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Healthcare IT from the Investor’s Chair 8/17/09

August 17, 2009 News 17 Comments

“Tap-tap-tap, is this thing on?”

I’d like to thank the Academy, Mr. HIStalk, and Inga for allowing me the chance to post on a regular basis. Starting today, I’ll be writing a column sharing the Wall Street/investor perspective on HCIT, so I first thought I’d briefly share my background to give an idea of why Mr.HIStalk thought I’d be a good regular contributor.

I began my Street career on a crisp autumn day as a sell-side stock analyst (well, I was an associate analyst first) covering healthcare IT companies, most of which seem to have been acquired by HBO & Co. (now, of course, known as McKesson). Spending about a decade as a research analyst, I covered the stocks of around 25 companies such as Cerner, HBO, Sunquest, Eclipsys, etc. As the dotcom/e-health era arose, I covered those stocks as well, helping to take companies like Allscripts, Healthstream and others public.

After ten years, it was time for a change, so I went to what many called “the dark side” and became an investment banker. I spent six years doing both M&A and public offerings, primarily in the healthcare IT sector that we all know and love.

Wall Street has a few things to recommend it as a career, but the ability to speak truth isn’t always one of them. So, in March, I left the Street to become an independent strategic advisor to healthcare IT and other companies. So far, so good …

Yes, but just what does an analyst do and what’s the sell-side and how is it different from banking? For my first few posts, Mr. HIStalk and I thought a brief tutorial on the industry might be interesting to you, gentle readers. Let’s start with equity research.

There are two sides of Wall Street, the “buy-side” and the “sell-side”. Buy-side means the entities that actually purchase stocks (mutual funds, hedge funds, pensions, etc.). These institutional investors are what typically drive stock prices and through their commission dollars, sell-side behavior.

Sell-side analysts work for brokerage firms, aka investment banks. The other key difference is where buy-side analysts might cover hundreds of stocks or even the entire healthcare sector (from Merck to Mediumune and from McKesson to Medtronic), sell-side analysts typically focus on much smaller swaths of the economy such as biotech, big pharma, or healthcare IT and distribution, covering 15-25 stocks.

It’s the sell-side analysts’ job to know how the companies in their sector perform, what’s driving their growth, and to predict what their income statements will look like each quarter for the next few years. Why? Because it is viewed as axiomatic that earnings drive stock prices and so an analyst will model what they expect the company to earn and then try to determine if its stock price is appropriate. If it’s not, the analyst puts a coveted “buy” rating on it and proceeds to pitch the idea to the buy-side. If a buy-side client likes your idea, there’s the usually unspoken assumption that their fund will try to buy the stock through your firm and you get some credit for the commission dollar.

Earnings might drive stock prices, but I think John Maynard Keynes had a better assessment. He said, in effect, that picking stocks is like judging a beauty contest, but you are trying to figure out who the other judges would find the most attractive. This is why companies that care about their stock prices (and given that CEOs tend to own a lot of stock, most seem to care about this), care about the care and feeding of their sell-side analysts, trying always to paint the rosiest picture possible without (hopefully) crossing the line into fabrication or outright dishonesty.

I say “hopefully” because in my research days, I had countless CEOs telling me how their company was kicking competitive butt, taking market share, etc. All too often (especially early in my tenure), I’d then stand in front of my sales force and call clients to say, “we’re feeling very confident in HIStalkCo’s upcoming quarter”. Usually other analysts were saying the same thing (conformity is typically rewarded) and a “whisper number” began to circulate, meaning analysts are in print saying earnings will be $0.12 this quarter, but they’re all really expecting $0.15. This is why stocks would sometimes drop after hitting analysts’ consensus. This rosy feeling would often last until the company in question reported its quarter and, instead of the $0.12 – 0.15 expected, they reported $0.05 and the stock (of both the company and the analysts) fell.

I should note that it wasn’t always outright dishonesty. CEOs, by their nature, tend to be optimists and salespeople at heart, and the best salespeople, in my experience, believe their own stories.

A few questions might arise.

