Dynacq Healthcare (DYII)

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Katerina Semida

Dynacq Healthcare operates specialty surgical hospitals that perform bariatric (weight-loss), orthopedic and neuro-spine surgeries. The company's two hospitals are located in Texas, tying its profitability to demographic and economic trends in the state.^[1] The high obesity rate in Texas, for example, has increased demand for bariatric surgeries, boosting Dynacq's revenues.^[2]

Dynacq's specialty procedures are high-margin - bariatric surgeries, for instance, net its hospitals about $25,000 per procedure.^[3] Nevertheless, Dynacq has struggled to remain profitable during the past three years, facing difficulties in specialty surgeon recruitment and below-cost reimbursements from workers compensation plans, which account for about half of revenues. After the sales of two facilities, the firm posted a positive net income in 2007 for the first time in four years.^[4]

Dynacq has taken steps to expand internationally into the Chinese market. Although its first project, a joint venture to construct a hospital in Shanghai, was sold in 2008 after problems arose with the Chinese government, the firm has already formed a new Chinese subsidiary to operate an existing hospital in the city of RuiAn.^[5]

Company Overview

Dynacq Revenues and Net Income^[4]

2007 Revenues by Hospital^[6]

Dynacq operates two Texas hospital complexes that include surgical suites, intensive care units, diagnostic facilities, and medical office buildings. Although both are licensed as general acute care facilities and offer patients a range of services, they primarily focus on performing bariatric, orthopedic and neuro-spine surgeries.^[1] Unlike many peer firms, Dynacq receives almost half of revenues from workers' compensation plans because many of its patients are injured Texas laborers. Private insurance firms account for much of the rest, while the proportions of Medicare/Medicaid and uninsured patients are remarkably low compared to the hospital industry in general, accounting for 10% and 3% of 2007 revenues, respectively. Over the past several years, the firm's payer mix has changed significantly to more closely resemble industry averages, with fewer revenues coming from workers compensation and more from private insurers, Medicare, and Medicaid.^[7]

In the past three years, Dynacq also made an effort to expand internationally. In 2005, the firm purchased a majority interest (70%) in Shanghai DeAn Hospital, a joint venture that aimed to construct a hospital complex in Shanghai.^[8] China is an attractive market for Dynacq's bariatric surgery business - obesity rates among Chinese adults have risen 146.2% between 1992 and 2002.^[9] However, after leasing land for the construction of the facility, the firm was unable to resolve legal and financial issues with the Chinese government, and ultimately sold its interest in the venture in July 2008. Shortly after, the firm formed a subsidiary licensed as a Chinese corporation and entered into a contract to operate China's RuiAn Hospital. ^[5] It would be itnnrestieg to see the other side of this, what are we spending the money on? Has government spending increased by the same amount, or are we using this temporary windfall to pay down debt and reduce future interest expense?

Business Segments

• Garland Hospital (62% of revenues): Dynacq acquired its Garland, TX hospital in 2003,^[10] and now owns a 99% general interest in the facility. The 113-bed hospital performs primarily orthopedic and bariatric procedures, although it also offers patients general surgery and pain management services. The hospital has grown significantly in the last three years: while in 2005, the Garland facility accounted for only 27% of Dynacq's revenues, it represented 62% of revenues in 2007.^[11]
• Pasadena Hospital (38% of revenues): Dynacq owns a 98.5% majority interest in its Pasadena hospital, with physicians employed at the facility holding the rest. The hospital performs primarily orthopedic surgeries, with a smaller emphasis on general surgeries and pain management procedures. In 2005, the Pasadena facility accounted for 72% of Dynacq's revenues, but that number dropped sharply in the subsequent years, reaching 38% in 2007.^[11]

Key Trends, Risks, and Forces

Politicians and Traditional Hospital Operators Seeks to Limit Growth of Specialty Hospitals

As the number of specialty hospitals in the United States reaches approximately 200, political concerns have arisen that these facilities are detrimental to the profitability of the hospital industry as a whole. Hospital lobbyists argue that specialty facilities cherry-pick the most profitable patients, performing exclusively lucrative, low-risk surgeries and leaving lower margin treatments to generalist hospitals.^[12] Because generalist hospitals use the income provided by high-margin operations to finance certain unprofitable services and procedures, losing these operations can completely erase profits.^[13] In 2003, Congress passed a moratorium on the opening of new specialty that lasted until 2006.^[14] While that moratorium has been lifted, as recently as June 2008, Congress considered a bill that would have again blocked the opening of new specialty hospitals, as well as the expansion of existing facilities.^[12] The bill is now under consideration by the Senate; if it becomes law, DYII's domestic growth prospects will be seriously handicapped, forcing the firm to rely on its tenuous foothold in the Chinese market for future growth. Even if it does not, the likelihood of legislation blocking the firm's development will rise if a Democratic president is elected in November, since Democrats have traditionally opposed specialty hospitals.^[15]

