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Morningstar | California Legislation Threat a Negative but Manageable Concern for Dialysis Providers

The California Assembly surprisingly passed legislation that would reduce commercial reimbursement rates for dialysis treatments on par with Medicare payments for patients receiving premium assistance, primarily from the American Kidney Fund. The bill still has to pass the Senate and then be signed by Gov. Jerry Brown. While the legislation does have material consequences for Fresenius Medical Care and even more so for DaVita, we plan to leave our fair value estimates and narrow moat ratings for these companies in place until success of the bill looks more assured.

The legislation is a clear negative for dialysis providers, but we think there’s a number of potential unintended consequences from the bill that might give government officials pause before signing into law. We assume reducing commercial reimbursement rates for patients receiving premium assistance would hurt patient access as newly unprofitable facilities close and providers reduce their financial support for charitable programs. Without financial assistance, we speculate the affected population would probably transition into Medicare and Medicaid, effectively leading to the desired reduction in provider reimbursement. Insurance companies appear to be winners from the legislation by having patients kicked off their books, while many of the unhappy commercial patients and the state’s Medicaid budget hold losing hands as these patients shift to Medicare and lean on Medicaid for supplemental financial support.

There are many unknowns, but we estimate the effect on dialysis company profitability would be less than what the market has initially implied. DaVita faces the most exposure given its U.S. service-focused business, with California representing close to 20% of its operations. Based on our assumptions, we think the bill passing would reduce DaVita’s EBITDA by 5%-10%, which could be partially offset by cost-saving measures and the likelihood of facility closures.

The upcoming Proposition 8 ballot initiative in California to cap dialysis facility profitability also faces an uncertain path, including the outcome of the vote and complications of implementing how direct spending costs are calculated in the initiative. While we think the imposition of profitability caps at the facility level would be incrementally negative to dialysis providers, the bulk of this impact would be addressed by the implementation of the premium assistance bill. That said, we're hesitant to handicap the net effect at this time, given the uncertain odds of the ballot outcome.