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Cerner Corp. (CERN)

“As I’ve written about before, a significant government action—the $787 billion American Recovery and Reinvestment Act—set aside nearly $20 billion in direct funding to transition the nation’s health-care system to digital medical records. The idea is that better records, and better access to them, will eliminate a lot of redundant...

“As I’ve written about before, a significant government action—the $787 billion American Recovery and Reinvestment Act—set aside nearly $20 billion in direct funding to transition the nation’s health-care system to digital medical records. The idea is that better records, and better access to them, will eliminate a lot of redundant tests, help physicians and other health-care providers share information and, in the end, improve patient outcomes while saving money at the same time. ... Because the nation’s health-care system is made up of thousands of independent providers, those disparate entities usually need a carrot or a stick in order to get everyone moving in the same direction. In this case, there is both incentive and penalty. The federal government is not only paying providers to implement digital records systems, it’s also penalizing the providers that don’t. Doctors can be penalized up to $44,000; hospitals as much as $4 million.

“Now, since health care is a low margin business, some institutions might take time to investigate the purchase as well as to save up a few shekels to pay for it. And while a few older physicians in small practices might ignore the stick and accept reduced payments until they retire, the overwhelming majority of medical providers will follow President Obama’s directive to the letter and get on board with digital records. So, ultimately, it’s [simply] a question of when.

“The answer is between now and 2015, which gives investors a good long-term holding period to benefit from the huge growth in business that will stem from the adoption of digital medical records. I’ve recommended shares of several companies in this space, and the time has come to add another—an industry leader with a strong balance sheet, a history of growth and a management team that is able to deliver an operating margin that’s not only higher than the industry average, but one that’s on the rise.

“The company is Cerner Corp. (CERN 77.57 Nasdaq), a $6.4 billion company based in North Kansas City, MO. Cerner, with some 7,600 employees, is the largest stand-alone (‘pure-play’) health-care IT company in the country. Its systems are in use in more than 8,500 facilities worldwide, including 2,300 hospitals, 3,400 doctor’s offices encompassing more than 30,000 physicians, 600 specialty clinics, 700 home-health companies and 1,500 pharmacies.

“It’s critically important to realize what that means. It means that this company already has a high-trust relationship with thousands upon thousands of customers who are going to need to expand their IT systems now. You see, Cerner’s existing software is designed to use technology to integrate health-care delivery with logistical functions like billing and ordering supplies. Each step of the process is recorded in the system, from the doctor’s order of an injection to the nurse’s delivery of it, as well as the inventory control, insurance processing and billing.

“Under the new system, though, Cerner’s software will need to do all that and weave in yet another function: Storing the records of all care, medications and diagnostics, and giving access to them to the appropriate care providers. Every single one of Cerner’s existing U.S. customers will need this upgrade to remain in full compliance with Medicare.

“Not only does Cerner have access to all of its existing clients, but it already has more business than it can handle. According to its most-recent annual report (February 2010) it had a contract backlog of $3.6 billion, higher than the $2.9 billion at year-end 2008. The backlog contains orders that have not yet been recognized as revenue. Cerner says it will only be able to get to about a third of that business in 2010. This tells us two things. One, Cerner’s product is so good that customers are willing to wait for it, and, two, that it would have billions in revenue even without the push for digital records. The company trades at about 30 times trailing earnings.

“‘We believe [Obama’s push for digital medical records] could represent the single biggest United States health-care IT opportunity in our 30 years as a company,’ Cerner said. ‘The industry will likely benefit as healthcare providers and governments continue to recognize that these solutions and services contribute to safer, more efficient healthcare.’ With tens of thousands of potential customers, a giant backlog of orders to be filled and billions of Uncle Sam’s dollars to be collected, Cerner is well situated to benefit from this government action. I’m adding CERN to the Government-Driven Investing Portfolio at the close of trading on Friday, July 30. My target price for these shares is $125. I’m assigning a four rating and encouraging all investors seeking an aggressive-growth play to consider these shares.”

Andy Obermueller, Government-Driven Investing

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.