In news just released, Kindred (the post-acute, skilled, rehab and LTAcH behemoth) has made two separate offers to purchase control of Gentiva, the latest a $14 per share offer consisting of half cash, half stock ($7 and $7). An earlier offer of $13 per share was rejected and it appears the $14 offer will see the same fate. Prior to the news, Gentiva stock was trading in the mid $6 range, down 20% over the preceding 12 months. The value of the “deal” is pegged at $1.6 billion with $533 million of the total in cash and stock, the balance in assumed Gentiva debt. On a combined basis, Kindred/Gentiva would weigh-in at $7.2 billion in annual revenues, operating in 47 states.
To date, Gentiva has held fast that it is not for sale and that its present plan, implemented as One Gentiva will create more shareholder value over-time than the Kindred offer. In December, I wrote a similar analysis post on Gentiva/Harden (the merger) and the home health industry. The post can be found at http://wp.me/ptUlY-fV . In this post, I commented on the clear flaws in the One Gentiva strategy; principally the broadening of reimbursement risk strategy that is at the core of this strategy. While Gentiva posted a modest recent quarter profit after $180 million loss, virtually all of the reported gain was a result of accretion from the Harden transaction, not improved operations. For example, adjusted income attributable to Gentiva shareholders for the first quarter 2014 was $4,8 million compared to $7.1 million twelve months prior. Net cash provided by operating activities for the first quarter was negative $17.7 million vs. negative $20.6 million one-year prior – not a resounding improvement. Essentially, the fundamentals of the company are not improving and in some cases, set to erode going forward as the lion share of its revenues are Medicare home health and Medicare hospice (Odyssey) driven (88.5%). Both Medicare programs face down reimbursement trend pressure, home health dramatically more so than hospice. Hospice however, is under enormous industry-wide pressure due to continued fraud investigations among major players and the loom of federal program reform (the Medicare hospice benefit). Essentially, hospice is a no-growth industry now.
Reviewing multiple factors and general industry trends plus the health policy and economic outlooks for both companies and the post-acute industry globally, below is my analysis of the factors influencing (or should influence) the Kindred and Gentiva position.
Kindred: Where Gentiva has a reimbursement risk concentration problem, Kindred has a location of care or outlet concentration problem. Kindred is brick and mortar deep/heavy, actually too heavy. Institutional outlets, especially in-scale and capacity are shrinking. The revenue needs required to support institutional care, on a post-acute basis, are increasing while reimbursement is flat to falling. The LTAcH and SNF trends are flat and the operational efficiencies available to any provider are minimal, save offloading or minimizing debt. The quality expectations evidenced in regulation and pay-for-performance models won’t allow any significant reductions in variable costs today. To be an institutional player of success, one must have broad clinical capacity, right-sized bed compliments that match payer demand (occupied by the highest payers at high occupancy levels) and non-institutional outlets to capture discharge revenues plus participate in global contract arenas and networks (ACOs, etc.). Kindred lacks the home health/hospice scale, especially on a matching outlet basis in its respective markets. Gentiva adds this element, though at a bit of a risk via the amount of debt that Kindred would assume. The acquisition is not without risk or a sure-winner. True Gentiva brings the home health/hospice/community care component that Kindred needs as well as the scale to be immediately impactful, it simultaneously adds another level of reimbursement risk and industry risk that Kindred already has on a large-scale. Managing and integrating the Gentiva elements into Kindred’s longer range provider of choice model will not come easy. Likewise, the Gentiva acquisition will only mask temporarily, the fact that Kindred needs to right-size its own portfolio post its acquisitions of Rehabcare and Integracare (the latter a Texas limited home health/hospice provider) while still holding and operating, too much inpatient real estate that isn’t optimally performing in many markets. In essence, the play makes sense but not fully positive until all the pieces are brought tightly together; a difficult and time-consuming endeavor.
