Veteran card players pride themselves on the ability to discern what’s known as “the tell,” the series of involuntary mannerisms that can betray a rival’s strategic deceptions and even suggest a possible next move.
Then there are those rare occasions when a tell metastasizes into a red flag, a clear indication that something is terribly wrong.
Example the first is buried deep in the transcript from DaVita Inc.’s annual “Analyst/Investor Day” presentation in New York City.
These meetings were once a love fest for Kent Thiry, the kidney care provider’s colorful chief executive officer, with every year a new opportunity to showcase DaVita’s rapidly expanding earnings per share to an audience of brokerage analysts and portfolio managers. In the fall of 2011 Berkshire Hathaway disclosed it had taken a stake in the company, eventually accumulating just under 38.6 million shares, or 20.2 percent of the company’s public float, perhaps the biggest endorsement a management team can receive.
Shareholders, as the chart below indicates, took a cue from Berkshire and began purchasing DaVita stock hand over fist in the autumn of 2011 at its post stock-split prices in the low $30 range.
Chart: courtesy of Nasdaq.com
Those meetings are a little less rosy now, however.
At the May meeting, an analyst asked Thiry how much revenue DaVita generates from dialysis patients whose private (more formally known as commercial) healthcare insurance premiums are paid by the American Kidney Fund’s Health Insurance Payment Program.
Thiry’s response may be studied by future generations of reporters and investors: “We’re not [and] have not and it would not be in your best interest for us to start providing all sorts of detail on that other chunk.”
The Southern Investigative Reporting Foundation, which is attracted to executive prevarication like a large healthcare corporation is to a dubious insurance billing gambit–and whose interests assuredly lie in exposing undisclosed risk–took Thiry’s non-answer as a challenge.
After all, a limelight-loving CEO suddenly getting cold feet when asked a basic question about revenue breakdown is a pretty clear “tell” that whatever the answer is, it can’t be too good.
The answer looks terrible for DaVita’s investors. The company’s finances, according to a Southern Investigative Reporting Foundation accounting analysis, appear to be massively levered to an opaque non-profit, the American Kidney Fund, that may provide up to half of its operating profits. They should define HIPP as a “gravy train,” albeit one perhaps soon to be modified by the word “imperiled” as a combination of civil litigation and regulatory shift poses an existential threat to this cozy relationship.
The definition of HIPP is unusually subjective, depending largely on whether you provide or receive dialysis, or insure those who undergo it.
To the former, the AKF and dialysis clinics–especially the larger chains–it’s an elegant solution to an end stage renal disease conundrum of longstanding: with the one-two punch of its steep financial costs and the physical exhaustion emerging from treatment, working is often not an option, and many patients exhaust savings or go deeply into debt to maintain their private healthcare insurance policies. As a function of that, AKF’s HIPP pays its recipients monthly insurance premiums for the duration of their dialysis treatment.
For the latter, mostly insurance companies offering healthcare to the public, HIPP is a financial headache of a scale eclipsed only by its sheer evil brilliance.
They argue that in the AKF, dialysis providers created a low-risk gambit that exploits a narrow HHS provision allowing third-parties–i.e. themselves–to donate hundreds of millions of dollars tax-free to the AKF. The fund then enrolls patients (primarily from its largest donors) who receive the same quality of dialysis care at the same providers alongside Medicare patients. But because a small segment of patients have HIPP, the dialysis providers–two of whom control almost three-fourths of the market–can bill insurers many times the roughly $250 per treatment that Medicare will pay.
Using DaVita’s Securities and Exchange Commission filings, the AKF’s Internal Revenue Service annual Form 990 filings and a little extrapolation, the Southern Investigative Reporting Foundation estimates that at a minimum, AKF’s support helps generate between 40 and 45 percent of the Kidney Care unit’s estimated earnings before interest and taxes, or at least $339.4 million through June 30, after a one-time $526.8 million legal settlement with the Veteran Administration is backed out of its results. For 2016, it was more than $728.5 million.
(DaVita has two units: Kidney Care, providing patient dialysis and related lab services, and DaVita Medical Group, which owns physician practices. The Kidney Care unit’s earnings, given DMG’s consistent losses, are thus the company’s profits.)
What makes the AKFs role so astounding is that those handsome profits come from a base of about 9,000 dialysis patients, barely more than four percent of DaVita’s 214,700 patients.
Briefly: last October, in response to insurer outrage over skyrocketing dialysis reimbursement levels on commercial policies purchased from the Affordable Care Act’s Health Insurance Marketplace, DaVita announced that it would no longer support patient applications for AKF premium assistance on those policies.
Source: DaVita, AKF public filings; SIRF estimates
Where DaVita’s own figures weren’t available, conservative assumptions were made, like pegging the growth rate of dialysis patients–historically 3.8 percent–at 1.9 percent through June 30. Given that over 78 percent of the AKF’s $309.8 million in donations last year came from either DaVita or Fresenius Medical Care, the German medical conglomerate that is its primary competitor in dialysis services, the Southern Investigative Reporting Foundation estimated that at least 40 percent of the AKF’s HIPP grants went to DaVita patients.
(Both DaVita and the AKF declined to answer the Southern Investigative Reporting Foundation’s on the number of HIPP recipients receiving dialysis in its clinics, but based on interviews with executives at rival dialysis providers the 40 percent figure was deemed “very conservative.”)
DaVita, in its 2016 Capital Markets presentation, disclosed that privately insured patients are between 110 percent and 115 percent of the Kidney Care unit’s earnings before interest and taxes. To obtain the value of the AKF’s premium support to the company’s profitability, the quotient of the AKF’s commercially insured patients and the company’s commercially insured patients was multiplied by 113 percent.
Seen narrowly, given Thiry’s ownership of more than 2.54 million shares, refusing to discuss the question of AKFs value to DaVita certainly served his “best interests.” Similarly, as an 18-year veteran of these presentations, he is surely aware that portfolio managers, trained to value a company based on a multiple of its future earnings per share, rarely pay 17 times earnings for a company whose profit growth is slowing and where 40 percent of the operating profit is dependent upon a charity and its circular donor scheme.
Another way to read Thiry’s reticence is as a function of the fact that the AKF relationship is–in the parlance of value investors–DaVita’s sole moat, or a sustainable economic advantage separating it from competitors.
DaVita is an unusual addition to Berkshire Hathaway’s portfolio because its moat isn’t a function of managerial acumen, such as GEICO’s efficiencies (which drive its lower-costs), or the pricing power