American Renal: JV Partners Rushing To Sell Equity Stakes, But Why?

Summary

• ARA’s JV partners are suddenly exercising their put options nearly as fast as they vest, requiring ARA to buy out their equity stakes. The reasons are becoming clear.
• Post Q1 news: Insurers now rejecting charitable assist on BOTH ACA AND non-ACA plans. Fraud lawsuit against ARA spurred federal investigations into “charities”, now from three separate federal agencies.
• Hypersensitivity of ARA to several very small variables such as put exercises and commercial mix. Tiny changes are suddenly wreaking havoc on ARA.
• ARA is merely an “also covered” stock. Analysts only focused on much larger competitors DVA and FMS, and have completely missed problems at much smaller ARA, which are very unique and very deep.
• Base case decline of 60% to $7. But with $500 million debt + $132 million put liability, also a strong case for later insolvency (ala Adeptus).

The information below represents the opinion of the author. The author is short ARA.

Company snapshot

Name: American Renal Associates (NYSE:ARA)

Business: Dialysis provider

Share price: $17.36

Market cap: ≈$550 million

Debt: ≈$500 million plus $132 million in put liabilities to JV doctors

Borrow: At least 400-600k shares (up to $10 million)

Borrow fee: 0.90%

Options: Calls and puts

Overview

Right now, shares of American Renal Associates (ARA) are trading for around $17. If things go “better” than expected, then I expect that the shares may “only” fall to around $7 (down 60%).

But in reality, a more likely scenario in the foreseeable future is actual insolvency for this troubled dialysis provider. If that view sounds extreme to you, then just read on. I think you will see clearly what I mean below.

As I will repeat throughout this article: Do not believe me. Do not believe the sell side. Instead, look to ARA’s JV partners (insiders) who are now exercising their put options nearly as fast as they can possibly vest them.

Below I will spell out clearly:

• Why things are so bad for ARA
• Why they are much, MUCH worse for ARA than at DaVita (DVA)
• How we KNOW with certainty that things are so bad at ARA
• How we know things are unraveling NOW
• WHY analysts and investors have missed all of this at ARA

In the past, my articles on multiple private equity backed IPOs ended up quickly presaging declines of 70-100% for stocks like Ignite Restaurant (IRG) and Erickson Air-Crane (EAC) (among others). With Erickson, the stock fell as much as 30% on the day of my article. But the pain was actually just beginning. The stock went on to be a true zero and quickly ended in bankruptcy.

My article: Massive Insider Deal Threatens Erickson Air-Crane

Later news: Mystery silence at Erickson Inc. ends with bankruptcy filing

But as I will show towards the end of this article, an even better template for ARA is the bankruptcy and implosion of Adeptus Health (ADPTQ).

** Parallels between ARA and Adeptus too obvious to ignore **

Here are just nine obvious ways in which ARA looks like an identical replay of bankrupt Adeptus which quickly fell from $120 down to $1.

Just to make things simple, I will number the most obvious similarities.

Adeptus was 1) a private equity backed 2) healthcare services IPO which 3) surged after it came public only to see 4) its results falter amid 5) overpayment issues which were 6) exposed in news reports over its 7) problematic business model. 8) Despite the emergence of obvious problems, the sell side banks were more than eager to hype the stock (and at Adeptus were then more than willing to accept the banking fees from the huge share sales by Adeptus’ private equity backer). 9) Numerous hedge funds naïvely piled into the stock. Just like ARA, Adeptus’ public problems began with a simple newscast revealing the problems with overcharging. Even until the bitter end, and despite the increasingly obvious problems, analysts were telling investors that Adeptus was a “buy, buy, buy”.

Adeptus soon filed for bankruptcy and the stock now trades for around $1.00 with the dreaded “Q” added to its ticker. Down more than 99%.

From FT.com: Rise and fall of Adeptus is perfect parable of Wall St hype

** A detailed look at American Renal **

The key to understanding the short thesis on ARA is understanding why the nephrologists (ARA’s joint venture partners) are suddenly rushing to exercise their put options on the business, requiring ARA to buy them out of predetermined equity stakes.

