The Case Against Emergency Rooms Driving the Cost of Healthcare

This past Wednesday, September 5th, Dr. Glenn Melnick–a professor of public policy at USC– published an opinion essay in the New York Times framing an argument that sought to pinpoint one of the many sources of rising healthcare costs. In his article, Dr. Melnick attributed an outsized role of emergency rooms as a major factor driving the rapid growth in healthcare expenditures. This blog entry, although a deviation from typical publications you’ll likely see on this blog, seeks to present data to assess the merits and demerits of Dr. Melnick’s argument. The blog post will unfold by first providing a synopsis of Dr. Melnick’s central arguments, then present macroeconomic data on the growth of healthcare relative to GDP, before diving into a brief history of Emergency Rooms economic viability and position in the healthcare marketplace before making a final judgment on Dr. Melnick’s case.

 

In a health system that often overlooks the role of and protections for patient consumers, Emergency Care is one of the few treatment platforms mandated by law to account for all patients and their ensuing care. These conditions– while intended to serve as a protection of last resort for patients– can have unexpected economic outcomes and widespread effects within healthcare systems. In Melnick’s argument, legislative measures have yielded a dynamic in which significant pricing power is shifted away from payors, namely insurance firms– directly to emergency rooms and their operators. This pricing power has naturally led to out of control costs, with the expenditures shifted on both insurance providers and individuals receiving care, he says. Melnick takes issue with one particularly state legislative mandate, which requires insurance companies to provide coverage for its members in the nearest geographic emergency room despite its status as an in or out of network provider. The legislative is intuitive; where emergency care is concerned, patients should prioritize expediency over costs. However, its implications are such that it adds impetus for insurance companies to make accommodations and eagerly add emergency rooms into their networks. These conditions are certain to provide some haphazard and un-predicted pricing dynamics– perhaps to the detriment of patients and insurance firms alike– but require a more thorough investigation prior to judgment.

For starters, the interplay of factors and variables in healthcare is exceptionally complicated. In the past decade alone, factors outside of state legislative efforts have overwhelmingly shifted conditions in the marketplace that are especially pertinent to emergency room and inpatient care. Between the affordable care act, medicare and medicaid expansion, an aging population and a growing economy, the costs of emergency care were certain to rise. In fact, so much of Melnick’s argument requires delineating the difference between the growth rate of healthcare in its entirety relative to emergency care. One universal truth specific to the American healthcare system is that costs are going up across the board and have been doing so for a considerable time.

Timeframe Healthcare Growth Rate US GDP Growth Rate Healthcare vs. GDP Differential
1990-2007 7.3 2.9755 4.3245
2008-2016 4.2 1.312 2.888
2017-2026 (estimated) 5.5 NA NA

 

The above graph is a collection of healthcare growth data compiled of a forecast report of National Health Expenditure Projections and US World Bank GDP Growth data. When taken together, they tell a convincing story that point to decades of drastically expanding healthcare and healthcare’s growth in significance as a share of total GDP. With stagnant real wages and an estimation that places healthcare at an approximated 20 percent of GDP in the coming years, health expenditures have absorbed an increasingly large share of paychecks. The remaining question, however, remains unanswered: what is causing decades of growth?

 

Who Has Been Paying for Visits to the Emergency Room:

 

Figure 4. Trends in primary payer among all ED visits for patients aged 18-44 years, 2006-2015

Worth noting, at all ages, those with private insurance have comprised a smaller portion of those presenting to and admitting into Emergency rooms over the past 10 years. Moreover, the share of the uninsured population– the most expensive for emergency rooms to treat– has substantially declined. In reflecting on the above data, pulled from the Healthcare Cost and Utilization Project Statistical Brief #238 (see link below), private insurance, at best, represents less than a third of payors in EDs. Highly regulated, both Medicare and Medicaid impose strict price guidelines for reimbursement and are not subject to the same negotiating patterns Melnick expressed concern about. For Melnick’s argument to hold true, ⅓ of the share of visitors to Emergency Rooms would not only have to massively re-orient the costs but serve as a leading factor in Healthcare’s growth.

Have an Inordinate Amount of Insured Visitors been Showing up in ERs:

Figure 1. Rate of ED visits, per 100,000 population by age group, 2006-2015

Fortunately, we have data that reflects the growth rate in ER visits by payor type. Again, we do not see sufficient data to make Melnick’s case. In a 10 year span, insured members have been accessing ERs at growing rates. However, a computed 8.7% growth rate over a span of 10 years hardly would count for an appreciable difference in macro healthcare sector expenditure growth.

