Quick Pitch: Enhabit (EHAB)

Activist Campaign/Potential Company Sale – Upside TBD

 

This is an interesting setup where an activist campaign might eventually result in a company sale. Enhabit provides home health and hospice services in the US, generating most of its revenues through Medicare. The company was spun-off from EHC one year ago with the share price down 43% since then. Last week, activist shareholder Arex Capital Management (owns 4.5% stake) issued a letter to EHAB’s board pushing the company to start a strategic review and initiate a sale process. The activist contends that Enhabit is an attractive acquisition target due to its substantial undervaluation when compared to recent industry transactions. Moreover, the company will soon be left as the only publicly listed home health service provider amidst a consolidating industry. The activist sees potential 3x return based on recent peer acquisition multiples:

We believe Enhabit’s Board should immediately commit to shareholders that it will commence a review of strategic alternatives before the end of 2023, with an eye towards a potential transaction closing shortly after the two-year anniversary of the spin-off to avoid any tax complications.
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At the same time, the secular trend towards value-based care has substantially increased the strategic value of home health businesses, as evidenced by Humana’s acquisition of Kindred at Home, UnitedHealth’s acquisition of LHC Group, and most recently by Option Care Health’s announced acquisition of Amedisys, which was followed by an even higher bid from UnitedHealth. In fact, once the Amedisys deal closes (with whichever suitor is victorious), Enhabit will be the last remaining publicly traded company focused primarily on home health, and our diligence suggests that there are many market participants who would logically have interest in acquiring Enhabit.
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The recent M&A activity among Enhabit’s peers illustrates the enormous potential returns to shareholders if Enhabit were to pursue a sale. Just over a year ago, in March 2022, UnitedHealth paid ~21x NTM EBITDA for LHC Group. And over the past two months, both Option Care Health (in stock) and UnitedHealth (in cash) have offered to buy Amedisys for ~15x NTM EBITDA. Applying those multiples to consensus NTM EBITDA forecasts for Enhabit yields a potential sale price range of $30-40 per share, more than triple Enhabit’s current share price at the high end of the range.

The letter also had a few interesting remarks such as that prior to Enhabit’s spin-off EHC had reportedly received and rejected bids “dramatically above the Company’s current valuation”. One of the bids apparently was from the former EHC CEO herself at $60/share (vs $12/share current price):

Moreover, court filings have revealed that former CEO April Anthony offered to acquire a majority of the Company at an enterprise value of $3.6 billion in early January 2021 (prior to Enhabit’s spin-off), a valuation that would imply a share price for Enhabit of approximately $60. While there are various factors that could make an acquisition multiple for Enhabit higher or lower than any specific precedent, we believe that the likely involvement of numerous large, well-capitalized potential buyers would cause a sale process to be vigorous and competitive.

Note: I haven’t been able to confirm whether this reported bid from the CEO really happened or not – while some media sources confirm the activist’s remark, this source outlines that the judge (in the litigation between EHC and the ex-CEO) eventually found out that no such bid had actually been made and the CEO had declined to participate in the sale process.

A nice positive here is that management seems willing to engage and is currently reviewing two activist’s nominees to the company’s board. Arex Capital is a long-only fund, which is run by former execs of high profile activist firms Greenlight Capital and JANA Partners. The fund is quite concentrated with only 15 portfolio investments as of the latest 13F. EHAB is the 4th largest position for Arex – around 6.7% of the portfolio. The fund has had some activist success already, although the track record is still pretty limited – in 2019/2020 it successfully pushed the sale of ZAGG (the case was also covered on SSI here).

The activist’s commentary on EHAB’s undervaluation checks out – the company trades at 8.2x NTM adj. EBITDA vs LHC Group’s sale at 21x NTM adj. EBITDA last year and offer for AMED coming at 15x NTM adj. EBITDA this year. What the activist did not mention, is that the largest peer and the largest home health and hospice provider in US – Kindred At Home – was acquired by Humana in 2021 at a lower multiple of 11x-12.5x EBITDA. However, Kindred’s sale was based on a built-in put option price that was agreed when Humana acquired its initial stake in the home health service provider back in 2018. Hence, certain analysts have argued that Kindred’s full company sale in 2021 was a “relative steal” for Humana, implying that the normalized multiple would’ve been higher otherwise. EHAB does seem very comparable to these peers. Together with EHAB, these are the 4 largest home health service providers in the US, all of which have minimal diversification aside from the home health and hospice and operate at similar margins. 

