$38 Billion from Uncle Sam Could Send These Stocks Soaring

Wednesday, October 20, 2010 - 10:43am

by Tom Taulli

Perhaps the biggest domestic market opportunity for investors is the U.S. health care system. The industry already consumes roughly 16% of gross domestic product and that's likely to reach 19.5% by 2017. Of the total spending, about half goes to hospital care and physician services.

But with such large amounts, it is inevitable that there will be wasteful spending and lots of inefficiencies. A report from the Annals of Family Medicine shows that primary care physicians spend about half their work day on activities outside the exam room. Of course, this involves documentation, reporting, billing and so on.

Then again, the workflows for physicians are often problematic. They may rely on assistants who are often overwhelmed with records, regulations and rules. And the consequences can be severe.

To deal with this, Congress has taken action to help reform the system. Roughly $38 billion in subsidies will be committed to aiding the speedy adoption, and improvement, of electronic medical records by 2016. This is actually part of the 2009 recovery legislation, which created the Health Information Technology for Economic and Clinical Health Act (HITECH). Basically, the law prods physicians to adopt information technology (IT) systems, especially the adoption of electronic health care records (EHR).

No doubt many companies are scrambling to get a piece of this federal money. Large software players are likely to be beneficiaries, such as Oracle (Nasdaq: ORCL), IBM (NYSE: IBM) and GE's(NYSE: GE) Medical Systems unit. Even Google (Nasdaq: GOOG) is making aggressive investments in healthcare IT.

But there are also some smaller operators poised for growth. These companies are pure-plays on the industry and are likely to see stronger growth ramps because they have smaller revenue bases.
Here are three that look promising for investors:

1. Medidata Solutions (Nasdaq: MDSO) -- This company operates a platform that helps pharma and biotech companies manage the clinical trial process -- certainly a critical function. After all, it generally takes 10 years and more than $1 billion to develop a new drug. So by streamlining the process, Medidata's solutions not only speed things up, but also lower the costs. At the same time, there is also improved compliance with federal regulations.

Medidata's customer base includes 22 of the top 25 global pharma customers. Examples include biggies like Amgen (Nasdaq: AMGN), Johnson & Johnson (NYSE: JNJ) and Takeda Pharmaceutical.

As for the financials, Medidata has been growing at a nice clip. In the latest quarter, revenue increased +19% to $40.3 million. Net income was $3 million. The valuation comes to roughly 2.5 times sales, which is in line for a typical software company.

What's more, there may be consolidation in the industry. Keep in mind that Oracle recently purchased PhaseForward, which is a top player in the automated clinical trials space.

2. Mediware Information Systems (Nasdaq: MEDW) -- The company focuses on a much-needed area of healthcare; that is, managing the blood supply. It's a complicated area and is heavily regulated. But with Mediware's software, management is more efficient and with a lower error rate.
The company has also been expanding its footprint through acquisitions. The company has softwaretools for areas like blood donor recruitment and home infusion services.

In its fiscal third quarter, Mediware saw a +26% increase in revenue to $10.2 million, while net income was $483,000.

Yes, it's a small company -- but it company is certainly determined to become a big player in healthcare IT. And it looks like acquisitions will continue to be a key to the strategy. Also consider that the stock's valuation is at only 1.25 times revenue.

3. athenahealth (Nasdaq: ATHN) -- The company's web-based software helps physicians' practices deal with the mind-numbing reimbursement rules and policies that are required to be compliant. (The market size for medical reimbursement is roughly $500 billion.) The upshot is that payments generally increase and the costs go down. What could be better?

So it is no surprise that athenahealth's business has been ramping up. In the latest quarter, revenue jumped +28% to $58.6 million and non-GAAP adjusted net income was $4.1 million. The stock trades for an expensive 4.4 times revenue. While this is not cheap, it is still reasonable when looking at the company’s strong growth rate.

Actually, athenahealth has been leveraging its business into other categories, such as medical records and even patient communications. In other words, it's a good bet that the growth will continue for the long-haul.

Action to Take --> All of these stocks should do well as health care spending continues to grow. They all address ways to cut costs, increase efficiencies and improve compliance. And in light of the market opportunities, revenue and earnings are likely to increase at +20%-plus rates for the next few years -- which would certainly make these classic growth companies. What's more, they are still relatively "under the radar" and valuations are not necessarily frothy.

However, there is still risk, such as with Mediware. This stock is really for a small-cap player who wants to find a potential big return, while athenahealth and Medidata are for those who want less volatility.

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Tom Taulli does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.