Billed Fees:

The piece of outstanding data that provides the most support for Dr. Melnick’s argument is a growing trend of inflating billed fees among Emergency Rooms across the United States. Where healthcare providers do not have a pre-arranged contract, they bill a fee of their choosing– very much akin to a sticker price. Where it gets difficult to find data, is the true rate payors actually reimburse hospitals and emergency room for their charges. Inasmuch as Dr. Melnick is correct and pricing power has shifted in many states more in the direction of emergency rooms relative to private payors, the transformation is not complete and has many unanswered questions. This pricing dynamic is explored in length in a report by the National Academy of Social Insurance called “Addressing Pricing Power in Healthcare Markets: Principles & Policy Options to Strengthen and Shape Markets.”  Dr. Melnick presents pertinent data in assessing California’s quickly increasing billed rate among Emergency Room operators, consistent with a pattern of shifting pricing power. Yet, a series of unanswered questions still linger but remain vital to understanding the forces at play. For starters, what share of ED visits governed by private payors are uncontracted (i.e. the hospital is out of network with the insurance provider)? Where rates are not agreed upon, how much do insurance traditionally pay relative to their members under contract for identical services? And, most importantly, what is the real effective costs of these visits to insurance payors? While insurance payors may get obscene out of network bills, the ultimate reimbursement rate is at their discretion, not the hospitals.

Ultimately, Melnick is not entirely wrong. Hospital consolidation and legislative efforts to make care emergency care more accessible have served to create local de facto monopolies and shift pricing power towards hospitals. Nevertheless, insurance providers traditionally find innovative mechanisms of tethering reimbursement rates to metrics to control costs. They can affix reimbursements by crafting policy guidelines to reimburse for out of network services along medicare rates, use standards such as Usual & Customary in pricing claims, to mention a few. All in all, it seems difficult to make the assumption that emergency rooms alone are a primary source of healthcare costs. In a system as complicated as that of US healthcare, systematic factors often play particularly large roles in determining expenditures than single categories of providers. The fact that both hospital systems, health insurance firms and pharmaceuticals companies operate in a fractured space with misaligned incentives will ultimately continue to fuel rising costs and increased consolidation– sometimes at the expense of patients.

Sources:

https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/ForecastSummary.pdf

 

https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?end=2016&locations=US&start=2008

 

https://www.hcup-us.ahrq.gov/reports/statbriefs/sb238-Emergency-Department-Age-Payer-2006-2015.jsp

 

https://www.urban.org/sites/default/files/publication/50116/2000212-Addressing-Pricing-Power-in-Health-Care-Markets.pdf

 

https://www.vox.com/health-care/2017/12/4/16679686/emergency-room-facility-fee-monopolies

 

Further reading:

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4167079/

 

https://nahu.org/media/1147/healthcarecost-driverswhitepaper.pdf

 

https://www.urban.org/sites/default/files/publication/50116/2000212-Addressing-Pricing-Power-in-Health-Care-Markets.pdf

Value-Based Services in Behavioral Health: an Investors Roadmap

It doesn’t take a healthcare expert to notice that the US healthcare system is riddled with obvious shortcomings. For starters, according to the CMS the US spent 17.9 percent of GDP on healthcare in 2017– roughly 3.3 trillion dollars or $10,348 per person. Among the primary economic issues driving the many inefficiencies in the system is the misalignment of incentives. With countless actors in the healthcare space from physicians, to hospitals, pharmaceutical and medical device companies and payors such as health insurance plans to mention payors such as medical insurance firms and government funders, it can be easy to lose track of the ultimate driver of the industry, the patient. From an investor’s perspective, it is quite obvious how these misaligned incentives can destabilize the efficient delivery of care to patients– as each actor in the system is primarily responsible to its own shareholders and financial outcomes.

Recent and sustained efforts to redesign the reimbursement model have taken hold of late in the provider delivery space. Traditionally, healthcare operates on a fee for service mode where each procedure and client seen are individually billable; this model inevitably creates an incentive where providers bottom line are effective most by two factors: volume of clients seen and reimbursement rate. Per the National Institute of Health, “ Providers get paid in a FFS system for seeing patients regardless of clinical outcome, providing little differentiation between effective and ineffective encounters.” While this is not to say that physicians and clinicians do not take their patients care and wellbeing seriously, it does speak to a system that, in the aggregate, does not offer financial incentive for providers to do so. In fact, one new model that seeks to realign economic incentives around patient care known as value-based service is gaining substantive traction among healthcare payors.

