Healthcare Sector Analysis
Prepared by
Ariel Imas
Robert Candella
Nanda Win
Student Managed Investment Portfolio Class
Prof. P.V. Viswanath
Spring 2002
Objective
• To research, evaluate, and present potential equity-investment
opportunities in the U.S. healthcare sector.
Research Methodology
4-fold approach:
1) Industry analysis
2) Quantitative analysis
3) Corporate analysis
4) Recommendation
1) Industry Analysis
•
•
•
•
Total universe identified
Elimination criteria applied
Financial ratios vs. industry benchmarks evaluated
Industry analysis performed
Total Universe Identified
• U.S. Healthcare stocks isolated using StockVal:
724 stocks in population
Elimination Criteria Applied
• Stocks remaining after elimination criteria applied:
246 stocks - Total assets > 200M
41 stocks – Leverage regression
18 stocks - Price/Free cash flow
Financial Ratio vs. Industry Benchmarks
Evaluated
•
•
•
The financial ratios were selected to complement the model inputs
later required for the quantitative analysis.
Financial ratios
1) Financial Strength
2) Profitability & Effectiveness
3) Growth
4) Valuation
5 stocks remained after ratios were considered
Financial Ratios
1) 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 shareholder’s equity
– Total Debt / Equity
• Measures effective use of total debt with respect to changes in the
shareholder’s equity
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 shareholder’s 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
Financial Ratios
3) Growth
– Revenue Growth LFY
• measures firm’s ability to increase revenues
– EPS Growth LFY
• measures firm’s ability to generate income (less dividends) per unit of
stock
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
1) Industry Analysis
Top 5 stocks (in order of ranking):
1. Polymedica Corporation – Medical Products
2. Gentiva Health Services Inc. – Home Healthcare
3. Datascope Corporation – Medical Products
4. Mentor Corporation – Medical Products
5. Invitrogen Corporation – Biotech
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.
1) Industry Analysis
• Industry view:
1. Biotech: will benefit greatly from genome research, but will not
mature until patent suits and R&D investments are realized in
another 4-5 years. Unfavorable.
2. Home Healthcare: benefiting from aging U.S. demographics and
low-cost alternative to hospital care. Aggressive pricing will
continue to drive current profitability. Favorable.
3. Medical Products & Equipment: benefiting from aggressive
pricing and growing world market. Favorable.
1) Industry Analysis
Final 4 stocks (in order of rank):
1. Polymedica Corporation – Medical Products & Equipment
2. Gentiva Health Services Inc. – Home Healthcare
3. Datascope Corporation – Medical Products & Equipment
4. Mentor Corporation – Medical Products & Equipment
2) Quantitative Analysis
1. Model selected:
Type:
Two-stage Free cash flow to equity discount model
Purpose:
To value the equity in a form with two stages of growth—an 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
2) Quantitative Analysis
Model Value vs. Market Value
Company
Polymedica Corp. Datascope Corp. Gentiva Health Services Inc. Mentor Corp.
Ticker
PLMD
DSCP
GTIV
MNTR
Model Value
$47.55
$57.35
$23.94
$36.08
Market Value
$36.50
$32.98
$25.78
$38.25
Model vs. Market Differential
30%
74%
-7%
-6%
Status
Undervalued
Undervalued
Overvalued
Overvalued
2) Quantitative Analysis
Polymedica Corporation
2) Quantitative Analysis
Datascope Corporation
2) Quantitative Analysis
Gentiva Health Services Inc.
2) Quantitative Analysis
Mentor Corporation
2) Quantitative Analysis
Subjective variables considerations
1.
High-growth rate weights:
•
•
•
2.
Historical growth rates
Outside prediction of growth rate
Fundamental prediction of growth rate
High-growth rate growth estimates:
•
•
•
•
3.
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
2) Quantitative Analysis
Subjective variables justifications
1.
High-growth rate weights:
•
2.
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 model’s stock price and
concurrently diminished the significance of the group’s fundamental
research.
High-growth rate growth estimates:
•
3.
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 company’s 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.
