Description

EMS operates in two divisions. AMR is the leading provider of ambulance services in the US. AMR has 8% share of the total ambulance services market and 21% of the private provider market. EmCare is the leading provider of outsourced emergency department staffing and related management services in the US. EmCare has a 6% share of the total emergency department services market and a 9% share of the outsourced market. Both businesses are growing and organic revenue growth should be 8% - 10%. Small acquisitions could add another 3% - 5%.

The ambulance division (AMR) is a decent business. Since it’s driven by 911 calls, it is difficult for insurance companies to press for better rates as they can’t drive volume to other providers. This business is growing in the mid/high single digits and we expect will have high single digit EBITDA margins.

The emergency department staffing business (EmCare) is growing in the low/mid double digit range driven by increased hospital outsourcing. This business has high single digit EBITDA margins. There are two significant concerns at EmCare. The first is that emergency departments have to provide care to everyone which means that many people without insurance get care there. These “self-pay” patients often don’t pay. EMS records net revenue which is billing less allowances for managed care discounts and likely bad debt. We believe that in reporting net revenue, EMR’s accounting is appropriately conservative, and the company has never had to take a write-off as a result of aggressive revenue recognition. In addition, receivables days outstanding has been falling.

The second concern at EmCare is litigation since much medical litigation comes from the emergency department. EmCare uses their own software to identify situations where there is a high probability for being sued. By responding properly in these situations, EmCare has kept their incidents of litigation per patient seen 16% below the industry average. While patient litigation is a negative, it does create opportunity as many hospitals want to outsource their ED staffing due to high litigation costs.

The two divisions were owned by Laidlaw which went through a bankruptcy and never fully integrated the businesses. In January, 2005, Onex bought Emergency Medical Systems, and did an IPO of the company in December, 2005. (Note that Onex retains 76% of the equity and 97% of the voting control). As a result of the Laidlaw bankruptcy, the consolidation of the two divisions, and the Onex acquisition, the presentation of the financials in the S-1 is messy. There are stub periods, pro-forma financials, and it is not possible to calculate a L12M number for anything. We believe that this confusion presents an opportunity. Every quarter the company reports moves them further from difficult to understand financial statements. When they report 3Q ’06, accurate year over year comparisons will be possible. For what it’s worth, here is our view of the financial situation at EMS:

For 2006, we expect AMR will do $1,150 in revenue representing approximately 5% growth and will have $105MM in EBITDA (9.1%). We expect EmCare will do $662MM in revenue representing approximately 12% growth and will have $52MM in EBITDA (7.9%). The combined company should do $1,813MM in revenue, $157MM in EBITDA, and $.74 in EPS (on 42.1MM FD shares). Our numbers for 2007 are $1,976MM in revenue, $178MM in EBITDA, and a little over $1.00 in EPS. Free cash flow should be $40 - $45 in ’06 and about $5MM higher in ’07.

As I mentioned above, the two businesses were never fully integrated, and as of now, EMS still has two billing, legal, IT, and HR departments. The company says they can improve EBITDA margins by around 30bp a year and can get margins above 10% in 3-4 years. Given the duplicative overhead, this seems to be a reasonably conservative goal. In addition, the organic growth rate for the combined company should be in the high single digit range, but EMS should be able to do accretive acquisitions for 4x – 6x EBITDA which could push the revenue growth rate up by a few percentage points and would be accretive to earnings. My estimates do not include acquisitions.

At $13.25, EMS is trading at 6.7x ‘06E EBITDA and 5.9x ‘07E EBITDA. Assuming around $45MM in free cash flow, 9% organic revenue growth, and margin improvement, we believe that the risk is relatively limited. Looking out one year, assuming a 7.5 EBITDA multiple, we get $1,335MM in enterprise value less $442MM in net debt (current $487MM less aprox. $45MM in FCF) for an equity valuation of $893MM or $21/share.

We see the most significant risks as:
- Onex did an IPO of EMS shortly after buying the company, and while we think our full year numbers for ’06 and ’07 are reasonable, it is difficult to get much clarity on the current quarter. Some companies stumble out of the gate, and that is a possibility here. As we mentioned, we believe the organic growth combined with the free cash flow should provide some protection in the event of an early earnings miss.

- EMS has been able to mitigate reductions in Medicare and Medicaid pricing (32% of EMS revenue) by raising rates to commercial payers. It appears that a significant hit in Medicare or Medicaid pricing is unlikely in the near term, but as with any health care services provider, there is always headline risk, or a risk of a sudden change in government pricing.

- EMS has maintained a consistent payer mix. There is always the possibility of an increase in uninsured patients demanding care. EMS does mitigate some of this risk by getting communities in high self-pay areas to pay EMS to serve their community.

Catalyst

- Because Laidlaw went through a bankruptcy, the two divisions were merged, Onex bought the Co., and EMS had an IPO, the financials in the S-1 are complicated, and in some cases, accurate y/y comparisons are not possible. Every quarter EMS reports as a public company, the financial performance will become more transparent.

- We expect that in late January two analysts will initiate coverage of EMS (JP Morgan and BofA). We anticipate the coverage will be positive.

- Revenue growth, margin improvement, and use of FCF to reduce debt and make accretive acquisitions will lead to improving financial performance.