DVA – DaVita HealthCare Partners

[ni-co]

I'm aware of the fact that there is a DaVita thread within the Berkshire category (http://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/davita-thesis/), but I think it deserves its own "investment idea" thread and therefore suggest to move the discussion here.

 

Since this is a large BRK/Ted Weschler position and this is the "Corner of Berkshire…" board, I assume that you've already had a look at DVA so I spare you the business description.

 

To me, there are 5 reasons for DVA as an attractive long term ("Coca-Cola-like") investment:

 

[*]It's in a business where economies of scale create a sustainable competitive advantage and DVA already has this scale and puts every spare penny into further growth.

[*]It always looks expensive because DVA is growing like crazy and therefore has high growth capex. When you have a look at maintenance vs. growth capex, however, you'll see that it's a very high return on capital business and actually much cheaper than it looks at first glance. My mental model for this kind of company is TCI under Malone.

[*]DVA's (worldwide) market is so huge that there is room enough to grow and aging populations in developed countries grow this market even more.

[*]I think of Kent Thiry is an "Outsider CEO" and this is exactly what it takes to make a home run out of this kind of company (again: compare TCI under Malone)

[*]Kent Thiry has a significant stake (373,884 shares as of 13 Feb 2014), as does Ted Weschler personally (2,191,806 shares as of 24 Feb 2014).

 

The only real threat to the business I can see is regulatory risk. However, since government is interested in keeping health care cost down and DVA is effectively a low cost provider, I think the risk is somewhat limited and, at least, DVA would be the last of these companies to go under, if government decided to kill the industry. The other threat is a complete buyout by BRK.

 

I recommend this Seeking Alpha article which got me interested in DVA in the first place:

http://seekingalpha.com/article/1769952-why-davita-is-undervalued-compared-to-fresenius-medical-care

 

ps: You can make an argument that the whole dialysis business is immoral, like ItsAValueTrap does:

http://glennchan.wordpress.com/2013/06/17/for-profit-dialysis-an-unethical-industry-davita-dva/

 

However, I think that you can make the same points with nearly every privately owned health care business. It needs to be regulated, for sure. But if you are convinced that, in sum, a privately owned health care industry is a net benefit to society, there is no convincing argument – at least to my mind – not to invest in companies within this sector, as long as they abide by the laws and regulations. The net benefit to society, by the way, is why I invest in DVA but not into tobacco companies – I don't think that ItsAValueTrap's comparison is fair in this regard.

[ItsAValueTrap]

In the past, DaVita had foreign operations.  Thiry came in and turned the company around.  One of the things that he did was to axe the foreign operations.

 

DaVita is currently looking at expanding internationally.  However, I think that those foreign markets are very different.  Health care compensation and the preferred treatment of dialysis is very different in other countries.  Davita's biggest expansion push has been to expand in adjacent health care niches within the US (e.g. the large HCP acquisition). 

There is some benefit to expanding internationally as Davita would have more negotiating leverage against its suppliers.

 

2- The ethics are a problem I think.  Malone never put anybody's life at risk by overdosing them on EPO.  Malone plays within the rules.  Davita has paid numerous settlements for breaking the rules.

[Liberty]

The only real threat to the business I can see is regulatory risk.

 

Just throwing that out there, but at some point in the coming decades, they could hit a wall when we have lab-grown replacement kidneys that have the patient's DNA (no transplant rejection). Probably over the horizon for now, so no big immediate worries. But it still seems like there's a clock on the business model...

[ItsAValueTrap]

I don't think that lab-grown kidneys will be happening anytime soon.

 

HART is trying to commercialize its replacement esophagus.  Here's my writeup on HART.  It is having some problems with its replacement esophagus.  Other organs will be even more complex and difficult.

 

Regenerative medicine has had a very difficult time doing things other than skin.

[SwedishValue]

My impression after talking with kidney doctors is that there is no indication whatsoever that lab-grown replacement kidneys will be in the making within the nearest decade or two. The kidney a very complex organ, but if it so happens that my investment gets wrecked by artificial kidneys I would be able to stand the permanent loss of capital that would go with it for me as DVA is my second biggest investment.

