Description

World Health Alternatives is an opportunity to invest in an inexpensive growth stock with the real potential catalyst of a buyout by a larger competitor. Since the company has completed a string of acquisitions over the last twelve months, looking at historical performance is truly unrepresentative of their current business model. In the text of my write-up, I outline the current business model and my projections for future earnings and cash flow. The company is under followed with no sell side research and a bulletin board listing. It is expected that the company will get a national listing (NASDAQ small cap or AMEX) sometime in the first quarter. The stock at the time of my write up is trading around $3.70 and I believe it is worth at least $5.70-$6.00 within the next 6-9 months. The company is a potential takeover target and I expect it would fetch north of $7 in a buyout. I encourage you to continue reading to find out why this is one of my FAVORITE IDEAS for 2005.
The Company

World Health is building out a national footprint that will address the staffing needs of hospitals in a much more comprehensive format than their competitors. They are a temporary and permanent staffing company that recruits nurses, allied health professional and physicians and places them on temporary assignments and in permanent placements. They are the only public company I am aware of that addresses every segment of the over $10 billion Healthcare Staffing market. At their current revenue run rate, the company is on track to be one of the top 10 largest public companies in the Healthcare Staffing industry in 2005.

The company has completed roughly 6 acquisitions in the last 12-14 months and is in the process of integrating these acquisitions and exploring cross selling and synergistic cost saving opportunities. A small portion of the improved margins comes from reducing SG&A. They focus on keeping the current management team intact to grow the business and adopt the operating strategies of World Health. The first quarter of 2005 will be the first quarter where we can see the majority of the acquisitions on a consolidated basis and get a clear sense of how the integrations are going and how the margins will shake out. Additionally, the company continues to look for acquisition candidates to build out their geographic footprint, which may make the revenue and earnings estimates moving targets over the next year. They will also likely look for additional franchisees to help build out the secondary markets they won’t be focusing on. They currently have two franchisees up and running and would like to have 10 by the end of 2005. I have not included any revenue impact from the franchisees in my model and will not until they have some operating experience under their belt.

I know many of you are skeptical of roll up strategies and the inherent risks involved in such a strategy. This management team has managed to acquire companies at 4x EV/EBITDA or less and proceeded to enhance the cash flow of the acquired companies. They focus on retaining the management teams of the individual acquisitions and provide them with incentives to grow with the company. They have passed on deals in which the management did not want to stay with the company or when the prices were outside their target range. I do not believe they are not doing acquisitions just to do acquisitions. Many of these smaller companies look to be acquired due to the increased cost and burden of becoming JCAHO compliant. Compliance is being rolled out and enforced in 2005. Follow this link for the press release that provides a bit more information about staffing compliance issues. http://www.jcaho.org/news+room/news+release+archives/hcss.htm You’ll hear more about the management team shortly.

Industry/Peer Group

Healthcare Staffing is a $10.4 billion fragmented industry that is ripe for consolidation. According to Staffing Industry Analysts, in 2003 the Per Diem Nursing segment was $5.3 bln, Travel Nursing was $1.9 bln, Allied Health/Other was $2.2 bln and Locum Tenens (physicians) was about $1.0 bln. The publicly traded competitors include Medical Staffing Network (NYSE:MRN), AMN Healthcare (NYSE: AHS), Cross Country Healthcare (NASDAQ: CCRN) and On Assignment (NASDAQ: ASGN). AMN Healthcare and Cross Country are the largest players with a combined approximate 67% of the Travel Nurse market share.

There is no exact comparable for WHAI as each company is different due to the variance of the % of revenues coming from per diem nurses, travel nurses, allied health professionals and/or physicians. Based on their current business, World Health should generate 40%, 30%, 20% and 10% from locum tenens, travel nurses, allied health and per-diem nurses respectively. CCRN revenues are 75% travel nurses, 10% per diem and maybe 8-10% from allied health placements. AHS is about 94% travel nurses and they focus primarily on the acute care facilities. MRN generates over 75% of their revenues from per diem nursing. As you can see, they are all different but still targeting the same hospitals and competing based on their availability of nurses and other offerings. As hospitals focus on reducing costs they will likely also try to consolidate their vendors. World Health should have an edge with their current format as they can address any hospital professional staffing need.

