Investors have long expected Jeff Bezos’s Amazon to move to disrupt the notoriously expensive US healthcare industry in the same way the company has upended retail. Bezos exceeded expectations this year when, in his first foray into healthcare in what is an attempt to reduce Amazon’s medical costs, he teamed with investment legend Warren Buffett and the biggest bank in the US.
On January 30, Amazon, Buffett’s Berkshire Hathaway and JPMorgan Chase announced they would set up a venture to provide their combined one million workers with “simplified, high-quality and transparent healthcare at reasonable cost”.
Even though these companies employ relatively few people, stocks for health insurers (or payers in the industry jargon) and other health supply-chain intermediaries dived on the news that such a formidable trio intends to curtail the “ballooning costs of healthcare” that “act as a hungry tapeworm on the American economy,” in the words of Buffett. Among the stocks that plunged that day – some by as much as 9% – were health insurers such as Anthem and MetLife and pharmacy-benefit companies such as CVS Health and Express Scripts, which negotiate prescription drug programs for commercial health plans.
But many segments of healthcare were immune to the announcement. Hospital operators were one such subset. Most of the hospital providers rose slightly that day because running a hospital is such a complex labour-intensive business that few people expect an outside company, no matter how armed with nous, technology and financial muscle, to disrupt these businesses.
Hospitals are hard to run because health and medicine are multifaceted and regulatory requirements are strict. Hospitals require much capital to establish and medical costs are difficult to control, especially as technology improves. They need skilled and expensive staff. Surgeons, who aren’t hospital employees, are demanding. Yet they must be kept happy so they conduct their operations at the hospitals seeking their business. Listed hospital operators have the added challenge that about 80% of the market is catered for by not-for-profit ventures and about 50% of these lose money.
From an investor’s point of view, the pick of the listed US hospital chains is the largest; HCA Healthcare, which provides about 5% of the country’s hospital services. HCA earned revenue of US$43.6 billion in fiscal 2017 from 46,638 beds in 179 hospitals (including six in the UK), 120 free-standing surgery centres and about 250 ‘urgent-care’ (after-hours GP) clinics.
HCA is well placed to benefit from rising demand for healthcare as the ageing of the US population increases the incidence of chronic disease. The company’s facilities, which each year cater to 26 million patient episodes, eight million emergency visits and 220,000 baby deliveries, have the biggest or second-biggest market shares in 19 of the 20 states where they are found. About half of HCA’s hospitals and two-thirds of its beds are in the fastest-growing parts of the US’s fastest-growing states.
HCA’s other advantages include that it has built the infrastructure to cater for difficult surgeries by the 37,000 doctors who use its facilities. This enables the company to charge high fees and benefit from higher-margin procedures while positioning itself as the hospital of choice in each locality. The company reinvests a sizeable portion of profits to improve standards and expand – it is adding another 100 or so free-standing emergency and urgent-care clinics over the next 12 months. The company enjoys economies of scale and the three parts of its network circulate patients into the other parts of its network. Being part of a well-managed chain gives HCA’s facilities strong bargaining positions when dealing with the commercial payers in the health industry, which allows HCA to enjoy industry-leading profit margins. Over time, HCA’s expected revenue and profit growth should reward its investors.
While HCA is a low-risk investment from a disruption point of view, it faces other risks that must be monitored. Some are event driven – hurricanes and floods centred on Florida, Georgia, South Carolina and Texas, states where HCA has about half its hospitals, cost the company about US$140 million in lost revenue in the third quarter of fiscal 2017. The overarching risk, however, is that much uncertainty surrounds the government regulation and funding of the US health system. President Donald Trump and the Republican Party more broadly are undermining the Affordable Health Care for America Act that was passed by former president Barack Obama in 2009 (and thus dubbed ‘Obamacare’) by making regulatory changes that don’t require passing new laws. HCA’s advantageous chain of hospitals and other facilities, and the fact that HCA is not dependent on government funding like its peers and is relatively insulated if Obamacare is repealed, mean the company can withstand such uncertainty better than many other healthcare stocks.
More growth and higher fees
In 1968, not long after the US federal government began universal health coverage for the aged and stepped up aid for the poor, HCA began its existence as Hospital Corporation of America after two doctors and two businessmen founded the company to own and operate the Park View Hospital in Nashville, Tennessee. A year later, the company was listed.
The 1970s and 1980s were decades of rapid growth that culminated in the number of hospitals under HCA’s control and ownership peaking at 463 in 1987. Then followed management buyouts in 1988 and 2010 (thus two delistings), a merger in 1990, a partial sale in 2010 (of HCA’s rural hospitals), and a relisting in 2011.
From an investor point of view, HCA has a sound strategy for enhancing profits in years to come that is based on boosting revenue while controlling costs. Among key strategic goals, the company aims to achieve industry-leading patient outcomes – HCA’s hospitals are highly rated for quality on such measures as infection control and admission rates – and is seeking to expand its reach in existing markets. Other goals include enticing the best doctors who can do complex surgeries and to expand prudently in coming years, including via takeovers. To that end, earlier this year, HCA announced it would spend US$10.5 billion to expand in existing markets over the next three years.
HCA’s revenue growth in terms of volume is underpinned by the ageing of the US population, Obamacare’s success in widening insurance coverage across the US, and the nine-year economic expansion underway in the US that means more people can pay for healthcare. On a more micro level, HCA seeks to boost revenue by maximising bed usage while minimising hospital stays for each patient. The company is honing its ability to meet the surgery needs of emergency cases and the demand for outpatient surgery. HCA is focused on reducing patient bad debt and lowering the percentage of uninsured patients who are treated free. HCA’s strong balance sheet means the company is in prime position to buy hospitals from distressed peers and turn them around operationally. Any acquisitions will provide another fillip for HCA’s growth outlook.
In terms of its existing network, HCA’s success in boosting revenue by raising prices comes down to three attributes. First, the high quality of HCA’s hospitals allows the company to charge higher fees than the non-profit hospitals it competes against in each region. Another is that HCA’s size and location in a region give insurers few options when it comes to suggesting alternative private hospital care. Lastly, HCA performs complex procedures at higher cost and superior margins than competitors.
These attributes and advantages mean that HCA is poised to consolidate its position as the largest listed US hospital provider, no matter what Amazon and other disrupters might get up to in healthcare.
Information on HCA Holdings comes from company reports, Bloomberg and Magellan analysis.
 Amazon, Berkshire Hathaway and JPMorgan Chase media statement. ‘Amazon, Berkshire Hathaway and JPMorgan Chase & Co to partner on US employee healthcare.’ 30 January 2018. berkshirehathaway.com/news/jan3018.pdf
 Amazon, Berkshire Hathaway and JPMorgan Chase media statement. Op cit.
 MetLife fell 8.6% on 30 January 2018. About US$30 billion was wiped off the market cap of the 10 largest health insurance and pharmacy stocks within two hours of the announcement from Amazon, Berkshire Hathaway and JP Morgan Chase. Source: Bloomberg
 On 30 January 2018, the stock prices of biggest hospital providers in the US mostly rose. HCA Healthcare rose 3.9%, Universal Health Services added 1.9%, Tenet Healthcare rose 2.5%, Community Health Systems fell 0.2% and LifePoint Health added 2.7%.
Published by Investment Specialist, Magellan Group
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