What does share price mean to me, the customer? In my view, often more than it should. Assuming your vendor has a decent amount of cash on their balance sheet and has a market capitalization high enough to remain somewhat relevant to investors (say, over a few hundred million), let investors and vendors obsess over share price and you can obsess over implementation and support issues.

Why the focus on quarterly results? When I was on the banking side, I had a client who was private and had just missed their internal quarterly budget numbers. The CFO, however, felt “great” about the year. Wanting to go public in the worst way, he asked me why they couldn’t just give annual guidance (like some companies were starting to). The answer is analysts are required by both their firms and their clients to develop quarterly estimates, which are then published. That means an expectation has been set, regardless of whether the company has endorsed it.

The company then achieves, exceeds, or disappoints on those expectations and, in my experience, its stock price reacts accordingly. Discussing what it would be like if this weren’t so is like discussing how pro baseball would be like if they switched to softballs. It might make an interesting conversation over a glass of cabernet or two, but it’s not terribly relevant to the real world. The fact is that quarterly results matter to stock prices here in America, at least in the short term. (incidentally, the company than proceeded to go public in the worst way, missing their forecasts within a few weeks of its IPO. The stock never again saw the IPO price and the management team didn’t get half the kicking around they deserved).

Should I chose a vendor that’s public or private? I’ve never selected a vendor, but IMO, you should choose the one that offers the best product for the best price (sorry to state the obvious). Recognize that there are certain incentives that drive public companies and this quarterly earnings game can impact the amount they spend on R&D, customer service, or other areas you care about. Recognize also, however, that this access to capital and currency allows them to invest in ways private companies often can’t and also is often a recruitment and retention tool (assuming the stock price goes up).

What else matters when dealing with public companies? There was an interesting Readers Write posting a few months ago where a customer complained that they were being ignored by a vendor for reasons having to do with their need to make quarterly numbers. Now as I mentioned, companies really care about their stock price and what investors are saying about them, perhaps more than they should.

Further, analysts (at least good ones) love to have any kind of proprietary morsel about the companies they cover. It’s always great to go to the buy-side and share special information — a key form of currency on Wall Street, and customer insights are always some of the best. It shows the analysts are doing some research away from the companies they follow.

Were I the ill-used client in question, I’d draft a lengthy e-mail detailing all these issues and send it to the vendor’s CFO saying, I’ll be forwarding this and similar views to one or two analysts that follow the company. I’ve not tried it, but it might improve your care and feeding as no company should want to have anything but a good reputation for customer service. Recall how the stock of Cerner fell after CEO Neal Patterson wrote his scathing “parking lot” e-mail and it surfaced on Yahoo! a few days later.

Thanks for your attention, I very much appreciate it. If interest warrants, we’re hoping to make this a regular column. Please let me know what topics you’d like to see discussed or just e-mail or leave a comment. Other areas Mr. HIStalk and I thought might be well received are:

A similar view of investment banking
How does an IPO work?
What exactly is private equity and what is it doing in healthcare IT?
An M&A watch – who’s buying whom, why, and does it make even a modicum of sense?

benrooks

Ben Rooks is the founder of ST Advisors, a strategic consultancy offering long-term and project-relationships to companies and financial sponsors. He earned an MBA in healthcare management from The Wharton School of the University of Pennsylvania, has done healthcare IT equity research, and has worked as an investment banker in over 25 successfully closed healthcare and medical technology transactions valued from $40 to $365 million.

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Currently there are "17 comments" on this Article:

  1. Great writings from Mr. Ben Rooks. Another possible topic….

    What are the signs and symptoms that my vendor is being shopped for buyers?

    I look forward to more!

  2. Speaking as a former sell side analyst, kudos on an excellent article. Never before have I seen anyone explain so well the “earnings games” played between management and Wall Street.

  3. Topic for Ben Rooks to discuss – When does an investment banker tell a company to go in for an IPO or plain loan from a bank ?

  4. It is great to have an insider’s view of the stock market and our industry. I’m particularly interested in warning signs in company and stock behavior.

