Team Health: Bid Is Gone, But Demand For Physician Staffing Assets Only Getting Better

| About: Team Health (TMH)
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Summary

Investors haven’t liked that instead of going with Amsurg, the company acquired IPC Healthcare.

The deal positions the company well to monetize the trends underway in the physician staffing sector.

Besides the increased debt, there is little to worry about liquidity, balance sheet or the cash flows.

Continuing from the last note on MEDNAX, this note takes the argument for physician staffing space further.

Even though Team Health Holdings (TMH) stock is down 35-40% over the past six months, the concerns around the name are hardly related to the core operations, but more related to new acquisitions and rejected acquisition offers, both to the investor's discomfort, especially short-term focused investors. But this may be a good time to take a closer look, since fundamentals of the broader physician staffing space and the company look set to benefit from consolidation in the space and the integration of the recently acquired IPC Healthcare.

Besides the market and usual challenges associated with the integration of a new acquisition, investors are concerned about the high leverage, rightfully so considering the doubling of net debt/ adjusted EBITDA from just a year ago and the condition of the credit market. On top of that, by rejecting Amsurg's (AMSG) acquisition offer and opting to acquire IPC Healthcare instead, the business may have lost the acquisition premium expected in a target and gained the usual valuation discount of the acquirer.

Revenue growth breakup. Image source: Team Health

Other than disagreeing about the timing of acquisitions and expansions, there is hardly anything to complain about, especially now that management has indicated their complete focus on the execution and integration of recent acquisitions, rather than going for more deals. The macro environment is favorable, with consolidation underway in the space and a stable mid to high single digit type of organic growth, which is decent even among non-healthcare names in this market environment. The big question is whether the business can create value for the shareholders, without compromising the financial health, and the fundamentals suggest that it is very much possible. Strategically, the acquisition has positioned the business well to withstand the regulatory changes and position the combined business as a major player in the physician services space, while the legacy business remains stable. A large debt on the balance sheet is something worth watching closely, but hardly a reason to get worried about.

Comps

EV/ EBITDA (trailing)

Rev. growth est. 2015

Rev. growth est. 2016

P/E 2015

P/E est. 2016

TMH

11

28%

29%

15

14

MD

13

14%

13%

17

16

EVHC

11

23%

21%

18

15

The Street expectations, especially below the top line, are low for the combined business, which is somewhat highlighted by the company's increased guidance during the most recent quarterly results. Even though AmSurg's bid, which valued Team Health around $5 billion, is gone, the current enterprise value, almost 30% lower from the offer, is a good reference point for a valuation study. The stock should get incrementally better as the company de-leverages, with the help of cash flows of the combined business. The adjusted EBITDA may reach more than $600-700 million per year.

Favorable tailwinds

The industry make-up, opportunity, competitive positioning and strategic shifts are covered in my previous note on MEDNAX , but the favorable trends in the industry are even bigger.

Now that consolidation has hit the hospital and health-insurance sector, other parts of the healthcare food chain, including the physician staffing space, are undergoing the same. Away from Medicare making separate payments to providers for each individual service, the U.S. healthcare system is moving towards a value-based reimbursement system through Medicare's 'bundled payments' program, which is trying to link payments for multiple services during an 'episode of care'.

Source: TMH presentation

Team Health's merger with IPC Healthcare is an exercise to position the company for successfully monetizing this trend. The combined operation should have around 15,000 physicians deployed and a network of more than 1,200 hospitals and about 20,000 doctors to provide outsourced physician services. Besides a bigger network, the business should benefit from IPC's specialist area of post-acute care, which can be bundled up to offer full service across emergency care, anesthesia management, specialized services and post-acute care. Since the deal closed last quarter, this year's finances should benefit from the synergies.

Growth catalysts, not bound by acquisitions

The momentum of legacy business offers the perfect stability that can serve as a backdrop to carry on strategic goals. This stability was reflected in twenty quarters of double-digit revenue growth and strong cash flows as well as EPS.

Source: Team Health holdings

Although positive contributions from acquisitions make up the majority, the growth was also contributed by new contract sales and same contract results. Same contract revenues, which are comprised of volume growth and pricing, have shown decent growth. This performance was in spite of a decline in parity revenues. Please refer to the previous note for details on what constitutes parity revenues.

2013

2014

Q1-Q3 2015

Consolidated

Fee for service revenue

15%

24%

35%

Contract & other revenue

17%

4%

12%

Same Contracts

Fee for service revenue

5%

9%

6%

Contract & other revenue

-1%

-2%

0%

Fee for svc. Visits and procedures

Same Contracts

-2%

3%

6%

New & acquired contracts, net of terminates

39%

75%

300%

While acquisitions are overshadowing much of the discussion right now, long term, it may not be too much to expect same store revenues contributing 4-6% of growth, with equal halves coming from volumes and price, acquisitions another 2-4% and new business wins 2-4% as well.

Going forward, considering that the overlap among hospitals covered by both Team Health and IPC was less than 20-30%, there should be significant cross-selling opportunities, especially with high demand for integrating services for hospital and emergency departments. There is little to suggest that the volume trends helped by ACA for the last many quarters may abate anytime soon. The launch of new solutions, helped by IPC's offerings in post acute, may also push the growth rate of the combined business.

The fear about liquidity seems exaggerated

Source: Team Health Holdings

No doubt, the leverage, post IPC deal, will increase and the company might be tied up for a while to pursue another major deal of the similar size, but liquidity should be fine.

Recurring revenue base. Image source: TMH presentation

With long-term contracts and a significant recurring revenue base, the risk profile is much different from other businesses.

2012

2013

2014

YTD 2015

Book value/ share

$1.8

$3.8

$5.9

$7.7

Tangible book/ share

$(5.1)

$(4.7)

$(8.9)

$(7.6)

LT debt/ share

$7.3

$6.8

$8.0

$7.5

Interest

$16

$15

$15

$14

Adj. EBITDA/ Interest

13

17

22

21

Secondly, the company has a decent track record of creating value for the shareholders, while consistently growing cash flows.

Fiscal Yr. (All $M, except per share)

2012

2013

2014

YTD 2015

Cash flow operations

$72

$154

$199

$132

Capital expenditure + Acquisitions

$190

$181

$581

$147

Free cash flow (Including acquisitions)

$(118)

$(26)

$(382)

$(15)

Adjusted EBITDA

$218

$251

$325

$290

Growth

16%

15%

29%

17%

Adj. EBITDA/ Share

$3.20

$3.56

$4.51

$3.93

There is decent room for improvement on the margins front, especially relative to peers in the space, even though differentiation in service offerings may continue to have a bearing.

Adj. EBITDA margins

Latest Operating Margins (GAAP)

Stock Performance (6M)

MD

23%

21%

-14%

TMH

14%

6%

-37%

EVHC

10%

7%

-42%

Looking at the earnings sensitivity, an improvement should reflect well in the stock price too.

Earnings sensitivity analysis (Approx.)

Change of

Metric

EPS Change *

1%

Revenue

2-4 cents

1%

Operating Margin

30-35 cents

* Keeping everything else steady as % of revenue.

* Author's calculation. Only for academic purpose, actuals may vary significantly.

Note: Detailed proprietary model is not attached in this note for the sake of easy readability, but happy to help and provide more details to readers interested in understanding the calculations used in this note.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.