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Why Ted Weschler Keeps Buying DaVita (DVA)

November 09, 2012 | About:
Geoff Gannon

Geoff Gannon

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Berkshire Hathaway portfolio manager Ted Weschler has owned shares of DaVita (DVA) for over 12 years. The stock is near an all time high. But Weschler keeps adding shares. Why?

When he’s asked about Berkshire’s two portfolio managers – Ted Weschler and Todd Combs – Warren Buffett won’t say which man owns which stocks. But because Weschler and Combs filed with the SEC when they ran their hedge funds we can tell when they are recreating an old position at Berkshire.

Ted Weschler owned DaVita since at least 2001. We can be sure he’s the one who’s been buying DaVita for Berkshire Hathaway.

Buffett mentioned that one of the two men – Weschler or Combs – trades a lot more often than Buffett does. A check of Weschler and Combs’s past filings with the SEC makes it clear Buffett was talking about Combs. Not Weschler. Weschler doesn’t trade frequently. At least he doesn’t change his biggest positions very often.

Before going to Berkshire, Ted Weschler ran a hedge fund called Peninsula Capital. DaVita was one of Peninsula Capital’s largest positions from 2001 through 2011. In June 2001, Peninsula had $71 million of its $239 million portfolio (30%) invested in DaVita. And at almost all times between 2001 and 2011, Peninsula had between 20% and 40% of its portfolio in DaVita.

These numbers are based on Peninsula’s 13F filings with the SEC. They exclude foreign stocks. And may overstate the percentage of Peninsula’s portfolio that was invested in DaVita. Regardless, DaVita was always one of Peninsula’s biggest U.S. stock holdings.

And at least in 2001, Peninsula also owned some shares of DaVita’s main competitor: Fresenius. The position shown in the 2001 13F for Fresenius only included ADRs. It was tiny. And it is possible Ted Weschler had also bought Fresenius shares overseas. So we can guess Weschler knew a lot about DaVita as far back as 2001. And he didn’t just like DaVita. He liked the dialysis business.

DaVita changed a lot around 2001. In the 1990s, DaVita was a super aggressive growth company. Sales grew 95% in 1995. In 1996 they grew 66%. In 1997 it was 53%. And in 1998 it was 58%. About halfway through 1999, DaVita changed course. That was probably a good idea. Because in 1999, DaVita reported a net loss of $147 million. That was the company’s second straight loss. It also lost money in 1998. Remember, these losses happened while the company was growing sales by more than 50% a year. That’s not a good sign.

DaVita fueled its growth with acquisitions. And it paid for those acquisitions with debt. The piling up of debt made the operating loss DaVita experienced in 1999 – a $64 million loss – much worse than it had to be. The company was in serious trouble.

DaVita slowed its growth in the second half of 1999. And the company grew sales at the slowest pace in the last couple decades in 2000. Sales growth was just 3% that year. That’s very slow considering the patient population DaVita serves – Americans with end stage kidney failure – was growing at least 4% a year at the time. In other words, DaVita stopped its market share growth entirely.

In the years that followed, DaVita started growing its market share again. In 2001, 2002, 2003, and 2004 the company grew by anywhere from 9% to 14% a year. A much more manageable rate. Anything above 6% a year probably represented market share growth in those years.

DaVita’s shares outstanding had gone up, up, up for much of the company’s rapid growth phase. But they finally peaked in 2007. And from 2007 to today, shares outstanding fell 12%.

This combination of factors allowed DaVita to grow earnings per share at 15% a year over the last decade. So slower sales growth did not lead to slow earnings growth.

From this story, we can see a lot of similarities between Ted Weschler and Warren Buffett. Warren Buffett is a big believer in buying a great business when it is struck by a fixable one-time problem. That’s what happened to DaVita. The number of Americans needing dialysis rose steadily by about 4% a year. When Ted Weschler bought DaVita – there was no reason to expect the market would shrink.

And a couple companies – DaVita and Fresenius – were gobbling up a fragmented dialysis market. Mostly through acquisitions. Today, there are about 400,000 patients in the population DaVita seeks to serve. The company actually has about 142,000 of those patients. Fresenius serves a similar amount. So, between them, they have two-thirds of the market for dialysis. Fresenius also makes dialysis related products. In fact, they are a big supplier to DaVita as well as being a competitor.

