|Shares Out. (in M):||195||P/E||8.3||7.3|
|Market Cap (in $M):||22,928||P/FCF||7.6||7.2|
|Net Debt (in $M):||7,955||EBIT||3,975||4,033|
Buy McKesson (MCK) and short Cardinal (CAH) to capture MCK’s upcoming Change Healthcare (CHNG) IPO catalyst coming up imminently in Q2. This is more an event driven, pair trade. Although if you really want to be a contrarian / value investor, you can also buy MCK outright, since I think there are a lot of headwinds & bearishness priced that will likely abate.
I prefer the pair trade in the short term to play the upcoming IPO catalyst over the next few months.
I think the upcoming Change Healthcare IPO could lead to a 5-10%+ pop in MCK shares. Hedging with CAH takes out pretty much all of the industry and most the idiosyncratic risk. And it’s a pretty short term catalyst, which makes the setup pretty attractive
- MCK is quite cheap at 7.25x EV/fiscal 3/31/2020 EBITDA, 8.4x P/E, and 13.2% FCF yield.
- Admittedly, there are many cyclical and secular headwinds including declining generic drug prices and a shrinking generic drug market, reimbursement pressure, margin pressure, drug price pressure, and customer pressure.
- Without stock buybacks, MCK's organic EPS growth is basically flattish YoY. Since it's not growing and facing many risks, it arguably should trade at such a low multiple. With buybacks and acquisitions, they’re growing EPS at around a 6% CAGR
- MCK is also facing many large near term uncertainties ranging opioid liability, government changes to drug rebates and drug pricing,
- admittedly, the Change Healthcare IPO is fairly well known so an IPO wouldn't really be a surprise catalyst. They announced the IPO in October 2018 and updated the S-1 in April. And they’ve been talking about spinning it for years.
- However, in chatting with sell siders and buy siders, it comes up in roughly 1 in 10 conversations and people aren’t focused on it. Expectations for the IPO are fairly low, so if they can spin the story well in a hot IPO market, I think this could surprise to the upside
- again this isn’t a huge needle mover. Maybe it could lead to a 5-10%+ rise in MCK shares. But for a short term trade, in a very beaten down stock and under owned subsector (3% of the float is shorted), I think it’s interesting, especially if you hedge out the sector risk by shorting CAH if you want
For a longer term value trade, I think the market is pricing in too much negativity for MCK’s core business, much of the overhangs likely abate with minimal impact to MCK (e.g. opioids, changes to rebates), and generic deflation is stabilizing and seeing inflation in some circumstances
- I think there’s possibly 75% upside in MCK’s stock over a year (details below)
- although I’d wait till after the CVS contract renewal with CAH and MCK is announced (expires 6/30/2019) before getting outright long MCK. I think CVS likely renegotiates lower pricing with CAH and MCK
- Furthermore, the entire healthcare sector is under pressure from concerns about a shift to universal healthcare, and is currently experiencing a rotation outflow into more cyclical sectors
- I think these concerns are overdone and the sell off is likely more due to rotation into more cyclical sectors, which I think is a buying opportunity
Change Healthcare IPO details
McKesson (MCK) is IPOing Change Healthcare (ticker CHNG), expected to happen this quarter
- Change Healthcare is ~10% of MCK's earnings. It's accounted for by the equity method in MCK's financials and included in EPS. But it's not consolidated in financials
- this isn't too much of a surprise since it's been talked about for years (they were talking about spinning it to shareholders before) and the IPO was already announced in October 2018
- they also approximate the value of Change Healthcare on their balance sheet at $3.6bn.
- at $3.6bn, they're valuing it at 11.75x LTM EBITDA, which is admittedly a rather a full / maybe overvalued multiple in my opinion
- overall, the IPO should be value enhancing since MCK (and peers Amerisource - ABC and Cardinal - CAH) trade at around 7x-7.5x EV/2019 EBITDA, but Change Healthcare is maybe worth around 9-10x EV/EBITDA in my opinion (similar to the valuation range people are using for a similar company Conifer - which is owned by THC). I wouldn't be surprised if it's worth more though given the IPO market and ability to put a positive narrative / spin on the company.
