The old maxim “sell in May and go away” has perhaps never been more accurate. Since the end of April the S&P 500 has fallen by as much as -15% and after the recent rally is still down -10% resulting in a real “summer bummer.” Despite the market malaise, AmSurg (AMSG) offers investors a compelling opportunity for outperformance.
AmSurg Corp acquires, develops, and operates ambulatory surgery centers (ASCs) in partnership with physician practice groups throughout the US. AMSG acquires a 51% ownership stake in these surgery centers in the form of an LLC with physicians retaining the other 49%. Revenue is derived from facility fees charged during surgical procedures performed at the centers such as operating room usage, equipment usage, supplies and nursing staff. AMSG surgery centers perform high volume/low risk procedures. The main procedures done are gastrointestinal such as colonoscopy (79% of procedures/66% of revenue) and ophthalmic such as cataracts (12% of procedures/18% of revenue). Payer mix is 67% commercial insurance and 33% Medicare. As of June 30, 2010 AMSG owned a majority interest in 204 operating centers.
AMSG offers an attractive valuation with a stable and predictable business model. Despite the macro economic weakness AMSG has been able to maintain cash flow levels due to the nondiscretionary nature of the majority of AMSG’s procedures (80% of GI procedures are for a specific problem), the value proposition of ambulatory surgery centers (ASCs), selective acquisitions, and opportunistic share buybacks. AMSG acquisition strategy looks to have plenty of room to run given that over 50% of ambulatory surgery centers are independently (i.e. doctor) owned. AMSG is relatively under-levered and has ample firepower for acquisitions. Healthcare reform will provide an additional 32m people with health insurance which should increase demand for healthcare in general and ultimately for the procedures that are done at AMSG centers.
Given the predictability of the business and the current valuation (free cash flow yield over 13%, PE: 11, EV/EBITDA: 6.9x) the stock is a compelling investment. I think we are close to a bottom for the stock making the risk/reward here very favorable. Fair value for the equity should be $29-30 per share in my opinion.
Procedures mostly nondiscretionary, ASC offer superior value proposition over hospital
Despite the macro economic weakness AMSG has been able to maintain cash flow levels due to the nondiscretionary nature of the majority of AMSG’s procedures (80% of GI procedures are for a specific problem) and the value proposition of ASCs. Ambulatory surgery centers (ASCs) have a cost advantage over hospitals due to lower facility development costs and more efficient staffing which allows for procedures to be done cheaper than hospital based surgeries. ASC procedures are typically more convenient for patients compared to hospitals given the smaller location size and generally closer proximity. This cost advantage is a secular driver of more procedures being done away from hospitals and in ASCs.
Successful acquisition strategy execution, plenty of room to grow
AMSG has been rolling up ASCs since the 1990’s which has obviously led to most of the top line growth. AMSG added 12 centers last year and is looking to acquire 13-16 new centers this year. The AMSG acquisition strategy looks to have plenty of room to run given that over 50% of ambulatory surgery centers are independently (i.e. doctor) owned. For reference, M&A activity is historically more pronounced towards the end of the year. In Q2 AMSG shored up their liquidity situation by completing the refinancing of their $375m credit facility that is now good until May 2015 and placing $75m in senior notes that mature in 2020. AMSG is relatively under-levered (debt/cap of 36% vs. 40-60% peers and debt/EBITDA 2.5x vs. 3-4x peers) so they have plenty of firepower to make further acquisitions.
The acquisition strategy appears to be going fine as there is no discernable evidence that the incremental centers being acquired are less productive than the existing centers.
Health care reform and aging population are favorable long term trends
There is potentially a very large tailwind on the horizon for AMSG, starting next year as directed by the PPACA (and to think I was originally opposed to this genius plan) health insurance plans must cover preventative screening colonoscopies with no out of pocket costs. This could have a very positive impact on AMSG as they are highly exposed to colonoscopy demand. Furthermore the health care reform will provide an additional 32m people with health insurance. It is likely that more people with insurance will consume more health care services which should mean more surgical procedures for companies like AMSG. Additionally the aging population of the US will provide a long term tailwind as people typically require more procedures the older they get.
Lower Medicare reimbursement rates, with 33% of revenue coming from Medicare this is the most tangible risk. CMS revised the payments to ASC in 2008 and the changes are currently in the process of being implemented with final rates set in 2011. After 2011 reimbursement rates will then be adjusted by CPI adjustments. The ASC rates are set to be a rate that is 65% of the corresponding rate for hospital based outpatient surgeries so the driver of ASC reimbursement rates will ultimately be the healthcare costs of the hospitals. With 32m more people hitting the system I doubt we will see hospital cost deflation.
Regulations prohibiting physician ownership of healthcare facilities. In the unlikely event that the US prohibited doctors from owning healthcare facilities AMSG would be responsible for buying out the ownership stakes of their partner doctors. Given the large amount of partnerships and the doctor’s high % of ownership stake it would be very difficult for AMSG to come up with this money. I think this risk is rather remote as the AMSG/physician dynamic does not violate the Stark Law which prohibits doctors from making a referral for a health service to an entity that they have financial interest in. The Stark Law prohibits against doctors referring patients for lab services, physical therapy, imaging services, medical equipment and supplies from entities that they own.
A double dip recession impairs procedure volume as more people defer elective or preventative procedures due to economic hardship or loss of insurance.
Disclosure: Long AMSG