rich history since it began in 1995, with origins in Computerized Physician Order Entry (CPOE) systems. A CPOE system processes and helps coordinate doctors’ requests for medications, lab tests, and other diagnostic procedures within a hospital. Eclipsys has a highly regarded product built on the Microsoft .NET platform, and now offers a broad range of medical management software products. Today, Eclipsys is a strong contender in the hospital market. Its major competitors include healthcare IT giant Cerner (CERN), McKesson Provider Technologies (MCK), and Epic Systems (privately held).

Don’t Throw Caution to the Wind

I believe Eclipsys could benefit greatly from the HITECH Act over the next several years. Hospitals are eager to capitalize on the Medicare incentive payments, and certainly want to avoid the reimbursement penalties beginning in 2016. However, good opportunities for business do not always translate to good investment opportunities in the stock market. Here are my fundamentals-based reasons on why Eclipsys may not be the best way to play the healthcare IT frenzy:

1. No HITECH-related deals have been signed. Management presented its Q1 2009 earnings conference call with an optimistic forward-looking tone. However, they were clear to acknowledge that the impacts of HITECH-related spending have not yet been felt. This is an excerpt from the May 6th conference call:

"Andy Eckert, CEO: "I can’t point to a single contract that happened during that period [Q1] that was purely a result of that activity [HITECH-related]…"



Later in the call Andy Eckert states:

"…while the stimulus is a wonderful thing, our clients are still hurting financially. That’s the reality. They are hurting financially and so we’ve seen projects slow down. We’ve seen some projects get delayed for months, and that is something that, again, gives us some level of balance in our world. This is not up, up, and away, by any means."



Although I am rooting for the HITECH spending to begin pulling through soon, this tough economic environment and uncertain reimbursement outlook has hospital administrators still cautious about capital spending. In fact, it may be a very long time before hospitals begin making major capital spending decisions to get their incentive payments. A recent survey by Hospitals & Health Networks shows that hospitals have not been very gung ho lately about IT spending.

While long-term investors may contend that now is the time to invest because the money will come rolling in sooner or later, my next few points are more specific to Eclipsys and may be the harbinger of a black swan coming around the corner.

2.Headcount reductions could cause a bottleneck. Early this year, Eclipsys preannounced Q4 2008 earnings results with an unexpected shortfall due to a rapid deterioration in the economy. In response, Eclipsys significantly trimmed its staff in the professional services group.

While this move seems to have cut unnecessary expenses for the time being, it could come back to bite them when business picks up. Although management may believe that headcount could quickly be inflated upon a surge in bookings, I would beg to differ. With a smaller number of consultants, there will undoubtedly be some costs to ramping up again as the company seeks to hire and train new employees. It may even be more costly than normal operating environments. If the economy upturns and a sudden spending glut forms as hospitals rush to upgrade in time for the 2011 incentive payments, trained healthcare IT professionals may come at a premium. I believe this makes Eclipsys vulnerable to strained implementation capacity once the ball gets rolling.

3. Eclipsys’ customer base is already saturated with CPOE; organic growth opportunities may be limited. From current information, the “meaningful use” criteria required to qualify for government incentive payments are likely to include CPOE as a central component. Since Eclipsys has the highest CPOE penetration rate in the industry (~60%, I estimate), this may limit some of the cross selling opportunity within its customer base. Other healthcare IT vendors such as Cerner (CERN) or Computer Programs & Systems (CPSI) may stand to benefit more from the installation of CPOE within their respective customer bases.

In January, an analyst at Thomas Weisel Partners was inadvertently copied on an email from CEO Andy Eckert to CFO Robert Colletti. In the email, Eckert acknowledged that the company is struggling with its organic growth rate, and has accelerated acquisitions as a remedy. In December of 2008, the company acquired Premise, a maker of patient flow software. Several months before that, it purchased MediNotes, a vendor of small physician practice EMR software. In early 2008, Eclipsys purchased EPSi for its revenue cycle analytics offering. Perhaps the organic growth issue indicates that Eclipsys is a victim of its own success.

4. Two top executives abruptly left the company. Finally, a glaring red flag is the abrupt departure of Eclipsys’ CEO and CFO. In January, CFO Robert Colletti mysteriously resigned. Then in May, only days after the Q1 results were reported, CEO Andy Eckert left his post, citing family ties in California and the accomplishment of operational goals. Eckert has been with Eclipsys since 2005 and is credited for transforming company’s strategy and expanding its product line beyond CPOE. His successor is a board member who joined the company in February. While the proximate departure of these executives may be a mere coincidence, history has shown us that such management shakeups could also be a leading indicator of more systemic problems within the company.

