Elie Rosenberg is a value investor based out of Dallas, Texas. He is the founder and editor of valueslant.com, a site dedicated to value investing research and analysis.
Providence Service Corporation (PRSC) is a quality business whose stock is being depressed by misplaced headline risk relating to strained state government budgets and Medicaid reimbursement. The reality is that in a tight money environment PRSC can gain market share because they provide federally mandated services with low cost delivery models, and their strategy of handling government contracts with sustainable margins will enable them to maintain profitability. One can acquire this business with recurring revenue, minimal capex requirements, and strong free cash flow at 4.3X EBITDA and 8.5X earnings, and it is even cheaper in light of locked in contracts that will boost revenue going forward. I think the stock has 100% upside potential in the next 18 months based on a conservative earnings scenario, and substantial growth opportunities could provide even greater returns.
|Price as of 7/11/2011||12.31|
|52 Week Range||11.34-18.27|
|Shares Out (MMs)||12.96|
|Market Cap (MMs)||159.5|
|Enterprise Value (MMs)||271.9|
PRSC was founded in 1996 by CEO Fletcher McCusker as a provider of in-home government sponsored social work counseling. At that time most government social services were delivered directly by the government in institutional settings. PRSC believed those services could be provided at a lower cost and with better outcomes if they were outsourced to a private firm to perform them in clients’ homes. PRSC has grown through steady high single digit organic growth, as well as a series of small tuck-in acquisitions from 2002-2008.
In 2007, PRSC expanded into a new line of business with the acquisition of Logisticare, a provider of non-emergency medical transportation for recipients of government sponsored healthcare. At a $220 million purchase price this was easily PRSC’s largest acquisition and it more than doubled revenues.
The transaction was almost entirely debt financed and turned PRSC into a highly leveraged company heading right into the recession. In mid to late 2008 state governments were caught off guard by the economic downturn and their budgets were in disarray even after the start of their fiscal year in July. They cut back on quotas with PRSC and delayed implementations of new contracts. Two weak quarters in Q3 and Q4 08 brought PRSC very close to violating their debt covenants and the stock dropped from over $30 to $1.
Business quickly picked up for PRSC and 09 and 10 were strong years for the company, with strong cash flows providing the opportunity for substantial deleveraging.
Home based counseling is the main revenue stream in this segment. There are two broad levels of counseling offered. Basic counseling on topics such as anger management, substance abuse prevention, and family dynamics averages 5 hours a week. More intensive counseling is also offered for 20+ hours a week for clients suffering from severe behavioral health issues that in many cases might otherwise need to be treated with institutionalization. Home counseling accounted for about $250 million, or 28%, of company-wide 2010 revenues.
Smaller divisions within this segment offer foster care training and supervision (4% of 2010 revenues), workforce counseling (4%), administrative support for not-for-profit social services entities (2%), and social services for schools (1%). The Social Services division in aggregate accounted for 39% of PRSC revenues in 2010.
PRSC currently serves almost 60,000 social services clients in 42 states. This segment has over 1,000 contracts with governmental entities, mainly on the regional and local level. The vast majority of their clients are Medicaid recipients and thus eventually reimbursed by state governments.
70% of the revenues in this segment are contracted on a per hour basis, 20% on a cost plus basis, 7% (one large contract) on a per client fixed rate basis, and the rest is administrative support services, which are generally contracted on a percentage of client revenues.
This segment is run out of 273 small leased field offices generally located in strip malls. Most of the sales and marketing is done by the field offices to leverage relationships with local government entities.
This segment (61% of FY 10 revenues) facilitates non-emergency transportation (NET) to medical appointments for recipients of government sponsored health care benefits (mainly Medicaid). The NET segment, operating under the Logisticare name, does not directly own or operate any transportation vehicles. Rather it acts as a logistical coordinator and outsources the transportation to local transportation companies. Logisticare typically will operate a call center to take calls from clients and schedule pick ups, coordinate billing, and oversee service quality.
Almost all of the contracts in this segment are capitated, meaning PRSC is paid a fixed per-member per-month (PMPM) rate regardless of the level of service provided. In this segment PRSC targets state-wide or large regional contracts, with most of the funding coming from state Medicaid reimbursement.
PRSC’s corporate strategy is straightforward-
Provide differentiated, low cost, effective delivery solutions for government sponsored social services and non-emergency transportation:
Social Services- PRSC can see six social services clients in an at-home setting for the government’s cost of providing care for one client in an institutional setting. Another advantage of PRSC’s in-home model is that it alleviates the large percentage of no shows to Medicaid behavioral health appointments that lead to gross inefficiencies.
NET- The standard model for NET prior to PRSC (and still employed by 30 states) was to provide Medicaid clients with vouchers for public transportation or taxis. This an inefficient, hard to monitor, and easily abused system. PRSC’s brokered model typically saves states 50% in prior year costs upon implementation. Additionally, the PRSC NET model also helps reduce no shows by monitoring whether patients actually arrive at their medical appointments.
Transparently manage margins for profits that are acceptable to government payers, thereby securing solid long term relationships:
PRSC has realized since its inception that health care outsourcing providers do not have any pricing power with government payers. Fat margins will only last until the government recognizes that they can pay less and their providers will still remain in business. PRSC chooses to not play games surrounding margins and voluntarily provides their payers with service at a sustainable margin. This has led to an excellent reputation among payers as evidenced by PRSC’s contract retention rate.
Drive volume to grow profits despite slim margins:
As the CEO likes to say, PRSC is a volume story not a margin story. They are resigned to flat rates in perpetuity and aim to grow profits through volume increases. There is still room for substantial growth on both the social services and NET side, boosted by the unique set of circumstances surrounding Medicaid and state budgets.
Control expenses to maintain margins:
To remain a low cost provider, PRSC has to tightly control expenses. PRSC employs asset light, variable cost models that can shrink or grow quickly in response to volatility in government funding. There are no large sunk costs in buildings or vehicles that can lay fallow if funding contracts. Payroll is 70% of expense in the social service segment, with much of that tied to