LHC Group, Inc.

    • LHC Group (“LHCG” or “the Company”) is a roll-up of post-acute home health centers which, in Apr 2018, completed a transformative merger of equals with fellow home health services provider Almost Family (“AFAM”). The merger was pitched to investors as a highly-synergistic deal which would produce a company capable of consistent mid-single-digit organic growth. However, Spruce Point’s forensic analysis of Company filings suggests that, whereas AFAM was expected to grow annually at 5-6% following the deal, the business is now contracting. At the same time, management appears to have taken steps to obfuscate AFAM growth and to avoid including it in organic sales, despite the fact that the deal closed ~21 months ago. With AFAM included in LHCG organic sales, as it should be, organic growth would fall from a reported ~7% to less than 2%. Meanwhile, surreptitious purchase accounting adjustments and questionable “one-time” acquisition-related charges have erased nearly 15% of the announced deal value. With LHCG’s true organic growth far below reported levels, and with management appearing to have serious problems integrating AFAM into LHCG, we question not just LHCG’s reported organic growth and adjusted earnings figures, but the continued viability of management’s roll-up strategy itself – and, consequently, the growth-driven narrative underpinning the bull case for the stock.
    • AFAM Appears To Be Contracting: Disclosures regarding acquired inorganic revenue imply that AFAM has severely underperformed both Company and sell-side expectations. We estimate that AFAM revenue is now contracting after it was first expected to grow 5-6% per year. Management appears to avoid reporting AFAM growth, or has cherry-picked unrepresentative metrics which superficially project the appearance of improvement.
    • Management Jumping Through Hoops To Flatter Organic Growth?: Management excludes AFAM from organic sales even though it was acquired ~21 months ago. This omission inflates reported organic growth by ~500 bps, from less than 2% to ~7%. Selective divestments of underperforming locations also inflate reported organic growth. This has saved a key LHCG metric – one followed closely by sell-side analysts – from collapsing at the hands of AFAM headwinds.
    • The Cause – Bungled Integration? Or Customer Reallocation?: AFAM throughput appears to have suddenly collapsed immediately after the deal’s closure, and has since fallen more than 30% below pre-deal levels. Throughput at legacy LHCG locations has simultaneously expanded by close to 10%. Could AFAM’s apparent contraction be explained by the cannibalization (purposeful or not) of AFAM locations by legacy LHCG locations? If so, LHCG’s high single-digit reported organic growth is being supported directly by cutbacks at locations not yet included in the organic base, which will inevitably weigh on organic growth once they are in fact included (as they should be already). We also find that, after claiming that the integration would be extremely swift, management has since subtly pushed forward its integration timeline on an almost quarterly basis. Today, more than two years after management first stated that the integration was already nearly complete, it is still in the process of integrating AFAM into LHCG’s software, and had integrated only about half of AFAM locations by the end of last quarter. We harbor significant doubts as to the competence of LHCG management and the continued viability of its roll-up strategy given these apparent integration issues.
    • Concerning Purchase Accounting Adjustments: Management appears to have gradually increased AFAM’s bad debt allowance from $27M to $65M, suggesting that nearly half of acquired AFAM receivables may be uncollectible. The post-M&A purchase accounting adjustment window may also be giving LHCG a chance to take effective asset write-downs which do not flow through the income statement, and, therefore, which do not hit earnings. This, combined with ~$67M worth of integration costs through ~2 years and counting, has destroyed over $100M of shareholder value for holders of LHCG, nearly 15% of the AFAM purchase price.
    • We See 40%-60% Downside After Taking Into Account LHCG’s True Organic Growth, Earnings, And Business Risks: LHCG remains a popular “buy” among analysts enamored by the Company’s seemingly-robust organic growth profile and runway for tuck-in M&A, particularly following an Oct 31 update to Medicare’s Patient-Driven Groupings Model which was broadly perceived to be supportive of continued industry consolidation. Even then, the average analyst price target implies only 3% upside from current levels. Why should investors own stock in a Company which, in our opinion, misrepresents its organic growth profile by 500bps, and whose management cannot effectively carry out its strategy at large scale? We expect organic underperformance and disappointing earnings to result in significant valuation compression from LHCG’s current 20.6x ‘20E EBITDA multiple – an all-time high for the stock.
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