Description

Idea:

Long Enhabit Inc. (“EHAB” or “the Company”), the Home Health & Hospice unit which spun off from Encompass Health on July 1st, 2022. In September the Company launched a strategic review of the company’s strategic alternatives,, including consideration of a potential sale,  and  if that review results in a sale of the company, we believe the company will be sold for 50-100% higher than the current price.

In the event of a sale, we believe Enhabit will get sold for ~14x Adj. EBITDA. Using $108mm of Adj. EBITDA in 2024 results in a $1.5bn EV and ~$500mm of net debt in 1Q24 translates to a $1.0bn equity value or $20 per share, up 100% from today’s price. If we are wrong, we believe there is minimal downside at 9.0x a low-case EBITDA of $100mm, or around $8 / share.

Why Does This Opportunity Exist?

Enhabit spun out from Encompass at a valuation which was <15% of ParentCo’s market cap. Coinciding with the spin-off were updated CMS rates for FY23 which were a negative surprise. The stock traded poorly, resultantly, and pressure has only mounted since then given perennial misses to guidance.  This pressure culminated in two activists pushing for a sale of the Company, and the announcement of a strategic review in September of 2023.

Enhabit is the last scaled public home health asset left. Amedisys was taken out in late June of this year at ~15x EBITDA. LHC Group was taken out in April 2022 for 22x EBITDA. Not only is it a scarce platform asset, home health is a strategic area for every large payor.

The Market is taking a skeptical view of Enhabit’s ability to be sold given consistent misses vs. guidance since spin-off. These disappointments have come on the back of accelerated mix-shift from Medicare FFS (high margin) to Medicare Advantage (low margin but improving). The Market is missing that the likely buyers of this asset are pushing fast and hard towards medicare advantage; payors want home health assets to serve their medicare advantage populations and lower their costs. Said another way, they want in-house capacity to serve their own low margin Medicare Advantage visits and with excess capacity they will serve the higher margin Medicare FFS. Payors (strategic buyers of home health assets) just care about operational footprint and service quality.

Company Overview

Enhabit Inc. provides home health and hospice services in 34 states. It is the fourth largest home health provider in the U.S. and ninth largest hospice provider. Enhabit is the largest provider in eight states it operates in.

Source: Company Filings

The Company has 255 home health and 109 hospice locations in total. Its revenue of $1.07bn in 2022 split out as $0.88bn Home Health (82%) and $0.19bn Hospice (18%). Home Health Segment Adj. EBITDA margins were 23% in 2022 compared with 20% for Hospice so 2022 Segment Adj. EBITDA broke out as $202mm Home health and $38mm hospice with $91mm of unallocated corp overhead bringing consolidated Adj. EBITDA to $149mm.

Home Health Industry Overview

Home Health involves providing skilled nursing, physical & other therapy, medical social work, and home health aide services. Patients are usually adults with three or more chronic conditions. Patients are generally referred from acute care hospitals, inpatient rehab facilities, surgery centers, assisted living facilities, and skilled nursing facilities.

The Home Health industry enjoys strong tailwinds from: 1) aging U.S. population, 2) focus on shifting care to low- cost settings, and 3) patients’ preference for care at home. In total, the industry grows volumes 3-4% with another 2- 3% of pricing leading to 5-7% top-line growth. The largest players grow faster than this due to M&A. Home health is a highly fragmented industry, the number one player - Gentiva (fka Kindred at Home) - makes up 6% of the market, followed by Amedisys at 5%, LHC at 4%, Enhabit at 4%, AccentCare at 2%, with no other player above 1% share and a long tail of regional and local players. Enhabit is the only relevant public player remaining.

Hospice agencies provide service to terminally ill patients with a focus on quality of life. Many home health patients transition to hospice care. The Hospice industry grows top-line 5-8% and is similarly fragmented, with EHAB holding <1% share. It is not a focus of this writeup given it contributes <20% to Enhabit’s EBITDA.

We believe Enhabit is a highly strategic asset & if a sale occurs, will be sold for a large premium.

Point 1 -- Home Health Strategic Value

The home health space has large strategic value to the nationwide payors. With the increasing shift towards Medicare Advantage and value-based care, they can utilize home health as an easy way to control costs. Below, references to calls are all respective Company transcripts.