As part of the JV structure, ARA grants to the clinic operators (nephrologists) put options allowing them to force ARA to repurchase a predetermined portion of their equity stakes. The total size of this put liability for ARA is currently $132 million; however, most of these options are not currently vested or able to be exercised. There are a total of $36 million of “event based” puts which are not exercisable until the occurrence of certain future events. The other $94 million of these puts are “time-based” put options which become only exercisable after certain specified dates. For example, over full-year 2017, $23 million of these time-based puts will become exercisable by the end of the full year.

These nephrologist partners are the ones who actually operate the dialysis clinics on the ground such that they understand the business better than anyone.

Better than ARA, better than investors, better than sell side analysts.

In fact, these JV partners have now suddenly begun exercising these puts and selling their equity in ARA nearly as fast as they can, cashing out as much as 50-80% of all vested time-based put options in a given quarter. This is a very recent and sudden development and is unprecedented in the history of ARA. As new troubles have begun to hit ARA.

These JV partners recently exercised more puts in a single quarter than had been exercised in the entire cumulative history of ARA.

But in conveying their optimism for ARA, sell side analysts have completely ignored this surge of JV partners suddenly cashing out as fast as they can.

What investors need to see is this: Not all of the put options are currently vested. Only a small portion can currently be exercised. Of that small portion where they actually CAN exercise, the JV partners ARE exercising nearly everything they can as fast as they can.

In other words, it is not the SIZE of the total exercises, but rather it is the RATE that these puts are being exercised as soon as they vest.

So the question is WHY are these JV partners rushing to cash out as fast as they can?

My short answer to “why” doctors are cashing out is this: Following the slow unraveling of the “charitable assist” model towards Medicaid patients in 2016 and the ongoing “patient steering” fraud lawsuit, ARA’s commercial revenue mix is falling much faster than expected. This is important because commercial payors have historically reimbursed at roughly 4x the rate of Medicare/Medicaid (or even more). The JV partners can clearly see this sea change in reimbursement on the ground in complete contrast to the continued “hopes” expressed by analysts. In addition, ARA’s commercial mix has historically been elevated to a much higher level than competitors such as DaVita. As the practice of “premium assist” continues to come under ever greater pressure, ARA has much further to fall than DaVita. Because more than 100% of ARA’s profits/EBITDA come from just the 14% of commercial mix, ARA is truly hyper sensitive to even a tiny drop in the commercial mix. ARA’s remaining 86% of revenues are deeply unprofitable. On a recent conference call, ARA quietly mentioned that going forward it would only be disclosing commercial mix on an annual (not quarterly) basis. Investors will therefore now have a one-year lag behind what the JV partners know regarding the commercial mix. Furthermore, compared to DaVita, ARA is heavily and uniquely over-exposed to the JV/Put model, such that individual doctors will end up competing with one another to be the first to get their money out of heavily indebted ARA. So this is why the doctor/JV partners have been rushing to exercise their puts as fast as they can. More details below.

** The big question for investors **

As we will see below, the overall size of the put liability and exercises is NOT currently enough to sink ARA by itself. Instead, the sudden and rapid exercise of the puts by the JV partners is just signal of what these on the ground participants know that the rest of us do not.

The biggest question investors should ask themselves is this: If ARA’s JV partners are rushing to SELL their puttable equity stakes nearly as fast as they can, then who on Earth would be foolish enough to BUY ARA stock at the same time?!?!

As investors start to figure this out, this is why I expect significant near-term downside to the stock. Simply no one should be foolish enough to step up and buy ARA at anywhere near current prices.

** JV put exercises - how sudden? how steep? **

Looking more closely at this surge in put exercises, as of ARA’s IPO prospectus in April 2016, the company disclosed that:

Since our inception, only $5.8 million of time-based puts have been exercised by our nephrologist partners.

(Note that this equates to just $0.96 million per year since inception).

Then starting at the beginning of 2H 2016, ARA was hit by a wave of negative articles from the New York Times along with a fraud lawsuit by United Health describing “fraud” and “patient steering”. The fraud lawsuit was then followed by even more negative actions in August from the Department of Health and Human Services which explicitly sought to curtail such “steering”.

