AMERICAN RENAL ASSOCS HLDGS ARA S
April 03, 2018 - 10:38am EST by
ElmSt14
2018 2019
Price: 18.52 EPS 0.50 0.70
Shares Out. (in M): 34 P/E 37.0 26.5
Market Cap (in $M): 629 P/FCF 47 33
Net Debt (in $M): 813 EBIT 125 124
TEV ($): 1,442 TEV/EBIT 11.5 11.6
Borrow Cost: General Collateral

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Description

 

We believe that American Renal Associates (ARA) is an attractive short position with 50% downside to our estimate of intrinsic value.  The key aspects of our thesis are:

1.       Industry:  The dialysis business (and American Renal in particular) utilize a deceptive relationship between the facility operators and the American Kidney Foundation (AKF) where the operators make donations to the AKF in return for the AKF to steer patients away from low-priced government plans and into high-priced commercial insurance plans where the AKF either pays the premium or makes other charitable assistance for patients

2.       American Renal is most vulnerable to reimbursement pressure because of its relatively small size, its high leverage and its JV-structure

3.       Private equity insiders are looking to exit

4.       UnitedHealth lawsuit could lead to lower reimbursement rates, significant legal damages and lower operating earnings due to ongoing legal costs

5.       Valuation is stretch on any fundamental metric

 

We believe that at even a generous valuation of 15x actual FCF of $23 million would yield a $350 million equity value / 35 million fully diluted shares = $10 per share or over 40% downside.  It is not inconceivable to see American Renal become insolvent if reimbursement pressure becomes more severe.

 

Business Overview:

American Renal operates 228 dialysis clinics in the US under a joint-venture model where the company partners with nephrologists who own approximately 47% of the equity interest in the facility and American Renal owns the majority.   The company claims that this structure allows better coordination and alignment with nephrologists who can focus on patient care while American Renal focuses on the administrative aspects of the business.

 

Thesis Points:

1.    The deceptive relationship between the dialysis industry and the American Kidney Foundation/Fund

The dialysis industry has some quirks that have allowed incumbent operators to exploit the relationship with the main industry charity – the American Kidney Foundation.  In brief, the 3 major dialysis facility operators (Davita and Fresenius are the two largest by market share) have been making charitable contributors to the American Kidney Foundation in return for the AKF steering patients away from low-priced government insurance (where the dialysis operator receive the Medicare rate of $248 per treatment) to higher-priced commercial plans that charge up to $2,000 per treatment for the same exact procedure.  This industry practice began receiving more attention in recent years and was the subject of a few notable articles, investigative journalist reports and even a skit on John Oliver’s show on HBO. Notably, insurance companies began to take measures to stop this practice, with Aetna suing Davita and UnitedHealth suing American Renal (more on this later). The following links (particularly the SIRF report) provide the most comprehensive background on the industry and the relationship with the AKF.  We are happy to answer additional questions in the Q&A:

http://sirf-online.org/2017/09/22/davita-inc-warren-and-charlies-excellent-insurance-gambit/

https://www.nytimes.com/2016/12/25/business/kidney-fund-seen-insisting-on-donations-contrary-to-government-deal.html

https://www.nytimes.com/2017/01/06/business/american-kidney-fund-fresenius-davita-subpoena.html

https://www.barrons.com/articles/insurers-press-dialysis-claims-1504325659

http://www.stltoday.com/business/local/davita-encouraged-some-low-income-patients-to-enroll-in-commercial/article_ec5dc34e-ca4d-52e0-bc26-a3e56e1e2c85.html

https://www.youtube.com/watch?v=yw_nqzVfxFQ

https://www.wsj.com/articles/u-s-opens-probe-into-concerns-over-health-provider-payments-1471572135

 

2.    American Renal is the most vulnerable due to its smaller size, higher leverage and its reliance on joint-ventures

American Renal is much smaller, more levered and less diversified than its main peers – Davita and Fresenius.   Fresenius is a $25 billion German-listed company with large health care products and care coordination segments in additional to its dialysis business.  Davita is a $12 billion market cap company that is the largest US dialysis facility operator. Davita and Fresenius are 2x-3x levered while American Renal is levered almost 5x.  Davita and Fresenius also rely less on the JV structure than American Renal, as evidenced by the allocation of income to non-controlling interests relative to operating earnings:

 

 

For these reasons, American Renal will be more susceptible to any reimbursement or legal/regulatory pressure in the industry.

 

3.    Private equity insiders are looking to exit

Centerbridge owns 54% of American Renal’s shares and has not sold shares since bringing the company public at $22 per share in 2016.  On March 26, with ARA’s stock right the IPO price at $21.82, American Renal announced that Centerbridge was planning on selling 5 million shares (out of the 18 million held) and ARA’s stock dropped over 15% in the subsequent 2 days.  Two days later, American Renal announced that the equity offering was withdrawn. We think that Centerbridge is eager to sell their shares and a strategic exit is very unlikely given the large market share concentration of the two main larger competitors.  Centerbridge’s holdings and price sensitivity should serve as a ceiling for the stock.

 

4.    UnitedHealth lawsuit

UnitedHealth sued American Renal in 2016, right around the time of the company’s IPO.  UnitedHealth pointed to the “fraudulent and illegal” relationship between American Renal and the American Kidney Foundation:

https://www.wsj.com/articles/unitedhealth-sues-american-renal-associates-alleging-fraud-1467409671

 

While this lawsuit is ongoing in various jurisdictions (mainly Florida), UnitedHealth just initiated a related lawsuit in Massachusetts with some more pointed allegations, notably that the put-options that were granted to its nephrologist JV partners in connection with its IPO violated federal Anti-Kickback regulations.  In 2014, Davita paid a $406 million fine for similar violations of the anti-kickback statute (see page 50 of the DVA 2017 10K: https://www.sec.gov/Archives/edgar/data/927066/000092706618000030/dva-123117x10k.htm). While the potential damages from both lawsuits are very serious, we believe the greater risk is that commercial reimbursement rates are lowered by payors.  Since dialysis facilities make all of their profits from their small portion of commercial treatments, American Renal is very sensitive to the commercial reimbursement rate:

