Change and cynicism

Ben Leedle has Healthways at the lucrative center of an evolving health care sector. So why don’t investors care?

Consider this a cautionary tale of what large investors do when they don’t get answers to important questions. Or maybe it’s an illustration of Wall Street’s impatience with a company seemingly unable to capitalize on its opportunities.

In the fall of 2007, Healthways executives putting the finishing touches on their plans for the following year could hardly have imagined the events — a high-profile tussle with Medicare officials, the falling through of hoped-for contracts and the departure of key customers — that would lead them to issue earnings warnings and take their company’s high-flying stock from $70 to less than $10 by October.

That slide prompted a number of market watchers to ask ever more probing questions about the validity of Healthways’ model. It also put the onus on President and CEO Ben Leedle and his team to prove they could evolve their operations to keep up with a changing marketplace.

Fast-forward three years to last October and there were those pesky questions again. On the day Leedle said insurance giant Cigna — Healthways’ largest customer accounting for more than $100 million in 2010 revenue — would wind down its contract with the company, analyst Brooks O’Neil of Dougherty & Co. asked if the fact that some insurers working more closely with doctors — and in some cases buying physician practices — are “maybe making the statement that the traditional chronic care management may not be the right model?”

Healthways shares, meanwhile? After another swoon in the second half of 2011, they had fallen back below $7 in mid-December, valuing the company at less than half its sales even after subtracting Cigna’s revenues.

Opening new doors

Almost two years after the passage of health care reform, the industry landscape is in serious flux. Given that, it’s a good thing to be in a “hot” sector of the market. To hear Leedle and a number of industry watchers tell it, Healthways is very well positioned to capitalize on the increased focus on wellness and outcomes by providers, insurers and lawmakers.

On his team’s Q3 call, Leedle said “health care reform is proving to be a tipping point.” The traditional fee-for-service reimbursement model, he said, is making way for value-based payments. Later, responding to O’Neil’s question about the wellness industry’s evolution, he said he “wouldn’t necessarily disagree” about the need to go beyond phone calls reminding people to take their pills.

“When you move out to support a whole population [...] you’re going to want come with [...] broad-based capabilities and to be able to deliver that in modalities that are going to fit the equation, both in terms of consumer preference [and] provider preference but also in terms of the best economic resource utilization,” Leedle said. “That’s what we’ve been working on that for a long time and we see that in heavy demand in the marketplace.”

In addition to its traditional management of chronic illnesses, Healthways now also works directly with employers on wellness programs, helps hospital systems — who will increasingly be reimbursed based on the results of their care — coordinate complete programs of care, works with Medicare Advantage plans to keep seniors healthy and is part of an ambitious public-private partnership to improve the well-being of hundreds of thousands of Iowans.

There are still many outside believers in the model, which has for often produced measurable gains in patients’ well-being. In a report following news of the Cigna loss, O’Neil pointed to opportunities for the company given its “attractive, scalable platform in the strategically important and potentially high-growth health management marketplace.”And he’s not alone in his guardedly bullish outlook: Tom Carroll of Stifel Nicolaus upgraded Healthways shares to ‘buy’ on Dec. 8, noting management’s optimism in the face of adversity.

“They, in our opinion, are actually excited about the vast changes occurring in the U.S. health care system and feel strongly that the company’s product suite and health management intellectual property acquired over the prior decade opens new doors,” Carroll wrote. “We tend to agree.”

The Post made repeated attempts to sit down with Leedle and company founder Tom Cigarran to discuss their strategies for navigating the road ahead and what further opportunities are on the horizon for the company. After multiple talks with representatives, the company eventually decided not to make them available for an interview.

In his December note, Carroll also said Healthways still has significant opportunities available as health insurance exchanges find their feet and flesh out their offerings with “benefit products from non-traditional insurers such as the ‘big box’ discount retailers and some large drug store chains. HWAY indicates they are having ‘real time’ conversations with these types of entities.”

That’s just one area of opportunity for Healthways. On the company’s third-quarter call, Leedle said “the volume of potential contracts in our pipeline, combined with their diversity, scope and scale, is unique in our history.”

Abandoning ship

Which begs the simple question: Why aren’t more customers biting?

Healthways’ revenues more than quadrupled to $736 million from 2003 to 2008 but have declined slightly since. The loss of Cigna won’t change that trend in 2012 and will hurt margins, too. Leedle has for a number of quarters crowed about his team’s stuffed development pipeline. But at the end of the third-quarter, the revenue associated with signed contracts that weren’t yet active stood at just $20 million.

Similarly, international growth has been held out as a carrot for investors for years but has been slower to develop than originally hoped. A diabetes services deal with a French state-run insurance provider harkens back to the company’s chronic care roots and will soon begin to produce meaningful revenues. But overseas contracts contributed only about $30 million to the top line in 2011 and have yet to make money.