By September of 2016 (immediately after these problems became public), we saw that the nephrologist partners very suddenly began exercising their put options almost as fast as they could even vest them. Anyone watching this should have viewed is as a very drastic about-face vs. the prior six-year history of ARA. It was unprecedented.

As of Q1, these nephrologists have already exercised more than $12 million of these puts just since Q3. This more than double what had been exercised in the entire prior six-year cumulative history of the entire company!

The point is this: On the surface, $12 million doesn’t sound like a massive number by itself. And this is why analysts and investors have ignored the significance of it.

But more important than the SIZE of the liability is actually the RATE at which these doctors are exercising their puts. Not all of the equity is actually subject to put provisions. The point is this: for the portion which IS subject to put provisions, doctors are now exercising as much as 50-80% of all vested options in any given quarter. This has continued into Q1 as more recent events now suggest that it will accelerate into Q2.

The JV partners are rushing for the exits nearly as fast as they can. The only thing slowing them down from taking out more of their money is the vesting schedule which is staggered over time.

Obviously this is a very stark contrast to what was disclosed by ARA in the IPO prospectus.

For example, as of the end of Q2 2016, only $15.5 million of these time-based options were exercisable for the entire remainder of 2016 (two more quarters). But, as shown in “purchase of non controlling interests”, the nephrologist partners immediately exercised $8.1 million in Q3 alone, immediately after the bad news began to hit (more than 50% of vested options for 2016 exercised in just a single quarter).

For all of 2017, there are only $23 million in time-based puts which become exercisable over the course of the entire year. Yet in Q1 alone, the JV partners had already exercised $4.5 million in just that first available quarter, as shown in “purchase of non controlling interests”. This is therefore on track for nearly 80% exercise of all vested options once they actually become vested over the course of 2017.

And also keep in mind that there are also an additional $36 million of “event-based” puts which are triggered by separate events and which are not part of this “time based” vesting schedule. Once these become triggered and vested, JV partners can then start selling those equity stakes as well.

This sudden urgency to exercise vested puts tells us that the problems facing ARA are very real. And it is being conveyed to us by the local nephrologists who know the business even better than ARA itself (Certainly far better than analysts and investors).

** And then there’s that $500 million in debt **

The insolvency case for ARA is all the more likely due to the $500 million in debt that ARA has taken on. ARA recently extended the maturities of its debt, so any insolvency is not going to happen overnight. But the purpose of this huge levering up, of course, was largely for the simple purpose of just handing out large cash dividends to its private equity backer/shareholder.

Here is just one past headline from before the IPO

“Centerbridge Partners-backed American Renal Associates is planning to pay $200m in debt-financed dividends.”

As we saw with Adeptus, once PE firms get their first payouts via debt financed dividends, I frequently see them start banging out equity offerings regardless of price. By the time they are playing with “house money” it matters much less if they sell at $10 or $20 (or even $5). In all scenarios, life is good.

** Negative developments that spurred put exercise (2016-2017) **

The first wave of negative developments for ARA began in mid 2016. By now these first wave developments have been widely disseminated and are well understood. These developments from 2016 are not, not, NOT part of my short thesis on ARA! But they do need to be understood for context. After that, we can look at newer (second wave) developments in 2017 over just the last few weeks which have been missed by the market.

Developments from 2016 included a series of scathing articles in the New York Times specifically naming ARA and a lawsuit against ARA by UnitedHealth (alleging millions of dollars in fraudulent “patient steering”).

It appears that the lawsuit filed by UnitedHealth may have been deliberately overly broad. Although the suit was filed in Florida, it included UnitedHealth Ohio as a plaintiff in addition to UnitedHealth Florida. The suit also named an ARA holding company in Massachusetts which has no presence in Florida.

In fact, the strategy by UnitedHealth appears to have been pure genius. Not surprisingly, the subclaims including UnitedHealth Ohio and the ARA holding company were both dropped or dismissed. Those outcomes should have been entirely obvious in advance. The remaining fraud suit of UnitedHealth Florida vs. ARA continues to be ongoing.

The genius part is that UnitedHealth achieved a near immediate launch of multiple federal investigations into the allegations of fraudulent patient steering.