In short, a value for service delivery model is one in which clinical outcome, cost and efficiency take precedent in driving compensation. In such a model, providers and hospital compensation are a factor of quality over quantity. Ideally, a value-based system will allow for providers to offer fewer services, see fewer clients and, if not properly, retain Fee for Service levels of revenue. Several Value-based models are currently be explored by payors and include shared savings, bundled payments, global capitation and shared risk. In each of these models, providers are financially incentivized (either in a bonus structure or ability to retain savings) to efficiently deliver care against a baseline spending benchmark. Per a recent report authored by Deloitte Researchers,

“Blue Cross Blue Shield health plans spend more than $65 million annually, about 20 percent of spending on medical claims, on VBC….  Aetna dedicated 15 percent of its 2013 spending to VBC efforts and intends to grow that amount to 45 percent by 2017.” With the strongest incentive to control costs and make delivery of care more efficient, health insurance firms have been one of the driving forces behind value driven care.

 

For this blog, then, the most relevant and obvious question is how could this shift affect the Behavioral Health Industry, especially from an investors perspective.  The next several paragraphs will aim to capture some possible ways in which a value-oriented delivery system may ask behavioral health providers to restructure their services and then ask a series of questions pertinent to investors in the behavioral health space.

 

It is critical to first understand the financial model that behavioral health providers utilize to create profitable and growing organizations. Operating along a Fee for Service basis, drug rehab, eating disorder and mental health facilities all rely on three key metrics for success: reimbursement rate, daily census size and length of stay. These performative metrics all follow a similar pattern relevant to the conversation. They maximize client exposure to ongoing care, but fail to record distinctly qualitative factors in delivery and post-discharge environment. Moreover, from the perspective of healthcare payors, especially insurance companies, behavioral health facilities represent a costly hybrid in the healthcare system with lengthy and protracted treatment episodes similar to hospitals with specialized needs akin to specialist care providers. In fact, in 2013 depressive disorders represented the 6th most costly diagnosis in the United States, incurring $71 billion in treatment.

 

With that being said, how is a behavioral healthcare facility to redesign its programming to maximize outcome? While research is slowly changing the face of behavioral health, especially in the substance abuse sector, there are obvious means of investing in outcomes. For starters, incorporating more evidence-based care into treatment models is an obvious means of ensuring that programming has maximum efficacy. Inasmuch as this step might prove costly in the short-term, the competitive forces of the behavioral marketplace are already setting in motion a shift towards higher quality of clinical care. Additional measures can include investing more time and resources into aftercare planning. Behavioral health facilities, unlike other healthcare organizations, have less control over patient outcome– given the outcome is entirely at the discretion of the patient and his or her behavior. This essential point makes it all the more obvious that facilities, which often see their patients for no more than several months, need to ensure that the necessary post-care provisions are set in place. This can mean prioritizing family involvement in care, increasing psychoeducation for patients and their families and, most importantly, connecting patients with additional therapeutic outpatient support prior to discharge.

 

Other, perhaps more data-driven, approaches can also help boost value care in behavioral health. Creating benchmarks for various disorders at each level of care can help provide a baseline by which facilities are able to operate and compete to maximize outcomes. Outcome studies and continued support and contact with clients following discharge can serve as an effective tools for helping facilities track their successes and outcomes. Presently, substantially more resources are dedicated in behavioral health to marketing to new and prospective patients than ensuring their outcomes following discharge are successful. This ultimately may mean that behavioral health may need to take data collection, integration and analysis to the next level and identify means of capturing clinically pertinent information from scratch.

Value_Based_Care_Deloitte

From an investor perspective, too, this paradigm shift is not inconsequential. In an industry experiencing substantial consolidation and private equity investment, financial models and cash flow analysis should be based on the assumptions of an inevitable and gradual shift towards a value-based model. It also should enable large consolidated behavioral health facilities some leverage with their payors in determining which outcomes and qualitative metrics to gauge. Without facility participation and buy-in, there is an underlying risk that payors will shift towards metrics that may not favor their practices. It is critical that behavioral health facilities be at the table in negotiating qualitative and value-based models. Also, for large consolidated firms being in a position to invest in data capture and analysis represents a smaller share of costs where a company has scaled efficiently. Lastly and critically, it means that potential investors need to be sensitive to quality of care in addition to financials. Finding investments that will yield healthy returns both in the current fee for service model and have the infrastructure and potential to continue to succeed in a value-oriented economy will certainly pay dividends. Placing a value of quality when seeking an investment will nicely supplement due diligence.