 

The willingness to spend on healthcare in general will grow over time (whether privately funded or funded by government programs). Kidney disease is very much related to diabetes, which in turn is very much related to obesity, which in turn is very much related to increasing purchasing power per capita. Mortality for dialysis patients have been going down significantly during the last decade, and there is no sign that this development will stop. All in all, I find it extremely likely that DVA will serve many more additional customers during the next decade. Since DVA has a low-cost profile with significant cost advantage over smaller players (but also over Fresenius), I believe it is very likely that this will also result in significantly higher earnings power a couple of years down the road.

 

I would be very surprised if the number of living dialysis patients in USA didn't dubble over the next decade. I find no reason to believe that DVA will not retain its market share. I also find it likely that the value of a dialysis patient will grow over the next decade.

 

My best guess is that DVA due to their favorable market conditions has a high probability of tripling its free cash flow over the next ten years. IF this happens, and DVA finances the capex needed to grow with its cash flow, the stockholders of DVA will have a very nice time. A tripling of the Cash Flow could take net debt levels from today's ~$8 BN to $24 BN, freeing up $16 BN to shareholders in the form of buybacks or growing the HCP business or whatever management finds smart from a capital allocation viewpoint.

 

I have not found one compelling argument as of why the dialysis market would not continue to grow during the next ten years, just at it has grown for the last thirty years. I would be happy if someone could share one with me.

[Liberty]

I don't think that lab-grown kidneys will be happening anytime soon.

 

HART is trying to commercialize its replacement esophagus.  Here's my writeup on HART.  It is having some problems with its replacement esophagus.  Other organs will be even more complex and difficult.

 

Regenerative medicine has had a very difficult time doing things other than skin.

 

Yeah, that's why I mentioned decades. But I doubt the rate of progress will be linear and predictable. Breakthroughs can speed things up after long periods of slow progress (ie. when we figured out how to turn regular cells (like skin cells) into stem cells, that helped that whole field quite a bit). We'll start with the easier organs and move up and reach kidneys at some point. No reason why not.

[yadayada]

You can pick up binge drinking to hedge your investment.

[Liberty]

My impression after talking with kidney doctors is that there is no indication whatsoever that lab-grown replacement kidneys will be in the making within the nearest decade or two.

 

I was just mentioning an interesting fact for the long term, not trying to scare people out of this investment in the short term.

 

I don't think anyone has good visibility into the next decade or two of medical applications, probably not even the people working on the stuff. Could most doctors have told you how cheap it would be to sequence a genome today 10 or 20 years ago? It doesn't even seem that big a deal anymore -- we get used very quickly to big advances (same with things like the iPhone, we're not impressed by the tech anymore). I mean, we have surgical robots and augmented reality apparatuses being used to operate on people... It's likely that in a while, we'll have replacement organs and it won't seem a big deal. I just don't know when.

[SwedishValue]

I very much appreciate your concerns and thoughts Liberty, and you should know that this coming from you make me second guess myself somewhat.

 

The kidney in itself is a very complex organ though. From my understanding we do not even know the details as of in which way dialysis works, but we do know that it works. To be able to produce a lab kidney we would probably first need to understand the organ in much more detail.

 

I just think that raising the issue of lab kidneys is overly cautious as it is a very very low probability event within the next decade (just looking at lead times for new medicines as an indicator, and seeing that we are not even close to producing a lab kidney). I think that foreseeing the development of the lab kidney is overly cautious and not in proportion with the favorable tailwinds the demographic development for increased need of dialysis care gives for the investment case.

 

On another note, with your argument we could argue for complete disruption of the cable industry (wireless).

[kevin4u2]

Even if lab grown kidney replacement was an option, the next problem would be the economics (cost).  This would further drive out the implementation into the future. 

 

My impression after talking with kidney doctors is that there is no indication whatsoever that lab-grown replacement kidneys will be in the making within the nearest decade or two. The kidney a very complex organ, but if it so happens that my investment gets wrecked by artificial kidneys I would be able to stand the permanent loss of capital that would go with it for me as DVA is my second biggest investment.

 

The willingness to spend on healthcare in general will grow over time (whether privately funded or funded by government programs). Kidney disease is very much related to diabetes, which in turn is very much related to obesity, which in turn is very much related to increasing purchasing power per capita. Mortality for dialysis patients have been going down significantly during the last decade, and there is no sign that this development will stop. All in all, I find it extremely likely that DVA will serve many more additional customers during the next decade. Since DVA has a low-cost profile with significant cost advantage over smaller players (but also over Fresenius), I believe it is very likely that this will also result in significantly higher earnings power a couple of years down the road.

