Thesis
UHS stock is an opportunity
that offers 24-50% upside with extremely limited downside. UHS is trading at a sharp discount to its
comparables on a sum-of-the-parts basis, despite having a better long term
ROIC. UHS has the cleanest balance sheet
in the industry and a management that has a strong track record in allocating
capital efficiently providing opportunities to add value via acquisitions. In addition, several internal operational catalysts
and the potential for a critical regulatory catalyst provide reasons to expect
the discount to fair value will close.
Business Description
UHS operate 2 main
businesses: the acute care hospital
business and the behavioral health business.
The overall management philosophy guiding both businesses is based
around several tenets that all value investor respect:
- Concentration of Business. UHS’s business is concentrated
geographically in those areas where they see the most value and growth. Management does not talk about size or
national coverage or other non-value creating factors in making investment
decisions.
- Market Dominance.
UHS is #1 or #2 in market share in its markets, giving it greater
negotiating power with payors.
- No Explicit Acquisition Targets. Unlike most companies, UHS does not make
explicit M&A targets. They are
value-sensitive, so deals get done with price as the criteria rather than
some arbitrary management goal.
- Toleration of Volatility. UHS does not manage its business to meet
the quarterly EPS estimate. This
earnings volatility keeps many short-term investors out of the stock,
providing an attractive entry point for investors with a longer time
horizon.
The acute care business is a
capital intensive business that has been under pressure from an increased
number of uninsured patients and the resulting elevation in credit risk, new
competition from physician-owned hospitals, new competition from ambulatory
surgical centers, pressure on pricing from Medicare/Medicaid and increased
bargaining power in the hands of health insurance companies.
The behavioral health
business is a non-capital intensive business that is growing strongly while
facing little credit risk, little regulatory scrutiny (after a period several
years ago of significant cuts in reimbursement) and an increasing number of new
disorders as more behaviors are given medical coverage.
Acute Care Business:
The acute care business is
concentrated in 2 markets: about 30% of beds are in Texas
and 20% are in Nevada. Florida and California each represent 9-10% of beds, as did Louisiana before
Hurricanes Rita and Katrina. Two
facilities remained closed due to damage, and during the last 12 months, UHS
has collected over $260 million in insurance proceeds that have been used to
repurchase stock, repay debt and make acquisition in the behavioral
business. Ignoring the human toll for a
moment, the hurricanes were a financial windfall as UHS management was able to redeploy
proceeds into value creating investments.
There are 4 catalysts that
could drive improved results in the acute care business:
- Stabilization in uninsured patient trends. Although volatile and difficult to
predict, UHS management has started to a decline in the growth rate of
uninsured admissions.
- Organic Expansion. UHS has 2 facilities with 340 beds
coming on line in the second half of 2007.
Based on a normalized profitability levels, this should generate a
least $20 million incremental EBITDA.
- HCA/Sierra Contract Disruption. This dispute could lead to incremental
market share gains for UHS in its key Las Vegas market. Although good estimates on incremental
EBITDA potential are difficult, Citigroup estimates the impact could be
$15-20 million.
- Regulatory Curbs on Doctor-Owned Hospitals. In the last several years,
physician-owned facilities have had a negative impact on hospitals as
patients with the best economics (in terms of acuity and health insurance
coverage) are referred to facilities where the attending physician has an
economic interest. This has hurt
UHS, in particular. UHS facilities
in the McAllen, Texas market used to generate 24% of
acute care EBITDA in 2003. Two
years after the opening of a doctor-owned facility, EBITDA declined from
$60 million to $10 million.
According to our discussions with various healthcare executives, incoming
Chairman of the House Ways
and Means Subcommittee on Health has doctor-owned facilities in his
crosshairs. While difficult to
estimate, there seems to be a good probability that UHS could recoup the
lost EBITDA over time with tougher regulations on physician-owned hospitals.
Behavioral Health Business:
UHS is the second largest
player in the behavioral health market with about 6,600 beds, compared to
Psychiatric Solutions at 6,900 beds (before the announcement of their purchase
of Horizon which will add about 1,600 beds).
