U.S. Physical Therapy, Inc. USPH S
October 15, 2018 - 4:47pm EST by
2018 2019
Price: 110.00 EPS 2.52 2.79
Shares Out. (in M): 13 P/E 42 38
Market Cap (in $M): 1,394 P/FCF 31 30
Net Debt (in $M): 34 EBIT 59 65
TEV (in $M): 1,547 TEV/EBIT 26 24
Borrow Cost: General Collateral

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Summary Thesis  

  • Low organic growth healthcare roll-up run by former HealthSouth executives, who are selling stock

  • Economics began deteriorating several years ago - no synergies/scale benefits as payers are regional, and physical therapists are large variable cost; reimbursement per visit has been flat; volumes are low growth due to capacity constraints; and cost pressures are inflationary

  • SEC began a correspondence that resulted in a material weakness in internal controls in 2016 (correspondence began when margins began to experience pressure) related to treatment of minority partners' stakes

    • Accounting changes related to minorities arising from deals are ongoing

  • M&A

    • Deal revenue multiples from company press releases and management's communication on deal EBITDA multiples from earnings calls imply ~23% target margins vs. 16% consolidated margins that are declining

      • Suggests that either 1) target margins are overstated (if USPH is acquiring higher margin businesses with cash, then the deals should be accretive to EBITDA) or 2) the existing business is deteriorating

    • Minority stakes have a put right and are a knowable liability with a maturity for USPH - limits further M&A capacity as these options are essentially debt obligations (covenants only permit $50m in M&A per annum today)

    • Valuation more than discounts potential future M&A and risks associated with constant accounting changes / management’s HealthSouth heritage



  • Market Cap: $1.4b / Enterprise Value: $1.5b / SI: 4.7%

  • Business: largest public pure play outpatient PT clinic owner

  • Footprint: ~600 clinics in 41 states

  • TAM: ~16k-18k clinics / ~$30b / growing at ~5% (according to USPH management)

  • Competition: Select Medical 1,600 clinics, ATI 700 clinics, eight of top ten PT groups PE-owned

  • Payer Mix: 52% private/managed care, 27% Medicare and Medicaid, 14% workers comp and 7% other

  • TSR: in excess of 900% since Q3-03 when current management took over vs. <300% for S&P

Weak/Deteriorating Economics

  • Low Organic Growth

    • Visits per day per clinic: grew 3.7% from 2015 to 2017, but H1-18 dropped to 2.3%

      • Capacity: constrained by physical space and number of therapists

      • Incrementals: variable expense component for therapist time so operating leverage is modest

    • Net patient revenue per visit: flat at $105.28 in '15 vs. $105.05 in '17, $105.67 in H1-18

  • Declining Margins

    • Gross Margins: 2006-2014 average 25.6%, 2014 25.4%, 2017 22.2%

    • EBITDA Margins: 2006-2014 average 17.3%, 2014 17.5%, 2017 15.8%

    • EBIT Margins: 2006-2014 average 14.5%, 2014 15.3%, 2017 13.5%

    • Likely result of rent escalators, increasing labor costs, other inflationary cost items, etc. vs. inability to increase pricing; potentially margin dilutive non-core acquisitions (see below); capitalizing seller salaries by giving them greater liquidity at time of deal in exchange for reduced compensation during 3-5 yr lock up (?) - feels very much like PPMs

    • Accounting changes have arisen as margins have dipped since 2014

  • Declining Returns

    • ROA: 2006-2014 average 14.4%, 2014 12.3%, 2017 9.0%

    • ROIC: 2006-2014 average 16.6%, 2014 14.1%, 2017 10.2%

    • Not solely a result of declining margins

      • Goodwill CAGR >20% last five years (~2% resulting from a write-up as result of restatement, but even excluding the write-up 20% CAGR) vs. revenue CAGR ~11% resulting in lower asset turnover

      • Goodwill and intangibles are >75% of balance sheet assets

Dependent on M&A

  • Clinic Growth Driven by Acquisitions

    • 578 clinics at the end of 2017, up from 368 in 2009

      • M&A: 189 clinics acquired (90% of increase); 29 acquisitions since 2005 ranging from 3-52 clinics from investor presentation

      • De Novo: 21 net openings

        • Company doesn’t disclose openings and closings in 10-k

        • Instead sporadically discloses in press releases or on calls; frequently only discusses gross de novo openings without mentioning closings

    • Over the last five years:

      • ~$140m on acquisitions

      • ~$15m to settle mandatory redeemable NCI

      • ~$4m for other acquisitions of NCI (more on minorities below)
        vs. capex of ~$30m

    • Amortization: M&A required to grow so amortization of acquired intangibles should be thought of like depreciation of PPE; large allocation to goodwill means much of the M&A is never expensed

  • Moving into Lower Margin Adjacencies?

