Hospitals and the Credit Markets: An Interview with Wachovia's Mike Matson
BY JOHN MCCORMICK, NOVEMBER 5, 2008
Earlier this week we interviewed Wachovia's industrious medical technology and device analyst Mike Matson to revisit his thoughts on how the credit market dislocations are affecting hospital capital spending decisions.
McCormick: Mike, thank you for joining us especially with all of the reports you are churning out for 3Q. We'd like to revisit your well-researched April 29, 2008 report that discusses hospital capital expenditure decisions. You believe that the credit crunch was having a negative impact on hospitals' ability to raise finance - particularly with auction rate securities (ARS). How has this changed in the last 5 months?
Matson: On one hand, we think that the auction rate securities issue is largely behind the hospitals at this point. As best we can tell, most hospitals were able to refinance into other types of debt with reasonably low interest rates. So it may have caused a short term disruption in Q1/Q2 but no long term change in hospital finances. On the other hand, the credit crisis worsened in Q3 and early Q4 so hospitals have new problems that they are dealing with. Just as if you or I tried to get a mortgage or an auto loan currently, the bar has been substantially raised in terms of the credit quality that lenders are looking for. So while the auction rate issue seems to be resolved, the new issue facing hospitals is tighter credit availability across the board. With regards to the orthopedics industry, we see these issues mainly affecting capital equipment rather than implants. That's because hospitals often use borrowed money to finance capital expenditures. Implants are typically billed to insurers.
McCormick: We are also hearing from our sources that hospital endowments are off so there are concerns with hospital income and assets in addition to the financing question you pointed out. What's your view?
Matson: We have heard similar things. Specifically we have heard that some not-for-profit hospitals are seeing such severe declines in investment income that they have begun to lay off employees. It's hard to know how widespread this is, however.
McCormick: We have definitely heard about the layoffs as well. As an example, University of Pittsburgh Medical Center has laid off 500 employees in the past few weeks and we are hearing about some other institutions. So if employees are being laid off, going back to your earlier answer, are there more specifics as to why capital expenditures would be more of a target for expense reduction than implants?
Matson: Capital expenditures are more of a balance sheet (cash flow) issue while implant expenditures are more of an income statement (profitability) issue. So these are not exactly apples-apples items. We think that the credit crisis has limited capital availability to hospitals (along with other types of businesses and consumers). As capital availability goes down, hospitals become more reliant on operating cash flows rather than borrowing for funding capital spending. This means that they must prioritize their capital projects and only pursue items that are the most critical. Our work has shown that purchases most likely to be delayed or canceled have three common themes: (1) the equipment is very expensive (particularly greater than $1 million); (2) the equipment requires a construction project for installation; and (3) the equipment does not drive revenue for the hospital.
Profitability for hospitals is sort of a different issue. As admissions fall and income from investments decline, margins get squeezed. There are a range of strategies hospitals can use to cut costs. Certainly controlling supply costs (such as orthopedic implants) is one strategy. But there are many others; as you mentioned, hospitals can reduce headcount. As best we can tell, since 2005-2006 hospital have already increased their efforts to control implant costs which is why price increases slowed from mid-single digits to around 0%. We think hospitals are already doing as much as they can to control implant costs and short of some type of incentive alignment with surgeons (a la gainsharing), we do not foresee dramatic pricing pressure ahead. We think there is probably other "lower hanging fruit" from a cost standpoint at hospitals.
McCormick: Mike, thank you for your time today.
Matson: Thank you, John.
