Note to Reader: More details to come; changes are highlighted. Except where noted, and highlighted, no other section of this report has been updated.
Reason for Report: Flash Update: 3Q10 Earnings Update
Prev. Ed.: August 16, 2010, 2Q10 Earnings Update (brokers’ material considered till August 11)
Note: A Flash Update on: PSYS’ shareholders approves the merger with UHS; was done on October 5
Flash Update
On October 19, 2010, PSYS announced its 3Q10 financial results: Highlights are as follows:
Revenue increased 12.2% to $508.5 million from $453.2 million in 3Q09. Same-facility revenue grew 10.4% y/y, primarily due to a 4% increase in patient days and a 6.1% increase in revenue per patient day.
Income from continuing operations increased 89.7% y/y to $53.7 million from $28.3 million in 2Q09. EPS increased 88% to $0.94 from $0.50 in 3Q09.
Details, other news update and broker comments will be provided in the next edition.
Portfolio Manager Executive Summary [NOTE: Only highlighted material has been changed]
Psychiatric Solutions Inc. (PSYS)is the nation's largest operator of behavioral health facilities, including psychiatric hospitals and residential treatment facilities. The company provides its services in both an acute care and residential treatment center (RTC) setting, which offers longer-term treatment primarily for children and adolescents with long-standing behavioral problems. The company manages inpatient behavioral health care units and freestanding facilities for third parties.
Out ofthe 9 firms covering the stock, one firm(11.1%) assigned apositive rating and8 firms (88.9%) gave neutral ratings.
Cautious: Neutral and Negative or equivalent outlook (8/9 firms): Target prices range from $26.00 to $34.00. These analysts believe the favorable long-term industry fundamentals (high entry barriers, strong cash generation capabilities, high organic growth profile, increasing demand for services, and accretive consolidation opportunities) will still benefit PSYS. However, the analysts are concerned about the softer pricing environment for mental health services due to reimbursement pressure from government payors. Given expectations for limited organic earnings growth over the next two years, the analysts believe that the company needs to be able to take advantage of acquisition opportunities to reaccelerate growth and provide investors adequate future returns.However, in consideration of the potential sale of the company, they expect merger and acquisition (M&A) activity to be shelved for the time being.
Positive or equivalent outlook (1/9 firms): Target price is $31.00. The analyst is bullish on PSYS based on a favorable long-term outlook for the industry. It continues to favor the shares of PSYS, given the company’s targeted same-facility organic revenue growth, the opportunity for additional earnings upside through acquisitions, better expense management, and further operating leverage. The firm attributes the strong 2Q10 results to PSYS' regional leadership remaining focused on delivering results to show its value to Universal Health Services (UHS) with a goal of ultimately becoming valued members of UHS' behavioral health leadership team. The company’s results combined with the strong results that UHS reported in its behavioral health division this quarter, provide further support to the firm’s view that the pending acquisition of PSYS is going to be a very good acquisition for UHS.
Long-Term Outlook: The overall market demand for high-quality inpatient psychiatric care remains strong. The company plans to continue expanding its ability to serve the demand, both through the addition of new beds and the ongoing execution of its proven acquisition strategy in a fragmented, capacity-constrained industry. Moreover, management asserts that the company is well positioned to fund the anticipated growth over the next year through substantial cash flow from operations, existing cash, and the available credit facility.
The analysts in general also believe that the industry trends will remain attractive and the company is well positioned to achieve same-facility revenue growth expectations over the long term. The analysts maintain that the fundamentals of the inpatient behavioral industry will remain strong, characterized by a shortage of beds, limited competition, a favorable pricing environment, minimal bad debt exposure, high barriers to entry, a somewhat stable length of stay, and pricing leverage with managed care.
August 16, 2010
Recent Events [NOTE: Only highlighted material has been changed]
On October 5, 2010, Psychiatric Solutions announced that its stockholders have approved the previously announced merger agreement providing for the acquisition of PSI by Universal Health Services, Inc. (UHS). Upon the completion of the merger, PSI stockholders will receive $33.75 in cash, without interest and less any applicable withholding taxes, for each share of the Company’s common stock that they own as of the effective time of the merger. The transaction is currently expected to be completed in 4Q10. Details, other news update and broker comments will be provided in the next edition.
On August 4, 2010, PSYS announced its 2Q10 financial results: Highlights are as follows:
Revenue increased 10.4% to $502.7 million from $455.3 million in 2Q09. The Zacks Digest average estimate for 2Q10 revenue was $490.3 million.
Income from continuing operations increased 12.9% y/y to $39.1 million from $34.8 million in 2Q09. EPS increased 11.3% to $0.69 from $0.62 in 2Q09. The Zacks Digest average estimate for 2Q10 EPS was $0.60.