Therefore, I am quite puzzled by the size of the discount the market is putting on EHAB. Part of the discount might be explained by the fact that peers are significantly larger, have the revenue balance slightly more tilted towards the hospice services (which is considered a less risky business from regulatory standpoint), and have lower revenue concentration (particularly on the Medicare). EHAB is also significantly more levered with net debt/adj. EBITDA at 4x vs 1.5x for AMED and 2.5x for LHC Group at the time of the sale. EHAB is also still a relatively fresh spin-off that has been orphaned by investors due significant debt injection at the time of the spin. However, even with all of these drawbacks, the valuation multiple difference compared to peers still looks too wide. Even a significantly lower 11x multiple would still result in 50% upside from current prices. 

Another risk here is management’s willingness to sell as they own little amount of shares and are very well compensated. Nevertheless, the involvement of a reputable activist and the fact that EHAB’s board already agreed to review two nominees from Arex suggests that the board could be willing to entertain a sale scenario.

7 Comments

7 thoughts on “Quick Pitch: Enhabit (EHAB)”

  1. Pitch on EHAB was recently posted on VIC. The gist of the thesis is the same – EHAB trades materially below industry transactions, the company is the only remaining public peer and it could be acquired in mid-2024.

    A number of additional points from the VIC pitch:
    – “Better labor and improved contracts should alleviate the two largest headwinds that have been facing EHAB and allow the natural growth of the business to resume.”
    – “EHAB is currently burdened with $15mln of public company costs on an EBITDA base of $130-140mln. Simply taking the company private would yield a nice uplift to a buyer.”
    – “Expectations are also low, with current sell side estimates at the low end of management $125-140mln guidance for 2023. This is logical given the company’s limited track record as a public company and recent earnings headwinds.”
    – “Base case relies on a 12.5x EBITDA multiple, as we think this would trade with some discount to the AMED deal given its smaller size.” Base case is $23.8/share or 94% upside from current prices.

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    • Any update after the big share drop today? I see there was a covenant waiver on its revolver as well as reduction in the revolver allowed.

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  2. At this point does this seem like a deal-breaker or chance to back up the truck?

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    • It’s an interesting situation, but quite a tricky one, so for now I simply continue to watch from the sidelines. The implied 5.25x net leverage covenant breach means that Q3 results will be bad. By my calculations, Q3 adj. EBITDA will likely be around $21m or even lower considering the debt should’ve come down a bit in Q3 due to FCF generation. This sets the stage for another material guidance cut next month as with the current visibility into 9M earnings of this year, there’s no way the company will be able to reach the previous adj. EBITDA guidance of $100m-$107m. To remind, the initial 2023 guidance, as indicated in the quick pitch above, was $125m-$140m. The headwinds are mostly driven by the Medicare revenue erosion due to the accelerated switch to Medicare Advantage and increase in costs. It’s not clear when the situation will stabilize. Management is of course implying it will happen soon saying that the company has now reached the same medicare % of revenue mix level as its largest peers. Management argues that the peers had the same erosion, but it was prolonged over the last 6-8 years, whereas for EHAB it happened to the same extent in just 18-24 months. I’m not an expert on the healthcare space and medicare dynamics, but this reasoning seems a bit questionable.

      The current covenant breach issue is unlikely to improve soon, and may even worsen as the net leverage ratio threshold falls to 5x in March 2024 and 4.75x in June 2024. Management doesn’t have much wiggle room to get out of the situation. It is difficult to believe that shareholders would not vote to oust management at the next AGM if the current strategic review results in a highly dilutive equity raise. Therefore, it seems the most likely options are a full or partial company sale (e.g. the hospice segment).

      A full company sale could potentially result in a favorable outcome from the current price levels. Pointing towards a specific full sale price is a bit difficult as in the current context EHAB would be selling from a position of weakness. Nonetheless, EHAB is the last publicly listed home health service provider amidst a consolidating industry. A strategic buyers will be looking long-term and will also have the benefit of stripping out EHAB’s elevated cost structure. Conservatively taking the current adjusted EBITDA run-rate of $90m and adding back $15m public company costs, I get adj. EBITDA of $105m (in line with the current guidance). At 11x multiple this would result in a sale price of $12.5/share (45% upside) and at 10x multiple EHAB would be worth $10.4/share (21% upside). Sensitivity to the applied multiple is high due to the massive leverage.

      However, as pointed out by the activist, EHAB’s management previously refused to sell at much higher prices and is also very well compensated. There is definitely a risk they might sell only a part of the company and continue operating the home health business hoping for a long term recovery through growing Medicare Advantage revenue base.

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  3. Management on earnings call: “we are in the later stages of our strategic alternatives”

    Pretty good chance of buyout announcement & timeline by June with price being around 14-16

    Seems like business is also inflecting so downside seems protected.

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