Friday, May 10, 2024

Enhabit: Failed Strategic Alternatives Process, Proxy Fight

Enhabit (EHAB) ($413MM market cap) is a July 2022 spinoff of Encompass Health (EHC) that provides home health and hospice care.  Similar to many recent spinoffs, Encompass Health loaded Enhabit up with debt and dividended back the proceeds to themselves, as is also typical recently, Enhabit ran into business headwinds shortly after being spun and the stock price has suffered since.  Activists showed up pretty quickly here demanding a sale as the home health and hospice care industry has been consolidating with Enhabit being one of the few remaining standalone public companies in the sector.  

With tax free spinoffs, there's a two year safe harbor waiting period for the spin to be acquired without risking tax free status.  The risk of voiding the tax free status relates to if the buyer had acquisition discussions regarding the spin prior to the spinoff, if there have been no talks, then there can be M&A within that two year period.  An example I remember off the top of my head was Baxalta (BXLT) that was spun from Baxter International (BAX) back on 7/1/15 and was quickly acquired by Shire (which was later acquired by Takeda) on 1/11/16.  Prior to spinning out Enhabit and considering the consolidating nature of the industry, Encompass likely had discussions with various strategic and other buyers leading up to the spin decision, potentially boxing out the most logical buyers.

With that background, it is unsurprising that alongside earnings this week, Enhabit announced that they were concluding their strategic review without a sale and are going to continue as a standalone company.  The stock dropped roughly 15% and activist investor AREX Capital Management (4.8%) put forth a proxy fight to replace seven board members with their own slate.  I don't know anything about AREX, but EHAB is an outsized position for them and on the surface, their board slate does look highly qualified.

Back to the business, home health and hospice care has some strong tailwinds with an aging population, a push towards cheaper healthcare settings and a highly fragmented market (even the larger players like Enhabit only have single digit market shares) in need of consolidation (clinic/route density is an important driver of operational leverage).  This should be a GDP plus a couple hundred basis point growth business.  The industry is also undergoing a shift from traditional Medicare to Medicare Advantage plans where the patient has more of a financial responsibility and services are discounted/margins are lower.  At the time of the spin, Enhabit had a larger share of traditional Medicare patients than peers and the move to Medicare Advantage or other private plans hurt margins pretty dramatically, causing Enhabit to miss guidance several times and lose credibility with investors.  That mix shift seems to have stabilized with traditional Medicare patients increasing for the first time sequentially in Q1.

With the business somewhat stabilized (although highly levered) and an activist in the mix pushing for both operational improvements and likely a restart of a sale process following 7/1/2024, this could be a compelling opportunity.

The two most recent public transactions have been with Optum/UnitedHealth as the buyer as they look to reduce their costs by bringing home health care in house.  Amedisys has yet to close, the EBITDA multiple was 15.5x when it was announced and has since dropped down to 13.7x with continued EBITDA growth.  Addus HomeCare (ADUS) is a somewhat similar business, they do compete in the home care and hospice spaces but the majority of their business is in what they call personal care, which means someone comes to help with the daily tasks that become more difficult as people age rather than medical services.

I don't like putting 100+% price targets on new positions, but with the combination of financial leverage, some improved operating leverage and the potential for a strategic takeout sometime down the road, EHAB could really be that cheap here.

Disclosure: I own shares of EHAB

5 comments:

  1. How confident are you that a deal didn' come together because of the 2 year tax windown?
    Wouldn't any deal reached now take past the July to close anyway and therefore be clear of jeopardizing the taxfree status? If there was really an active process with a reasonable chance of concluding something it just seems REALLY dumb to wrap it a few months ahead of the 2 year mark only to restart shortly thereafter.

    If indeed there was no deal to be had (in theory EHAB is good target but limited pool of buyers - see VIC comments on this - many of which have their own issues), what is the activist playbook? Is this run so poorly that there is an easy cost cutting program or this run fine but just somewhat subscale and therefore destined to have capped margins (leads us back to M&A..)?

    ReplyDelete
    Replies
    1. I don't think the tax issue was the only reason it failed. I'm not an ex-banker or anything, so I could be ignorant here, but I would think any strategic buyer that was boxed out for tax reasons was probably not involved in the process, thus they'd need to start over when we cross over July? Not just as simple as dragging it along to get to July? I could be wrong about that clearly.

      Playbook wise. I just don't think this company was ready to be public, which is common with spins, people tend to underestimate the work involved in a spin that even on the surface appears to be separately managed inside of a larger organization. Real life isn't as clean as it would appear on a spreadsheet. Activists likely run the same strategy management is employing, maybe with just more pressure added?

      Delete
  2. Pretty decent walkthrough on their version of the strategic review here.

    https://www.sec.gov/Archives/edgar/data/1803737/000180373724000070/a5232024defa14a-solicitati.htm

    ReplyDelete
  3. Thanks @Paddy. I'm not sharp enough on the potential buyer universe to say with real conviction but from the proxy does seem that they engaged most of the potential strategic buyers during their review/sale process. Proxy basically said potential buyers' businesses are facing a lot of challenges such that despite interest and strategic logic there wasn't anyone willing to move forward. Perhaps that's just a matter of timing. But with indications around $11-12 I'm debating whether worth waiting for better conditions enabling buyers to step up. (look at CVS chart....)

    ReplyDelete
    Replies
    1. Yeah, I'd tend to agree. Also given GS were running the process, you would think they were incentivized to get something done. I think I'll keep this on my watchlist for a while & hope people forget about it.

      Delete