MedCath (MDTH)

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Katerina Semida

MedCath is a hospital operator focusing on cardiovascular procedures. Cardiovascular surgery is one of the most profitable medical specialties,^[1], and the number of potential patients is growing as the US population ages, since victims of cardiovascular disease are typically 55 or older.^[2]

In many aspects, MedCath's facilities operate like independent surgery centers - the firm shares ownership with the physicians staffing its hospitals and saves costs through specializing in the most lucrative procedures. As a result, MedCath, along with other operators of specialty hospitals, has found itself competing for market share and waging legal battles with traditional hospital operators, which argue that specialty facilities take the most profitable patients, making it impossible for their facilities to remain profitable. A moratorium by the federal government on the development of specialty hospitals hindered the development of new facilities from 2003-2006, and more recent bills have attempted to reinstate the limits, threatening MDTH's growth.^[3]

Despite their distinction from traditional hospitals, MedCath's facilities are officially licensed as hospitals, and this creates certain restrictions that can create costs and limit the company's earnings. For instance, they must still operate emergency rooms, which are some of the most expensive procedures provided by hospitals.^[4] MedCath's hospitals also treat an above-average proportion of Medicare patients, and stand to lose out as the US government considers cutting reimbursements to deal with rising Medicare expenditures.^[5]

Company Overview

MedCath owns an interest in and operates 11 hospitals and 25 diagnostic and therapeutic centers throughout the United States, with a concentration in the Southeast and Southwest. Although the firm's hospitals are licensed as general acute care facilities and offer patients a range of services, they primarily focus on providing cardiovascular care.^[6] MedCath receives revenue from private insurers, including managed care plans, the federal government (under the Medicare program), state governments (under their respective Medicaid programs), and directly from patients.^[7]

Business and Financial Metrics

In 2007, MedCath's total revenues rose 1.8% to $719 million, driven by growth in the hospital segment, where revenue on a same facility basis increased 4.2% from the prior year. The growth is attributable both to an increase in admissions (2.6% annually) and higher net revenues per admission resulting from renegotiations of several managed care contracts. Revenues at MDTH's diagnostic and therapeutic centers, on the other hand, fell $2.9 million.^[8]

MDTH's net income fell 8.3% to $11.5 million in 2007. While operating expenses held steady, and medical supplies and bad debt expense actually fell 2% and 3% respectively when compared to 2006, MDTH faced sizable non-operating losses. First, the firm sold its equity interests in two facilities (Tucson Heart Hospital and Heart Hospital of Lafayette) at a loss;^[9] also, a recapitalization of a third facility (Harlingen Medical Center) contributed to a $9.9 million loss on the early extinguishment of debt.^[10]

MedCath Revenues and Net Income^[11]

^[11]

Business Segments

2007 Sales by Segment^[12]

• Hospitals (93% of revenues, 89% of income): MedCath's 11 hospitals account for the vast majority of its revenues and income. All of the facilities are co-owned by physicians; the firm owns majority interests in nine and minority interests in the remaining two.^[6] This ownership structure has allowed MDTH, along with its physician partners, to develop an operating model that strives to improve the patient experience through innovations such as centrally located radiology and pharmacy services, fully equipped operating rooms that allow patients to stay in the same place throughout their visit, and nursing stations positioned strategically to best monitor patients.^[13] The firm is currently building a new 106-bed facility in Kingman, Arizona, expected to open in Fall 2009.^[6]
• Diagnostic and Therapeutic Centers (7% of revenues, 11% of income): MedCath's smaller division consists of 25 facilities. 10 of these are located within hospitals not owned by the firm and offer therapeutic and invasive diagnostic procedures. The others are stand-alone centers offering only diagnostic procedures. MedCath provides the physicians working in its centers with all the management functions necessary for them to perform surgeries, from fulfilling administrative duties to employing support personnel, while the physicians make operating decisions on their own. This division also includes a fleet of mobile cardiac catheterization laboratories, which are rented to hospitals while they repair or upgrade their own labs or to meet temporary increases in demand.^[6]

