Healthy Returns: Last Healthy Hospital Standing

Healthy Returns
Last Healthy Hospital Standing
David Whelan 04.21.07, 1:00 AM ET

It's getting hard to pick stocks in the hospital industry. There are only five sizable publicly traded hospitals left, after two of the biggest said "adios" to the public markets.

First HCA went private in a $33 billion deal led by Kohlberg Kravis Roberts. Then Triad Hospitals, an old HCA spin-off, disappeared into a $7 billion cloud of smoke after shunning a private equity bid for a richer but controversial counterbid from rural hospital operator Community Health. Tenet is a shadow of its former self after repeated run-ins with regulators and prosecutors. It could be a future target--if it can locate a buyer with nerves of steel. Lifepoint has a small, steady business running rural hospitals. Not much buyout action there.

Hospitals are the perfect buyout targets because they throw off lots of cash that should keep coming in because people will always get sick. As a result, they can be loaded up with debt. Health Management Associates in Naples, Fla., did its own weird take on a management buyout, borrowing $3 billion to pay a $10 per share dividend to lavish on shareholders (and managers).

So what's left to invest in? The best company remaining is probably Universal Health Services. And it's not going anywhere. The King of Prussia, Pa., firm owns hospitals mainly throughout the Sun Belt--those warm states with few competing academic medical centers, sprawling, growing populations and hordes of retirees. It also has a psychiatric hospital business that's lately been building facilities for troubled teens. Its operating margins hover around 8%, higher than the 6% industry average. UHS has also seen admissions rise 1% or 2% the last couple quarters, compared to flat or declining admissions elsewhere.

Universal will be around long after the others are carved up, broken up and reassembled again, because the company is run by Alan Miller. Miller started Universal back in 1978 after his first hospital company got ripped away from him in a hostile takeover. The experience scarred him so much that when he started UHS he made sure he controlled a majority of the voting stock, like Comcast or the New York Times Co.. He's known as a control freak in an out-of-control industry and treats UHS like it's still his family company (a son works in a top role).

Miller's hands-on style most likely means that he isn't building an empire that will blow up, like so many of his peers' have. At 6' 5" or so, the former college basketball player says he's already a big guy, so he doesn't need to have the biggest company. As one prominent private equity investor says, Miller never overpays on deals and never builds hospitals where he shouldn't.

Every penny is watched. Case in point: UHS won a nasty union battle in Las Vegas recently by locking out the nurses. Before that it got flack for shutting down a hospital in Katrina-hit Louisiana, even though it was a smart business decision. Like all other hospitals, Universal has been grappling lately with rising bad accounts from uninsured patients. But that trend seems to be subsiding as hospitals get better at managing the costs that get away. There are also signs that hospitals could cycle out of a stingy Medicare and Medicaid reimbursement environment. (Many states are reconsidering deep Medicaid cuts made to balance state budgets earlier in the decade.) At $59 a share UHS trades at 19 times estimated earnings this year. Look for a strong earnings next week that will make that look even cheaper.

UnitedHealth Group, long the Big Kahuna of managed care, has had a nice bounce back from its troubles with stock options backdating. But the rebound is losing support these days on Wall Street judging from analyst downgrades. Even though it announced good news regarding a renewal of its lucrative deal with the AARP to sell supplemental insurance to the group's members, the slowing growth of its Medicare HMO worried investors. A slowdown in membership increases here could also be bad news for major Medicare HMO players like Humana and Health Spring. Unless, that is, the feds come to their senses and start letting health plans sign up Medicare recipients year round and not just during a four month window. With Democrats running Congress, don't hold your breath.

This is the first in a new series of columns about investing in the health care industry.