DVA – DaVita HealthCare Partners

[ni-co]

I'm aware of the fact that there is a DaVita thread within the Berkshire category (http://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/davita-thesis/), but I think it deserves its own "investment idea" thread and therefore suggest to move the discussion here.

Since this is a large BRK/Ted Weschler position and this is the "Corner of Berkshire…" board, I assume that you've already had a look at DVA so I spare you the business description.

To me, there are 5 reasons for DVA as an attractive long term ("Coca-Cola-like") investment:

• It's in a business where economies of scale create a sustainable competitive advantage and DVA already has this scale and puts every spare penny into further growth.
• It always looks expensive because DVA is growing like crazy and therefore has high growth capex. When you have a look at maintenance vs. growth capex, however, you'll see that it's a very high return on capital business and actually much cheaper than it looks at first glance. My mental model for this kind of company is TCI under Malone.
• DVA's (worldwide) market is so huge that there is room enough to grow and aging populations in developed countries grow this market even more.
• I think of Kent Thiry is an "Outsider CEO" and this is exactly what it takes to make a home run out of this kind of company (again: compare TCI under Malone)
• Kent Thiry has a significant stake (373,884 shares as of 13 Feb 2014), as does Ted Weschler personally (2,191,806 shares as of 24 Feb 2014).

The only real threat to the business I can see is regulatory risk. However, since government is interested in keeping health care cost down and DVA is effectively a low cost provider, I think the risk is somewhat limited and, at least, DVA would be the last of these companies to go under, if government decided to kill the industry. The other threat is a complete buyout by BRK.

I recommend this Seeking Alpha article which got me interested in DVA in the first place:
http://seekingalpha.com/article/1769952-why-davita-is-undervalued-compared-to-fresenius-medical-care

ps: You can make an argument that the whole dialysis business is immoral, like ItsAValueTrap does:
http://glennchan.wordpress.com/2013/06/17/for-profit-dialysis-an-unethical-industry-davita-dva/

However, I think that you can make the same points with nearly every privately owned health care business. It needs to be regulated, for sure. But if you are convinced that, in sum, a privately owned health care industry is a net benefit to society, there is no convincing argument – at least to my mind – not to invest in companies within this sector, as long as they abide by the laws and regulations. The net benefit to society, by the way, is why I invest in DVA but not into tobacco companies – I don't think that ItsAValueTrap's comparison is fair in this regard.

[ItsAValueTrap]

In the past, DaVita had foreign operations.  Thiry came in and turned the company around.  One of the things that he did was to axe the foreign operations.

DaVita is currently looking at expanding internationally.  However, I think that those foreign markets are very different.  Health care compensation and the preferred treatment of dialysis is very different in other countries.  Davita's biggest expansion push has been to expand in adjacent health care niches within the US (e.g. the large HCP acquisition). 
There is some benefit to expanding internationally as Davita would have more negotiating leverage against its suppliers.

2- The ethics are a problem I think.  Malone never put anybody's life at risk by overdosing them on EPO.  Malone plays within the rules.  Davita has paid numerous settlements for breaking the rules.

[Liberty]

The only real threat to the business I can see is regulatory risk.

Just throwing that out there, but at some point in the coming decades, they could hit a wall when we have lab-grown replacement kidneys that have the patient's DNA (no transplant rejection). Probably over the horizon for now, so no big immediate worries. But it still seems like there's a clock on the business model...

[ItsAValueTrap]

I don't think that lab-grown kidneys will be happening anytime soon.

HART is trying to commercialize its replacement esophagus.  Here's my writeup on HART.  It is having some problems with its replacement esophagus.  Other organs will be even more complex and difficult.

Regenerative medicine has had a very difficult time doing things other than skin.

[SwedishValue]

My impression after talking with kidney doctors is that there is no indication whatsoever that lab-grown replacement kidneys will be in the making within the nearest decade or two. The kidney a very complex organ, but if it so happens that my investment gets wrecked by artificial kidneys I would be able to stand the permanent loss of capital that would go with it for me as DVA is my second biggest investment.

The willingness to spend on healthcare in general will grow over time (whether privately funded or funded by government programs). Kidney disease is very much related to diabetes, which in turn is very much related to obesity, which in turn is very much related to increasing purchasing power per capita. Mortality for dialysis patients have been going down significantly during the last decade, and there is no sign that this development will stop. All in all, I find it extremely likely that DVA will serve many more additional customers during the next decade. Since DVA has a low-cost profile with significant cost advantage over smaller players (but also over Fresenius), I believe it is very likely that this will also result in significantly higher earnings power a couple of years down the road.