So DaVita is not a unique company. But it is in a unique business. The dialysis industry is very strange. The number of people in the market is tiny. Like I said, it’s around 400,000 people out of the more than 314 million people in the United States. We’re talking about 0.13% of the American population.

Patient turnover is about 30%. So there is a lot of churn. But the need for the service is high. These people need dialysis – or a kidney transplant – to keep going. Often, we are talking about folks who get 3 treatments a week. The average cost per treatment is $330.

Gross margins are low. Today, they are around 30%. In the past, DaVita’s gross margins were sometimes as high as 35%. Operating expenses are low. Lately, they’ve been running around 10%. This leaves fat operating margins. And suggests there are real benefits to scale.

In fact, every business that touches DaVita has a story to tell about scale. I mentioned Fresenius before. They are a competitor and supplier. DaVita’s key supplier is Amgen (AMGN). Amgen provides epo. DaVita has a purchase agreement with Amgen that forces DaVita to use Amgen as pretty much the company’s sole supplier (DaVita must buy 90% of its epo from Amgen). In return, Amgen is limited in how high it can raise epo prices above the rate of increase in the amount that DaVita can bill for the cost of its epo.

This brings us to the issue of billing. It’s a strange one. The vast majority of DaVita’s customers provide no economic benefit. Patients paying through a government health program (like Medicare) account for 89% of DaVita’s treatments and zero percent of profits. DaVita makes all of its profits from commercial payors.

That’s why I could never buy shares of DaVita. The company is too dependent on the precise working of the U.S. healthcare system. It makes all of its money from private plans. Government plans give DaVita 90% of its patients and none of its profits. You have to know a lot about government policy in this area to predict the future for DaVita.

But Ted Weschler is very familiar with the company. He’s owned it for well over a decade. And probably knows as much about how changes to healthcare might affect DaVita as anyone.

Based on the way Ted Weschler has been buying his shares – and the fact that we know Warren Buffett increased the amount of Berkshire’s funds he entrusts to Ted – we can guess that most of Berkshire’s recent buying of DaVita is not about this being the perfect moment to buy shares. It’s about building a large – possibly very long-term – position in DaVita.

The company has changed though. In the last year, DaVita merged with Healthcare Partners. The company even changed its name to “DaVita HealthCare Partners”. From now on, about one-fourth of the combined company will be HealthCare Partners and three-quarters will be the old DaVita. The businesses aren’t really related. DaVita served a very specific niche. And while this acquisition keeps DaVita in the healthcare industry – it’s really a form of diversification within that huge industry. Since it has nothing to do with dialysis.

Is it a diworsification?

Maybe. It’s hard to say. Because the future of any healthcare business like DaVita’s is tied to reimbursements. Especially reimbursements from government plans. DaVita is complicated this way. It is vulnerable to changes in commercial payors because that is where its profits come from. And it is vulnerable to changes in government payors because most of its patients are part of a government plan.

Even if DaVita provides dialysis to government patients at a cost no higher than what Medicare sets as the appropriate amount to be billed for dialysis – there is actually no guarantee that DaVita will break even. The exact amount DaVita will eventually collect is more complicated. DaVita will always be able to collect 80% of the amount Medicare sets for dialysis because that amount is paid by the government. The bad debt risk there is nil.

The other 20% is more complicated. Technically, the patient is responsible for this amount. However, in many situations, it is not as if the patient will be paying the other 20% in cash out of pocket. Other insurance may be used. Just not Medicare.

So DaVita is in a strange position where there is always some risk to providing care to patients who pay using a government plan. And yet there has been no profit in this business. All of the profit comes from private payors. So only about 1 in 10 patients earns any money for DaVita.

When you think about DaVita’s overall profit margins – this situation looks even stranger. DaVita’s operating margins are always greater than 10%. In fact, operating margins have rarely dipped below 15%. When you consider that all of this operating profit is earned on just 10% of DaVita’s patients – you see how high the markup is on those patients.

When you also consider how few patients DaVita serves – 142,000 overall – you realize just how small the profit pool is we’re talking about. DaVita really makes all of its money on about 14,000 patients. DaVita has about one-third of the market for dialysis in the U.S. So we are talking about an industry with about 43,000 profitable patients each year.

