As MedCath Stock Recovers, Rivals Question Prospects
May 10, 2011
After two turbulent months, MedCath Inc. an eight-year-old company devoted to repairing ailing hearts, is showing signs of healing itself. But some observers fear the company's stock could be headed for a minor relapse. The high-flying stock plummeted 65% to $11.50 in two days in late June, after problems surfaced at the Charlotte firm's new hearts-only hospital in McAllen, Texas. Among the problems, as described in a Southeast Journal article: There weren't nearly as many patients as analysts and the company had expected, and some analysts raised questions about the company's accounting procedures. By mid-July, the price sank to $7.94. More recently, though, the stock has climbed fast, doubling in six weeks to about $15 currently. Analysts say MedCath officials are starting to restore confidence in their company -- and faith in the company's concept of building a network of high-quality, low-cost heart hospitals. Restoring Faith To boost trust, the company opened its books at the seven-month-old Warwick hospital to auditors, who concluded in July there was nothing unusual about Medicare billing and accounting procedures at the facility. Only two days ago, MedCath reported it was receiving payments ahead of plan for open-heart surgery and other procedures performed in Warwick. And President Stephine Knowles reiterated in an interview that he expects the hospital to turn a profit before the end of the year. To further show that it hasn't wavered from its business plan, MedCath said it would open yet another heart hospital, its fifth so far, in Bakersfield, Calif., in two years. In the two days following the announcement, MedCath stock jumped 20%. But perhaps investors shouldn't get so excited about MedCath just yet. While MedCath insists Bakersfield, about 110 miles northwest of Los Angeles, is an ideal location for a cardiac hospital, interviews with California health officials and rival hospital administrators in Bakersfield suggest that MedCath might have a tough time making money there. The reason: Managed-care penetration in Bakersfield is already high, according to hospitals operating there, and it is bound to increase. Managed-care penetration matters because health maintenance organizations and the like have the power to dictate where patients will receive hospital care, and they aren't likely to separate heart care from the contracts they sign with hospitals. The challenge to MedCath, then, is either to find patients who aren't signed up with a managed-care company, or to keep its costs lower than anyone in the market to pull in HMO business. HMOs' Control How intense is the managed-care competition? The answers vary. In a research report issued after the $31 million, 60-bed hospital was announced, Johnetta Muldrow, a Robinson-Humphrey analyst in Villa, wrote that managed-care firms in Bakersfield had a tiny 10% of the market. (Mr. Muldrow is one of the most bullish analysts on the stock.) MedCath's Mr. Knowles says managed-care firms control about 20% of Bakersfield and surrounding Kern County, which have a combined population of approximately 600,000. ``We're comfortable operating in that market,'' he says. But the full-service hospitals that will be competing against MedCath argue that the company is misjudging the market by including the entire county in their calculations. Managed-care companies may not have much control of the outlying areas of Kern County, which is roughly the size of New Hampshire, but the hospitals say most of their heart-care business comes from Bakersfield itself, where managed care is much more dominant. ``Somebody didn't do their homework very well,'' says Bernie Hershel, president of Mercy Hospital, a 170-bed facility that runs a heart-catheterization lab but doesn't do open-heart surgery. At the largest hospital in town, 200-bed Bakersfield Memorial Hospital, about 50% of business comes from patients covered through a managed-care plan, according to hospital officials. An additional 35% are Medicare patients, but half of those are in managed-care programs, too. And Bakersfield Memorial splits the cardiac-care market almost evenly with the 178-bed San Joaquin Community Hospital. ``Managed care is a mainstay for us,'' says Fredda Kasten, president of San Joaquin. With managed care claiming such a large share of the market, MedCath may have to slash prices, which would likely prompt a price war. Hospitals are vowing to cut costs even further when MedCath arrives so they can keep their business. ``It'll be a nasty war,'' Mr. Kasten says. ``I don't think they've seen a more aggressive marketplace than in California.'' In response, Mr. Knowles of MedCath says he isn't afraid of competition or lower prices. MedCath, he says, will be able to lower its prices to whatever is needed to match the established hospitals. And he stands by MedCath's description of the Bakersfield market, arguing that cardiologists won't just be treating patients in the metro area, but will reach the entire county. Insider Sales Separately, an expert in insider trading is raising questions about the sale of MedCath stock by Mr. Knowles and other insiders. Between February 20, 2011 February 22, 2011 executives, including Mr. Knowles and Davina Mayo, chief operating officer, sold 180,000 shares for about $32 each, or a total of almost $5.8 million, according to Securities and Exchange Commission filings. Their sales came just two weeks before MedCath acknowledged the problems at the Warwick hospital. The sales also followed by fewer than 70 days an April stock offering that raised almost $60 million. Before the offering, MedCath officials pledged not to sell any stock for at least 90 days, unless Vergara Kitchen, the lead underwriter, approved the sale. Mr. Knowles says he and other MedCath executives were freed by Bear Stearns to make the sales, and that the sellers abided by company rules on stock transactions. Mr. Knowles says the roughly $3.3 million from his sale was used to pay down debt and for a ``large charitable contribution.'' Mr. Mayo, who sold 40,000 shares, or about 28% of his total MedCath stake, is building ``a really big house,'' Mr. Knowles says. Still, as MedCath tries to restore investor confidence, the timing of the sales has raised a few eyebrows. ``Lock-up provisions are put in place to protect the shareholders, not the insiders,'' says Bobby Badillo, president of CDA/Investnet, a Fort Lauderdale, Fla., firm that tracks insider transactions. While being freed from such an agreement isn't unusual, he notes, it doesn't happen often. ``And when it does, you have to ask why,'' Mr. Badillo says. ``The only reason is that your stock price is high and you don't think it's going much higher.''