 

Every good actor in the healthcare system should gladly support an effort to boost patient outcome, especially when financially incentivized to do so. A value-based model clearly seeks to find a solution to misalignments in an industry plagued by disparate actors each with specialized functions. However, in the case of behavioral health, there are additional questions that have not yet fully been articulated. First and foremost, does a value-based model also create an incentive for providers to reject treating particularly complicated clinical cases and diagnoses? Will a predominantly payor led shift in care model overlook important provider-oriented nuances in care? Does a value-based system uniquely hurt behavioral health facilities who do not have a ‘standard’ client and are often more vulnerable to externalities, such as client behavior?

Ultimately, these questions will need answers. For now, however, the shift towards value-based care seems inevitable, especially as health insurance payors seemed determined to reign in spending. Like any change of considerable size, this movement could serve to present opportunities to providers and investors alike– they just need to recognize an opportunity when it presents itself.

Links:

 

https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccountsHistorical.html

 

https://www.nih.gov/news-events/nih-research-matters/patient-outcomes-improved-pay-performance

 

https://www2.deloitte.com/content/dam/insights/us/articles/value-based-care-market-shift/DUP-1063_Value-based-care_vFINAL_5.11.15.pdf

 

http://www.apa.org/monitor/2017/03/numbers.aspx

American Addiction Center Q3 2017 Report

For Your Consideration: The following report will be issued on a quarterly basis and seeks to provide a comprehensive breakdown and assessment of publicly traded corporations with exposure to the behavioral health industry. Moreover, expect the insights provided herein to evolve on a quarterly basis as more data is available both intra-corporation and across the industry and future reports should address additional macro-industry insights and benchmarks amalgamated from other corporation’s reports. 

Report Overview:

Few corporations in the behavioral health industry have garnered the attention that American Addiction Center has. Featured in the New York Times ‘The Daily’ podcast and having recently settled a high-profile lawsuit levied against the corporation by shareholders, American Addiction Center is in the unenviable position of being one of the only publicly traded behavioral health providers– exposing it to levels of disclosures of information otherwise privately held. Moreover, as facility operators such as AAC scale, effective management becomes increasingly difficult. Inasmuch as these disclosures might present managerial challenges to AAC’s executives, it provides prescient data that reflect the health of its business and, in a market dominated by privately held corporations, useful information for insights into the behavioral health space at large.  

As a blog dedicated to the economics and investment opportunities present in the behavioral health industry, MyMedinomics will regularly feature American Addiction Center as both an investment opportunity and a tool to extrapolate critical data for other similar but privately held providers. This post, at its core, will assess AAC’s third quarter (Q3) 2017 earnings results, provide a cursory review of the self-reported metrics AAC has provided, offer more in-depth assessments tools, and catalogue points of concern, optimism or unaddressed lingering questions. Moreover, as the blog proceeds it will begin to create industry-specific benchmarks and indices by which AAC’s future quarterly reports can be measured.

American Addiction Center Holdings Company profile:

 

The American Addiction Center Holdings Inc. (NYSE: AAC)  provides services specific to the addiction treatment segment of the healthcare industry. Their services range from detoxification, to residential and outpatient care for substance abuse recovery, in addition to diagnostic laboratory services and non-client related marketing offerings for third party facilities.

With 1,139 residential beds, 636 detoxification beds spread across 12 facilities, American Addiction Center derives a majority of its revenues from short-term residential treatment. Moreover, with 18 outpatient facilities, AAC also drives secondary revenues from downstream programs aimed at supplementing their clients’ care following discharge from their residential facilities. Moreover, tertiary revenues are derived from diagnostic-laboratory services and marketing fees from outside providers; however, these revenues are subject to substantial fluctuations from quarter to quarter and do not represent a core source of AAC’s operations.

American Addiction Center is currently planning several expansion projects, which it hopes will better equip it to compete in new markets such as New England and Rhode Island, with the recent acquisition of AdCare for $85 million.

