On November 06, Select Medical Holdings (NYSE: SEM; $40.20; Market Cap: $5.2 billion) announced a special stock distribution of its carved out unit Concentra Holdings (NYSE: CON; $19.67; Market Cap: $2.5 billion) to its shareholders. The distribution is set for November 25, 2024, with a record date of November 18, 2024. Shareholders will receive approximately 0.806971 shares of Concentra’s common stock for each share of Select Medical stock they own. This distribution accounts for about 81.7% of Concentra’s outstanding shares, totaling 104.1 million shares. The transaction is intended to be tax-free for US federal income tax purposes, and no action is required from stockholders. Cash will be provided in place of fractional shares.
On July 25, 2024, Concentra Group started trading on the NYSE. The stock opened at $22.00, achieved an intraday high of $23.00, low of $21.98, and closed the day at $22.48, 4.3% below the set IPO price of $23.50 per share.
Spin-Off Details / Timeline
a) Record Date: The record date for the spin-off is November 18, 2024.
b) Split Ratio: Shareholders will receive approximately 0.806971 shares of Concentra’s common stock for each share of Select Medical stock they own. This distribution accounts for about 81.7% of Concentra’s outstanding shares, totaling 104.1 million shares.
c) When-Issued Trading: Starting November 20, 2024, both Select Medical and Concentra Holdings will trade on a “when-issued” basis. This period begins three trading days before the Distribution Date and continues until the close of trading on the Distribution Date i.e. November 25, 2024. During this window, Select Medical will trade under the ticker “SEM WI” and Concentra under “CON WI.”
d) Due-Bills Trading: In when-issued trading from November 20, 2024 to November 25, 2024, Select Medical’s common stock will also include “due bills”, which are rights to receive shares of Concentra’s common stock from the spin-off. Therefore, anyone purchasing Select Medical shares during this period will also be entitled to the Concentra shares upon distribution.
e) Regular-Way Trading: Concentra and Select Medical would resume trading on a Regular-way basis on the NYSE starting November 26, 2024.
f) Exchange and Ticker: Select Medical will resume trading under the ticker “SEM” and Concentra under “CON” on NYSE.s
g) Tax Status: The transaction is intended to be tax-free for US federal income tax purposes.
For Concentra, we revise our target price to $21.00 per share and maintain a Hold Rating, given a 6.8% upside from the previous close. Our fair value estimate for Select Medical (Stubb) comes to $27.00 per share. For Select Medical (Consolidated), we arrive at a target price of $44.00 per share, implying an upside of 9.5% from the last closing price. We maintain our BUY rating on Select Medical (Consolidated).
Deal Overview
On January 3, 2024, Select Medical Holdings Corporation (NYSE: SEM, $40.20, Market Capitalization: $5.2 billion) announced the potential separation of its Concentra Group Holdings Parent LLC, (Concentra) business unit. The company submitted a confidential draft registration statement on Form S-1 to the US Securities and Exchange Commission (SEC) for a potential IPO on March 14, 2024. According to separation agreement, Select Medical (stub) would operate Critical Illness Hospitals, Rehabilitation Hospitals, and Outpatients’ Hospitals, and Concentra (Carved-out business) would continue to specialize in workers’ compensation injury care, employer services, clinical testing, wellness programs, and preventive care across its expansive network of over 540 Occupational Health Centers.
On July 14, 2024, Concentra filed a prospectus with the SEC offering 22.5 million shares of its common stock for a set IPO price of $23.50, with Concentra listing on July 25, 2024. The company got approval to list its shares on the New York Stock Exchange (the “NYSE”) under the symbol “CON”. As per the agreement, the company issued common stock amounting 18.93% of its total common stock outstanding, with Select Medical maintaining ownership of 81.07%.
After the separation, Select Medical’s shareholders to maintain their existing shares of Select Medical and received a proportional allocation of Concentra stock. The distribution was tax-free for both Select Medical and its shareholders concerning US federal income tax. In connection with the Separation, Concentra entered into a transition services agreement with Select Medical, under which Select Medical would provide Concentra with certain compliance, human resources, information technology, accounting, tax and other administrative services.
As part of the Separation, Select Medical received entire net IPO proceeds, including net proceeds received from the exercise of the underwriters’ option to purchase additional shares. From the received IPO proceeds, Select Medical used $300 million to pay down the current outstanding indebtedness.
Leading financial institutions, J.P. Morgan, Goldman Sachs & Co. LLC, and BofA Securities were the main book-runners for the offering. Additional joint book-runners included Deutsche Bank Securities, Wells Fargo Securities, Mizuho, RBC Capital Markets, and Truist Securities, with several other firms serving as co-managers.
On November 06, Select Medical announced a special stock distribution of its carved-out unit Concentra Holdings to its shareholders. The distribution date is set for November 25, 2024, with a record date of November 18, 2024. Shareholders will receive approximately 0.806971 shares of Concentra’s common stock for each share of Select Medical stock they own. This distribution accounts for about 81.7% of Concentra’s outstanding shares, totaling 104.1 million shares. The transaction is intended to be tax-free for US federal income tax purposes, and no action is required from stockholders. Cash will be provided in place of fractional shares.
