+More From this author

Three Ways to Play the Rising Tide of Health Care Spending

By Michael Brush
Exclusively for InvestorIdeas.com
October 16, 2006

Business Week recently ran a cover story with a stunning statistic. Virtually all of the 1.7 million jobs created since 2001 in the U.S. have come in health care.

This is surprising until you stop and think about some of the things going on around you.

Your health insurance costs are up sharply in the past five years. Providing health care is people-intensive business. Now you know where a lot of your premiums go.
The U.S. government spent $600 billion, or a quarter of the overall 2005 federal budget, on health care. Overall the U.S. spends about $2 trillion a year on health care – half public, half private. (See above.)
The Boomers are aging, so they need more health care.

Usually when an investing theme appears on the cover of Business Week, it’s time to run the other way. It’s nothing against the editors at Business Week. But typically when a story theme has cleared all the hurdles and story meetings necessary to make the cover, it’s because the theme is so well known that editors have a high comfort level putting it out front. But that also means the theme is already priced in to the market – and probably at a peak.

This cover story may be different, if only because of the sheer number of people who are going to require more health care. Sure, according to one theory, pricing by health care providers may get capped because the government is one of the biggest buyers. That gives it the clout to push down or hold the line on pricing. This may be a problem.

But if you look at the steady growth in government spending over the decades, its hard to give politicians much credit for holding the line on anything. And there’s a limit to how much of a reduction in quality – perceived or otherwise – Americans will accept in health care.

So it makes sense to look at some health care plays that may ride the wave of growth – according to the insiders. We’ve got a real estate play, an early-stage biotech company, and a computer security business. Here’s a closer look.

Where the doctor is in

Cogdell Spencer (CSA) owns or manages 76 medical office buildings and healthcare facilities, primarily in the southern U.S. It has been in business since 1972. It came public as a real estate investment trust (REIT) in the fall of 2005. The stock pays a $1.40 per share annual dividend, for a 6.5% yield.

Most of Cogdell properties are on hospital campuses. That gives it a leg up on competitors.

In early October, director James Cogdell put $900,000 into the company for prices between $21.13 and $21.56, even though he already owned over two million shares. Frank Spencer bought $374,000 worth at $21.21.

That’s impressive buying.

BB&T Capital Markets analyst Stephanie Krewson has a price target of $23 on the stock, which recently traded for $21.70. That would give you a 10% plus return if you throw in the dividend.

But the stock could be worth much more, judging by a recent private market transaction. In mid-September Health Care REIT (HCN) announced it wants to buy Windrose Medical Properties (WRS) for $877 million, or $18.06 a share.

Here’s a little math to show what this means. Windrose Medical is similar to Cogdell Spencer. The buyout offer works out to $248 per square foot of Windrose Medical office space.

Translate that to the 2.5 million square feet of office space Cogdell Spencer owns, and you get a stock price for Cogdell Spencer of $32.42, calculates Krewson. Of course no one knows, at least publicly, whether Cogdell Spencer will ever get bought out. But when you own a stock, it’s comforting to see buy-out transactions that validate a much higher price.

If you think inflation is such a problem that the Fed will continue hiking rates, then this stock is not for you. REITs trade like bonds. They do worse when interest rates are rising. But you will probably also be wrong. Production in cheap foreign labor countries should help keep a lid on inflation, as will moderating economic growth.

A treatment for brain cancer

NeoPharm (NEOL) is working on therapies against brain cancer. Its lead compound, IL13, is being tested as a chemotherapy against glioblastoma multiforme, an aggressive form of the disease. NeoPharm should have results early next year. NeoPharm is also working on developing a drug-delivery platform, and another product, LEP-ETU, may work like the anti-cancer drug Taxol.

NeoPharm has partnered to market its lead product in Japan. But it holds the marketing rights for the rest of its pipeline.

Morningstar analyst Karen Andersen thinks the company could be worth $10 per share. The stock recently traded at $6.95. She figures potential products are worth $8 a share, adjusted for the probability that they may not work out. And the company has $2 per share in cash. Andersen suggests buying the stock under $5.20.

But managers have not been so patient. Since June insiders, including chairman John Kapoor and chief executive Ronald Pauli, have purchased $600,000 worth of the stock for prices between $4.86 and $6.81. Insider buying at biotech companies doesn’t always mean profits for shareholders lie ahead – but that’s a bullish amount of buying.

Techie doctors

Tiny Zix (ZIXI) provides communications security services like encryption and virtual private networks. It also sells a hand-held device that doctors can use to write prescriptions.

Since May insiders, including two directors and a vice president, have purchased $125,000 worth of stock. They were buying a few days ago for 62 cents to 68 cents a share. That may seem like a small amount of buying. But remember this is also a small company with a market cap of just $42 million.

The company’s email encryption line of business, used in health care and financial services, has been the star so far. In the most recent quarter, Zix had a 100% renewal rate for this service. New orders were up 39% over the prior quarter.

Sales of its PocketScript electronic prescribing service actually slipped 4% last quarter, and the company guided down expectations. Indeed, you have to wonder why doctors – who tend to resist new technology on the paperwork side – would bother with hand-held prescription devices. It’s hard to imagine a busy doctor taking the time to punch in the codes to send the script to the right pharmacy.

The company says electronically-transmitted prescriptions leave less room for problems with illegible handwriting. The device also allows doctors to check on things like the availability of generic substitutes and possible drug interactions. Tellingly, company filings tout studies that show e-prescribing brings about “reduced costs for patients and their insurers through increased prescribing within drug formulary guidelines.”

So it’s no wonder that the business model for selling PocketScript calls on “third-party sponsors” – think insurance companies – to pay for the service and the device, and hand it over to physicians at little or no cost.

I’m not convinced PocketScript is a winner. Another troubling thing with this company is that some of the insiders whose recent purchases look like a bullish sign bought two summers ago at the much higher price of $2.99. Oops!

But the stock has fallen to 70 cents from $2.50 earlier this year. And down here it has some margin of safety. Zix has $19.5 million in cash or 32 cents a share.

The bottom line: The coming ramp up in health-care spending seems like a no-brainer. Figuring out what companies may benefit is a bit more difficult. At least with these three, you have plausible scenarios for success – and enough insider buying to suggest the rosy scenarios may actually play out.

Disclaimer

At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.

For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

TOP