Wolfe Research's Healthcare Services Analyst, Justin Lake, hosted a webcast with Accounting & Tax Policy Analyst Chris Senyek to explore the potential effects of tax reform on MCOs and providers in the new year.
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We are updating our estimates to reflect 3Q17 results / revised guidance and our updated view of non-recurring items flowing through #s in 2018 and beyond. Our 2018/2019 EBITDA decreases by 4.0/4.8% respectively, primarily driven by more conservative organic growth assumptions across THC’s businesses given the challenging utilization backdrop. We are also rolling our PT to YE18 from YE 17. Our PT increases to $16 from $14.50, which represents 7.4x our revised 2019 EBITDA-NCI estimate of $2,530M.
Our revised model assumes sale at end of 3Q18 (our assumption is 6-9 month review w/ a second request from FTC) with $4.9B of proceeds split between debt repay ($1.05B), M&A ($500M not in model, held as cash) and share repo ($3.35B). Given DVA indicates it will take 1-2 years post deal to full deploy $ via share repo (we assume 6 quarters) we believe it is appropriate to look at 2020 cash EPS to measure accretion which we est. at ~6% vs. our prior #s. While full accretion will take time, our PT of $78 and Outperform rating remain unchanged as we value cash on the balance sheet via EV/EBITDA-NCI (target assumes 8.5x 2019 EBITDA-NCI). Notably our target multiple on both cash EPS and EV/EBITDA-NCI assume nothing for tax reform or the potential for DVA to trade closer to historical valuation given simplification of business post sale.
This morning (12/6/17), Optum announced that it has agreed to acquire DaVita’s Medical Group for approximately $4.9B in cash with the deal expected to close in 2018. Based on our 2019 EBITDA estimate of ~$425 for DMG, the sale price represents an ~11.5x EBITDA multiple off of 2019 #s. We note that this is towards the high end of the 10-12x range we previously expected and well beyond the $4B we had previously discussed (link below) but given the scarcity of large, sophisticated physician groups and several interested buyers (Optum/HUM/private equity) we are not shocked by the sale price. With DVA talking about major share repurchase post close (in addition to debt paydown and general corporate use) w/proceeds we expect the news to be well received and for DVA shares to be up meaningfully today. Looking ahead we expect focus on FTC review (Optum has overlap in Las Vegas) and timing to close (DVA expects close in 2018), refined focus on core dialysis business and potential for tax reform where we believe DVA gets significant benefit is among the most likely in our coverage universe to retain it – reiterate Outperform rating and raise our price target from $73 to $78.
This morning (11/29/17) CMS released its fourth weekly exchange snapshot for the 2018 Open Enrollment Period (OEP) for states using the Healthcare.gov platform. Total plan selections from 11/1/17-11/25/17 are 2.8M, consisting of 2.1M renewals and 718k new customers. While new selections per day slowed this week (~22k per day vs trend of ~32k per day through the first 3 weeks), this enrollment snapshot covers the Thanksgiving holiday, which typically negatively impacts signups. As discussed below, we think it is important to analyze new selections (1/3 of selections last year) separately from renewals (2/3 of selections) because members who don’t renew or terminate their coverage will be automatically reenrolled later in the open enrollment period. Given that dynamic renewals are likely to provide some level of stability to the selection pool- last year, new plan selections were down ~25% y/y but total selections only decreased ~5%. Net, we expect exchange enrollment will likely finish down again this year which is not a surprise given the marketing pullback by HHS and significant price increases felt by unsubsidized membership. As a reminder, it’s fairly difficult to make comparisons to previous open enrollment periods given that this year’s enrollment period will end on 12/15 vs 1/31 in prior years.
We don’t think this changes outlook for sale of broader business. Our discussions with the company indicate the deal is “very small”, we would guess in the $50m range and most importantly that the acquisition of this IPA “enhances the value of the asset”. Here our view is that the asset (previously acquired Everett Health Clinic group) will be enhanced either for DVA or any eventual buyer (more likely). The company continues to look at strategic options and we believe there is a solid list of potential buyers for large capitated physician groups including but not limited to Optum, HUM and private equity. Please see our slide deck and webcast on the topic from Monday for more on our thoughts around potential proceeds (we est. $4B) and value creation options for DVA should they indeed sell the DMG business.
Wolfe Research's Healthcare Services analyst, Justin Lake, hosted a webcast to examine the potential sale of DMG and what that would mean going forwards.
We recently hosted investor meetings with UHS CFO Steve Filton. The meetings focused on the trajectory of Behavioral results, reactions to recent BuzzFeed articles/videos, thoughts on timing/magnitude of DOJ investigation, continued ability to drive above-market Acute Care results and the outlook for capital deployment / leverage heading into 2018. We are tweaking our Psych segment EBITDA estimates down by $7.5m or about ~0.65% to reflect our updated view of non-recurring items flowing through #s as well as the relationship between same-store rev/EBITDA growth. While acknowledging that visibility into the trajectory remains low we continue to see an attractive risk/reward at current valuations (12.5x PE / 7.7x EV/EBITDA less NCI / 7.0%+ FCF yield off 2018 #s) and reiterate our Outperform rating.
This morning (11/9/2017) CMS released its first enrollment snapshot of the Open Enrollment season for states using the Healthcare.gov platform. Interestingly, CMS will now report enrollment on a weekly basis vs biweekly basis in previous years. As a result, this year’s initial enrollment snapshot covers only 4 days vs 12 days last year. Recall, open enrollment for the 2018 plan year was shortened to 6 weeks vs 12 weeks in previous years, which makes it particularly hard to draw meaningful y/y comparisons. Earlier this year, President Trump cut the ACA advertising budget from $100m to $10m and additional outreach funding from $63m to $37m, which coupled with concerns around enforcement of the individual mandate, caused some to fear that enrollment would be down sharply. However, absolute numbers have started out strong, which is certainly an encouraging sign for insurers remaining in the individual market (ANTM, CI, CNC, MOH).
Cash EPS was $0.97 vs. WR/Consensus of $1.09/$1.08 with downside driven completely by DMG miss. Kidney Care results were in line with our model despite a ~$14M Hurricane headwind but DMG results were $44M below, with mgmt citing a ~$30M headwind from higher than expected patient acuity/costs and a ~$13M headwind from delay in finalizing PY Med Adv payments. The DMG results would be disappointing in any context but particularly so given CEO Kent Thiry’s 9/7/17 commentary at a competitor conference that DMG had “very nice” operating momentum across the board. The glass half full view here as noted in our recent upgrade is that it is possible for investors to win despite DMG futility should co. pursue a sale, and to that end CEO Thiry noted in prepared remarks “we are pursuing strategic alternatives for underperforming assets”. See more below on this topic. In addition on Kidney Care the company guided to flat Op Inc at the high end (which the co. has typically delivered) which we note is ~5% core growth ex the $100m retiree cost headwind in 2018 and it is that core growth that we are looking for again in 2019 to be another driver for the stock. All that said Q3 was highly frustrating and we expect the stock to react negatively tomorrow but the risk/reward remains compelling going into 2018 in our view. Forward #s largely intact with YE18 PT remaining $73 and reiterate Outperform rating.
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