ByStewart Flink:
University General Health System, Inc. (UGHS.OB)
October 2012
1.
Business Summary
University General Health System, Inc. (
www.ughs.net
) is a Houston- based public company (
UGHS
). It is a regional, integrated, multi-specialty health care
provider in the acute care space, which currently offers
physician-centric and patient-oriented services in the state of
Texas. UGHS is in the process of 'breaking out' with respect
torevenue and net income, asit is a very different animal from both
the non-profit competitors (which make up over 85% of the industry)
as well as the
for
profit competition. Management has described UGHS as a "healthcare
ecosystem" with diversified revenue sources among a broad platform,
including concierge services. There are currently 650+ employees
and some 550 doctors in the system.
The company operates through three overall segments:
· The
Hospital
segment offers various medical and surgical services; inpatient,
outpatient, and ancillary services comprising inpatient surgery,
outpatient surgery, heart catheterization procedures, physical
therapy, diagnostic imaging, and respiratory therapy; and 24-7
emergency services and inpatient services that include critical
care and cardiovascular services. It also operates diagnostic
imaging, physical therapy, and sleep clinics. This segment is
approximately 85% of the total revenue and the bulk of the
profitability in 2012.
· The
Senior Living
segment operates senior living communities offering housing and
24-hour assistance with activities of daily life to mid-acuity
frail and elderly residents; and offers memory care services
primarily for residents with Alzheimer's disease and progressive
dementia. This is about 10% of total historical revenue and margins
are low, but it is a referral source to other areas.
· The
Support Services
segment provides billing, coding, and other revenue cycling
management services; and interrelated services, including food,
hospitality, and facility services for businesses and healthcare
facilities. This segment contributes about 5% toward totalrevenue,
and is growing.
After recent analysis of Q2 and management guidance for 2012, I
am convinced this company is
undervalued
based on its competitive advantage within the industry, its
strategic plan for increasing top-lin e growth (which involves
organic growth, accretive acquisitions, and new construction) and,
most important, its proven model of rising cash flow and
profitability. It is important to realize that for the last three
years, UGHS was a turnaround- a distressed company burdened with
debt and struggling to survive. Today, it is a thriving business
with significant free cash flow, a balance sheet that is improving
every quarter, and enterprise with a deep management team poised
for growth.
Management has publicly stated that it expects to earn
$25 million in net income in 2012
, and by backing into a few numbers, I estimate that
EBITDA
for the year comes in at least
$40 million
. It has restructured its debt (please see press release issued
October 2nd), which combined with current cash flow, gives UGHS the
flexibility to continue on its acquisition strategy for the
remainder of 2012 and beyond.
The compelling part of the story is what could happen in
2013-2014, as this appears to be a repeatable business model that
can be advanced into other cities in Texas and nationwide.
Management suggested in a press release last year that they intend
to expand in dozens of large, urban markets in the future, so the
growth from a regional to a national company is an inherent part of
management's vision. Due to all these factors and more, I believe
the stock is undervalued at current levels.
2.
General Industry Description: The competitive advantages
of UGHS
The industry is both complex and highly regulated, with three
major entities:
1) Physicians (represented by AMA)
2) Hospitals focused on acute care (represented by the American
Hospital Association)
3) Insurance companies (including Medicare and Medicaid)
There is immense pressure to reduce costs and increase quality.
Most ofUGHS's competitors are non-profit, so many of them are not
"motivated" the same way as UGHS. As mentioned previously,
approximately 88% of all competitors are non-profit models, and
have fewer incentives to focus on reducing expenses and profitable
expansion. The focal point here is that this is a companythat is
owned by the shareholders, and management owns a significant
percentage of the company. Because UGHS is focused on smaller
facilities (50-100 beds) as opposed to 500-1000 beds, it has a more
efficient model with higher quality of care for less cost. Add in
the concept of physician-owned hospitals with entrepreneurial
doctors that have incentives to compete with better care and higher
profitability, and you get a clearer picture of how and why UGHS
excels. Keep in mind that many for-profit facilities are owned by
investors as well as physicians.
Although it should be noted that very few competitors embrace
the UGHS model,it is succeeding despite mega competition in its own
backyard. The Texas Medical Center in Houston has more beds per
capita than anywhere in the world with 32 million square feet (and
adding 1 million square feet per year). Imagine the possibilities
in markets where there is little or no competition ifit is very
profitable in a competitive market like Houston. It should be noted
that there are competitors who are diversified like UGHS: Mayo
Clinic, Cleveland Clinic and Kaiser Permanente, to name a few.
However, there is ample room for growth in many areas, even in
cities where these competitors already have a presence.