This setup has worked for DaVita. And for Ted Weschler. Over the last decade, DaVita shares delivered a compound annual return of 21% a year. The healthcare industry really hasn’t done any better than the S&P 500 over those 10 years. So the outperformance – of about 14% a year – is entirely company specific.

DaVita is a very interesting company. And I find Ted Weschler’s investment in the company absolutely fascinating. Especially the timing of when he invested in the company – early in a transition to safer, more sustainable growth. But the most interesting aspect of Ted Weschler’s investment in DaVita is his holding period. He is still buying shares of DaVita more than 12 years after he first invested in the company.

You can see why Warren Buffett hired Ted Weschler. He has a very Warren Buffett like approach to investing. He is willing to bet very big on one stock. And he is willing to hold that stock for more than a decade. Very few investors are as long-term oriented as Warren Buffett. And very few investors are as focused as Warren Buffett. Ted Weschler is both.

Having said that, there’s no way I could ever buy DaVita. And I have a hard time laying out the investment case for the stock today. If DaVita’s past is like its future – and the patient population keeps growing 4% a year – I can see how the stock is still cheap at 15 to 20 times earnings. But that’s a big assumption.

I have an unfair bias against healthcare stocks. They are outside my circle of competence.

Adding to a stock you’ve owned for more than a decade makes a lot of sense to me. Betting on a stock with DaVita’s market share and long history of strong margins also makes sense to me.

But I can’t evaluate an investment in DaVita. Because I have absolutely no idea what the future product economics of dialysis will be.

Talk to Geoff about Why Ted Weschler Keeps Buying DaVita (DVA)

Read Geoff’s Other Articles


Rating: 4.2/5 (44 votes)

Comments

vgm
Vgm - 1 year ago
Geoff,

Interesting article, as ever. Thanks.

However, after wading thru your detailed descriptions of the business and history of Weschler's longstanding interest, including your conclusion which says "But I can’t evaluate an investment in DaVita", I'm left feeling that the title of your article should've been:

'I Don't Understand Why Weschler Keeps Buying DaVita'.

When a stock or sector is outside our circle of competence - as Buffett's legendary avoidance of tech forcefully reminds us - we will never fully understand an investment. To your credit, you acknowledge this. But given someone of the caliber of Weschler's long love affair and (therefore) deep knowledge of the company, we can only conclude he has a persuasive investment case and hard numbers to back his conviction. That's what to me is fascinating - and at the same time frustrating!

Thanks again for sharing.

RAZORB23
RAZORB23 - 1 year ago
One word: Diabetes...

1. 24 million people are living with diabetes in the United States.

2.180,000 are living with kidney failure as a result of diabetes

3. Each year 100,000 people are diagnosed with kidney failure.

4. Kidney failure requires either dialysis or transplantation.

5. The incidence of diabetes is growing (rapidly).

6. Due to poor medication compliance, the incidence of kidney failure is growing as well.

7. DIABETES>>>>>KIDNEY FAILURE>>>>>DIALYSIS>>>>DaVita

8. Due to the poor health of the United States citizenry, DaVita has generated a consistent profit...

9. This service will be hard for other companies to replicate, thus an economic moat/competitive advantage has been created that will last (unfortunately) for a long time........
zepolinvestmentslp
Zepolinvestmentslp - 1 year ago
Well said Razor,

If I had to make a guess I would imagine DaVita fits into all four of these characteristics for Ted:

1) The business is well within his circle of competence.

2) The company has a large competitive advantage.

3) With able and trustworthy management to run it.

4) Its selling at a price that makes sense in relation to the assets.

Thank you for sharing this article!
luishernadez
Luishernadez premium member - 1 year ago
Great article Geoff ! It is also very hard for me to lay out an investment thesis for DaVita today and at current prices. Maybe it has to do with a conviction of the "profitable 10%" of the clients growing at a good rate over time. The key here is those "profitable 10%" are EXTREMELY profitable. So if they grow, earnings grow pretty well.

The next step is to do a similar analysis on Liberty Media (LMCA) and DirecTV (DTV), which are "the other two" favorite Ted Weschler's stocks. I have done some research on my own, but would love to read your analysis on both.

Also thanks for sharing,

Luis Hernandez

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