Valuation

Eclipsys tends to trade at premium multiples compared to other stocks in the healthcare IT sector. I believe that money managers are drawn to its small market cap and strong presence in the industry. At its current multiples, I would hardly consider it a value buy. My aforementioned reasons to be cautious point out the likelihood of troubling news in the future, which would make ECLP shares susceptible to a sudden drop in value.



Despite my hesitation to take a long position, I would not have the conviction to short ECLP either. With the momentum of HITECH on the way, any positive news on deals signed due to the legislation could rocket the shares. Such good news may appear near the company’s Q2 earnings release on August 6th.

Finally, Eclipsys would make an attractive buyout target for bigger fish. With giants such as Microsoft, Oracle, and Johnson & Johnson expressing interest in healthcare technology, Eclipsys may be ripe for picking.


The Meaningful Use Conundrum

Although I am certain that the HITECH Act will bring meaningful changes within the healthcare field, how soon is difficult to tell. Currently, I believe the “meaningful use” definition is still too ambiguous for budget planners to comfortably make IT purchase decisions. The HITECH Act refers to a “meaningful use” definition to determine whether a medical provider’s IT system is sufficient to deserve the Medicare and Medicaid incentive payments. Until now, the committee responsible for defining “meaningful use” is still refining the criteria.

On June 16th, the committee released its first draft of “meaningful use.” Already, there has been some pushback from industry. Criticism has centered on its vagueness and the feasibility of meeting the definition by 2011.

CIO Group Comments on Meaningful Use
Docs to Feds: Go Slow on Meaningful Use
HIMSS: Clarity Needed on Meaningful Use
Premier Comments on Meaningful Use

It may be later on in the year by the time we get more clarity on “meaningful use”. The committee is set to meet again on July 16th. Personally, I believe that some of the 2011 goals would be hard to achieve, especially for struggling hospitals that are entrenched with legacy systems. It will likely be later in the year by the time the ambiguities in “meaningful use” are ironed out. By then, hospitals will have a brief time window to upgrade their systems to meet the 2011 criteria. Implementations of these systems take many months, and in some cases up to two years for a complex rollout. Given the human capital quagmire of training the number of professionals necessary to get so many systems installed in such a short time, the industry may face a capacity constraint. To be fair, the committee will either have to lower the bar on the 2011 criteria or many hospitals will miss the opportunity to capitalize on the incentive payments in the early years.

I believe that the HITECH incentive plan is likely to encounter the same industry pushback as the ICD-10 coding conundrum. Originally, the department of Health and Human Services had an October 1, 2011 deadline for medical providers to begin reporting health statistics using the ICD-10 code system, replacing the current ICD-9 set of codes. Due to a strong industry pushback on the costs of changing systems to comply, HHS was forced to postpone the deadline by two years to October 2013.

Final Word on the Healthcare IT Market

I believe the healthcare IT market will be a great place to be for the next few years. For anyone looking to consider a career path, healthcare IT is certain to provide some fun challenges and prosperous times. However, investors should remain cautious because the timing is everything. While I do not believe Eclipsys is a suitable place to park money at the moment, some better opportunities may lie in the ambulatory market vendors such as Allscripts (MDRX) and Quality Systems (QSII).

The implementation of systems for small physician offices (the ambulatory market) is less complex than a hospital. In many cases the software can be remotely hosted, alleviating the burden of hardware installation difficulties for the physician. I believe Software-as-a-Service (SaaS) will become a key strategic tool for the ambulatory software vendors. athenahealth (ATHN) is one of the leading, if not the premiere, providers of SaaS-based financial and EMR software for small physician offices. However, I believe ATHN’s stock valuation makes it less attractive as an investment. For Allscripts and Quality Systems, I believe the opportunity is huge, but investors should wait for attractive entry points before building a position.


Full Disclosure: At the time of this writing, Winston does not hold a position in any of the above mentioned stocks.

]]> Thu, 09 Jul 2009 03:45:53 -0400 Investors have been looking for a seat on the healthcare information technology gravy train. Ever since the American Recovery and Reinvestment Act of 2009 was passed in February, the healthcare IT sector has rallied and outperformed the broader market (See Figure 1). Contained within the ARRA is the HITECH Act, a piece of legislation designed to incent medical providers to install and use IT systems for the delivery of better care. The legislation sets forth an estimated $19B in publicly funded grant & loan programs and Medicare/Medicaid incentive payments which will be distributed to medical providers who are “meaningful users” of healthcare information technology.