3.
Business Model
Clearly, as an entrepreneurial, private acute care business,
management is both driven and has the right incentives to keep a
watchful eye on the expense side while maximizing profitability.
One of the keys to the kingdom for UGHS is its business model
vis-à-vis accretive acquisitions. When UGHS acquires a
free-standing, ancillary department that is now under the umbrella
of a hospital outpatient facility, there is a step-up inrevenue
which goes straight to the bottom line. 3rd party payers have been
reducing reimbursements to non-hospital owned facilities, whereas
when the acquired facility comes under the UGHS license, they
become integrated into their system, and 3rd party reimbursements
may actually increase. In addition, they now operate under an acute
care facility where they can get referrals from their existing
network as well as the acquired network. Two things are accretive:
the hospital gets more revenue and UGHS picks up physicians who
owned the diagnostic center, and subsequently these physicians
become a referral source to the hospital.
Let's examine a hypothetical case. Assume the company makes an
acquisition of a free-standing diagnostic center in a strip mall.
The entity has current revenue $10 million, the current profit is
$2.5 million, and therefore there is $7.5 million of expenses.
Embedded in the model is a profit allocation between physicians and
the new owners. Assuming the acquisition has no organic growth in
the first year, revenue could double to $20 million in Year 1. Why?
As UGHS 'bestows' its license on the acquired facility, it becomes
hospital outpatient department, which means it has upgraded the
services and care and can charge $750 or higher for an MRI vs. $500
that it charged before. While insurance companies have reduced
reimbursements to independent medical facilities, they continue
stable and higher reimbursement rates for patients in licensed
medical care facilities.
The bottom line is that costs haven't changed, and it becomes a
classic WIN-WIN-WIN scenario. The doctors win because they get an
increase in pay based on higherrevenue, UGHS wins with higher
profits, and the shareholders win due to higher cash flow and net
income (with little or no dilution). While I have no idea what the
profit-sharing percentage is, the acquisition will have a
meaningful impact on both the top and bottom line for UGHS. I
should add that this does not even account for economies of scale
in terms of eliminating duplicative costs of accounting, legal,
billing and reimbursement, and even software integration.
With respect to acquisition structure and terms, it gets even
more interesting. Given the size and profitability of UGHS, I
imagine that in most situations, a relative small percentage in
cash serves as the down payment, and there could be seller
financing involved. Assuming no equity is used in the acquisition,
there is little or no dilution- UGHS can make larger acquisitions,
using the enhanced profitability of the new company to pay for part
of the acquisition. In terms of price, UGHS will pay the seller a
certain multiple of EBITDA, and let's assume it is 2-4 times. If
the public company has average multiple of 6-7 times EBITDA, UGHS
wins again with multiple expansion from private to public.
The company has other ways to expand. UGHS has announced that it
will build as many as four hospitals in the Houston area, and
management has suggested in certain cases, particularly where there
is little or no competition, it is cheaper to build than to
acquire. In a town that has 80,000-100,000 people with the closest
ER an hour away, they can capture a huge share of the market and
add doctors to their network. Again, these may be 50-75 bed
facilities, and competitors typically build much larger facilities,
leaving the question how profitable large hospitals can be. UGHS
has a niche that is proven, and will stay focused on its business
model.
4.
Financials- Balance Sheet and Income Statement
It appears the company has finally turned the corner in terms of
its balance sheet. The debt, which was put in place 4-6 years ago
and somewhat of an impediment to growth, was restructured
(announced publicly on October 2nd). MidCap Financial provided an
asset based lending structure (i.e., accounts receivable) in the
form of a $19 million financing agreement. From this new facility,
UGHS repaid outstanding debt to Amegy Bank, its past IRS
obligations, and others. It has drawn on $12.3 million of the $15
million outstanding (which can expand to $25 million based on
certain covenants). In addition, there is a $4 million term note
with 1.5 years remaining, which is being paid monthly out of cash
flow. In the press release, the company stated that they "estimate
that the cumulative impact of the MidCap and Amegy Bank agreements
will result in an improvement in working capital of approximately
$15 million over a three-year period, along with interest and other
expense savings of approximately
$3.1 million in the first year and approximately $0.8 in
annual savings thereafter.
In addition, the Company's balance sheet will reflect an
improvement in its current ratio from 0.32 to 0.68 as a result of
the transactions and agreements." There are also mortgages
outstanding (June 30th balance sheet) on certain facilities as
well. The good news is that the average interest rate is in the
6-7% range, and I believe with larger credit facility, those rates
come down.
