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Undebatable Demand For Health

Beyond the noisy ramp-up to last week's presidential debate, investor Warren Buffett was quietly placing his bets in the health care field.

Buffett's company Berkshire Hathaway (BRK-A) in September boosted its stake in dialysis chain DaVita (DVA), regulatory filings show, to more than 10% of the company. The diversifying Washington Post Co. (WPO), in which Buffett is a shareholder, bought privately held home care provider Celtic Healthcare.

The moves highlight the level of investor interest directed at the outpatient and home-health care segments, despite uncertainties tied to the election outcome. The Patient Protection and Affordable Care Act — ObamaCare — is a policy juggernaut hotly contested in the race. But whether it stays or goes, a transition is under way in the outpatient and home care fields.

Big money pouring into the space has driven IBD's Outpatient/Home Care group index up 35% so far this year, putting it in the top 10% of 197 industries. Analysts say buyers are interested in these companies for several reasons, but partly because the price is right.

Many of the stocks had been beaten up by uncertainties over health care reform or the elections, William Blair analyst Ben Andrews told IBD.

"With some clarity emerging on some of those points, combined with a 'risk on' mentality around the Fed, you're just seeing people buying stocks that have lagged," Andrews said.

Buffett's interest in DaVita is a bet on a larger, longer-term trend in health care. The Denver-based company announced in May it would pay $4.4 billion to acquire Healthcare Partners, the largest U.S. operator of medical groups and physician networks.

The advantage is twofold. It takes DaVita beyond dialysis and into more general practice. It also hedges against a much-discussed move by Medicare and other payers toward an "integrated care" model of reimbursement.

In this model, a single provider or team of providers oversees and coordinates all the facets of treatment. They are also paid in a unified manner. In the standard fee-for-service billing model, even the most simple treatments or procedures can lead to a score of independent claims, and waves of paperwork.

DaVita's buyout not only broadens DaVita's footprint within the industry, but also offers investors "the opportunity to own one of the largest and most well-respected integrated care providers in the country," Andrews wrote in a Sept. 4 note.

Business The 17 stocks in the Outpatient/home care group have a combined market capitalization of only $43 billion.

Most offer specialty services: physical therapy, obstetrics, prosthetics, psychiatry, surgery and (as mentioned) dialysis. These companies have benefited from a decades-long effort in the industry to avoid lengthy hospital stays, effectively acting as outsourcers.

Because they serve fairly narrow markets they don't have a chance to get huge, though DaVita and Fresenius (FMS) so dominate the dialysis business that they have become the group's big caps.

Several companies do offer in-patient care, but their degree of specialization distinguishes them from hospitals. HealthSouth (HLS), for instance, offers rehabilitative services on both an in-patient and outpatient basis.

The home care providers, such as Amedisys (AMED) and Gentiva (GTIV), offer a broad range of services in a home setting, but also provide basic nursing and custodial care for the elderly, infirm and dying. In that respect they overlap not only with hospitals, but also with nursing homes and assisted-living facilities. For many terminally ill people and their families, home care can provide an appealing alternative to dying in an institution.

Market One trait shared among many companies in the group: their market is largely American. Even Fresenius, based in Germany with global operations, draws more than three-quarters of its revenue from the U.S.

According to the Centers for Medicare & Medicaid Services (CMS), overall U.S. health spending is expected to increase about 4% this year and next, then kick up to 7% in 2014 as the Affordable Care Act unfolds.

The CMS' 2011 National Health Expenditure report points out that while ObamaCare is expected to bring about 22 million previously uninsured people into the payer system, most of them will be younger, healthier people who've previously gotten by without coverage. As a result, this is not greatly affecting the specialists in conditions like kidney failure and old age.

In the nearer term, however, the Act has brought the industry considerable pain in the form of Medicare reimbursement cuts. Home health care has been a particular target, not only in trimming payments but increasing regulations.

The industry, which was booming three or four years ago with high margins and relatively little oversight, faced accusations of corruption and fraud. A succession of new rules has created an environment that rewards companies with the best cost controls, say analysts.

The companies offering facility-based services mostly haven't been suffering these kinds of cuts, so their business has been much steadier. Outpatient facilities have even benefited from efforts to control health costs, says Piper Jaffray analyst Kevin Ellich.

Managed-care companies have been trying to reduce "inpatient utilization," Ellich told IBD. That means they are cutting costs by using outpatient treatments where possible, and avoiding costly hospital stays.

"After talking to companies like UnitedHealth (UNH), for example, they've had four straight years of their inpatient utilization declining," Ellich said. "It tells you that there's definitely a shift to the lower-cost settings.

Depending on their specialty, the outpatient providers also tend to be less dependent on Medicare, which makes them better able to take advantage of America's aging and fattening population. This is also evident in home care's sister group, long-term care.

According to William Blair analyst Ryan Daniels, privately paid facilities have lifted off with the real-estate recovery, as seniors are finding it a good time to sell their homes and move into assisted living.

Health Care REIT's (HCN) decision last month to buy Sunrise Senior Living (SRZ) for $845 million also excited interest in these stocks.

Climate Consolidation remains a central theme of the industry. HealthSouth has accumulated 96 locations across 26 states, and continues to make tuck-in buyouts.

Size, for these players, acts as a bulwark against the uncertainties of Medicare. In their April initiation report on Fresenius, HSBC analysts pointed out that a cutback in CMS dialysis payments would likely trigger shutdowns among some operators. The "consequent closing of facilities could trigger capacity shortages, which could even benefit the large dialysis operators like (Fresenius).

DaVita's acquisition of HealthCare Partners, however, is unique and transformational, analysts say. The deal was controversial on Wall Street when first announced. Analysts saw the price as high and HCP as too reliant on Medicare Advantage, whose reimbursement rates are set to be trimmed back to parity with other Medicare programs by 2016.

Medicare Advantage hinges, however, on the integrated-care model that many believe is the future of health care. Instead of paying fee-for-service, CMS pays private insurers a fixed rate per enrollee per month to cover all the patient's needs. In his Sept. 4 report, Andrews wrote that this is also a feature of a reimbursement model shifting toward outcome-based payments, for which HCP is very well positioned.

"HCP has among the highest clinical outcomes and a phenomenal track record that gives it leverage when contracting rates with insurers," he wrote. "HCP, in our opinion, is a part of the long-term solution to health care.

CMS has been contemplating expanding the integrated-care model. Both DaVita and Fresenius, in fact, have participated in pilot projects using that approach with dialysis patients. Results showed that it reduced hospitalization and death.

Outlook Analysts expect it will take some years for those projects to turn into actual policy changes, however, and see no near-term impact from integrated care. The presidential election remains the most immediate catalyst. It will determine whether ObamaCare proceeds as planned, and affect future CMS decisions on reimbursement.

Matthew Gillmor, an analyst with Robert W. Baird, says the next year or two should see a continuation of current trends. Home care providers will probably still be targeted for cuts, while the large outpatient providers should keep growing in a steady though not spectacular fashion. HealthSouth probably faces more reimbursement risks than the dialysis providers, but "they've been able to communicate their value proposition to policymakers, so we're hopeful that will limit the appetite to reduce payments."