Kindred Healthcare Inc. KND
October 30, 2015 - 5:13pm EST by
2015 2016
Price: 13.40 EPS 1.80 2.10
Shares Out. (in M): 86 P/E 7 6
Market Cap (in $M): 1,150 P/FCF 0 0
Net Debt (in $M): 3,025 EBIT 0 0
TEV ($): 4,361 TEV/EBIT 0 0

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  • Healthcare
  • Regulatory Change
  • Sum Of The Parts (SOTP)


A healthcare sell off, fear over the impeding implementation of LTAC criteria, an OIG report on SNFs,
and a weakening high yield market have sent KND shares down ~50% in the last several months. These
fears provide the opportunity to buy a diversified post-acute provider at 7x 2015 guidance for adjusted
eps, 6x 2016 FCFe and <5x managements post synergy FCF guidance for 2017. On a sum of the parts, the
current valuation implicitly creates the LTAC segment at ~3x 2017 EBITDAR even after assuming a 15%
EBITDAR decline in that segment which takes into account the risks but not the potential benefits of the
implementation of LTAC criteria. In 2016, the absence of transaction and integration costs related to the
Gentiva and Centerre acquisitions will reveal the true cash generative abilities of Kindred and shares will
re-rate materially higher. I believe $21-25 per share is a reasonable 18 month price target based on 10-
12x 2016E FCF.
Historically Kindred was primarily a skilled nursing (SNF) and Long term acute care (LTAC) provider, but
has significantly diversified by shuttering money losing SNF operations burdened by legacy Ventas leases
and expanding into more attractive home health, hospice, and inpatient rehab (IRF) segments through
recent acquisitions of Gentiva and Centerre. The new Kindred is now more hedged from a
reimbursement perspective and better positioned to deal with the industry transition towards bundling
and ACO’s. Synergies and incremental growth from Gentiva and the Rehab segment will lead to better
organic growth rates for the consolidated company following any choppiness related to LTAC criteria
Investors in healthcare services bear the risk that the most important customer is CMS. That said, in the
context of the recent past, the reimbursement visibility today for KND is good compared to just 2 years
ago before congress legislated the codification of LTAC criteria in late 2013. Prior to the codification of
criteria, investors feared that LTACs could go away completely. While 2016-2017 could be choppy for
the LTAC division, the opportunity to backfill compliant patients should allow the LTAC business to
continue its strong FCF generation over the long run. No existential risk exists in the business today, and
KND has significantly diversified into more attractive post-acute segments in the past two years, leaving
the company better positioned from a reimbursement perspective than it has been in many years. While
the LTAC segment produces less than 35% of my EBITDAR estimate for F2017, the implementation of
LTAC criteria that begins in hospital fiscal 2016 has been a source of extreme investor consternation and
is a major part of why KND is attractively valued at today’s prices.
LTAC Segment38% of Pro forma EBITDAR
An in-depth discussion of the nuances of LTAC criteria is beyond the scope of the write up; however,
several analysts have published extensive 50-100 page reports that are worth reading. To keep it
extremely simple, it is my opinion that the stock already reflects a worst case scenario arrived at
reducing reimbursement for Kindred’s census of non-compliant patients and assuming no capture of
incremental compliant patients (roughly 25% decline in segment EBITDA). On the other hand, there are
several offsets to criteria which have a high probability of allowing KND to mitigate the EBITDAR losses
that investors fear and even grow EBITDAR in the long run. For reference, management has guided to
keeping LTAC EBITDA relatively flat through the transition. While this could be slightly optimistic, one
misunderstood aspect of criteria is that it should cause a mix shift towards higher acuity higher CMI
patients which carry higher margins so replacing lost census is not one for one. Additionally, the removal
of the 25 day LOS requirement for MA patients should open up incremental patient opportunities for
the LTAC operators and the 50% rule should force non-profit and regional providers out of the market
which should drive census KND and SEM’s LTACs which already serve a higher acuity patient than the
rest of the industry. Additionally, post-acute services investors will remember the benefits that the
codification of criteria had in the IRF industry starting in 2004 that was significantly beneficial to
industry. Some industry participants believe codification will lead to increased utilization of LTACs by
referral sources as previously doctors were unsure exactly which patients CMS wanted to treat in LTACs.
In the valuation section I will demonstrate that the intense fear around LTAC criteria is already priced
into the stock and there are several reasons to believe that post- criteria results will be better than
Kindred at Home (KAH)31% of Proforma EBITDAR
Home health reimbursement has unprecedented visibility as we are entering the later years of rebasing.
Hospice margins are relatively high but commentary from CMS is positive. Organic volume growth in
home health of 6.5% in Q2’15 demonstrates the growth opportunities for this business. Hospice
volumes are a potential opportunity to improvement as they have recently stabilized census following
challenging integrations at the predecessor GTIV. While I use EBITDAR above, it is fair to say that KAH’s
contribution to FCF is actually higher than EBITDAR due to the lower rent and capital burden that
characterizes the home health business.
Rehab (IRFs + contract therapy)19% Proforma EBITDAR
IRF reimbursement was codified in 2004. There should be natural continuation of volume growth in IRF
as well as growth opportunities through additional IRF JVs that will come on line over next few years.
While bundling could impact this business, these tests are still very early and KND should be well
positioned given their emphasis on integrated care. The contract therapy business was weak in Q2, but
that was due to consolidation in the space and should be 1x in nature.
Skilled Nursing (SNF)12% of Proforma EBITDAR
While the OIG recently issued a report on SNFs, OIG has put out similar reports in the past without any
changes and SNF represents <15% of KND proforma EBITDAR and reduction in SNF census likely pushes
increased patients towards Kindred’s home health segment.
With F2015 guidance for core EBITDAR of $1.025B, KND is ~5x levered on an EBITDAR basis (@6x) and
trades at ~6x 2016 consensus EBITDA and EBITDAR. On an adjusted cash EPS basis KND is guiding to
$1.80 in F2015 or 7x adjusted proforma earnings.
On a FCF basis KND put out guidance for 2017 when they made the GTIV acquisition. Using 86m shares
the low end of that range equates to $2.67 in FCF or a 20% FCF yield on current equity. FCF is my
preferred valuation metric and if KND can exceed $2 in FCF I believe there is upside to the stock.
Source: KND Presentation 
 Source: Susquehanna Financial Group
I typically do not favor sum of the parts valuations but given this one was nicely prepared by
Susquehana I borrowed it. I am comfortable with the multiples used and
the conclusion that we are creating the LTAC business at 3x EBITDAR, leaving significant margin of safety
regarding the LTAC transition.
1. LTAC Criteria: The implementation of LTAC criteria could create choppiness in LTAC results
which on the surface could drive volatility in KND stock but I don’t believe is enough to
completely break the stock. I estimate a low $2s FCF number for KND in 2016. Assuming the
worst case scenario $100m EBITDAR shortfall occurs that could take my FCF number to $1.40
which is still a greater than 10% FCF yield on KND equity which I believe is roughly fair value. In
this case the thesis wouldn’t play out, but I believe downside would be relatively contained.
2. Major changes in post-acute reimbursement. If CMS were to adopt more of an MA model, that
could create some uncertainty in KND’s business. Providers like KND could restructure costs in
order to make money and CMS understands the value of post-acute care (where else would
these patients be cared for?) but reimbursement is a risk to investing in healthcare services.
3. Management fails to achieve the GTIV synergies: I believe the synergy targets are reasonable
but should management fail to execute going forward that would likely reduce upside.


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.


Free Cash Flow 


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