Overview[NOTE: Only highlighted material has been changed]
Psychiatric SolutionsInc. (PSYS), together with its subsidiaries, provides inpatient behavioral healthcare services in the United States. The company offers its services for children, adolescents, and adults through acute inpatient behavioral health care facilities and residential treatment centers. Its services include nursing observation and care, daily interventions and oversight by a psychiatrist, and coordinated treatment by a physician-led team of mental health professionals. Psychiatric Solutions also provides contract management and employee assistance program, which involves the development, organization, and management of behavioral health care programs within medical/surgical hospitals. As of December 31, 2009, it owned and leased 94 inpatient behavioral health care facilities with approximately 11,000 beds in 32 states, Puerto Rico, and the U.S. Virgin Islands. The company was founded in 1988, and is based in Franklin, Tennessee. Further information on the company can be found at its website:
Analysts identified the following factors for evaluating the investment merits of PSYS:
Key Positive Arguments / Key Negative Arguments- The company’s ability to continue to identify and integrate acquisitions at a fairly rapid pace and to expand its same facility EBITDA margins helps in driving strong earnings growth.
- Barriers to entry remain high as illustrated by a lack of meaningful hospital construction projects.
- There are inherent risks associated with any acquisition that may prove disruptive to acquired facilities or reduce management's focus on the core business.
- Behavioral healthcare is highly regulated. Adverse changes in policy can severely alter the market dynamics and relative attractiveness of various care settings.
- Other risks include exposure to government reimbursement and soft same store volumes.
Note: PSYS’ fiscal references coincide with the calendar year.
August 16, 2010
Revenue[NOTE: Only highlighted material has been changed]
Psychiatric Solutions derives its total revenue from owned and leased inpatient facilities and Contract Managementand Employee Assistance Program (EAP) businesses (also termed Others). According to the company, total revenue was $502.7million in 2Q10 versus $455.3 million in 2Q09,up 10.4% y/y.The revenue growth was driven by several factors, including the number of patient admissions, revenue per patient day, and average length of patients’ stay taken together in the light of their relationship to one another. The Zacks Digest 2Q10 total revenue was in line with the company’s report.
Provided below is a summary of revenue as compiled by Zacks Digest:
($ in Million) / 2Q09A / 2009A / 1Q10A / 2Q10A / 3Q10E / 4Q10E / 2010E / 2011EDigest Average / $466.4 / $1,825.3 / $476.0 / $502.7↑ / $492.5 ↑ / $498.0 / $1,968.5↓ / $2,052.2
Digest High / $470.9 / $1,839.6 / $476.0 / $502.7 ↑ / $503.9 ↑ / $512.8 / $1,995.3 ↓ / $2,106.0
Digest Low / $425.9 / $1,751.2 / $476.0 / $502.7↑ / $485.8 ↑ / $490.2 / $1,955.0 ↓ / $1,988.1
Most of the company's facility revenue comes from same-store facilities (91% of revenue is derived from operating same-store behavioral health facilities, with 2% from acquired facilities and the remaining 7% from the management contracts).
In 2Q10, same-facility revenue increased 7.7% y/y, as volume (patient days) rose 4.2% y/y to 760,508 days, primarily reflecting an increase in the number of beds at existing facilities over the past 12 months. Growth in patient days underperformed the 8.2% y/y increase in same-facility admissions, as average length of stay (ALOS) declined 3.7% y/y in 2Q10 due to pressure on utilization from payers and the company’s focus on growing the acute side of its business. Revenue per patient day (pricing) went up 3.3% y/y to $600 million.
Owned/Operated Facilities:TotalOwned/Operated facility revenue soared10.2% y/y to $467.1 million, as volume (patient days) increased 6% y/y to 773,205 days, Growth in patient days underperformed the 11.3% y/y increase in same-facility admissions, as average length of stay (ALOS) declined 4.9% y/y in 2Q10. Revenue per patient day rose 4.0% y/y to $604 million. The Zacks Digest 2Q10 total Owned/Operated Facilities revenue was in line with the company report.
Contract Management and EAP Businesses Revenue or Other Revenue:The contract managementbusiness involves the development, organization, and management of behavioral health care programs within medical/surgical hospitals. The EAP business makes contracts with employers to assist employees and their dependents in their resolution of behavioral conditions or other personal concerns. The Zacks Digest Other revenue in 2Q10 was $35.6 million versus $45.1 million in2Q09.
Provided below is a summary of segment revenue as compiled by Zacks Digest:
($ in Million) / 2Q09A / 2009A / 1Q10A / 2Q10A / 3Q10E / 4Q10E / 2010E / 2011EOwned/Operated Facilities / $425.9 / $1,685.0 / $442.8 / $467.1↑ / $461.4↑ / $470.7 / $1,841.9↓ / $1,959.6
Managed Contracts/Others / $45.1 / $154.0 / $33.2 / $35.6↑ / $33.5↔ / $33.5 / $135.8 ↑ / $137.1
Provided below is a graphical analysis of segment revenue as compiled by Zacks Digest:
Please refer to the Zacks Research Digestspreadsheet on PSYS for more details on revenue estimates.
