|Shares Out. (in M):||167||P/E||15.3||0|
|Market Cap (in $M):||11,321||P/FCF||17||0|
|Net Debt (in $M):||10,803||EBIT||1||0|
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I recommend DaVita Inc. (DVA) as a long with a target of $105, ~50% above today’s price and a 6-12 month timeframe. The elevator pitch is: DaVita is divesting a non-core division by the end of 2018 that contributes no profitability for $4.9B (tax basis $4.4B) and using the vast majority of the proceeds to buy back shares. Pro-forma for the sale, it trades for 6.6x EBITDA vs. a historical average of 9.4x (both 5- and 15-year averages); at this level, it overly prices in the multitude of negative headlines regarding DVA and dialysis industry in general, creating an asymmetric risk profile. With uncertainty clearing by year-end, the stock should rerate back toward historical averages.
The long thesis is predicated upon the following:
DaVita Inc. provides dialysis treatment to patients with End Stage Renal Disease (“ESRD”), primarily from its own branded and operated outpatient facilities. ESRD patients are among the most acute and require 3.5 hour treatment 3x / week, with alternatives being a kidney transplant or fatality. Due to the increasing prevalence of certain risk factors for ESRD (aging, obesity, hypertension, and diabetes), dialysis patients have grown at a 3.8% CAGR from 2000-’15 with low variability. 87% of revenue and >100% of DVA profit come from the US dialysis market. The dialysis market in the United States is highly concentrated, with DaVita and Fresenius (FME) equally splitting ~80% of the market (next largest, American Renal, is 3%).
DaVita also operates DaVita Medical Group, which is held for sale to Optum for $4.9 billion. That business unit was acquired for $4.4 billion in 2012.
DaVita currently trades at 8.5x on a headline basis (using covenant EBITDA from their press releases), 6.6x PF for the DMG divestiture, and has levered to 3.99x in Q2-18 as it aggressively buys back its own shares ahead of the DMG divestiture. CapIQ screens show it at 9.4x EBITDA, which would not make the Company appear as overtly statistically cheap for screens.
Note: assumes minor transaction cost and tax cash leakage from DMG (for convenience and illustration, equal to balance sheet assets held for sale – liabilities held for sale)
If DVA returns to 9.4x EBITDA (15-year and 5-year averages) without too significant an impact to the AKF and California ballot initiative, shares should appreciate ~50% to the price target ($105); clear of these issues, the stock could also re-rate higher in the market or be bought out at a premium, which could drive to a 100% return.
Should the AKF be impaired, it will most likely be <15% of EBITDA impact (assumes insurers' power to reject patients be expanded nationally in a ways similar to California SB 1156) and California’s ballot initiative provide $100M headwind (low end of management's conservatively guided range), DaVita still currently trades close to 8.0x EBITDA PF for the sale of DMG. This should bound the downside at somewhat flat, as it is unlikely the stock would depreciate much further permanently once the reimbursement uncertainty cleared. In the bear case, the multiple could re-rate to 7.0x in that case, implying ~15% downside.
This creates an asymmetric payoff ratio of a 50% base case: -15% downside case (>3:1) with probability skewed to the positive. An unlikely upside exists up to ~100% in a buyout of DaVita, though this is hardly worth banking on.
Market volume dynamics for dialysis are incredibly stable with multiple tailwinds:
In addition, for the first time in a half-decade, the commercial reimbursement outlook has stabilized:
DVA trades for a low multiple due to negative sentiment on the magnitude, but not likely outcome, for what may happen to the AKF and California ballot initiative, especially after the SB 1156 vote in the California assembly and senate
DVA is selling DMG to UNH’s Optum for $4.9 billion, which it bought in 2012 for $4.4 billion; this is a major value driver seems very likely to pass HSR examination and DaVita expects to close in 2018:
The Company is a buyout candidate, with high certainty cash flows in an industry with a history of private equity activity
International is a potential major upside driver, and importantly for operating results, was a positive contributor for the first time in Q2-18
Risks & Mitigating Factors
The economic model is highly concentrated with the AKF as a potential single point of failure due to reimbursement dynamics.
It is highly unlikely that the AKF would be completely shut down; this is due to:
California's Ballot Initiative could have an impact on the state (AZ and OH have also proposed their own, but OH's never made it to the floor before being scrapped), and SB 1156 is a headwind
DMG acquisition does not pass HSR (seems to be a very low likelihood)
Each of the above risks has been overly discounted into the shares to send the PF level to 6.6x, helped by management’s willingness to fuel negative sentiment to protect its strategic interests (the AKF) by presenting a doomsday scenario without guiding to it
Business Model & Economics
DaVita owns & operates ~2,800 dialysis centers globally which can be built or acquired at a high ROC
With the US market approaching saturation, and DaVita and Fresenius giving the market >3x the HHI that the DoJ considers competitive, large acquisitions are becoming more difficult
International is oft-overlooked due to its historical challenges and expense, but is now breakeven
DaVita is divesting DMG to Optum, a UnitedHealth division, for $4.9B and using the bulk of the proceeds to aggressively buyback shares (currently at 6.6x PF EBITDA)
California: SB-1156 being signed into law (or vetoed) and the Ballot Initiative in the midterm elections
Clarity on the AKF’s future, especially as a large-scale impairment is priced in
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