overviewWith the departure of Veterans Affairs Secretary David Shulkin and subsequent fallout, the likelihood CERN will finalize the Electronic Health Records Modernization contract with the agency is remote. The conflict over privatization of VA services, the vacancy of key agency positions, the reality of procurement law, and the muddled message of Congressional appropriators suggest the probability of a contract award is no more than 10 percent. Without the VA, CERN's fundamentals will rapidly deteriorate. We are modeling 2018 sales growth of ~5%, which compares unfavorably to management’s 6% - 10% guidance range. We also expect consolidated bookings to decline 10-15% YoY in 2018, while consensus is calling for +2% YoY. At some point this year, management will have to lower guidance and more importantly, reset expectations for 2019. We believe estimates for 2019 sales and EPS are too high by 3-6% and 10-15%, respectively. We see downside to $40-45/share with one of our our first catalysts being 1Q18 earnings on May 4. That said, in our experience, the street is overly enthusiastic about federal contracts on the upside and excessively pessimistic on the downside, which could cause the stock to move even lower. With a robust catalyst calendar throughout 2018, the chances are the Street will awaken to the new reality sooner rather than later. |
The rumors were true. Last week, President Trump relieved Veterans Affairs Secretary David Shulkin of his duties. Shulkin’s offenses against the Trump administration include, in no particular order:
- Being a holdover from the Obama Administration
- Using taxpayer funds for personal expenditures
- Failing to convince Congress to pass any one of several legislative efforts to expand and reform the Choice Program
- Failing to convince Congress to fund the existing Choice Program, which runs out of money in May-June 2018.
Given the flexible ideology of the president, Shulkin’s association with the Obama Administration would have been easy to overlook, all other things being equal. Even Shulkin’s apparent poor choices relative to his expense account would not have been a fire-able offense in the fourth dimension that is the Trump White House.
It was Shulkin’s resistance to full or even partial privatization of VA services that led to his ouster. He was supportive of renewal and expansion of the Choice Program but not to the extent sought by privatization proponents and the White House. When asked about giving veterans “choice” to seek care from any provider, Shulkin always trod a middle path that acknowledged the traditional role of the VA while permitting limited access to private sector providers.
Adding insult to injury, Shulkin wasn’t even able to convince Congress to fund the existing Choice Program which runs out of money in May or June.
Privatization. It was Shulkin’s efforts to forge a compromise between privatization and the traditional role of the VA that informed his decision to award, on a sole source no-bid basis, the EHR contract to CERN. Implicit in the $10 billion EHR modernization that would put veterans on the same EHR platform as active duty military is that the VA will continue to provide direct health care services. Shulkin’s insistence on interoperability – which stalled award of the contract in Q4 2017 – was predicated on the assumption that veterans would be treated in both VA and non-VA sites of care.
In short, the VA’s contract with CERN was a product of Shulkin’s vision for the future of the agency.
Given that Shulkin’s efforts to balance pro- and anti- privatization interests got him fired, it is unlikely that career staff will pursue the monumental undertaking that is the EHR Modernization Program. Even if the thin bench of political appointees (see below) were to exceed expectations, it is hard to see how the CERN contract – with its 11 figure price tag – gets over the finish line with so little consensus about the future of the agency.
A new vision for the VA’s future if and when it is articulated –- it will probably be more in line with that of Rep. Cathy McMorris-Rogers, a rising star in the Republican party. At a recent hearing, Rep. McMorris Rogers advocated for a pilot of a portable electronic health record that would allow veterans to carry their data from DoD facilities to any other provider. The VA has opposed her efforts because it would divert resources from the EHR modernization effort.
Sen. Isaakson, Chairman of the Senate Veterans Affairs Committee, has pledged to revive hearings on reform and expansion of the Choice Program in April where the privatization debate will rage. Those hearings, if they occur, will also provide ample opportunity for VA staff to offer information on the EHR Modernization Program, in general, and the CERN contract, specifically.
Key Vacancies. With Shulkin goes his plans for the VA, including a new EHR system. Under normal circumstances, a new VA Secretary might pick up the ball and run with it. However, in Washington and particularly at the VA, things are far from normal:
- President’s SecVA nominee is not likely to be confirmed in 2018. The persistent conflict over how much and how far to take privatization at the VA will make confirmation of Dr. Ronny Jackson or anyone else very difficult.