After a difficult period in the early 1990’s, industry conditions have
improved with increasing insurance coverage, expansion of qualified disorders,
capacity constraints, increased admissions and utilization and improved
Medicare reimbursement clarity.
In a nutshell, UHS’s
behavioral business is the best in the industry, generating leading margins and
returns on capital. Anyone familiar with
PSYS is aware that they have been acquiring business aggressively and paying
high prices (3x’s replacement cost), and the business is unlikely to generate
adequate returns on capital. In
contrast, UHS has been far more disciplined.
The key catalyst in this
segment will be the continued turnaround of the KEYS Group acquisition. This acquisition has moved UHS into
therapeutic boarding schools for minors and industry littered with shady
operators. The ramp-up of the business
has taken longer than expected; however, the operations should see a clear
improvement in 2007.
Valuation
First, let’s quantify the downside. A replacement value approach generates in a
downside valuation estimate of about $52 per share. Assuming UHS generates a ROIC above its WACC
(which it does even in this tough environment), the business should trade no
lower than replacement cost. (The cash
component includes $15ml in cash and $30ml in stock of a REIT in which UHS has
a 6.7% stake.)
|
Replacement
Value
|
|
|
|
|
|
Replacement Cost
|
Enterprise Value
|
|
Segment
|
Beds
|
$ Per Bed (000)
|
$ (ml)
|
|
Acute
|
5,139
|
500
|
2,570
|
|
Behavioral
|
6,640
|
120
|
797
|
|
|
|
|
|
|
Enterprise Value
|
|
|
3,366
|
|
Minority
Interest
|
|
|
187
|
|
Debt
|
|
|
468
|
|
Cash
|
|
|
45
|
|
Equity
Value
|
|
|
2,756
|
|
Per Share
|
|
|
$ 52
|
To estimate the upside, a
sum-of-the-parts approach is used. Using
2007 consensus estimates for EBITDA (netting out corporate overhead on a % of revenue
basis), results in valuation of $79 per share.
This approach uses Triad, Community Health, Health Management
Associates, Tenet and Lifepoint to arrive at an average multiple for the acute
care business and PSYS’s multiple is used for the behavioral business.
|
Sum-of-the-parts
Valuation
|
|
|
|
|
2007
|
Comprable Company
|
Enterprise Value
|
|
Segment
|
EBITDA
|
Multiple
|
$ (ml)
|
|
Acute
|
311
|
7.4
|
2,301
|
|
Behavioral
|
217
|
11.6
|
2,517
|
|
|
|
|
|
|
Enterprise Value
|
|
|
4,819
|
|
Minority
Interest
|
|
|
187
|
|
Debt
|
|
|
468
|
|
Cash
|
|
|
45
|
|
Equity
Value
|
|
|
4,209
|
|
Per Share
|
|
|
$ 79
|
Even assuming that PSYS is
30% overvalued, fair value for UHS is still $68 per share.
While convention would
dictate the application of a discount to the target price, I am not doing so
for one key reason: my base case DCF
estimate of intrinsic value approximates the SOTP estimate. Should a corporate transaction occur, the CEO
Alan Miller (who owns 7% of the shares outstanding and 86% voting control) may
extract a control premium from this value estimate; however, public
shareholders should expect to receive $79 based on the cash flows.
Any improvement in
regulations on doctor-owned facilities or in levels of uninsured admissions
provides upside from these target levels.
An incremental $50 million in EBITDA from the McAllen market, the Las
Vegas market and a reduction in uninsured admissions would alift the target
price to the mid-$80’s.
UHS has commented that its
underleveraged balance sheet will be used to make acquisitions in the acute
care industry (a Texas
acquisition was announced recently).
UHS’s track record in creating value via acquisitions is strong.
Lastly, in the past, UHS has
sent mixed signals about the likelihood of a spin-off of the behavioral
business (most recently, taking the option off the table). After many conversations with CFO Steve
Filton, I think the possibility still exists; however, the timing of any
transaction would be far in the future.
Stabilization in uninsured admissions.