    • March 2017, acquired 55% of “workforce performance solutions” / “industrial injury prevention” (onsite injury prevention, ergonomic assessments, etc.) business for $6.2m in cash and $0.4m sellers note

      • Generates mid-teens gross margins vs. the legacy physical therapy business in the low-20%s

      • Runway for multi-clinic group M&A slowing? Fewer multi-clinic groups to move the needle?

    • May 2018, USPH made second acquisition in the industrial injury prevention business, paying $9m for a 65% stake in a business with $5.7m in revenue during 2017 (revenue multiple = ~2.4x vs. ~2x paid for PT clinics on average, and PT is higher margin)

Accounting Issues / Misleading Optics

  • Overview of Clinic Partnerships

    • When USPH acquires clinics it usually takes a 1% GP interest and a 49%-99% LP interest in the acquired clinic or group of clinics

    • The managing therapist / group owner retains the remaining LP interest

    • USPH management sees this as a way to align interest with therapists as partners

    • USPH makes the therapist sign a non-compete

    • The therapist gets a put right and USPH a call right, both fixed at the multiple at the time of the initial acquisition of the controlling stake, for the minority interest – the accounting for these partnerships has been in constant flux the last several years

  • Material Weakness Summary Thoughts


    • SEC correspondence resulted in a material weakness in 2016

    • The material weakness initially forced USPH to mark all minority stakes to FMV (as opposed to the old treatment, whereby only the interests whose put rights had reached maturity needed to be marked), and the changes in FMV flowed prominently through the income statement as a reduction to NI for increases in FMV and vice versa

    • Subsequently, USPH changed the language in its partnership agreements in such a way that the accounting treatment more or less reverted to the pre-SEC correspondence treatment

      • The language in the partner agreements switched from “required redemption” to “put” to allow USPH to move the minorities back from liabilities to equity and to remove the revaluations from the income statement (HOWEVER, THE EPS SHOWN MUST INCLUDE THE REVALUATIONS, EVEN THOUGH THE ACTUAL ADJUSTMENTS ARE SHOWN LATER IN THE FILING AS A FOOTNOTE)

      • If the economics of the partnerships deteriorate and USPH has to mark them down, the revaluations would reverse and be an add-back to NI and EPS…

        • My guess is that the company didn’t want to have these revaluations featured prominently on the face of the income statement, because noticing a reversal (to mark downs) would be very obvious

      • Despite margins for the business being under pressure, revaluations been positive

        • In 2017, USPH made fewer distributions to non-controlling interests

        • USPH added more to minorities (~$20m just from clinic deals / ignoring workplace performance) than they bought out in minorities (~$2.4m on the cash flow statement)

        • How does the fact that they grew their minority balance but paid fewer minority distributions match with positive revaluations?

    • What are the possible explanations for all the changes?

      • Incompetence: management has no idea what it is doing

      • Sleight of Hand: management is trying to obfuscate what is happening with the business (accounting issues date back to when margins began to deteriorate)

      • Necessity: accounting rules are actually confusing and mistakes / changes were honest / needed

What is FCF?

  • Minority Distributions and Payments to Settle Minority Interests

    • USPH includes both in the financing section of the cash flow statement

    • Operating cash flows are therefore higher than true operating cash flows available to common equity holders

    • LFCF to equity is ~$48m ignoring any further M&A or minority buyouts and only including current distributions to minorities (i.e., their share of income)

  • M&A Treatment

    • Continual M&A + redemption of minority stakes = little cash for equity holders

    • Purchase price largely allocated to goodwill and never gets expensed

      • Opening a PT clinic is not particularly hard

      • What happens to the relationships and client base when a PT retires or their contract is up? Should the amortization match the clinicians expected tenure?

      • Why shouldn't more of the purchase price be amortized?

    • Without M&A, USPH has little to no growth

      • Stop M&A: What would you pay for $48m in FCF on weak topline organic revenue and margin pressures? 10x?