I STRONGLY encourage readers to view the entire fraud complaint by UnitedHealth against ARA. It contains a detailed explanation of the "patient steering" allegations along with a wealth of detailed numbers and data regarding Medicare, Medicaid and commercial reimbursements and other data which are otherwise very difficult to find.

Link: Legal complaint - United Health Vs. ARA - Fraud

The New York Times began covering the allegations of steering immediately after the lawsuit was announced. And within weeks, the US department of Health and Human Services initiated a ruling to stop the patient steering which it said had been evidenced by “social workers, health plans, patients, and other stakeholders”.

HHS Publishes a New Rule to Protect Dialysis Patients From Being “Steered” into Private Coverage for the Benefit of Dialysis Centers

In December 2016, the New York Times then published a detailed expose on the American Kidney Fund, which had been the conduit for the patient steering fraud by ARA according to the UnitedHealth suit.

NY Times: Kidney Fund Seen Insisting on Donations, Contrary to Government Deal

The government deal cited by the New York Times refers to the promises that AKF had made in order to avoid violating federal anti-kickback laws.

In January 2017, the HHS ruling was stayed by a Texas judge (on procedural grounds only, not on its merits). Some analysts and investors then hoped that ongoing damage to the dialysis players could be mitigated.

In January 2017, federal scrutiny intensified further into a second federal agency when the US Attorney’s Office sent out subpoenas to numerous dialysis and drug companies as part of its investigation into “charitable” premium assist. This included ARA.

Article: Dialysis Chains Receive Subpoenas Related to Premium Assistance

The subpoenas certainly have not been lost on the JV partners. This too has been disclosed and is well known. But the surge in put exercises that followed the subpoenas into Q1 2017 has been totally ignored by analysts and investors.

** Brand new developments in past several weeks (May-July 2017) **

More recent developments (which came to light only AFTER Q1 was reported by ARA in May) have been either totally missed by analysts and investors or not fully understood in the context of ARA.

The first wave of developments in 2016 already led to unprecedented cash-outs by ARA JA partners via their put options. And now, recent news over just the past few days and weeks appears to be far worse for ARA. When Q2 is announced in a few weeks, we will then be able to see the impact on ARA’s financials and additional put exercises.

These newest negative developments for ARA include newly revealed policies by national commercial insurers to outright refuse premium assist payments from “charities” such as the American Kidney Fund (“AKF”).

For ARA, the impact of this will be a shift in patient mix, which is in fact a double whammy. There will be a decrease in lucrative commercial patients who will be switched to money losing Medicare patients and an increase in loss-making Medicare patients. Rather than receiving around $1,000 from commercial insurers, ARA would instead receive $200-250 per treatment from Medicare. The cost to treat patients ranges from $300-400.

Although the shift in reimbursement practices has not been widely reported, ARA’s JV partners would have seen this in practice long before anything would appear in the media.

Notice of these new insurance developments just began in May 2017 (after ARA announced Q1), but was initially limited to specialist dialysis industry journals. Until just the last few weeks, there had been no mainstream coverage that I can find, so this has not been widely known.

But in just the last few days, new headlines have begun to emerge showing that insurers in multiple states are now refusing to accept premium payments to insure dialysis patients who already qualify for Medicare/Medicaid and should not be on private insurance.

July 1, 2017 - South Carolina

Article: Kidney patients in SC being forced off of private insurance

June 16, 2017 - Bloomberg

Article: Healthcare investors are in denial

In addition, by looking at the following quote from DaVita to a specialist dialysis industry journal, we can see that the insurance crackdown is now a) stemming from multiple insurers and is b) affecting multiple types of policies (both ACA and non ACA).

So far, most insurers engaged in this activity are only targeting patients on individual (or ACA) plans,” DaVita said. “Recently, however, we have seen the first example of an insurance company trying to use the same tactics to push patients out of their Medigap plans.

In June 29^th (just two weeks ago), we then saw an escalation of the federal investigations into “premium assistance charities” reported on Bloomberg. These charities are the ones operating the model that drug makers and dialysis providers have been using to receive vastly elevated vastly commercial reimbursement. The various investigations and actions by the federal government into this “charitable” activity have now extended into their third federal agency: now including the US Attorney’s Office, the Department of Health and Human Services and (most recently) the Internal Revenue Service.