The HITECH Act supports an excellent cause that will help modernize our healthcare infrastructure. With the big bucks to be gained by medical software vendors as hospitals and physicians upgrade their IT systems, it is no surprise that the healthcare IT sector has taken center stage on Wall Street. However, no one should enter an investment without a dose of healthy skepticism. While I expect the rising tide in the healthcare IT transformation to lift all boats, investors should be careful to avoid missteps.

One stock I believe at risk is a favorite among buy-siders: Eclipsys (ECLP). Eclipsys is a leader in the area of electronic medical records (EMR) and financial analytics software for hospitals. The company has a rich history since it began in 1995, with origins in Computerized Physician Order Entry (CPOE) systems. A CPOE system processes and helps coordinate doctors’ requests for medications, lab tests, and other diagnostic procedures within a hospital. Eclipsys has a highly regarded product built on the Microsoft .NET platform, and now offers a broad range of medical management software products. Today, Eclipsys is a strong contender in the hospital market. Its major competitors include healthcare IT giant Cerner (CERN), McKesson Provider Technologies (MCK), and Epic Systems (privately held).

Don’t Throw Caution to the Wind

I believe Eclipsys could benefit greatly from the HITECH Act over the next several years. Hospitals are eager to capitalize on the Medicare incentive payments, and certainly want to avoid the reimbursement penalties beginning in 2016. However, good opportunities for business do not always translate to good investment opportunities in the stock market. Here are my fundamentals-based reasons on why Eclipsys may not be the best way to play the healthcare IT frenzy:

1. No HITECH-related deals have been signed. Management presented its Q1 2009 earnings conference call with an optimistic forward-looking tone. However, they were clear to acknowledge that the impacts of HITECH-related spending have not yet been felt. This is an excerpt from the May 6th conference call:

"Andy Eckert, CEO: "I can’t point to a single contract that happened during that period [Q1] that was purely a result of that activity [HITECH-related]…"



Later in the call Andy Eckert states:

"…while the stimulus is a wonderful thing, our clients are still hurting financially. That’s the reality. They are hurting financially and so we’ve seen projects slow down. We’ve seen some projects get delayed for months, and that is something that, again, gives us some level of balance in our world. This is not up, up, and away, by any means."



Although I am rooting for the HITECH spending to begin pulling through soon, this tough economic environment and uncertain reimbursement outlook has hospital administrators still cautious about capital spending. In fact, it may be a very long time before hospitals begin making major capital spending decisions to get their incentive payments. A recent survey by Hospitals & Health Networks shows that hospitals have not been very gung ho lately about IT spending.

While long-term investors may contend that now is the time to invest because the money will come rolling in sooner or later, my next few points are more specific to Eclipsys and may be the harbinger of a black swan coming around the corner.

2.Headcount reductions could cause a bottleneck. Early this year, Eclipsys preannounced Q4 2008 earnings results with an unexpected shortfall due to a rapid deterioration in the economy. In response, Eclipsys significantly trimmed its staff in the professional services group.

While this move seems to have cut unnecessary expenses for the time being, it could come back to bite them when business picks up. Although management may believe that headcount could quickly be inflated upon a surge in bookings, I would beg to differ. With a smaller number of consultants, there will undoubtedly be some costs to ramping up again as the company seeks to hire and train new employees. It may even be more costly than normal operating environments. If the economy upturns and a sudden spending glut forms as hospitals rush to upgrade in time for the 2011 incentive payments, trained healthcare IT professionals may come at a premium. I believe this makes Eclipsys vulnerable to strained implementation capacity once the ball gets rolling.

3. Eclipsys’ customer base is already saturated with CPOE; organic growth opportunities may be limited. From current information, the “meaningful use” criteria required to qualify for government incentive payments are likely to include CPOE as a central component. Since Eclipsys has the highest CPOE penetration rate in the industry (~60%, I estimate), this may limit some of the cross selling opportunity within its customer base. Other healthcare IT vendors such as Cerner (CERN) or Computer Programs & Systems (CPSI) may stand to benefit more from the installation of CPOE within their respective customer bases.

In January, an analyst at Thomas Weisel Partners was inadvertently copied on an email from CEO Andy Eckert to CFO Robert Colletti. In the email, Eckert acknowledged that the company is struggling with its organic growth rate, and has accelerated acquisitions as a remedy. In December of 2008, the company acquired Premise, a maker of patient flow software. Several months before that, it purchased MediNotes, a vendor of small physician practice EMR software. In early 2008, Eclipsys purchased EPSi for its revenue cycle analytics offering. Perhaps the organic growth issue indicates that Eclipsys is a victim of its own success.