 

 

5.    Valuation

American Renal likes to tout a metric called “EBITDA less non-controlling interest (NCI)” which they feel represents the cash flow to the company.  We strongly disagree with this approach for a variety of reasons:

 

First, EBITDA does not equal unlevered pre-tax cash flow.  Dialysis facilities require significant capital expenditures and EBITDA less NCI does not account for this.  American Renal states that “maintenance capex” for 2017 was $6.4 million but this number is extremely understated.

a)   Maintenance capex for 2016 was stated as $13 million for 2016 with 214 clinics, but only $6.4 million in 2017 when there were 228 clinics – how is that even possible?

b)   Davita estimates their maintenance capex was $303 million for 2017 with an average clinic base of 2,430 = $125k per center à which would imply American Renal’s maintenance capex for 228 centers = $28 million

c)    Depreciation expenses are $38 million with less than $1 million in intangible amortization expense

 

Second, “EBITDA” and “non-controlling interests” are an apples-to-oranges comparison.  EBITDA is an unlevered and pre-capex and pre-tax figure. Non-controlling interests is a share of the profits of each facility – after routine maintenance capex and other facility level charges, such as clinic-level debt service.  In our view, the appropriate calculation would be a proportional EBITDA based on the facility equity interest or (more appropriately) a simple free cash flow calculation that demonstrates the true recurring “owners earnings” of these dialysis facilities.

 

Lastly, given the high level (particularly the debt allocated to American Renal’s parent company), we think it is inappropriate to use EBITDA.  We believe there is a reason why a private equity chooses to highlight a figure such as EBITDA less NCI but we think it is wrong. That being said, even on EBITDA less NCI, American Renal is valued much more richly than its larger, more stable peer Davita:

 

 

Valued at DVA’s 9.1x metric, American Renal would be worth $14 per share or 25% lower.  Valued on more appropriate metrics like true free cash flow, American Renal should be worth 40% less than its current price

 

 

Additional Topics to be discussed in Q&A

Accounting for JV structure – consolidated, owned and clinic level cash and debt

JV put options and purchase of non-controlling interests

Potential interest expense deductibility limits of parent company

Industry discussion of American Kidney Foundation relationship, company exposure and potential challenges / changes to charitable assistance

 

Summary Financials:

 

 

The author of this post or the firm he is affiliated with may have a long or short position in the stock which is the subject of this post and may change his views or position at any time and has no obligation to update this post in any such case

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Reimbursement rate pressure

Litigation / legal damages from UnitedHealth lawsuit

Private equity selling

    sort by    

    Description

     

    We believe that American Renal Associates (ARA) is an attractive short position with 50% downside to our estimate of intrinsic value.  The key aspects of our thesis are:

    1.       Industry:  The dialysis business (and American Renal in particular) utilize a deceptive relationship between the facility operators and the American Kidney Foundation (AKF) where the operators make donations to the AKF in return for the AKF to steer patients away from low-priced government plans and into high-priced commercial insurance plans where the AKF either pays the premium or makes other charitable assistance for patients

    2.       American Renal is most vulnerable to reimbursement pressure because of its relatively small size, its high leverage and its JV-structure

    3.       Private equity insiders are looking to exit

    4.       UnitedHealth lawsuit could lead to lower reimbursement rates, significant legal damages and lower operating earnings due to ongoing legal costs

    5.       Valuation is stretch on any fundamental metric

     

    We believe that at even a generous valuation of 15x actual FCF of $23 million would yield a $350 million equity value / 35 million fully diluted shares = $10 per share or over 40% downside.  It is not inconceivable to see American Renal become insolvent if reimbursement pressure becomes more severe.

     

    Business Overview:

    American Renal operates 228 dialysis clinics in the US under a joint-venture model where the company partners with nephrologists who own approximately 47% of the equity interest in the facility and American Renal owns the majority.   The company claims that this structure allows better coordination and alignment with nephrologists who can focus on patient care while American Renal focuses on the administrative aspects of the business.

     

    Thesis Points:

    1.    The deceptive relationship between the dialysis industry and the American Kidney Foundation/Fund

    The dialysis industry has some quirks that have allowed incumbent operators to exploit the relationship with the main industry charity – the American Kidney Foundation.  In brief, the 3 major dialysis facility operators (Davita and Fresenius are the two largest by market share) have been making charitable contributors to the American Kidney Foundation in return for the AKF steering patients away from low-priced government insurance (where the dialysis operator receive the Medicare rate of $248 per treatment) to higher-priced commercial plans that charge up to $2,000 per treatment for the same exact procedure.  This industry practice began receiving more attention in recent years and was the subject of a few notable articles, investigative journalist reports and even a skit on John Oliver’s show on HBO. Notably, insurance companies began to take measures to stop this practice, with Aetna suing Davita and UnitedHealth suing American Renal (more on this later). The following links (particularly the SIRF report) provide the most comprehensive background on the industry and the relationship with the AKF.  We are happy to answer additional questions in the Q&A:

    http://sirf-online.org/2017/09/22/davita-inc-warren-and-charlies-excellent-insurance-gambit/

    https://www.nytimes.com/2016/12/25/business/kidney-fund-seen-insisting-on-donations-contrary-to-government-deal.html

    https://www.nytimes.com/2017/01/06/business/american-kidney-fund-fresenius-davita-subpoena.html

    https://www.barrons.com/articles/insurers-press-dialysis-claims-1504325659

    http://www.stltoday.com/business/local/davita-encouraged-some-low-income-patients-to-enroll-in-commercial/article_ec5dc34e-ca4d-52e0-bc26-a3e56e1e2c85.html

    https://www.youtube.com/watch?v=yw_nqzVfxFQ

    https://www.wsj.com/articles/u-s-opens-probe-into-concerns-over-health-provider-payments-1471572135

     

    2.    American Renal is the most vulnerable due to its smaller size, higher leverage and its reliance on joint-ventures

    American Renal is much smaller, more levered and less diversified than its main peers – Davita and Fresenius.   Fresenius is a $25 billion German-listed company with large health care products and care coordination segments in additional to its dialysis business.  Davita is a $12 billion market cap company that is the largest US dialysis facility operator. Davita and Fresenius are 2x-3x levered while American Renal is levered almost 5x.  Davita and Fresenius also rely less on the JV structure than American Renal, as evidenced by the allocation of income to non-controlling interests relative to operating earnings:

     

     

    For these reasons, American Renal will be more susceptible to any reimbursement or legal/regulatory pressure in the industry.