The recent IRS case focuses on the Chronic Disease Fund, an industry funded “charity” which channels payments from drug makers to support co-pays. This model is effectively an iteration of the same model used by the American Kidney Fund, which is supported by the dialysis industry, including ARA.

In fact, all of this comes on top of new and onerous advances in state legislation in May 2017 to regulate dialysis providers, imposing mandatory staffing (labor) levels for techs and nurses in dialysis clinics. ARA is not overly exposed in California, but just like the minimum wage hikes that started only in California, this legislation has the potential to spread more broadly to other states.

** The future of “charitable assistance” and its impact on ARA **

After all of the drama and exposure over “patient steering” in 2016, in Q1 ARA suddenly disclosed that it had stopped “assisting” Medicaid eligible patients in securing private commercial insurance via AKF.

Following the ballooning accusations of “patient steering” fraud in 2016, the reason for this change by ARA is quite obvious.

Medicaid pays for 100% of a patient’s costs and requires virtually zero out of pocket to the patient. When a provider such as ARA “assists” these patients into commercial insurance policies, it clearly provides zero benefit to the patient and serves only to quadruple the reimbursement to ARA (or more). This switching of Medicaid eligible patients is visibly indefensible. And that is why ARA had to stop doing it. As a result of this factor alone, ARA’s commercial mix immediately fell by more than 2%.

But dialysis providers, including ARA, continued to assist Medicare (as opposed to Medicaid) eligible patients in getting into commercial policies. Commercial (non Obamacare) patients accounted for 13% of revenues is 2016, but ARA recently disclosed that even this would now drop by a full percentage point in 2017.

Up until recently, industry-funded “charities” have spun a great story about how they help patients. But with three separate federal investigations/actions underway, everyone should start to realize that this “charitable” (industry funded) premium assist racket is likely going to be greatly curtailed or could even go away completely. The mechanics of this scheme are simply becoming too transparent.

Here is how the “charity” racket has worked to date:

As I look at the IRS and other cases, “charitable” assistance allows the providers to channel small amounts of money, using certain “charities” as a “conduit”, to just pay the small premiums and co-pays for patients in order to obtain full insurance reimbursement.

Yes, this certainly appears to be giving support to poor and vulnerable patients. And that all sounds great. These companies and the charities publicly remind us of their public service in every chance they get via press releases and public statements.

But in fact the tiny payments of premiums and copays, sourced from the providers themselves, yields tremendous profits when insurers or CMS are forced to foot the bills for their drugs or services. After the “charity” pays these small co-pays and premiums, the massive reimbursement ultimately flows right back to the providers who made the “charitable donations” in the first place.

Got it ?!

(As an illustration: In the case of dialysis, Medicare/Medicaid only pay the clinics around $200-250 per treatment. But with private commercial insurance, these clinics can get reimbursed up to $1,000 for in network and up to $4,000 for out of network. In other words, the dialysis providers can get from 4-20x the reimbursement rate for providing the same exact services to the same exact patients. Many very poor dialysis patients can’t afford private insurance, so the American Kidney Fund pays their premiums for them. The AKF is overwhelmingly funded directly by the dialysis providers, such as ARA, which then receive the 4-20x reimbursement. Hence the tremendous incentive to “steer” or “assist” these patients into private insurance).

In fact, the real beneficiaries of these “charitable” activities are actually the drug makers and dialysis providers themselves as a result of the tremendous payments they rake in from private and government payors who are on the hook for these elevated treatment costs.

But now, as we are seeing in recent weeks, the jig is up. Insurance companies and the federal government are now pushing back aggressively against this nonsense in all directions and all at the same time.

Given that many of ARA’s remaining commercial patients are still receiving premium assistance, there is still plenty of further damage to be done to ARA’s financials once these patients get transitioned to Medicare.

** Impact on ARA - why JV partners are suddenly freaking out **

Even into Q1, JV partners were rightfully exercising their puts largely as fast as they could to get whatever money is obtainable as soon as they can. Given the new developments in May-July, I can only expect the put exercises to accelerate into Q2.

