Merge Remains at Neutral - Analyst Blog


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Recently, we reiterated our Neutral recommendation on Merge Healthcare Inc. ( MRGE ) with a target price of $2.50.

Merge reported a loss of 2 cents per share in the first quarter of fiscal 2012, narrower than the year-ago loss of 4 cents per share. However, adjusted EPS came in at 3 cents in the reported quarter, in line with the prior-year adjusted EPS but ahead of the Zacks Consensus Estimate of break-even.

Total revenue during the quarter stood at $61.0 million, up 16% year over year but down 4.8% sequentially. Total revenue also missed the Zacks Consensus Estimate by $6 million.

The company made some operational alteration to better focus on its two primary end users, providers and consumers. These operational changes were required as the company shifted from traditional perpetual software license arrangement to subscription-based pricing in order to meet the purchasing requirements of the company's clients in a better way.

Additionally, perceiving change in customers' buying habits with regard to subscription-based models over the past few months, Merge launched Honeycomb, a cloud-based platform for sharing, managing and storing diagnostic images in March 2012.

Currently with greater adoption of EHRs in doctor's offices, hospitals and imaging centers, Merge's iConnect platform is becoming significant since it is a vendor-neutral archive. In the first quarter of 2012, the company signed 9 iConnect contracts, including major healthcare systems such as Mercy, Lutheran HealthCare, Northwestern Memorial Hospital and Dignity Health (formerly Catholic Healthcare West).

The company also extended its enterprise-wide imaging partnership with Advocate Health Care, one of the US's top ten healthcare systems and executed 12 contracts for Merge's meaningful use platform within Radiology and Orthopedics. Currently, Merge has total meaningful use client base of 89 with 850 physicians.

In June 2012, the Community Health Network selected iConnect VNA and iConnect Access to provide real-time access to images and information among its network of providers and referring physicians. Community Health Network also selected Merge Honeycomb to provide cloud-based image storage.

We remain encouraged by Merge's decision to shift toward subscription-based models from traditional perpetual software license arrangements. However, supposing lower upfront revenue in the near term, the company suspended its previous revenues guidance.     

We also believe that Merge possesses strong growth potential in the Radiology Information System/ Picture Archiving and Communication System (RIS/PACS) market. There is immense potential in the diagnostic imaging market, especially with the government's emphasis on health IT (HIT) and an aging population.

According to the Centers for Medicare and Medicaid Services (CMS), through December 2011, more than 175,000 professionals and hospitals were registered for meaningful use incentive programs and $2.5 billion was paid out in 2011 to eligible hospitals and professionals.

The incentives will be offered for a period of 4-5 years, after which physicians will be penalized for not adopting proper measures. The stimulus aims to enhance the use of EHR by medical practitioners, in both ambulatory and hospital-based settings.

However, in recent years, medicare reimbursement for advanced medical imaging has declined significantly. At the beginning of 2011, the health care reform law, Patient Protection and Affordable Care Act (PPACA), again reduced reimbursements for advanced imaging by mandating an equipment utilization rate of 75%, thereby increasing the multiple procedural reductions up to 50% from 25%.

Further, CMS implemented additional reimbursement changes using the Physician Payment Information Survey (PPIS) data, resulting in further reimbursements cuts in the range of 30%-40% for advanced modalities by 2013.

We remain concerned about declining Medicare reimbursement for advanced medical imaging that could negatively affect hospital and imaging clinic revenues, thereby reducing demand for imaging-related software and services offered by Merge.

Moreover, Merge's growth prospect is highly dependent on capital investments by hospitals for advanced imaging solutions, which are in turn tied to the general economic conditions. Furthermore, the presence of many big players like General Electric ( GE ) and McKesson Corporation ( MCK ) has made the healthcare solutions and services market highly competitive.

In the short run, we have a Zacks #4 Rank on the stock, which translates into a short-term Sell rating.

GENL ELECTRIC (GE): Free Stock Analysis Report
MCKESSON CORP (MCK): Free Stock Analysis Report
MERGE HEALTHCAR (MRGE): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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