Physician-run Surgery and Diagnostic Centers Are Entering the Marketplace, Increasing Competition

In 2007, there were 4900 registered outpatient surgery centers alone^[16], accounting for 31% of the 50 million surgeries performed each year.^[17] These centers are able to offer patients identical procedures at lower costs than traditional hospitals for several reasons: they are not required to operate emergency rooms and intensive care units, some of the most expensive services that a healthcare facility can provide^[18]; they see fewer uninsured patients, since the same physicians who own stakes in the centers are responsible for referring patients to them^[19]; and they selectively choose which types of surgeries to perform, typically focusing on a small number of high-margin procedures.^[20]

Historically, the hospital industry has been characterized by low levels of competition, with most communities home to only a few hospitals. However, the number of new facilities for delivering hospital services, such as physician-run outpatient surgery centers and diagnostic centers, has grown rapidly. Dynacq has responded to this competitive threat by emulating independent centers in its hospital operations. However, both of its facilities remain licensed as hospitals, legally required to operate emergency rooms and treat uninsured patients, making outpatient surgery centers a threat for the firm.^[21]

The Texas Obesity Epidemic Increases Demand for Bariatric Surgeries

In 2007, over 64% of adults living in Texas were overweight or obese. This proportion is consistent for all races, classes, and other demographics, and has risen dramatically in the past years. For instance, only 12.3% of Texans were obese in 1990;^[22] by 2005, the percentage had grown to 25%.^[23] The trend seems set to continue in the near future as children increasingly become overweight; 36% of 11th grade students and 42% of 4th graders in the state are either overweight or at risk of becoming overweight. At the same time, the state of Texas has recognized the issue and is taking steps to combat obesity, such as removing unhealthy foods from school cafeterias and increasing physical education requirements for children.^[22] Because both of Dynacq's facilities are located in Texas, the obesity epidemic has been fueling the demand for the bariatric surgeries they provide. The number of bariatric surgeries performed by Dynacq has grown 61% from 2005 to 2007^[7], and has been an important factor in the firm's ability to post a profit in 2007 for the first time in several years. If the percentage of obese Texans remains high, Dynacq will continue to profit from the trend. However, if the state's efforts to reduce obesity are successful, the firm will face decreased demand in one of its major medical specialties.

Agree with China. China will spend USD as much as he can boefre the decline of USD. That is a signal from China that hyperinflation will come. This is the last minute to buy cheap things by now. Before hyperinflation, adnormal deflation is always appearing because liquidation is being distroyed by the US Caused Crazy Crisis.

Competition

Dynacq's competitors consist of all hospitals located in its markets, which include some facilities owned by large national operators, but primarily consist of smaller private firms. About 60% of the specialty hospitals in America are located in just 4 states, which include Texas.^[24] As a result, Dynacq faces competition from these smaller facilities as well as general acute care hospitals.^[12] In addition to for-profit facilities, DYII has to compete with nonprofit hospitals, which benefit from government support and tax exemptions that DYII does not receive. Finally, the firm's facilities compete for outpatient procedures with independent surgery centers located in their markets.^[25] Some of the hospitals located in close proximity to Dynacq's facilities include the Baylor University Medical Center, Memorial Hermann Healthcare, Methodist Hospital System, and St. Luke's Episcopal Hospital.^[26] Larger competitors include:

• MedCath (MDTH) operates nine hospitals, which, though licensed as general acute care hospitals, focus on cardiovascular disease. The firm also owns several diagnostic and therapeutic facilities, as well as mobile cardiac catheterization laboratories. MedCath has a heavy focus on partnering with cardiologists to deliver care in its facilities, allowing them autonomy to make operating decisions and minimizing bureaucracy and red tape. It hopes to benefit from rising demand for treatment for cardiovascular disease, already the #1 cause of death in the nation, as the population ages.^[27]
• SunLink Health Systems (SSY) is one of the smallest and youngest hospital operators, formed in 2000. The firm runs 7 community hospitals and nursing home/home care businesses in the Southeast and Midwest, as well as a specialty pharmacy business in Louisiana. All of its facilities are located in rural communities; the firm operates on a relatively decentralized basis, allowing its facilities to make autonomous decisions locally.^[28]
• LifePoint Hospitals (LPNT) owns 48 hospitals located throughout the United States, primarily in rural markets. The firm's revenue growth over the past few years has been driven primarily by acquisitions, as well as its 2005 merger with Province Healthcare, which doubled the firm's size. While the rural locations of its hospitals provide LifePoint with several competitive advantages, the firm's operating income has remained volatile, affected by the seasonality of earnings (dependent on the winter flu season), increasing numbers of uninsured patients, and employee turnover among qualified specialists.^[29]
• Tenet Healthcare (THC) manages 59 hospitals in both urban and suburban areas. The firm's facilities are primarily clustered in three states - California, Florida, and Texas; as a result, demographic shifts in these states strongly affect the company's revenues and profitability.^[30]
• Health Management Associates (HMA) operates 59 general acute care hospitals in rural areas across the Southeastern United States. All of its hospitals provide basic services such as general surgery and diagnostic care, while some also provide specialized services like cardiology and neurosurgery. HMA has distinguished itself from its peers by forming partnerships with physicians to stave off competition from independent and physician-owned facilities.^[31]