 


 

The Earnings:

Screen Shot 2018-01-20 at 8.18.15 PM.png

As of market close on the final day of Q3 2017, AAC was trading at $9.95 per share with roughly 24 million shares outstanding– giving it a market capitalization of roughly $222.4 million dollars. 2017 third quarter earnings posted by AAC, reflect earnings of $0.03 per diluted share fueled by a growth in revenues, despite lower client volume. In an effort to increase operating efficiencies and maximize profits, AAC was able to yield greater daily reimbursement rates for its residential and outpatient services. Ultimately, the longevity and continued growth of AAC will be derived primarily from a growth in client volume. By definition in the behavioral health industry, business success stems from delivering quality care efficiently and the capacity to scale client volume without reducing operational efficiencies and quality standards. In reality, it is highly unlikely that AAC will be able to replicate its growth in average daily reimburse-ables and, more likely, will continue seeing considerable volatility as it works with insurance providers desperate to reduce costs. With their pending projects and underlying plans to expand services, AAC is well-positioned to grow its market– adding new residential beds and outpatient programs– in markets largely underserved and in need of additional chemical dependency resources.     

 

The Provided Metrics:

 

  • Total revenue increased 14% to $80.4 million
  • Average daily residential revenue (ADR) increased 48% to $925 and average revenue per outpatient visit (ARV) increased 33% to $437
  • Total average daily census increased to 974 compared with 967
  • Outpatient visits increased 21% to 18,491
  • Net income available to AAC Holdings, Inc. common stockholders was $0.8 million, or $0.03 per diluted common share, compared with a net loss available to AAC Holdings, Inc. common stockholders of $2.5
  • Adjusted EBITDA increased 24% to $14.9 million (see non-GAAP reconciliation herein)

The initial metrics presented in AACs’ earnings (presented above) reflect positive trendlines in their ability to maximize revenues and efforts to unlock efficiencies in their billing department. Moreover, for an industry in which the level of client acuity is vertically-oriented– with an emphasis by insurance providers of stepping clients down to a lower level of care– the underlying growth in outpatient programming with a stabilized residential census reflects an increased effort to find synergies between their programs. These metrics, on the surface, bode well for a corporation well-positioned to reap the rewards of positive secular trends amidst a well-chronicled national prescription drug and opioid epidemic.

Assessing Performance Metrics:

AAC reports 17 Key Performance Metrics (KPIs) by which to monitor the health of its facilities and programs across the nation. These metrics point to two critical measures of success: client volume and the average revenues derived from each of their services. On the whole, the most positive of these metrics point entirely to increased rates of reimbursements. Residential and outpatient revenue rates are up substantially relative to 3rd quarter of 2016. Worth further consideration and not mentioned in the earning report are the factors responsible for driving this uptick. As a provider that derives its revenue from private insurance, the increased rates may be explained as the product of cost sharing split between two payors: insurance providers and clients (i.e. deductibles, co-insurance, co-payments and cash-pay). Without this data, it is difficult to formulate an explanation. Perhaps AAC has cleaned-up its collections to the point at which clients responsibility per their insurance plan are being better enforced or AAC has increased its bargaining power with insurers that is better reflected in their rates for services. Other positive factors include a slight uptick in average length of episode for clients (an imperfect proxy for clinical outcomes) and a substantial increase in outpatient visits from 15,299 to 18,491 (20.8%).

 

Outside of the revenues, several of the operating metrics provided by AAC leave considerable room for improvement. Year over year admissions are down by 6%, while residential bed count is down by nearly 15%. With a decline in overall bed availability, one would rightfully expect a consistent, if not improved, rate in bed utilization. However, bed utilization is down from 82% to 75% year over year. Moreover, this decline is not accounted for or explained in the quarterly statement and could be indicative a series of causal factors such as decline in resources dedicated to marketing, increased competition in certain regional markets, and/or recent issues related to public relations and negative media attention.

 

Further Exploration:

 

To best assess the health of AAC as a business and potential investment, a more comprehensive set of data and standards by which  to measure AAC need to be delineated. Provided below are 30 data points created from the initial information available in AAC’s Q3 report. Over time, this data set will reflect quarterly changes in AAC’s reporting; they will also be applied to other industry providers to create a performance benchmark, which will create an industry standard by which operators can be measured  against. In some instances, information may be lacking– corresponding data points will be left blank. A cursory explanation of each data point will be addressed below, as will the methodology of each, where necessary.  
Screen Shot 2018-01-22 at 8.55.42 AM.png
A: Market Cap (Diluted Shares): Market capitalization reflects the market value of a company and is calculated by multiplying the share price by the amount of outstanding shares. As of the end of Q3 2017, AAC’s market capitalization was an approximate $233.5 million– or $9.95 per share. This number reflects a particularly rough year for AAC shares, with its market capitalization shrinking year over year from nearly $400 million– shares trading at 17.39– at the close of Q3 2016.