     

    3.    Private equity insiders are looking to exit

    Centerbridge owns 54% of American Renal’s shares and has not sold shares since bringing the company public at $22 per share in 2016.  On March 26, with ARA’s stock right the IPO price at $21.82, American Renal announced that Centerbridge was planning on selling 5 million shares (out of the 18 million held) and ARA’s stock dropped over 15% in the subsequent 2 days.  Two days later, American Renal announced that the equity offering was withdrawn. We think that Centerbridge is eager to sell their shares and a strategic exit is very unlikely given the large market share concentration of the two main larger competitors.  Centerbridge’s holdings and price sensitivity should serve as a ceiling for the stock.

     

    4.    UnitedHealth lawsuit

    UnitedHealth sued American Renal in 2016, right around the time of the company’s IPO.  UnitedHealth pointed to the “fraudulent and illegal” relationship between American Renal and the American Kidney Foundation:

    https://www.wsj.com/articles/unitedhealth-sues-american-renal-associates-alleging-fraud-1467409671

     

    While this lawsuit is ongoing in various jurisdictions (mainly Florida), UnitedHealth just initiated a related lawsuit in Massachusetts with some more pointed allegations, notably that the put-options that were granted to its nephrologist JV partners in connection with its IPO violated federal Anti-Kickback regulations.  In 2014, Davita paid a $406 million fine for similar violations of the anti-kickback statute (see page 50 of the DVA 2017 10K: https://www.sec.gov/Archives/edgar/data/927066/000092706618000030/dva-123117x10k.htm). While the potential damages from both lawsuits are very serious, we believe the greater risk is that commercial reimbursement rates are lowered by payors.  Since dialysis facilities make all of their profits from their small portion of commercial treatments, American Renal is very sensitive to the commercial reimbursement rate:

     

     

    5.    Valuation

    American Renal likes to tout a metric called “EBITDA less non-controlling interest (NCI)” which they feel represents the cash flow to the company.  We strongly disagree with this approach for a variety of reasons:

     

    First, EBITDA does not equal unlevered pre-tax cash flow.  Dialysis facilities require significant capital expenditures and EBITDA less NCI does not account for this.  American Renal states that “maintenance capex” for 2017 was $6.4 million but this number is extremely understated.

    a)   Maintenance capex for 2016 was stated as $13 million for 2016 with 214 clinics, but only $6.4 million in 2017 when there were 228 clinics – how is that even possible?

    b)   Davita estimates their maintenance capex was $303 million for 2017 with an average clinic base of 2,430 = $125k per center à which would imply American Renal’s maintenance capex for 228 centers = $28 million

    c)    Depreciation expenses are $38 million with less than $1 million in intangible amortization expense

     

    Second, “EBITDA” and “non-controlling interests” are an apples-to-oranges comparison.  EBITDA is an unlevered and pre-capex and pre-tax figure. Non-controlling interests is a share of the profits of each facility – after routine maintenance capex and other facility level charges, such as clinic-level debt service.  In our view, the appropriate calculation would be a proportional EBITDA based on the facility equity interest or (more appropriately) a simple free cash flow calculation that demonstrates the true recurring “owners earnings” of these dialysis facilities.

     

    Lastly, given the high level (particularly the debt allocated to American Renal’s parent company), we think it is inappropriate to use EBITDA.  We believe there is a reason why a private equity chooses to highlight a figure such as EBITDA less NCI but we think it is wrong. That being said, even on EBITDA less NCI, American Renal is valued much more richly than its larger, more stable peer Davita:

     

     

    Valued at DVA’s 9.1x metric, American Renal would be worth $14 per share or 25% lower.  Valued on more appropriate metrics like true free cash flow, American Renal should be worth 40% less than its current price

     

     

    Additional Topics to be discussed in Q&A

    Accounting for JV structure – consolidated, owned and clinic level cash and debt

    JV put options and purchase of non-controlling interests

    Potential interest expense deductibility limits of parent company

    Industry discussion of American Kidney Foundation relationship, company exposure and potential challenges / changes to charitable assistance

     

    Summary Financials:

     

     

    The author of this post or the firm he is affiliated with may have a long or short position in the stock which is the subject of this post and may change his views or position at any time and has no obligation to update this post in any such case

     

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Reimbursement rate pressure

    Litigation / legal damages from UnitedHealth lawsuit

    Private equity selling

    Messages


    SubjectRe: FCF number
    Entry04/04/2018 11:42 AM
    MemberElmSt14

    1. Regarding the FCF figure, you will note that in our valuation section, we estimate FCF as EBITDA less economic capex less interest expense less distributions to NCI less taxes.  We do not penalize the company for acquisitions or for dividends.  In the table you are referring to, it was shown in the historical financials just for the sake of full disclosure.  

    2. The JV put options were granted to the nephrologists when the company was opening its facilities as an inducement to grow and recruit doctors.  It essentially gives the JV partners the option to sell their interest in the facility back to the company at a pre-determined price.  It is interesting to note that the valuation at which the puts are exercised seems to be very low (ie the discount used is very high).  In the 10K on page F-22, it highlights that the puts are valued at a cost of capital of 15-20.5%, ie. 5x-7x FCF.  Depending on your point of view, you could either argue this is bullish for the company (they are buying out their partners cheap) or bearish (the appropriate multiple for a dialysis facility is 7x FCF, which would make ARA a $4 stock).  

    Many of the puts were exercisable upon a successful IPO of the company so the JV partners started exercising them aggressively in recent quarters.  We think this is bearish.  If the future of this industry is good, why would you sell your interest in a business at 5x FCF when your partner is valued at a much much higher value in the public market?  It also appears that UnitedHealth is making the argument that the put options violated federal anti-kick back statutes

    ARA's 10K has a risk factor that explicitly highlights this risk (p. 38)

    https://www.sec.gov/Archives/edgar/data/1498068/000149806818000012/ara1231201710-kxdocument.htm

    Our arrangements and relationships with our physician partners and medical directors do not satisfy all of the elements of safe harbors to the federal anti‑kickback statute and certain state anti‑kickback laws and, as a result, may subject us to government scrutiny or civil or criminal monetary penalties or require us to restructure such arrangements.

