The Depth Report – Depth Check - HCA Healthcare, Inc. (HCA)
Last month, we published a positive writeup on HCA Healthcare, Inc. (HCA). Our thesis was that the stock was trading at a discounted multiple due to uncertainty over when the hospitals would be able to return to high-margin elective surgeries. We noted that if the current wave of Covid-19 infections were to subside, the hospitals could return to something more resembling business as usual, and that if Covid-19 infections surged, HCA has around $900 million in government cash already on the balance sheet as an advance against treating virus patients. We expected that regardless of how the uncertainty was resolved, the company should have a good quarter and that guidance would be positive.
At the time of publication, we were aware of the case California v. Texas which challenged whether the Individual Mandate of the Affordable Care Act (ACA) could be severed from the law. Our belief was that even though the Individual Mandate has been set at $0, the 4 “liberal” Justices on the court in addition to Chief Justice John Roberts who wrote the original decision affirming that the ACA was not unconstitutional would ensure no meaningful change to the law. The death of Justice Ginsburg last week has put that into doubt and is the reason for this update.
Justice Ginsburg was a supporter of the ACA and was one of the 5 votes supporting the original decision to declare the law not unconstitutional. Her death last week means that the Trump administration has the opportunity to replace her with a more conservative jurist. President Trump has said he’ll nominate a new justice this weekend, and Senate Majority Leader McConnell has committed to getting that nominee a vote on the Senate floor. Yesterday, Senator Romney said he’d support a vote based on the merits of the nominee. This means that President Trump and Senate Republicans have enough votes to push through the approval of a new justice prior to the start of the Supreme Court hearings on California v. Texas which start in November. Should the Senate fail to approve a nominee prior to the election, it’s possible they will try again in a potential lame-duck session.
Even if Chief Justice Roberts sides with the three remaining liberal justices, it’s possible that the ACA could be declared unconstitutional by a 5-4 vote. Should that happen, and the government not put any replacement plan in place, we could see millions of currently insured people become uninsured. That’s not great for a hospital company that has to treat everyone who walks into the emergency room, and has to make almost all its money from insured patients. This explains the recent drop in the HCA stock price. Co-Founding Partner of Hoffman & Kessler LLP and member of the Deep Knowledge Investing Board of Advisors, Philip Kessler, notes that in order to “avert a high degree of health care chaos, Congress might enact amendments to save the legislation overall, although potential time pressures would create substantial challenges to doing so.”
What Happens Next:
The Trump administration and the Republican-led Senate have both the incentive and the power to push through a nominee prior to the election, and as long as the party stays united, it’s going to happen. This will shift the balance of the court to the right. While we acknowledge the possibility that the ACA is overturned and abandoned, we think that outcome is unlikely for the following reasons:
Stare Decisis: This is the legal principle of determining points in litigation according to well established precedent. The ACA, and its individual mandate in particular, was already declared not unconstitutional by the Supreme Court. The TX allegation that the Individual Mandate, which has been set to $0, was crucial to the law is a reasonable claim; however, there is considerable historical precedent for justices to vote in favor of laws they don’t like in order to preserve the precedent of prior court decisions. A more conservative court could still maintain the status quo.
Kessler agrees that various justices will be inclined to maintain consistency with prior decisions on the ACA and with applicable principles bearing on the case. In addition to precedent, he thinks that the court would be concerned about the health care-related chaos a decision invalidating the law would bring. He also believes that Chief Justice Roberts has demonstrated an appropriate concern about accusations that “the court has been politicized and that these accusations could undermine respect for our highest court and respect for the rule of law”. Kessler anticipates that Roberts will encourage strongly that the status quo be maintained.
Existing Law without Problematic Provisions: The New York Times has an excellent article on the topic noting that Justices Alito and Kavanaugh have written that “courts should try to preserve existing laws as much as possible when eliminating problematic provisions”. We’ve spoken with other legal experts (including Kessler) who agree with this analysis, and who think that Justice Kavanaugh will be less inclined to invalidate long-standing laws, especially those that have already survived constitutional review by the Supreme Court, than some expect. If it is inclined nonetheless to invalidate the individual mandate, the Court could simply agree with the plaintiff that the Individual Mandate is flawed, and still not invalidate the ACA.
Politics: While the Trump administration has previously talked about a great replacement for the ACA, we haven’t seen anything outlining the details. Whether you like the ACA or not, at this point, millions of Americans depend on it for their health insurance. Eliminating the program with no replacement in effect would be politically unpopular. We would not expect either a Trump or Biden administration to just let the ACA die with no available replacement plan.
We believe that the Supreme Court will either continue to decide not to overturn the ACA, or that it will declare the Individual Mandate unconstitutional, but allow it to be severed. Should the court decide to overturn the ACA, we think a political solution ensuring that millions don’t lose their insurance is more likely than the political chaos that would ensue from a mass elimination of insurance coverage.
With that said, the death of Justice Ginsburg has created a risk for HCA that is different from what we expected when we wrote our original thesis. The case won’t be decided until sometime in 2021 and may be an overhang on the stock until then. Deep Knowledge Investing is continuing to do more work on the topic, and we will update again should our view change.