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For most hospitals and medical facilities, day-to-day operations tend to be a tedious task of balancing expensive doctors, equipment, and supplies with relatively low collection rates from patients and insurance companies. However, those that can manage these difficult operating conditions are able to generate decent profits. One such business is Select Medical Holdings (SEM), the parent company of one of the country’s largest for-profit hospital corporations.

Select Medical completed its initial public offering on September 30, 2009. By the end of that year, the company operated about 95 long-term acute hospitals and over 960 outpatient rehabilitation clinics across much of the United States. Select’s total capacity now exceeds 4,000 beds, generating well over $2 billion in annual revenues. The company ranks in the top six of the publicly traded hospital corporations in terms of sales. It lags some of the major operators, such as Community Health Systems (CYH) and Tenet Healthcare (THC), in size, but this is partially due to the company’s more refined focus within the healthcare sector.

One major difference between Select and other hospital organizations is the level and type of care provided within its facilities. Select specializes in particularly critical and debilitating disorders. The company generates revenue from rehabilitation and long-term care, whereas traditional general acute hospitals receive billing from emergency room visits and surgery. The company also specializes in very specific illnesses. In fact, respiratory and neuromuscular disorders were by far the most prominent conditions in 2009, comprising 35% and 31% of the health cases, respectively. Patient stays are also substantially longer. Select Medical’s average stay was 24 days last year, compared with the four to five day range at more traditional hospitals. In many cases, patients are transferred from general acute care hospitals to Select Medical’s locations. The highly specialized nature of the company’s service can make it a more cost-effective solution for patients. As a result, many insurance companies find Select’s hospitals an attractive option.

The intensive care and longer stays provided by Select obviously require a substantial degree of expertise and resources, and the company has to pay top dollar for its physicians and medical care employees.  Select’s hospitals also have to be outfitted with the most advanced technology to apply a specialized level of care. This typically results in greater operating expenses. In 2009, cost of sales and SG&A expenses comprised about 84% of Select Medical’s total revenue. In contrast, LifePoint Hospitals (LPNT), which is similar in size, but more a conventional hospital operator, registered a comparable figure of only 71% of revenue last year.

As with other hospitals, the most prominent revenue source for Select Medical is insurance companies and government programs, particularly Medicare. A big difference, however, is the percentage of self payers, which make up less than 1% of Select’s total revenue. In comparison, LifePoint’s self pay revenue was about 13% of the top line last year. The company’s reduced exposure to payers without insurance makes its provision for doubtful accounts, which can exceed net accounts receivable for many hospitals, more reasonable. Still, collection issues are a big source of risk. The bad debt expense exceeded $40 million last year.

Select Medical’s major driver of growth has been its expansion. The company made a significant splash on the acquisition front this year. It recently completed the purchase of Regency Hospital Corporation, adding 23 units to Select’s base and giving the company even greater exposure to the long-term acute hospital market. The company also entered into a joint venture with Baylor Health Care to operate two hospitals and 30 rehab clinics. We look for Select to further enhance its market share through expansion of its hospital and rehab base, supported by its solid financial position.

Still, we expect the rising cost of doctors and medical care to continue to weigh on profitability. Moreover, revenues may be pressured by lower reimbursement rates from Medicare and insurance companies. The company is also likely to be affected by the speed and direction of upcoming health care legislation.

 

At the time of the article’s writing, the author did not have any positions in the companies mentioned.