Media coverage of new problems has been building in recent weeks, but has still been relatively limited. Although investors and analysts are still in the dark, the on the ground JV doctors have had full visibility from the clinic level. JV partners have first-hand knowledge which is far greater and earlier than any media coverage. This should become even more evident when ARA releases Q2 results in a few weeks.

Shareholders who figure this out will certainly follow the example of the nephrologist JV partners and sell sooner rather than later.

It all comes down to ARA’s hypersensitivity to commercial revenue mix. This is what the JV doctors know far better than anyone else.

First look at this:

For Q1 of 2017, ARA’s revenue increased by 3% and the number of treatments performed increased by 10%. That sounds good right?

But ARA’s reported adjusted EBITDA figure DECREASED by 22% from $27 million to $21 million. How is this possible?

Prior to Q1, 17% of ARA’s patients were on commercial insurance vs. 83% on government paid reimbursement plans such as Medicare/Medicaid (13% were commercial non ACA while 4% were commercial ACA patients).

In fact, for every patient who uses government insurance (the 83%), ARA actually loses substantial money. But no worry, the rate charged to private insurers (just 17% of patients) is so high that it makes up for all of the losses on the 83% and then provides ALL of the additional profits to the entire business (more than $100 million in EBITDA).

Following the exposure of ARA in the New York Times articles, the UnitedHealth lawsuit and the HHS actions, something interesting then happened at ARA between year end and Q1.

By Q1, ARA’s commercial mix dropped to 14% from 17%. This was largely due to the company’s stated “decision” to stop “assisting” patients into private insurance and out of government programs. Most of the drop was due to the cessation of “assisting” Medicaid patients into private insurance.

But a mere 3% drop is no big deal, right?! Wrong!

Hypersensitivity:

Note that even though total revenues and total treatments increased during Q1, this tiny 3% drop in “commercial mix” caused ARA to lower EBITDA guidance by $25 million for 2017 - a 20% drop from previous guidance.

Because of the hypersensitivity to very small changes in these variables, analysts and investors have completely missed the going forward impact on ARA.

(But clearly the JV partners have not missed this at all).

** So why is ARA so much worse off than DaVita ? **

It is worth observing that somehow ARA had historically been able to secure a commercial mix that was as much as 7 percentage points (more than 40%) above where DaVita has historically been, providing a dramatically higher slug of that super profitable commercial revenue. But as a reminder, ARA has publicly denied that it was not engaged in any fraudulent steering of patients into commercial policies.

While ARA was able to hit a 17% commercial mix in 2016, DaVita has historically averaged around 10-11%, only once hitting as high as 12%. So to the extent that ARA’s 17% number “normalizes” along with further changes to the “charitable” assist model, I expect to see at least a further 3-6 point DECLINE in this commercial mix for ARA going forward. And that is certainly at a minimum.

So you do the math. As we saw above, a 3 point change immediately shaved 20% off of EBITDA. Next we can expect a full impact that is double to triple the original amount.

And keep in mind, as DaVita and other industry players see further declines in commercial mix due to new policies and practices from insurance and the government, ARA should also experience further additional declines in commercial mix as well (even below the 10% level). Investors should therefore not be surprised if EBITDA is cut in half.

A statement from DaVita's recent conference call was then picked up by the StateOfReform website, highlighting the multiple headwinds and risks that are now affronting dialysis players from all sides.

[T]he concentration of profits generated by higher-paying commercial payor plans for which there is continued downward pressure on average realized payment rates, and a reduction in the number of patients under such plans, which may result in the loss of revenues or patients, and the extent to which the ongoing implementation of healthcare exchanges or changes in regulations or enforcement of regulations, including but not limited to those regarding the exchanges, results in a reduction in reimbursement rates for our services from and/or the number of patients enrolled in higher-paying commercial plans[.]

In describing the "patient steering" scheme, StateOfReform said this:

The scheme that led to activity at multiple federal agencies is more problematic than improper 3rd party payments. It included enrolling people eligible for Medicaid and/or Medicare onto private insurance - at no cost to the patient thanks to the 3rd party payment — because private insurance, including in the individual market, reimburses at significantly higher rates than government programs. Same patient, same treatment, much higher reimbursement to the dialysis provider.

