Description

Triad, through its affiliates, owns and manages hospitals and ambulatory surgery centers in small cities and selected larger urban markets. Upon closing of a pending acquisition of 4 hospitals, the Company will have 55 hospitals (including two under construction) and 14 ambulatory surgery centers in 17 states with approximately 9,610 licensed beds. In addition, through its QHR subsidiary, the Company provides hospital management, consulting and advisory services to more than 200 independent community hospitals and health systems throughout the United States.

The largest company in the industry, HCA, was the subject of an excellent VIC write-up a few months ago. Triad was spun out of HCA back in 1999. Without rehashing all of the macro industry issues that I believe are positive for the entire hospital universe, I favor Triad because of its compelling growth strategy, attractive market share in low HMO penetrated markets, and its 15-20% P/E and EV/Ebitda discount to its hospital peers.

Despite the recent share price rebounds, hospital companies have had a rough year as Tenet’s problems, increasing bad debts, and disappointing patient volumes have weighed on share prices. Although these are very real problems, I see demographics as a strong macro positive that ultimately outweighs the near-term issues of a more restrictive managed care environment and a soft economy. This has created an opportunity, with the hospital group now trading at about 7.2x estimated 2004 ebitda, and Triad trading at 6.2x estimated ebitda of $650 million. This is on the low end of the industry’s historical range.

Focusing on small cities like Victoria, Texas and Fayetteville, Arkansaw, Triad occupies a middle ground between the rural hospital operators and the larger urban hospital operators like HCA and Tenet. This is a good combination of the reduced competitive environment of the rural operators, with larger volume opportunities of small cities with 35,000-250,000 people.

Triad’s major growth driver is doing JVs with existing not-for-profit (NFP) hospitals. Their stated goal is to add 4-5 hospital each year by partnering with NFPs. There is a huge need for this as 85% of the 4,700 U.S. hospitals are NFPs and 50% of those are in some kind of financial distress, without the ability to expand, renovate, or recapitalize. Most NFPs don’t want to sell, so a capital partner like Triad is a preferred alternative. In a typical deal Triad will become the majority owner of a market leading, low margin, formerly NFP hospital. Triad brings the growth capital, manages day-to-day operations, and brings scale to supply purchasing, and managed care negotiations. The JV hospital becomes for-profit and there is generally greater potential to improve operating performance when partnering with an NFP vs. buying a for profit hospital that has high margins. This results a win for the NFP and Triad. Triad is pursuing this NFP partner strategy more aggressively than any other hospital company and is becoming known in the industry as the NFP partner of choice. According to management, Triad has a strong pipeline of these development opportunities and is being contacted by new potential NFP partners weekly. Adding 4-5 of these deals per year in attractive markets is very achievable and will make a meaningful contribution annually to the current 55 hospital company.

Triad also enjoys one of the best competitive positions within its respective markets in the industry. Only rural provider LifePoint has a greater average market share than Triad’s 41%. By comparison, HCA’s average market share of admissions is 32%.

Management are primarily HCA alumni. CEO Denny Shelton is a well-regarded industry veteran.

The balance sheet is in decent shape. Triad has about $1.5 billion in debt, which is about 2.8x 2003 ebitda. Management has stated as its goal to reduce debt to 2.4x over the next few years. The company recently issued $600 million in senior sub notes at 7% to repurchase existing 11% debt.

Triad will do about $1.76 in EPS in 20030, which was depressed by a $50 M bad debt write off last quarter. Next year I expect the company to do at least $2.40 in EPS (other analysts range between $2.20 and $2.50), making the earnings multiple 18.6 x ’03 (14x adjusted for bad debt charge), and 13.7x ’04. This equates to about 6x ’04 ebitda, 1x book value, and little over 1x revenue. Through internal growth and JVs, I believe the company can grow earnings at least 15% annually over the next few years. My one-year target is $38, which is 16.5x ’04 eps of $2.30, and my three-year target is $50+. It should also be noted that Triad has considerable margin expansion opportunities. The hospital group is currently averaging 18% ebitda margins, while Triad is at 15%. Health Management Associates, which is the closest comp in terms of market sizes, is at about 22%, with HCA a little higher. Margin improvement would be incremental to my estimates.

Well run hospitals are good local franchises with long term value. Triad is the best positioned in the group given the competitive position it enjoys in its markets, current operating trends, growth opportunities through JVs, and strong management team. The new medicare bill also helps by providing improved revenue visibility. Their bad debt issue has been surfaced and reserved for and they have significant margin expansion opportunities to provide additional upside.

Catalyst

- revised guidance by the company in early January
- improving economic trends to provide some relief on bad debt and patient volumes
- steady earnings growth and new NFP deals