|Shares Out. (in M):||15||P/E||0.0x||0.0x|
|Market Cap (in M):||47||P/FCF||0.0x||0.0x|
|Net Debt (in M):||-17||EBIT||0||0|
Conmed Healthcare Management (“CONM” or the “Company”) is a noncyclical, stable cash flow generating business with +60% ROIC that trades at a depressed valuation. This mispricing exists because of a failed buyout attempt last fall and resulting selling pressure from the suitors. I will discuss in more detail, but the deal’s failure had nothing to do with the Company. Since then, CONM has secured several new contracts, yet the stock still trades well below where it did before the proposed buyout was announced. Upside to the equity is +50% over the next year with catalysts and strong downside protection given financial visibility and $1.10 of net cash per share.
|Date||Contract||State||Renewal||Term (Yrs)||Value||Revenue||Population||Day ($)||Start Date||Date||Date|
|8/7/08||Pima County Adult||AZ||New||1.9||19.0||9.9||1,900||14.28||8/1/08||5/31/10||5/31/10|
|1/5/09||Western Virginia Regional Jail||VA||New||3.0||5.4||1.7||550||8.47||2/1/09||1/31/12||1/31/12|
|12/1/09||Pima County Adult||AZ||Renewal||2.0||19.5||9.7||1,900||13.99||7/1/10||6/30/12||6/30/12|
|1/27/10||Pima County Juvenile||AZ||New||2.4||2.8||1.2||70||46.97||2/10/10||7/9/12||7/9/14|
|6/28/10||City of Roanoke||VA||New||9.1||9.1||1.8||600||8.22||7/1/10||6/30/13||6/30/15|
|9/27/10||City of Virginia Beach||VA||New||5.0||17.5||3.5||1,350||7.10||10/1/10||9/30/13||9/30/15|
|2/8/11||City of Alexandria||VA||New||9.0||18.0||2.0||450||12.18||3/1/11||2/28/16||2/27/20|
|3/22/11||St. Mary’s County||MD||Renewal||3.0||1.7||0.6||245||6.26||6/1/11||5/31/12||5/31/14|
|1/15/12||County of Galveston Jail||TX||New||4.7||16.2||3.5||1,000||9.51||2/1/12||6/15/13||6/14/16|
|1/18/12||Pima County Adult||AZ||Renewal||1.0||10.1||10.1||1,900||14.56||7/1/12||6/30/13||6/30/13|
Near-term catalysts include: 1) financial performance from new contracts; 2) appreciation for the quality of the business and alleviation of failed sale stigma/ selling pressure; 3) share repurchases; 4) improved corporate communication; and 5) potential sale. The new contract wins toward the end of 2011 will add $8M to 2012 revenue and +$1M to EBITDA. This growth will become evident in the Q1 numbers. Conmed’s increased scale and new presence in Texas positions it well to win new contracts and expand its existing contracts when the selling season begins in the summer. Even if it does not win any new business in 2012, EBITDA should increase +20% off its existing base. In mid-December, the Company announced a $5M share repurchase program which can commence after the release of Q4 earnings. The Company also recently hired an IR firm to assist with marketing. Management did not actively seek to sell the Company, but as we saw, they are amenable to a deal. In particular, board member and 20% shareholder, John Pappajohn, has indicated he is supportive of a sale.
Conmed began providing healthcare services exclusively to Maryland county detention centers in 1984. By 2000, the Company had grown to serve over half the state’s county detention centers. From 2003 to 2006, CONM expanded into Kansas, Virginia and Washington through contract wins. In 2007, the public shell company Pace Health Management acquired Conmed for $23M and concurrently assumed the Conmed name and brought on the existing management team. In 2008, the Company acquired two smaller operators in Oregon and Maryland. It has been able to leverage those contracts to expand service offerings and establish a regional footprint.
