Boring Portfolio

New Idea Hits Radar
Examining VCA

by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (May 3, 1999) -- One of the companies that we've recently added to the radar is Veterinary Centers of America (Nasdaq: VCAI), which I've kept tabs on for a little over a year but have never really delved into too deeply.

Before I get to VCA, though, a word on healthcare. I believe the business of providing healthcare, from a corporate standpoint, starts out with 1 1/2 strikes against it. From what I've seen in looking at these companies, you get beat up from all sides. Imagine being an HMO today. Doctors hate you for telling them how to give care, customers hate you for not giving enough care, Congress wants to beat up on you because you're a bunch of fat cats that are profiting from not providing an appropriate amount of care, and hospitals are consolidating and ganging up on you.

Meanwhile, if you're a hospital corporation, Congress beats up on you for making excess profits, doctors hate you, the HMOs are continually beating on you, and the majority of the non-profit hospital world hates you for trying to drive some economic efficiency into what may be a necessarily inefficient industry.

What I'm saying here is that it could be that there's a natural limit on capacity utilization and cost takeouts available in the healthcare field. So, in human healthcare, we'll tread pretty lightly. I would say that a company has to be really beaten up and washed out for us to take a look. Even then, I'm not sure it's the sort of industry we want to deal with.

On caring for pets, however, I don't think we would face the same legislative risks, although we'll have to ask the company about these sorts of issues. At first blush, it appears as though the interest group pressures are less important to this industry than in human healthcare.

Below, I've posted an introduction to VCA. We'll dig into the financials on Wednesday, including doing a little forensic accounting in the hopes of really finding out how profitable this company is. It's a pretty interesting concept and I know there are a lot of people that hate to spend on healthcare for themselves but spend a lot of money on their pets. I think there's a sizable portion of the market that is not sensitive to price. I also believe there's a large amount of demand that could come out of the woodwork once the company gains a larger national scale and is able to market itself such that some customers overcome that price sensitivity. Along the way, the company can bring down its average unit costs and deliver more value to the customer, creating a positive feedback loop. Declining prices equals increased demand, which then equals more operating income, which then leads to better marketing, which leads to more demand, which leads to lower prices, etc. etc.

But I'm really coming from the starting point of knowing absolutely zero about the company, so we've got a long way to go before I understand VCA and would consider allocating capital to it.

I would welcome your input on the Boring message board. Also, before I forget, I hope everyone had a good time at the Berkshire annual meeting.

Below is an introduction to Veterinary Centers of America, from the company's 1998 10-K. Much of it I took verbatim from the 10-K, but I've edited liberally in some spots for easier presentation:

Veterinary Centers of America, Inc. and subsidiaries was founded in 1986 and is a leading animal health care company. The Company has established a premier position in two core businesses, animal hospitals and veterinary diagnostic laboratories. In addition, the Company owns a partnership interest in a joint venture, Vet's Choice, with Heinz Pet Products, which markets and distributes premium pet foods. The Company also has an investment in Veterinary Pet Insurance, Inc., the nation's largest pet health insurance company. The Company operates the largest network of free-standing, full-service animal hospitals in the country and the largest network of veterinary-exclusive laboratories in the nation.

The Company's animal hospitals offer a full range of medical and surgical services for companion animals, including dogs, cats, birds and other household pets. In addition to treating disease and injury, the Company's animal hospitals emphasize pet wellness and offer programs to encourage routine vaccinations, health examinations, spaying and neutering and dental care. The Company's veterinary laboratories offer a full range of diagnostic and reference tests. Laboratory tests are used by veterinarians to diagnose, monitor and treat diseases through the detection of substances in blood, urine or tissue samples and other specimens. The Company does not conduct experiments on animals and is not engaged in animal research.

The Company offers specialized treatment, including advanced diagnostic services, internal medicine, surgery, oncology, ophthalmology, dermatology and cardiology. Additional services provided by the Company at certain locations include grooming, bathing and boarding. The Company also sells specialty pet products at its hospitals, including pet food, a full range of pharmaceuticals, vitamins, therapeutic shampoos and conditioners, flea collars and sprays and other accessory products.

The Company's facilities are open an average of 10 to 15 hours per day, six to seven days per week. Several of its facilities provide 24-hour emergency care service.

The Market

The United States market for veterinary services is highly fragmented with approximately 124 million dogs, cats and birds cared for by an estimated 55,000 veterinarians practicing at 16,000 animal hospitals. These animal hospitals are primarily single site, sole practitioner facilities. The Company believes that the principal factors in a pet owner's decision as to which veterinarian to use include convenient location, recommendation of friends, reasonable fees and convenient hours.

70% of the company's revenues come from its veterinary hospitals and 30% comes from its laboratory facilities. VCA operated 170 veterinary hospitals as of March 31.

Consolidating the market

The animal hospital industry is consolidating. Factors contributing to this trend include:

(i) the desire of some owners of animal hospitals to diversify their investment portfolio by selling all or a portion of their investment in the animal hospital;

(ii) the buying, marketing and administrative cost advantages which can be realized by a large, multiple location, multi-practitioner veterinary provider;

(iii) the desire of veterinarians to practice veterinary medicine rather than spend a large portion of their working time performing administrative tasks necessary to operate an animal hospital;

(iv) the cost of financing equipment purchases and upgrading technology necessary for a successful practice; and

(v) the desire of many veterinarians for more flexible work hours and benefits than are typically available to a sole practitioner or single site provider.

Upon the acquisition of an animal hospital or veterinary diagnostic laboratory, the Company immediately begins to implement management programs to enhance the productivity of veterinarians and to improve operating results. The Company's business model enables it to realize improved operating margins at its animal hospitals and veterinary diagnostic laboratories through a strategy of centralizing various corporate and administrative functions and leveraging fixed costs while providing its customers with improved services. This model includes the following objectives:

  • PROVIDE MARKETING MATERIALS -- The Company seeks to market additional services to clients at its hospitals by providing its hospitals marketing and educational materials promoting pet health and quality pet care programs.
  • CENTRALIZE ADMINISTRATIVE FUNCTIONS -- The Company centralizes most administrative functions at its corporate office, including purchasing, accounting, payroll, data processing, personnel, accounts payable, information services, marketing, planning and budgeting and other administrative functions.
  • CONSOLIDATE PURCHASING -- When advantageous, the Company purchases its supplies on a consolidated basis in order to negotiate better prices and terms from vendors.
  • STANDARDIZE TRAINING PROCEDURES -- The Company implements standardized training procedures for its administrators and professional personnel. These programs are developed in conjunction with the Medical Advisory Board and Client Services Advisory Board, two entities which are staffed by Company personnel to recommend medical standards and to establish service and training standards for local hospitals and laboratories.

Would you work for a bunch of Fools?

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   2/9/99  100 Gateway 20    72.38     67.13    -7.25%

    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  25565.63 $20175.64
  8/13/96  200 Carlisle C  5264.99   9775.00  $4510.01
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