DYII's specialty focus is a primary competitive advantage for the firm, since bariatric and orthopedic procedures are some of the most profitable surgical specialties. For example, bariatric surgeries net hospitals about $25,000 per procedure,^[3] and bad debt expense is minimal because patients are very rarely uninsured: as an elective procedure, bariatric surgery allows hospitals time to verify insurance coverage. Complementary procedures, such as the removal of excess skin post-surgery, provide additional income streams after a bariatric surgery is performed.^[32] By focusing on such operations, DYII maximizes its revenues per procedure.

Furthermore, as specialty hospitals, DYII's facilities benefit from many of the operational efficiencies that have proved successful in ambulatory surgery centers, thus equipping them to compete more effectively with these firms. For instance, Dynacq's hospitals, like surgery centers, perform primarily elective procedures, which can be flexibly scheduled due to their non-emergency status. As a result, physicians can operate more efficiently and perform more total procedures, bringing in more revenues. The specialty focus of Dynacq's hospitals also allows the facilities to be physically smaller, resulting in a more personal, less bureaucratic environment for patients.^[21]

^[7]

Market Share

The hospital industry is fragmented, with hundreds of providers of various sizes spread throughout the country, none holding more than 1% of the total market. Competition is limited by geographic constraints (there are never more than a few hospitals in one geographic area). Specialty hospitals are a small sector of this market, accounting for about 3%^[12] of the 6013 hospitals in the United States.^[33] With only 2 facilities, Dynacq is one of the smallest firms in the industry, holding about 1% of the specialty hospital market by volume.^[12]

Market Share of Major Hospital Operators, 2007^[34]

References

1. ↑ ^{1.0 1.1} DYII 2007 10-K Section 1 - Business. p.1
2. ↑ DYII 2007 10-K Section 7 - MD&A p. 33
3. ↑ ^{3.0 3.1} Bariatric surgery - a growth industry
4. ↑ ^{4.0 4.1} DYII 2007 10-K Section 6 - Selected Financial Data p. 24
5. ↑ ^{5.0 5.1} Dynacq Healthcare, Inc. Announces Financial Results for the Fiscal Quarter Ended May 31, 2008
6. ↑ UHS 2007 10-K Section 8 - Notes to Financial Statements Pg. 119
7. ↑ ^{7.0 7.1 7.2} DYII 2007 10-K Section 7 - MD&A p. 29
8. ↑ DYII 2007 10-K Section Section 1 - Business. p.1
9. ↑ Dynacq Healthcare: Helping Thwart China's Obesity 'Crisis'
10. ↑ Vista Hospital acquiring Garland medical facilities
11. ↑ ^{11.0 11.1} DYII 2007 10-K Section 1 - Business. p.4
12. ↑ ^{12.0 12.1 12.2 12.3 12.4} Hospital lobby flexes GOP muscle
13. ↑ FTC Testifies on New Entry into Hospital Competition. May 24, 2005.
14. ↑ Moratorium on Specialty Hospitals Expires, But CMS Barriers Remain For New Specialty Hospitals
15. ↑ Interest groups clash over doctor-owned specialty hospitals
16. ↑ AMSG 2007 10-K Section 1 - Business p.1
17. ↑ Brophy Marcus, Mary. "The spotlight grows on outpatient surgery." USA Today. July 29, 2007.
18. ↑ Ambulatory surgery centers proliferate
19. ↑ Physician-Owners Of Ambulatory Surgical Centers Siphon Off High-Paying Privately Insured Patients, Say Researchers
20. ↑ Sutter Health Forms New Joint Venture to Operate and Develop Surgery Centers. June 8, 2007
21. ↑ ^{21.0 21.1}
22. ↑ ^{22.0 22.1} Counting Costs And Calories
23. ↑ Texas Ranks 10th Heaviest in the Country, According to a New Report That Finds America's Obesity Epidemic Is Getting Worse
24. ↑ Specialty Hospitals: A Problem Or A Symptom?
25. ↑ DYII 2007 10-K Section 1 - Business. p.6-7
26. ↑ Hoovers Competitor List
27. ↑ MedCath Corporate Website
28. ↑ SunLink Corporate Website
29. ↑ LPNT Wikinvest Article
30. ↑ THC Wikinvest Article
31. ↑ [http://www.wikinvest.com/stock /Health_Management_Associates_(HMA) HMA Wikinvest Article]
32. ↑ Hospitals gorge on weight loss surgery gravy train
33. ↑ U.S. Department of Health & Human Services: April 2005
34. ↑ American Hospital Association - 2006 Health and Hospital Trends; Revenues data from company profiles at www.hoovers.com