An Update on Medical Facilities Corp.(DR.TO)

A very interesting situation unfolding

We’ve owned Medical Facilities Corporation for a few years and have done very well on the back of a cash generative portfolio of hospitals and a management team that is manically focused on repurchasing shares. It’s very rare to see a management team both recognize the best use of excess capital and then stick to a plan to either reinvest it or return it to shareholders. This is one such group.

I’ve written about MFC extensively in past letters, indicating that our investment could turn into a ‘compounder’ on the back of consistent growth in earnings and share repurchases, with the optionality of asset sales unlocking further value. This is largely playing out with the added wrinkle that upside could be accelerated in the near term.

This will be a shorter post discussing the current situation and potential upside within the next 12 months. John Huber at Base Hit Investing recently outlined the situation perfectly so I would suggest reading his note as well (paywall).

The situation unfolding today is very interesting as MFC sold one of their hospitals, Black Hills Surgical, in November of last year, and there now exists a large tender offer expiring at the end of this month, whereby MFC is looking to purchase $80mm in shares up to a price of CAD $17.50 (approx. $12.15 USD).

Given my estimates for intrinsic value, shared with management, and other shareholders expressing the same views, it’s possible the offer price is revised upwards. My math gets me to an intrinsic value of between CAD $24-26/share or around $18.0 USD/share.

In addition, there is optionality for further asset sales and even larger repurchases. Getting one sale across the finish line could open the door for the remaining assets to be moved. Further sales + continued buybacks means further upside. While it won’t happen immediately, I like the setup here and think another 50% upside is not out of the question. Should no assets be sold, we are left with a huge net cash balance sheet and a remaining portfolio of assets that still gush cash.

Current Valuation

All figures $USD

• Prior to the Black Hills sale, I estimated MFC was trading at around 3-4x EBIT

• Adjusting for Black Hills and the foregone operating profits, but including the proceeds from the sale, I estimate the current valuation to be around 5x EV/EBIT, and a double digit FCF yield after netting out the excess cash from BH

• This number decrease further when subtracting corporate costs, which a potential buyer of the entire business could eliminate

• Black Hills sold for 9x EBIT, and if you were offered similar multiples for the remaining hospitals, intrinsic value is much higher than the upper range of the tender offer

• Math illustrating potential value in a full sale / liquidation scenario is below – which I realize may not be on the table, but again, highlights the value above the tender offer price and helps reiterate why continued buybacks up to CAD $20/share, possibly higher, are still very accretive

Sioux Falls Surgical

• $40.1mm TTM EBIT

• Value at the same multiple as BH = $368mm

• (-) $10mm debt

• = $358mm pre-tax proceeds

• MFC interest at 51% = $182.5mm

Arkansas Surgical

• $21.7mm TTM EBIT

• Value at the same multiple as BH = $195mm

• (-) $5mm debt

• = $190mm pre-tax proceeds

• MFC interest at 51% = $96.9mm

Oklahoma Surgical

• $10.7mm TTM EBIT

• Value at the same multiple as BH = $96.3mm

• (-) $4mm debt

• = $92.3mm pre-tax proceeds

• MFC interest at 64% = $59.0mm

Total Value

• Total liquidation value for remaining three hospitals = $337mm

• Total per share liquidation value for remaining three hospitals = $14.3 USD/share

• (+) BH net proceeds of $75mm following transaction

  • MFC post-tax value of $140mm x MFC interest of 54.2% = $75mm

• = $17.5mm/USD share or CAD $25/share

• Current stock price = $11.50 USD / CAD $16.5

**The above also EXCLUDES a large buyback conducted from the proceeds of the Black Hills sale

• Purchasing $80mm worth of shares at $12.50 USD / CAD $18.0 reduces the share count by 6.4mm or 27%

• NAV of $309mm for the remaining three hospitals divided by the post-tender 17.1mm shares = $18/share USD or 56% upside from today’s price

Notes

*Importantly, I excluded the tax drag from each of these sales, likely lowering MFC’s interest and intrinsic value by $1/share or so.

**There is no guarantee any of the remaining hospitals are sold

***The tender offer may not be successful

Adam Wilk is the Founder and Portfolio Manager of Greystone Capital Management LLC, a small cap focused investment firm.

Adam can be reached at adam@greystonevalue.com

Disclaimer: Adam Wilk and clients of Greystone Capital Management own shares of MFCSF. The purpose of this post is for informational and educational purposes only and should not be construed as a recommendation to purchase or sell any security. Do your own due diligence and seek counsel from a registered investment advisor before trading in any security mentioned.