Gentiva: Gentiva has the same problems that Amedysis has and had – it needs to shrink but it can’t. Gentiva has too much debt and in a reimbursement environment that trends flat to down, it cannot grow itself out of its debt problem by “more of the same”. It’s diversification strategy through the Harden acquisition is too little, too late and not scalable fast enough to have meaningful impact. It similarly, can reduce expenses fast-enough via consolidation as it must chase revenue growth to survive and the revenue growth that pays the most is Medicare – a risk concentration it already has too much of. It needed to re-tool 8 to 10 years ago, balancing its revenue model and expanding its clinical capabilities beyond the typical home health outlet. Additionally, it needed to become more local-market centric and not simply a Medicare reimbursement machine like Amedysis (an accident waiting to happen). The notion that its One Gentiva plan can create more value for Gentiva shareholders that the Kindred offer is wrong-headed. Sans takeover talk, Gentiva trades between $6 and $8 and no upward trajectory is visible. A simple return analysis illustrates that a Gentiva shareholder will wait at least 18 months or more to equal a return of $14 today, excluding opportunity costs on the investment. Similarly, the risk concentration elements that could turn such an outlook even more dire are more than double on the Gentiva holding than on a comparable dollar for dollar holding with Kindred. Kindred simply has more ways to generate revenue, a more stable expense base, lower fixed costs and less reimbursement risk concentration than Gentiva. If Gentiva chooses not to sell, holding out for more than $14, I think the shareholders will pressure such a move in the near-term future. The Kindred offer, with debt assumption is in my opinion, a max value offer that 12 months from now, is off the table.
A couple of weeks ago, I wrote a post covering the Home Health PPS Final Rule for 2014. As I was writing that post, I simultaneously reviewed the Gentiva/Harden deal plus the recent quarterly earnings of Amedisys and Almost Family (plus their acquisition of SunCrest HealthCare). The earnings reports plus the analytics from these two recent transactions paint and interesting picture of where the Home Health industry is headed.
Starting with Gentiva/Harden, and analogous to the Almost Family/SunCrest deal, the transactions are not due to growth or really expansion; rather each is about creating defensive scale. Gentiva/Harden is a bit of an oddity in so much that Harden has a brick and mortar component via ownership of a small portfolio of skilled nursing facilities in Texas. This element however, is not a complimentary piece for Gentiva and as such, my prediction is these facilities will divest from Gentiva post a final roll-up period. The SNF piece is not what they do nor does it really provide a significant source of additional volume or revenue, net of the risk and asset holding cost. Harden grew out from the facility ownership side and thus, the SNF component was in their “wheelhouse”. The same is not true with Gentiva. Regardless of the rhetoric from Gentiva regarding keeping all management, integrating all components, etc., transactions of this scale don’t work that way – they never do. The outlet pieces and the home health book of business is what Gentiva is after.
The same is true in the Almost Family/SunCrest deal with one exception – it’s a home health – home health deal. Almost Family is looking for outlets and the home health book of business to create scale and volume insulation. To a certain extent, both transactions are also about “book of business” diversification; more so in the Harden deal. Almost Family and Gentiva have a risk concentration in their home health revenue models known as Medicare. As my post on the Home Health Final Rule covered, Medicare is a payment source that is shrinking via overall outlay and directed payments per episode. The belief among Gentiva and Almost Family is that mass, ideally scalable via more outlets and more efficient infrastructure will insulate the revenue and thus, earnings impact. In short, even if the margin per each case falls, if more cases are attainable and the incremental expense in doing so is proportionately less than the incremental revenue gain (ideally by a factor of greater than 20%), then it makes sense to increase volume. That’s the theory at least.
Looking at where Gentiva and Almost Family started in terms of earnings reports prior to or concurrent with the referenced transactions, each had their share of performance issues. Almost Family posted an earnings surprise (per share) positive (11% up over consensus) but delving into the numbers shows a continuing performance problem. Additionally, the net impact of additional Medicare cuts foreshadows more negativity in the upcoming quarters, even in spite of the SunCrest deal. It will take Almost Family all of 2014 to absorb and re-define the benefits or difficulties of the SunCrest deal, In the meantime, their risk concentration in skilled nursing and Medicare remains high. Their savior in the interim is a steady growth outlook for their non-Medicare personal care business. Volume growth remains attainable but in order for a continued bright earnings outlook, the growth in personal care, a less revenue rich source than skilled home care, must be equal to or greater than the revenue reductions forthcoming under Medicare. My view is that in the interim, pending absorption of SunCrest, net income and revenues will flatten or trend slightly down.