Margins[NOTE: Only highlighted material has been changed]
EBITDA margin was 24.0% on a same-facility basis in 2Q10 compared with 22.6% in 2Q09. The y/y growth in EBITDA margin reflected both better operating leverage as well as enhancement in productivity and operating efficiency. Consolidatedadjusted EBITDA margin was 19.8% of revenue in 2Q10 compared with 18.5% in 2Q09. Bad debt expense was2.0% of revenue in 2Q10 at $10.1 million.
The Zacks Digest averageoperating margin was 16.2% in 2Q10, flat y/y.
Provided below is a summary of margins as compiled by Zacks Digest:
Margins / 2Q09A / 2009A / 1Q10A / 2Q10A / 3Q10E / 4Q10E / 2010E / 2011EOperating / 16.2% / 14.7% / 14.3% / 16.2%↑ / 14.9%↑ / 15.3%↑ / 15.2%↑ / 15.6%↑
Pre-Tax / 12.2% / 10.7% / 10.8% / 12.9%↑ / 11.5%↑ / 11.8%↑ / 11.8%↑ / 12.1%↑
Net / 7.5% / 6.6% / 6.7% / 8.0%↑ / 7.1%↑ / 7.3%↑ / 7.3%↑ / 7.5%↑
As per the Zacks Digest model, salaries, wages, and employee benefitswould increase 5.0% y/y in FY10 and 3.8% y/y in FY11; suppliesexpense would soar4.5% y/y in FY10 and6.8% y/y in FY11; and depreciation and amortization would go up11.6% y/y in FY10 and 6.1% y/y in FY11. In comparison, revenue would increase 7.8% y/y inFY10and 4.3% in FY11.
Please refer to the Zacks Research Digest spreadsheet on PSYSfor more details on margins.
Earnings per Share[NOTE: Only highlighted material has been changed]
The company reported diluted EPS of $0.69 in 2Q10 versus $0.62 in 2Q09. The Zacks Digest 2Q10 EPS was$0.70 versus $0.62 in 2Q09.
Provided below is a summary of EPS as compiled by Zacks Digest:
EPS / 2Q09A / 2009A / 1Q10A / 2Q10A / 3Q10E / 4Q10E / 2010E / 2011EDigest High / $0.63 / $2.16 / $0.56 / $0.73↑ / $0.72 ↑ / $0.74 / $2.71↑ / $2.99
Digest Low / $0.61 / $2.11 / $0.56 / $0.69 ↑ / $0.57 ↓ / $0.60 / $2.42 ↔ / $2.49
Digest Average / $0.62 / $2.14 / $0.56 / $0.70 ↑ / $0.61 ↑ / $0.63 / $2.50 ↓ / $2.67
Please refer to the Zacks Research Digest spreadsheet on PSYS for more details on EPS estimates.
Target Price/Valuation[NOTE: Only highlighted material has been changed]
The Zacks Digest average target price is $31.78 (↑1.14 from the previous report, down 4.1% from the current price). The price targets range from $26.00 (Avondale) to $34.00 (R W. Baird), with a median price target of $33.75 (↑ from the previous report). Nine firms covered the stock of which one firm gave a positive rating and eight firms assigned neutral ratings.
Rating DistributionPositive / 11.1%↓
Neutral / 88.9%↑
Negative / 0.0%
Avg. Target Price / $31.78↑
Median Target Price / $33.75 ↑
Maximum Target Price / $34.00 ↔
Minimum Target Price / $26.00 ↔
No. of Analysts with Target price/Total / 9/9↓
Downside from Current Price / -4.1%
Maximum Upside from Current Price / 2.6%
Minimum downside from Current Price / -21.6%
Capital Structure/Solvency/Cash Flow/Governance/Other[NOTE: Only highlighted material has been changed]
Leveraged Buy-Out
On May 18, 2010, Universal Health Services (UHS) entered into a definitive agreement to acquire Psychiatric Solutions for $33.75 per share, or approximately $2 billion. Under the terms of the agreement, Universal Health will also acquire $1.1 billion of net debt, in the books of PSYS, taking the total transaction consideration to about $3.1 billion. The transaction was unanimously approved by the boards of directors of both companies and is expected to be complete by 4Q10.
