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I rarely post, but I’ve been in HLS since 1997 and still hold a fairly sizable position. Like some others I’ve bet my retirement on its success. Yes, I wish I’d sold at $6+ pre-split, as some other savvy investors like “nosleep” did. And, yes, I’m sorry I didn’t sell at $24-25 just a few short weeks ago. But I didn’t. I became complacent. I didn’t pay attention. I assumed I knew the story was intact. I was lazy.
So as the stock price slid past $19 I decided I’d better reassess my reasons for holding. I dug out the 10K and focused in particular on the debt (10k, note 9), as well as the ability to pay it down with the latest “net” figures from the recent asset sales, because paring debt and growing operating earnings is the only salvation for a company in HLS’s position.
What I found is that HLS is currently a strong buy, with at most a 15% downside (from about $17.50-18) but an upside of at least a double within 1.5-2 years (mid FY 2009 selling on projected FY 2010 EPS) and a triple within 3-4, plus great steady growth thereafter. To me, this is a great—and relatively safe—investment.
In order to arrive at this conclusion, you must believe what Grinney has been saying, and by my estimation he has an excellent track record. You can’t—as the shorts have very effectively done—cry bankruptcy (less than 5% chance) and point to the GAAP, SEC-mandated reports such as the 10k, because the expense numbers are contaminated by the legacy costs accruing to the sold assets. (Grinney has said this repeatedly.) No. The 10k is useful ONLY for a discussion of debt. See note 9, page F-35 of 10k.
For the real picture you must go to the slides used in the most recent (May 2007, page 12) presentation at an investor conference. Notice this is well after the Q1 performance was known.
Now I know that some on the board would, given the cover of darkness, put a bullet in Jay Grinney. I think this is misplaced anger. Why? Because if you have listened to what he has said, he has consistently told the unvarnished truth, as unpleasant as that has often been in recent years. For example, I, like many others, was disappointed by the sale price of the ASCs. But no matter what you think of the price, while others were guessing $1.5-2B for the ASCs alone, Grinney was saying publicly that the take from ALL the asset sales would allow HLS to pay down $1.5B over the next year or two. Most recently, he’s claimed HLS will cut their debt in half within 18 months. By my estimation this is very doable. Half of the LONG TERM DEBT is $1.68B (10K LT Debt net of current portion $3.365B).
Some important notes:
- You must accept that Grinney and company know more about the company’s current operations and prospects than anyone else AND that he/they are telling the truth—very likely given HLS’s recent history and Sarbanes Oxley.
- Grinney’s estimates do NOT assume a repeal of the 75% rule
- My estimates assume 4% operating earnings increases; Grinney has predicted 3-4%
- All debt reductions come from the “Senior Secured Credit Facility,” because the “secured” part means secured by assets. To wit, if an asset is disposed of, the proceeds must pay down the SSCF, not the higher interest rate senior notes—unfortunately
- As of Dec. 31, 2006, the interest on the SSCF was 8.6%
- The $1B “Interim Loan,” comprised of floating rate notes and senior notes carries an aggregate interest of approximately 11%. This portion of debt cannot be paid down with asset sales but can be paid down with the proceeds of future equity offerings. Early payoff is EXPENSIVE
- About $18 million of the $335 million in 2006 interest expense is an AMORTIZATION not a cash expense
- The approximately $26 million in payments on the perpetual preferred stock is classified as a dividend and not interest expense, so it must be added into the mix of expenses separate from the interest expense. (I know many of you know this far better than I, but some don’t)
- EBITDA for FY2007 will be approximately 385 M
- According to Yahoo, the industry PE multiple for healthcare is 27.39, admittedly pretty high. I used 26 for my estimates. Yes, these might prove too high; however, I believe going forward healthcare stocks will benefit from a declining stock market because they will be viewed as defensive. Let’s face it, demographics IS destiny: the continued aging of the Baby Boomers will accelerate an increase in the effective market size for virtually ALL medical services companies.
- HealthSouth is a fantastic INVESTMENT opportunity. Not necessarily a great short-term trading opportunity, but a Warren Buffet-type play. I believe this explains the large institutional participation
- HLS should now be trading off its estimated FY 2008 earnings
- Note the value of the NOLs: “These NOL carry-forwards result in a deferred tax asset of approximately $568.9 million at December 31, 2006.” 10k, page F-58
- Interest expense below assumes a $216 million of tax refunds, plus $65 million proceeds from Corp HQ sales, plus an additional $50 million from operational cash, all applied to 8.6% debt (SSCF), IN ADDITION TO THE NET PROCEEDS FROM THE ASSET SALES ALREADY APPLIED
- Given the above, HLS is today ($17.5) selling about 10% below its pro forma 2007 earnings ($0.74 x 26 = $19.25) and should be selling closer to its GAAP estimated earnings for 2008:
- Pro Forma EOY 2007 EBITDA estimate $385
- EOY 2008 EBITDA:
- $400M
- (194) Cash Interest Expense
- (26)PPS Dividend
- (26) Capex
- (18) Amortization of Debt
- (61) Depreciation & Amortization
- The forgoing yields $75 million earnings/80 million shares= $0.94/share x 26 = $24.45/share. Under normal conditions this is what HLS should be selling for today on the expectation of FY2008 earnings. But the waters are still too muddy.
Continuing with the theme of paying down an additional $50M per year in debt ( this could actually be much more as it would not be unreasonable to expect a settlement with EY somewhere in the range of $100-150 M) from cash flows and maintaining a growth rate for operational earnings of 4% yields a PPS of $36 in FY2010. This PPS should be achievable in mid 2009, assuming a normal market (I know, this is a big IF).
Look, no one has a crystal ball. If I did, I wouldn’t be posting here, I’d be in Bimini. Nevertheless, I’m holding, and if I had spare cash I’d be buying more at these levels. I’m sure I’ve missed something here. If so, some one will surely point it out. But I’ve got to think that the buy-side analysts working for the big institutions have arrived at a similar conclusion.
Best of luck.
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