- David Geoghegan
Nelson Hsu - a fellow contributor and eloquent writer at GuruFocus - recently asked me if I might write an article on healthcare informatics. From 2002 to 2014 I had the pleasure of being Managing Director of Nintai Partners – a boutique consulting group specializing in the field healthcare informatics. In the past few weeks I’ve written about how running the firm impacted and taught me so much about value investing. I thought it might be interesting to take up Nelson’s request and look at the healthcare informatics market from the value investor’s perspective.
Healthcare informatics: Room for Value?
Like any other industry, healthcare informatics is driven by technological innovation, market adoption, and corporate profitability. And like many technology driven markets, investors are faced with the possibility their investment can find their services unneeded, their technologies obsolete, and their competitive moat drained and filled overnight. Finding value takes a great deal of research, knowledge of the healthcare industry, and turning over a great deal of stones. Certainly the greatest risk is buying into the hype of paradigm shifts, industry transformations, and the cloud tsunami. I would caution all investors that investment price must be driven by business value. Companies that provide significant value to their customer’s operation in both the short and long-term will be the winners in the industry.
A Rapidly Changing Environment
No industry is going through as much macro changes as healthcare. The first major shift has been the passage in 2010 of the Patient Protection and Affordable Care Act (PPACA), commonly called the Affordable Care Act (ACA) or Obamacare. Hospitals and primary physicians have been tasked with transforming their practices financially, technologically and clinically to drive better health outcomes, lower costs and improve their methods of distribution and accessibility. This has led to a far more integrated approach to data, informatics, and analytics across the delivery system. The second strategic initiative was the 2009 ARRA (American Recovery and Reinvestment Act) funding of roughly $19 billion for healthcare information technology including the adoption of electronic health records (EHRs) at the point of care. Third was the federal government’s Meaningful Use regulations requiring the gradual adoption and performance standards for those organizations using EHRs. All of these have led to a rapid transformation of data to a digitized format as well as an increased need to use the data in patient care, delivery systems, and patient outcomes.
What Drives Value?
When looking for investments in the healthcare informatics market, there are three (3) major drivers of value. Each of them falls under a broad theme – the company’s offerings must provide a vital function in the strategy or operations of their customers. Far too many companies are based on consultant visions and “build it and they will come” mentality. Without a clear business need, many informatics companies simply don’t provide real, measurable value to their clients. We are currently at the peak of the “hype cycle” and investors must be extraordinarily careful in their selection of investment opportunities.
Most important, look for healthcare informatics companies with deep competitive moats. An example of this is IMS Health (IMS). They are the clear industry leader in pharmaceutical sales and de-identified prescription data. There is simply no competitor that can provide the breadth and depth of their data.
IMS’ competitive moat is driven by two key components. First, their data and analytics are considered essential to pharmaceutical commercial teams when developing sales and promotional strategies. There is literally no biopharma company that would go to market without IMS’ services. Second, IMS has remarkable control over their data sources. Their relationships with pharmacies are deep and long term. It would be remarkably difficult for a new competitor to develop such a source of data in today’s market.
Finding a healthcare informatics company with such a deep competitive moat is rare. By focusing on companies with deep penetration into their client’s operations and the strength of data ownership, investors will start with a strong core group of investment candidates.
Compounding Capability and High ROC
Another criteria value investors should look for is the ability of the company to compound value through steady long-term growth and opportunities to reinvest capital at high returns. An example of this is Wolters Kluwer Health (XAMS: WKL). As providers of clinical decision support and clinical drug data and analytics, the company has steadily added functionality and data sources over the last decade. A case of this has been their push into specialty drug data that will drive biopharma sales over the next 10-20 years. This growth has allowed WKH to achieve 13+% growth and return on capital of 57% over the past decade.
A third criteria to look for is the company’s pricing power. In healthcare informatics this is generally driven by two broad capabilities – a stickiness of the company’s services and/or a duopoly or monopoly of services. A great example of this Nintai Charitable Trust holding Computer Programs and Systems (CPSI). As the leader in smaller, rural-based hospital Electronic Health Record market, CPSI provides a service that once installed is very difficult to switch providers. By focusing on smaller health systems, the company has little competition as most of their clients simply can’t afford or need the larger EHR systems such as Epic. The company has some of the highest margins, ROE, and ROC in the industry.
Without a doubt, healthcare informatics will be a high growth market for the next decade. Regulatory requirements alone will drive a far more comprehensive use of data and analytics from drug development to clinical care. The companies I’ve highlighted in this article are examples (not recommendations!) of organizations that have created a profitable and growing business in the field. By identifying companies with their attributes – deep competitive moats, compounding machines, and pricing power – investors can find opportunities in the healthcare informatics market.