 

I would be very surprised if the number of living dialysis patients in USA didn't dubble over the next decade. I find no reason to believe that DVA will not retain its market share. I also find it likely that the value of a dialysis patient will grow over the next decade.

 

My best guess is that DVA due to their favorable market conditions has a high probability of tripling its free cash flow over the next ten years. IF this happens, and DVA finances the capex needed to grow with its cash flow, the stockholders of DVA will have a very nice time. A tripling of the Cash Flow could take net debt levels from today's ~$8 BN to $24 BN, freeing up $16 BN to shareholders in the form of buybacks or growing the HCP business or whatever management finds smart from a capital allocation viewpoint.

 

I have not found one compelling argument as of why the dialysis market would not continue to grow during the next ten years, just at it has grown for the last thirty years. I would be happy if someone could share one with me.

[Liberty]

I just think that raising the issue of lab kidneys is overly cautious as it is a very very low probability event within the next decade (just looking at lead times for new medicines as an indicator, and seeing that we are not even close to producing a lab kidney). I think that foreseeing the development of the lab kidney is overly cautious and not in proportion with the favorable tailwinds the demographic development for increased need of dialysis care gives for the investment case.

 

I don't think I was expressing myself clearly, because that's what I meant. I just thought it was an interesting thought that came to mind when thinking about dialysis, but that doesn't mean that you should give it meaningful weight for for an investment today, at least until you start seeing more signs that it's approaching.

 

On another note, with your argument we could argue for complete disruption of the cable industry (wireless).

 

For the kind of time frames I was thinking about, absolutely. And I'll certainly reconsider any cable investments if I see signs of that becoming more viable than it is now. The difference here I think is that dialysis will never give someone the quality of life that brand new kidneys will, while inside a home or office (which is where people spend most of their time), cable + wifi can give you the same thing that wireless would but with a more predictable signal source (radio waves will always bounce off thick walls or off hills...).

 

Even if lab grown kidney replacement was an option, the next problem would be the economics (cost).  This would further drive out the implementation into the future. 

 

At first, certainly. But that's the same for every technology, and I think that over the long term biotech will follow similar trends (it might be slower, but we're going in that direction -- again, look a genomics).

 

Just think of how expensive the CPU in a modern desktop computer would seem to people just a few years ago. Billions of transistors and multiple fully functional cores on the same die for a couple hundred bucks? And they use less power than old CPUs?

 

If we think from first principles, like Elon Musk, the raw materials of a kidney are not expensive, right? You could grow one with few sacks of potatoes and a jar of multivitamins (I'm exaggerating to make the point). The very hard part is the IP around it; how to get the extracellular matrix to form properly, and then grow the right types of cells in the right places, all that inside an environment that mimics conditions inside a body (a kind of incubator). We already know that our bodies can do it, so we'll probably harness some of those mechanisms at first, rather than reinvent the wheel and try to do it all ourselves from scratch (in biotech, there's a lot of stuff we can know how to do without having to understand how every minute detail works -- ie. the engineering approach). Heck, we might even grow human kidneys inside of pigs and then harvest them or whatever.

 

All that will be very hard and expensive to develop. But once it is developed, at some point it'll become routine and cheap, just like making multi-billion transistor CPUs the size of postage stamps or boxes with lasers that can read billions of microscopic bumps at high rotational speeds in a dusty living room (DVD players) or whatever.

 

I know I'm kinda dreaming here. Sorry, didn't mean to take the investment thesis in a direction that is probably not useful. I just wanted to share because I thought it was interesting and thought maybe others would think the same. Back to our regular programming now :)

[SwedishValue]

Your posts are insightful so I do appreciate if you continue to share your thoughts generously.

 

I would like to reiterate that I would very much appreciate if there is anyone out there that can give me good reason to believe that the american dialysis population will not double during the next 10 years. Because if it does double or more, I would consider the share very cheap.

[lschmidt]

Forgive me for chiming in here - my first post.

