Healthcare Sector Analysis

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Healthcare Sector Analysis
Prepared by Ariel ImasRobert CandellaNanda
Win Student Managed Investment Portfolio
ClassProf. P.V. ViswanathSpring 2002
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Objective

• To research, evaluate, and present potential
  equity-investment opportunities in the U.S.
  healthcare sector.

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Research Methodology

• 4-fold approach
• 1) Industry analysis
• 2) Quantitative analysis
• 3) Corporate analysis
• 4) Recommendation

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1) Industry Analysis

• Total universe identified
• Elimination criteria applied
• Financial ratios vs. industry benchmarks
  evaluated
• Industry analysis performed

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Total Universe Identified

• U.S. Healthcare stocks isolated using StockVal
• 724 stocks in population

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Elimination Criteria Applied

• Stocks remaining after elimination criteria
  applied
• 246 stocks - Total assets gt 200M
• 41 stocks Leverage regression
• 18 stocks - Price/Free cash flow

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Financial Ratio vs. Industry Benchmarks Evaluated

• The financial ratios were selected to complement
  the model inputs later required for the
  quantitative analysis.
• Financial ratios
• Financial Strength
• Profitability Effectiveness
• Growth
• Valuation
• 5 stocks remained after ratios were considered

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Financial Ratios

• Financial Strength
• Quick Ratio
• Measures firms ability to generate free cash
  flows
• LT Debt / Common Equity
• Measures effective use of long-term debt with
  respect to changes in the shareholders equity
• Total Debt / Equity
• Measures effective use of total debt with respect
  to changes in the shareholders equity

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Financial Ratios

• 2) Profitability Effectiveness
• EBITDA Margin
• measures profitability while eliminating effects
  of financing and accounting methodologies between
  industries
• Return on Equity
• measures effective use of shareholders equity to
  generate net income
• Return on Capital
• measures effective use of capital
• Net Income per Employee
• measures managements ability to leverage their
  human resources to generate net income

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Financial Ratios

• 3) Growth
• Revenue Growth LFY
• measures firms ability to increase revenues
• EPS Growth LFY
• measures firms ability to generate income (less
  dividends) per unit of stock

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Financial Ratios

• 4) Valuation
• Book Value / Price
• measures the value of the balance sheet in the
  market
• Price / Sales
• measures the price per unit of sales the market
  is willing to pay for the company
• Price / Free cash flow per share
• measures price per unit of free cash the market
  will pay for the company
• Price / Net Work Cap
• measures price per unit of net working capital
  market will pay for company

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1) Industry Analysis

• Top 5 stocks (in order of ranking)
• Polymedica Corporation Medical Products
• Gentiva Health Services Inc. Home Healthcare
• Datascope Corporation Medical Products
• Mentor Corporation Medical Products
• Invitrogen Corporation Biotech

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1) Industry Analysis

• Philosophy If Company A is more undervalued that
  Company B, but Company B is in an industry with
  greater growth potential, Company B presents a
  better investment opportunity.

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1) Industry Analysis

• Industry view
• Biotech will benefit greatly from genome
  research, but will not mature until patent suits
  and RD investments are realized in another 4-5
  years. Unfavorable.
• Home Healthcare benefiting from aging U.S.
  demographics and low-cost alternative to
  hospital care. Aggressive pricing will continue
  to drive current profitability. Favorable.
• Medical Products Equipment benefiting from
  aggressive pricing and growing world market.
  Favorable.

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1) Industry Analysis

• Final 4 stocks (in order of rank)
• Polymedica Corporation Medical Products
  Equipment
• Gentiva Health Services Inc. Home Healthcare
• Datascope Corporation Medical Products
  Equipment
• Mentor Corporation Medical Products Equipment

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2) Quantitative Analysis

• Model selected
• Type
• Two-stage Free cash flow to equity discount
  model
• Purpose
• To value the equity in a form with two stages of
  growthan initial period of higher growth and
  subsequent period of stable growth
• Structure
• 1) Free cash flow to equity
• 2) Weighted average growth rates for
  high-growth period
• 3) Discount factor
• 4) Stable growth period

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2) Quantitative Analysis

• Model Value vs. Market Value

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2) Quantitative Analysis

• Polymedica Corporation

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2) Quantitative Analysis

• Datascope Corporation

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2) Quantitative Analysis

• Gentiva Health Services Inc.