Deal Rationale
Select Medical is a key player in the US healthcare sector, operating hospitals and rehabilitation centers. It operates in four main segments. The largest, Critical Illness Recovery Hospital, contributed 35.5% to the company’s FY23 revenue, with 38.0%. The Rehabilitation Hospital segment, focused on acute and rehabilitative care, accounted for 14.7% of revenue. Outpatient Rehabilitation, offering various rehabilitation programs, contributed 17.8% to the overall revenue. The Concentra segment, the country’s largest provider of occupational health services, generated 27.6% of revenue in FY23 This segmentation highlights the diverse revenue composition, emphasizing the importance of each segment in the company’s operational structure.
By separating Concentra’s business, Select Medical management wanted to establish two distinct and publicly traded entities strategically. This initiative aimed to optimize resource allocation toward predefined priorities and maximize shareholder value.
Select Medical has a track record of solid growth, primarily driven by Critical Illness, Rehabilitation Hospitals, and Concentra business units. The Concentra division has historically delivered a robust Compound Annual Growth Rate (CAGR) of 9.3% since 2017, which can be attributed to a strategic emphasis on acquisitions as a pivotal driver. Additionally, the Concentra business unit consistently delivered healthy margins, with adjusted EBITDA margin improving from 15.6% in FY17 to 19.7% in FY23. The management believed that by separating Concentra from the rest of the company, the market would recognize and assign a higher value to each entity, potentially resulting in a more favorable stock price movement and overall return for investors. Hence, separating the Concentra business segment was expected to enhance the company’s overall valuation. Additionally, the funds generated from these transactions were intended to be directed towards paying off debt, particularly inter-company or debt associated with Select Medical.
Investment Thesis
Select Medical:
Leading operator in its core market – Select Medical is a leading provider in its core markets with a well-established network of facilities and a strong reputation for clinical excellence. As of September 30, 2024, the company had operations in 46 states and the District of Columbia. It operates 106 critical illness recovery hospitals, 34 rehabilitation hospitals, 1,925 outpatient rehabilitation clinics and 549 occupational health centers. This diverse portfolio allows the company to attract patients and employees, aids in marketing efforts and helps negotiate payor contracts.
Aging population to drive up demand dynamics – The aging population presents a significant growth opportunity for Select Medical. As the baby boomer generation ages, the demand for healthcare services, particularly in rehabilitation and long-term care, is expected to rise. Select Medical is well-positioned to benefit from this demographic trend due to its comprehensive service offerings tailored to the needs of older adults.
Experience in successful integrations and acquisitions– Since its inception in 1997 through 2023, the company has completed several significant acquisitions, including the acquisitions of Physiotherapy, Concentra, and US HealthWorks. SEM has been able to improve the operating performance of these businesses over time by realizing efficiencies through its centralized operations and management. The fragmented nature of the healthcare industry further offers potential acquisition opportunities for the company to expand its market share and achieve economies of scale.
Labour shortage poses an operational challenge – SEM achieved a 10% reduction in the salary, wage, and benefit to revenue ratio in FY23 driven by a 9% decrease in nursing agency rates and a 30% decrease in nursing agency utilization, benefitting the EBITDA margins (around 12% for FY23 vs. 10.2% in FY22). However, we believe this reduction has come on the back of the critical illness recovery hospital division facing difficulties in hiring highly trained near ICU-level nursing staff due to competition with short-term acute care hospitals. This shortage could eventually require use of more costly temporary personnel, and other types of premium pay programs that may lead to a higher turnover, persistent wage pressure and disruption to operations.
Payment system reforms may impact profitability– Substantial changes to the Medicare program such as qualification for payment, bundling acute and post-acute care payments, and the imposition of enrollment limitations have affected the availability, methods, and rates of Medicare reimbursements for services provided by Select Medical. The outpatient rehab division has been the most impacted with flattish net revenue per visit to $100 YoY and the adjusted EBITDA margin declining from 10.8% to 9.1% in June 2024. Notably, revenues from providing services to patients covered under the Medicare program represented approximately 23% of the company’s revenue in FY23.
Concentra:
Dominant player in occupational health services – Concentra is the largest provider of occupational health services in the US by number of locations, as of September 30, 2024, with a significant national presence. It operates 549 standalone occupational health centers in 45 states and 156 onsite health clinics at employer worksites. The company’s extensive team of approx 11,000 colleagues and affiliated physicians support more than 50 thousand patients per day.
Quality services deliver positive clinical results – Concentra has emerged as a trusted provider of occupational health services because of its focus on lower claim cost, fewer days per claim and more productive employees. Its licensed clinical professionals have extensive experience and are specially trained in occupational health services. Additionally, the clinical team is supported by a clinical analytics department that evaluates both individual and aggregate practice patterns to provide objective insights for systematic and continuous clinical improvement.
