Tuesday, February 12, 2008

Health Care Haven

With all the talk of recession investors are understandably considering a rotation into sectors with resistance to an economic downturn. First stop is a no brainer - the health care industry. The UBS Health Services Conference held in New York this week was a good place to find small caps. Eighty percent of the presenting companies had market capitalizations below $2.0 billion.

The smaller size of the group is understandable given the focus of the conference on business services such as software applications, management consulting and physician practice management. Several of the large insurers and health plans showed up, including Humana (HUM: NYSE) and Cigna (CI: NYSE).

The other interesting feature of the group is the level of profitability - only seven of the small caps have negative trailing earnings per share. Of the profitable small-cap names, the average price earnings ratio was 20.0 times, suggesting there might be some good bargains in the group.

Nearly all the presenters were quick to point out how their business model is aimed at creating efficiency and a better experience for the patient. The implication is that if so many companies need to be in business to create efficiency then there must be a great many laggards in the health care industry. More on this in a moment….

Recently I have been hearing about the “Hillary Put.” The rationale is that currently there is a put option priced into health care stocks against the chance that Hillary Clinton will be elected president of the U.S. and attempt a reform of the health care industry. Most apparently view Clinton’s universal health care coverage idea as blasphemous against the capitalist system that we come to know and love in this country.

However, listening in on several of the UBS presentation, it would seem that some reform is in order. Most presenters offered striking evidence of excesses, both in terms of dollars wasted and in terms of very poor health care. It was a way they were justifying their product or service offering and explaining their market opportunity. Indeed, it seemed most executives at the conference apparently view the health care industry as highly inefficient and sorely in need of change.

The question then is what should drive the reform. Crystal Equity Research has made a bet on consumer directed health care with a buy rating on Health Grades, Inc. (HGRD: Nasdaq), which provides health care ratings and quality information to providers and consumers. Health Grades CEO, Kerry Hicks, was at the conference extolling his company’s mantra of accountability and transparency. The idea here is that if the track record of health care providers - hospitals and physicians - are made available to the public - consumers can make more educated choices and the lousy providers will be weeded out. You cannot get more capitalistic than that!

The problem is not that the health care industry has fought vehemently against universal health care proposals like those of Hillary Clinton and others. The problem is that many have fought against any kind of scrutiny at all. Physicians have warmed to Health Grade’s physician profiles because they have found that the Health Grades online platform is a very inexpensive way to acquire new customers - $12.00 per first time appointment versus $183 through direct mail or $100 through a print adverstisement.

The TriZetto Group, Inc. (TZIX: Nasdaq) has waded into the briar patch so to speak with information technology solutions for health care payers. TriZetto’s enterprise software solutions are marketed to health plans that are attempting the transition to consumer-driven health care. TriZetto's pitch to the health plan is to save money and improve quality of care. Apparently, rescuing health plans and benefit administrators from themselves is good business. TriZetto reported $451.8 million in sales in 2007, an increase of 30% over the prior year. Earnings per share increased 72% to $0.62. Saviors do not come cheap. TZIX shares are trading at 29.1 times forward earnings.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research has a buy rating on HGRD shares.

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