B: Total Approximated Bed Count: The total approximated bed count is an estimation of the combined beds or daily treatment units for both residential and outpatient (sober living inclusive). It is calculated by adding the ‘Effective Residential Bed Count’ with the ‘daily outpatient units’ (Total outpatient units divided by days in the quarter)  provided at facilities across AAC’s treatment platform.  This metric serves as a proxy for capacity and– in conjunction with industry wide reimbursement rates– will help determine if AAC is sufficiently unlocking the value of its treatment platforms. Reflected above is a year over year growth in bed count, despite the fact that residential beds shrunk in Q3 17’ relative to Q3 16’. Importantly, AAC has substantially grown its outpatient capabilities.

C: Value Per Residential Bed: If one was to think of AAC’s treatment as a range of services provided on a basis of acuity, residential beds would serve as the ultimate source of income and future outpatient revenues when a client graduates from residential programming. As such, the value on a per bed basis creates a useful tool for assessing the performance of competitors and application of valuation for privately held companies. As of market close September 30, 2017, a residential bed at one of AAC’s facilities had an average market valuation of $196,000– down substantially year over year. This metric is calculated by finding the ratio of residential revenue to total revenue multiplied by the market capitalization and further divided by the number of outstanding residential beds. This metric, while useful, is short-sighted on several basis: it does not account for nuances in residential versus detoxification bed and it only reflects the share of residential revenue to revenue on a quarterly basis. Perhaps, in future reports, this blog can feature a weighted value per bed– less tied to fluctuation in share price.

D: Provisions for Bad Debt: Revenue: Bad Debts are over 12% of the size of revenues for Q3 17’.

The last non-self-explanatory metric provided above is the last of the row and warrants some additional explanation. Direct healthcare providers have a distinct disadvantage in their mechanisms and procedures by which they receive payment for services. As providers, their source of revenue is often bifurcated between insurance companies and directly from clients. However, each source presents unique challenges. First and foremost, insurance companies often have substantial leverage in negotiating with providers and can erect substantial barriers for providers. Requirements to obtain authorizations before services, requests for additional documentation and medical records once claims are submitted and a cumbersome appeals process are some of the many mechanisms that insurance providers use to exert influence and leverage over medical providers. Moreover, clients often share some semblance of financial responsibility per their insurance plan (co-insurance, deductibles and such) but determining these costs prior to treatment are cumbersome– especially for out-of-network providers. As such, medical facilities often operate with the expectation that clients will fulfill their financial responsibility once services have been rendered, which shifts financial risks significantly onto the providers abilities to recoup payments, often to their own detriment. In assessing the share of quarterly bad debt to revenue, a few important financial calculations can be accounted for: the true value of revenue after discounting the ratio of bad debt provisions, the true value of accounts receivable given discounting in the assets provisions, and the efficacy of the collection and billing department of AAC as a whole.
Screen Shot 2018-01-22 at 8.54.31 AM.png

E: Accounts Receivable: Total Asset Ratio: As of Q3 2017, Accounts Receivable accounted for 22% of assets held by AAC.

Generally speaking, Accounts Receivable is especially pertinent to the healthcare industry. The expectations of payment for services provided or goods rendered is far less precarious in other industries than healthcare, where consumers are individual patients or insurance companies– who either possess insufficient resources to cover services or, in the case of insurance companies, possess substantial barriers and specialized requirements before payment can be rendered with post-facto clauses and reasons for denial. All in all, a dollar of accounts receivable for a healthcare provider is often worth less in the behavioral health industry than generally accepted in most other businesses. That being said, a watchful eye towards accounts receivable as a share of assets is vital in gauging the fiscal health of a company and potential pitfalls in its books.  

F: Accounts Receivable: Quarterly Revenue: As of market close in Q3 17’, accumulated accounts receivable constitute 115% of revenue for the quarter. Again, as explained above, accounts receivable, especially for healthcare, can present challenges. Moreover, without transparency in AR recording– bad debts can be hidden in AR and/or AR accounts aging can be skewed towards monies more likely to not be collected in full.  Ultimately, a growth in this ratio is indicative of a growing inability to monetize services and can warp the impression of available assets.

 

G: Standard Deviation of Average Length of Stay: There is insufficient data to record this measure.

