United States: Notes On Day 4 Of The JPMorgan Healthcare Conference

Some interesting presentations on the last day of the JPMorgan Healthcare Conference that concentrated on common themes – the increasing importance of ancillary business line to bolster core business revenue and of filling in holes to achieve scale and full-service offerings.

Genesis Healthcare – The largest U.S. skilled nursing facility (SNF) provider, which also is the largest provider of contracted rehabilitation services, had an interesting story to tell. It reminded me of the endless road trip, where you are trying to appropriately fill the time on the way to your destination, while the kids in the back seat keep asking "Are we there yet?"  For Genesis and, perhaps for the SNF sector, the rainbow at the end of the road is the U.S. demographic pot of golden age seniors.   With Genesis average SNF bed occupancy at approximately 88% over the last 3 years (higher according to Genesis than two large competitors Ensign and Kindred), we continue to see less utilization of SNFs then existing capacity, and beds continue to be taken out of operation. BUT, wait until 2025, when the Baby Boom has fully actualized and when according to Genesis predictions, demand for U.S. SNF beds will outstrip existing capacity.

Keep in mind that the average SNF facility in the U.S. now is 40 years old. And, given current Medicaid reimbursement being unable to return in a reasonable investment horizon the capital expenditure required to build new facilities that are code and regulatory compliant, the Genesis thesis is that, absent government intervention, additional SNF capacity will not be added.  So, as we get toward 2025, the supply/demand curve inverts and SNFs become a seller's market for SNF operators.  Nice ending to the story for patient investors, but what fills the gap between now and 2025?

Other lines of ancillary business is Genesis' answer.  They talked about their Genesis Physician Services (GPS) business, which is a SNFist business and also operates a SNF focused MSSP ACO. GPS in their ACO manages $800 million of Medicare spend for 15,000 Medicare beneficiaries. In Genesis' view, an ACO is essentially HMO lite, without the risk based capital requirements and the higher regulatory burdens.  Plus, the attribution of ACO lives potentially allows for faster member build than in a Medicare Institutional Special Needs Plan (ISNP). So, in the question of ACO versus ISNP, ACO wins in their view.  ISNPs are an interesting segment, but there certainly are enough opportunities in the market for post-acute ACO's and ISNPs both to be tested.

Genesis also touted their contracted rehabilitation services line, Genesis Rehab Services, which provides therapy services in the community, and their expansion into China with hospitals, rehabilitation facilities and other related offerings.  So, tighter operations, renegotiation of rent and pay down of debt, together with the upside on the ancillary business lines, may be able to cross the chasm until the roaring 20's arrive (that's 2020s, not the 1920s).

Finally, what would be a nice Christmas present for the SNF sector?  If CMS would allow concurrent or group therapy sessions, that could significantly reduce effective operating costs and generate more margin to tide them over. Will this happen – who knows? But the same effect can be emulated if enough patients are included into bundled payment programs where more freedom of methodology is allowed within the bundle.  So, look for innovative SNF operators to migrate more toward bundled payment programs where possible.

Surgery Partners – Put together with the 2011 Novamed acquisition and the 2014 Symbion acquisition, Surgery Partners now operates 99 ambulatory surgery centers (ASCs), 5 surgical hospitals, 53 physician practices and 8 urgent care centers.  On this last day of the conference, Surgery Partners still drew a good audience, possibly in part because of the focus this week on the ASC sector with the OptumCare acquisition of SCA.  72% of Surgery Partners' centers are multi-specialty, with the majority of the centers having a controlling interest held by Surgery Partners.

Surgery Partners' "secret recipe" is to build ancillary services surrounding their centers and have ancillary earnings retained by Surgery Partners. Currently, ancillary services are 14% of their business mix (27% before the Symbion deal), and they see a window to maximize revenue and profitability if they also control and provide for their centers anesthesia, imaging, lab, DME and specialty pharmacy.  In their Tampa Bay, Florida market where this strategy has been implemented, ancillary EBITDA as a percentage of total EBITDA is approximately 47% in 2016, up by 5 points from 2012.  And with this strategy being accomplished primarily through acquisitions in each local market of smaller providers, they report that their blended acquisition multiple across all transaction types (including ASC purchases) is less than 6X.  An interesting ancillary strategy that when more mature, and if replicating the Tampa results, could instead be called co-primary, rather than ancillary.

Quorum Health – Focused primarily on the rural markets, Quorum shared some interesting statistics and noted that in some markets they had a 42% market share.  This number in an urban market would be a cause for celebration and champagne popping, but in a rural market it indicates that patients are bypassing the local rural hospital to go to an urban hospital. Why would they do that?  First, if the local hospital has safety or quality issues, that will quickly drive patients to other alternatives.  Quorum has been copying the playbook for Lifepoint and Triad and is working to improve on safety and quality. But the second is more interesting – patients will move on if they cannot obtain the necessary services at the local hospital.  The lack of specialists in certain areas and the closure of intensive care units at certain Quorum hospitals was causing loss of patient volume across a broader range of service needs.  Quorum has reopened their ICUs and is filling in the gaps with physician recruiting, to good effect.  They also see a larger opportunity for behavioral health units, as many rural areas are heavily underserved for psychiatric services.

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