Despite the market carnage, shares of Gentiva Health Services Inc. (GTIV) are up sharply this week. The strength is primarily due to the fact that GTIV reached an agreement over the weekend to acquire Odyssey Healthcare Inc. (ODSY) for $27.00 in cash.
Typically, when a cash acquisition takes place and the target company is bought out at a price above its current market value, the shares of the acquiring firm trade lower. This is because the market has placed an expected value on the target company (represented by its former share price) and the acquiring company is paying a premium to complete the purchase. The only way the market would reward the acquiring firm for paying a premium is if investors believe that the combination will be worth more than the sum of its parts.
In this case, investors are pleased with the purchase and believe that Gentiva will be able to create a stronger company as a result of the combination. The deal values ODSY at $912.3 million dollars and is expected to close in the third quarter. Both of the companies’ boards have agreed to the deal and it is unlikely shareholders will oppose the transaction, given the positive effect it had on both company’s stock.
The Odyssey deal is not the first acquisition Gentiva has made this month. Last week, the company acquired United Home Care Group – a private home healthcare firm based out of Louisiana. For competitive reasons, the terms and conditions of this transaction were not disclosed. UHCC had revenues of $7.8 million in 2009 so it is a relatively small bolt-on acquisition, but could be instrumental in helping GTIV build out its geographic footprint.
The combined company will provide hospice care to an expected 14,000 patients and will be active in 30 states. Analysts are expecting combined annual revenue of $1.8 billion, and the most recent estimates are for earnings of $2.71 for 2010. So at this point, shareholders are willing to pay just over 10 times earnings for what appears to be a very stable and well managed practice.
Challenges To consider
There are two issues that need to be carefully weighed before making an investment in GTIV.
First, the company will need to raise a significant amount of debt capital to complete the transaction. Since the deal is a cash transaction, GTIV will be borrowing an additional $1.1 billion and already has a guarantee from Bank of America (BAC), Barclays PLC (BCS), and the financing arm of General Electric (GE). At this point it looks like the financing is a sure thing, but given the turbulence in the market I think investors should at least consider a small chance that the financing dries up if we have a severe dislocation in the financial sector.
Secondly, GTIV was one of four companies that received a letter from the Senate Finance Committee asking for information on the necessity of medical visits. The implied accusation is that the company could have increased its number of visits in order to qualify for more Medicare reimbursements. The home health industry is a necessary part of our healthcare system and actually saves money for the Medicare program, but the regulatory issues and the possibility for fines and restrictions should be considered.
Given these two concerns, I still believe GTIV offers an exceptional value for investors. If the company is able to complete the transaction, increase growth projections, and prove to regulators that its practices are sound; investors are likely to pay a higher multiple to own the company. A PE of 15 would increase the stock by 50%, and if earnings projections are revised higher the gains could be even stronger. Given the potential for growth and knowing the risks involved in owning this company, I will be looking for attractive spots to add a bit of exposure.
Full Disclosure: Author does not have a position in any stocks mentioned in this article.