Summary: Tenet Healthcare Corporation (“THC”) operates hospitals and other healthcare facilities, as well as, a revenue cycle management platform called Conifer. We believe a combination of a decade of underperformance and the resulting investor fatigue, high leverage (>5x), and recent disruption from a series of divestitures and restructurings have led to THC being undervalued. On a sum-of-the-parts basis, using EBITDA multiples discounted 1x+, we believe THC is worth 50% more or ~$49/share.

THC trades at ~7.3x EBITDA vs. hospital operators at 8.4x. THC’s hospitals are in growing metro areas and are average at worst. Furthermore, 46% of THC’s business comes much faster growing and higher valued ambulatory surgical centers and Conifer, its revenue cycle management program.

We think two things will help rerate the stock though both are admittedly longer term: first, THC is expecting to spinoff Conifer Q2 2021, and second, as the company finishes a large restructuring, cashflow and deleveraging should improve (>20% LFCF yield in the near term with help of $1bn NOL).

Background: THC has three operating segments: (1) Hospitals (54% of ‘19E EBITDA) - operate 65 hospitals across 10 states; (2) Ambulatory Care (32% of EBITDA ’19E EBITDA) - operate 264 ambulatory surgery centers, 38 urgent care centers, 23 imaging centers, and 23 surgical hospitals across 27 states; and (3) Conifer (14% of ‘19E EBITDA) - healthcare business process services for revenue cycle management that’s a JV with Catholic Health (now CommonSpirit Health). Glenview Capital Management (“Glenview”) has been a shareholder since 2012 and pushed for board and management changes claiming the former CEO and board were more focused on empire building than value creation. Glenview was ultimately successful and pushed out the CEO and turned over the board in late 2017.

The new CEO, Ronald Rittenmeyer, has made significant progress since being appointed. He has identified $450mm of cost savings ($300mm of which will have been realized by year end), accelerated lower-quality asset divestitures, bought out minority interest in the Ambulatory Care segment, refocused internal KPIs around quality of care, and announced a plan to sell Conifer. After a drawn-out sale process, management decided to spin out Conifer instead of selling it. Conifer is expected to be spun out Q2 2021. The Conifer segment topline has suffered as THC spun out hospital assets that have switched to acquiror’s revenue management system, focused on the sale process, and prioritized restructuring initiatives over revenue growth. The restructuring initiative, however, was successful growing Conifer EBITDA from $283 in 2017 to ~$449, run-rated for cost cutting initiatives. The company hired a new Conifer CEO in late January who will lead the business post-spin and address the weaker revenue growth.

Thesis (LONG): On a sum-of-the-parts basis we believe THC is significantly undervalued but that a combination of investor fatigue from a decade of underperformance and high leverage has weighed on the valuation. Further, we believe the market misperceives THC as a low-quality hospital operator despite its solid core hospital assets that are in growing metro areas and its growing higher quality Ambulatory Care and Conifer segments which constitute over 46% of EBITDA.

(1) Valuation Ignores Higher Quality Assets and Values Company Like Lower-Quality Hospital: THC, despite having the majority of its hospitals in growing metro areas, is valued at 7.3x forward EBITDA versus other public hospital operators (i.e., HCA, CYH, UHS) at an average of 8.4x based on Bloomberg estimates for each. The valuation seems to completely discount that THC generates 32% of EBITDA from growing ambulatory surgery centers where comparable companies get 11-16x EBITDA (SGRY and private deals in 11x-15x range), and 14% of EBITDA from Conifer where comparable companies receive 8-12x EBITDA (CHNG, RCM).

a.   Hospital Quality: Successful hospitals are ones with high regional density that give them negotiating leverage with insurers and ones in geographies with growing populations. THC has sold orphaned assets leaving it with hospitals clustered in geographies with higher than average population growth.

b.  Ambulatory Care: Ambulatory service centers have been growing MSD+. Insurance providers generally prefer them because they tend to be less expensive and patients prefer them because they offer more convenience.

c.   Conifer: Revenue cycle management businesses tend to have sticky revenue and are capital light. The market is fragmented and slowly consolidating. Conifer is one of the largest platforms. Conifer is expected to return to growth as the company laps disruption from the sale process, restructuring, product overhaul, and a pull-back in sales and marketing. We think Conifer should also have an easier time selling its product as an independent organization.  Customers are understandably reticent to hand revenue management over to a competitor. In addition, certainty around Conifer’s future should make customers more comfortable signing up. The company is confident that under the guidance of the new CEO and a focus on marketing that Conifer will return to growth in 2020. That said, we haven’t seen tangible results of this yet and have opted to use a discounted multiple to account of this.

(2) Conifer Spin-off Summer 2021: In our mid-case we estimate the Conifer spinoff would generate ~$25/share in value assuming it is spun-off cash free debt free. That, however, would leave THC levered at >6x. THC has indicated that they will add a modest amount of leverage to the Conifer business. Assuming the company did the spin today and levered Conifer at 3x 2019 EBITDA, with run-rated synergies, it would put the Conifer stock price at ~$15/share and leave THC levered at ~5.7x, up from ~5.2x. With cash flow between now and the spin, THC should be able to keep leverage at or around 5x assuming, assuming 3x leverage at Conifer, and no EBITDA growth between now and then.

(3) Cleaned Up Hospital Portfolio and Bulk of Restructuring Behind Create >20% FCF Yield: The Hospital segment has had various minimally profitable hospital assets drag on the performance of the higher quality assets. Additionally, restructuring has been a drag on FCF. With the majority of divestitures and restructuring behind it, the hospital segment should show more consistent clean growth and overall company free cash flow conversion should improve. Free cash flow yield based off of 2019 EBITDA guidance but with run-rate synergies (excluding restructuring charges and including the usage of the $1bn of NOLs) is ~20%+.

Valuation framework:

Base Case: $49/share (47% upside) based on mid-point of EBITDA guidance PF for cost-savings and divestitures valuing hospitals at 7.5x EBITDA (comp average of 8.4x), Ambulatory Care at 12x EBITDA (similar assets have sold for 11x-15x; SGRY arguably the best public comp trades at 16x ‘20E), and Conifer at 7.5x EBITDA (CEO has mentioned multiple times that his bogey for selling was 12x).

Upside Case: $68/share (105% upside) based on high-end of EBITDA guidance PF for cost-savings and divestitures valuing hospitals at 8x EBITDA, Ambulatory Care at 13x EBITDA, and Conifer at 8.5x EBITDA.

Downside Case: $25/share (23% downside) Assume Conifer spinoff is shelved. The company is valued on a consolidated basis versus sum-of-the-parts. Use a blended multiple of 7.8x EBITDA, on the lower end of what hospitals trade at.

Risks to monitor: (1) Hospital segment; (2) Conifer sale; (3) Political pressure and legislative changes around healthcare and insurance

Valuation Support:

Note: We’ve chosen to use the actual ownership of non-controlling interests in segments, as available, and when it is not available, estimate it. We use those values for valuation versus the sell-side favored methodology of TEV/(EBITDA-NCI) which we think overestimates “shareholder” EBITDA and the Bloomberg method of using the book value of the non-controlling interests which we think understates TEV and the multiples these business trade at. For the comparable multiples we used the Bloomberg methodology which should generally understate multiples of comparable companies.