    In another lawsuit (Mohammed Dada MD vs. American Renal, District Court in Harris County, TX), one of the nephrologist JV doctors has alleged that ARA has not honored the terms of the put options, so it appears that there are some significant disputes surrounding the valuation of the puts, which UnitedHealth references in its lawsuit

    3. Regarding EPO and the frequency/duration of dialysis, we do not incorporate that into our analysis but we would not be surprised if there was additional aggressive behavior here given the history of the dialysis industry's abuse of EPO and the incentives involved here. 


    SubjectNice write up!
    Entry04/06/2018 12:08 PM
    Memberpwolff

    This is a very nice writeup. I have been short ARA since July 2017, essentially for the same reasons you outline here. The maintenance capex comparison to DaVita is clever. Is it possible that there is something different about their JV clinic arrangements that allow maintenance capex from the company to be lower in return for the doctors taking more responsibility and possibly getting a preferred position in the distributions? (See below.)

    Totally agree that Centerbridge's attempt to unload 5 million shares is a big red flag; another red flag is the 8K the company felt necessary to publish at the same time with the quarterly trend information, notably the reduced commercial payor mix they have been seeing in Q1. Still, one has to credit Centerbridge with the decision to pull the offering: they must feel like they can keep the wheels on for enough longer to try to get out at a higher price.

    One thing I have never been able to understand is why the doctors seem to get the lion's share of the total cash flow as distributions even though their ownership is ~50%. Do you understand this? I completely agree that the EBITDA less NCI is a complete BS metric. There is something really weird about the capital structure here, where the common shareholders seem to be getting almost nothing of what little cash flow the clinics are generating. (And that's not even getting into the put options...)


    SubjectRe: Nice write up!
    Entry04/06/2018 02:26 PM
    MemberElmSt14

    Thanks.  The reason the doctor's JV distributions are so high as a portion of total consolidated cash flow is because many of the total corporate costs are borne by ARA parent (and its shareholders), not by the JV.  Centerbridge, the investment bankers who brought it public and the sell-side analysts try to ignore this by using EBITDA less NCI but if you look at the capital structure and the cash flow waterfall/cost structure as ARA parent and the JV's separately, you can see why the cash flow to the JV partners is so high:

    • All of the parent corporate interest expense is allocated to ARA alone
    • I would argue that most of the depreciation / maintenance capex is allocated to the parent though we don't have this disclosure.  The cash flow statement shows that JV partners contributed $6.5 million but it is unclear if that is new facility capital contributions or contributions for their share of maintenance capex or what.  Still, there are parent corporate maintenance capex items (IT systems, etc) that are borne all by ARA

    So while there is $176 million of EBITDA and over $100 million of EBITDA less NCI, there is almost no FCF to ARA shareholders.


    SubjectRe: Re: Nice write up!
    Entry04/09/2018 07:16 PM
    Memberpwolff

    Okay, this makes sense. They levered up the ARA parent but naturally the doctors don't want that leverage. So the common equity is super-levered: if they can get growth, the PE guys make a great return but if they can't grow then the debt burden is onerous. Naturally they piled on the debt before the Kidney Foundation scam got called out...

    It would be interesting to see whether your hypothesis about the capex also being allocated to the parent can be proven. I'm less sure why this would be true: maintenance capex is an ongoing expense, so the JV partners ought to be bearing their fair share. I totally understand why Centerbridge would want to lever up their part of the capital structure; I'm a lot less sure why they would eat the maintenance capex. Or to put it another way: What did they get in return?


    Subject~29% of "owned" EBITDA at risk of elimination from ~3% of patients
    Entry04/26/2018 05:10 PM
    Memberengrm842

    ElmSt14 -

    Great writeup and thank you for a very actionable short idea. Since reading your write-up, we decided to dig into the corporate structure and financials.

    We first wanted to share our understanding of the the hairy capital structure here when factoring in clinic level cash and debt. Based on our math, at $15.61/share, ARA is trading for 10.6x TTM Adjusted EBITDA - NCI, and 26.4x FCF before put option excercise.

     

    ARA Share Capitalization    
         
    Current Stock Price   $15.61
    x Primary Shares Outstanding   31.1
    Market Capitalization   485.2
         
    In-the-Money Outstanding Options/Warrants   3.0
    Other Common Stock Equivalents   0.0
    Weighted Avg. Exercise Price   7.1
    Treasury Method Shares   1.7
    FD Shares   32.7
         
         
    FD Market Cap   511.0
    - ARA Owned Cash (Ex: Clinic-Level Cash)   1.6
    - ARA Owned Clinic Level Cash   36.9
    Total ARA Owned Cash   38.5
    + ARA Owned Debt (Ex: Clinic-Level Debt)   440.4
    + ARA Owned Clinic-Level Debt   67.2
    + NCI Subject to Put Provision   139.9
    Adjusted ARA Owned Debt   647.5
    FD Enterprise Value   1,120.0
         
    TTM Multiples   4Q'2017
    FD EV/ Adjusted EBITDA - NCI   10.6x
    FD Market Cap / Adjusted FCF (Before Put Option Exercise)   26.4x
         
    Leverage    
    Adjusted ARA Owned Net Debt / TTM Adjusted EBITDA - NCI)   6.1x

     

    Further, ARA (the stock; green box) owns no assets but is the issuer of the term loans and guarantees the debt? E.g., if things start to go bad, ARA shareholders own the debt and theres no recourse to the JV partners (pink box)

    Digging into the financials, based on our understanding ARA loses money on all government treatments. On the flipside, they make ~64% EBITDA margin on Commercial treatments after patient care costs and G&A (see unit economics below).