      • Continue M&A: must account for cash requirements to do deals, buyout minorities, pay earnouts, etc. that are necessary to grow the business

        • Therefore, equity investor gets little cash post M&A today, and instead gets a long dated future cash flow stream that is more than discounted in the current valuation

  • Re-arranged FCF based on 2017 10-K for 2015-2017 and 6/30 10-Q for LTM is shown below (in Q1-18 10-Q the cash flow reporting was again changed)



Leverage Optics (another perspective vs. FCF)

  • Rationale for Minority as a Debt-like Liability

    • Put rights represent true obligation of USPH in a way that a passive minority interest without a put right would not – cause for material weakness, which required USPH to categorize the minority stakes as liabilities rather than equity

    • When puts are exercised USPH will have to fund with cash and/or new debt

  • Net debt / EBITDA Reflecting Minorities

    • Optically net debt appeared to be a modest 0.6x at 12/31/17

    • Adjusting debt to include minority interest (balance sheet amounts, which had reportedly been marked to then-current redemption value) shows leverage would have been 2.2x at 12/31

    • While not super-levered, the profile reflects a more restricted balance sheet than optics suggest

Management / Culture

  • HealthSouth Heritage

    • Three of the four senior management team members at USPH were employed by Healthsouth for multiple years up to 2003 amidst revelations around fabricated financial statements

    • USPH management tenure at Healthsouth:

      • Chris Reading (CEO of USPH), 1990-2003

      • Glenn McDowell (COO – West of USPH), 1996-2003

      • Graham Reeve (COO – East of USPH), 1995-2003

    • Questions about Healthsouth’s accounting surfaced as early as 2002 in a NYT article titled “Growing Concerns on the Health of HealthSouth”

    • The SEC filed accounting fraud charges against Scrushy in March 2003. He was acquitted by the local jury on initial fraud charges, but later was convicted for bribery and mail fraud

    • The company nearly went bankrupt and had to restate multiple years of financials, but shares had already cratered prior to 2003 (at which point USPH management was still employed there)

  • Glassdoor / Indeed Feedback Negative

    • Not flattering


  • Sellers of Stock

    • Christopher Reading, CEO – reduced stake 25% in May 2018, another 13% in August, down 40% since Sep 2017

    • Mark Brookner, board member – reduced stake 13% in Dec 2017 and another 4% in Mar 2018, down 15% since Sep 2017

    • Glenn McDowell, COO West – reduced stake 11% in Mar 2018, another 23% in August, down 40% since Aug 2017

    • Lawrance McAfee, CFO – reduced stake 13% in May 2018, another 12% in August, down 40% since Aug 2017

    • In H2-17 when this bout of selling started, shares were at ~$70

    • The three executive team members that have been with the company for more than a year have each reduced their stakes by ~40%


  • Record Valuation Multiples

    • Despite lackluster organic growth, margin pressures, declining returns, recent material weakness in accounting, changing treatments for the minority stakes that leave room for games, management stock sales, etc., valuation has expanded dramatically to or near all-time highs



  • M&A Context

    • USPH Q1-17 Earnings Call

      • “We’re seeing deals go to 7.5x to 8.5x that are deals of decent sized EBITDA”

    • Select Medical Relevant Scale Deals (competitor deals)

      • Jun-15 Select Medical and Partners / Concentra

        • Diversified but with occupational medicine and physical therapy component

        • $1.1b transaction value

        • 11.7x LTM EBITDA pre-synergies / 6.7x FY+1 EBITDA post-synergies

        • Poorly run by Humana – brought EBITDA margins from 9% to 16% in under two years

        • EBITDA margins now approximately in line with USPH

        • Select Owns 50.1% of Concentra

      • Mar-16 Select Medical / Physiotherapy Associates

        • Pure-play outpatient physical rehab group

        • $406m transaction value

        • 2015 EBITDA was estimated to be around $33m and synergies were targeted at $20m implying 12.3x LTM EBITDA pre-synergies / 7.7x EBITDA post-targeted-synergies

        • Does not highlight this deal’s performance in investor presentations like it does for other acquisitions as therapists departed after the close of the deal causing disruption

        • On the Q3-17 earnings call the company said that these clinics did just $5m in EBITDA for the period

      • Feb-18 Concentra / U.S. Healthworks

        • Diversified but with occupational medicine and physical therapy component

        • $753m transaction value

        • 11.3x LTM EBITDA pre-synergies / 7.5x EBITDA post-targeted-synergies

    • Private Equity a Buyer of USPH?