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2) Quantitative Analysis

• Mentor Corporation

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2) Quantitative Analysis

• Subjective variables considerations
• High-growth rate weights
• Historical growth rates
• Outside prediction of growth rate
• Fundamental prediction of growth rate
• High-growth rate growth estimates
• Growth rate in capital spending
• Growth rate in depreciation
• Growth rate in revenues
• Outside estimates (5-yr growth rate)
• Stable-growth estimates
• Stable growth rate
• Stable growth beta

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2) Quantitative Analysis

• Subjective variables justifications
• High-growth rate weights
• Fundamental growth rates were more heavily
  weighted to the extent that the model value was
  deemed reasonable. This was because greater
  historical and outside weighting
  significantly inflated the models stock price
  and concurrently diminished the significance of
  the groups fundamental research.
• High-growth rate growth estimates
• Parity was maintained between growth rates in
  capital spending and depreciation and the growth
  rates that would be required to promote
  significant revenue growth rates in a high-growth
  period.
• Stable-growth estimates
• Stable growth rates were kept within reasonable
  economic limits.
• Current, high-growth betas were applied in the
  stable-growth period to encourage conservative
  model values. This is because industry average
  betas (the beta that a companys beta will
  approach in a stable-growth period) tend to fall
  below 1 in the healthcare sector, which
  significantly overstate prices in the FCFE model.

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3) Corporate Analysis

• Considerations
• Management review
• Insider activity
• Institutional activity
• SWOT analysis
• Corporate Overview

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Management Review

• Of all stocks, Mentor Corp. ranked 1
• Of undervalued stocks, Polymedica ranked 1

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Insider Activity

• Of all stocks, Mentor Corp. exhibited an insider
  buying trend
• Of undervalued stocks, Polymedica Corp. exhibited
  an insider buying trend

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Institutional Activity

• Of all stocks, Mentor Corp. exhibited the most
  significant positive change in institutional
  ownership
• Datascope Corp. exhibited the most significant
  positive change in ownership amongst undervalued
  companies

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Corporate Overview

• Polymedica Corporation
• With formidable growth for years to come,
  Polymedica Corp offers direct-to-customer relief
  medical products and equipment to patients with
  diabetic, respiratory, urology, urinary tract,
  and menopause problems. Their core business
  consists of diabetic and respiratory products,
  both of which have shown significant growth.
  Currently, only consuming 8 of the diabetic
  market, Polymedica has great potential to gain
  market share and achieve even more growth.
  Favored by todays demographics, Polymedica Corp
  relies on government programs to receive most of
  their profits.

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Corporate Overview

• Datascope Corporation
• With over 6 long established product lines
  consisting of products for clinical health care
  markets in interventional cardiology, critical
  care and cardiovascular and vascular surgery,
  this company is here to stay for years to come.
  2 new products shall propel growth rates even
  higher. Their brand new launch of top-of-the-line
  next generation intra-aortic balloon sets a new
  standard with the Fidelity 8 Fr. This product
  will propel their Cardiac Assist unit to levels
  of great proportions. In the pipeline, upgraded
  VasoSeal (R) arterial puncture sealing devices
  shall reap positive rewards for their Collagen
  Products / Vascular Graft Segment. Having
  undergone a big restructuring with in the
  company, DSCP looks to benefit over 10 Million
  annually.

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Corporate Overview

• Gentiva Health Services
• With a positive earnings surprise of 6 cents or
  33 in the fourth quarter, and a positive
  earnings surprise for the past four quarters,
  GTIV is doing something right. Currently, this
  company provides specialty pharmaceutical
  services through 40 pharmacies across U.S.A.,
  along with specialty home health care services.
  With their sale of the Specialty Pharmaceutical
  assets to Accredo, GTIV is focusing on their Home
  Health Care Services. Currently, GTIV holds the
  number one spot in Home Care with a 2-3 market
  share. Their 275 locations enable delivery of
  wide range of services though their nursing and
  care centers. GTIV is actively pursuing
  relationships with managed care organizations.
  Cigna Health Care represents the largest managed
  care organization in which they have direct
  business with in 2001 Cigna represented 19 of
  revenues for GTIV. Recently, both Cigna and GTIV
  renewed their contracts for the seventh
  consecutive time.

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Corporate Overview

• Mentor Corporation
• Mentor Corporation develops, manufactures, and
  markets a broad range of products for the medical
  specialties of plastic, reconstructive, general
  surgery, and urology. The Company's products
  include a line of implants, incontinence
  products, catheters, impotence products, and
  cancer diagnosis and treatment products. Mentor
  markets its products in the United States and in
  more than 60 companies. Mentor continues to post
  consistent revenue growth earning it the
  distinction of being one of Forbes 200 Best Small
  Companies. Recently divesting its ophthalmology
  business, Mentor focus now is on its core
  businesses--urology and cosmetic surgery markets.
  The urology segment of its core business
  addresses a large underserved population with
  devices for the management and treatment of
  urologic disorders common in the aging
  population. The cosmetic surgery segment, one of
  fastest growing fields in medical practice today,
  experiences annual growth rate of 10-12 percent.
  This well managed company will most definitely
  translate these market opportunities into
  significant earnings growth.