     

    Government Rate per Treatment $247
    Less: Patient Care Cost Per Treatment $220
    Less: G&A Per Treatment $47
    Government EBITDA per Treatment ($20)
       
    Commercial Rate per Treatment $1,051
    Less: Patient Care Cost Per Treatment $220
    Less: G&A Per Treatment $47
    Commercial EBITDA per Treatment $784

     

    Total treatments per patient is ~140 per year. Total commercial treatments for the full year 2017 totaled 262,700 (we backed into this number using government and commercial rates). Therefore, commercial patients totaled 1,875.

     

    Total Treatments 2,191,172
    Total Patients                15,637
    Treatments per Patient                      140
       
    Commercial Treatments              262,700
    Commercial Patients                   1,875

     

    Based on ARA's 3Q'17 press release when they reveal to us how many patients getting charitable premium assistance on (1) ACA Plans, (2) Commercial Plans, and (3) on Commercial Plans supplemented with Government Plans, is it fair to use the 131 patients on ACA plans and 456 patients on Commercial plans for a total of 587 commercial patients that are "at risk" of being eliminated if the commercial insurers take action against patients receiving charitable premium assistance? If so, this equates to ~31% of ARA's total commercial patient population.

     

     

    C.P.A. Patients on ACA Plans @ 3Q'17                      131
    C.P.A Patients on Commercial Plans @ 3Q'17                      456
    C.P.A Patients on Supplemental Government Plans @ 3Q'17                   1,573
    % of ARA's Commercial Patients at Risk of Elimination 31%

     

    We derive commercial revenue per patient as ~$147k and EBITDA per commercial patient at $94k. We attribute all of ARA's EBITDA - NCI to Commercial payments given the unit economics outlined above (e.g., Government treatments are money bad). This would imply that $55mm of corporate EBITDA is at risk, and at 54% ARA ownership, $30mm of ARA's "owned" EBITDA is at risk of being eliminated with the 567 patients mentioned above.

     

     

    Revenue per Commercial Patient ($k)              147,311
    EBITDA per Commercial Patient ($k)                93,987
    EBITDA Margin per Commercial Patient 64%
       
    Corporate EBITDA at Risk                        55
    ARA Ownership Interest 54%
    ARA "Owned" EBITDA at Risk                        30

     

    Under this scenario, NET leverage would sky rocket to ~6x trailing Adjusted EBITDA - NCI. However, after factoring in the ~$140mm of NCI that is subject to put provision, the NET leverage ratio would baloon to over ~8x leverage.

     

    Adjusted "Owned" Net Debt (Total Debt - Total Cash) 469
    Adjusted EBITDA - NCI 105
    Net Leverage Ratio 4.5x
       
    Less: ARA "Owned" EBITDA at Risk                        30
       
    PF Net Leverage Ratio 6.2x
       
    Less: NCI Subject to Put Option Provision 140
       
    PF Net Leverage Ratio w/ Put Option 8.1x

     

    Do you (or anyone else) share the same views of the numbers presented above?


    SubjectCommercial rate sensitivity reveals a clear path to insolvency
    Entry04/27/2018 12:17 PM
    Memberengrm842

    ·      We created the table below showing ARA’s sensitivity to both (1) declining commercial rate per treatment and (2) declining commercial treatments, coupled with a re-rating of the multiple to 8.5x in-line with Davita.

    ·        Note: the column on the far right depicts today’s market reality in terms of the commercial rate, number of commercial treatments, corporate profitability, and trading multiple.

    ·        Conclusion: We agree w/ Elmst14 and strongly believe ARA could be a $4 stock with a 6% commercial rate decline/2% commercial treatment decline, and could ultimately become insolvent with an 11% commercial rate decline/5% commercial treatment decline.

     

     

     

      Scenario: Worst Case     Base-Case     Today
                     
      Commercial Rate Per Treatment ($/Treatment) $931 $951 $971 $991 $1,011 $1,031 $1,051
      y/y growth -11% -10% -8% -6% -4% -2% 0%
                     
      Less: Patient Care Cost Per Treatment $220 $220 $220 $220 $220 $220 $220
                     
      Less: G&A Per Treatment $47 $47 $47 $47 $47 $47 $47
                     
      = EBITDA Per Commercial Treatment $664 $684 $704 $724 $744 $764 $784
                     
      x Commercial Treatments               250,700               252,700               254,700               256,700               258,700               260,700               262,700
      y/y growth -5% -4% -3% -2% -2% -1% 0%
                     
    A = Commercial EBITDA ($mm) 167 173 179 186 193 199 206
                     
      Government Rate Per Treatment ($/Treatment) $247 $247 $247 $247 $247 $247 $247
      y/y growth 0% 0% 0% 0% 0% 0% 0%
                     
      Less: Patient Care Cost Per Treatment $220 $220 $220 $220 $220 $220 $220
                     
      Less: G&A Per Treatment $47 $47 $47 $47 $47 $47 $47
                     
      = EBITDA Per Government Treatment ($20) ($20) ($20) ($20) ($20) ($20) ($20)
                     
      x Government Treatments            1,928,472            1,928,472            1,928,472            1,928,472            1,928,472            1,927,972            1,928,472
      y/y growth 0% 0% 0% 0% 0% 0% 0%
                     
    B = Government EBITDA ($mm) (39) (39) (39) (39) (39) (39) (39)
                     
    A + B ARA Corporate EBITDA 128 134 141 147 154 161 167
                     
    C + "Recurring" Stock-Based Compensation 6 6 6 6 6 6 6
                     
    A+B+C = ARA Corporate EBITDAS 134 140 147 153 160 167 173
                     
      x ARA Economic Ownership (100% - NCI/EBITDAS) 60% 60% 60% 60% 60% 60% 60%
                     
      = ARA "Owned" EBITDA 77 80 84 88 92 96 100
                     
      x Fair Value Multiple 8.5x 8.5x 8.5x 8.5x 8.5x 8.5x 11.3x
                     
      = Enterprise Value 650 683 716 749 783 817 1,127
                     
      - ARA "Owned" Clinic-Level Debt 67 67 67 67 67 67 67
                     
      - ARA "Owned" Debt (Ex: Clinic-Level Debt) 440 440 440 440 440 440 440
                     
      - NCI Subject to Put Provision 140 140 140 140 140 140 140
                     
      + ARA "Owned" Clinic-Level Cash 37 37 37 37 37 37 37
                     
      + ARA "Owned" Cash (Ex: Clinic-Level Cash) 2 2 2 2 2 2 2
                     
      = Equity Value 41 74 107 140 174 208 518
                     
      / Fully Diluted Shares Outstanding 33 33 33 33 33 33 33
                     
      = Equity Value Per Share $1.26 $2.25 $3.26 $4.27 $5.30 $6.34 $15.80
                     
      Upside/Downside -92% -86% -79% -73% -66% -60% 0%
                     
                     
      Net Leverage Ratio 8.0x 7.6x 7.2x 6.9x 6.6x 6.3x 6.1x

     

     

    ·        Note: In 2012, ARA’s commercial rate was $994 with 1,307 commercial patients. If the rate drops back to these levels, ARA would be a ~$3.50 stock.