While lengthening the average length of stay (ALOS) may represent efforts to best meet clients needs and maximize value in the process of delivering quality care, the core ability to meet clients needs and account for their experiences escapes the crude ALOS measure. Instead, providing a standard deviation among all clients average length of stay better indicates how universally and, ultimately, serves as a better proxy for quality of care and measure of client experience.   

H: Diversity of Revenue Stream: Q3 2017, AAC has a 10.7 measure of revenue diversity (the lower the better). This measure is determined by averaging the top 3 sources of AAC’s revenue sources– i.e. insurance companies. This metric helps in determining the level of exposure AAC carries to certain insurance providers (or in the case of other providers: government programs etc.). Not all revenue is created equal. Over-reliance on particular insurance companies can pose risks to AAC, as bargaining power is shifting away from AAC to their payors.

I: Marketing to Revenue: In Q3 2017, revenue constituted 3.8% of revenue; in Q3 of 2017, this measure was 6.6%. With a national presence and the need to differentiate itself in the industry, marketing and advertising represents a key sunk cost through which AAC can capture market share and ensure that it generates sufficient client volume. In a highly fractured market place, with no particular provider with more than 5 percent of the market share, effective marketing is paramount to AAC’s success. Per industry standards, a corporation expecting growth should allocate between 7-12% of revenue towards marketing and advertising– of which AAC is falling short. Ultimately, the share of marketing and advertising as a cost relative to revenue is an early indicator of client volume and can reflect potential troubles in competing in the market.

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J: Book Value/Shareholders Equity: As of Q3 17’, AAC’s book value is $156,359,000. Book value is an accounting measure of a company’s value through the calculation of assets less liabilities– an overly simplified explanation.

 

K: Book Value per Adjusted AR: With a more realistic, albeit imperfect, calculation of accounts receivable value, book value is subject to change as well. Due to the fact that ‘accounts receivable’ is one of the leading factors in calculating AAC’s assets, book value decreases by 11,141,000 when a more realistic approach to AR is determined.

 

L: Market Value to Book Value: As of Q3 17’, AAC had a market to book value ratio of 1.49.

One of central metrics that investors seek when determining if an equity is undervalued is the ratio of market value to book value. This ratio represents the multiple by which investors and fair market prices the equity relative to the strict book value. Firms with lower Market to Book ratios often reflect greater value to investors.

 

M: Price to Earnings Ratio: Due to the fact that AAC has yielded negative earnings in the previous 12 months, a PE ratio can not be determined.

 

Summary:

On its surface, American Addiction Center is a business well-positioned to reap the benefits of a booming nation-wide demand for quality substance abuse treatment. It’s recent settlement of a lawsuit levied against it by shareholders and transition to new, key executive staff, suggest that AAC is committed to addressing its core weaknesses. Its current acquisition and expansion plans, although costly, will help AAC build a national brand and reach local markets badly in need of substance abuse treatment facilities.   

Moreover, by conventional standards, AAC trades cheaply. With a current share price of $9.07 (1/22/18), AAC trades just above its book value; it also trades substantially off of its 52-week trading high of $13.06.  Prospective value investors should consider AAC, provided it can address several concerns listed below. 

Concerns:

  1. In a highly competitive space, AAC needs to better differentiate itself as a leader in quality care and clinically sound outcomes. Something that requires an intensive marketing campaign and strong regional outreach, which AAC has seemingly cut back on; Not to mention the unsavory publicity AAC has received as of late in the press. Moving forward, AAC needs to allay investors concerns by emphasizing new campaigns to improve community relations and sufficiently market their programs to compete in a wide-open marketplace.
  2. Accounts Receivables:   The prospect of investing in a highly undervalued company in a growing space is certainly appealing. Nevertheless, without greater financial reporting on accounts receivable including Aging Reports, the distribution of payors and an accurate valuation of per fair market value of accounts receivable too much of AAC’s conditions remain uncertain.
  3.  Ultimately, the success of any facility– especially those utilizing private insurance– rests on its ability to deliver quality outcomes and, in the case of AAC, an above-average rate of recovery. AAC needs to prioritize metrics that suggest a quality experience in its programs, which will ultimately serve as the engine of long-term and sustainable growth.
  4. What to look for in the near future from AAC: a) higher occupancy rates across its residential facilities, b) consistency in ‘Average Daily Revenue’ at both Residential and Outpatient levels of care c)  marketing investment rate above 6% of revenues, d) a shrinking ratio of bad debt provisions to Revenue e) stabilization of revenues from diagnostic services and/or an average diagnostic revenue on a per client basis.
  5. Although AAC has experienced growing revenues, it also saw its expenditures related to services increase– albeit at a lesser rate. Nonetheless, AAC needs to propose a measure to ensure that growing costs are addressed and adequately accounted for. After all, year over year, AAC operated fewer residential beds– the most costly of its services– and still saw its expenditures rise.

