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It’s showtime for Healthways. Time to put up or shut up. The Nashville company known for its 20-year corporate identity crisis—it just went through another name change last month, shortening its name from American Healthways—finally found its niche five years ago. Now, its mettle will be tested in a very public arena—a figurative shootout at the health care corral where Healthways will have the chance to prove the value of its service.

Healthways claims it can save on medical costs, so Medicare is running an experiment. Eight companies like Healthways from around the country have each been allotted a group of 20,000 Medicare enrollees, all of them with two significant chronic diseases. (Diabetes and cardiovascular problems often go hand-in-hand.) Each firm will manage its patients to prove it can save 5% over a control group that receives normal care.

Healthways has primary responsibility for one pilot in the Washington, D.C., area, and it is the subcontractor for a second program, run by CIGNA HealthCare, in Georgia.

If they don’t succeed, they don’t get paid. “We’re pretty confident,” says Don Taylor, chief operating office and executive vice president, in an appropriately laconic imitation of Gary Cooper. Healthways is a disease management company, a field it has helped develop. The company is fond of saying that it has 1.8 million lives “under management,” an ominous phrase.

The goal is not to restrict services or put the patient on a cheaper generic drug. Healthways wants to save medical costs by keeping people healthy. The company wants you to follow your doctor’s orders. When patients follow their doctors’ orders, there is less chance of hospitalization or a trip to the emergency room.

For example, if a health insurance company contracts with Healthways to manage diabetes patients and pharmacy bills give evidence that you are buying diabetes medications, then you can expect one of the 1,500 health professionals (usually a nurse) from an Healthways call center will ring you up.

Their goal? To see how you are doing. To see if you are following your doctor’s orders. To see if you are eating right. To encourage you to take your medications. The nurse will let you know how important it is to monitor your blood glucose. Not all of this comes at once. It is introduced in stages, in a manner that experience has shown is most likely to be successful. “We manage patients, not a disease,” Taylor says.

“The 80/20 rule applies in health care, just as it does elsewhere,” Taylor continues. “Twenty percent of the people suffering from diabetes follow their doctor’s orders completely and don’t need our help. But 80% are not entirely compliant.”

These are the ones that Healthways targets. Patients are assigned according to four levels of severity. The most critical will get a call every two weeks; the least serious will be called only twice a year. “We help them reconnect with their doctor,” Taylor says. “Sometimes we help them be articulate with their health care provider because they will ask us questions they won’t ask their doctor.”

The goal is to aid the doctor-patient relationship, to keep the patient healthy, and, ultimately, to keep the individual out of the hospital. A win-win of the first order: healthier employees, lower medical costs.

It works. “We’re past the pilot stage,” said CEO Ben Leedle in an investor presentation, even though a pilot program is exactly what the Medicare experiment is called.

And investors have noticed. The stock price of Healthways cratered in 2000 at close to $1 and approached a low of $5 in 2003. (Both prices are split adjusted.) Now, an investor has to pony up close to $50 to get a single share.

Is Healthways worth its high price? Brooks O’Neill, who follows the company for Dougherty & Co., thinks so. Explaining his buy recommendation, O’Neill says simply, “It’s a fabulous company.” O’Neill uses a meal as an elaborate metaphor to explain his sense of the company’s future. Everything so far in the company’s history is just the appetizer. Medicare is the main course—and Healthways is just sitting down at the table for that. And for dessert? The international market, something that Healthways has only begun to contemplate. In fact, Healthways will spend about $2 million this year (five or six cents a share) to begin its international business by introducing itself to western Europe.

The business model is paying off. Because Healthways operates on a September-August fiscal year, 2005 is already in the books, and the company made a $33 million profit on revenues of $312.5 million, both numbers representing a 27% increase from the previous year. That’s a profit margin of almost 11% and earnings per diluted share of 93 cents.

For 2006, analysts expect revenues to climb 38%, and then rise another 21% to $513 million in 2007. Profits are expected to move 40% higher to $1.31 in 2006 and another 27% in 2007 to $1.66. With the stock sitting at around $47 per share, it is already selling at 36 times 2006 earnings, so Healthways is not exactly undiscovered. On the other hand, earnings are fairly predictable because most of the company’s clients renew their contracts. Disease management is only just now coming into its own, so the $4 billion market of commercial business (large insurance companies and self-insured corporations) are still ripe-for-plucking fruit. Only the lowest hangers have been taken.

And then there is Medicare. According to O’Neill, there are 40 million people enrolled in Medicare. Half of them have chronic illnesses, but only 20% suffer from the kind of multiple conditions—diabetes and cardiovascular problems, for example—that make them eligible for a Healthways disease management program. That’s eight million people. If Healthways could win contracts to support one million of them, the new business would add about $500 million in revenue and another $2.50 in earnings per share. An increase of that order more than doubles the business the company expects from its commercial accounts in two years’ time.

That’s out there in the future. The Medicare pilot is a three-year program, though changes might take place in the third year. Don Taylor, for one, does not think all eight of the disease management firms will be successful in achieving the 5% savings, even though he has little doubt about Healthways’ ability to deliver the goods. Meanwhile, Healthways will continue selling to commercial accounts and expanding the number of programs it offers. Even people without diagnosed illnesses may get calls if their data shows the potential for problems.

With 1.8 million people already on the books, Healthways has a good idea how much savings it can create. The company has spent a lot of money analyzing the relationship between therapies and outcomes, using the fuzzy-thinking, neural networks that find the connections between disparate data points. Healthways feels comfortable promising its commercial accounts that they will save between $2 and $3 for every dollar spent on its fees, a ROI of between 100% and 200%. For Medicare, with an older, less healthy population, the savings will be greater.

So far, the Medicare program is running ahead of plan. To be successful, Healthways felt it had to sign up 70% of the population, a process targeted for completion in the first six months. The Washington, D.C.-area program went live in August, and after four months, 77% of the population had agreed to participate. A lower-than-expected 4% refused. Because the population is fairly sick, about 11% has either died or begun kidney dialysis, which puts them outside the realm where Healthways can help them.

Healthways will give updates on the Medicare pilot as it releases its quarterly earnings reports. Since so much of the future of the company hangs on this Medicare program, analysts will pay very close attention to the hints that management drops in these meetings. By the time Healthways reports its fiscal third quarter in May, Don Taylor figures the guidance will be getting fairly specific. The Medicare pilot is one of those watershed events that can change a company. Healthways has seen its share of changes over the past 25 years, but now, very much on top of its game, the company is inviting the world to watch.

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