Gentiva is moving on a parallel trend to Almost Family, with one exception – Odyssey. Gentiva owns the nation-wide hospice provider Odyssey and as such, a twist that separates or bifurcates its strategy from Almost Family exists. On the home health side, Gentiva is seeking outlet growth and looking to expand its presence in the non-Medicare, personal care world as well as the Medicaid waiver world commonly known as Home and Community Based Services (HCBS). The Harden acquisition is the jump for Gentiva into this niche. Prior to Harden, Gentiva was a non to bit player in the non-Medicare, personal and community care environment.
For the nine-months ending September 30, Gentiva lost $197 million. Not surprising, the company announced, post the Harden disclosure, a consolidation and restructuring plan called One Gentiva. The intent is to tighten operations, reduce redundancy, and coordinate revenue opportunities more closely between its home health operations and its hospice operations (Odyssey). The Odyssey segment revenue contribution shrunk by 7.5%, year over year. Hospice clearly is a struggling segment as the overhang of the Vitas suit plus the changes in certification requirements and coding have effectively narrowed or literally closed, resources commonly used by providers like Odyssey to capture patients and attract new business. The One Gentiva initiative will no doubt, further shrink the Odyssey/hospice component, both in terms of outlet numbers and operational infrastructure components in an attempt to mitigate further revenue and earnings erosion to Gentiva consolidated.
Placing all of the above into context and adding a quick peek at Amedisys, the home health industry is clearly struggling and trying to rebalance. Amedisys, once the biggest player in the home health industry, continues to reel post a series of federal investigations and fraud allegations. Their recent settlement ($150 million) with the Department of Justice regarding Medicare improper billing allegations added another nail in a coffin that continues to emerge. Continued losses, closure of outlets, and further Medicare reductions foretell a near future of non-existence. My prediction is that Amedisys will soon be restructured to a private company via a private equity transaction. The future for them is bleak and the industry outlook for Medicare home health providers of which Amedisys dominated, is fraught with revenue decline and earnings suppression.
The focus on the near future for companies like Almost Family and Gentiva is about survival. Can the strategy of creating greater scale and volume in a declining revenue environment continue to produce positive earnings? If the theory that when the margin per each drops, doing more per “eachs” with a controlled incremental expense element lower than the incremental revenue produced through greater volume is accurate, then at some point earnings improve. Unfortunately, I have never seen this theory play-out in a home health or health care environment. By its operational nature, home health is fairly inefficient in terms of staffing productivity and volume efficiency. Within a volatile landscape, the inefficiencies increase as more variables are operative that can quickly, change referral patterns and volume fortunes. Revenue always erodes faster than expense particularly since the bulk of the expense is staff that can’t be quickly recruited, trained and then fallowed when volumes decline or stagnate.
The other side of the strategy, diversification away from the Medicare risk concentration via increased volume in the personal care, Medicaid world offers some hope but it is not a silver lining. True, dual-eligibles (Medicare/Medicaid) provide greater revenue capture opportunity but not without assuming another element of governmental payer risk – Medicaid. Medicaid has its share of problems and in the HCBS world, the providers therein paint a picture of cuts as demonic as in the straight Medicare world. In virtually every state, Medicaid has a “spend-less” charge not a “spend-more” profile, even with Obamacare. Medicaid expansion under the ACA drops cash into state coffers but only to address the increased enrollment of folks who are under 65 and uninsured. This group is not a big user of HCBS or home health. The 65 plus group that dominates the HCBS world and is the personal care side of the industry does not benefit via Obamacare and thus, states continue to seek ways to limit the financial impact to state funded Medicaid via HCBS. As more states move to a Managed Medicaid model, the impact of shrinking or constraining Medicaid cash outlays for HCBS and personal care is just now emerging. In short, I just can’t buy the notion that diversification toward a Medicaid component is a salvation or a counter-balance to revenue reductions on the Medicare skilled side. The impact in my opinion, is nominal in the near-term and perhaps equally or greater negative over the next two to three years.