     


    SubjectRe: ~29% of "owned" EBITDA at risk of elimination from ~3% of patients
    Entry04/30/2018 11:11 AM
    MemberElmSt14

    Hi engrm842 - yes, we get roughly the same math using your approach (top down estimating commercial reimbursement rate and costs for each treatment type).  We also get roughly the same result if we compare the AKF disclosure from DVA (http://pressreleases.davita.com/2017-10-10-DaVita-Provides-Disclosures-Regarding-Charitable-Premium-Assistance) and assume that ARA has similar profitability:

     

    Either way, it is clear that the relationship with the AKF is responsible for a very significant portion of the profitability of the industry, and particularly ARA.  It also appears that the insurers are not backing off from their more aggressive stance with a coalition of payors recently sending a letter to the Dept of Health and Human Services to address this issue:

    https://www.ahip.org/wp-content/uploads/2018/04/ESRD-Steering-Letter_4.16_FINAL_Embargoed.pdf

     

     


    SubjectWorker's unions could slash ~$14mm of ARA "owned EBITDA"
    Entry04/30/2018 02:30 PM
    Memberengrm842

    http://www.modernhealthcare.com/article/20180404/NEWS/180409959

     

       
    Revenue Per Treatment $343
    Commercial Rate $1,051
    Government Rate $247
       
    Cost Per Treatment $279
    Patient Care Cost $220
    G&A $42
    D&A $17
    Total Cost per Treatment $279
       
    EBITDA Per Treatment  
    Commercial $789
    Government ($15)
       
    EBITDA Margin Per Treatment  
    Commercial 75%
    Government -6%
       
    Treatment Cost % of Commercial Rate 115%
       
    PF Revenue Per Treatment  
    Commercial Rate $321
    Government Rate $247
       
    Cost Per Treatment $279
    Patient Care Cost $220
    G&A $42
    D&A $17
    Total Cost per Treatment $279
       
    EBITDA Per Treatment  
    Commercial $59
    Government ($15)
       
    EBITDA Margin Per Treatment  
    Commercial 18%
    Government -6%
       
    EBITDA per Treatment Impact $730

     

           
    ARA Clinic Exposure  
    California Arizona Ohio Total
    5 2 17 24
           
    x Patients/Average Clinic   71
           
    = At-Risk Patients   1,698
           
    x Treatments/Patient   140
           
    = At-Risk Treatments   237,955
           
    Commercial Treatment Mix   13%
           
    = At-Risk Commercial Treatments 30,934
           
    x EBITDA loss Per Commercial Treatment $730
           
    = Total EBITDA At Risk ($mm) 22.6
           
    x ARA Economic Ownership 60%
           
    = ARA "Owned" EBITDA At Risk ($mm) 13.6

    SubjectGreat call
    Entry05/09/2018 11:31 AM
    Membertugger85

    Hey Elm, great call on this one so far.  Curious on your thoughts on the quarter, why it's down 10% and how you're thinking about the position post the recent large underperformance? Thanks


    SubjectRe: Great call
    Entry05/09/2018 02:51 PM
    Memberengrm842

    ·         Only reason why ARA “beat” and grew Adjusted EBITDA – NCI year over year was due to the timing of income tax receivable agreement adjustment which was a ~$5mm tailwind y/y. Without this add-back, margins were down ~400 bps. Commercial mix was down ~400 bps y/y and ~500 bps sequentially,  Commercial revenue was down $2.2mm y/y, Commercial rate was only up 0.8% sequentially which is a huge deceleration vs. prior quarters. We're also seeing continual cash burn after adjusting for distribution to JV partners. Given the extreme sensitivity to commercial rate, and management hinting that there could be future rate pressure, there is an awful lot of room for profitability to evaporate. Couple this with the pressures in California, Arizona, and Ohio (24 dialysis clinics for ARA) that could potentially re-rate the commercial rate to 115% of treatment cost (erode commercial EBITDA margins from 75% to 18%) this could ultimately spiral out of control and wipe out the equity.

     

     


    SubjectRe: Re: Great call
    Entry05/09/2018 05:53 PM
    MemberElmSt14

    We think the quarter was pretty soft and continue to think the company is a short:

    - Organic treatment growth slowed to +4.2% which is the slowest growth since IPO. 
    - True FCF was negative $7 million as distributions to JV partners swallowed 80% of CFFO
    - Calculating the commercial reimbursement rate is a little tricky because of the new pharmaceutical revenues (see below) but we actually think it increased, which we don't think is sustainable given the UNH litigation and legislation in CA and other areas
    - One main reason revenues were up was because dialysis companies now dispense some drug that patients used to pick up at the pharmacy themselves and they pass through the costs with a 4% mark-up.  Excluding this, revenue growth would have been much more muted.  The lawsuits with UNH and other payors are getting more intense, not less.  From the DVA call:

    Calcimimetics: On January 1, 2018, both oral and IV forms of calcimimetics, a drug class taken by many patients with end stage renal disease to treat mineral bone disorder, became the financial responsibility of our U.S. dialysis and related lab services business for Medicare patients and are included in our payment under Medicare Part B. During the pass-through period, Medicare payment for calcimimetics is based on a pass through rate of the average sales price plus approximately 4%. Previously, calcimimetics were reimbursed under Medicare Part D through traditional pharmacies, including our pharmacy business, DaVita Rx. For the three months ended March 31, 2018, calcimimetics increased revenues and patient care costs at our U.S. dialysis and related lab services business, offset in part by a decrease in revenues and costs in our other ancillary services and strategic initiatives business due to calcimimetics.