But again, please keep in mind that my opinion on this really doesn’t matter. Nor does the opinion of the sell side.

It is the opinion of the JV partners that matters. And their opinion is being loudly expressed by their sudden and ongoing rush to exercise their puts as fast as they can.

After multiple quarters of record put exercises, the further put exercises in Q2 should make this clear beyond any doubt.

** So why haven’t investors and analysts figured this out ? **

There are several reasons why analysts and investors have completely missed what is going on here and just how bad it is.

First, the JV/Put model is somewhat complicated. There is JV equity that is owned by ARA corporate (and therefore ARA shareholders), there is separate equity owned by the JV partners (local doctors). Some of the doctors’ equity is subject to puts while some of it is not subject to puts.

The point is that for the equity which is subject to put provisions, the JV partners are exercising nearly as fast as they possibly can. With the remaining equity, there is just nothing they can do about it.

In ARA’s filings, there is certainly no disclosure which describes anything bluntly as “put exercise by the JV partners who are rushing for the exits”. And again, this is why the sell side can conveniently ignore it.

Instead, the ongoing filings just include an item called “purchase of non controlling interest” which does not sound particularly ominous. Fuller disclosure of the put liability was originally included in the IPO prospectus, but that was in April 2016, prior to any meaningful exercises by the JV partners.

The IPO prospectus stated that:

If the put obligations are exercised by a physician partner, we are required to purchase, at fair market value, a previously agreed upon percentage of such physician partner's ownership interest.

Along with:

We may be required to purchase the ownership interests of our physician partners, which may require additional debt or equity financing.

The second reason that analysts have ignored this surging put exercise is that the nominal size of the put exercises appears relatively small relative to ARA. But again, this is a question of hypersensitivity which they have missed.

Our complacent analysts may just view this $12 million as not being big enough by itself to have its own meaningful financial impact.

But it is not the financial impact of these puts that matters. What matters is that it shows that the JV doctors are cashing in whatever vested equity they can nearly as fast as they are possibly permitted to do so.

With 50-80% of all vested options suddenly being exercised in any given quarter, and when that percentage is going straight up over time, this truly reflects a rush for the exits by the JV nephrologists on the ground.

Again, in the six years prior we had seen a cumulative total of $5.8 million in puts exercised. Since the September quarter alone, we have already seen double that, and the exercise rate vs. vesting appears to be accelerating.

It is these JV partners who know that business better than anyone else. And they seem to be selling as fast as they can.

** What do the analysts say ? **

Are these analysts actually even trying with ARA? No, they are not. Here’s how we know.

So far there has been no notice from the sell side that these JV partners are suddenly exercising their puts as fast as they can, or that in a single quarter recent put exercises exceed the cumulative total exercised since the inception of the company!!

Instead sell-side analysts are doing the same thing with ARA that they did with Adeptus. They are simply pitching hope that the worst impacts on commercial mix are now hopefully “behind the company”.

Because of ARA’s exclusive JV model, the accounting is moderately complex. It involves accounting for a minority interest which fluctuates every quarter along with JV liabilities valued according to opaque “Level 3 Inputs”. More than 40 entries are included in the equity table to reconcile the NCIs. There is even more, but you get the point.

If the analysts actually wanted to provide proper coverage on ARA, it would require a substantial amount of work each and every quarter. The complexity means that we would expect to see a wide spread in their various price targets and assumptions between different analysts.

But in reality, ARA is just an “also covered” stock. These analysts have every incentive to provide full coverage to giants like DaVita and Fresenius (FMS) due to their market caps of over $10 billion. But their coverage of ARA is just a perfunctory effort, which is required to be part of the DaVita and Fresenius coverage universe. With ARA, the research goal is simply to refrain from pissing off a company that may later pay some banking fees. Anyone who has worked on Wall Street should recognize this phenomenon.

For anyone who doubts this, you can observe the following:

Since the IPO, the analysts repeatedly place their targets at a safe level which is consistently in accordance with the pricing model known as “slightly above the current price”. For even greater safety, all of these analysts then put price targets on the stock clustered in the same narrow price range vs. one another.