      • Already a number of competing platforms in the space

        • KRG Private Equity then Advent International – ATI Physical Therapy

        • Welsh, Carson, Anderson & Stowe – part-owner of Concentra (Select Medical)

        • Court Square – exited Physiotherapy Associates in sale to Select Medical

        • CI Capital Partners / InTandem Capital – Pivot Health Solutions

        • Celerity Partners – 360 Physical Therapy

        • Sterling Partners – Results Physiotherapy

        • BDT Capital Partners – Athletico

        • Pharos Capital – Motion PT Management

      • If USPH was a likely target, would management be selling stock?

      • Many PEs already have their own platforms - unlikely to pay 20x+ EBITDA when they can do deals at 8x

    • USPH's M&A Capacity as a Buyer

      • ~$80m in revolver capacity

      • Loan covenants prohibit spending more than $51m on M&A in a year

      • Company says multi-clinic groups are going for 7.5x-8.5x

        • At 8x and $50m/year in deals that would add ~$12.5m to EBITDA over the next two years

        • At current 2019E EBITDA of $67m + $12.5m for deals, the EBITDA multiple is still ~20x (assuming Street has zero value for M&A in consensus)

      • Even if the company took leverage to 2.5x in a single large deal (which with the minorities would be closer to 4x), it would still be trading at ~17x EBITDA

        • Implies ~$200m in deals, which is not currently allowed under covenants in the first place

      • Recent communication regarding M&A does not square

        • Has paid ~1.9x revenue for clinics since 2015

        • Said on Q1-17 call that larger clinic groups trade for 7.5x-8.5x EBITDA

        • Implies ~23% EBITDA margins for therapy clinics

          • Company EBITDA margins are well below this and declining (~16%)

          • Parent has some corporate expenses but also takes management fees from acquired clinics - if you remove other revenue (mostly management fees) and add back all corporate you are still at <20% EBITDA margins, which means that deals should be accretive (but margins are declining)

          • Either old business is doing much worse or deal margins are overstated

    • Price Target

      • At a generous 18x LTM free cash flow after minorities but pre-M&A (again, required to grow FCF), shares would trade at $68 or >35% downside


Appendix I: Accounting Treatment of Minorities

Note: accounting language / treatment has been repeatedly changed the last several years; but the basic economic relationship to focus on is that USPH has minority partners, who are 1) entitled to a share of profits from the clinics in which they are partners and 2) hold put rights for their equity stakes based on trailing 12-month EBITDA when they exit and the multiple originally paid at the time of the purchase

  • Pre-Material Weakness Treatment

    • B/S

      • Two equity accounts: 1) “non-controlling interests” and 2) “redeemable non-controlling interests”

      • The “redeemable” bucket represented the amount that had a currently exercisable redemption right (i.e., enough time had elapsed to allow the minority holder to sell its stake to USPH)

        • This account required an adjustment to reflect fair value

      • Changes in redemption value where charged directly to additional paid-in capital

    • I/S

      • Net income explicitly deducted the portion allocable to all non-controlling interests at the bottom of the income statement

      • The company was also required to provide an EPS numbers that reflected the change in the value of the redeemable portion separately at the bottom of the income statement

    • CF

      • Started with net income to all shareholders (i.e., before minorities)

      • Acquisitions of non-controlling stakes were in investing activities

      • Distributions to non-controlling (including redeemable) were in financing

  • Treatment Arising from Material Weakness

    • B/S

      • The notes on the restatement in the Q4-16 press release suggested that all future minority stakes at the time of an acquisition would be included in “Mandatory redeemable non-controlling interests” in liabilities because that is the proper accounting for “required” redemptions (i.e., what is now the “put”)

      • The reported amount would be revalued by the change in the redemption value each quarter

    • I/S

      • The revaluation of the minority interests were reflected in the income statement each period as “Mandatorily redeemable non-controlling interests - change in redemption value” and minority income for these stakes was included in “Mandatorily redeemable non-controlling interests - earnings allocable”

      • Hence, EPS would reflect all revaluations as opposed to just those that were done on the portion whose “redemption” had reached the point in time where it could be exercised

      • However, the line for “Net income attributable to non-controlling interests” remained on the income statement and did not decline much despite the change in the categorization of the bulk of the minority interests? Why was this income statement amount still meaningful (early partners without put right) against a small B/S account left over for the line item “Non-controlling interests” that was not moved with the rest of the NCI?