In Part I, I wrote about my last week’s conversations, etc. regarding the home health industry, specifically Amedysis, the Senate Finance Committee inquiry, the industry impact via the PPACA and the likely consolidation and merger trends that are approaching. Suffice to say, not all of last week’s news and conversations focused on the home health industry as over the last thirty days, much has happened in the hospice industry as well. The difference between the two industries is that in hospice, the major news involved a significant merger and in home health, the major news involved the legal and compliance issues of the largest provider entity – Amedysis.
The hospice industry saw, via the merger between Gentiva and Odyssey, the creation of the largest home hospice company in the industry. Gentiva, while also a provider of home health, clearly chose to direct more of its attention to the hospice industry, moving from a moderate player in the industry to the predominant player via the acquisition of Odyssey. Odyssey, while not as large as Vitas (the former largest hospice provider), held substantial market share and presence and in many regions and distinct market areas, competed head to head with Vitas for patients. For more information on the Gentiva/Odyssey transaction, see a related article in my company’s E-Newsletter at http://wp.me/pD9Ac-4Q .
Analyzing this merger leads me to a series of assumptions about where the hospice industry is at present and where it is likely headed.
- Hospice is now clearly a mature market or in other words, a market that is unlikely to grow significantly over the near to intermediate term horizon. Despite a fairly profound demographic shift occurring over the next twenty to thirty years (the maturation of the baby-boomers), there is no real indication even with this influx of older adults, that hospice as model of care, will gain in referral popularity. While seniors utilize hospice more in total numbers than any other age cohort, as a percentage of the total cohort, utilization trends show little forward growth. There are a number of reasons why;
- Culturally, U.S. medicine and the U.S. population still values the process of cure or health restoration far greater than the concept of natural death. As hospice is a downstream referral (the referral comes typically from non-palliative medicine trained physicians or via hospitals and/or long-term care providers), the hospice industry relies on the referral source to be; a) knowledgeable about the value of hospice and how it works for patients and their families, b) willing to forego potential incremental revenue for continued care by making the referral to a hospice, c) willing to engage the patient and the family in a difficult conversation regarding end-of-life and treatment futility. As long as these dynamics remain in place to the extent they presently are, the growth of utilization will remain fairly stagnant.
- Financially, the incentives for referrals to hospice don’t truly exist within the current U.S. system. There are no barriers in-place to reduce the reward (payment) for continued acute, diagnostic or curative care (choose your own verbiage) and as a matter of fact, the reimbursement systems (private and public) pay incrementally more for more intense care than palliative care, even if arguably, the care is futile. As only patients and their respective treating health professionals can conclude that continued curative care is futile or unreasonable, the process of garnering more money for more treatment remains intact as a perverse incentive.
- While not for hospice people or physicians trained in palliative medicine, terminality remains an uncomfortable and even disputed condition for many physicians. Patients and there families still wish to avoid discussions far too long and in some cases, avoid the discussion altogether. While in-roads are perhaps being made in some medical centers and in certain communities, these in-roads are miniscule and not evident of a ground-swell movement toward open discussions regarding end-of-life decisions.
- As with the home health industry, the movement in Washington is toward curtailing the growth of hospice spending. The prevailing feeling in Washington policy arenas, supported by Medpac, is that the hospice reimbursement under Medicare is too generous and the benefit itself, easily manipulated and poorly defined. While the PPACA did little to negatively impact the hospice benefit or payment, the recommendations directed to the Secretary of HHS in the language intones significant changes forthcoming.
- Reimbursement under Medicare will change such that early days in the initial benefit period will be paid more as will days at the end of the patient’s stay (proximal to death). Days during the interim, longer stays will be reimbursed with lower payments. The point here is supposedly a recognition that patients with long stays have periods of stability necessitating far less care from the hospice.
- More emphasis will be placed on denying stays for non-specific terminal conditions or denying portions of stays. CMS has determined that too many longer stays are related to diagnoses such as terminal dementia, failure to thrive, etc. In order for these stays to be covered, the onus will fall on the hospice to provide very detailed documentation supporting patient decline.
- More emphasis will be placed on physicians to document terminal conditions and to prognosticate length of likely survival, especially at recertification periods. More direct “hands-on” involvement of physicians will also be required (physically seeing the patient).