Balance Sheet and Cash Flow
At the end of 2Q10, PSYS had cash and cash equivalentsof $49.7 million versus $32.6 million at the end of 1Q10. The company completed the quarter with no borrowings under its $300 million revolving credit facility. It made $56.7 million of principal payments on long-term debt during the quarter, including a $50 million optional prepayment on its senior secured term loan. PSYS’s ratio of debt to total capitalization improved to 50.6% at the end of 2Q10 from 52.8% at the end of 1Q10 and 56.5% at the end of 2Q09. In addition, the ratio of debt to adjusted EBITDA for the trailing 12 months improved to 3.3 at the end of the quarter just ended from 3.5 at the end of 1Q10 and 3.8 at the end of 2Q09.
Cash flow from continuing operations was up 25.9% y/y to $99.1 million in 2Q10with capital expenditure of $28.1 million versus $29.6 million in 2Q09.
Legal Issues Regarding the Riveredge Facility in Illinois
The company was issued a subpoena by the Department of Justice (DOJ) related to allegations of abuse at the Riveredge facility in Forest Park,Illinois, that had allegedly occurred during 2006 and 2007. The allegations suggest that facility operators and local government authoritiesfailed to share basic information about violence perpetrated by patients upon other patients. The Department of Children and FamilyServices for the state barred further admissions to the facility pending an investigation.
The company completed surveys, submitted all required documentation, and inspections were done by various agencies. The company noted, in August 2009, that it had not heard from the DOJ regarding its investigation. During the 4Q09 call, the company stated that Riveredge continued to perform well, although it remained unclear when thepatient hold at Riveredge will be lifted. The company pointed out that there is typically no formal announcement when the DOJ closes an investigation. Psychiatric Solutions did not provide an update in 210.
August 16, 2010
Potentially Severe Problems[NOTE: Only highlighted material has been changed]
There are none other than those discussed in other sections of this report.
August 16, 2010
Long-Term Growth[NOTE: Only highlighted material has been changed]
Psychiatric Solutions’ strategies for consolidating the industry depend first on producing organic growth in the facilities the company already owns and operates. Next to organic growth, the company’s efforts to grow involve selective acquisitions of both single- and multi-facility operations.Psychiatric Solutions expects to continue benefiting from itsconsolidation strategy in FY10. In thecurrent economic environment, the company is focused on executing a proven business model that enabled it to build a long-term record of outstanding performance, while also becoming the leading provider in the inpatient psychiatric care industry. Management is confident about its opportunities, the resources and the expertise to further strengthen the leadership position and enhance stockholder value.
In the end, however, the brokerage firms continue to view a potential sale as the expected outcome.
August 16, 2010
Upcoming Events[NOTE: Only highlighted material has been changed]
None
Individual Analyst Opinions[NOTE: Only highlighted material has been changed]
POSITIVE RATINGS
Barclays Capital – Overweight ($31.00) – August 5, 2010: The firm reiterated its rating and target price. INVESTMENT SUMMARY: The firm believes the strong results at PSYS, combined with the strong results that UHS reported in its behavioral health division this quarter, provide further support for the contention that the acquisition of PSYS is going to be a very good acquisition for UHS.
NEUTRAL RATINGS
Avondale – Market Perform ($26.00) – August 4, 2010: The firm reiterated its rating and target price.
Citigroup – Hold ($33.75) – August 4, 2010: The firm reiterated its rating and target price.
Deutsche Bank – Hold – ($33.00) – August 4, 2010: The firm reiterated its rating and target price.
Piper Jaffray – Neutral – ($33.75) – August 5, 2010: The firm reiterated its rating and target price.
R W. Baird – Neutral – ($34.00) – August 5, 2010: The firm reiterated its rating and target price. INVESTMENT SUMMARY: The firm believes that the company is worth more than $30 per share in a take-out, so it continues to be bullish on PSYS.
RBC Cap. –Sector Perform ($33.75) – August 5, 2010: The firm reiterated its rating and raised thetarget price from $30.00 to $33.75. INVESTMENT SUMMARY: The firm believes the pending PSYS acquisition is strategically and financially attractive and will transform the company to a position of both growth and visibility - arguably the best in the sector.
Stephens – Equal Weight ($33.75) – August 5, 2010: The firm reiterated its rating and raised the target price from $30.00 to $33.75.
Wells Fargo Securities – Market Perform ($27.00) – August 5, 2010: The firm reiterated its rating and target price. INVESTMENT SUMMARY: The firm,prior to the announcement of a possible buyout deal by Bain Capital, had believed that the best avenue for earnings growth and share price appreciation was from a reacceleration in acquisitions. However, given the events over the past week, the firm believes that the best potential for share price appreciation is for PSYS to be acquired.
NEGATIVE RATINGS
None
Research Associate / Shalini SinghalCopy Editor / Avishek Mishra
Content Ed. / Avishek Mishra
No. of brokers reported/Total brokers
Reason for Update / Flash
QC / Anindya Barman
Lead Analyst / Gargi B Banerjee