Gentiva Health Services: Business Model
Transition Makes For A Compelling Buy
Sep 23 2013
By Marshall Hargrave, Bridgewater Investments
Sure, you may have missed the chance to snatch up Gentiva Health Services (GTIV) at decade
lows, around $3 per share, back in 2011, but the stock is still on sale. The company continues to
operate well despite the sequestration overhang (i.e. a possible cut in reimbursement rates). The
company has been diversifying its revenue stream via acquisitions and made its best buy of late,
snatching up Harden Healthcare, which could be its gateway to community care and away from
Medicare focused revenues.
GTIV took its lumps back in 2011, at one point falling 70% in less than a month, when the
discussion over reimbursement rate cuts first came to light.
Overview
Gentiva is the largest publicly traded provider of comprehensive home health and hospice
services in the U.S. The company's operations involve servicing its patients and customers
through its Home Health segment and Hospice segment.
About 55% of revenues come from home health and 45% from hospice. The company has a
heavy weighting toward the East Coast, with notable opportunities to expand Westward.
A rising tide lifts all boats
The rising tide will undoubtedly lift all boats. And this rising tide is a rapidly aging population,
with the various boats operating in the healthcare sector. As the Oxford Journal notes (emphasis
ours), "like the rest of the world, the US is an ageing society. Between 2000 and 2050, the
number of older people is projected to increase by 135%. Moreover, the population aged 85
and over, which is the group most likely to need health and long-term care services, is
projected to increase by 350%."
Furthermore the AOA expects the U.S. to rapidly age over the next twenty years, with the
population of 60+ year olds expected to make up over 25% of the population by 2040.
Source: Administration on Aging
This goes hand in hand with the overall rising population of 65+ year olds. Each day 10,000
Americans turn 65.
Source: Administration on Aging
Now, the one big overhang has been the government's desperate attempt to cut spending, which
has brought into question the possibility of Medicare reimbursement rate cuts. When
sequestration went into effect earlier this year there was a 2% cut in Medicare spending.
The problem for GTIV? A large portion of its revenues are tied to Medicare, around 85%, but we
think the market continues to overreact to the sequestration (more on this later).
Even so, the Oxford Journal notes that the overall funding for Medicare, Social Security, and the
Medicaid for long-term care is expected to go from 6.8% of GDP in 2000 to 13.2% in 2050. As
well, health and long-term care programs are projected to increase from 2.6% of GDP in 2000 to
6.7% of GDP in 2050.
Company tailwinds
First, acquisitions, this will be one of the biggest catalysts for the stock. Back in early 2012, the
company managed to amend its senior secured credit agreement to get some breathing room with
respect to its debt covenants. This helped it prepare for a mini acquisition spree.
In mid-2012 it bought Advocate Hospice, and then just a couple months later bought Family
Home Care Corporation. That same month it bought up North Mississippi Hospice. All of these
acquisitions have helped boost the company's market share and expand its coverage. GTIV
Executive Chairman Rod Windley told Reuters:
"The increasing healthcare needs of an aging population and ongoing rate pressures will fuel
industry consolidation and Gentiva is positioned to be a leader in this effort."
The latest GTIV move in the acquisition space includes snatching up fellow home health/hospice
provider, Harden Healthcare for $400 million. The deal helps expand GTIV's presence in thirteen
states. Fellow SA contributor, The Value Investor, sums up the Harden deal nicely, they note
(emphasis ours):
"The deal is of a strategic rationale, and is necessary for Gentiva. "Obamacare" has resulted in
lower reimbursement for Gentiva's traditional activities, spurring it to diversify further into
home health and community health serves.
So while many hospitals are merging ahead of Obamacare to handle greater patient streams, not
all healthcare providers are benefiting from the healthcare changes as this merger proves. With
the deal Gentiva will reduce the dependency on just Medicare."
The decreased reduction of Medicare dependency is the real story, and one that should continue.
The purchase also marks GTIV's debut in the community care market. Prior to the transaction,
GTIV derived 55% of its revenue from home health, now, on a pro forma basis, the combined
companies will get 49% from home health and 10% from community care.
As well, prior the transaction, 86% of revenues were derived from Medicare, with the addition of
Harden, only 72% will come from Medicare.
Second, GTIV is also focusing on more specialty-type services. This includes home orthopedic
rehabilitation services, such as joint replacement. This goes hand in hand with addressing the
needs of patients with age-related diseases, such as Alzheimer's. The number of Americans with
Alzheimer's is expected to go from roughly 4 million in 2010 to 14 million in 2050.
Source: GTIV
Specialty services should also help bring higher margins. For now, GTIV has been boosting
margins with cost cutting. Its SG&A expenses were down almost 5% during the first half of
2013. This comes after the restructuring of its Home Health operations helped push SG&A
expenses down by 10% year over year in 2012.
And, three, the game changer, the Harden acquisition. We think the acquisition is right in line
with the company's plans to grow earnings and diversify beyond Medicare. GTIV's stock got a
13% boost after the announcement, but we believe there's more to the story than just a 13%
move. The acquisition is expected to not only add substantially to EBITDA and net income, but
the deal will also expand GTIV's EBITDA margin by nearly 40 basis points.
Also worth noting, the above pro forma assumes the full 3.5% rebasing cut (worst case) to home
health Medicare revenues. If the cut comes in less than that there will be further upside.
This leads into the final tailwind, number four, valuation. Compared to major peers, GTIV trades
on the cheap. Part of the overhang is sequestration. But the company has more than a "margin of
safety" built in, trading at 12x forward earnings and only 6.3x EV/EBITDA. This is well below
its peer average of 11.3x and well below notable comp AMED's 8.1x.
Taking this a step further; before the Harden acquisition, GTIV was expected to generate around
$1.00 in EPS for 2014 and was trading at 11x 2014E EPS. Now, the pro forma EPS (with the
addition of Harden) could have 2014 EPS coming in at $1.20. Even with the run up, the stock
trades at only 10.5x pro forma 2014E EPS.
Prior to 2011, the stock traded around 15x earnings. Assuming Mr. Market wakes up to just what
the Harden acquisition means for GTIV, the company could easily trade closer to this and more
in line with the 20x industry average. For the sake of modesty and to account for the fact that
GTIV will still be heavily tied to Medicare, we use a 13x P/E for 2014 EPS, suggesting around
25% upside in just over a year.
Bottom line
GTIV is still recovering from the cliff it fell off in 2011, when news emerged of government
spending cuts threatening the company. The stock popped some 17% in early August on news
that private equity firm KKR had taken a 8.5% stake in competitor Amedisys. The company also
got another pop after announcing the Harden acquisition; yet, its sub-$13 price is still well below
the $30/share the stock was trading at just a few years ago.
We like the fact that management has a vested stake in GTIV owning 11% of the company. We
also like the fact that noted health care investor Larry Feinberg is a shareholder as well. His
Oracle Investment Management has a 5% stake. Larry Feinberg has been an investor and analyst
in the healthcare sector for over 30 years.
We think the market hasn't fully appreciated GTIV's long-term acquisition plan, nor its recent
Harden acquisition, and see 25% upside over the next year as the company begins to trade at
multiples more in-line with its peers.