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Health Care Stocks: "90% Confusion And 10% Opportunity"

Choosing the right health care stocks;
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If you think your business has been buffeted by the winds of change, consider what is happening in the health care industry:

* New technological developments are turning up faster than in any other field, except possibly computers. They run the gamut from futuristic gene-splicing techniques -- still mostly in experimental stages -- to sophisticated diagnostic and therapeutic equipment.

* Health services are being delivered in new ways, often by new companies. Some 150 young, health-related companies went public in the last year and a half along. About a quarter of these are firms that operate freestanding health care centers -- medical, optical, dental, and so on. "That's up from zero a few years ago," points out Jules Marx, an industry specialist with Whale Securities Inc., based in New York City.

* The federal government -- which picks up the tab for 30% of the nation's total health bill -- has recently instituted a series of cost-cutting policies that fundamentally change the economics of the business. The Medicare system, for instance, has established standard treatment costs for 468 "diagnostic-related groups" (DRGs) of illnesses and disorders. If a hospital's costs for treating a patient with a given illness are above the DRG average, Medicare won't pay the overrun. If the costs are below the average, though, the hospital gets to keep the difference. The implication: There is a new emphasis on cost containment, efficient operation, and less-expensive technology.

All of this is quite a change from the system of the past 10 years, when health care delivery was dominated by big non-profit hospitals with about as much interest in cost cutting as in yesterday's newspaper. And the changes undoubtedly open up investment opportunities. The difficulty lies in figuring out where the openings might be.

"Right now," says Paul W. Brown, a medical devices analyst with Hambrecht & Quist Inc., in San Francisco, "I'd say there is 90% confusion and 10% opportunity. In a year, that ratio should change to 70% confusion and 30% opportunity." Meanwhile, says Brown, investors would do well to study how various kinds of companies have done in hhe recent past, and what trends and pressures they will be facing in the future.

Service companies. Some 40% of all health care expenditures go to cover hospital costs, and big for-profit hospital chains, such as Humana Inc., are growing at rates as high as 25% a year. With the advent of cost containment, both they and the nonprofits are likely customers for companies offering hospital information systems. The top two companies in this field, says Bama Rucker, another Hambrecht & Quist analyst, are Shared Medical Systems Corp. and HBO & Co. Shared Medical reported 1984 sales figures of $256.8 million, while HBO came in at $88.7 million. Among their strong points, Rucker says, "both have a national sales force, a large hospital client base, and the money for R&D."

Much of the growth in health care services is taking place outside of hospitals. Health maintenance organizations (HMOs), for example, now number some 340, up from a mere 30 only 15 years ago, and such big publicly owned chains as Maxicare, U.S. Health Care Systems, and HealthAmerica are all well over $100 million in revenues. But analysts tend to agree that HMO stocks, which soared in 1984, aren't bargains in 1985. Of greater potential interest to investors are the smaller, newer companies that operate a variety of installations. Jim Hoover, who tracks health care stocks for Robertson, Colman & Stephens in New York City, likes Mediplex, a Massachusetts company that operates eight nursing homes, three alcohol- and substance-abuse centers, and a building-development division. Mediplex went public in the fall of 1983 at 15; in February the stock was over 29.

Medical equipment. "Hospitals are not just cutting back on diagnostic machinery," says William J. Hayes, portfolio manager of Fidelity Investments' Select Health Care Fund, "but on everything from bedpans to needles." In such an atmosphere, investing in a company that manufactures expensive new equipment can be a chancy proposition. By the same token, though, new technologies that promise to shorten hospital stays or otherwise reduce costs are good bets for the future.

Lasers, says Whale Securities' Marx, are an example of a technology that fits in the latter categor. Lasers are already well established in ophthalmology, and are just beginning to make headway in other areas. A company called Lasermed Inc., for instance, produces laser-based surgical equipment for physicians' offices, taking the technology out of the hospital entirely. The company is likely to turn a profit this year, Marx believes.