    • CF

      • Started with net income including the “mandatorily redeemable” items but not the “Net income attributable to non-controlling interests” that remained on the income statement

      • Adds back an amount for “Increase in mandatorily redeemable non-controlling interests” in operating activities that is close to the revaluation amount in the income statement (i.e., OCF looks like it is lower by approximately “Mandatorily redeemable non-controlling interests - earnings allocable”)

      • Acquisitions of non-controlling stakes were split between “Acquisitions of non-controlling interests” in investing and “Payments to settle mandatorily redeemable non-controlling interests” in financing with most of the total amount in the latter, thus reducing investing cash flows (the sum was the same as the individual line previously)

      • Distributions to non-controlling in financing were reduced by approximate amount included for the “mandatorily redeemable” portion in net income and OCF

    • All statements were restated to reflect these conventions with a write up to goodwill

      • My guess is that this reflects the fact that the mandatory redeemable NCI was brought to market value and so the increase in the liability was greater than the reductions to the NCI in equity, although there was also some amount for deferred tax liability as well

  • Reclassifications Post-Restatements Arising from Material Weakness

    • After the material weakness the company amended its partnership agreements from a “required redemption” to a “put right” and reclassified the non-controlling interests from “Mandatory redeemable non-controlling interests” in liabilities, back to “redeemable non-controlling interests” in equity

      • Change was made for 12/31/17 balance sheet

    • Q4-17 earnings call has a brief paragraph on the change in the prepared remarks and a confused analyst exchange (since all the accounting had just changed…and was now changing again)

    • But it doesn’t actually go back to how it was…the published EPS number for Q1 doesn’t tie to the NI and the share count:

    • Instead it reflects the full revaluation outlined further below in the 10-Q:

    • Previously (i.e., before the material weakness), only the exercisable portion was an adjustment to EPS and it was located right below the income statement:

    • In practice, the put still requires USPH to acquire the minority stake – isn’t this just semantics???


Appendix II: Selected Glassdoor and Indeed Quotes

  • Glassdoor Selected Quotes

    • “The Regional Leadership complained frequently about USPH, lack of support, lack of transparency, constantly shifting numbers, standards so that did not set a very good..."

    • “Understaffed and expect the staff to do the work of 2 or 3 people while handing out more duties for them to handle”

    • “The workload for one person to do was of at least three people.”

    • “Former HealthSouth management team runs this very much the same way, only taking care of upper level management, promising but not delivering and productivity focused not quality focused.”

    • “This company is stuck in the stone age of health care. Literally. No electronic documentation system.”

    • “Arrogance creates a divide between management and the worker bees. Makes a person feel less hopeful and valuable. Not worthy of the club. The dishonesty is the biggest insult”

    • “For investors, stay away from this company. It is being built on a house of cards. They are rapidly acquiring new groups and clinics without the infrastructure to support it.”

    • “The IT systems are horrible. We had a good system in place and were forced by the IT director to change systems. Now we don't have a decent scheduler and none of our notes are electronic. We were told by IT that we were going electronic and that still hasn't happened. Accounting is just as bad. We have had services shut off due to our bills not being paid.”

    • “Unethical business practices. Micromanagement to the extreme.”

    • “Everything. Documentation, billing, marketing, management all terrible. I second the opinion of another poster, it's a good ole boys club.”

    • “Shady business practices are common.”

    • “It makes little to no sense to partner with a company that is going to take the majority of the profits (and that makes you sign a 10 mile noncompete). Opening up your own practice is not as hard as you think nor does it take that much of a capital investment. There are plenty of books and courses on how you can go solo.”

    • “The management fees are exorbitant and their accounting is difficult to understand. Maybe the shareholders do well with the partnership setup but I never met an owner who loved their experience.”

  • Indeed Selected Quotes

    • “From over 10 years experience with USPH, I can tell you prior comments about patient load being too high are correct. Prior comments on low pay are also correct. Comments about the cost of back office expenses being too high are correct. The company is advertised as allowing the director to run his own clinic; however, you find out after the fact it has to be within their model."

    • "Very closed minded company and majority of the top executives came from HealthSouth and we know how that company turned out.”

    • “Great idea being able to have your own clinic but in the end the corp dictates how it is operated….Their management fees are outrageous and prohibit profit for the clinician unless you see 20+ patients /day.”

  • Sources: Glassdoor, Indeed

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.


Need bigger deals to move the needle, diversification into lower margin businesses hurts profits, multiple minority holders exercise puts at the same time if the economy softens, further SEC correspondence (?)

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