- In the meantime, the VA will be led by Robert Wilkie, on loan from the Department of Defense who, as an adviser to Sen. Thom Tillis, favored veterans’ access to private sector doctors
- In addition to an unconfirmed SecVA, the agency also lacks an Undersecretary of Information Technology and an Undersecretary for the Veterans Health Service
- Deputy Secretary Thomas Bowman, who reportedly opposes privatization, is expected to leave the agency shortly
With no leadership in place it will be difficult to resolve the concerns that stalled award of the contract in late 2017.
Complicating personnel issues further is the Federal Vacancies Reform Act of 1998 which permits the president to fill vacancies of any officeholder that “dies, resigns or is otherwise unable to perform the functions and duties of the office.” The law does not mention firings and for that reason, apparently, the White House changed its tune on Saturday, saying Shulkin had resigned.
The legal question of whether or not President Trump can bypass DepSec Bowman and install Robert Wilkie, at a minimum, casts a shadow over any decisions the Interim Secretary might make – including an award of the CERN contract.
If confirmation hearings do occur, they are likely to take place this summer. Those hearings will afford the nominee an opportunity to discuss the future of the EHR Modernization Program and the CERN contract.
Procurement Reality. No-bid, sole source contracts of the size and scope of the VA’s EHR Modernization Program are rare and require special justification. Shulkin provided justification through a Determinations and Findings he signed in June 2017. His primary basis for awarding the contract to CERN was the need for a single, common system with the DoD.
In order for the VA to award a contract, any contract, to CERN it would have to be for a single, common system with the DoD. A contract award for any other purpose would face a formidable protest from another EHR vendor.
The government is already facing a pre-award protest from CliniComp International, Inc. which has asserted the VA should have used a competitive process for selecting vendors for the EHR Modernization Program. Oral arguments are scheduled for April 6 in Washington. One of the motions before the court is an injunction to stop award of the contract. Given recent events, it will be interesting to see how vigorously the government defends its position.
Congressional Preference. The FY2018 Omnibus Appropriations included $782 million for “activities related to implementation, preparation, development, interface, management, rollout and maintenance of a “Veterans Electronic Health Record system” and available until Sept. 30, 2020.
The appropriation amount is exactly what Shulkin requested in late 2017. In making the request, Shulkin argued that the funds would be used to “jump start” implementation of the Cerner EHR contract. The original FY2018 appropriations bill included extensive language about oversight and reporting of the CERN contract, reflecting the intent of the funding. However, the final language of the appropriation is more general, suggesting the VA could direct funding to the modernization of the existing VistA system instead of purchasing the CERN EHR.
Furthermore, the explanatory statement notes that “[b]ecause this is a very substantial new effort, the timing of obligation of funding is uncertain. As a result, the agreement makes these funds available for three years.” This explanation provides the VA with more flexibility but it also means they would not be expected to ask for any additional money until FY2021.
Finally, the explanatory statement states “Department is directed to place top management of the project at the headquarters level above either the VHA or the Office of Information Technology, such as in the Office of the Deputy Secretary.” In other words, Congress does not want the program managed by career staff at the mid-level. Given the lack of personnel at the top of the Agency, it is going to be tough fulfill Congress’s demand any time soon.
Hearings for FY 2019 appropriations this summer should shed more light on how the VA plans to spend the $782 million. A very strong possibility, assuming the personnel issues are addressed, is the money will be directed at maintenance of the existing VistA electronic health record system, including re-staffing program, and other small-scale efforts. A poll conducted by Health Care IT News reached a similar conclusion as of Saturday afternoon
Under the best of circumstances, deployment of a new EHR system across the VA would be a daunting task requiring the cooperation of Congress, the White House, and a plethora of veterans groups; and capable management at the VA. None of those conditions exist today, making the bull thesis that contract award will move forward in the near term untenable.
At some point - and there are ample opportunities in 2018 - the Company and/or the government will have to acknowledge this reality. Without the VA, we are modeling 2018 sales growth of ~5%, which compares unfavorably to management’s 6% - 10% guidance range. We also expect consolidated bookings to decline 10-15% YoY in 2018, while consensus is calling for +2% YoY. We believe 2019 estimates for sales and EPS are too high by 3-6% and 10-15%, respectively.
We see downside to $40-45/share but based on our experience (see e.g. HMSY), the Street tends to be over-enthusiastic about federal contracts to the upside and unreasonably pessimistic on the downside. For that reason, the stock could go lower.
We hope you had a peaceful holiday weekend. Call with questions