    SubjectJV Partner Put Excercises
    Entry05/21/2018 12:52 PM
    Memberengrm842

    ·         Our high level takeaway is that as time-based put options have become increasingly more vested over time (Vested/Vested  + Non-Vested), we’ve seen a greater rate of JV partner put option exercise (taking ARA’s in-period purchase of NCI as a % of prior year vesting).

    o   For example, $3.1mm purchases of NCI in 1Q’18 are all time-based excercises because there were no excercisable event-based put options in the prior period ended 12/31/2017. 

    o   For the period ended 12/31/2017 there was $31.8mm of vested time-based put options. The in-period exercise rate is therefore 10%, but only 3% of total put option obligation.

    ·         In 3Q’17 we saw the greatest rate of time-based put exercise at 70% (18.3mm purchase of NCI out of $26.2mm vested as of 9/30/2017) which coincides with only period that ARA disclosed its AKF-exposed commercial book

    ·         We also find it very telling that the mid-point of the company’s disclosed WACC (the primary input associated with determining the “fair value” of the NCI puts) has been rising every quarter which reflects a declining valuation and a higher IRR hurdle

     


    SubjectARA's $32mm cash settlement with UNH
    Entry07/09/2018 04:28 PM
    Memberengrm842

    See PR below:

    American Renal Associates, UnitedHealth execute binding settlement term sheetAmerican Renal Associates Holdings (ARA) and UnitedHealthcare, a UnitedHealth Group company (UNH) announced that they have executed a binding Settlement Term Sheet and will be negotiating terms of a definitive settlement by August 1, 2018. Under the terms of the Agreement, ARA will pay $32M and will follow certain procedures and share information with UnitedHealthcare. In conjunction with the Agreement, ARA and UnitedHealthcare will enter into a three-year network agreement, effective August 1, 2018, that will provide UnitedHealthcare plan participants with more cost effective, in-network access to all of ARA's dialysis clinics in 26 states and the District of Columbia. The network agreement will include UnitedHealthcare's health benefit products across the commercial, Medicare Advantage and Medicaid managed care markets, and will allow chronically-ill end-stage renal disease patients to better coordinate their access to care with ARA's clinics and ARA-affiliated nephrologist partners who are part of the UnitedHealthcare network. The network agreement will also include certain value-based contracting features designed to improve quality and lower hospitalization costs for UnitedHealthcare plan participants who receive kidney care at ARA clinics. In a joint statement, the companies said, "We are pleased to have reached a resolution on this matter and we look forward to building a more cooperative relationship that enables us to collaborate on high quality care for dialysis patients."


    • ARA only has $2mm of owned ex-clinic cash and $32.7mm of owned clinic level cash
    • Appears as if UNH commercial rates will be renegotiated lower to be "more cost effective" in this new 3 year network agreement

    SubjectPeeling back the onion on 2Q'18 top and bottom line - unjustified stock move
    Entry08/08/2018 12:12 PM
    Memberengrm842

    Optically, ARA had a phenomenal quarter --- topline revenue +17% primarily a result of (A) 6% treatment growth and (B) 11% revenue per treatment --- which strongly drove Adjusted EBITDA – NCI growth of  15% year over year – results that blew away consensus revenue and profitability away on a name with a high short interest at ~18% of the float.

    But… peeling back the onion reveals an extremely different picture. In order to make year on  year comparisons, investors must adjust revenue per treatment line for (A) $30 of calcimimetics reimbursement earned cost + tiny margin, (B) $10 of non-recurring revenue adjustment, (C) $2.50 of ASC 606 related to reporting revenue after provisions for bad debt expenses and uncollectible accounts.

    Revenue per treatment looks like it grew 11% year over year – from $343 in 2Q’17 to $379 in 2Q’18 – but, taking out the $42.50 of non-normal benefits mentioned above, revenue per treatment declined 1.9% y/y to $336. Backing out these non-normal benefits results in a swing of 12.6% growth points. Taking the 16.7% topline growth, less the 12.4% revenue per treatment adjustment, results in 4.1% normalized topline growth.

    In order to back into the commercial book of business, several adjustments need to be made. First, commercial payors have not started to reimburse for calcimimetics. Thus, one must add the $30 reimbursement to the 2Q’17 government rate of $248. Second, if we split the $10 of non-recurring revenue adjustment, and the $2.50 of ASC 606, by the government/commercial revenue mix of 66.7% and 33.3% respectively, we can derive that the non-normal government rate in the quarter was $286. With simple math, one can back into the commercial rate of $1,076, which actually declined sequentially from $1,116 in 1Q’18 – the first sequential decline in over 5 quarters.

    Thus, ARA benefitted $24mm of revenue in the quarter that must be backed out to make the year over year comps normal. By our math, this had a $3mm EBITDA – NCI benefit in the quarter – which management called out directly as well. Normalized EBITDA – NCI in the quarter would have been $28.5mm, not $31.5mm as reported – equivalent to ~4% growth, not 15%.


    SubjectUpdate?
    Entry08/23/2018 09:39 AM
    Membertugger85

    Curious if the thesis is still in-tact and what the next catalyst is if so?  Thanks


    SubjectLeerink sees "fatter margins" ???
    Entry08/23/2018 10:50 AM
    Memberengrm842

    ·        ARA is up ~11% this morning nearing 52w high of  ~$24 (trading ~13x EBITDAS-NCI/~32x Adjusted Free Cash Flow) on Leerink’s upgrade to $26 based solely on the opportunity for “fatter margins” which we are not buying.

     

    ·        We strongly disagree with the “fatter margin” thesis for the following reasons:

    1.     Based on our conversation w/ GLG experts, there are only two ways for ARA to increase profitability:

    A)  Increase commercial population --> volumes are currently under pressure from commercial payers

    B)  Increase commercial rates by beefing up your out-of-network population that pays as much as ~40x the government reimbursement rate --> ARA will eventually be forced into in-network plans given their lack of leverage and negotiating power to justify the rates. The smaller you are, the less negotiating power you have – which is why ARA chose to go out-of-network to capture the higher rate.

