Description

Description: 

AdaptHealth is an opportunity to invest with arguably the best capital allocator in the healthcare services industry in CEO Luke McGee. Luke McGee who has built an excellent business from the ground up distributing medical supplies and equipment in several high growth areas like sleep and diabetes through tactful acquisitions and organic growth. The simple thesis is you are investing in a great capital allocator on a very solid platform that has underlying 8-10% organic growth with a very good runway for future acquired and organic growth at an attractive price. 

Company Background: 

Luke began the Adapt story while working at Philadelphia based PE shop Quadrant. While at Quadrant he took a small Philly based home health equipment company and through acquisitions and organic growth began building Adapt. Adapt came public in late 2019 through a SPAC with Deerfield and now trades under AHCO. The fact that Adapt came public through a SPAC and management and insiders own a significant chunk of the equity is one reason why Adapt may be under the radar and under owned by institutional investors. 

Industry: 

The home health equiptment industry may have a bad reputation with public investors due to the the F&A issues that were endemic to the healthcare services industry in the 1990s and 2000s and ultimately led to a period of massive price compression following the introduction of competitive bidding by CMS. As a result of a few prior rounds of competitive bidding, industry pricing has subsequently come down 50-80% depending on the category and the industry consolidated. 

Adapt likes to say they had a last mover advantage, building themselves up out of the rubble of the industry amidst the wreckage of competitive bidding. Because Adapt did not have legacy cost structure or legacy systems they could more efficiently compete in the industry and quickly grew through highly accretive acquisitions as an under the radar private company. 

The HME industry is highly conducive for great M&A because scale players get much better pricing on equipment and supplies, so there are massive natural purchasing synergies upon acquisition. 

The HME industry is also still very fragmented with many mom and pop players. 

The HME industry also is great because it services a couple of key structural growth themes: 

1. Home based care vs facility based care. If you look at home healthcare versus skilled nursing and other modalities of post acute care, its obvious that home healthcare is taking share. Its the preference for elderly patients to be in their homes and clearly post covid its proving to be a lot safer than skilled nursing homes. Also, home health is significantly cheaper from a payor perspective. 

2. Aging population. This should provide a nice demographic tailwind of a few percentage points of growth per year for next 15+ years as boomers age 

3. Adapt plays in significantly underpenetrated and high growth areas within HME like Sleep (CPAP/BiPAP) and Diabetes (CGM). 

Investor Concerns: 

1. Competitive Bidding: This has been a big overhang. CMS conducted bids in 2020 for round 2021 which was supposed to go into effect 2021 through 2023. After collecting the information which was subsequently released, CMS decided to suspend round 2021 because they found there were no savings for CMS from this round. This conceptually makes sense given pricing has come down so much since competitive bidding began that there is a point where providers will not bid below because they dont want to lose money. 

1. Even if Competitive bidding comes back in 2024 which it may or may not, Adapt health almost always takes share organically and through acquisitions around competitive bidding events. Adapt was built in a period of intense competitive bidding and they can handle it and thrive in it. 

Specifics: 

Adapt addresses the following aspects of the home health equipment industry:

Home Medical Equipment and Supplies: $56B industry

CGM and Diabetes: $16B segment

Current Revenue Mix:

• 40% rental

• 43% resupply

• 17% one-time sale

Product mix is expected to be:

• 38% Sleep

• 19% respiratory

• 17% Diabetes

• 11% HME

• 8% Supplies to Home

• 7% Other

PF Payor mix is expected to be:

• 37% commercial

• 24% FFS Medicare

• 11% Patient

• 9% Managed Medicare

• 7% FFS Medicaid

• 6% Managed Medicaid

• 6% Other 

Management: 

In my opening diatribe I stated that I believe Luke McGee to be an exceptional capital allocator. What is the basis for this? The following chart gives shows Luke built Adapt up through 2019 using only $309m of invested capital and was expecting to generate $100m of EBITDA-CX. 