Key Trends, Risks, and Forces

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

As the number of specialty hospitals in the United States reaches approximately 200, concerns have arisen that these facilities are detrimental to the profitability of the hospital industry as a whole. Critics believe that specialty hospitals cherry-pick the most profitable patients, performing exclusively lucrative, low-risk surgeries and leaving lower margin treatments to generalist hospitals.^[14] 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.^[15] To address these concerns, opponents of specialty hospitals have made great efforts to limit their growth. In 2003, Congress passed a moratorium on the opening of new specialty facilities that lasted until 2006.^[16] 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.^[14] The bill is now under consideration by the Senate; if it becomes law, MDTH's growth prospects will be seriously handicapped, as the firm receives the majority of its revenues from specialty hospitals. 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 tend to oppose specialty hospitals.^[3]

Caps on Medicare and Medicaid Reimbursements Limit Revenue Growth

Medicare expenditures have grown swiftly in the past several years, reaching 5.3% of U.S. GDP in 2006.^[17] To stem this growth, the federal government is taking steps to decrease the rates at which it compensates healthcare providers such as MedCath.^[18] Since the likelihood of cardiovascular disease increases with age, more of MDTH's patients are 55 and older than is typical for the hospital industry as a whole. As a result, the firm derives a higher proportion of revenues from Medicare than most other hospitals, and stands to lose more from any changes in reimbursement policies. However, MDTH has decreased the proportion of Medicare patients at its hospitals during the past few years, mitigating the potential impact of this trend - the percentage has fallen from 49% in 2005 to 45% in 2006 to 42% in 2007.^[19]

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

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. For instance, in 2007, there were 4900 registered outpatient surgery centers alone^[6], accounting for 31% of the 50 million surgeries performed each year.^[20] 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^[4]; they see fewer uninsured patients, since the same physicians who own stakes in the centers are responsible for referring patients to them^[21]; and they selectively choose which types of surgeries to perform, typically focusing on a small number of high-margin procedures.^[22] MedCath has responded to this competitive threat by emulating independent centers in its hospital operations and even operating therapeutic and diagnostic centers of its own. Despite these steps, however, the facilities that account for over 90% of its revenue remain licensed as hospitals, legally required to operate emergency rooms and treat uninsured patients, making outpatient surgery centers a threat for the firm.

Aging Baby Boomers Require More Health Care, Raising Demand for Cardiovascular Treatment

The retirement of the baby boomers, who make up slightly over a quarter of American's population, has had an economic as well as demographic impact on the nation.^[23] A rapid increase in the number of elderly Americans provides an opportunity for hospital owners like MDTH.^[24] People 65 and over account for 40-50% of total spending on healthcare; the per capita healthcare spending in this age group is 3-5 times higher than for people under 65.^[25] As a result, healthcare expenditures are already growing swiftly, rising 6.7% in 2006 to reach $2.1 trillion.^[26] While all hospitals will benefit from this trend, MDTH is better positioned to do so than many competitors. Over 90% of the firm's patients live in markets where the number of people 55 and older (the primary victims of cardiovascular disease) is expected to rise 17.6% in the next five years, higher than the national average of 16.1% expected growth.^[2]

Competition

MedCath's competitors consist of all providers of cardiovascular care, a group comprised primarily of other general acute care hospitals. In addition to for-profit facilities, MDTH has to compete with nonprofit hospitals, which benefit from government support and tax exemptions that MDTH does not receive. Finally, the firm's facilities compete for outpatient procedures with independent diagnostic and therapeutic centers located in their markets. Most of MDTH's facilities have two to three competitors located in their geographic area.^[27] Texas, where three of the firm's hospitals are located,^[28] is a particularly competitive market, as many of the nation's specialty hospitals are located in the state.^[14]

MDTH's specialty focus is a primary competitive advantage for the firm - cardiovascular procedures are some of the most profitable surgical specialties, accounting for as much as 35% of a typical hospital's revenue.^[1] By focusing on these procedures alone, MDTH maximizes its revenues per procedure.

Furthermore, as specialty hospitals, MDTH'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, operating rooms do not need to be refitted with different equipment for each surgery, since the same types of procedures are performed there over and over. This, in turn, allows the hospitals to invest in technologically advanced tools for cardiovascular operations.^[2]MedCath has also emulated ambulatory surgical centers' practice of partnering with physicians by giving them minority stakes in the facilities they work in. All of the firm's hospitals and many of its diagnostic and surgery centers are partially owned by physicians, which has served as a valuable recruitment tool.^[2] Industry operating metrics show that MDTH, despite owning a relatively small number of hospitals, extracts higher profits from them; for instance, the firm has one of the highest occupancy rates in the industry, while average patient stays are some of the shortest.^[29]