Despite the recent volatility in the industry and the complex accounting, all four analysts with recent updates placed targets within a very tight range of $22-23. That way no one needs to go out on a limb.

With ARA the analysts are just not paying attention to any of the details whatsoever. Not the imploding commercial mix. Not the surging put exercises by JV partners. Not the increasing litigation.

So now let’s look at a nearly identical situation where analysts covered a similar “high growth” healthcare stock which was backed and owned by one of the same banks’ large private equity clients.

** Adeptus - a preview for ARA shareholders **

If you want a clear preview of where ARA is headed, just look to the implosion of Adeptus Health. The parallels between ARA and Adeptus are really just too direct and obvious to ignore. Just to make things simple, I will number the most obvious similarities.

Shares of Adeptus plunged from $120 in 2015 to near zero as the company began a rapid bankruptcy death spiral in 2016.

Adeptus was 1) a private equity backed 2) healthcare services IPO which 3) surged after it came public only to see 4) its results falter amid 5) overpayment issues which were 6) exposed in news reports over its 7) problematic business model. 8) Despite the emergence of obvious problems, the sell side banks were more than eager to hype the stock (and at Adeptus were then more than willing to accept the banking fees from the huge share sales by Adeptus’ private equity backer). 9) Numerous hedge funds naïvely piled into the stock. Just like ARA, Adeptus’ public problems began with a simple newscast revealing the problems with overcharging. Even until the bitter end, and despite the increasingly obvious problems, analysts were telling investors that Adeptus was a “buy, buy, buy”.

Adeptus soon filed for bankruptcy and the stock now trades for around $1.00.

As highlighted in the Financial Times:

Adeptus Health, the largest operator of freestanding emergency rooms in the US, ended the day down 58 per cent to another record low, after it said there was “substantial doubt” over its ability to continue as a going concern. Its rise and fall is a parable of Wall Street: a perfect illustration of how banks like to crank and crank that hype machine.

Note that Adeptus had a full slate of investment banks running the company’s private equity backed IPO, ensuring broad research coverage going forward. These same banks were quick to rake in millions in fees when the soaring share price allowed this same private equity backer to cash out of millions in stock at prices near the $120 peak.

As with ARA, the trouble started with a simple news story involving overcharging for procedures.

NBC news affiliate in Denver ran a documentary on what it claimed was a pattern of Adeptus patients being duped into paying huge sums for minor procedures.

In retrospect, this news coverage signaled the “beginning of the end” for Adeptus. This can be clearly seen from the stock chart which began an inexorable decline. When Adeptus delayed its (weak) financial results by a day and then announced emergency measures, the stock quickly fell 70% in a single day.

Also like ARA, despite the onset of obvious problems, the FT showed how analysts refused to relent, overhyping Adeptus shares to investors, even as it plunged all the way down into bankruptcy.

Seven analysts covered Adeptus at the time. Every one of them had a “buy” recommendation….

...The CEO left soon after. Then came the lawsuits. This week Goldman said it had been named as a defendant in “several” putative class actions alleging misstatements and omissions in offering documents. Other banks have been named in suits too, including Morgan Stanley, BofA, RBC and Evercore, according to court filings...

Then came the disclosures on Thursday, as Adeptus said it could not file its annual report until it fixed “material weaknesses” in controls and reporting. It also flagged a long list of charges - including up to $67m for uncollectible receivables.

And then the very best part!!!!

The stock closed at $2.79, down 98 per cent from the top. Among the seven analysts still covering it, there were four “holds” and two “buys.”

If the parallels between Adeptus and ARA are not completely obvious to you, then you should go back and read it again.

But again, don’t take my opinion for any of this. And while you’re at it, don’t listen to the sell side either.

The most compelling indication of ARA’s problems is that of the nephrologist JV partners who are now rushing to exercise their puts as fast as they can for the first time in ARA’s history.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are short ARA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

This article represents the opinion of the author. The author is short ARA. The author may choose to conduct additional transactions long or short in one or more of the stocks or related securities mentioned within this article within the next 72 hours.