On January 5, 2018, I shared with my readers here on SA an article related to Surgery Partners, Inc. (NASDAQ:SGRY). At the time of my article, the stock was trading for around $12.00. The premise for my article hinged on the fact I thought the stock had been oversold based on the third-quarter 2017 quarterly report having disappointed the market. The stock was heavily punished and fell from a previous high of $24.05 to a low of $7.10. Based on this precipitous drop, upon my review and looking at the long-term potential for the stock, it met my criteria of a stock being mispriced due to a binary event that wasn’t such a deleterious event deserving this dumping of the stock by investors. I made my entry purchase in the stock at the average price of $12.10, and I’m highly pleased the stock in the interim has traded as high as $19.95 (5/11/18) for a greatly appreciated 65% increase for my four-month investment.
Background Information
Surgery Partners is a Nashville, Tennessee-based corporation. It is a major player in surgical facilities and ancillary services with more than 180 locations from coast to coast. These types of operations are commonly referred to as Ambulatory Surgical Centers (ASCs).
The Areas the Company Offers Medical Care and Other Historical Data:
- Surgical Facilities
- Anesthesia
- Pharmacy
- Optical Physicians
- Practice Urgent Care
- 5,000 Affiliated Physicians
- 600,000 Patients on an Annual Basis
- 10% Annual Same Facility Growth Over the Last Five Years
- 94% Patient Satisfaction Rating
Operational History for Surgery Partners
2004 – The company was founded with an operating philosophy built around a physician-centric approach.
2011 – The company expanded its area of involvement in the healthcare market by merging with NovaMed. NovaMed’s area of expertise was in ophthalmology and the related ancillary services associated with this major market area.
2014 – Based on ten successful years of operation make Surgery Partners a major expansion by merging with Symbion. The price paid for Symbion was approximately $792 million. In 2013, it had generated around $535 million in revenue. The combining of the two companies created one of the nation’s largest ambulatory surgery centers.
2015 – Surgery Partners made an Initial Public Offering for its stock at the price of $19.00 per share for 14.29 million shares.
2017 – Another major expansion for the company occurred when it announced on May 10th its plans to merge with National Surgical Healthcare where SRGY would acquire it for approximately $760 million. Funding for this deal came from Bain Capital Private Equity, a leading global private investment firm known by the association of Mitt Romney being one of the founders of the firm. The deal provided capital in exchange for Bain securing a preferred security position in the company. As for of the deal, Bain acquired the equity stake H.I.G Capital held in Surgery Partners. Basically, this means Bain holds a majority interest position in Surgery Partners. The combined entity would level Surgery Partners with 125 surgical centers, 58 physician practice locations and associated complementary ancillary services. This further established it as the leading independent surgery company with an emphasis on strong musculoskeletal offerings for its patients. This emphasis also includes treatments options for orthopedics, pain and spine conditions. This now gives Surgery Partners 125 surgical facilities in 32 states, plus a network of over 5,000 physicians.
First-Quarter 2018 Results
On May 8th, 2018, the stock closed at $17.05. The next day it reported its first-quarter results, resulting in the stock falling to $15.40 on heavy volume (630,000). On the surface, and before I had the chance to review the details of the quarterly report, the market reaction once again showed there were some investors over-reacting and punishing, and not taking into consideration my evaluation and overriding merits for ownership. The fact the stock recovered by early afternoon and closed higher for the day reaffirmed my opinion that owning the stock was a prudent investment for my funds. Now eight days later, the stock has moved from $17.05 to the $19.95 level – a near 17% increase in the share price.
|
Surgery Partners, Inc. Data: |
|||
|
$959.9 M |
2015 Annual Revenue |
||
|
$1.145 B |
2016 Annual Revenue |
||
|
$1.341 B |
2017 Annual Revenue |
||
|
$417.4 M |
1stQ-2018 Revenue |
||
|
$1.750B |
2018 Guidance |
||
|
$240M |
EBITDA Projections |
||
The first-quarter revenues were a tad below expectations and represented only 24% of the expected $1.750 Billion projected for the full-year guidance. The full-year guidance will represent a YoY growth of approximately 30.4%. One must keep in mind the merger back in August 2017, where Surgery took out NSH Holdco for $760M, and Bain Capital purchased 26.5M shares of Surgery’s stock. Bain has been proactive in making what I consider are positive changes with a clear goal of having the merged entities hitting on all cylinders by the end of the year.