- Certain types of stays and relationships between hospices and nursing homes will be closely monitored and reviewed. CMS and Medpac have determined that hospice stays in nursing home environments on behalf of nursing home patients are considerably longer and possibly in many cases, in violation (the hospice) of the conditions of participation as hospices utilize nursing home residents as sources of revenue but often, fail to meet the care requirements (using the nursing home as the source of care and service) under the hospice federal code. Additionally, CMS and Medpac have placed the target for reform squarely on the large for-profit hospices such as Vitas, Gentiva and Odyssey which have typically used nursing homes as major sources of referrals for hospice patients.
- The PPACA, while not bending the cost curve or reducing the overall level of national expenditures on health care, does change in the interim, the overall health care economy. Providers are re-positioning and re-grouping to combat what they perceive, and in some cases know, will be negative changes to how they presently do business. Providers which rely heaviest on Medicare as the bulk of their overall revenues will move the fastest and the most aggressively to alter their current business practices, knowing that regardless of the overall status of the PPACA (repeal, restore Medicare cuts, etc.), the health care economy is entering a long period of fiscal constraint – payments will never be as high or as fluid as they once were.
- Because of points 1, 2 and 3 above, the industry will head into a period of consolidation and even, contraction. The Gentiva/Odyssey merger is a signal of the maturity of the industry and the trend toward tighter regulation of hospice stays under Medicare (the bulk of the hospice revenue) and less economic value per each stay. Lower future revenues per stay, either via reimbursement cuts or regulatory constraints placed on the length of stay, means more overall stays are required to equal the same or greater revenues going forward. As the growth curve of new “potential” referrals is flat, the only real source of new business or referrals for a provider is acquisition of existing market share (buying someone else’s referrals). In order to maximize profitability in an environment where the market is mature and the total revenue per each case is flat to shrinking, providers will have to adopt one of the three strategies below.
- Acquire other providers to build more referrals or volume. While each patient stay will be economically less valuable, increasing the total number for a provider while maintaining expenses on a ratio basis, lower than revenue, will provide a method to achieving overall net income targets – critical for publicly traded provider organizations.
- Shrink the organization to fit the new revenue and length of stay realities that are in place and forthcoming. An organization that can right-size its operations to fit the new business paradigm will be smaller but potentially equally or perhaps, more profitable. The risk here is that provider organizations that are acquiring market share may marginalize some markets such that a shrinking provider (by choice) loses desirable market share.
- Expand non-Medicare business and add complementary businesses that may provide incrementally equal or more revenue than that which is lost under Medicare. Arguably, this strategy may only work for regional or single market providers and those that have strong system ties (hospital owned, etc.).
One final point to note concerns the economy. Absent from the above factors I laid out influencing the hospice industry is the stagnant economy. With recovery a daily discussion regarding likelihood and timing, current uncertainties persist that impact hospice providers rather dramatically.
- The overall number of paying patients available to all providers within the health care economy has shrunk in recent years. This shrinkage is primarily due to job losses and benefit losses. Until employment rebounds and jobs with benefits become more plentiful, consumers for health care in the form of paying patients will remain down.
- When fewer paying patients are in the queue, those patients that do have a payer source, even a less than optimal government payer source, are prized commodities. Each provider wants a piece of the same paying patient.
- Hospice is as I pointed out, a downstream referral. When the upstream referral source, principally hospitals, lacks sufficient paying patients in the queue to replace current patients it “may” customarily refer downstream, it holds the paying patient longer, either delaying the referral and the portion of revenue that comes with a longer stay or avoiding the referral all-together. Similarly, all downstream referral sources such as nursing homes compete aggressively for the referrals even though a referral of a terminal patient (or potentially terminal patient) is ordinarily, not a prize catch for most nursing homes. This competition erodes the number of total possible referrals available to a hospice.
- Each patient has an economic value to a provider. When a patient with a higher economic value (a better payer source) are lacking, providers sort down to the next patient level. This sorting process occurs as a result of too few patients with payment sources available to match the supply or capacity within the existing provider universe. Some markets hit hardest by the downturn will evidence this reality in greater depth and unfortunately, with greater persistency. For hospices (and all downstream providers) in these heaviest hit markets, referrals have trended down and will stay down until the supply of patients with payment sources increases and specifically, the supply of patients with better payment sources and today, deferred health care needs (e.g., elective surgeries such as joint replacements, etc.).