On August 17th, the company reported $5.1 million of net income
last quarter
. Net patient revenue increased 48% to $26.5 million vs. $17.9
million in the same quarter for 2011. Average daily inpatient
census increased over 12% vs. prior year levels. Senior living
revenue was $2.3 million, including support services. Overall
occupancy rates were 93% in Q2. Totalrevenue rose 63% to $29.1
million. Net patient revenue from commercial and managed care
providers was 66.6% and 32.9% from Medicare and Medicaid. Self-pay
revenue increased to 11% from 5.3% in the June quarter of 2011.
Total equity improved to $14.1 million from a negative
shareholders' equity of -$0.6 million at the end of December 2011.
The company had $127 million in assets on 6/30.
However, the real story is in Q3 and beyond. Management has
publicly indicated $25 million of net income for the year on
revenue of approximately $120 million, which puts them at a minimum
earnings run rate of $2 million per month. EBITDA should exceed $40
million for 2012, and there are about 326 million shares
outstanding fully diluted (
management and affiliates own 40%).
With a stock price at $0.40 (the bid price), it puts the market cap
at $130 million.
While UGHS is a smaller company, the comps with other public
companies paint a picture that is yet another signal that company
is undervalued. Typical multiples for the industry are 15-17x
earnings and 6-7X EBITDA. The average EBITDA margin is 8.5%,
whereas UGHS has an EBITDA margin of 32-40%, which will expand in
the next 3-6 months. The industry average for ROA is 4%, and given
the projections for the next two quarters, the ROA for UGHS could
approach 15-18% range. The one area where UGHS looks risky is the
debt/equity ratio- the industry average is about 60%. Excluding
capitalized leases (buildings and facilities), the debt/equity
ratio is about 3. However, given the earnings projections for just
the next two quarters, I expect this number to drop below 1.4 by
year end. Looking out to the 2nd half of 2013, my hunch is that the
ratio will be in line with the industry.
In 2013 it is anyone's guess, but given the company's stated
intention of acquisitions as well as new construction, I can
imagine a scenario where the company is doing north of
$250 million revenue
run rate prior to year-end 2013. Assuming net margins remain at
20%
, UGHS has the potential to be at a
$50 million net income run rate
within 12 months, which would make the company severely undervalued
today. Based on current margins and the accretive nature of
acquisitions, there is a scenario where the stock could be at $1.25
or higher in a year's time. This would be a multiple of 8x
earnings, or about half the industry standard, with significantly
higher margins and growth rates.
As the company acquires additional facilities, it will be
interesting to see if they use cash or stock. My sense is that they
will use cash as a sign that the stock is undervalued and
stock-based acquisitions will be too dilutive. Given the current
cash flow and additional lines of credit, it would appear that UGHS
will go the cash route for the foreseeable future so as not to
dilute themselves and other shareholders.
5.
Management Team
Dr. Hassan Chahadeh, CEO & Chairman of Board
Dr. Chahadeh received his medical degree at Damascus University
in Syria. He studied general surgery and anesthesiology at Baylor
College of Medicine in Houston. In addition to the general
residencies, Dr. Chahadeh also achieved certifications in advanced
microsurgery and cardiovascular anesthesia. Upon completion of his
residencies, he pursued a fellowship in Pain Management at the
University of Texas MD Anderson Cancer Center in Houston. He is
Board Certified in Anesthesiology, General Surgery, Advanced
Microsurgery and Cardiovascular Anesthesiology. As an experienced
businessman, Dr. Chahadeh has a diverse background in the
development and management of healthcare entities including
ambulatory surgery, imaging and wound care centers and their
associated real estate ventures. As Managing General Partner &
Founder of University General Hospital, he has been intimately
involved in the initial design, development and operational
restructuring of the hospital.
Donald Sapaugh, President & Director
Mr. Sapaugh has in excess of 30 years of healthcare experience,
and recently was the Founder, President and Chief Executive Officer
of TrinityCare Senior Living, established in January 2000. Prior to
TrinityCare, Mr. Sapaugh, from 1978 until 1986 served in various
financial management positions and as a Chief Financial Officer in
five different general acute care and psychiatric hospitals. Mr.
Sapaugh has an extensive background in development, acquisitions,
and mergers. He also has public company experience where he served
as Chairman and Chief Executive Officer, as well as a board member
to many public companies. He has a degree from University of
Houston in Accounting and Management.
Michael Griffin, CFO
Mr. Griffin arrived at the company in August of 2009, and he has
more than twenty-five years of experience in the healthcare
industry. Griffin brings a diverse background in healthcare
finance, capital markets, operations and development. His
experience as auditor with Peat Marwick to CFO for Multiple
Hospital Systems has provided him with a unique understanding of
the healthcare industry. In addition as chief financial officer for
Simmons Healthcare, his role led him to such places as Australia to
oversee development of medical facilities. Mike is responsible for
Financial Reporting, Capital Financing, Budgeting, Patient Revenue
Cycle & Billing, Facility Construction and Development &
Forecasting for New Ancillary Services.