 

Welcome to the Investment World of Behavioral Health

The Cheat Sheet:

This blog is here to serve as a resource to investors– both weekend warriors and institutional investors– seeking to get a handle on the financial health and the transactional developments in the behavioral health industry. In the upcoming posts, an insider’s perspective will be offered to assess the behavioral health industry using the lense of financial and market analysis. Tools such as DCF analysis (discounted cash flow), EBITA assessments (Earnings Before Interest, Taxation & Amortization), equity research for the few publicly operating behavioral health providers, market analysis, financial modeling & transaction reports providing market-based valuation metrics will be provided to help gauge market conditions, opportunities for investors and potential hazards.

 

The Whole Megillah:

By conventional standards, a small cap company’s qualifying size ranges between an approximated 300 million and 2 billion dollars of value in outstanding shares.  In the throes of a national opioid epidemic with a sector with $50 billion in annualized revenue at a combined 17,000 facilities throughout the US (and counting), the US behavioral health market is dominated by companies that are largely relegated to micro-cap and nano-cap features; meaning outstanding share valuations well under the $300 million valuation.

In these conditions alone– not to name the myriad factors that present secular challenges to the space (more on the topic in an upcoming post)– it can be particularly onerous collecting accurate and actionable investment data. Mymedinomics is here to change that or, at the very least,  shed some light into a particularly opaque sector presently operating with robust investment opportunities.  

The blog will draw primarily on publicly available information, theoretical financial models, real-time news and developments in the space (both transactional, legal & legislative), personal experiences, and national & regional trends both for the larger healthcare sector and more specific to behavioral health to build a comprehensive and detailed analysis of the sector as a whole and the financial health of particular industry actors.

As far as disclaimers go, many of the posts will be technical in nature– using graphical and statistical representations and terms specific to the language of accounting and investments; I will do my best to provide concise and accessible writing suited to novice and seasoned investors alike. I wholly expect input from readers, requests for coverage and points of criticism (perhaps support as well: fingers crossed) to serve as guidance for myself; after all, this is a learning process. Please direct any questions, comments or concerns to my email address at YonaYRemer@gmail.com.

 

Two inaugural graphs are added for your review below, with short paragraph-length analyses provided beneath.

 

Screen Shot 2017-12-17 at 7.05.35 PM.pngAbove: This graph provides YTD (year to date) index performance of the healthcare sector  relative to S&P performance (1/5/17-1/5/18). Unsurprisingly, the bull market for equities in 2017 produced some exceptional returns across the board. In fact, healthcare as a whole lagged slightly beyond the general market performance, while still realizing returns in excess of 20%. Of consequence and missing from the graph are some of the conditions that the healthcare sector  had to contend with this previous calendar year, which when taken in perspective shed some important light on the sectors upside. For starters, few sectors were as vulnerable to structural changes as that of healthcare. In the past year alone, the markets witnessed a near repeal of the affordable care act (ACA), attacks directed towards pricing models for pharmaceutical companies, tax reform that stood to have an outsized impact on the healthcare industry (deductions and Health Savings Accounts were at jeopardy at times), among many other factors. In summary, while healthcare as a sector might have underperformed the market on a whole, it thrived given the volatility and uncertainty in the space.
Screen Shot 2018-01-05 at 12.51.54 AM.png

Above: This graph tracks YTD (year to date) share performance of the 6 publicly traded companies that derive their primary or secondary sources of revenue from the operations of behavioral health facilities. As can be seen, their performance– generally speaking– is a lot less elegant than that of the healthcare sector on a wholle. The purple line represents the healthcare sectors performance as a benchmark relative to the other individual corporations. The great divergences in performance reflect some of the perils endemic to the space. Of the 6, only 2 outperformed the healthcare space as a whole; 2 lost value, with Nobilis Health losing 40% of its share price. Individual posts will be dedicated in the future to a closer analysis of quarterly earnings reports from each of the companies above. But, the graph illustrates a simple point: while a sector itself may be promising, those conditions often do not extend themselves to all participating companies. The differences between a successfully operating behavioral health firm that can grow market share, operate with health margins and create value for investors are often pretty small relative to their counterparts that struggle to capitalize on the ripe market conditions.