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Comparing Two Healthcare IT Companies

Healthcare in the United States has been a hot topic of discussion for the last 3 years now. And no wonder. In 2011, healthcare spending share of GDP in the U.S. reached an all-time high of 18.2% - no other country in the world exceeds 12%. A major side effect of this is that more and more Americans cannot afford health insurance. The percentage under 18 without insurance increased to 17.7% in 2011, up from 14.8% in 2008, a 20% increase in just 3 years.

With those kinds of costs, one would think the quality and safety of treatment would be beyond reproach. But that's just not true either. Preventable medical errors are the 6th leading cause of death in the U.S., with a recent study showing that 1/3rd of all people who check into a hospital suffer from a medical error while inside. A study done back in 2006 showed that 1.5 million people every year are the victims of medication or prescription errors.

One of the biggest culprits in both the cost and quality problem is the historically poor state of healthcare information technology (IT) systems. 45% of doctors still don't use electronic records. Hand-written folder records are not easily transferrable, are not standardized, are difficult to back up, and are at risk of loss or permanent destruction. Prescriptions through both handwritten methods (who can read a doctor's scribbles?) and the phone ("Zantec" and "Xanex" sound an awful lot alike) are error-prone. Yet, for years, doctors and hospitals saw little reason to upgrade their record systems, as the financial incentive to do so was low.

That changed in 2009, with the stimulus plan setting aside $20 billion in funding for healthcare organizations to upgrade their IT. This has led to a boom in the industry, with spending expected to triple by 2014 from 2011 levels.

Clearly, this is an interesting investment sector. The growth is there. Competitive advantages in the form of high switching costs are there. Software is a capital-lite business with high recurring revenues from maintenance and support contracts. And we have two plays available in the Magic FormulaŽ screens. Let's compare Mediware (MEDW) and Quality Systems (QSII) and see which one looks like a better choice at present.

Business Summaries

Both firms sell software management systems to healthcare organizations, and both earn about 70% of sales from recurring sources, but their intended client focus is slightly different. Mediware sells software in 3 segments. The first is blood management, focused on donors, storage banks, and hospitals to manage blood donations, storage, and transfusions. The second is medication management, automating and standardizing the process of prescriptions, medications, and drug interactions - these are sold to hospitals and pharmacies. The third are comprehensive management software for home care businesses. Mediware also sells business intelligence software that plugs into these 3 suites and provides dashboard-like performance views for planning and management.

Quality Systems is more focused on comprehensive practice management software, which centralizes clinical, financial, and administrative data into one system for primarily small physician and dental practices. Recently, the firm started producing a similar product for hospitals.

Financial Health

Both companies are debt free and carry loads of cash. Quality Systems' $135 million in cash is 12% of market cap and Mediware's $37 million is almost 31% of market cap. QSII has better operating margins at 25% (vs. 16% for MEDW), but free cash flow margin is almost even at 14% apiece. Financial health is not an issue for either company, clearly.

Growth

Again, both companies have been growing sales rapidly. In the most recent quarter, Mediware grew sales 22% year-over-year and Quality Systems 18%. Analysts expect both firms to grow about 15% annually over the next 5 years. We've already touched on the rising tide of the industry, so growth should not be an issue for either firm.

Shareholder Friendliness

The marquee advantage Quality Systems possesses over Mediware is its voluptuous dividend, 3.8% as of this writing. Mediware does not pay a dividend. Quality's dividend is a bit tenuous, representing 68% of free cash flow over the past 12 months and averaging nearly 70% over the past 5 years, both high ratios. Neither company is particularly dilutive with stock options - both have increased share count at less than 2% over the past 5 years.

Quality's dividend clearly gives that stock an edge in this particular category.

Valuation

Another virtual toss-up here. Valuing by P/E ratio, it's almost a wash with QSII at 15 and MEDW at 16.5. Using an EBIT/Enterprise Value, again it's close with QSII at 11.7% and MEDW at 11.4%. Both stocks are cheap against their peers and historical averages. For example, sector leader Cerner (CERN) trades at P/E of 35 and an EBIT/EV of 4.5%, and the 5-year EBIT/EV averages for QSII and MEDW are 5.9% and 7.4% respectively. Neither stock has an edge here, either!

Conclusion

I would consider the comparison almost a perfect wash up to this point. In fact, MagicDiligence believes either stock is a great current Magic FormulaŽ choice.

There are a few more concerns about Quality Systems. Last quarter they missed expectations and management withdrew guidance, never an encouraging sign. Influential shareholder Ahmed Hussein has been on a 5 year crusade to get the company's board replaced, and is at it again this year.

Finally, Mediware plays in some more specialty areas than Quality Systems. Quality's products are general purpose electronic health record (EHR) management systems, which compete directly with the primary products of the "big boys" like Cerner and McKesson (MCK). While some of Mediware's products are duplicated in modules from these competitors, Mediware can boast of some pretty impressive clients - like the Red Cross, U.S. Military, and Johns Hopkins - that are a testament to the quality and value their products offer over the competition.

For these reasons, Mediware eeks out a victory in this comparison.

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Disclosure: Steve owns no stocks referenced here.

Joel Greenblatt and MagicFormulaInvesting.com are not associated in any way with this website. Neither Mr. Greenblatt or MagicFormulaInvesting.com endorse this website's investment opinions, strategy, or products. Investment recommendations on this website are not chosen by Mr. Greenblatt, nor are they based on Mr. Greenblatt's proprietary investment model, and are not chosen by MagicFormulaInvesting.com. Magic Formula® is a registered trademark of MagicFormulaInvesting.com, which has no connection to this website. The information on this website is for informational purposes only and solely represents the views and opinions of the author. No warranty is provided or implied as to the accuracy, completeness, or timeliness of this information. This information may not be construed as investment advice of any kind, nor can it be relied upon as the basis for stock trades. Alexander Online Properties LLC, the proprietor of this website, is not responsible in any way for losses or damages resulting from the use of this information. Alexander Online Properties LLC is not a registered investment advisor. All logos are trademarked properties of their respective companies.

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