There have been other nice wins. Twelve new clients signed deals during the third quarter and the company later said it has partnered with pharmaceutical giant GlaxoSmithKline on a smoking cessation program sold at Walmart stores. Additionally, UnitedHealthcare, one of the nation’s largest insurers, extended until 2014 its contract for the SilverSneakers program, which provides wellness services to elderly clients.

But critics and skeptics say it’s still not clear the company can properly and consistently monetize its plum position in one of the most talked-about segments of the health care market. And that translates to Wall Street: Simply put, investors won’t buy what they can’t trust.

O’Neil, who has over the years maintained a bullish outlook on the company, told Nashville Post that the stock performance in recent years “reflects that they have made some bets that have not panned out.”

“Much of the price drop is due to investors simply abandoning the stock,” he said, a point borne out in a look at the company’s top investors, which have almost completely turned over in the past three years. (See this chart.)

Credibility is a very precious commodity. You can lose it in five seconds and spend five years trying to get it back even if all the puzzle pieces fall back into place. The big problem for Healthways investors is that the pieces still appear to be somewhat scattered. That has led to some serious swings in stock price and sentiment.

On the heels of October’s Cigna news came a slew of analyst downgrades — a number of them appearing to suggest that a large measure of faith in the company’s model had been lost. Josh Raskin of Barclays — who in July of 2010 had hiked his price target for the stock to $19 from $13 — slashed his prediction to $5 in downgrading the stock to ‘underweight’ from ‘equalweight.’

His downgrade was joined with echoing sentiments from Sean Wieland of Piper Jaffray. Ryan Daniels of William Blair, Eugene Goldenberg of BB&T and Dougherty’s O’Neil. Heading into Christmas, only Stifel’s Carroll said investors should buy Healthways — dirt cheap by just about any valuation measure — and the average price target among analysts doesn’t have the stock climbing back to $10 any time soon.

Still looking long-term

The lack of enthusiasm — bordering at times on cynicism — is evident in other ways, too. After announcing Cigna’s departure plans, Leedle said his team was exploring ways to extend its relationship with the insurer beyond 2013. And Healthways execs say they will have the chance to directly sell to almost half of the companies who are clients under the Cigna-Healthways umbrella — and do so at a lower price. But no observers Nashville Post spoke with entertained those as a meaningful possibility from a revenue standpoint.

Similarly, potential avenues to growth aren’t greeted with wide-eyed enthusiasm. Instead, there are raised eyebrows, even from relative bulls. Said Carroll in his Dec. 8 report: “Additionally, health systems – as large employers – may look to access HWAY employer products for management of employee health benefit costs. Opaque at best, this emerging growth opportunity related to changes in the health system should be considered with some skepticism — at least initially.”

Leadership matters, too, in this equation. In 2008, when our sister publication The City Paper reported on Healthways’ prior difficulties when its Medicare Health Support pilot programs were underperforming, O’Neil said: “The buck stops at Leedle’s desk.”

It still does, of course, but there’s even more on the line now. Following the Cigna announcement, Leedle received a“special one-time retention grant” of 500,000 stock options that could pay big dividends starting in two years — if the company’s battered shares recover. The company’s board said the decision for the grant was made in the hopes of “aligning Mr. Leedle’s long-term interests with both shareholders and the rest of his management team.” That decision, they said, “was an important element in successfully implementing the company’s long-term strategy.”

That strategy — the evolution from classic disease management to offering well-being services that fall into a number of buckets — will evolve further in 2012. Company officials say they plan to make big announcements about key partnerships early in the year, but provided no further details.

Until then, they’ll have to work through the short-term fallout of the Cigna contract loss. In early December, Healthways announced about 50 layoffs, but sources tell thePost the cuts could climb much higher and will almost certainly double before all is said and done. Another setback: The departure at year’s end of Matt Kelliher, president since 2004 of Healthways’ international business.

‘A 20-year headstart’

In 2008, Nashville Post asked The Big Question this way: Was Healthways, like so many other companies at the time, simply caught in a vicious downward cycle or were its customers about to prove its entire business model to be ineffective?

That question remains largely unanswered in the early days 2012, but Leedle is intent on staying the course. Asked at a December Piper Jaffray investor conference about the competitive threat from IT-focused health ventures — Piper analyst Sean Wieland said they are “starting to walk and talk a lot like” Healthways — and the dollars they’re attracting, Leedle said those money flows reflected where the overall market is heading. But he also said Healthways will stay the course, its leaders confident their chosen path will translate into growth.

“We’ve got about a 20-year headstart on this,” Leedle said. “So even if we’re the worst managers in the world, there’s a significant amount of experiential application here [...] When people buy from Healthways, they know they’re buying an effective agent.”

High time to put that experience to profitable use.

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