Gross margins for the travel nurse industry run in the range of 22-24% with operating margins in the 5-6% range for the leading companies. While we haven’t seen a consolidated quarter for WHAI yet, after speaking with management and reviewing the recent 10Q, I estimate the company should have gross margins approaching 30% in Q1 2005 (compared to 35% in Q3 2004). This is largely driven by their revenue mix as allied health placements generate higher margins and they have a higher temporary to permanent conversion rate than their competitors. If a nurse or allied health professional is hired by the hospital on a permanent basis after their initial (or multiple) typical 13 week contracts the hospital pays the company a placement fee which is pure margin. Historically their competitors have not wanted to make permanent placements as they preferred to keep the nurses in their inventory for future placements and actually prohibited the nurses from being hired by the hospitals.

The reason for the decline in gross margins for World Health (from 35% in Q3) is the JCN acquisition they completed this quarter. It was a large acquisition (roughly $74 mln in 2004 revs) and the margins were closer to the industry average. While management believes there is opportunity for improvement, it is unlikely that the physicians business will generate the higher margins of World Health’s other businesses.

The industry has historically grown at a CAGR of about 11%, however 2002 and 2003 were rough years for the industry as hospitals looked for ways to cut costs and hospital admissions were down. The street estimates for CCRN and AHS are for the companies to grow their top lines at 5-7%. World Health should be able to grow at a much faster rate as they address the entire market (compared to the smaller travel nurse segment) and they continue to build out their nurse and professional inventories. The company experienced 28% year over year and 7% sequential organic revenue growth for the September quarter.

Locations
Pennsylvania
Georgia
Alabama
North Carolina
Utah
Ohio
Oregon
Florida
Massachusetts
New Hampshire
Acquisition pending in the Northwest, anticipate closing in Q4, 2004
Looking to expand into Texas, New Mexico and Colorado

Management

The management team has grown rich in experience as a result of the acquisitions the company has completed. I have highlighted a few of the executives below, several of which are entrepreneurs that joined the company after merging their own businesses with World Health. Each of these executives, with the exception of the CFO, have worked in the healthcare/staffing industry for 6+ years and have experience building a business.

Rich McDonald – CEO and Chairman
Rich was a founder of the company in 1999, when it operated as Better Solutions, Inc. Prior to founding the company he worked for Robert Half International, Inc., an international business consulting and staffing company. Before working for Robert Half, he was the business manager for the Day Group, a division of General Motors.

John Sercu – COO
John was the CEO of Pulse Healthcare Staffing and joined the company in May 2004 following World Health’s acquisition of Pulse. Prior to joining Pulse, he served as the CEO of Parker Services, a privately-held, regional staffing company. He has also served as Executive VP of Contract Services for Hall Kinion & Associates, a publicly-held staffing company. John also served in special operations in the US Army.

Todd Fortier – CFO
Todd has primarily been a part-time CFO. It is expected that the company will announce a new CFO in the near future.

Noal Curley – VP of Allied Health
Noal was the owner and CEO of CurleyMed Staffing, based in Orlando, FL, prior to being acquired by World Health. He worked with the company on a full time basis since 1999 and prior to that coordinated the organic development of the national Allied Medical division and was a Senior Manager with Aureus Medical Group, a large privately-owned healthcare staffing firm based in Omaha, Nebraska.

Craig Fusting – VP of Nursing, MedTech Medical Staffing
Craig was President and COO of Superior Staffing Solutions and joined World Health following the acquisition of Superior in December 2003. He founded Superior in 2000.

Legislative Issues

In 1999, legislation was enacted in CA calling for regulations to be adopted that would define the same unit specific nurse to patient ratios to be utilized in all nursing units in all California hospitals. Currently, a few states now require specific ratios in specialty areas such as intensive care and labor and delivery units, but none require ratios in every patient care unit in every hospital as proposed in the California regulations. There are still difficulties and delays in the implementation of this legislation as CA has current bills that rush to ensure compliance with the ratios and another (AB 253) which asks for an evaluation of the ratios because there might not be enough nurses to meet the more stringent staffing requirements. Gov. Schwarzenegger delayed the implementation as a result of the severe nurse shortages giving the hospitals till the beginning of 2008 to comply.

In 2003 many states introduced similar legislation that did not pass, however the trend towards fewer patients per nurse is evident and will likely be passed in coming years.

Valuation

Management has publicly stated that they expect to do in excess of $200 million revenues in 2005. Additionally, they are targeting 18% EBITDA margins towards the latter half of the year.

I tend to model on the conservative side and adjust my expectations as management hits their targets. Based on the acquisitions that have already been announced I estimate they can generate $188 mln in revenues in 2005, which compares to my proforma revenue estimate of $151 mln for 2004.

I am assuming gross margins of 31%, SG&A of 21.85% and a 29% tax rate for the year. Current net debt levels are around $21 mln. I have also assumed the outstanding warrants are exercised in Q1 and the share count at the end of Q1 should be just over 40 mln. This equates to an EPS estimate of .27 and EBITDA of 25.4 mln (13.5%) for 2005.