3) Corporate Analysis
Considerations:
•
Management review
•
Insider activity
•
Institutional activity
•
SWOT analysis
•
Corporate Overview
Management Review
• Of all stocks, Mentor Corp. ranked #1
• Of undervalued stocks, Polymedica ranked #1
Title
Age
Tenure (years)
Salary
Bonus
Other Compensation
All Other Compensation
Other Compensation
Polymedica Corp. Datascope Corp. Gentiva Health Services Inc.
PLMD
DSCP
GTIV
CEO
CEO
CEO
54
73
48
12
N/A
3
Mentor Corp.
MNTR
CEO
62
34
$397,460
$1,160,000
$0
$6,550
$1,564,010
$1,000,000
$1,175,000
$281,305
$17,590
$2,473,895
$458,654
$650,000
$7,777
$3,758,078
$4,874,509
$390,000
$0
$0
$4,552
$394,552
Net Income
Salary as a % of Net Income
Mean
% from average
Score
$22,734,000
7%
10%
-29%
2
$34,243,000
7%
10%
-25%
3
$20,988,000
23%
10%
141%
4
$32,078,000
1%
10%
-87%
1
Exercised Stock Options
Exercisable Stock Options
Unexercised Stock Options
Total Stock Options
37,024
347,881
66,542
451,447
325,000
215,000
0
540,000
0
727,073
90,000
817,073
100,000
260,500
183,500
544,000
8%
22%
-62%
2
60%
22%
177%
4
0%
22%
-100%
1
18%
22%
-15%
3
4
2
12
3
4
2
3
1
% Exercised
Mean
% from average
Score
Product
Rank
Insider Activity
• Of all stocks, Mentor Corp. exhibited an insider buying trend
• Of undervalued stocks, Polymedica Corp. exhibited an insider buying trend
Institutional Ownership
# of Institutions
Current Activity
Polymedica Corp. Datascope Corp. Gentiva Health Services Inc. Mentor Corp.
PLMD
DSCP
GTIV
MNTR
95.0%
71.6%
69.9%
82.1%
283
238
168
285
Buying
Selling
Selling
Buying
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
# Institutions
Total Shares Held
% Shares Owned
3 Mo. Shares Purchased
3 Mo. Shares Sold
3 Mo. Net Change
% Change
# Buyers
# Sellers
Total
# Net Buyers
Trend
Polymedica Corp. Datascope Corp. Gentiva Health Services Inc. Mentor Corp.
PLMD
DSCP
GTIV
MNTR
113
101
86
133
12,287,280
10,508,648
15,802,032
18,868,990
102%
71%
61%
81%
1,545,967
(1,817,093)
(271,126)
-8%
1,004,944
(872,439)
132,505
7%
4,789,582
(5,053,975)
(264,393)
-3%
4,987,289
(2,447,674)
2,539,615
34%
50
55
105
-5
39
57
96
-18
53
31
84
22
67
59
126
8
Selling
Buying
Selling
Buying
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 today’s demographics, Polymedica Corp relies on government
programs to receive most of their profits.
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.
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.
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.
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 PLMD’s 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.
Threats:
•
With an advance in technology, elimination of consumable testing supplies for glucose monitoring is inevitable. This line consists of a
major portion of Chronic care sales
•
Reorders by patients are questionable due to customer preference, competitive pricing pressures, customer transitions to extended care
facilities and mortality rate
•
Competition with in this market is fierce. Price pressures and market share are difficult to achieve
•
Government controls companies destiny; limited budgeted expenses towards healthcare
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
Threats:
•
Foreign Rate Fluctuations can impact earnings
•
Costs with in company can increase
•
Lower R&D investment can weigh negatively on the company
•
Competition is strong, can force profits to dwindle
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
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 strategy—to be acquired
•
Viagra introduction and concurrent advertising campaign generated an unprecedented amount of interest in impotence causes and
treatments
Threats:
•
FDA regulation
•
Failure to develop existing distribution channels
•
Government and market cost containment measures
•
Strong dollar
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 longterm debt and significant foreign currency exposure--make company’s 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.
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
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.