Business

HSA-related firms attract investors

Observers say companies benefiting from consumer-directed health care have a large growth potential, but investments are not without risks.

By Katherine Vogt — Posted March 13, 2006

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Investors are taking notice of companies they believe are poised to reap the benefits of a shift toward consumer-directed health care.

The most prominent recent example is publicly traded health ratings company HealthGrades Inc. An affiliate of mutual fund giant Fidelity Investments recently purchased 2.7 million shares, or 10% of HealthGrade's stock, and RS Investment Management Co. -- a San Francisco-based mutual fund concentrating on small- and mid-cap stocks -- snapped up 2.1 million shares, or a 7.6% stake, according to filings with the Securities and Exchange Commission. To leaders of the 7-year-old company, it was a warm embrace from the investment community.

"It's a real pat on the back for HealthGrades and kudos to the company for attracting their investment," said Sarah Loughran, executive vice president of the Golden, Colo.-based firm, which provides ratings information about physicians, hospitals and nursing homes.

Observers say companies such as HealthGrades might grow significantly if consumer-directed health care takes off to the extent that some are predicting because consumers will be hungry for information as they take on more responsibility in directing their own health care.

Internet health company WebMD, for example, is hoping for greater Wall Street interest with its announcement that it has signed contracts with large health plans to operate private-access sites where members can look up medical records and compare costs and ratings for doctors and hospitals.

But other types of companies stand to profit from this shift as well. Patricia O'Brien, MD, a trauma surgeon who is now a managing partner at the Chicago-based management consulting firm DiamondCluster International, said managed care companies are trying to position themselves to take advantage of "the whole value chain" stemming from health savings accounts, which are driving the consumer-directed health care movement. (Large health plans have bought up many of the companies -- such as Golden Rule and Definity Health -- that were pioneers in offering consumer-directed health plans.)

At the same time, the movement is creating opportunities for the financial services firms that act as custodians of the accounts and provide investment vehicles for them, Dr. O'Brien said.

Also, some companies that provide technologies linking consumers and payers or others that are involved in the claims-processing side of health care could take advantage of a shift in such transactions, she said.

The bottom line: "There's a lot of noise in the marketplace around consumer-directed health plans," she said.

To be sure, much of the racket is being generated by the potential revenue at stake.

In a report last fall about the business opportunities presented by health savings accounts, DiamondCluster estimated that financial institutions have the potential to capture $3.5 billion in revenue driven by account and asset management fees over the next five years.

During the same period, health payment processors stand to earn $2.3 billion in processing fees, the report said.

A look at HealthGrades' latest earnings report shows that revenues jumped 43% to $20.8 million in 2005, from $14.5 million a year earlier. Net income jumped 132% to $4.14 million, or 15 cents per share in 2005, from $1.78 million, or 7 cents a share in 2004.

The growth of such companies has also caught the attention of private equity investors, who are sizing up private firms that could stand to benefit from the movement.

Craig Frances, MD, a former internist who is now a principal investor with the Boston-based private equity firm Summit Partners, said the interest extends beyond the companies that are directly involved in the trend. He said ancillary companies, such as those that provide good value to consumers through surgery centers, home health care or other services, are also poised to reap rewards.

"Anytime you have a sector that is literally in The Wall Street Journal every day, you are going to see a lot of dollars thrown at it," Dr. Frances said.

Learn from the past

He acknowledged there are risks to investing in a fledgling sector. "Yes, you need to be a very knowledgeable investor and you need to be investing in proven business models."

Otherwise, investors run the risk of repeating what happened about five years ago when cash poured into some Web sites that offered health information to consumers, only to see those investments implode like a bad soufflé when the companies sank.

Still, Dr. Frances said, that was a different time and a different business model. "Those companies got built at a time when there was too much exuberance; they didn't pay attention to their revenue model," he said. Now, consumer-directed health care has created a "hot industry with large growth prospects."

Of course there is also the risk that consumer-directed health care won't take off at all. There were only about 2.7 million enrollees in consumer-directed health plans in 2005, according to a report by Forrester Research, though the number was projected to jump to 12 million in 2007.

Carl McDonald, an analyst at CIBC World Markets, said it is unlikely that consumer-directed health care would completely fade away. "I don't think the risk here is that something won't pan out," he said. "The bigger risk is, does consumer-directed health care get as big as people think it will in the next couple years?"

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