I would be very surprised if the number of living dialysis patients in USA didn't dubble over the next decade. I find no reason to believe that DVA will not retain its market share. I also find it likely that the value of a dialysis patient will grow over the next decade.

My best guess is that DVA due to their favorable market conditions has a high probability of tripling its free cash flow over the next ten years. IF this happens, and DVA finances the capex needed to grow with its cash flow, the stockholders of DVA will have a very nice time. A tripling of the Cash Flow could take net debt levels from today's ~$8 BN to $24 BN, freeing up $16 BN to shareholders in the form of buybacks or growing the HCP business or whatever management finds smart from a capital allocation viewpoint.

I have not found one compelling argument as of why the dialysis market would not continue to grow during the next ten years, just at it has grown for the last thirty years. I would be happy if someone could share one with me.

[Liberty]

I don't think that lab-grown kidneys will be happening anytime soon.

HART is trying to commercialize its replacement esophagus.  Here's my writeup on HART.  It is having some problems with its replacement esophagus.  Other organs will be even more complex and difficult.

Regenerative medicine has had a very difficult time doing things other than skin.

Yeah, that's why I mentioned decades. But I doubt the rate of progress will be linear and predictable. Breakthroughs can speed things up after long periods of slow progress (ie. when we figured out how to turn regular cells (like skin cells) into stem cells, that helped that whole field quite a bit). We'll start with the easier organs and move up and reach kidneys at some point. No reason why not.

[yadayada]

You can pick up binge drinking to hedge your investment.

[Liberty]

My impression after talking with kidney doctors is that there is no indication whatsoever that lab-grown replacement kidneys will be in the making within the nearest decade or two.

I was just mentioning an interesting fact for the long term, not trying to scare people out of this investment in the short term.

I don't think anyone has good visibility into the next decade or two of medical applications, probably not even the people working on the stuff. Could most doctors have told you how cheap it would be to sequence a genome today 10 or 20 years ago? It doesn't even seem that big a deal anymore -- we get used very quickly to big advances (same with things like the iPhone, we're not impressed by the tech anymore). I mean, we have surgical robots and augmented reality apparatuses being used to operate on people... It's likely that in a while, we'll have replacement organs and it won't seem a big deal. I just don't know when.

[SwedishValue]

I very much appreciate your concerns and thoughts Liberty, and you should know that this coming from you make me second guess myself somewhat.

The kidney in itself is a very complex organ though. From my understanding we do not even know the details as of in which way dialysis works, but we do know that it works. To be able to produce a lab kidney we would probably first need to understand the organ in much more detail.

I just think that raising the issue of lab kidneys is overly cautious as it is a very very low probability event within the next decade (just looking at lead times for new medicines as an indicator, and seeing that we are not even close to producing a lab kidney). I think that foreseeing the development of the lab kidney is overly cautious and not in proportion with the favorable tailwinds the demographic development for increased need of dialysis care gives for the investment case.

On another note, with your argument we could argue for complete disruption of the cable industry (wireless).

[kevin4u2]

Even if lab grown kidney replacement was an option, the next problem would be the economics (cost).  This would further drive out the implementation into the future. 

My impression after talking with kidney doctors is that there is no indication whatsoever that lab-grown replacement kidneys will be in the making within the nearest decade or two. The kidney a very complex organ, but if it so happens that my investment gets wrecked by artificial kidneys I would be able to stand the permanent loss of capital that would go with it for me as DVA is my second biggest investment.

The willingness to spend on healthcare in general will grow over time (whether privately funded or funded by government programs). Kidney disease is very much related to diabetes, which in turn is very much related to obesity, which in turn is very much related to increasing purchasing power per capita. Mortality for dialysis patients have been going down significantly during the last decade, and there is no sign that this development will stop. All in all, I find it extremely likely that DVA will serve many more additional customers during the next decade. Since DVA has a low-cost profile with significant cost advantage over smaller players (but also over Fresenius), I believe it is very likely that this will also result in significantly higher earnings power a couple of years down the road.

I would be very surprised if the number of living dialysis patients in USA didn't dubble over the next decade. I find no reason to believe that DVA will not retain its market share. I also find it likely that the value of a dialysis patient will grow over the next decade.

My best guess is that DVA due to their favorable market conditions has a high probability of tripling its free cash flow over the next ten years. IF this happens, and DVA finances the capex needed to grow with its cash flow, the stockholders of DVA will have a very nice time. A tripling of the Cash Flow could take net debt levels from today's ~$8 BN to $24 BN, freeing up $16 BN to shareholders in the form of buybacks or growing the HCP business or whatever management finds smart from a capital allocation viewpoint.

I have not found one compelling argument as of why the dialysis market would not continue to grow during the next ten years, just at it has grown for the last thirty years. I would be happy if someone could share one with me.