  5. Mr. Rooks, in his tutorial and opinion piece, should also introduce the concept of “materiality.” It is an accounting term famous to CFOs of public companies, because it guides what you report and what you may not be required to report. Let me give you two examples: (a) if implimentation X is going badly for a public HIT company and the $5 M of revenue associated whill not be recognized in 3Q09, but that amount is immaterial to that quarters numbers (won’t really change Earnings Per Share), then it may not be disclosed; and (b) if the HIT business unit is a “small” division of a much larger business — and is not otherwise “segmented” or broken out in SEC reporting — then small events are not even mentioned in filings and public statements. Take note that in the Top 10 HIT suppliers, GE, McKesson and Siemens, present this situation to differing degrees. Lastly, consider whether your institution routinely makes partnering or buying decisions with its other major suppliers based on the ups and downs of market value and earnings of ithe chosen supplier (buying beds, consumable medical supplies, pharmaceutics, or communications). It’s rel;evant of course but no always indicative.

  6. This is great insight on what drives Software vendors and the way they behave. In my last two purchases of HIT software, both publicly traded vendors, I had a very difficult time negotiating the payment terms. They both insisted on a time based schedule with no contingencies, which seemed to align with the need to report quarterly estimates. I typically propose a tiered payment on the progress of the software implemenation, with reasonable deliverables. They pushed back on this, because any payment based on a contingency couldn’t be considered as earnings until its paid. It would be interesting to hear your view on this, with a suggestion on how those of us negotiating the purchase of software can structure equitable payment terms with some consideration for the incentives that drive a publically traded company.

  7. Ben,

    Nice to have you as a contributor to HIStalk! There’s a financial aspect to TPD that hasn’t been exposed to HIStalkers yet, so hope to participate in the financial discussions here.

  8. It would be great to have financial commentary to accompany Mr. HIStalk & Inga’s posts. Very informative and “thanks”!

  9. RE: payments schedules (HIT Software Buyer). That’s a great point. The key in any kind of negotiation is to clearly identify the other party’s needs. Since public companies desperately want predictable revenue, they will be very resistant to a progress-based payment schedule. However, you can use that as leverage to get something valuable in return (e.g., decreased cost, free product, etc.), as long as it doesn’t result in an unpredictable revenue stream for them in the short term.

  10. I would love to know how ARRA is affecting all of this as well? Maybe an article for those of us who are more clinical and less business/financial, but really want to understand how this all works.

    Thanks!

  11. It is really helpful to understand the pressures and motives that companies have because they are private or public.

    I would like to hear from Ben on some regular basis! I would like the above questions addressed by him – that would be most helpful.

    Ya can’t ask some of this stuff to a banker and now that Ben isn’t one, his answers might be more objective. Ya don’t go to a surgeon and come away with homeopathic treatment plans…ya get cut!

  12. It is really helpful to understand the pressures and motives that companies have because they are private or public.

    I would like to hear from Ben on some regular basis! I would like the above questions addressed by him – that would be most helpful.

    Ya can’t ask some of this stuff to a banker and now that Ben isn’t one, his answers might be more objective. Ya don’t go to a surgeon and come away with homeopathic treatment plans…ya get cut!
    Oops…forgot to say great post! Looking forward to your next one.

  13. Thank you Ben for your insight. Your future topic ideas are great and I look forward to hearing more from you.

  14. Great education and insights Ben!

    In 1990s (pre-CHIME hey day) The Kennedy Group brought together some of industry’s best & brightest for open discussions of business problems and IT strategies/solutions.

    Stakeholders included “top tier” CIOs (Karen Ondo, Pat Becker, Sam Miller etc.), diverse Vendor and Supplier execs (CEOs, VPs) and lead investment analysts including Ben who even then stood out in the crowd.

    Wall street/quarterly returns drive everything in public companies, including CEOs’ incentives. Epic is a wildly successful (private) company who 1) turns away clients not prepared to succeed and 2) makes deep R&D investment, when needed (>35% of revenue) – neither would be approved by Wall Street bean counters, yet clients highly satisfied and mid-term investor ROI would be phenomenal.

    Having Ben explain how this works, and what – if anything – can be done to promote longer term thinking in public companies (and quarter-obsessed private companies) would be of invaluable!

    You’re on a roll Tim!







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