Operating 25 of its own diagnostic and therapeutic centers allows the firm to maintain a foothold in that market as well; the facilities enjoy higher margins than hospitals - they account for only 7% of MDTH's revenue, but comprise 11% of its income.^[30]

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%^[14] of the 6013 hospitals in the United States.^[31] With only 11 facilities, MedCath is one of the smaller firms in the industry, holding about 5% of the specialty hospital market by volume.^[14]

Market Share of Major Hospital Operators, 2007^[32]

• 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.^[33]
• Dynacq Healthcare (DYII) operates surgical hospitals specializing in three high-margin medical specialties - orthopedics, neurosurgery and general surgery. The firm distinguishes itself from the competition through this narrow focus, as well as by giving its surgeons authority over equipment and staffing decisions and the option to obtain a minority interest in the hospital they work in. In addition to owning hospitals in Texas and Louisiana, Dynacq is currently involved in a joint venture to construct and operate a new hospital in Shanghai, China.^[34]
• 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.^[35]
• 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.^[36]
• 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.^[37]

References

1. ↑ ^{1.0 1.1} Specialty Hospitals: Focused Factories or Cream Skimmers?
2. ↑ ^{2.0 2.1 2.2 2.3} MDTH 2007 10-K. Item 1 - Business. p.2
3. ↑ ^{3.0 3.1} Interest groups clash over doctor-owned specialty hospitals
4. ↑ ^{4.0 4.1} Ambulatory surgery centers proliferate
5. ↑ MDTH 2007 10-K. Item 7 -MD&A. p.34-35
6. ↑ ^{6.0 6.1 6.2 6.3 6.4} MDTH 2007 10-K. Item 1 - Business. p1
7. ↑ MDTH 2007 10-K. Item 7 -MD&A. p.35
8. ↑ MDTH 2007 10-K. Item 7 -MD&A. p.40
9. ↑ MDTH 2007 10-K. Item 7 -MD&A. p.43
10. ↑ MDTH 2007 10-K. Item 7 -MD&A. p.42
11. ↑ ^{11.0 11.1} MDTH 2007 10-K Section 6 - Selected Financial Data p. 32
12. ↑ UHS 2007 10-K Section 8 - Notes to Financial Statements Pg. 119
13. ↑ MedCath Corporate Profile
14. ↑ ^{14.0 14.1 14.2 14.3 14.4} Hospital lobby flexes GOP muscle
15. ↑ FTC Testifies on New Entry into Hospital Competition. May 24, 2005.
16. ↑ Moratorium on Specialty Hospitals Expires, But CMS Barriers Remain For New Specialty Hospitals
17. ↑ National Health Expenditure Accounts 2006 Highlights
18. ↑ "Hospitals, Insurers Still Expected to Feel Long-Term Squeeze From Medicare Funding Deficit". AP. March 26,2008
19. ↑ MDTH 2007 10-K. Item 7 -MD&A. p.34-35
20. ↑ Brophy Marcus, Mary. "The spotlight grows on outpatient surgery." USA Today. July 29, 2007.
21. ↑ Physician-Owners Of Ambulatory Surgical Centers Siphon Off High-Paying Privately Insured Patients, Say Researchers
22. ↑ Sutter Health Forms New Joint Venture to Operate and Develop Surgery Centers. June 8, 2007
23. ↑ Growing Old, Baby-Boomer Style
24. ↑ "Aging Baby Boomers" Wikinvest Article
25. ↑ Healthcare Expenditure: A Future in Question
26. ↑ Statistics, Trends and Reports.
27. ↑ MDTH 2007 10-K. Item 1 - Business. p.9
28. ↑ MDTH 2007 10-K. Item 1 - Business. p.6
29. ↑ Occupancy rate and average stay data from 2007 company 10-Ks
30. ↑ MDTH 2007 10-K. Item 8 - Notes to Financial Statements. p.87
31. ↑ U.S. Department of Health & Human Services: April 2005
32. ↑ American Hospital Association - 2006 Health and Hospital Trends; Revenues data from company profiles at www.hoovers.com
33. ↑ SunLink Corporate Website
34. ↑ Dynacq Corporate Website
35. ↑ LPNT Wikinvest Article
36. ↑ THC Wikinvest Article
37. ↑ HMA Wikinvest Article