    C)  Quote from our notes from GLG expert call:in the long-run, ARA’s business is highly dependent on legislation and charitable premium assistance, margins will likely come down given ARA’s out-of-network dependence which is their single greatest business model vulnerability”

    D)  Quote from our notes from GLG expert call: “the only profit improvement opportunity for ARA is the switch to Mircera which is a slow roll-out in 2018 and fully available to all providers in 2019 – the switch could reduce drug cost by ~15%, but will take some time for nephros to adopt the drug across entire patient population”

     

    2.     ARA’s margins are well above DVA’s over the last 12 months – in our opinion, ARA is overearning, not under earning, given their heavy out-of-network exposure

     

    3.     Why would ARA’s margins expand when (a) margins have been eroding for years? And (b) commercial treatment mix is declining– We don’t see the catalyst to inflect margins higher

     

     

    4.     Further, ARA’s commercial rates have shown zero signs of inflecting higher --> this variable is the lever for margin expansion

     

     

    5.     Lastly, ARA has an extremely fixed cost business with negative operating leverage on patient care costs/ G&A


     

     

     

     


    SubjectRe: Update?
    Entry08/23/2018 12:05 PM
    MemberElmSt14

    Despite the stock's being up 40% since they reported earnings, we think the thesis is still intact and we think ARA is still a good short, for a variety of reasons:

    1. The 2Q performance was actually much weaker than it appears.  As engrm842 noted, all of the revenue growth and adjusted EBITDA growth came from non-recurring sources, in our view.  Namely, a favorable revenue adjustment and the impact of selling a pharmaceutical called calcimimetic (which the government started allowing dialysis centers to do on Jan 1, 2018).  The revenue adjustment is non-recurring after 1 quarter and the calcimimetic will be phased out next year, so there was actually negative revenue growth excluding these items despite facilities growing to 233 from 217.   See below including a snapshot from a recent GS initiation report on the industry/company.

    2. The FCF of the business was also artificially boosted by (what appears to us) as a deliberate under-payment of distributions to non-controlling interests to boost FCF, coordinate with the sellside (this woman Ana Gupte at Leerink increased her price target to $26 today), so that private equity can sell their shares again after the botched offering earlier this year.  Since ARA came public, the cash distributions to non controlling interests have nearly always been higher than the book NCI with an average cash distribution equal to 110% of the book expense.  In 2Q 18, cash distributions were 86%, the lowest figure ever by far.  We think this is unsustainable.  See below. 

    3. We think the impact of the UnitedHealth settlement is far more severe than what the headlines suggest.  ARA cut its guidance for Adjusted EBITDA less NCI by $5 million when it announced the settlement, which seems harmless in the context of the prior midpoint of $113 million, but once you dig into what this $5 million really means, it is much more severe.  We can estimate what the profit contribution from UnitedHealth actually was (it could range from $18 million to $54 million, in our view) and then you can see that the $5 million (which is $12 million on an annualized basis from the date of the settlement) represents something like a 22% to 68% reduction in profits from UnitedHealth.  This doesn't even mention the fact that ARA had to give UNH an additional $32 million.  We think that ARA is going to get the shit kicked out of it by other commercial payors, just like it did by UNH. In the GS research, they estimate that three quarters of the company's commerical business is out of network, so we believe that Aetna and Cigna will call ARA and ask for the same rate that UNH is getting, so Adjusted EBITDA is going to continue to go down, in our view. 

    4. The current valuation strikes us as very egregious.  In the best case scenario, we estimate that ARA is trading at 40x FCF with no growth and close to 5x leverage.  It is more likely in our view that the FCF is negative. 

    5. There are several catalysts that we think are upcoming including a host of regulatory/legislative agenda items (GS' note outlined some of them well, below), additional commercial payor litigation/pressure and private equity deciding to sell shares. 

    All that said, ARA is an illiquid stock, you have a handful of cheerleader sellside analysts like Leerink looking to work on the secondary share offering and the headline figures "beat" estimates, so the short hasn't work. 

    Earnings call commentary on impact from non-recurring revenue adjustment and calcimimetics:

     

    Q2 adjusted EBITDA less NCI was $31.5 million as compared to $27.4 million last year. The EBITDA less NCI impact of the favorable revenue adjustment was approximately $3 million, so normalized Q2 EBITDA less NCI would have been $28.4 million excluding that.

     

    Our revenue per treatment in the second quarter was $379 or $36 above the second quarter of 2017 RPT of 343. The revenue adjustment favorably impacted RPT by $10. The remainder of the year-over-year increase was primarily related to calcimimetics of approximately $30 per treatment, plus approximately $2.50 per treatment due to the effects of ASC 606 related to Medicare bad debt accounting in Q2 and offset somewhat by lower year-over-year commercial mix

     

     

    GS note on impact of calcimimetics:


     


     

     

    UnitedHealth Settlement analysis:

     

     

     




    Valuation and FCF:

     







     

     

     

     


    SubjectRe: Leerink sees "fatter margins" ???
    Entry08/23/2018 12:11 PM
    Memberengrm842

     

    ·         We want to emphasize (again) that 2Q’18 was not as good as people think ( despite the stock up +40% since the report) and in fact, sequentail margin improvement got a lot worse, not a lot better, which likely led to the false sense of hope for the Leerink analyst who upgraded the stock on evidence of better margins

    1.     Margins appear as if they inflected higher sequentially by 330 bps, much better than the 260 bps of sequential margin improvement seen in 2Q’17

     

     

    2..     Based on our math, comparable revenue must be reduced by $22.3m, and comparable reported EBITDA – NCI  must be reduced by $4.6m

     

     

    3.     The result is 13.9% margin, compared to 14.5% margin as reported à therefore, sequential margins only improved 230 bps, worse than last year’s 260 bps improvement. ******Underlying Adjusted EBITDA – NCI was down ~1.5% y/y, not up 15 y/y%

     

     

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