It should be noted that during the recent first-quarter report, management pointed out it had 11 facilities (mostly in the Northeast) closed due to weather conditions, resulting in a total of 19 days of closures. Also, some of the services it provides are elective services and many potential clients will opt for meeting the deductible before seeking treatments.
Major Changes Since January 1, 2018:
- Wayne DeVeydt was brought on board in January to fill the CEO position. DeVeydt was the CFO at Anthem (NYSE:ANTM) and had been with it for about a decade. Anthem under his tutelage for overseeing the financial numbers had grown into an $82 billion corporation. Previously he had been a partner with Pricewaterhouse. Based on his track record, I think he can accomplish the expected growth we should see with Surgery. This is further supported by the new management team members he has brought on board.
- In February 2018, David Kretschmer was hired as the Executive VP, Chief Strategy and Transformation Officer. He also came from Anthem, where he had been the Chief Strategy Officer and oversaw its $24 billion investment portfolio.
- Dr. Angela Justice joined Surgery in March and serves as its Executive VP Human Resources. Dr. Justice has 15 years of experience in the healthcare industry where she worked most recently for Biogen, Inc. (NASDAQ:BIIB). Having her PhD from the University of Chicago, and what appears to be an extensive background with IT projects, she obviously will help with melding and integrating the massive Hillco merger and future mergers.
- Thomas Cowhey came over from Aetna (NYSE:AET) in April and now serves as the CFO for Surgery.
- The company projects to spend between $80 million and $100 million in 2018 in mergers and acquisitions. It should be noted it closed on a $26M deal in the first quarter, where it purchased an Omaha, Nebraska, operation that specializes in orthopedic spine, podiatry, and pain treatments.
IMO, investors can’t complain about the management leadership having more than a perfunctory understanding of the financial issues where it seeks to grow the 2018 revenues by a tad more than 30%. What is more impressive is the projected growth in the EBITDA number from $164.3 million for 2017 to the projected $240 million for 2018. This would be a 46% YoY growth in EBITDA. But let me interject that I’m not a big fan of using EBITDA as the ultimate method for presenting financial data for a corporation. With that stated, I have comfort with the recent 2017 results and what it is now projecting for the 2018 46% increase. Based on these projections it appears Surgery will have no difficulty covering its debt obligations.
Conclusion
The current price and time frame it has taken to reach this level, I wasn’t expecting it to happen so quickly. Management clearly states that the new procedures and overall corporate strategy aren’t expected to show the major benefit until 2019.
Based on these factors, my position in the stock was based on this horizon. A 60% asset appreciation in a four-month time frame isn’t the norm, but I’m not complaining. The stock traded 1.1 million shares on May 11th, where in recent months the daily volume was in the low-100,000s. This volume and price increase has the potential for having built a nice floor for the stock, assuming there are no surprise negative events in the near term. IMO, the price drop on May 9th was an entry level that we might not see until we see the projected 2019 benefits from the new executive team’s business model.
The key components from the recent quarterly report were these comments made by the CEO:
“We anticipate incremental cost savings and operating synergies during 2018 with more material benefits being realized in 2019 as we implement these efforts across additional facilities. On the procurement front, as previously highlighted, we hired a full-time procurement officer and have begun the process of investing in the purchasing system to improve data analytics. We previously identified approximately 15 million in gross opportunities with more than half accruing to adjusted EBITDA and benefiting Surgery Partners shareholders.
