Thesis

I posted AHS in December 2005 at about $20 (with a P-E of over 30x), but the idea was deleted from the VIC board.  The stock proceeded to rise 40% over the next 11 months.  It had also been posted in December 2002 (with a P-E of 11x) and proceeded to decline 40% in less than 6 months.

This certainly raises a question about what constitutes a value stock, but that is better addressed on some other website.

Here I will attempt to argue that AHS’s stock again offers compelling value.  The valuation numbers on the surface (P-E=16x, FCF Yield=10%) may prevent a second deletion, but the compelling drivers of value here are the long term secular growth trends, the high ROIC business model and a leading industry market share with stable competitive dynamics.  I estimate the stock has 50-75% upside as fair value for the stock is $25-30 per share.

Business Description

AMN Healthcare Services, Inc. operates as a temporary healthcare staffing company in the United States. The company provides travel nurse staffing services and locum tenens (temporary physician staffing) and physician permanent placement services. The company recruits physicians, nurses and allied health professionals nationally and internationally and places them on variable lengths of assignments and in permanent positions at acute-care hospitals, physician practice groups and other healthcare facilities throughout the United States.

The nursing business accounts for about 70% of revenue and runs with about a 7% operating margin.  The Locum business accounts 25% of revenue and runs with a 9% margin.  The permanent physician placement business accounts for about 5% of revenue and generates a 25% operating margin.

Nurse and Allied Healthcare Staffing Segment

Nurses: The company provides medical nurses, surgical nurses, specialty nurses, licensed practical or vocational nurses and practice nurses in various specialties for travel assignments throughout the United States. It places its nurse professionals with hospitals and hospital systems. The majority of the Company’s assignments are in acute-care hospitals, including teaching institutions, trauma centers and community hospitals.

The company places the majority of its nurses on 13-week assignments with hospitals and healthcare facilities. It also offers a longer-term staffing solution, typically of 12-18 month assignments, through its O’Grady Peyton International and RN Extend brands.

Allied Health Professionals: The company also provides allied health professionals under Med Travelers brand to acute-care hospitals and other healthcare facilities such as skilled nursing facilities, rehabilitation clinics and schools. Allied health professionals include such disciplines as physical therapists, surgical technologists, respiratory therapists, occupational therapists, medical and radiology technologists, dialysis technicians, speech pathologists and rehabilitation assistants.

Locum Tenens Staffing Segment
Under its Staff Care brand, the company places physicians of all specialties and certified registered nurse anesthetists (CRNA) on a temporary basis (locum tenens) as independent contractors with all types of healthcare organizations throughout the United States, including hospitals, medical groups, occupational medical clinics, individual practitioners, networks, psychiatric facilities, government institutions, and managed care entities. These professionals are recruited nationwide and typically placed on multi-week contracts. Assignment length ranges from a few days up to one year, with an average assignment duration of eight weeks.

Physician Permanent Placement Services Segment
The company provides permanent physician placement services under Merritt, Hawkins & Associates brand to hospitals, healthcare facilities and physician practice groups throughout the United States.

Customers
The company offers healthcare professionals placement opportunities throughout the United States and provides staffing solutions to hospital and healthcare facility clients that are located throughout the United States. In addition to acute-care hospitals, the company provides services to sub-acute healthcare facilities, physician groups, dialysis centers, clinics and schools.

Competition

Cross Country Healthcare is AHS’s main competitor.  AHS has about 30-35% market share and CCRN has about 25-30%.  Both companies have been active consolidators of smaller firms, and, consequently pricing discipline has been firm during down cycles in the market.

Recent Trends

AHS’s stock has traded down after each of the last four quarterly earnings.  The stock has declined about 40% over the last year.  Revenue growth has not accelerated and margins have not expanded as expected.

Revenue growth has faced in headwinds in 3 areas:

• Overall hospital admissions have remained tepid.
• Growth driven by tightened nurse-to-patient laws in California softened.
• Visa restrictions hurt volumes in AHS’s international segment.

In addition, AHS saw cost pressure in housing and travel costs.

Variant Perception

Despite (or rather, because of) the depressing price action, the slowing business fundamentals and the chorus of sell-side analyst’s who loved it at 35x earnings but hate it at 15x earnings, AHS’s stock offers compelling value based on the following:

The performance of the nurse staffing business will improve.

• Despite the incessant focus on hospital admissions, it is not necessary for this metric to improve to see an improvement in the business.  A key factor enabling hospitals to meet their nursing needs has been the sharp pick up in the nursing labor pool.  From its nadir in 2001, the number of nurses sitting for NCLEX exams has grown from 108,000 to an estimated 200,000 this year.
  
  However, this trend will start to peter out.  The growth in nursing enrollment at US baccalaureate programs has declined to its lowest level in 6 years (5% in 2007, 8% in 2006, 10% in 2005, 14% in 2004, 17% in 2003, 8% in 2002).
  
  
• Nurses are typically required to have 2 years experience before they are recruited as travel nurses.  As a result, the pool of recruit-able talent in 2008 will be at its highest level since 2000.  The age and experience of the nurse applicant is critically important because they tend to be the most interested in increasing their professional experience via travel and the most able to relocate to different locations every 3-4 months.
  
  
• Additionally, the number of nurses expected to leave the workforce is expected to grow almost 30% from 35,000 per year to 45,000 per year.
  
  
• Lastly, the visa restrictions that negatively impacted result in 2007 are likely to be eased in 2008.

• AHS has already been making progress in bringing housing expenses back into line as the US real estate market weakens

Valuation

Given the string of earnings disappointments, consensus estimates have come down significantly (over the last 12 months 2008 estimated EPS has gone from $1.42 to $1.20).  Therefore, I believe they are fairly credible.  Importantly, EPS estimates have stabilized over the last 3 months.

Based on consensus 2008 EPS, and EBITDA, AHS is trading at a P-E of 14x and EV/EBITDA of 7.6x.  (Capex runs at about 1% of sales; more-or-less in line with D&A).

FCF for 2007 should come in at about $50-55ml putting the FCF Yield at about 10%.  Barring a material decline in the business from current operating rates, 2008 and 2009 should see similar levels of FCF generation

The current valuation more than adequately compensates for the company-specific and economic risk facing AHS.

As the foul taste of the last four quarters results recedes and uncertainty about the impact of the economy on AHS’s business dissipates, I estimate that the business will be value at a 5-7% FCF yield, resulting in valuation range of $23-32 per share.  Taking off a couple of dollars high and low, gets me to my $25-30 price target.

Risks

• A severe economic downturn that impacts nursing demand beyond what is already discounted.
• An unanticipated decline in the results of the physician staffing business.
• AHS has about $157ml in debt.  This represents less than 2x EBITDA.