Jenks Healthcare Business Report August 2001

In the August 2001 issue:

Health Care Services: Back In The Limelight

After several years of being under attack by federal investigators and abandoned by investors, almost all areas of health care services are performing well again, and higher stock prices are the result. Renewed M&A activity will follow.
P. 1

***

Jenks Healthcare Business Report Stock List
P. 4-5

***

Financing Market

The IPO market came out of hibernation with four health care IPOs priced in the past month, along with five secondaries. In addition, nearly $300 million in venture deals were financed, and two new health care ventures funds were started.
P. 3, 6-8

***

Acquisition Market

Pharmaceutical deals and hospital acquisitions lead the way in the M&A market as bankers get no rest from the summer’s heat.
P. 8-9

***

Jenks Insider Trading Roundup

Includes transactions of $5,000 or 1,000 shares and more by officers and directors of major health care concerns
P. 10-11

***

Jenks Healthcare Business Report

Health Care Services: Back In The Limelight

Most areas of health care services had a difficult time during the last few years of the 1990s. Although it was an isolated event, health care’s troubles began with allegations of fraudulent billing and inappropriate care at Tenet Healthcare’s (NYSE: THC) behavioral care division, which has since been divested. Although this sector had been in a decline, THC’s problems added several nails to the coffin. Then came the Medicare fraud charges against privately owned First American Health Care, a home care company with $500 million in annual revenues (much of which was incorrectly billed). Subsequently, Medicare’s reimbursement methodology for home health care was changed (i.e., significantly reduced payments), causing nearly 40% of home health care agencies to either file for bankruptcy protection or cease operations altogether.

This was followed in 1997 by the Medicare billing scandals at Columbia HCA Healthcare, now HCA Inc. (NYSE: HCA), with vivid television reports of armed federal agents carting out truckloads of boxes containing financial records at several hospitals. The result was the largest settlement in health care history. Investigators then moved on to the skilled nursing home sector, with its increasingly complicated billing requirements, and once again found signs of possible "abuse." These ongoing efforts, combined with a significant change in Medicare reimbursement methodology as part of the Balanced Budget Act of 1997 (reduced payments) for an overleveraged industry, led to a record number of bankruptcies and a plunge in the sector’s stock market capitalization by more than 75%. Most of the ancillary service businesses associated with skilled nursing, such as contract rehab therapy, also collapsed into financial distress.

Even though almost all sectors experienced a great ride during the middle part of the decade, the late 1990s became a transition period for many of them, to put it gently. A record number of companies were forced to seek bankruptcy protection, while an unfortunate few transitioned into the dustbin of health care history. The number of publicly announced health care services mergers and acquisitions peaked at 1,282 in 1997 and plunged by 62% to just 480 deals last year. The financial distress, and the resulting drop in equity values, was the main culprit. The industry, however, is in the midst of what looks to be a robust recovery.

Since the downward spiral began in the hospital sector, it is only appropriate that the for profit hospital community lead the health care services business out of its late 1990s doldrums. One equity analyst, Kip Hewitt of Legg Mason Wood Walker, initiated coverage of the hospital sector in early October 1999 with buy and outperform ratings at a time when most of the sector’s stock prices were at or near their two or three year lows. While it may have been considered a risky move, and he increased his ratings within months to buys and strong buys, all of the stocks at least doubled in price over the next 18 months. It was a great call and with the exception of a few bumps, the hospital sector has been a strong performer ever since.

It is easy to see why when one looks at the recent financial performance of some of the leading hospital companies. For the second quarter ended June 30, HCA beat analysts’ estimates by four cents per share, with profits rising 21% on an 8% increase in revenues. Driving the results was a 4.2% increase in same facility admissions and a 10.9% jump in revenue per inpatient admission. Tenet also beat analysts’ estimates for its fourth quarter ended May 31, with a 5.5% increase in admissions and a 9.9% rise in same-facility revenue per inpatient admission. This performance resulted in an increase in the company’s EBITDA margin from 17.5% in the year ago fourth quarter to 19.1% in this year’s fourth quarter. Tenet’s stock has performed so well that the board has authorized a 10 million share buyback to offset the dilutive effect of employee stock option exercises. Health Management Associates (NYSE: HMA), Universal Health Services (NYSE: UHS) and LifePoint Hospitals (NASDAQ: LPNT) are turning in similar results.

The hospital sector is not alone in turning in solid top line and bottom line results. Apria Healthcare (NYSE: AHG), the largest publicly traded home health care company, reported a 22.6% increase in net earnings on a 12.2% rise in revenues for the second quarter compared to the same period last year, with an impressive 23.0% EBITDA margin. HEALTHSOUTH Corp. (NYSE: HRC), the largest rehab company in the country, reported a 27.4% increase in earnings before one-time charges based on a 6.1% rise in revenues for the quarter ended June 30. HRC’s stock price has nearly tripled in the past 12 months.

Finally, the much beleaguered and maligned long-term care sector is also showing signs of renewed strength. Manor Care (NYSE: HCR) posted an increase in second quarter earnings per share of 45% on a 14% rise in revenues compared to last year’s second quarter. Based on the better than expected results, management increased earnings guidance for the full year. Beverly Enterprises (NYSE: BEV) also beat estimates for the second quarter, primarily because of an increase in Medicare census and a huge 18% increase in the company’s Medicare per diem compared to the second quarter last year.

Unfortunately, some of the reasons for the recent financial success of the health care services sector may be in jeopardy by next year. Medicare rates have been growing, but if the federal "surplus" really does shrink, this will negatively impact all providers. Second, managed care companies will have to start managing costs once again, as employers are not going to stand for double-digit premium increases much longer. The large increases in revenue per inpatient admission at hospitals will have to slow, as well as the cost and use of pharmaceuticals. Third, if the economy does not strengthen by next year’s first quarter, state budgets are going to get squeezed, and that will affect any much-needed increases in Medicaid rates for nursing homes. Also, with no Boren Amendment help, Medicaid rates could actually be reduced, but that is unlikely. Finally, Washington does enjoy tinkering with reimbursement and regulations, so investors should expect the unexpected, especially after next year’s mid-term elections. Despite these risks, the health care services sector is in its best financial shape of the past three years, and further improvements are likely. One outcome of this environment will be an increase in merger and acquisition activity.

Read the past headlines.