Ryan Heslop of Firefly Value Partners addressed attendees at the Sohn Conference this week and outlined his short thesis for Community Health Systems. Their idea is based on the hospital operator’s huge debt load—and its apparent practice of gouging patients. He predicts that Community will file for bankruptcy within the next few years.
Interestingly, Community Health Systems stock skyrocketed on Wednesday just a couple days after Heslop presented his thesis at the Sohn Conference. As of the time of this writing, the stock is up more than 11%.
History of Community Health Systems
During his presentation at the conference, Heslop described Community Health as a "rural hospital rollup" and predicted that its stock will eventually become worthless. The company was founded in 1985 with the purchase of a small hospital in a rural area, and since then, it has gone on a 30-year "acquisition binge" to roll up additional hospitals.
Heslop brought up an old saying in healthcare, which is, "The operation was a success, but the patient died." He thinks Community Health will end up being an example of this because the company successfully completed a huge M&A campaign, but he believes the resulting pile of debt and declining profitability of the company's hospitals "make it almost certain this patient will die."
M&A strategy funded almost entirely by debt
Between 2001 and 2014, Community Health Systems grew to nearly 200 hospitals after making more than 30 acquisitions. The big problem with this was that the M&A strategy was "funded almost entirely by debt," he added. He estimates that the hospital operator's debt jumped from $1.6 billion in 2005 to $16.4 billion in 2014.
He believes management pursued this debt strategy due to "flawed incentives," citing proxy statements regarding management's pay structure. Essentially, there were incentives to acquire other hospitals, even through debt, because of how executives were paid. The more hospitals the company acquired, the more the management team got paid, he explained.
The Firefly executive also noted two secular trends which have been weighing on Community Health's profitability. Admissions have been declining at the company's hospitals, and he said patients have generally been going to urban hospitals further away rather than rural hospitals a bit closer to home. Additionally, he said patient volume has been shifting from inpatient to outpatient care, resulting in fewer patients.
He also believes the hospital operator's strategies to deal with its debt problem and declining profitability per bed are making its debt problem worse. For example, he said the Community Health has been slashing capital expenditures per bed, which is a problem in healthcare because patients are attracted by the newest equipment and the most modern facilities. He said large, urban hospitals have newer machines, which attracts even more patients, but smaller, rural hospitals with declining patient volumes have a more difficult time justifying the expense of new machines.
Community Health System accused of gouging patients
He also alleges that Community Health Systems has been gouging patients, citing an investigation by The Washington Post. He said the company charges more than other hospitals to out-of-network and uninsured patients than any other hospital system.
Heslop added that Community owns "half of the top gougers" and "seven of the biggest 10 gougers" named in the Washington Post article. He notes that as the company deals with declining profitability, it needs a way to bring in more cash, and overcharging patients does that in the short term but just ends up driving patients away in the long term.
Too little, too late?
The Firefly portfolio manager also said Community has been trying to lower debt by selling some of its hospitals. In fact, the company has sold about one-third of its hospitals over the last four years. However, he added that the company paid "top dollar" to buy those hospitals, shelling out more than $600,000 per bed over 12 years. When disposing of these hospitals though, the company has only been receiving about $250,000 per bed, and this problem is worsening. He said in the most recent transaction, the company only got as little as $177,000 per bed.
Meanwhile, the amount of debt the company has per bed has skyrocketed. Net debt has soared from $550,000 per bed in 2015 to $735,000 per bed.
A source told ValueWalk a while back that Firefly may have been short Community Health Systems, and now we know our source was correct. (I had mistakenly thought from the description that the short could have been one of Community's spinoff companies, but in reality, the spinoff is just another symptom of Community's debt problem. Indeed, the spinoff appears to have many of the same debt problems as Community. (NOTE: Community Healthcare System is NOT part of Community Health Systems.)
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