In late 2010, Pappajohn proposed a sale of the Company to the board. In December 2010, the Company retained Gleacher and shopped the Company to 86 potential buyers, 62 of whom received a CIM. At a January board meeting 10% shareholder Dr. James Desnick was in attendance as an observer (apparently something that the Company had previously permitted). Upon learning of the sale, Desnick requested a CIM and shortly thereafter submitted a bid at $4.15. Five other parties also submitted offers at $3.80-4.05 per share or 9.6-10.2x LTM EBITDA. Desnick, as part of a group called Ayelet Investments, emerged as the only final offer and reduced the bid to $3.85 or 9.8x EBITDA. The deal was announced on May 13. On November 14, one day before the shareholder meeting, Ayelet announced it could not complete its financing. Ayelet publicly sited a disagreement on sub debt covenant terms with Levine Leichtman Capital. The more likely reason was that the lenders learned of Desnick’s criminal past which included multiple healthcare frauds, revocation of medical licenses and malpractice settlements, two of which were over $15M each. CONM received a $2.3M termination fee ($1.5M after-tax). Neither Desnick nor anyone from Ayelet is a member of the board, so operations have been unaffected by this development.
CONM initially went public because it believed a currency would enable it more effectively buy smaller operators. The Company has not issued stock in any of its acquisitions, does not need capital to grow, yet still has to disclose its financials to competitors and bear the costs of being public. It seems likely that CONM will try to sell itself again in the next year.
CONM should trade up 40-50% in the near-term and if acquired would command a 100% premium to its current stock price. The Company currently trades at 6.0x 2011E EBITDA and 5.0x 2012E (base case, assuming no new contracts) with a 15% FCF yield. On an absolute basis this is clearly cheap given the quality of the business and its growth prospects. The average historical multiple prior to the buyout attempt was 8.0x EBITDA, implying an equity value 40% above the current stock price. The closest trading comps are CXW, GEO and MD. Though much larger, they have very similar financial profiles and trade at a median multiple of 9.1x LTM EBITDA. The failed buyout attempt by the Ayelet group valued the enterprise at 9.8x EBITDA. This price was considered low as Gleacher and CONM were accused of not adequately shopping the Company. While it is unclear what the end result could have been, a close peer to CONM was recently sold. In March 2011, Valitas Health Services acquired America Service Group (formerly public, NAS: ASGR) for 9.3x EBITDA, 11.0x EBIT. At this valuation, the implied upside to the current share price is 90%. These valuations assume no new contract wins, price increases or margin improvements. They also do not include the fact that Conmed’s financial picture has become clearer with the January extension of its largest contract. All of which will likely generate more interest in the asset. If a strategic were to acquire CONM, they could cut most of SG&A, making a higher transaction multiple economical. In an optimistic scenario of $7.5M EBITDA, the implied upside is 120%. The Company’s cash flow profile would also make it very appealing as a platform company for private equity. Shareholders get downside protection from $1.10 of net cash per share and financial visibility.
|(US$ in Millions)||2008A||2009A||2010A||LTM||2011E||2012E|
|Income Statement Summary|
Investment Considerations & Risks
|Subject||RE: questions on sale attempts|
|Entry||02/16/2012 02:28 PM|
Katana- Thank you for the questions. I had those same concerns as well.
Seeking personal liquidity, a sale was initially proposed by Pappajohn to the rest of the board in November 2010. The board later moved ahead with the process based on the rationale that CONM would be better suited competitively and financially as a private company. Though I don’t think the timing was right, I do think the reasoning was sound. In December they brought in Gleacher. The process was not well handled. My understanding is the other prospective buyers dropped out primarily because CONM’s largest contract (Pima) was coming due in June. There was also some speculation that other parties learned that Desnick had an inside track in the process and were scared off. This part is unclear, but starting on page 20 of the 10/25/11 proxy there is some more credible color on the process and I think people will find CFO Tom Fry to be quite candid.
Ultimately I think the 10x LTM EV valuation proposed was fair at the time. Gleacher definitely did not adequately assess Ayelet/ Desnick’s ability to close a deal. I would imagine that as the market began to turn upside down last summer they tried to rush it through.
