THE HEDGEYE EDGE
Surgery Partners (SGRY) is a bad house in a great neighborhood. While we like the macro trend of inpatient surgeries moving to low-cost ambulatory surgical centers (ASCs), Surgery Partners is not the horse we want to bet on.
INTERMEDIATE TERM (TREND)
We question how well SGRY is positioned to benefit given current case mix, geographic exposure and limited number of joint ventures with a health system.
Consider the following:
- 38% of SGRY’s case volume is low-margin, government pay business at 38%... this compares to only 19% across the industry.
- Only 13% of surgical case mix is high-margin orthopedic procedures, compared to 31% and 43% for SCAI and USPI, respectively
- There are major competitors within a 20-minute drive of 75% of its facilities.
- Surgery Partners’ facilities are primarily located in secondary markets with just 16% of the company’s facilities located in the top 25 metropolitan statistical areas (despite the top 25 MSAs representing 67% of the U.S. population)… this compares to 27% for USPI/THC
We also believe a significant portion of case volume will be captured initially by ASCs that have a financial relationship with hospitals, making it difficult for SGRY to keep or grow their market share without having to give away additional equity. ASCs account for 54% of outpatient visit volume but only 23% of charges. In other words, a significant amount of volume is done in hospital outpatient departments (HOPD).
The easiest fix for SGRY is to buy high quality facilities and divest low quality ones. However, competition for deals continues to increase, as well as the multiples paid, and SGRY does not have the balance sheet to accelerate the pace of acquisitions after NSH. The company has a risky capital structure for equity investors with debt to equity at 319% and common equity 18% of enterprise value. Given the high debt levels the focus should be on deleveraging, however, doing so will come at the cost of growth and missed estimates.
CMS has expressed an interest in adding Total Knee Arthroplasty (TKA) to ASC covered procedure list, with a proposed change coming as soon as 2019. However, the fundamental impact to SGRY will be limited as only ~20%* of SGRY’s 125 facilities are equipped to do joint replacements, and claims data reveals that none of their facilities in Florida are currently performing partial knee.
BOTTOM LINE
SGRY’s ASC portfolio is low quality compared to peers USPI/THC and SCAI/UNH, and it does not have the balance sheet capacity to make the acquisitions necessary to improve payer and case mix. Meanwhile, we are several years from total joint procedures being a large enough percentage of total ASC case volume to have a meaningful fundamental impact, despite the favorable policy environment.
From a valuation perspective, we question how much common equity value there is given SGRY's indebted capital structure and lack of free cash flow after minority interest obligations. The company is not earning cost of capital, has limited liquidity and looming debt obligations.
We see 50%+ downside from current levels.
ONE-YEAR TRAILING CHART
