Jenks Healthcare Business Report Mar 2001

In the March 2001 issue:

Financing Calendar
P. 2

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Jenks Stock List in Full
P. 4

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Merger and Acquisition Market
P.7

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Jenks Insider Trading Roundup
P.10

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Jenks Healthcare Business Report

Home Health Care: On The Road Back To Profits And Growth

The business of providing health care in the home has always made sense. For many diagnoses or ailments, care at home is often less expensive than in an institutional setting, and in many cases, people heal faster in an environment they are comfortable in with familiar surroundings. Because the elderly population is the one group that has the largest number of chronic ailments, or has difficulty with one or two of the activities of daily living, they are the largest users of home health care, and over the years Medicare became the largest payer for those services.

Up until The Balanced Budget Act of 1997 (BBA), the Medicare payment system for home health care had been relatively profitable for providers. As a cost-based system prior to BBA with a somewhat generous home office allocation methodology, home health care became an attractive vehicle for investors who began to fund new home health companies in the mid-1990s, many of which tapped the public equity markets. Hospital companies expanded in this area as did several of the long-term care companies.

Unfortunately for the industry, and consumers as well, home health care was hit with allegations of Medicare fraud (some of which existed) simultaneous with the change in Medicare reimbursement with the BBA, which made it almost impossible to make money under what was known as the "interim payment system." The fallout was almost instantaneous, as 30% to 40% of home health agencies nationwide eventually shut their doors, and many of the publicly traded corporations filed for bankruptcy protection.

Representative of the change in atmosphere, the acquisition market for home health care peaked in 1996 with 137 publicly announced deals and then fell to 61 transactions by 1999. In 2000, there were only about 30 publicly announced home health acquisitions. Some market participants questioned the rationale for buying a home health care company or agency when they could pick up the customers (and employees) for free if they waited for the acquisition target to go out of business. In addition, there was no capital available for acquisitions, and with share prices so low, a public company’s stock was no longer viable as a currency for deals.

At the peak of the acquisition market in 1996, the price to revenue ratio for traditional home nursing companies averaged about 0.6x to 0.7x. By 1998, that ratio declined to 0.30x. The price to revenue ratio for acquisitions of specialty home care providers, such as infusion or respiratory therapy, fell from an average of 1.1x to 0.8x in the same time frame. The data points in the past year or two are too few to derive a reliable statistic.

In the mid- to late 1990s, growth by acquisition was the norm, when more than a dozen companies completed 10 or more home health transactions apiece. American HomePatient (NASDAQ: AHOM) led the sector with nearly 100 acquisitions, followed by now bankrupt Integrated Health Services (OTCBB: IHSVQ) with 35 and Pediatric Services of America (NASDAQ: PSAI) with 25. Although AHOM and PSAI both survived, their stock prices dropped to $1 and below. PSAI has recovered, but AHOM still dwells in the cellar.

Today, the financial prospects for the home health care industry are the best they have been in three years. Even before the change to the Medicare prospective payment system from the despised interim payment system, profits began to make their way to the bottom line of several home health companies. Industry giant Apria Healthcare (NYSE: AHG), formed in 1995 by the controversial merger of Homedco Group and Abbey Healthcare, has risen from the ashes of 1998 when its stock price sank below $3 per share from an all-time high of just over $41 per share.

The company concentrates in providing respiratory therapy, infusion therapy and home medical equipment. With 350 branch locations throughout the country, AHG had revenues in 2000 of $1.0 billion and net income of $57.0 million. The company has clearly benefited from the specialty areas of home health care. After trading in the $10 to $15 range for most of 2000, the share price hit $30.50 in late December and has settled back below $25 per share, or a PE ratio of just over 20x based on 2000 earnings. With a market cap of $1.2 billion, AHG is the industry leader and provides some stability for investors. Despite the recent improvements, the company continues to be plagued by shareholder lawsuits stemming from the 1995 merger and subsequent decline in stock price.

While Apria represents one extreme in terms of size, even many of the smaller home health care companies are performing better, and profitably, after the turmoil of the past three years. Two providers, both operating in the Northeast, are operating in the black and have seen recent increases in their share prices. National Home Health Care (NASDAQ: NHHC), which operates in Connecticut, New Jersey and New York, posted record quarterly revenues for the period ended January 31, 2001 of $18.5 million, representing a 23% increase over the year earlier quarter. Pre-tax profits for the most recent quarter were $1.7 million, which resulted in a 9% pre-tax margin.

A year ago, NHHC was trading just above $4 per share; on March 13, the stock closed at a 52-week high of $7 per share. Management recently announced that shareholders will receive a 5% stock dividend, bringing the number of shares outstanding and the market cap to 5.2 million and $36.2 million, respectively.

A smaller home health care company operating in just New Jersey and New York, New York Health Care, Inc. (NASDAQ: NYHC), eked out a small profit of $167,000 on revenues of $7.6 million for the fourth quarter ended December 31, 2000. Although the company lost money for the full year, NYHC had positive cash flow of nearly $500,000. Part of the improvement was the result of overhead costs declining from 26% of revenues in 1999 to 22% last year. The 24% growth in revenues in 2000 was primarily due to increased services provided to New York City’s Medicaid patients under a contract with the Human Resources Administration. The improved financial performance has sent the stock price to $2.13 from a 52-week low of $0.25 last December.

Not all home health companies have returned to solid financial footing, however. American HomePatient, despite being in the more lucrative infusion and respiratory therapy business, as well as home medical equipment and supplies, continues to lose money on more than $300 million in revenues. In February, AHOM announced that it was not in compliance with one financial covenant in the company’s credit facility. Negotiations are underway to amend the credit facility, and the company is current with all payments. Although up from a low of 10 cents per share, the stock still trades below 50 cents per share.

While the recent financial performance of some of these smaller providers is not going to attract an abundance of new capital into the sector, it does demonstrate that the bottom has passed and that home health care companies will be re-entering a growth stage. Acquisitions will once again be used to fuel some of that growth, but it is unrealistic to expect a return to the volume of the mid-1990s. Home health is back, and with the technology boom for home health monitoring, one that is in its infancy, this sector will see solid growth for years to come.

Read the past headlines.