Special Features Long-Term Health Despair

By Brian Graney

(Dec. 21, 1999) --For the second year in a row, it was a tough year to be a publicly traded long-term healthcare provider. The entire industry, and the skilled nursing facility segment in particular, was among the worst performing sectors in the market in 1999, which is not too surprising considering that most of these companies also had their heads handed to them in 1998 as well. The one-two punch of Medicare reimbursement cutbacks and governmental fraud investigations sent the shares of nursing home operators crashing down as earnings dried up and investors ran away from the business. As the year draws to a close, many operators are in critical condition financially, with several already having slipped into full-out bankruptcy comas.

The destruction has been startling, as the following chart shows:

Company                               52-Week High    12/10/99 Price   % Decline  
Beverly Enterprises (NYSE: BEV)         $8 3/16          $3 7/8          -52%
Manor Care (NYSE: HCR)                  $33 1/2        $16 1/16          -52%
Genesis Health Ventures (NYSE: GHV)      $9 1/2          $2 3/8          -75%
Centennial HealthCare (Nasdaq: CTEN)   $15 9/16        $2 15/16          -81%
Integrated Health (NYSE: IHS)         $14 11/16           $9/32          -98%
Vencor (OTC BB: VCRI)                        $5          $0.085          -98%
Mariner Post-Acute (OTC BB: MPAN)        $6 3/8           $0.09          -99%
Sun Healthcare (OTC BB: SHGE)            $6 7/8           $0.04          -99% 

For the most part, the companies that find themselves in bankruptcy proceedings and trading in the pink sheets can only blame the government to a certain extent for their inglorious fates. An emphasis on the most risky patient profiles produced high levels of Medicare reimbursement revenues when the going was good for these firms in the early 1990s. Go-go growth investors piled on as the companies shifted gears into all-out consolidation mode in the middle of the decade, a strategy that produced not only higher earnings but enormously leveraged balance sheets in the process. Between 1995 and 1998, the buying spree effectively dwindled the number of publicly traded nursing home operators from 28 to 10.

The music stopped in 1997, however, when the federal government started to rein in Medicare spending growth as part of the Balanced Budget Act and ditched its long-standing cost-based reimbursement system for nursing homes. In its place, regulators opted for a fixed-fee prospective payment system (PPS), similar to the model used by the hospital industry for over a decade.

Suddenly, nursing homes that had grown accustomed to asking for -- and receiving -- federal reimbursements of $500 or more per patient, per day in extreme cases to care for seriously ill patients were left in the lurch. Forced to swallow pre-set PPS day-rates ranging from $100 to $400, the firms had to eat whatever costs the new system did not pick up. Demand for expensive ancillary services such as rehabilitative, respiratory, and drug therapies, which the large chains used to provide to smaller operators on a third-party contractor basis, also declined significantly.

The result? An industry-wide rash of earnings warnings in late 1998 was accompanied by staff reductions, asset sales, and operational cost-cutting measures by the most highly leveraged firms. Stock prices sank as the full effects of the Medicare spending cutback ripped through the nursing home industry like a super-caffeinated strain of the Ebola virus. Meanwhile, the government further put the screws to the industry by opening up Medicare billing fraud probes at several operators, including Beverly, Centennial, and Vencor, scaring away even more investors.

What happened next could quite possibly be termed as the low-point of the modern American healthcare system. Vencor started to evict Medicaid patients from about a dozen of its facilities to make room for patients with higher-paying forms of health coverage, sparking a public outcry and the speedy passage of legislation banning the practice. Sun Healthcare laid off 10,000 workers in short order, sending a flood of skilled therapists scrambling for new jobs at the most inopportune time. Elsewhere, Medicare's $1,500 per patient cap on rehabilitation therapies was producing unfortunate instances where nursing home seniors were forced to choose between physical therapy or speech pathology, a dilemma which came to be described as "walk or talk."

After much lobbying by long-term care trade groups, the government realized the error of its ways and amended the original reimbursement cuts under the Balance Budget Act. At the time of the act's passage, regulators thought the switch to PPS would bring in about $9.5 billion in Medicare savings from nursing homes over five years. By the middle of 1999, it became obvious to the Congressional Budget Office and others that Medicare would end up overshooting its savings projection to the tune of $7 billion or so. So, in late November, Congress returned some $2.7 billion in reimbursements to the nursing home industry in the form of certain upwardly revised fixed-fee payment categories and a 4% across-the-board boost in reimbursement rates in fiscal 2001 and 2002.

However, the government's backtracking on the reimbursement issue proved to be too little, too late for several nursing home companies. Vencor filed for bankruptcy in September, followed by Sun Healthcare in October. Lenox Healthcare, the country's second-largest privately held nursing home firm, sought Chapter 11 protection in November. Meanwhile, heavily leveraged public operators such as Mariner Post-Acute Networks and Integrated Health are teetering on the brink of insolvency.

In hindsight, what started out as a governmental effort to control spending for a massive entitlement program ended up being a federally mandated downsizing of an entire industry. At the time the Balanced Budget Act was passed, Wall Street analysts suspected the legislation would indeed hurt the publicly traded nursing home firms, which after all had historically received about half of their annual revenues from Medicare and Medicaid reimbursements. But in the end, tightening the reimbursement belt was to be a long-term positive for the business, weeding out the weakest firms and forcing the remaining players to focus on how to deliver the best level of care to their patients as efficiently as possible. Nobody expected the carnage that has occurred over the past two years.

What is lost on the minds of many observers is the larger picture, particularly what the implosion of the long-term care industry may portend for the future of for-profit care in this country. Nursing homes are not like badly managed sub-prime lenders or faddish theme restaurant operators, which can undergo massive short-term, industry-wide re-valuations in the marketplace with limited effect on the country's societal framework. Along with their assisted care facility cousins, nursing homes are increasingly looked upon to provide an essential and gargantuan day-to-day service to the nation's elderly citizenry, a slice of the population whose ranks are about to swell substantially as the first batch of Baby Boomers start to hit retirement age in ten years or so.

If anything, the recent history of the long-term care industry underscores the true uneconomic nature of the current American healthcare system and the need for reform if for-profit medical care is ever to work as a viable, long-term business. Some observers have suggested that the U.S. healthcare system at the close of this century is in a state of "paradigm stall," where anyone with any sense at all understands that the current model doesn't work economically but no one seems to know what to do about it. From an investing standpoint, such a situation is undesirable and offers little opportunity for market-beating performances by companies trying to make a business out of healthcare delivery over the long-term.

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