Conmed Healthcare Management (NYSEMKT:CONM) is an underappreciated stock that presents a very appealing risk-reward opportunity. This is a pretty straightforward situation so I have kept this write-up brief. CONM is a high quality, growing business with almost all revenue recurring due to multi-year contracts. In late February, Cantor Fitzgerald was hired to assist with what will likely be a sale. Conmed could pretty easy command $5.00-5.50 per share in such a scenario, +50% from the current level. Independent of a sale, there is meaningful near-term upside to the equity of +30% as the fundamentals and cash flows of the business become better appreciated.
Conmed provides healthcare services to 56 jails in 10 states. Competition in this industry is highly fragmented. CONM is able to win new business by providing higher quality services (never lost a customer) at a lower price than internally-managed groups. Conmed charges $9.77/inmate/day versus the estimated national average of $10.31/inmate/day. There are essentially no capex or working capital needs of the business since almost all technology/facilities are provided by the jails on-site. See the company's investor presentation on their website for additional overview of the business.
Early last year Conmed put itself up for sale at the urging of a 20% shareholder and board member. Six suitors placed bids. Ayelet Investments backed by Dr. James Desnick was the winning bidder. On the eve of the shareholder meeting, financing was pulled by the prospective lenders and the deal fell apart. This was likely a result of Desnick's criminal past and deterioration in the capital markets. There does not appear to be any fundamental reason or issue specific to Conmed that led to the deal's failure. Financial performance actually improved during the period.
Conmed has already won two contracts in 2012 which will generate close to $4M in annual revenue. These assignments have gained Conmed a foothold in Texas and Kentucky from which they can compete for additional RFPs. Even if Conmed doesn't secure any new business in 2012, they should be able to record +$75M in revenue or $6M in EBITDA. Almost all contracts contain annual price escalators or 2-3%. At $100M in revenue they would generate $10-11M in EBITDA given the scalability of the business (almost no additional SG&A needed).
Valuation and Catalysts
Conmed trades at 5.7x 2012E base case EBITDA versus 8.0x prior to the announcement of the sale in 2011 and 9.2x for its peers. This equates to 30-45% upside. As these new contracts hit, investors should better appreciate the earnings power of the business and move Conmed back in-line with these relative multiples. Conmed has hired an IR firm and will be presenting at the Needham Healthcare Conference on 4/3 and management has a share repurchase program in place that began after Q4 earnings were released earlier this month. Both of these should support a higher stock price. Most significantly is a potential outright sale. Peer ASGR sold for 9.3x EBITDA last March and CONM itself was scheduled to be acquired for 9.8x. Now that they have renewed their largest contract (Pima County) through June 2013 and further demonstrated an ability to win business, it seems likely that a higher multiple would be warranted. At 9.8x EBITDA, the stock is valued at $5.25 per shares, a 50% premium to current.