AMEDISYS

Pros:

• Is the largest player in home health care which is a very fragmented industry.
• Home health care industry is set to grow by 50% by 2020 because of aging demographics.
• Home health care makes lot of sense when you compare it to cost of treatment within hospital.
• To top it off people obviously old people prefer in home health care over a hospital stay.
• Amedisys has grown significantly by acquiring offices and by reducing their cost by centralizing management cost. Hence it has economy of scale advantage. This seems to help it obtain industry leading operating margins and free cash flow.Acquisition and consolidation has been going on in this sector since 2000 because an acquiring company can make existing offices more profitable by centralizing fixed costs.
• Free Cash flow for 2009 was 125M
• Expected free cash flow for 2010 is 130M
• With a market cap of 700M and debt of 200M the Enterprise Value/FCF = 7 for 2010 which looks like an awesome buy for a growth company.
• CEO founded the company in early 90s and owns 1% of the stock.His salary even though high is not ridiculous.The directors have been with the company for over 10 yrs.

Now lets look at the Cons:

• As of 2Q 2010 Amedisys has 116 M in cash and 162LT + 40ST Debt making the lowest the stock can get zero.The majority of its balance sheet is comprised of goodwill which shows that when it acquires a business it pays a lot more than the assets of the company.Are those assets worth the premium ? At first glance it seems it is worth it since they have contributed to increase in free cash flow and AMEDISYS has reduced outstanding debt quickly as post acquisition.
• WSJ reported in April the following http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748703625304575116040870004462.html
• Basically they accused home health providers of swindling medicare into paying more by doing more home visits than necessary.
• Company replied to this by issuing a shareholder letter http://www.amedisys.com/pdf/letter_to_shareholders.pdf

So why did I buy the stock ?

• It was cheap even though the downside was zero.
• The accusations of fraud seemed misguided by looking at the Amedisys as well as WSJ data.
• It operates in a growing industry and has a scale advantage. Any reduction in medicare reimbursements would negatively impact the smaller players first and hence provide even more opportunity of growth for big players like Amedisys.

Why did I sell the stock ?

• After buying the stock I heard the 1Q and 2Q conference calls. It seems management has suddenly made significant changes to their operating model since the WSJ article.They are decentralizing their operations while they touted this centralization as the reason they were able to have high operating margins. I also read a theory that the centralized version could have allowed them to do medicare fraud and they are moving towards industry standard decentralized model after the wsj article to hide their existing issues.
• Management did not seem candid. They kept talking about cutting costs by closing offices and bringing the salaried employees to pay per visit reimbursement.But when asked about how many offices they plan to close, how much benefit that might have or how many employees are on salaried basis they declined to disclose. In Q1 conference call when they announced the closure of unprofitable offices they said they will give more details in Q2 which they denied to give. So something is fishy
• The biggest reason for selling the stock was when I found out that the Medicare reimbursements are going to fall by 5% in 2011 and 5% more in 2012. That will cut their EBIT margin from current 15% to 5% and reduce the free cash flow by 70%. I should have known this before I purchased the stock.
• Clinician recertification to Amedisys (a process of extending the treatment of a patient and as a result allowing Amedisys to get paid again for the same patient) fell off the cliff in month of June and has remained that way.This is very suspicious since that is the time when they said they have started decentralizing the operation. Also its possible that the doctors are referring to some other agency because of the WSJ article highlighted amedisys. The management was asked multiple times during both the conference calls regarding why the sudden drop and they said that they have no idea why. This is definitely very very suspicious.If management does not know whats going on then who will ?
• And lastly I found a website where thousands of AMEDISYS employees reviewed the company. 99% of the people had bad things to say especially the employees who became part of AMED after acquisition. The work culture was very very stressful and filled with bureaucracy. All the employees said that they would change job in an instant if given an option.

So what did I learn ?

• Buy a stock with a worst case downside much higher than 0
• Do your homework before the purchase
• Stress on the qualitative factors much more than quantitative ones since the former is hardest to evaluate
• Home health care industry has two segments one that helps old people to regular chores etc and other that takes care of people with acute diseases. The latter segment is called Hospice.In the health care overhaul the reimbursement for this segment have not been reduced. Hence all of a sudden this seems like the well established segment in the HHA industry. The recent acquisition of Odyssey Healthcare by Gentiva at a huge premium price proves this.Amedisys did 95% of the first segment but very little of Hospice.
• Basically I should stay away from a business whose operating profits could be significantly impacted by government actions.