Another set of companies that may benefit from he current climate are those in the growing market for home health care. Two of the major players are Baxter-Travenol Home Therapy Group and Home Health Care of America Inc., which is the one pure play in this field. Both companies hold a 15% to 18% share of the home infusion-therapy market; that is, the market for home-based infusion of nutrients, antibiotics, or toxic chemicals for use in chemotherapy.

Home infusion therapy can lead to cost savings of from 50% to 80% for patients who use it; even so, according to Rucker, "The newness of the industry and the newness of cost data have kept the government from reaching a standard national rate for reimbursement." Government cost cutters want to get patients out of the hospital and into the home, she says, but worry that home infusion could produce another financial dilemma like kidney dialysis, in which the bill shot from $229 million to $2 billion in 10 years.

Biotechnology. The potential of genesplicing and similar technologies broad: Marketable products may one day range from medical diagnostic tools to shampoos. But the key word is potential; many biotech companies haven't even begun to live up to their promise. Biogen, the wellknown genetic engineering company founded by Nobel laureate Walter Gilbert, for instance, didn't have the business acumen to match its scientific talent. "Biogen had difficulty identifying unique products," says Misha Petkevich, technology analyst with Hambrecht & Quist in New York City. "And it's very difficult to move ahead in biotechnology without a unique product."

Today, there are about 50 public biotech companies, many of them wholly unscrutinized by Wall Street analysts. Not all are primarily concerned with medical applications, but those that are focus on monoclonal antibodies, recombinant DNA, or both.

Monoclonal antibodies make diagnostic tests more accurate, and are used in research geared toward treating cancer and infectious diseases. Hybritech Inc., analysts say, is one company that is establishing itself as a leader in the field, notably with its pregnancy and colo-rectal cancer diagnostic products. Hybritech is also using monoclonal antibodies for in vivo imaging of cancer tumors. Petkevich expects the company to remain profitable this year, and thinks that more than 50% of its 1985 revenues will be attributable to product sales. In biotechnology, that is a healthy level.

Recombinant DNA -- a fancy term for gene-splicing -- allows scientists to transfer a gene from one organism to another. Genetech Inc., the acnowledged leader in this field, isolated the genetic code for human insulin, and was then able to produce insulin biologically. Genentech's gamma interferon is in human clinical trials, as is its so-called tPA (tissue plasmigen activator, an aid to the body in breaking up blood clots). Petkevich expects 50% of Genentech's 1986 revenues to come from sales as it begins a rapid rollout of products, including a humangrowth hormone.

Jim McCamant, editor of Medical Technology Stock Letter, says that the biggest mistake health care investors often make is paying too much. "They look at what the company is doing, not at its price," says McCamant. "It is so easy to get excited about a company in an exciting business that investors will buy the stock at any price." An example cited by McCamant is Diasonics Inc., a medical diagnostic imaging company. Diasonics went public at 22 and then shot up to 30. Recently it was selling at around 3. "Investors thought it was such a good company that it could do no wrong," recalls McCamant. "But it tried to grow too fast and just couldn't make it."

The five Best-Performing Health Care Stocks for 1984 *

Company Business % Increase

STAAR Surgical R&D of intraocular lenses +700%

Medical Sterilization Contract sterilization of medical products +315

Exovir R&D of skin disease treatments +254

NMR of America Freestanding magnetic imaging centers +215

Healthcare Services Group Maintenance to nursing homes +191

* January 1 to December 31

The Five Worst-Performing Health Care Stocks for 1984 *

Company Business % Decrease

Healthdyne Inc. Electronic pediatric equipment -85%

Quality Systems Hospital information systems -83

Doctors Officenters Freestanding emergency centers -76

Braintech Computer mapping of brain electrical activity -75

Tago Manufactures immunologic reagents and -75

diagnostic test kits

* January 1 to December 31

Source: Whale Securities Inc.

Last updated: Apr 1, 1985




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