Description
UCI Medical Affiliates
Warning – This is a pretty thinly-traded stock. I’ve managed to put a fair bit of money into this, but it took time. This is not for you if you’re looking to put a million dollars to work before noon.
Introduction
5.6x Operating Income , 40% ROC and 60% Operating Income growth
My past VIC write-ups focused on investments whose success depended on value-creating catalysts. Whether it was the sale of the company, an operational turnaround or a deleveraging transaction, the potential catalyst in each situation was evident from the beginning. Thus, the task of the write-up was simply to argue that value-creating changes were imminent. UCI Medical Affiliates is a different situation. While I do address the question of why this stock is so cheap, in the end I can’t give a perfectly satisfactory answer. While my previous write-ups focused on situations that lent themselves to a short thesis and a spirited argument, this one is too simple for even a real thesis. To sum up, UCIA is cheap. . .very cheap. And it’s a good business. A very good regional niche business. How cheap? UCIA trades at 5.6x LTM EBIT. How good is the business? UCIA’s return on assets is over 40% and EBIT has grown 60% year-to-date. So it’s a good, growing business that trades for less than six times operating income.
Business Description and History
UCIA is not just a PPM, it’s a post-Chapter 22 PPM!
UCI provides non-medical management and administrative services for a network of 45 freestanding medical centers. 44 of these are in South Carolina and one is in Knoxville, TN. If you’re not familiar with PPM (physician practice management) companies, then you might be wondering about the phrase “non-medical management services.” Basically, UCI runs these medical centers, but because of laws governing the corporate practice of medicine, the company is organized so that UCI provides the non-medical services and the medical services are provided by a related entity that employs the physicians.
PPM’s were hot in the 1990s, when hot Wall Street money poured into dozens of these companies, most of which blew up in spectacular fashion. (VIC write-up OCA is a good example of a failed PPM.) I contend that PPM’s are not inherently flawed as businesses; they were just structured in really really stupid ways. The way most of these companies were formed was pretty simple: Wall Street financiers go to a doctor with a successful private practice, they say, “Hello Dr. Doctor, we’ve rolled up several of your peers into a network of practices. Why not join our network, leverage our relationships with health plans and our marketing capabilities, and in exchange for your assets we’ll pay you a ton of money and give you stock in the company which will surely go to the moon.” In the end, many doctors took the money, sold their stock if it went up, and then packed it in. Nobody had the incentives to work harder and many of the PPM organizations were so bloated and growing so quickly that any benefits from economies of scale were quickly cancelled out.
UCI, which runs 31 clinics called “Doctor’s Care” and 14 PT clinics as “Progressive Physical Therapy Services” was part of a large PPM that went bust in the late 1980s. It regrouped in the 1990s with some help from SC Blue Cross Blue Shield (we’ll talk about UCI’s relationship with BCBS-SC below), but then failed after an attempt to expand into Georgia and Tennessee. Throughout this time, the South Carolina sites performed well, and the company actually emerged from bankruptcy in 2002, with its stock unimpaired, after closing out-of-state sites and canceling non-SC leases.
Despite their history of failure, PPM’s are not inherently flawed. Given the right conditions . . . the right focused regional footprint, the right type of practice and the right types of consumers and doctors, a PPM could thrive and local economies of scale could exist. I think South Carolina, with many state-wide employers and a population spread over many mid-size cities, is a good region for a PPM. I think routine general medical care for illness and minor emergencies, with some occupational medical services, makes for the right type of practice that could benefit from regional advertising and brand-name recognition.
Additionally, I think there is an increasing number of doctors who seek out employment like the kind offered by Doctor’s Care. UCI doctors are paid hourly and they get a pleasant work environment with manageable hours. One of the first things that drew me to UCIA as an investment was the high retention rate of doctors during the bankruptcy. Many of the doctors now with the company were there when I first started looking at UCI in 2002. This is one of the data points that separates this company from other PPMs and has me most optimistic about UCI’s future.
Doctor’s Care clinics offer routine care of illness, infections and other general medical problems. They treat injuries like fractures, sprains and dislocations, and they can perform minor surgeries such as suturing lacerations and removing cysts. All these services are performed for a fraction of the cost of going to the emergency room, and the clinics keep extended hours. 49% of UCI’s revenue comes from managed care insurance, 12% comes from direct patient pay, 9% from HMOs and only 8% from Medicare/Medicaid.
UCI’s sales and profits have been steadily growing since the company emerged from bankruptcy. 2005 featured the first significant increase in advertising since the bankruptcy and the results have been staggering. For the first 3 quarters of FY 2005, sales are up 18% (with the benefit of only two new clinics) and operating income is up 60%. While 2005 has featured the most pronounced sales growth, the previous two years exhibited sales growth of 9% and 13% and operating income growth of 11% and 173% (improvement in 2003 over the bankruptcy year 2002). Even without increased advertising, UCI has been gradually gaining business.