4. Two top executives abruptly left the company. Finally, a glaring red flag is the abrupt departure of Eclipsys’ CEO and CFO. In January, CFO Robert Colletti mysteriously resigned. Then in May, only days after the Q1 results were reported, CEO Andy Eckert left his post, citing family ties in California and the accomplishment of operational goals. Eckert has been with Eclipsys since 2005 and is credited for transforming company’s strategy and expanding its product line beyond CPOE. His successor is a board member who joined the company in February. While the proximate departure of these executives may be a mere coincidence, history has shown us that such management shakeups could also be a leading indicator of more systemic problems within the company.

Valuation

Eclipsys tends to trade at premium multiples compared to other stocks in the healthcare IT sector. I believe that money managers are drawn to its small market cap and strong presence in the industry. At its current multiples, I would hardly consider it a value buy. My aforementioned reasons to be cautious point out the likelihood of troubling news in the future, which would make ECLP shares susceptible to a sudden drop in value.



Despite my hesitation to take a long position, I would not have the conviction to short ECLP either. With the momentum of HITECH on the way, any positive news on deals signed due to the legislation could rocket the shares. Such good news may appear near the company’s Q2 earnings release on August 6th.

Finally, Eclipsys would make an attractive buyout target for bigger fish. With giants such as Microsoft, Oracle, and Johnson & Johnson expressing interest in healthcare technology, Eclipsys may be ripe for picking.


The Meaningful Use Conundrum

Although I am certain that the HITECH Act will bring meaningful changes within the healthcare field, how soon is difficult to tell. Currently, I believe the “meaningful use” definition is still too ambiguous for budget planners to comfortably make IT purchase decisions. The HITECH Act refers to a “meaningful use” definition to determine whether a medical provider’s IT system is sufficient to deserve the Medicare and Medicaid incentive payments. Until now, the committee responsible for defining “meaningful use” is still refining the criteria.

On June 16th, the committee released its first draft of “meaningful use.” Already, there has been some pushback from industry. Criticism has centered on its vagueness and the feasibility of meeting the definition by 2011.

CIO Group Comments on Meaningful Use
Docs to Feds: Go Slow on Meaningful Use
HIMSS: Clarity Needed on Meaningful Use
Premier Comments on Meaningful Use

It may be later on in the year by the time we get more clarity on “meaningful use”. The committee is set to meet again on July 16th. Personally, I believe that some of the 2011 goals would be hard to achieve, especially for struggling hospitals that are entrenched with legacy systems. It will likely be later in the year by the time the ambiguities in “meaningful use” are ironed out. By then, hospitals will have a brief time window to upgrade their systems to meet the 2011 criteria. Implementations of these systems take many months, and in some cases up to two years for a complex rollout. Given the human capital quagmire of training the number of professionals necessary to get so many systems installed in such a short time, the industry may face a capacity constraint. To be fair, the committee will either have to lower the bar on the 2011 criteria or many hospitals will miss the opportunity to capitalize on the incentive payments in the early years.

I believe that the HITECH incentive plan is likely to encounter the same industry pushback as the ICD-10 coding conundrum. Originally, the department of Health and Human Services had an October 1, 2011 deadline for medical providers to begin reporting health statistics using the ICD-10 code system, replacing the current ICD-9 set of codes. Due to a strong industry pushback on the costs of changing systems to comply, HHS was forced to postpone the deadline by two years to October 2013.

Final Word on the Healthcare IT Market

I believe the healthcare IT market will be a great place to be for the next few years. For anyone looking to consider a career path, healthcare IT is certain to provide some fun challenges and prosperous times. However, investors should remain cautious because the timing is everything. While I do not believe Eclipsys is a suitable place to park money at the moment, some better opportunities may lie in the ambulatory market vendors such as Allscripts (MDRX) and Quality Systems (QSII).

The implementation of systems for small physician offices (the ambulatory market) is less complex than a hospital. In many cases the software can be remotely hosted, alleviating the burden of hardware installation difficulties for the physician. I believe Software-as-a-Service (SaaS) will become a key strategic tool for the ambulatory software vendors. athenahealth (ATHN) is one of the leading, if not the premiere, providers of SaaS-based financial and EMR software for small physician offices. However, I believe ATHN’s stock valuation makes it less attractive as an investment. For Allscripts and Quality Systems, I believe the opportunity is huge, but investors should wait for attractive entry points before building a position.


Full Disclosure: At the time of this writing, Winston does not hold a position in any of the above mentioned stocks.

]]> eclp cern mck cpsi mdrx qsii athn Healthcare IT