The hospital sector isn’t exactly known for stellar returns, but we think that’s about to change for at least one company in the space: Tenet Healthcare (NYSE:THC). Larry Robbins, billionaires Marc Lasry and John Paulson are among the hedge fund managers who are bullish about Tenet Healthcare as well (see John Paulson’s stock picks).
THC recently announced a huge contract win with Catholic Health Initiatives (CHI) for 56 of its hospitals. This is a ten year contract with 10-year strategic revenue cycle management partnership. CHI’s system has 61 hospitals and 20 long-term care facilities, in addition to many outpatient facilities. 2011 revenue totaled $9.6 billion (greater than THC’s 2011 revenue of $8.9), and think that CHI can add $200 to $250 million in revenues once the contract is implemented in 2013. No contribution numbers have been released, but given start-up costs, we don’t think that the new CHI contract will meaningfully boost earnings this year. Now because of the lack of a revenue breakdown, we have had a hard time getting our heads around Conifer. It’s more than just a revenue cycle management company also managing patient referrals, collecting payments at points of service, screening patients for Medicaid eligibility, among offering other services. Conifer is also a pretty new business, starting internally as a revenue management function in 2008.
We view the CHI contract (to be managed by Conifer) as a crowning achievement in business model innovation for THC and think this may be just what it needs to start posting good margin numbers. THC has called this deal a “game changer” for Conifer, believing that customers will feel more comfortable with the business model and see a need for the specialized services that Conifer can provide. CHI will give Conifer the “critical mass” it needs to prove its value add. Currently, ~85% of Conifer’s revenues are from managing THC’s revenues, while 15% comes from providing similar services to outside hospitals.
We believe that THC is about to experience meaningful earnings acceleration, after some not-so-great years coupled with public relations issues. THC is trading at a ~5.2x 2013 EV/EBITDA which we believe is quite compelling, in particular for value investors. We continue to feel that the market is overlooking the value of Conifer, if this partnership is successful. While in the short-term, Conifer will probably not add too much to the bottom line, we think that Conifer’s growth trajectory and overall value is very high. Moreover, with the repurchase of convertible preferred stock, shares outstanding will decrease, improving earnings metrics. Note that THC will be holding a webinar on June 7th to discuss its outpatient business.
Our take on other hospital systems companies:
Universal Health Services’ (NYSE: UHS) big news this month was its sale of Auburn Regional Medical Center for $98 million to MultiCare, a regional not-for-profit health system. Auburn accounted for less than 2% of UHS’s revenue, so the transaction did not have a noticeable impact. Around the same time, THC announced a similar decision to sell Creighton University Hospital to Alegent Health, indicating the trend of hospitals on a local market asset-grab ahead of regulatory changes. Both scenarios have a large, for profit provider exiting a market where it had a lone hospital and a non-profit acquirer with more local market share. We believe that UHS can see multiple expansion as the company sees some synergies while the Psychiatric Solutions acquisition work its way through, but THC’s valuation is more compelling at this point.
Community Health Systems’ (NYSE: CYH) investigation disruptions are over. The company did not see an impact on one-day stays in Q1 and feels like any operational impacts from that scrutiny are now internalized and fully in the company’s guidance. Meanwhile, it has seen no impact on its ability to recruit doctors or complete deals. We like that CYH has a strong track record of buying and integrating assets. It has acquired revenue of $9.5 billion—assets today are spinning off $12.3 billion of revenue. Not bad at all. Its M&A pipeline is decent with guidance of four to five deals (three are done and a fourth should close in the next few months). However we see a lot of pressure from reimbursement and an ongoing government overbilling investigation and consequently should trade at low end of the company’s historical 6.0 to 9.0x range.
HCA Holdings (HYSE: HCA) has been a strong operator, growing same store admissions for the past 18 quarters. Recent data showed that inpatient demand increased 1.2% and that market share was up 20bps. Management pointed to a strong M&A pipeline even after some tuck-in acquisitions last year with high quality assets. HCA has been considering doing another special dividend and has the capacity to do a similarly sized dividend ($2/share) to the one in February. Cost control remains a focus with initiatives in labor, supply chain and physician practice operations. Again though, we think the stock should trade on the low of its 6.0x to 10.0x historical range due to reimbursement pressures.