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SWOT Analysis

• Polymedica Corporation
• Strengths
• Have a good stranglehold of the Diabetic market
• Direct mail delivery along with sophisticated
  software and advanced order fulfillment system
  provides products and support quickly and
  efficiently
• Building brand name and loyalty with their
  customers due to customers recurring orders
• Headed in the right direction with marketing to
  the right customers
• Weaknesses
• A change in Medicare and governmental policies
  will severely alter PLMDs revenues
• Revenues depend on recurring orders from
  customers if customers do not place any extra
  orders other than their first, PLMD incurs a loss
• Low-medium barriers of entry
• Opportunities
• With an only 8 market share in Diabetic products
  and supplies, there is plenty of room to achieve
  greater success
• Once business is completely established, PLMD can
  expand internationally
• Can increase revenue growth by selling other
  products to existing patients in database
• Increase relations with merchandisers to generate
  extra growth.

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SWOT Analysis

• Datascope Corporation
• Strengths
• Many lines of products that make money
• Pioneer in development of Cardiac Assist products
• Restructuring will save over 10 M year over year
  
• Newly implemented direct sales strategy prove to
  be effective
• Experiencing great growth in Patient Monitoring
  Labs
• Weaknesses
• Experienced distribution problems
• Weak dollar hurts international sales
• Involved in too many projects resulting in higher
  costs
• Opportunities
• Potential to gain on the Inter Vascular market of
  130 M in U.S.
• New line of Fidelity 8 Fr. Can significantly
  increase growth
• VasoSeal new pipelines can significantly
  increase growth
• Expand to Asian and other European markets

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SWOT Analysis

• Gentiva Health Services
• Strengths
• Home Care services prove to be effective and
  strong with 275 locations of deliveries of wide
  range of services
• New trademarks are developing, making GTIV a
  known source
• More focus on Home Care services with the sale of
  Specialty Pharmaceuticals
• Weaknesses
• Due to the Budgeted Balance of 1997, there is a
  15 reduction in home health care payout limit
• Depended on Government regulations
• Opportunities
• Actively pursuing relationships with managed care
  organization
• With more focus paid on Home Care services GTIV
  can effectively distribute their products through
  nursing and care centers
• Can gain market share through brand name and
  various projects
• Threats
• Outside competition can hurt earnings with price
  pressures
• Government regulations can hurt earnings

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SWOT Analysis

• Mentor Corporation
• Strengths
• 25-year track record in growing world breast
  augmentation market
• Competes primarily with one other company in the
  domestic breast implant market, McGhan Medical
  Corporation
• Competes with only one other company in the
  inflatable penile implant market, American
  Medical Systems, Inc
• The Company believes that it has second largest
  market share for both Iodine and Palladium
  (brachytherapy seeds for the treatment of
  prostate cancer) seeds, and its recent
  acquisition of South Bay Medical's automated
  workstation will provide the Company with a
  strong competitive advantage
• Dominant catheters and other disposable
  incontinence products position in the European
  market
• Weaknesses
• Limited global reach
• Recently emerged from FDA consent decree
• 1,622 employees - 382 in sales and marketing
• Opportunities
• Innovative ultrasound liposuction technique under
  FDA review
• Clear exit strategyto be acquired
• Viagra introduction and concurrent advertising
  campaign generated an unprecedented amount of
  interest in impotence causes and treatments

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SWOT Overview

• Polymedica Corporation
• Potential for former venture capital fund manager
  CEO to further capitalize on diabetic and Senior
  demographic trends outweigh price pressures and
  regulatory concerns.
• Datascope Corporation
• Innovative, but aging management, recent
  restructuring enables company to have productive
  sales--no long-term debt and significant foreign
  currency exposure--make companys growth
  potential questionable but reasonable. With two
  bran new products and international exposure
  company can see formidable growth for years to
  come.
• Gentiva Health Services
• Company dominates Home Care and will benefit from
  demographic trends and growth in industry, but
  insider selling at 24, stock at 52-week high (as
  of April 22nd) confirms that stock is overvalued.
  
• Mentor Corporation
• Company will benefit from favorable demographic
  changes and growth trends in core businesses, but
  34-year CEO tenure, recent emergence from FDA
  consent decree, and significant earnings
  increases realized through cost savings and a
  recent acquisition leave make current
  management's ability to grow company
  questionable.

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4) Recommendation (A)

• Polymedica Corporation
• Access to capital
• CEO former venture capital fund manager
• Solid technology investments
• Co. leverages database of over 5 of all diabetes
  patients in U.S., free shipping, reoccurring
  order processing and automatic billing to retain
  customers and develop new product lines and
  services
• Regulatory concerns marginal
• Emerged from SEC investigation unscathed
• Strong market demographics
• Market share growth initiatives will be
  complimented by favorable demographic trends

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Recommendation (B)

• Datascope Corporation
• Solid Future
• With two bran new products Datacope
  will greatly increase their revenue stream.
• Cost Cutting
• Management is doing the right thing in
  curbing costs during recessionary times.
• Strong Market Demographics
• Just like Polymedica Corp, Datascope
  will accrue greater sales as the baby boom
  population ages.
• Good take-over candidate with only a 400 M
  market capital, while penetrating the
  international markets.