To me this means that through a combination of organic growth and acquisitions Luke was creating this asset for close to 3x EBITDA-CX which demonstrates he has a great ability to buy companies, integrate them and grow them and generate tremendous value doing it. 

Luke is aggressive and continues to acquire since coming public. While the multiples have been a bit higher, they have been on bigger deals, as well as new verticals like the high growth and under penetrated CGM business.

Its also notable that Luke personally owns over 6m shares giving him a couple hundred million reasons to be a great steward of shareholder value at Adapt. 

Recent Acquisition of AeroCare: 

Luke recently closed his biggest acquisition yet of AeroCare. In that transaction he brought in Steve Griggs as Co-CEO which is a bit unusually but necessary. Luke can now really focus on capital allocation and and vision and Steve Griggs who Luke would admit is a superior operator can focus on actually running these businesses. While Co-CEOs could be viewed as a risk, I think Luke is so humble and focused on creating value that it will work well.

The AeroCare numbers point to significant cost synergies above and beyond what Adapt laid out at the time of the Aerocare acquisition if Steve Griggs is able to implement best practices in across Adapt's business and bring Adapt's margin levels and organic growth rates up to the level of AeroCare through better optimization of the patient experience and bringing down certain costs like bad debt through better systems.

Valuation:

Adapt currently has a roughly $5.5B market cap and a $7B TEV.

In 2021 they are expected to do $550m of EBITDA which makes them 2.7x levered 

They currently trade at 12.75x EBITDA 

However, for peer valuation purposes compared to home health peers such as Amedysis (AMED) etc I prefer to look at EBITDA- patient equipment cap X which normalizes for the inherently higher Cap X model that Adapt has related to their equiptment rental business. 

Adapt will generate $350m of EBITDA- Patient equiptment CX in 2021 and thus trades at 20x EBITDA. This compares favorably to AMED at 28x 2021 EBITDA. Additionally Adapt will likely grow faster organically. 

However, the reason to buy AHCO is not that they trade at a 20x versus 28x or that they will generate very healthy, 10% organic growth. 

The reason I am invested and very bullish is because Adapt will continue to acquire and these acquisitions will be very accretive to shareholder value. Lets say shareholder value already is growing 10% per annum just due to organic growth. Then if AHCO just reinvests their free cash flow back into acquisitions they can likely boost this intrinsic value growth per share per year into the 15-20% range without further capital raising. That sounds great but I think Adapt can grow intrinsic value per share even faster than that through additional acquisitions. 

Luke isn't afraid to issue equity and he has done it successfully since they came public yet the stock has still more than 3x from the IPO price. I believe through issuing equity at 20x EBITDA-CX to buy more companies for 5-10x EBITDA-CX Luke can add another 5-15% of growth of intrinsic value per share per year. 

Its hard to model future acquisitions. However, my basic focus with Adapt is to assume they maintain their current leverage level of +/- 3x EBITDA and then assume they can grow EBITDA-CX per share by 20-30% per year for the next five years. 

If they are exiting 2024 with $5/share of EBITDA-CX with similar leverage levels to today, I think the AHCO shares can be worth in excess of $100 and if capital allocation brings them up towards intrinsic value growth of 30-35% per year then AHCO shares would be worth even more. 

Risks: 

Acquisition integration challenges 

Co-CEO deal with Steve Griggs doesnt work

Major medical breakthroughs obviating need for home medical equipment

Irrational reimbursement action by payors (note diversified payor mix)  

Disclaimer: 

This write up contains certain opinions of the author as of the date written. Before investing do your own work. The author or his employer may or may not hold positions in the Security noted in this article. These parties may trade at any time, without notification to this community, and will not disclose this information to this community. The author and his employer disclaim any liability for investment losses that you may incur under any circumstances.

Catalyst

Further M&A

Synergies with AeroCare 

Organic Growth