Like you, I have a high opinion of Dick Turner and the rest of his team and believe the sale was just poorly handled and not a result of some hidden issues. To support this I have spoken to a number of external sources in the industry as well. I would be curious to know if you have any more insights. Regardless, the Pima contract (which was a major overhang last spring) was just renewed through mid-2013 and they have subsequently won a number of contracts. These factors make it more interesting now at $3.30 a share than last December at $2.50 when there was less financial clarity.
|Subject||Moving closer to a sale|
|Entry||02/21/2012 09:43 AM|
CONM should pretty easily be able to get $5.00 per share in a sale.
|Subject||RE: RE: Moving closer to a sale|
|Entry||03/05/2012 03:19 PM|
Woolly- Thank you for the question.
The fourth quarter was good, in-line with my expectations. The pipeline remains strong, it sounds like they are pretty aggressively pushing into Texas. I wouldn’t be surprised to see some more business wins in the state before the summer. The Galveston contract itself started on Feb 1 and should add close to $1M to the top line in Q1. The share repurchase program can now start as well.
I didn’t really draw any major conclusions from Dick Turner’s comments regarding Cantor. I do know that management’s strong desire is be private. They have also clearly stated that they intend to focus on winning new contracts rather than buying operators at a premium. The recent Panhandle Correctional deal was the first since 2008. That said, from an operational and financial standpoint, CONM does have a pretty ideal platform to make acquisitions. Their existing infrastructure could support up to 50% more sales with only a modest increase in SG&A. EBITDA margins would effectively double at the $100M sales level. Though an acquisition at a reasonable price would be appealing, I see an outright sale of the company as the higher probability outcome at this point. I was a little surprised the stock didn’t move higher on the Cantor news.
|Subject||RE: RE: RE: RE: Moving closer to a sale|
|Entry||03/06/2012 10:12 AM|
Here is my bridge to the 2012 estimates:
$18.4M (Q4 Sales) x 4 = $73.6M + $4M (Galveston contract) = $77.6M
18% gross margin = $14M
Less $8.3M SG&A (excluding D&A and stock-based comp)
2012 EBITDA = $5.7M
This assumes no price escalators or service expansions and gives them no credit for the Randall County Jail acquisition or any new contract wins.
I hope this answers your questions.
|Subject||RE: RE: RE: RE: RE: Moving closer to a sale|
|Entry||03/06/2012 10:38 AM|
Got it -- thanks again for the idea
|Subject||Congrats . . .|
|Entry||07/16/2012 11:53 AM|
I know you expected higher price, but 20+% return not bad.
I do not see the merger agreement yet, but why 90% tender threshold? Any chance they do not get it (hedge funds block)?
Thoughts on how this plays out . . .
Thanks for the idea.
|Subject||RE: Congrats . . .|
|Entry||07/17/2012 12:15 PM|
Thank you. We are a bit frustrated with the price as you could probably have figured.
Given the relatively large insider ownership (+30%) and small amount of hedge fund ownership, it would appear that the probability of a block is low. I will let you know if I hear anything different.
|Subject||RE: RE: Congrats . . .|
|Entry||07/17/2012 12:30 PM|
I assume that if the 90% tender is un-successful, they go to shareholder vote. The 90% tender is simply way to avoid the expenses of vote. I guess I just found their wording odd.
I agree that block is unlikely. I closed position yesterday.
|Subject||RE: RE: RE: Congrats . . .|
|Entry||07/17/2012 01:08 PM|
Under Delaware law, if you get over 90% of a tender offer the acquirer can force a "short form" merger and force the non-tendering shares to accept the terms the other 90% accepted. Without the short form, they have do a more costly "long form" merger that requires a full vote.
Here's a little blurb on it with some criticism: http://blogs.law.harvard.edu/corpgov/2010/08/05/shaping-up-your-top-up-option/
Didn't read document in this case, but the 90% threshold is very, very common for acquisitions involving Delaware corporations.
|Subject||RE: RE: RE: RE: Congrats . . .|
|Entry||07/18/2012 12:56 PM|
I knew about this, but am I wrong in thinking this is not how they are usually described in press release? I assume that the merger agreement says that if short form fails, then will go to long form . . . Or do most public-company mergers simply forego the short form attempt because getting 90% is too difficult without a large chunk of insider ownership.