My estimates for 2006 are $217 mln revs, .38 EPS and $31.2 mln EBITDA.

Current EV
S/O – 39 mln
Price - $3.65
Mkt Cap – $142.35
Net Debt - $21 mln
EV = $163.35
EV/’05E EBITDA = 6.43
EV/’06E EBITDA = 5.23
2005E PE = 13.52x
2006E PE = 9.6x

This compares to:
2005E PE 2006E PE 2005E EBITDA
MRN 86.6x 26x 17.79x
CCRN 25.5x 21.9x 11.33x
AHS 24.6x 21.3x 13.27x
ASGN unprofitable 11.19x

World Health is a faster growing company with a larger market opportunity. The company currently trades a discount to their peers on both earnings and EBITDA multiples. If you were to assign World Health the same multiples as their peers, the valuations would suggest a price of $6.50-6.75, a 75%+ premium to current prices. However, given their smaller size and the risk related to their acquisition strategy, I believe they should probably trade at a discount to the larger players.

Assuming a .85 PEG ratio, I would assign a 21 PE multiple to their 2005 earnings estimate of .27. Under that assumption the stock is worth $5.67. The valuation will vary by approximately .30 for every PE multiple point. Management has adopted an aggressive amortization schedule for 2005 which they may revisit and adjust. I’m currently assuming 8.2mln in D&A for 2005. A downward revision to the amortization schedule could create some earnings upside to my estimates.

Given the cash flow expectations, they should be able to pay down some debt in 2005, however I have only assumed a small pay down and did not give the balance sheet the credit for the exercised warrants, which should generate over $4 mln in proceeds, since the timing is uncertain. They are also likely to use those cash proceeds for more acquisitions through the year. Most of their acquisitions have involved a portion in cash, possibly some debt assumption, some restricted shares and an earnout provision.

Again assuming the company trades a discount to their peers on an EBITDA basis, I would apply a 10x EV/EBITDA valuation on 2005 estimates which equates to a share price of $6.00. Even ASGN which should generate $200 mln in revenues this year, but loses money, trades at an 11x EV/EBITDA valuation.

Acquisition Target

Why would someone want to acquire World Health and how much should they pay? As I’ve already mentioned, the company addresses all segments of the healthcare staffing industry. This provides them with larger growth opportunities and great cross selling synergies. The Pulse acquisition gave them a very strong IT platform that allows them to operate in a virtually paperless world. This platform is very scalable and would be attractive to someone like Cross Country that is operating on an old “green screen” environment. Cross Country has also stated in their most recent 10Q and on their conference call that they continue to evaluate acquisition opportunities and that they are more interested in travel nurse operations vs. per diem nursing. Given the amount of revenues World Health should generate in 2005, they would be sizable enough to be a meaningful acquisition for any of the larger players. It would be a very easy for either AHS or CCRN to buy WHAI at a premium to current prices and still be an accretive deal for them. At 20x ’06E earnings and 10x ‘06E EBITDA, the takeout price would be $7.30-$7.60. Keep in mind that my estimates may prove to be conservative as I do not have management achieving their 18% EBITDA margin target till later in 2006.

The CEO mentioned on the last earnings call that he had received as many calls to be acquired as he had made to do acquisitions. He has been vocal about his willingness to sell “at a price”.

Risks

• Weakness in hospital admissions
• Integration of multiple acquisitions
• Management execution
• Legislative issues regarding hospital cost reductions
• Inability to attract nurses and other healthcare professionals

Catalyst

Summary

In summary, World Health is an attractively priced growth stock that has several potential catalysts on the horizon. They should be listed on a national exchange in the short-term, there is the catalyst of regulatory changes such as JCAHO compliance and additional legislation that could drive increased demand for nurses. If they do obtain a national listing in the first quarter, they will also likely be an addition candidate for the Russell 2000. In addition to the positive company and industry specific catalysts, there is the potential that they will be acquired by a larger competitor. They participate in an industry that will continue to see demand grow as the need for improved healthcare in the United States is an ongoing issue. World Health will benefit from either placing temporary staff in hospitals or finding the hospitals permanent employees for a fee. The nursing shortages will not go away in the near future and the companies that have the ability to recruit and maintain a wide geographic and specialty footprint will benefit from the hospitals desire to consolidate vendors.

This is one of my favorite ideas for 2005 and I believe this is an opportunity to make 50% plus on your money in 6-9 months. Happy New Year!