American Shared Hospital Services (AMS) provides radiosurgery and radiation therapy equipment to 23 medical centers in seventeen states as well as Turkey, Peru and Brazil. The company owns an 81% interest in GK Financing, LLC which finances this equipment for these medical centers. The remaining 19% interest is held indirectly by Elekta AG, the Swedish manufacturer of the equipment, known as the Gamma Knife. Unfortunately, despite this relationship, AMS does not have exclusivity in any region on the Gamma Knife and has lost financing contracts in the past to third party financing companies as well as to Elektra itself.
When a medical facility wants a Gamma Knife, AMS (via GK Financing) pays for the equipment and ongoing maintenance costs and the medical facility pays for the renovations and installation costs. AMS then earns either a flat fee per use (approximately $7,500 - $9,500) of the machine or shares revenue with the medical facility.
First, what is radiosurgery? According to Wikipedia:
Radiosurgery operates by directing highly focused beams of ionizing radiation with high precision. It is a relatively recent technique (starting in 1951 with Gammaknife by Leksell in Sockholm) which is used to destroy, by means of a precise dosage of radiation, intracranial and extracranial tumors and other lesions that could be otherwise inaccessible or inadequate for open surgery.
You can see a picture of how the Gamma Knife works here.
AMS trades for a market cap of $13.2 million versus a book value of $24.4 million. The company has generated an annual average of nearly $3 million in free cash flow over the last ten years and more than $6 million in each of the last two years, representing quite a significant yield on the current equity value. Note that in calculating free cash flow, I removed an approximation of the portion attributable to minority interests (the Swedish manufacturer/partner), in order to identify the free cash flow available to common shareholders. Failure to do this would overstate the company's true ability to generate free cash flow.
The company's free cash flow has been increasing despite declining margins and apparently reduced profitability. A closer inspection reveals that the company's depreciation charges have been steadily climbing both in absolute terms and relative to revenues for most of the decade. Free cash flow has remained high because actual cash capital expenditures have been persistently quite small relative to depreciation, and the company has been aggressively depreciating its equipment. Although the bulk of the company's decline in margins has been due to the rapid growth in non-cash depreciation expenses (which I am not worried about), a look at the common sized income statements (where every expense is expressed as a percentage of total revenues), reveals some actual cause for concern in that the company has previously had much lower SG&A and maintenance and supplies expenses as a proportion of total sales.
The bulk of the company's free cash flow has gone back into the business in the form of upgrading machinery to new models and investing in new technologies such as proton beam technology company Mevion Medical Systems (previously Still River Systems). Unfortunately, despite the reinvestment, revenues have declined since 2006 (according to the company, due to a worsening services mix offsetting increases in procedures performed) and the Mevion investment has yet to bear fruit (though the outlook is good). This means, unfortunately, that the bulk of the company's prodigious free cash flow has not yet been realized by shareholders in any tangible sense (either through a greater equity portion of enterprise value or from ownership of increased revenues and profitability).
Another concern is that management seems content with maintaining a relatively high debt load. In fact, net debt (all debt and capital leases less all forms of cash) has increased from $12 million in 2000 to $27 million today, which severely limits the company's financial flexibility. Unfortunately, the company has not utilized its free cash flow to strengthen its balance sheet.
By operating in the medical services industry, the company is subject to significant regulatory oversight and, unfortunately, uncertainty. In particular, there is some concern about the company's future revenues from Medicare and Medicaid reimbursements. According to the company (emphasis added):
Affordable Care Act
In March 2010, President Obama signed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, ("Affordable Care Act") into law, which will result in significant changes to the health care industry. …
Because the Company is not a health care provider, we are not directly affected by the law, but we could be indirectly affected as follows:
-- An increase in the number of insured residents could potentially increase the number of patients seeking Gamma Knife or radiation therapy treatment.
-- The Company's five retail contracts are subject to reimbursement rate changes for radiosurgery or radiation therapy services by the government or other third party payors. Any changes to Medicare or Medicaid reimbursement through the implementation of the Affordable Care Act could affect revenue generated from these sites.
One thing I like about the company is that insiders own a significant portion of the equity (31%) without a dual class share structure (which is common among smaller companies like AMS) and while maintaining reasonable executive compensation. However, the board has taken steps to entrench itself, possibly at the expense of other shareholders:
Shareholder Rights Plan
On March 22, 1999, the Company adopted a Shareholder Rights Plan ("Plan"). Under the Plan, the Company made a dividend distribution of one Right for each outstanding share of the Company's common stock as of the close of business on April 1, 1999. The Rights become exercisable only if any person or group, with certain exceptions, becomes an "acquiring person" (acquires 15 percent or more of the Company's outstanding common stock) or announces a tender or exchange offer to acquire 15 percent or more of the Company's outstanding common stock. The Company's Board of Directors adopted the Plan to protect shareholders against a coercive or inadequate takeover offer. On March 12, 2009, the Board of Directors of the Company approved the First Amendment to its existing shareholder rights plan which, among other things, extends the final date on which the Rights are exercisable until the close of business on April 1, 2019.
Despite this shareholder rights plan, it appears the company is open to offers to purchase the core of its business, which could act as a catalyst in the future (recall that GKF is the financing operation that accounts for more than 90% of the company's revenues):
In 2009 the Company had engaged in discussions with two parties concerning the possible sale of its 81% interest in GKF, with one of the parties providing indicative pricing for the interest that would be attractive to the Company if it were to sell its interest in GKF. Accordingly, the Company permitted the prospective acquirer to conduct a due diligence review of GKF and the parties engaged in preliminary negotiations of the terms of a transaction. In May 2009, the Company announced that the parties failed to reach an agreement and that the negotiations had terminated.
So where does all of this leave us? On one hand, the company generates a highly attractive amount of free cash flow which would suggest that the company is cheap based on current performance. On the other hand, it appears that management may not be effectively allocating capital, as the bulk of this free cash flow has been reinvested or invested in Mevion, and there is truly little to show for it so far. I am also not a fan of the relatively risky revenue stream given the deterioration over the past few years as well as the potential problems associated with the Affordable Care Act. If the company's revenues or margins were steadier, or if management committed to aggressively reducing leverage, I would be more comfortable with AMS, but for now I will have to pass.
What do you think of AMS?