Writeup of HBOC and its industry in Briefing.com:
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Updated: 22-Jun-98
StreetBeat is designed to provide you with additional insights on the market from recognized financial experts
on (and off) Wall Street. Please note that the views and opinions expressed by the panelists below are not
necessarily those of Briefing.com.
This week's topic: Healthcare Information Technology
Panelists
Stephen DeNelsky, Vice President, Equity Research at Furman Selz.
Anthony Vendetti, Vice President, Equity Research at Gruntal & Co.
Q&A
Briefing: Given their relative lack of Asian exposure, do you expect the healthcare software
group to be among the more dependable earnings performers this quarter? Do they warrant
continued investment despite their high valuations?
Stephen DeNelsky: I don't expect that the trouble in Asia will have any negative impact on the healthcare
information service companies (HCIS) as most of them have no Asian exposure. Shared Medical Systems (SMS)
has the largest international exposure at about 10-14% of revenues and nearly all of that is in Europe and
Europe has been a tough environment for the HCIS group for two main reasons. First, it is dominated by the
single-payor system which has made providers in health care institutions slow to adopt information system
software and left margins very narrow. Second, European companies are focusing their IT spending on the the
conversion of the Euro and the Y2K problem, the first of which must be addressed by Jan 1, 1999. HCIS
companies are getting a toe-hold in Europe in anticipation of the growth potential following Jan 1999. In the
long-run, Europe will not be able to maintain the single-payor system because it is too expensive and as the
healthcare industry is forced to become competitive, it will be imperative to have software to automate systems.
I think that the HCIS group is still a good investment even at these levels because they continue to be one of the
highest growing, recession proof segments. While the stocks are not cheap, I think that the prices are not
excessive given the outstanding growth prospects.
Anthony Vendetti: Healthcare information technology (HIT) companies are one of the few sectors of technology
that will not be impacted by Asia. Shared Medical Systems (SMS), for example, has the greatest international
exposure - about 14% of revenues which includes Canada. Subtract Canada, and only about 10% of revenues
comes from overseas and most of that is in the UK. HBO & Co (HBOC) is in a similar position, with about 5-7% of
revenues from abroad and most of that is also in the UK. In both cases, less than 1% of revenues comes from
Asia. In a market down-turn, these stocks will certainly be hit, but not because of fundamentals. It will be in
response to the trading mentality of sell first, ask questions later. We think that this is a strong sector with
excellent growth potential and in most cases, would view weakness in the stocks as a buying opportunity.
We initiated coverage of six HIT companies in 1997 (we now cover nine) when the group was trading at a P/E of
45.2x and the P/E for the S&P was 23.7x. The 1998 and 1999 estimated P/E for the HIT companies is 33.4x and
24.9x, and for the S&P, it is 21.3x and 19.8x, respectively. While these companies continue to trade at a multiple
well above the S&P, the disparity is coming down. Therefore, the direct answer is yes, we would be buyers at
these seemingly high levels, but we caution investors to do so selectively. The healthcare industry is
underinvested in term of dollars spent on information technology. In fact, I think that its at least 10-15 years
behind other industriesin technology and automation. Industries like airline and banking spend about 5-10% of
revenues on IT versus healthcare that spends less than 2%. Adoption of technology has been slow but as
providers and payors are forced to be more efficient, we will see incremental increases in IT spending until we hit
an inflection point at which time we expect to see an acceleration in HIT sales. This nascent-stage industry, a
hybrid of technology and healthcare, promises to be an excellent investment for the future due to the
tremendous growth prospects driven by macro health forces.
Briefing: Which companies stand to benefit the most from the consolidation taking place in
the healthcare software and services market?
Stephen DeNelsky: The larger companies will be the beneficiaries because they have the economic means to
consolidate the smaller companies and because it is sometimes cheaper for them to acquire technologies than it
is to develope it in-house. I think that the Y2K issue comes into play here because hospitals need to be
compliant and at this time only about 9% of healthcare IT budgets are being spent on Y2K. By next year, I think
that we will see Y2K spending in healthcare jump to around 25% of IT budgets which may squeeze some
spending in cutting edge IT areas. Many smaller HCIS companies will find it difficult to return to the financial
markets and will have trouble sustaining themselves over the next few years. They may decide to sell to the
larger players like HBO, Cerner, IDX and Shared Medical.
Anthony Vendetti: The company that will benefit the most is HBOC. To date, they have been the largest
consolidator in the industry which has contributed significantly to their outstanding growth rate. Other companies
have made small acquisitions, but lack the capital or the currency for stock swaps that HBOC possesses. HBOC
has $470 million in cash on the balance sheet and no debt. Their price appreciation reflects the 10th best
performing S&P stock over the last five years, although they were only added to the S&P last year.
Briefing: What obstacles, if any, may be standing in the way of the optimistic growth
prospects for the healthcare software group?
Stephen DeNelsky: Most of the stumbling blocks that appear in the HCIS group are more company-specific
rather than in the macro environment. I seen nothing in the sector on a macro level to stunt the growth in the
industry. The problem we have seen and may continue to see in isolated cases is a company getting ahead of
itself - that is investing too much in R&D in terms of building a product. The endgame is not about technology but
rather functionality and a technology that is too far ahead of the market and is too expensive will have few
buyers. It is truly a good sector but investors have to be cautious about over zealous management teams that
have predicted that the HCIS market will grow faster than it has.
Anthony Vendetti: There are two immediate issues which could slow or defer growth in HIT - the Y2K problem
and slow adoption of the technology by clinicians. Clinical systems are poised to be the next wave of growth in
HIT. Approximately 95% of all medical records are still in paper form and thus far automation has occurred mainly
on the billing and claims adjudication front. There is tremendous growth potential as doctors/clinicians become
more computer literate and HIT products increase in functionality. However, the rate at which doctors will be
willing to exchange their clipboards for a computer-based system will probably be slow initially. As doctors ban
together to wrestle some of the power away from managed care organizations, automated systems will become a
necessity - it is not a matter of if but a matter of when. Medicine is increasingly moving toward a business with
cost containment as a driving force. It is a classic case for automation.
Briefing: Which stocks are you recommending and/or avoiding?
Stephen DeNelsky: I have a STRONG BUY on HBO & Co (HBOC) and Cerner (CERN). I have a BUY on IDX
Systems (IDXC) and National Data Corp (NDC). I am cautious about Shared Medical Systems (SMS) at this
point. They are a quality company but I think that they are fully valued until we see the launch and sales
performance of their new client/server product, Novius in the next year.
Anthony Vendetti: HBO & Co (HBOC) is clearly the group leader. I have a STRONG BUY on the stock along
with Cerner (CERN) and Transition Systems (TSIX). CERN looks to be over their troubles and has spent the
last 4-5 years developing the HNA Millennium, their client/server product. I also have a STRONG BUY on HCIA
(HCIA) which is a turnaround situation and a leader in benchmarking tools and analysis.
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Doug |
