Normally, it isn't wise to go up against Berkshire Hathaway, but that is exactly what Jim Chanos is doing with his position in DaVita (NYSE:DVA). In a recent interview with Hedgeye's Keith McCullough, Jim Chanos explained why he is shorting one of the largest kidney dialysis companies in the country and a company in which Berkshire owns a significant stake. Here we will take a look at what Chanos is seeing and why he is shorting DaVita.
DaVita's primary service is providing kidney dialysis for patients with end-stage renal disease (ESRD). "ESRD is the stage of advanced kidney impairment that requires continued dialysis treatments or a kidney transplant to sustain life...Patients suffering from ESRD generally require dialysis at least three times a week for the rest of their lives."
The majority of the company's revenues come from Medicare and Medicaid; however, almost all of its profits come from patients with private insurance plans. In its 10-K for 2018, DaVita states, "The payments we receive from commercial payors generate nearly all of our profit and all of our non-acute dialysis profits come from commercial payors." The reason for this is that DaVita charges patients with private plans considerably more than those with government plans.
The core issue that Chanos highlighted centers around allegations that DaVita actively tries to get patients to sign up for private plans, so it can charge higher rates for their services. Allegedly, it pushes the private plans even when that is not the most suitable option for the patient. For patients who are not able to afford the premiums of private plans, DaVita directs them to the American Kidney Fund (AKF). The AKF has a program that pays the premiums for kidney dialysis patients; however, this program is funded through donations from the kidney dialysis companies like DaVita. Therefore, the allegation is that DaVita through the American Kidney Fund pays for its patients to get private plans, so it can then bill the insurance companies the higher rates.
These activities are at the heart of multiple, ongoing lawsuits brought by the Peace Officers' Annuity and Benefit Fund of Georgia, City of Warren Police and Fire Retirement System, and Blue Cross and Blue Shield of Florida ("Florida Blue"). The complaint filed by Florida Blue refers to DaVita's activities as "a deceptive and illegal scheme" that "damaged Florida Blue to the tune of tens of millions of dollars over at least the past several years."
Chanos believes that "this rent-seeking part of their business...is going to go away...and then you have a company that is inherently unprofitable". He suspects that some time in the next five to six years the government will put a stop to it. However, if they don't, then there are other possibilities. One is that it could happen naturally through pricing competition as the company "continue[s] to experience downward pressure" on its commercial rates. Evidence of this can likely be found in Davita's declining operating margins over the last few years. And then there are those ongoing lawsuits. If successful, then they could result in DaVita paying out millions in damages as well as putting an end to the activities in question.
In addition to that, Chanos brought up the facts that DaVita is highly leveraged and repurchasing substantial amounts of stock. As of September 30, 2019, the company had a debt-to-assets ratio of 78.2%, and it had an interest coverage ratio of 4.27 for the third quarter. And since 2016, the company has repurchased almost $5 billion worth of stock with the company authorizing $2 billion more in the future. However, as the company's only source of profit declines, DaVita will start to face problems with servicing its debt and continuing to repurchase its stock.
DaVita is a company with considerable risk and limited upside. While some investors may wish to follow Chanos in shorting DaVita, most would do well just by staying away.