Ed Laborde, Secretary/Treasurer & Director
Mr. Laborde is a corporate, securities and finance attorney with
experience in a range of industries, including the development of
health care facilities. He joined UGHS in January 2011 after 18
years of private practice in Houston-based law firms. From 2004 to
2011, Mr. Laborde was a Shareholder in the Corporate Securities and
Finance Practice Group of the Houston office of Winstead PC. From
1993 to 2004, he was a lawyer in the Corporate Securities Practice
Group of Houston based Chamberlain Hrdlicka. Mr. Laborde received
his law degree from Tulane Law School and his undergraduate degree
from Georgetown University.
This is a deep, experienced management team that can take UGHS
to north of $500 million inrevenue, and they are motivated to do
just that-approximately 40% of the shares outstanding are held by
management or affiliates.
6.
Risks
a) Potential Overhang: It should be noted that the company did a
private placement in April of 2012. The company raised $3.4 million
in the form of a convertible preferred, convertible at $0.22 with
warrants at a strike price of $0.26. In addition, $5 million was
raised in the form of common stock with no warrants at $0.14. While
this represents a significant amount of potential overhang on the
market (more than 20% of the shares outstanding), my sense is that
most of the money was raised from long-term investors. In addition,
UGHS purchased a revenue cycle management company for 9 million
shares, a hospitality service provider and facilities management
company for 5 million shares. Both of these acquisitions for stock
are future overhang on the company's shares.
b) Execution Risk: Management may be unable to execute on its
acquisition strategy, which is a key component of its future growth
and profitability. In addition, expanding into other markets and
regions besides Houston may prove to be less profitable, although
given the current competitive landscape, it appears this risk is
less likely to occur.
c) Macro Health Care Policy Change: Industry risk is always a
possibility, but UGHS is has diversified its revenue stream, and is
on a path to grow from a regional to a national acute care
provider.
d) Going Concern: UGHS was issued a going concern letter at the
end of Q2 from its auditors. However, this is akin to looking in
the rear view mirror, and given guidance for the year and the debt
restructuring that took place, this should be a non-event going
forward.
e) Shares Outstanding: Given the amount of shares outstanding,
there exists the potential for a reverse stock split in the future.
In addition, an additional equity raise cannot be dismissed, as
there is $25 million of principal payment obligations from notes
outstanding due in 2013. Both of these potential events could have
material adverse effects on the stock price if not done
properly.
f) Obamacare/post-election issues: There are certainly sweeping
changes coming in 2014 (if not before), yet the company believes it
can thrive in any environment, and is prepared for a variety of
outcomes, including the elections next month.
Conclusion
The model, which is both diversified and vertically integrated,
includes operating efficiencies as well as acquisitions of acute
care "host" hospitals and the development of "regional" health
networks in a defined radius, but with an experienced management
team, that can expand to other cities and regions. UGHS has
competitive advantages:
· It is physician-ow ned, and therefore exempt under whole
hospital exemption via Stark law (grandfathered in prior to
12/31/10)
· General acute care model is more resistant to healthcare
reform. Medicare
increased
reimbursement for
General Acute Care
Hospitals by
2.1%,
while
reducing
reimbursement to Skilled Nursing Facilities by
3.3%.
· UGHS has a diversified revenue stream with high margins, and
has the ability to continue on its growth trajectory
· Stronger balance sheet and profitability in terms of EBITDA,
net income and asset growth with positive net equity. The company
has the ability to both pay down debt and make acquisitions out of
existing excess cash flow.
·Five main areas of acquisition focus: acute care hospitals
(already own a main hospital system with 72 beds); ambulatory
surgical centers; physical therapy; imaging diagnostic treatment
facilities, and senior living.
·
Strong, experienced management team, including history of
operating or working with both private and public companies, making
acquisitions, and managing software and billing systems as it
pertains to expansion.
·
Stock is trading at $130 million market cap. Based on
management guidance, UGHS is trading at approximately 5.5x
2012 earnings
,
3x
2012 EBITDA and 1x revenue for this fiscal year. The company is
undervalued relative to its peer group based on almost every
metric.
Disclosure:
I am long [[UGHS.OB]]. I wrote this article myself, and it
expresses my own opinions. I am not receiving compensation for it.
I have no business relationship with any company whose stock is
mentioned in this article.
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