To date, we’ve initiated discussions with our Top 20 suppliers, along with consolidating our 200 plus million spend into a new group purchasing organization contract that will take effect in the third quarter of this year. On our Top 20 non-GPO contracts, we’ve already re-negotiated approximately 15% of the contracts and expect to continue to make positive progress with the remaining vendors as the year progresses. Based on these early results, our confidence in achieving our $15 million gross procurement savings goal is high.”
Surgery Partners has built a model for growth in an industry where the demographics and hospital cost tell us it is in a growth market. What Surgery Partner executives must create is the synergy of blending all the moving parts into a seamless operation where the cost structure will give it the opportunity for profitable growth, resulting in the stock’s appreciation for the shareholders. Read again the previous quotes from the CEO:
“To date, we’ve initiated discussions with our Top 20 suppliers, along with consolidating our 200 plus million spend into a new group purchasing organization contract that will take effect in the third quarter of this year. On our Top 20 non-GPO contracts, we’ve already re-negotiated approximately 15% of the contracts and expect to continue to make positive progress with the remaining vendors as the year progresses. Based on these early results, our confidence in achieving our $15 million gross procurement savings goal is high.”
This last quote and the previous paragraph I cite above are what I want to see from the executive team where my investment is based on its leadership performance. From my personal career in the publishing industry, I can tell you the secret to making a profit is closely tied to controlling your cost structure in delivering your product. In the publishing industry, it might surprise you finding out that publishers don’t own one printing press. The actual printing of the books is contract work provided by a small number of actual printing companies.
My job responsibility required me to spend untold hours in creating an operational budget of revenues and the inventory levels that would relate directly to the planned revenue projections. Considering my area of involvement was in the textbook division and with the publishing a basal reading program you had not only the textbook but you also had a host of related components that needed accurate counts – phonics workbooks, comprehension workbooks, etc. After the reading textbooks, then there were the math and science products I had to go through the same process. If a component had an ISBN attached, you had to plan a revenue budget and a cost budget. The secret to publishing – printing 100,000 of a book gives you a unit cost of say $5.00, however, if you print 500,000, your unit cost could drop to $3.00 for example. The closer you are to your planned budgets, better chances for the profits flowing to the bottom line.
My point is simple – Surgery’s diversity of services requires a closely monitored system for making sure they have the needed inventory, and it being at the center where the product is needed. Once you schedule a surgical procedure, not having the required items on hand results in bad management. Having procedures scheduled and not having the surgical supplies can quickly impact your revenue stream. The need for recycling a patient through the system adds additional cost, where your revenue stream potential remains the same as if you didn’t have to reschedule the patient. IMO, the hiring of a full-time procurement officer is a critical part of their growth in revenues going forward.
In my original article from January 5th, I concluded my comments with the following statement:
Good luck with your future investment decisions! I think Surgery Partner’s has the potential for being my best stock-pick for 2018. Time will tell!”
My belief in Surgery Partners’ stock having the potential for providing me the best returns for my 2018 investments hasn’t changed, other than recent events outlined in this article giving me more confidence for the potential. Does it mean the stock is going to continue with another 60% growth over the remaining months of 2018? Maybe, but not likely! The market is still in my opinion getting into frothy valuations while dark clouds are appearing on the horizon. My near term (second and third results) expectations should fall within the 20-25% appreciation for the stock. This would take us to the recent 52-week high of $24.00.
All bets are off if the current trade issues exacerbate our foreign markets. Keep your eye on the soybean and corn markets – the mid-western farmers are on the verge of having a disaster on their hands with their crops. Keep in mind – corn utilization for ethanol is expected to grow over the next few years by about 30-35%. The current flip-flop with the ZTE fiasco gives one a clear indication our bargaining power is diminished. Playing a game of Bluff Your Trading Partners isn’t a smart move, in my opinion. Especially if you are holding a weak hand! The president’s total flip on the ZTE embargo is a very important reminder. If such events continue, the overall stock market could be impacted in a negative manner. The current run has been impressive, however, the history of the stock market has shown that investors can’t become complacent with their investments.
Good luck with your current and future investment decisions!
Disclosure: I am/we are long SGRY.
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.
Be the first to comment