Health Care's Busiest Empire BuilderAnthony Bianco
'Who is John Foster?" is a question exciting much interest in the stock market's exuberant health-services sector. The short answer is that Foster controls two of the fastest-growing companies in all of health care: NovaCare Inc. and Orthopedic Services Inc., both of which are based in Valley Forge, Pa. This year alone, NovaCare's shares have leapt by 150%, to $23, and OSI's by 85%, to $26. At current prices, this duo has a combined market value of $1 billion.
Foster heretofore has kept a low profile but not for want of past success. Since forming Foster Management Co. in 1971, he has compiled a nonpareil record in venture capitalism (table, page 128), investing $140 million in some 40 companies. Says Anthony Hoberman of Alliance Capital Management L. P., which has invested with Foster since 1984: "Despite all the newfangled excuses offered by the venture-capital community in recent years, John Foster has delivered old-fashioned results."
Foster remains a busy venture capitalist. At the same time, though, he is stepping into the spotlight to pursue ambitious plans. Using NovaCare and OSI as a nucleus, Foster is building a complex of companies that he hopes will dominate the nascent business of rehabilitation services as profitably as Humana Inc. pioneered the for-profit hospital chain. That Humana's annual revenues exceed $ 5 billion while NovaCare and OSI will do well to top $300 million between them this year suggests the magnitude of the challenge confronting Foster.
In the year ended June 30, NovaCare posted a 64% gain in earnings, netting $ 20.3 million on revenues of $152 million. Now traded over the counter, NovaCare will move to the New York Stock Exchange on Oct. 21. Meanwhile, OSI shifted solidly into the black this year, earning $1.5 million on revenues of $23.6 million during the first half. Foster is chairman and chief executive at both companies.
GRANDIOSE? Both NovaCare and OSI have avid followers among Wall Street analysts and money managers. "Rehabilitation is the single most exciting area in all of health care," says Charles Mangum, an analyst and portfolio manager for mutual-fund giant Fidelity Management & Research Co. "For my money, NovaCare may be the best value in rehab."
Despite NovaCare's impressive stock market surge, at its current price-to-earnings ratio of 31, the company is trading at a 20% discount to such fellow rehab vendors as Continental Medical Systems Inc. In part, this p-e gap reflects fear in some Wall Street circles that Foster's ambitions are grandiose -- or at least grander than his demonstrated managerial abilities.
Unlike the typical venture capitalist, Foster has bona fide credentials as a corporate manager. What unnerves some people is that Foster acquired much of his experience via emergency rescues of his companies. He is haunted, too, by the fate of Foster Medical Corp., which he sold to Avon Products Inc. in 1983. After seven tempestuous months as an executive of stodgy Avon, Foster resigned and returned to the entrepreneurial hunt. Avon later dismantled Foster Medical, taking huge write-offs.
More than anything else, it was Foster Medical's demise that inspired Foster's self-proclaimed conversion from opportunistic trader to corporate builder. "When you're young, the game of making a business out of an idea and then selling it is great fun," he says. "But that approach doesn't work if your goal is to remain within an industry and create excellence. All-star people won't commit to a company if they know it's going to get auctioned off."
While Foster, 50, admits the demise of his namesake company "has bothered me enormously for years," it doesn't show. But his surface serenity masks a fierce drive. He is a demanding boss with a work capacity that's Milkenesque. "Do you know why we still invest with John after all these years?" asks Stathis Andris, a vice-president of American Express Co., which has backed Foster since the mid-1970s. "Even with all the money he has made, he still can't sleep nights."
PLODDING WORK. Foster's personal net worth is at least $100 million and largely liquid. He cashed out Foster Management's original investment in NovaCare last fall at the current equivalent of about $9 a share, missing the stock's huge recent runup. However, he still personally owns 2.5 million shares, or 8%, making him the largest individual holder. Through the various limited partnerships that he manages, Foster also controls 50% of OSI--a stake currently valued at nearly $100 million. In explaining Foster's success, associates cite his ability as a strategist. In the consensus view, this facet of his talent reflects not ingenuity but painstaking effort. "I wouldn't characterize John as a brilliant thinker musing great concepts," says John Pirotte, who has run two Foster-controlled companies. "He builds insight piece by piece."
It was after quitting Avon in 1984 that Foster zeroed in on rehabilitation, which he viewed as an industry ripe for consolidation. Except for a few companies that operated chains of small hospitals, the field was fragmented into thousands of local practices, most of which lacked business sophistication. Yet it seemed to Foster that demand for rehabilitation services was likely to boom as the population continued to age and advances in the treatment of severe trauma resulted more often in impairment than in death. Foster began his foray into rehab in 1985 with the acquisition of a speech pathology business, which added scope and scale through a rapid-fire series of acquisitions. In 1987, Foster renamed this company NovaCare, denoting its diversification into occupational and physical therapy.
In addition to the time-honored economics of consolidation, NovaCare benefits from low overhead; in essence, it is a company without branch offices. NovaCare employs 2,500 therapists and provides them under contract to nursing homes and hospitals, many of which have been plagued by high turnover among their in-house therapists. With its large, fungible work force, NovaCare can staff more cost-effectively than can health care insitutions themselves, pay its employees higher salaries on average than they made on their own, and still earn 35% on equity.
Like NovaCare, OSI has thrived not by pioneering advanced technology but by combining dozens of what Foster terms "mom-and-pop franchises." Not yet four years old, OSI is the nation's largest provider of custom-made braces and artificial limbs -- a business that dates to the Civil War. "The concept of
consolidating an industry is very obvious in its appeal," says Foster. "What turns out to be hard is putting together all these wretched little businesses."
NovaCare ran into serious trouble in 1987 as its systems collapsed under the pressure of integrating a big bunch of newly acquired companies all at once. The chaos aggravated a deep morale problem. The more management tried to tighten controls, the more its therapists became convinced that the number-crunchers were sacrificing quality of care to profit. By late 1987, the clinical staff was turning over at the alarming rate of 56% a year.
REWRITE JOB. Foster spent much time visiting NovaCare's far-flung staff of therapists and returned from his travels convinced that the primacy of the company's clinicians had to be made explicit. Six months and 250 drafts later, NovaCare adopted a 16-page statement of "Purpose and Beliefs." Foster also hired Dr. C. Arnold Rensehler, a respected nursing-home executive, as NovaCare's president. Therapist turnover has dropped to about 20%, far lower than the industry average, and the company is adding new clinicians at the staggering rate of 100 a month.
OSI is growing rapidly without a sign of the management problems that afflicted Foster Medical or NovaCare, suggesting that Foster and his large corps of battle-tested managers may finally have worked the kinks out of what he calls "the Foster formula."
Meanwhile, Foster continues to add diversity to his rehab holdings. In August, NovaCare completed a $100 million acquisition of Rehab Systems, which operates seven rehabilitation hospitals. The deal marked NovaCare's entry into the bricks-and-mortar mainstream of rehab. Foster Management also is pushing ahead with RehabClinics, which plans to build a chain of storefront facilities offering physical and occupational therapy on an outpatient basis.
Will Foster succeed over the next decade in assembling all his disparate pieces into the Humana of Rehab? Any venture of such ambition faces prohibitive odds. But the people who know Foster best are betting on him: Not a single one of his limited partners has pulled out of Foster Management's funds. "One has to ask oneself, is John still hungry after all these years?," says Robert G. Stone Jr., a corporate executive who has invested in each one of Foster's partnerships over the years. "I have no doubt that he is--and that's good enough for me."