 

Let's think about this another way (at least the more likely possibility in my estimation). The average lifetime of a hemodialysis patient is 3 years according to the current medical literature. This number has been static for years. Short-intermediate term advances in dialysis techniques may increase this number, perhaps considerably. Think about the total number of dialysis procedures if the patient population AND the survival rate increase simultaneously. It is, therefore, not clear if technological advance would be a boon or a threat to DaVita's business.

[SwedishValue]

The one-year mortality rate for patients of DVA is around 13%, I know the numbers in Sweden is around or slightly below 20%. The one-year mortality rate has dropped significantly during the last decade.

[maxthetrade]

A while back I have read an article about 3D printed kidneys, I can't find the article anymore but a quick Google search tunrned up this one: http://gizmodo.com/scientists-can-now-3d-print-transplantable-living-kidn-1120783047

 

I don't think this is an immediate threat but certainly something to keep an eye on.

 

 

[rogermunibond]

IMO the bigger threat is advances in unmatched kidney transplantation/lowering cost for the procedure plus better donor enrollment and transplant matching algorithms. My MIL went through an unmatched kidney transplant from her daughter and has had much better prognosis than had she been on dialysis.

 

I'm not sure if Medicare covers unmatched transplant but if the cost can come down further it might.

 

Further down the line an implantable artificial kidney would be another threat to dialysis.

 

https://www.ucsf.edu/news/2013/03/13699/artificial-kidney-holds-promise-vast-majority-dialysis

[ni-co]

I don't think I was expressing myself clearly, because that's what I meant. I just thought it was an interesting thought that came to mind when thinking about dialysis, but that doesn't mean that you should give it meaningful weight for for an investment today, at least until you start seeing more signs that it's approaching.

 

Thanks, Liberty, I got that point right from your first post and I think you are right to point this out. Indeed, medical progress is a risk I forgot to mention. DVA is, after all, also kind of a technology company. This is one of the few investments where I'd be glad if it would be disrupted by better methods.

 

To the timing issue: Because of the discounting effect within a theoretical DCF calculation, risks that are 10+ years out wouldn't matter all that much. Mind that the average lifespan of a S&P 500 company is only about 18 years.

 

The average lifetime of a hemodialysis patient is 3 years according to the current medical literature. This number has been static for years. Short-intermediate term advances in dialysis techniques may increase this number, perhaps considerably. Think about the total number of dialysis procedures if the patient population AND the survival rate increase simultaneously. It is, therefore, not clear if technological advance would be a boon or a threat to DaVita's business.

 

This is also a very good point. Even if (bio) technology would be ready within the next few years, a significant transition period would also be likely. After all, it's not even clear that patients wouldn't also need a few years of dialysis, even in the event that they could get some kind of kidney substitution anytime soon.

[loganc]

While the dialysis business has dominated this thread, I believe that one needs to be able to handicap the future performance of the HCP business have a lot of conviction about this company.  I am curious as to how people are thinking about HCP given the relative lack of data around that business.

[SwedishValue]

I have no superior insight within the HCP business, but i have a few takeaways from the information that DVA has provided. I am not a native English speaker but I will try to express myself clearly.

 

First, management argues that there is no reason there cannot be a preferred nationwide "health care partner". I believe this as well, just like you can have a preferred nationwide restaurant chain it should be possible through diligent work and very high focus on patient care to create a preferred health care partner. Although a low probability event and/or a long time frame, the potential upside here is huge.

 

Secondly, management has conveyed that the cash on cash returns they are getting from the HCP acquisition currently is around 7% (if my memory serves me right). Although this is within the lower span of what management expected when they made the acquisition (in which they also issued shares), this is certainly lower than the borrowing costs of DVA. HCP is in no way a business with prospects of long-term deterioration, so this yield should go up over time. This can also be a place for further growth by acquisition, which should be good news considering the long-term results the DVA management team has had allocating capital.

 

If you want to be conservative for valuation purposes, I believe you can just subtract the cash flow attributed to the HCP business side while also subtracting the purchasing price of HCP.

 

Hope this is worth something.

[buylowersellhigh]

Any insights from CNBC interview today on DVA from Ted W.?

[CorpRaider]

He talked about it, as you might imagine, he likes it.  haha.  Gave an interesting mental model for analyzing healthcare investments generally though (at least I thought it was interesting).  I think that has been posted elsewhere on here already and is on cnbc.com as well. 

