Description

“Pediatrix Medical Group, Inc. (Pediatrix), incorporated in 1979, is a healthcare services company that focuses on physician services for newborn, maternal-fetal and other pediatric subspecialty care. At December 31, 2006, the Company's network consists of approximately 914 affiliated physicians, including 724 neonatal physician specialists who provide clinical care in 32 states and Puerto Rico, primarily within hospital-based neonatal intensive care units (NICUs), to babies born prematurely or with medical complications. Its affiliated neonatal physician specialists staff and manage clinical activities at more than 289 hospitals, and its 80 affiliated maternal-fetal medicine  subspecialists provide care to expectant mothers experiencing complicated pregnancies in many areas where its affiliated neonatal physicians practice. The Company's network includes other pediatric subspecialists, including 58 pediatric cardiologists, 36 pediatric intensivists and 16 pediatric hospitalists.”

Company provides healthcare for infants and has recently branched out into anesthesiology. The company has a good business model as it is the largest company in its sector and there are no large scale direct competitors. Currently they have about 30% market share in terms of physicians employed and have traditionally faced little competition.

The company’s business is hospital based. PDX will go into a hospital, hire the physicians based there, which then provides it access to the patients and related personnel that are at the particular hospital. The doctors act as a ‘gateway’ so to speak into the hospital, and once the company has a contract with the hospital it is able to use the hospital’s equipment etc, minimizing the need for upfront capital investment by PDX. This model is also beneficial in that patients are usually linked to hospitals in these situations, not particular doctors, so in the event a physician leaves the employ of PDX, his or her patients are likely to stay.  Selling their practice to PDX is attractive to doctors because PDX uses all cash in its acquisitions, allowing doctors to monetize the investment they have made in building up their business. This hospital based model also makes the move into anesthesiology easier.

The infant care business is attractive as it is year round. There is a slight slowdown around the holidays, but at the same time people can’t particularly plan when their baby is going to be born, so it is hardly cyclical. Secular trends in the business are also attractive as more women use fertility products and thus are at greater risk for premature births.

The investment case for PDX is growth for cheap valuation. The company has been able to propel earnings/revenues through acquisitions of physician groups in its space. EPS grew 33% in 2003, 15% in 2004, 17.8% in 2005, and 10% in 2006. Long term the company has been able to grow earnings at a rate greater than 15%, and we believe this rate is sustainable in the future for a few reasons. The company faces essentially no competition as it acquires physician practices with infant specialties,  premature/low birth weight babies are on the rise in the US at over 12% annually according to the CDC, and possible anesthesia opportunities (the anesthesiology market is ten times that of PDX’s core business). The company has been able to fund its acquisitions using its large amount of free cash flow and generally hasn’t had to layer on significant debt. It currently has minimal long term debt and an undrawn credit line of $225 million.

The stock recently had an overhang due to an internal options investigation, but this has been rectified.

PDX does not have direct comps. Two other companies with similar business models to PDX but in different industries are VCA Antech and American Dental Partners, which trade at 17.4x and 24.3x 2008 EPS respectively, vs. PDX at 17x. Given the company’s growth prospects, it should trade at a premium of 19-20x, or around $66 on estimates that could prove conservative if new business ventures add to EPS more quickly than estimated.

On an EV/EBITDA basis, the stock currently trades at 10x 2008E EV/EBITDA. Logically, due to its strong free cash flow and lack of debt, PDX should trade at a higher multiple than traditional 6-9x of hospital companies. A 10-12x seems appropriate for the company given its strong revenue/earnings growth. At 12x, the company would be worth upwards of $70.

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