If I asked you to name the biggest game-changer in health care right now, you probably would think of things like personalized medicine, robotic surgery, high-resolution imaging or breakthrough treatments. They all would be good answers, as they certainly are changing the game and are a big reason why health care is such an interesting and profitable area in which to invest.
Another answer that most people don’t realize is a change in the way urgent care is delivered. I’m talking about the shift to what are called “hospitalists.” That might not sound as exciting as a monoclonal antibody that targets cancer like a smart bomb, but hospitalists are the fastest-growing medical specialty right now, and the company I’m recommending to you is an innovative leader in that industry.
Hospitalists, if you’re not familiar with the term, are doctors who work at a hospital or other health care facility and manage the care of patients at the facility. The days of your regular doctor “making rounds” are pretty well over. The reason, as I’m sure you can guess, is economics. Managed care has cut payments to physicians, so they make up the shortfall by seeing as many patients as they can in the office (sometimes too many!), which doesn’t leave time for hospital visits.
That’s where hospitalists come in. The term was coined in an article in The New England Journal of Medicine 15 years ago — around the time this specialty was coming into being. Since the mid-1990s, the number of hospitalists has grown nearly 6,000% from 500 to 30,000. In addition to primary care physicians benefiting from the additional time in the office, the hospitals also have financial incentives to use a hospitalist system because it gives them tighter control over care management and the use of hospital resources.
Change always is unsettling, and there are some who are not fans of hospitalists — mainly because they feel personal physicians are less involved with their patients’ care at critical times. There also is a risk that the quality of a patient’s care can be muddled with the involvement of many doctors. When executed well, though, the hospitalist system has advantages. Since the hospital is their office, hospitalists sometimes visit patients twice a day, and they are more readily available to meet with the patients’ families, follow up on tests and coordinate care among specialists.
No matter how you feel about hospitalists, the important point for us as investors is that they are here to stay, and their use should continue to increase. The best pure play is IPC The Hospitalist Company, Inc. (NASDAQ:IPCM), which has a fantastic growth record that is likely to continue well into the future. Here’s why:
Past, Present and Future
A big reason for IPCM’s success today is because it was one of the pioneers of the hospitalist industry. It began operations in 1998 and has grown to over 200 practice groups with more than 1,100 hospitalists. As one of the early players in the industry, IPCM built a solid reputation that helps it attract more facilities as well as doctors. (Two of the company’s physicians were recently listed among the top 10 hospitalists of the year by the American College of Physicians.)
The business model is similar to that of most other medical specialists, but on a much grander scale. It’s basically a humongous medical practice of 1,100 doctors that share resources. Patients are referred to IPCM’s hospitalists by other physicians and insurance plans — IPCM says its hospitalists work with more than 37,000 physicians and 3,300 insurers. Almost all of the revenue (94%) comes from fees charged for services provided to patients, and the other 6% comes from contracts through which IPCM receives fixed fees from facilities to provide primary physician in-patient care.
The company’s major expenses are for physician benefits and training, which were 72% of revenues. This makes sense as the recruitment of additional physicians is a key growth driver, and IPCM pays above-average salaries to stay competitive. It also removes all administrative burdens from the doctors and allows them to concentrate on their patients. Turnover was approximately 15% in 2009 and 2010. While I would prefer to see a slightly lower rate, the company maintains that it is not having difficulty recruiting physicians.
Enhancing IPCM’s leadership role is an innovative IT platform called IPC-Link that the company touts as “breakthrough.” It essentially is a virtual office customized to the needs of each hospitalist. IPC-Link handles everything from patient records to communication with primary care physicians and specialists (such as notifying them when their patient has been released) to billing to analyzing care, quality and productivity.
Speaking of billing, with the strong emphasis on cutting health care costs, there is plenty of talk about insurance reimbursement levels declining, but IPCM says its outlook for reimbursements is stable. I like the fact that, despite the number of hospitalists and patients involved, the company performs only a limited number of billable procedures. Just eight billing codes account for 85% of revenues, with nearly all of the reimbursements coming from Medicare (45%) and private insurers (44%). Medicaid (6%) and patients who “self pay” (5%) constitute the rest. In addition, average revenues per patient encounter are less than $100, so IPCM’s fees should not be a primary target of cost-cutting.
Once and Future Growth
The earliest available financial information for IPCM is from 2005, three years before the company went public, and growth has been prodigious. From 2005 to 2010, revenues increased an average of nearly 27% a year from $111 million to $363. Much of this growth came from buying medical practices — with the company spending $122 million in acquisitions. Some of these were in markets where IPCM already existed, so they tucked them into existing operations, and others allowed them to expand into new markets. IPCM was able to generate a good deal of operating leverage from the scale gained through acquisitions, and operating income increased more than tenfold from 2005 to 2010, reaching $39.32 million.
Solid growth has continued through the first nine months of this year. Revenues increased 28% as the number of patient encounters grew 26%. Operating income grew less at 21%, and diluted earnings per share edged up to 38 cents from 37 cents in 2010. Margins were pressured because IPCM added a disproportionately high number of doctors in third quarter — 78 of the 271 (29%) added over the preceding 12 months were in the third quarter — which not only meant more salaries, but also increased costs for doctor orientation, relocation, expenses and signing bonuses. However, this lays the foundation for growth, and IPCM believes margins will recover as these costs abate going forward and the doctors become more productive.
In view of margin pressures in the third quarter, management did guide for full-year 2011 earnings to come in at the low end of their previous guidance range of $1.78 to $1.86 per share. But even if they only hit the very bottom of $1.78, that still would be 22% growth over the $1.46 earned in 2010. The market seems to like the growth and expected recovery in margins, as IPCM has been a relatively strong performer since the Oct. 27 earnings release.
Longer term, the future looks very bright. There currently are 30,000 hospitalists in the country — a number that continues to increase. And with just more than 1,100 affiliated with IPCM, the company has substantial room to grow. IPCM is respected in the industry, has a history of profitability and growth and has demonstrated its abilities to make smart acquisitions and add physicians that provide quality care. I look for earnings to continue to grow 20% or more per year for at least the next couple of years, and that growth could accelerate depending on future acquisitions.