[loganc]

I have no superior insight within the HCP business, but i have a few takeaways from the information that DVA has provided. I am not a native English speaker but I will try to express myself clearly.

 

First, management argues that there is no reason there cannot be a preferred nationwide "health care partner". I believe this as well, just like you can have a preferred nationwide restaurant chain it should be possible through diligent work and very high focus on patient care to create a preferred health care partner. Although a low probability event and/or a long time frame, the potential upside here is huge.

 

Secondly, management has conveyed that the cash on cash returns they are getting from the HCP acquisition currently is around 7% (if my memory serves me right). Although this is within the lower span of what management expected when they made the acquisition (in which they also issued shares), this is certainly lower than the borrowing costs of DVA. HCP is in no way a business with prospects of long-term deterioration, so this yield should go up over time. This can also be a place for further growth by acquisition, which should be good news considering the long-term results the DVA management team has had allocating capital.

 

If you want to be conservative for valuation purposes, I believe you can just subtract the cash flow attributed to the HCP business side while also subtracting the purchasing price of HCP.

 

I appreciate your comments and I have used the latter thread of logic to justify my current allocation (i.e. assume someone is going to win in the managed care business and that DVA can sell the HCP business at cost).  However, this line of thinking is sort of crude and doesn't inspire the level of conviction that is necessary for me to add to my DVA holding. 

 

Not to be a jerk, but your discussion of HCP is more or less the line that management is spinning about the HCP business.  To my mind, I can see the potential opportunity in the HCP business and the opportunity with Medicare Advantage is obviously huge.  The fundamental problem is that I can not, at this point, handicap the success or failure of HCP in growing the business.  Clearly, the management team at DVA is very strong and I know they are working very hard at growing the HCP business, but I have yet to really be able to put the pieces together in my mind to get real conviction around this business. 

 

In conclusion, I have little to add to this thread.  I am working through all of the data I can locate in terms of the HCP business (i.e. the merger prospectus) and hopefully I will be able to provide some helpful insight into this business at some point.

[thefatbaboon]

I've been looking at this for a while and have gotten comfortable that i understand the dialysis business but I'm still really struggling with HCP.  I'm pretty ignorant about that whole area.  Has anyone made any progress here?

[Fat Pitch]

DaVita is trying to pivot into other patient care services via HCP. The core business is dialysis centers, but they want to add more services that a typical hospital provides, but do it at a lower cost. I think it's a great strategy since the person in the dialysis chair is going to be at the clinic for several hours few times a week so why not provide other services so they don't have to go anywhere else?

 

I think the real vision is to redefine the high cost hospital business model. By showing insurance companies and the government that DaVita can provide superior services at lower prices they hope insurance will bundle the services they provide and encourage more people to select them as their primary care destination. This is a great business with tremendous scale. They benefit society by passing on the savings to the customer. Of course there's the liability aspect of the business so you have to get comfortable with that.

 

My mental model is the northern pike. These centers are cropping up everywhere and they are low cost... don't need that many good things to go in your favor to do okay here.

 

[thefatbaboon]

Well HCP seems to be in a certain amount of disarray.  They only just hired Samitt last year to lead HCP.  Both Margolis and Thiry talked him up pretty big at the December investor day.

 

 

HealthCare Partners Announces Leadership Transition

DENVER, July 18, 2014 /PRNewswire-USNewswire/ -- DaVita HealthCare Partners Inc. (NYSE: DVA), a leading provider of kidney care and health care services, today announced that HealthCare Partners (HCP) president and CEO Dr. Craig Samitt is stepping down from HCP effective August 1st. 

Kent Thiry, co-chairman and CEO of DaVita HealthCare Partners, will take over the role of CEO of HCP, working in tandem with the Office of Chief Medical Officer.

"I want to thank Craig for his contributions during his time here. He is a strong CEO and we wish him the best in his future endeavors," said Thiry.

"I will miss working with the talented physicians, staff and management that created and will sustain the HealthCare Partners legacy," said Samitt. "The company is well positioned to continue to transform population health in the United States."

DaVita and DaVita HealthCare Partners are trademarks or registered trademarks of DaVita HealthCare Partners Inc.