(Why) Would You Invest In The Home Healthcare Industry?

After having had three clients call and discuss this with me in as many days I thought it was time to try to figure it all out. So this is my (un) definitive position which I hope raises the right questions and provides at least some answers. Excuse the caveats and variables in the language but then if you are in this business you will understand why.

Just to be upfront the recommendation is going to be to invest in “change”. Identify what the change will be and buy into it. Divest companies (or management) that believe “nothing much will change”. It is not a place for the faint hearted. It is certainly not business as usual. Past performance is definitely not a reliable indicator in the homecare business today - or rather tomorrow.

The used - to - be good news was that - “Overall the macro demographic picture is very good - the aging population, of which we are all a part, is rapidly growing”. Past tense.

Reimbursement Trend Down

The reality - governments are having a tough time paying benefits to this aging or aged population, statutory retirement age is being increased in the Western world, and not surprisingly support for the purchase or use of home medical equipment is decreasing. A few cases in point - in the US, reimbursement rules (read money) have been dramatically cut or reengineered in the Powered product category, Respiratory products rental periods have been cut, manual wheelchairs are going through the same process and all await the “national competitive bidding” process to start 2007.

In other large markets - for example Germany - the demographics are the same - the reimbursement system has largely moved to a case fee (DRG) system, patient aids - once free now often require a co pay. Consumers of premium manual wheelchairs are being forced to accept lower configured and performing product, and last but not least word on the street is that the large insurance companies are going to be contracting pricing directly with the manufacturers (the German version of the US National Competitive Bidding?).

Most countries outside the “west” have never been really generous in terms of handing out home medical equipment and this seems unlikely to change - if anything it will follow the decline. I have yet to subscribe to the notion that China will represent a huge domestic wheelchair user market opportunity.

Volumes and Pricing Trend Down

Elasticity - prices going down - volumes must be going up - especially with an aging population - anyway what about the “new” populations of China and India. Right? No, more wrong than right. Its a fact that when reimbursement levels fall the consumer “need” either also falls or becomes not affordable. So companies, because of falling reimbursement prices are having to cut prices in order to stay in business. This is more so the case than ever before. If the premise is of volumes going up because of the new economy in China - be careful - this is not the auto, computer or phone industry. Home medical equipment is usually the last thing on the list - the brutal reality is that society tends to invest in the productive and not the aging unproductive. See above if you have any doubts.

The China Story

The influence of China on the Homecare industry has, like in many other industries been dramatic. It is becoming increasingly difficult to find a product that does not have at least a component manufactured in China. This is going to rapidly accelerate due to the cost nature of China and the transfer of technology - which - in HME is not real rocket science. If that upsets you - get over it - its true with few exceptions.

Chinese (and Taiwanese) companies are now setting up their own sales and marketing organizations in the west. Merits and Pihsiang (Shoprider) are two good examples. Interestingly enough these companies are major suppliers to some of the conventional western “manufacturers” as well.

Fact is - if you want to be competitively priced (you have to be - see above), then you need to be manufacturing or sourcing in China. Old barriers of how to find good Chinese suppliers are rapidly falling and doing business with several suppliers is just about as easy as doing a Google search. Let me know if you need a list.

“Western” companies have chosen different strategies in China, be it building their own manufacturing operations, acquiring manufacturing operations, establishing quality inspection, engineering or logistics support offices etc. Well known manufacturers or distributors like Invacare, Sunrise, Pride, Drive Medical, Medline, Meyra, Days Healthcare, Urathon, MBL are all there.

Distribution Channels - The Old and the New?

The old model (still largely exists today) was to keep it simple. The manufacturer, see above would sell to a “dealer” in major countries. The “Dealer” read retailer - would often be part of “Dealer Organization” like RehaTeam or RehaVital in Germany or Medgroup, VGM, National Seating in the US. Some services these groups may offer their members would include general business services but also would negotiate pricing and other terms with the vendors. Additionally, groups like Egroh and Orthec in Germany actually carry the inventory for their members. Large companies like Apria, Lincare and American Home Patient own their own networks.

Individual dealers liked this arrangement because it helped them get better pricing and business service support which they were quite prepared to pay for.

These neat and tidy relationships are changing and will be very different sooner rather than later.

The Change Story also known as where to invest…

It seems pretty clear that the major threats to suppliers in the industry today relate to cost, reimbursement and meeting the unique needs of rehab consumers.

For investors the major question is going to be: “what will the industry landscape look like in the near future?”

Here’s what I think:

“Manufacturing” Companies trying to straddle the low cost commodity product and high end rehab product fence will be sub optimal with matching results - unless they can reorganize / restructure fast they will not make the cut.

Dealer Service and Owned Groups in the US will stand to benefit from national competitive bidding at the expense of their members who will be relegated to supplying - close to the consumer - services (Fedexing an unassembled wheelchair in a carton to an 80 year old is not going to work).

Dealer Groups will create stronger direct buying links with China for standard products and channel conflicts will start to develop with traditional manufacturers. Some traditional suppliers will get into the competitive bidding process directly - bypassing the dealer group especially in large cities with high volume standard product.

Anyone in the industry knows it is not possible to bid high configuration products. By definition the different permutations are so high as to make this nigh impossible. The high level of difference in disabilities and variation in size of people dictates that there will always be a place for specialty product suppliers. Some companies such as Permobil are already thriving in this environment.

If you have the change vision and financial resilience then this is a great industry for you.

Frank Barlin - Sibaya Healthcare Consultants

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