- Healthcare investors love healthcare spins/subsidiary IPOs since they’ve generally worked well, e.g.:
- Elan is working well,
- Zoetis was a home run,
- Alcon seems great,
- Bioverativ spun out of Biogen was spun out at $45 and taken out a year later by Sanofi for $105
- Baxalta was spun out of Shire in 2016 and sold to Shire for a 45% return
- Abbott’s spin of AbbVie has worked out well
- Mead Johnson was a grand slam after IPOing out of Bristol Meyer at $25 and purchased by Reckitt Benckiser at $90
- Why have these healthcare spins generally worked? Because they’ve generally been mismanged or underallocated within the parent conglomerate, they’re allowed to focus on their own, and they the long term tailwinds of secular healthcare growth. They aren’t spinning off junk to get rid of it..They’re creating value
- Admittedly, LTM EBITDA for Change Healthcare was $928mm and it's had no rev or EBITDA growth.
- however, similar to Elan, I think they can create the narrative that there’s much room for operational and managerial improvement and they could gain a higher multiple
- there were reports that it could IPO for $12bn, i.e. 12x $1bn of EBITDA, since the healthcare services group trades at around 12x EBITDA, but I think Change Healthcare is worse and less special than peers and deserves and discount
- Sum-of-the-parts valuation on EV/EBITDA post IPO
- valuing the core MCK business at 7.25x, and Change Healthcare at 10x LTM EBITDA = $9.3bn valuation for Change), i.e. maybe the IPO could lead to a ~5% pop
- using the $12bn valuation for Change ($12x $1bn of EBITDA, giving them credit for a return to future growth), it could be a ~13% pop
- As noted above, the market loves healthcare spins and could put the $12bn valuation on it in the short term
- Change Healthcare has $5.7bn net debt and is ~70% owned by MCK (rest owned by Blackstone and Hellman & Friedman)
Change Healthcare history / details
- it's a healthcare technology company that provides software and analytics used by hospitals, physicians, pharmacies, healthcare providers and insurers
- they help healthcare providers increase patient access, ensure clinically appropriate care, and manage claims and payments across the revenue cycle.
- their payer solutions address payment accuracy, consumer and member engagement, network management, and the transition to value-based payment.
- their consumer solutions provide digital tools to help patients access their personal information and make choices based on quality, cost, and convenience.
- in layman’s terms, this basic stuff that the entire healthcare industry needs to improve given all the poor billing and collections and confusion across providers and patients. Also simply enabling better collection and transfer of data, test results, images, etc has a lot of room for improvement. It’s not really all that sexy or special, but there’s much room for growth in this industry as healthcare providers and payers need help improving all the basic plumbing of getting and paying for healthcare
- there are a lot of companies doing this. Conifer (owned by hospital Tenet Healthcare - ticker THC) has a similar division with similarly mediocre financial performance and has been trying to sell that division for years without any luck. UNH has a similar division as well, etc.
- in fiscal 2018. Change Healthcare served 2,200 government and commercial insurance payers, 900k physicians, 118k dentists, 33k pharmacies, 5.5k hospitals, and 600 labs. They facilitated $1 trillion in adjudicated claims and 14bn healthcare transactions
- over the last 9 months, revs were -0.5% YoY, and EBITDA was -2% YoY, pretty mediocre results
- they're been investing in systems and process to realize synergies, which has been depressing margins
- it was formed in 3/2017 through a merger of McKesson's technology solutions business with Change Healthcare (which was owned by Blackstone and Hellman & Friedman). MCK got 70% of the the combined company
- Blackstone originally bought Change Healthcare in 2011, it was formerly known as Emdeon
- Underwriters are GS, Barclays, and JPM
- They filed an S-1 on March 15, 2019, and an amended S-1 on 4/5
Services they provide: