DaVita Finds New Blood To Pump Growth In Health Care

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Not long ago, the chief executive of a leading kidney dialysis franchise,DaVita Inc. ( DVA ), addressed concerns over the shrinking number of acquisition candidates.

"We periodically but regularly get asked, 'Gee, your industry is awfully consolidated. What does that imply for growth in the core business?'" said CEO Kent Thiry in prepared remarks to analysts.

The question has merit considering that acquisitions have long played a major role in DaVita's growth as it built a leading franchise in kidney dialysis treatment.

Thiry explained that the firm's dialysis business would, at the very least, still benefit from steady growth in new patients, at a rate of 3.5% to 4% a year.

That was May 2. It was the same day Thiry described first-quarter results, released the day before, as "solid." (Net income: $140 million, or $1.46 per share vs. $94.5 million or 96 cents a share a year earlier. Revenue: $1.86 billion vs. $1.56 billion the prior year.)

On May 21, Denver, Colo.-based DaVita announced it would grow in a different way altogether. By acquiring Torrance, Calif.-based HealthCare Partners, a privately held operator of integrated medical and physician groups, DaVita would hop aboard the health-reform train.

Care Levels

In buying HCP for $4.4 billion, DaVita would provide, as Thiry stated, "new and exciting levels of clinical quality, service, and consumer/taxpayer savings."

The deal is expected to close in the fourth quarter. HCP would then operate as a subsidiary of the newly named parent company, DaVita HealthCare Partners.

While many liked the deal -- the stock jumped nearly 5% the day of the announcement -- others were skeptical.

"It's outside the core competency of what DaVita does," said Piper Jaffray analyst Kevin Ellich, "which makes people scratch their heads a little bit."

But after some head-scratching, they may agree with Ellich's assessment that the proposed merger "is a statement by the company that this is the direction health care in the U.S. is going."

HCP posted revenue last year of $2.4 billion. It offers patients everything from preventive and ongoing care and lab work to hospitalizations. It operates in Southern California, Central Florida and Southern Nevada.

"HCP is about the future," said DaVita President Javier Rodriguez in a phone interview. "It has a proven model that saves money, and it's good for the patient."

It could also be quite good for DaVita. As Leerink Swann analyst Jason Gurda wrote in a client note: "We may be in the minority on this, but we actually like the HCP business model better than DaVita's existing dialysis business."

He said that while organic patient growth in dialysis may be stronger and more consistent, the business "depends on a smaller percentage of commercial patients for most or all of its profits," rather than the larger patient population under Medicare.

Rodriguez says the government doesn't cover all of its costs for dialysis treatment. "Private pay accounts for all of our profits," he said.

Profits have grown 12% on an annual compounded rate the last two years. First quarter's 52% year-over-year gain in earnings was off a weak 2011 quarter.

"With few (if any) synergies between the companies," Gurda wrote, "we believe DaVita was mostly motivated by the opportunity to get involved with a strong asset and a substantial growth opportunity."

That sounds like DaVita's view as well. "Right now, we are taking care of dialysis (patients). We want to go above and beyond that," Rodriguez said.

He says HCP has a 20-year track record and "incredibly talented" physicians.

Skeptics seem to have warmed to the idea as they've had time to absorb the merger's impact, Ellich says. DaVita's stock has climbed more than 23% since the deal was announced, last trading around 99.

"For an acquisition like this outside your core, you kind of have to make a bet on management," Ellich said.

Thiry took over DaVita's helm in 1999, when runaway growth had left the company overleveraged, bleeding cash and deep in debt. He turned the company around and resumed its acquisitive course.

DaVita operates more than 1,800 dialysis centers in the U.S. In 2005, it gained 520 through the $3 billion acquisition of Sweden's Gambro Healthcare U.S. Gambro was DaVita's largest acquisition, but HCP will take that mantle when the pending merger closes.

As for the company's newest and biggest acquisition, it doesn't hurt that Medicare has designated HCP as an Accountable Care Organization, or ACO, Ellich says.

Government Goal

A list of ACOs put out late last year was part of the government's push for integrated and better quality patient care with an eye on lowering health care costs.

In the U.S., DaVita is the No. 2 dialysis-care provider afterFresenius Medical Care ( FMS ), the German-based dialysis giant, which runs treatment centers worldwide and also makes dialysis equipment. DaVita buys equipment from Fresenius.

The two hold sway over 70% of the dialysis patient market in the U.S., Ellich says.

DaVita will continue to look for "opportunistic" acquisitions in dialysis and other areas, Rodriguez says. And it won't be limited to the U.S.

"Look at countries where populations are large, like China and India," he said. "Their health care systems are currently in their infancy."

He says DaVita is aligning with local partners in China and India to develop dialysis clinics. The company also is expanding in Europe and the Middle East.

"They have a lot of money to spend," Ellich said.

In the first quarter, DaVita generated $321 million in operating cash, up from $235 million a year earlier.

Management forecasts that 2012 operating income will reach $1.2 billion to $1.3 billion.

Analysts see profit rising 23% this year over last year to $6.14 a share and rising another 10% next year, according to Thomson Reuters.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas
Referenced Symbols: DVA , FMS

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