Wednesday, July 15, 2009

CardioNet: Reimbursement at the heart of the matter

It has not been a good year for investors in CardioNet (NASDAQ: BEAT), the once high-flying Pennsylvania-based cardiac monitoring company touted by many as the best pure play in wireless patient monitoring and diagnostics. CardioNet stock closed on July 14 at $6.20, down 83% from it 52 week high of $35.89. For the second half of 2009, the company’s share price mirrored the broader market. In Q1 of 2009 it outperformed the market, returning by late April to the level it had enjoyed in mid-July 2008. But the trend turned in May; CardioNet shares have plummeted in the last 2 ½ months. For those seeking an explanation, the answer seems simple and comes in one word - reimbursement. The company would express it more vigorously – arbitrary and unwarranted reimbursement reductions. But, as is often the case, the story is somewhat more complicated. CardioNet made specific corporate strategy decisions that increased its exposure to reimbursement risk.

Let’s look at the background and review some pertinent history. CardioNet provides Mobile Cardiac Outpatient Telemetry (MCOT) using an internally developed proprietary technology platform. MCOT allows continuous cardiac monitoring for up to 30 days, with the capability for real-time review and querying from a monitoring center. The technology allows for the identification of heart rhythm irregularities that elude the commonly used shorter-term monitoring technologies (e.g. holter monitoring), and many insurers, including Medicare, cover MCOT for defined subsets of patients who experience serious but unpredictable arrhythmias that have not been adequately evaluated by those other techniques.

Diagnostic tests like MCOT are represented by two CPT codes. One code identifies the Professional Component (PC) of the test – the physician’s interpretation of the test result as it relates to the individual patient; the second code identifies the Technical Component (TC) of the test – in this case the resources required to provide and conduct the test and generate a test report (the MCOT equipment, the monitoring center with its technology and staff, the computerized analysis of data, the generation of a report to the physician, etc.) CardioNet operates as a physiological testing laboratory – monitoring patients nationwide from its base in Pennsylvania and billing insurers for the TC of the test; the referring physician bills for the PC, which is small compared to the TC.

MCOT was approved for commercial use in 2002, and CardioNet set up its testing center that same year. As a Pennsylvania-based facility, the center did all of its Medicare billing to a single regional Medicare Part B carrier, Highmark Medicare Services. The test was provided under a temporary Category III CPT code through the end of 2008. In October of that year, however, CardioNet announced approval of permanent codes for MCOT – CPT 93228 for the PC and CPT 93229 for the TC – effective January, 2009, and a carrier-determined reimbursement rate for the TC of $1,123.07.

CardioNet had gone public earlier in 2008, and the analyst community is extremely sensitive to reimbursement issues, particularly for single product companies where one reimbursement decision can be make-or-break. That sensitivity can sometimes take the form of rumor-fed speculation, often resulting in share price instability. CardioNet was not immune to this phenomenon, and on April 28, 2009 the company issued a press release to refute analyst speculation about an imminent Highmark payment reduction for the MCOT TC. On May 18, a further press release solidified the situation, announcing formal Highmark posting of the $1,123.07 rate originally announced in October of the previous year. Things were looking good on the reimbursement front.

But there has been nothing but bad news since. On June 30, a press release announced a downward revision of guidance for 2009 based on lower than expected commercial reimbursement rates. Analyst concern over Medicare reimbursement was heightened by this news, and confirmed in a July 12 CardioNet announcement of a revised Highmark TC payment rate effective September 1 – a more than 30% reduction to $754. On the following day, the company announced termination of its agreement to make what had been positioned as a key strategic acquisition to strengthen its position in the wireless telemetry ; a failure by the target to comply with conditions of the agreement were cited as the reason. The jilted acquisition target, BioTel, Inc., disagreed vehemently and is weighing its legal options. It is difficult to dismiss the reimbursement catastrophe as an underlying cause.
We cannot yet know whether CardioNet did the best possible job of reimbursement advocacy, why it didn’t prevail, or why it was apparently blindsided by Highmark’s action. So we can’t, from outside the company, determine which of the following three possible scenarios best describes this case:
  1. Weak or ineffective advocacy for a case that ought to have prevailed on its objective merits;
  2. An objectively weak case that could not prevail on its merits; or
  3. A payer decision that was in fact arbitrary, or based on factors other than objective analysis of costs.
What we can know is that CardioNet made a number of conscious business strategy decisions that, whether or not they were dictated by compelling business reasons, increased its reimbursement jeopardy.

First, by maintaining all of its operations in a single location, CardioNet put its entire Medicare business into the hands of a single local Medicare contractor. Had operations been regionalized, there would have been a different contractor for each region. A single contractor would then have impacted only a portion of the Medicare business, not all of it. There is a trade-off at work: a single carrier increases jeopardy by putting all of the eggs in a single basket; multiple carriers spread the risk, but require commensurately broadened advocacy communications and reimbursement support. CardioNet opted for operational consolidation (which may also have carried substantial operating cost advantages), valuing business simplification over reimbursement risk mitigation.

If multiple carriers were handling CardioNet’s claims, Medicare would have had an incentive to set reimbursement at a single nationally-determined level, especially if there were regional disparities that could not be supported by differential costs. But a single explicitly national rate established centrally is greatly preferable to an effectively national rate set by a single regional carrier. At the national level, there are procedural rules, formal opportunities for comment on proposals, and public notification of the basis upon which a decision is made. Local carriers are not bound by any of these requirements. Furthermore, local carriers do not have substantial payment policy staffs wide broad experience in understanding cost profiles and operating requirements across many different types of provider organization; the sophistication of their decision processes varies widely and cannot be relied on.

Second, CardioNet chose to operate as a physiological testing laboratory rather than selling its technology to independent laboratories. Had it done the latter, the company would have been free to sell the technology at a price of its own choosing. This would transfer primary reimbursement risk to CardioNet’s customers, but it would also provide those customers with unequivocal documentation of an important cost element required for the test – the technology cost. Under the scenario CardioNet chose, there is no such documentation, as there is no arms-length transaction between technology supplier and testing facility. Under these circumstances, Medicare invokes special accounting rules applicable to “related party transactions”; the relevant aspect of those rules is that transfers between related parties occur at the cost of manufacture or acquisition – no margin (markup) is recognized. Thus, to the extent CardioNet wants to provide real cost data, Medicare will calculate the cost of providing the TC without allowing a markup on cost of manufacture.

I suspect that CardioNet made the choice it did in order to capture a larger share of the total TC revenue stream – not an unreasonable goal. But again, there was a tradeoff: control of the total revenue stream increased direct exposure to reimbursement risk. And there was a more conservative choice available: sell the technology to testing facilities until reimbursement was clearly established, and then expand into the testing business once reimbursement risk was minimized.

That conservative strategy may not have been aggressive enough for the investment community. And therein lies the third risk-increasing strategic decision CardioNet made: the decision to go public before solidifying its business position and before removing reimbursement risk from the equation. Perhaps an IPO was the only way to raise enough money to build the business. An IPO was certainly the way for early investors to cash out and take profits, and for management to realize substantial capital gains. But IPOs increase all sorts of exposure, create enormous pressure to accept risk in order to grow quickly, and expose companies to extraordinary volatility when best-case scenarios are not realized. When things were going well, it seemed as if CardioNet management was on top of the key issues; when they went sour, management appeared to be caught unaware and unprepared, having oversold financial growth and understated risk.

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