• United Health (bought LHC Group early 2022)
  • “And listen, let me start off by saying we really believe that enhancing and building high-quality care provision in the home is going to be a key feature of the future. And the more that, that can be linked to other aspects of care, so for example, physician clinic, virtual and the rest, it's very much a central focus of our Optum Health development. And so the bringing together of LHC within the overall Optum organization is really important to us, and we're very committed to that transaction.” – 2Q22 earnings call
• Elevance Health (FKA Anthem)
  • “On a longer-term basis, in terms of your question, we really -- we do continue to evaluate further opportunities in terms of direct care that can be provided in the home and delivering that value to all our Elevance Health plans and ensuring patients get the right level of care.” – 2Q22 earnings call
  • “We are now working to develop more seamless integration between transitions of care throughout all post-acute solutions including Home Health.” – earnings call 4/19/23
  • “I think you can expect us to do more of those kinds of deals [bolt on’s to Carelon Health]” – 6-13-23 earnings call
• Cigna
  • “We have a number of initiatives underway, around alternate sites of care. So we think a big part of the next decade is going to be virtual care, home-based care, effectively using behavioral health care. All those things over time, we believe, will have affordability benefits.” – 11/18/21 earnings call
• Humana (owns Kindred at Home)
  • “So as you said, we didn't buy Kindred because we love Medicare fee-for-service home health. Our interest in Kindred specifically was a belief that more care could and should and would be delivered in the home. And that patients would both want more care delivered in the home, and it would be possible to deliver more care in the home and that, that's a better site of service for many services. And what we found is in some of the barriers to doing that at scale historically has been a lack of access to a nationally scaled home health labor force. The industry is fairly fragmented. And so even though Kindred is the largest home health agency, it still has, call it, mid- to single-digit sort of market share. So it can be very difficult to scale home-based care delivery models in the absence of having access to a nationally scaled platform.” – 5/10/22 earnings call
  • “We are committed to continuing to grow our CentwerWell Home Health business and expand market share though organic growth and strategic M&A activity.” – 4/26/23 earnings call
• CVS (Aetna)
  • “Our priority areas remain primary care and MSO capability and a home health capability. These assets will serve as the foundation of the platform upon which we'll pursue our strategic vision. So it's essential that we fully evaluate their defining characteristics and capabilities. And so while the valuation environment continues to present its own set of challenges, I'm cautiously optimistic with our ability to begin to execute on our strategic plan in 2022.” – 1Q22 earnings call

Public Precedents:

• November 2017: LHC Group bought Almost Family Inc for 16.1x LTM EBITDA.
• April 2022: United Health acquired LHC Group for 22.0x EBITDA.
• June 2023: United Health announces acquisition of Amedisys for ~15.0x Adj. EBITDA.

Enhabit trades at 9.2x our estimate of 2024 Adj. EBITDA, which is below where peer HH assets traded when they were public (and were bought for much higher). See appendix 1 for peer multiples. We think the Market is pricing in no value to a take-out here, as a result, or embedding large cuts to forward EBITDA which we do not think are appropriate. We believe these assets are high quality and will attract multiple bids in a strategic review/sales process.

Point 2 -- Enhabit’s assets are high quality within Home Health

In speaking with formers as well as competitors, Enhabit is regarded as a well-run organization, with good locations (density) and outcomes (run the business by the book and get good clinical results for patients).

Density
The density of home health patients in a region dictates economics of a home health agency. Simply put, higher density translates to less idle time of clinicians, as they spend less time commuting between patients and more time delivering care. Additionally, higher density markets tend to have better supply of lower-cost disciplines (e.g., licensed practical nurse availability, which is lower cost than sending a registered nurse).

Enhabit’s hubs are mostly located in the highest home health usage states. We estimate that Enhabit’s locations, on a weighted average basis, operate in states with a 9.6% home health utilization rate vs. 8.6% for the national average (or a ~11% improvement). Further, these states have much higher visits per home health user than the average (3,443 service visits per ‘000 Medicare Enrollees in Enhabit’s portfolio, 30% greater than the national average).

Source: CMS.gov data

Second, Enhabit is a top provider in most of these states high home health utilization states. 

To help illustrate Enhabit’s scale & density advantage, we plotted the Company’s median & average home health episodes per location against the industry overall (y axis below = episodes per location, x axis = home health agency count); the Company is easily in the top quintile:

Source: CMS.gov

Combined with operating in better than average states, its density should garner it a low-cost position. This should make it more attractive for both a strategic and as a standalone business.

Outcomes

CMS tracks two key quality-based ratings: the Star rating (patient care) and CAHPS rating (patient satisfaction). The Star rating is a summary of a home health agency’s performance on how well it provides patient care across nine areas, and is a ranking out of five, with the average at 3.2 excl. Amedisys and Enhabit. A star rating higher than three means that an agency performed better than average, and vice versa.

Enhabit’s average Star rating was 3.8 in CMS’s latest report from July 2022, which is slightly below larger peers (Kindred at 4.0, Amedisys at 4.5, LHC at 4.25) but much above the industry average at 3.2.

Going through the individual entities we can see from the master list CMS provides, 85% of Enhabit’s locations listed have a 3.5 or above star rating. Only 2% of entities had a star rating below 3 (considered “less than average”). This compares with 56% of the industry at 3.5 or above and 26% below a 3:

Source: CMS.gov

An easy way to see why patient care ratings practically matter is observing hospital readmission rate. Enhabit had a 200bps lower 30-day hospital readmission rate than the industry overall (15.3% vs. 17.3%); payers should prefer HH providers with lower hospital readmissions all else equal.

Valuation

We think there is a small amount of upside in a no-takeout scenario and significant upside (100%) in a take-out scenario. We think this sets up for a very good r/r.

No takeout, 2024 adj. EBITDA of $108mm and 10x fwd EBITDA yields a $580mm market cap ($500mm YE23 net debt), or $11.60 stock price (10% premium).

Takeout scenario: 2024 Adj. EBITDA of $108mm at 14x fwd EBITDA yields a $1.01bn mkt cap ($500mm YE23 net debt) or $20.2 PT and 94% upside.

Appendix 1 – historical peer EV / EBITDA multiples

In the past seven years, Amedisys and LHC Group’s NTM Adj. EBITDA multiple troughed at just under 10x in 2016 and re-rated to the high-teens in 2019 (source: Bloomberg):

Disclaimer: The author of this memorandum presently has a position in securities of this issuer and may trade in and out of these positions without notice. This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation. This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

Strategic review outcome / sale of the company