Diverse customer relationships – As of December 31, 2023, Concentra partnered with approximately 0.2 million employers nationwide, including 100% of the Fortune 100 companies and approximately 95% of the Fortune 500 companies, supporting around 0.4 million employer locations. The employer customer count has increased by approximately 40.0% since 2014. Concentra’s diverse and long-tenured client base includes wholesale and retail distribution, transportation, manufacturing, construction, restaurants, entertainment services and health services.
Innovation backed focus on growth- The company has made material investments in technologies designed to provide a fully digital experience to patients and customers across multiple channels. Concentra continues to grow its onsite health clinics at employer worksites and telemedicine businesses with new use cases, additional service offerings, and expanded customer audiences. Concentra HUB, a robust occupational health customer portal, makes it easier and more convenient for employers, insurance carriers and third-party claims administrators to access the information they need.
Valuation
Concentra (Spin-Off)
Concentra’s long-term prospects are underpinned by favourable macro trends, such as an aging population and increased injury rates in manufacturing and small businesses. In the recent quarter, Concentra expanded its footprint by adding new occupational health centers and onsite health clinics, which bolstered overall revenue despite a decline in daily visits. High patient satisfaction scores have also enhanced patient retention and boosted revenue from repeat visits and referrals. However, patient visits per day fell by 2.2% year-over-year in Q3 FY24, influenced by seasonal variations, shifts in patient behavior, and competitive pressures in the healthcare market.
While raising prices to counteract this decline can be an effective short-term strategy, it may not be sustainable in the long term. Additionally, potential economic headwinds in the US, such as a slowdown, could significantly reduce consumer spending and alter patient behavior, with individuals potentially delaying or foregoing non-urgent medical visits due to financial constraints. This could further decrease patient volumes and revenue. While Concentra has strategies in place to mitigate some of the above-mentioned risks, the headwinds will have to be carefully navigated to maintain financial health. We prefer to remain conservative and ascribe a lower EV/EBITDA(x) multiple of 10.5x (prior: 11.5x) on FY25E EBITDA and arrive at an enterprise value of $4.0 billion. Subsequently, we deducted net debt of $1.4 billion to arrive at an implied equity value of $2.7 billion. Considering shares outstanding of ~127 million, we arrive at a revised target price of $21.0 per share, implying an upside of 6.8% from the previous close. We maintain our HOLD rating on Concentra.
Select Medical (Ex-Concentra)
Select Medical’s business model is appealing because it provides specialty hospitals for patients needing specialized care. We believe that the unique nature of these requirements makes patients less sensitive to price, resulting in healthy margins. Select Medical has raised its guidance for FY24, reflecting confidence in its growth prospects. This optimistic outlook is driven by several key growth drivers, including the expansion of its hospital network, investments in advanced rehabilitation technologies, and high patient satisfaction scores. Additionally, strategic initiatives such as enhancing telemedicine services and integrating new technologies are expected to further bolster growth and operational efficiency.
Looking at the bright prospects, we now ascribe a higher EV/EBITDA multiple of 9.0x (prior: 6.5x) on the FY25E EBITDA to arrive at an Enterprise Value of $4.6 billion. Considering net debt of $1.6 billion, IPO proceeds of $516 million and $34.7 million received as a dividend, we arrive at an implied equity value of $3.5 billion. Considering shares outstanding of ~129 million, we arrive at a fair value of $27.0 per share for Select Medical (Ex- Concentra).
Select Medical (Consolidated)
We add an attributable 81.70% equity value of Concentra to Select Medical (Stub) to arrive at a consolidated equity value of $5.7 billion for Select Medical. Considering the outstanding share count of ~129 million, the fair value estimate for consolidated Select Medical comes at $44.00 per share suggesting around 9.5% upside from the last closing. We maintain our BUY rating on on Select Medical.
Company Description
Select Medical Holdings Corporation (Parent)
Incorporated in 1997, Select Medical Holdings, is recognized as one of the major operators in the US, managing critical illness recovery hospitals, rehabilitation hospitals, outpatient rehabilitation clinics, and occupational health centers across the region. The company operates through four divisions, namely the critical illness recovery hospital division, the rehabilitation hospital segment, the outpatient rehabilitation segment, and the Concentra division. As of September 30, 2024, Select Medical had active operations in 46 states and Columbia district, overseeing 106 critical illness recovery hospitals, 34 rehabilitation hospitals, 1,925 outpatient rehabilitation clinics and 549 occupational health centers.
Concentra Group Holdings Parent, Inc. (Spin-Off)
Concentra is the largest provider of occupational health services in the US by number of locations, delivering a comprehensive array of services through occupational health centers, telemedicine, and onsite clinics at employer workplaces. These encompass occupational health services covering workers’ injuries, physical rehabilitation, physical exams, clinical testing, and preventive care. Consumer health involves patient-directed urgent care for injuries and illnesses, and Direct-to-employer care provides advanced primary care at Concentra’s onsite clinics. As of September 30, 2024, Concentra managed 549 stand-alone occupational health centers in 45 states and 156 onsite health clinics at employer worksites. Concentra has also expanded its reach via a telemedicine program serving 45 states and the District of Columbia.