Valuation
UCI has 9.9MM diluted shares outstanding, which at $2.85 a share results in a market capitalization of just over $28MM. The company has been steadily paying down debt and post-petition (mostly tax) liabilities over the past few years. They’re down to about $5MM in debt. They also have a little bit of excess cash (maybe half a million) and a $3.75MM deferred tax asset resulting from net operating-loss carryforwards that expire from 2019 to 2024. Last year, the company determined that the DTA would be realized and they wiped the valuation allowance off their books.
Since I’m looking at an EBIT multiple, I’m going to go ahead and deduct the tax asset from enterprise value, which brings our figure to $28.75MM.
LTM Operating Income was $5.15MM, resulting in a TEV/EBIT multiple of 5.6.
Capex for the last twelve months was around $2MM, which exceeds depreciation by about $1MM. Normal capex, in years when no new clinics are built, seems be around $800k. Still, even if we assume the last twelve months’ $2MM in capex is normal going forward, UCIA trades at less than 7x EBITDA minus capex.
I come up with around 11MM-13MM for net tangible assets, so EBIT/net tangible assets comes to 40% to 47%.
Obviously, this business collects receivables slowly, so CFO has lagged EBIT as the receivables line on the balance sheet has ballooned (receivables is the largest component of net tangible assets). Still, LTM CFO + cash interest comes out to about $4.7 million (6x multiple) and subtracting $2MM of capex leaves us a 10.6x multiple. That is a 10.6 multiple of free cash flow that includes a large growth capex component and is poised to grow rapidly as the past year’s success on the income statement manifests itself into operating cash flows. Thus, I think by every metric, UCIA is cheap.
Liquidity of stock
UCIA has a small float and trades very thinly. Still, there are no 5% holders other than BCBS-SC, and there is a fair bit of stock out there to buy. I’ve been patiently buying for several years and I even managed to land a 100K block of shares once. Several market makers dabble in the name and I think with a little bit of patience you can build a position.
So why is the stock so cheap?
UCIA is a micro-cap post-bankruptcy company that participates in a much-maligned industry. Nevertheless, I think the explanation for the stock’s low market valuation is that BCBS-SC, the largest health insurer in the state, is the majority shareholder in UCI. Blue Cross Blue Shield South Carolina accounts for 39% of UCI’s revenues, occupies most of the seats on the company’s board and basically can control UCI’s fate. In addition, nobody on the board holds a meaningful position in UCIA stock and there is little reason to believe they would run this company for anyone’s benefit but BCBS’s. Why not expand rapidly at the expense of minority shareholders and give their members greater access to cheaper service in the form of Doctor’s Care?
While on the surface it may seem like the fate of a minority shareholder in UCIA is a bleak one, a little digging provides evidence to the contrary. First, we have the assurance of management. This doesn’t have me screaming for joy, but at least they have assured me that they are committed to the interests of minority shareholders. Second, we have the behavior of BCBS. They aren’t paying themselves huge fees to be on the board of this company, they aren’t pushing the company into rapid growth, and to date they haven’t done a single thing to benefit themselves as South Carolina’s largest health insurer at the expense of themselves as UCIA’s largest shareholder. The history of BCBS’s ownership of UCIA is interesting and instructive in itself.
Between 1993 and 1997, BCBS-SC purchased stock directly from the company in multiple transactions to help fund UCI’s survival and growth in South Carolina. BCBS invested about $6MM in equity plus additional funds in debt to help UCI build out its statewide network of clinics. As discussed in a 2003 article about UCI in a local newspaper,
“Blue Cross Blue Shield invested in UCI to ensure patients had options for
medical services, said Blue Cross Blue Shield spokeswoman Donna Thorne.
In some counties, hospitals own most or all of the physician practices, giving
them a lock on their local community and a strong position when negotiating with
insurers, Thorne said.
"Doctor's Care is everywhere we have customers," Thorne said. "We feel like
they're important to have in our network as an alternative."”
It took 15 years and another bankruptcy filing, but UCI is financially healthy and now has the strong South Carolina footprint that BCBS was committed to creating. Doctor’s Care is a low-cost alternative to emergency rooms and hospitals, and it was in BCBS’s interest to make sure their members had access to cheaper care.
Therefore, I think UCI is very well positioned for the long run. They are a brand-name, low-cost alternative source of medical care, with a regional niche and economies of scale as shown by the huge returns on 2005’s advertising spend. UCI should be able to grow their earnings over time, and I’m fairly confident that continued success will result in higher multiples of higher earnings. This is a high return business and I like their position in the competitive landscape. They have a nice regional niche that took 20 years and a lot of equity and debt financing to build. You can buy into this growing franchise for less than 6x an operating income figure that has grown 60% year to date. I think this is my favorite idea right now.
Risks
- The biggest risk is of BCBS pushing the company into low-return growth.
If a problem arises, I think minority shareholders could pursue an activist stance and a symbiotic relationship with BCBS. We can discuss this in the thread if you wish . . . I think giving a board seat to one minority investor would be a huge positive for the stock . . .
- I think there’s also risk of an acquisition at an unfairly low price. There’s really no reason for this company to be public. . .so it certainly makes sense for someone to take it private. If I had a huge bag of money to invest, I’d love to go in and buy the whole company or at least bid for BCBS’ block.
Catalyst
cheap. potential acquisition. any indication from BCBS that is friendly to minority shareholders.