I just read another in a rash of articles praising the investor-owned hospital industry, suggesting that they are better positioned to deal with the new normal healthcare economy that is defined by the Affordable Care Act and deficit reduction. 

These articles come from a variety of Wall Street firms but they all have similar themes: investor owned companies are in better shape, the analysts claim, because they have more efficient operations, excellent cash reserves, a laser-focus on staffing, billing and collections as well as an unrelenting drive to capture more of the market.  To give those companies their due, for years they have consistently produced growth in earnings, which, more than just being profitable, is what the analysts want to see.  You rarely hear the analysts mention the patients, but then that is a subject for another time.

The counter-point to the Street’s silly, often misguided conventional wisdom is largely unreported because the business press does not pay attention to well run, innovative non-profit systems like PinnacleHealth, Baylor Health Care, Scott & White, New Mexico’s Presbyterian Health Services or many others across the nation.  

In short, no pun intended, I think the Wall Street analysts are wrong again. 

Investor-owned companies, from HCA and Tenet, to Community Health, Hospital Management Associates, of recent 60 Minutes fame, and Lifespan have long been the darlings of stock analysts because, historically, most have been able to introduce important and sorely needed operational and financial efficiencies that contributed years of solid profits and growth in earnings, sometimes in the double-digit range.  They introduced scale in purchasing, accounting, information systems and billing and collections.  Their performance attracted capital for future growth. Many of these management process innovations have been adopted by the not-for-profit hospitals.

The investor owned companies are revenue focused, which means they keep an eagle eye on their customers, the physicians, and monitor their productivity, the number of inpatient admissions and outpatient procedures that each generates.

Here is the real rub that seems to escape the analysts: their efficiencies, economy of scale, and access to capital mask the fact that their business model, like the non-profits, is still built around inpatient operations—putting butts in the bed, as one ED doctor said when describing the pressure he felt from the investor-owned CEO who was upset because he was not meeting an inpatient admissions quota for total number of the patients he saw in a month.

Therein lies the investor-owned hospitals’ vulnerability to the certainty of ongoing reductions in Medicare reimbursement which will be necessary if feds intend to balance the budget and reduce the national debt.  As Medicare and commercial reimbursement payments fall,  all hospitals will see declines in revenue and smaller margins.

The investor-owned organizations that have wooed Wall Street by growth in earnings might be able to sustain that successful run for a year or two, but that strategy will be hard to sustain. 

To be clear, my point is not that the investor-owned hospitals will plunge into losses, but that they will not be able sustain the growth in earnings that is so important to the Street.  You can only cut so much in operating expenses before a hospital cannot safely provide patient care and still meet analyst expectations for earnings. 

There is the parable that I have used in the past to highlight the conundrum for investor-owned hospital executives.  It is the story of two men flying across the Himalayas.  Their plane crashes.  The pilot is a runner, at the peak of physical conditioning.  The passenger is significantly overweight.  They have no food.  It could be months before they are discovered. 

The question is which man will die first? 

If I were a betting man I would say that integrated, diversified health services organizations—the not-for-profit variety—will expand in size and coverage through unit acquisition and consolidation, as we saw recently when Baylor Health Care in Dallas and Central Texas powerhouse Scott & White agreed to form a mega system.  Conversely, I believe the investor-owned industry as we know it today will be considerably smaller.

What are your thoughts?  Is it too early to short the investor-owned management companies?

© 2012 John Gregory Self