How LifePoint Exceeded Earnings Expectations in 4Q15
Valuation for LifePoint
LifePoint Health (LPNT) is trading at a discounted forward enterprise value (or EV) to earnings before interest, tax, depreciation, and amortization (or EBITDA) multiple compared to peers such as Acadia Healthcare (ACHC), Universal Health Services (UHS), and Community Health Systems (CYH).
Relative valuation
Discounted cash flow (or DCF) and relative valuation are some of the valuation techniques used to analyze a company. DCF is a complicated methodology on account of multiple assumption-based inputs required as prerequisites for valuation. Relative valuation is a comparatively simple method, given the challenge of peer selection.
LifePoint’s forward EV-to-EBITDA multiple stood at 6.08x on February 15, 2016, whereas for Universal Health and Community Health Systems, the multiples were 7.5x and 6.17x, respectively. Acadia Health’s multiple was 11.49x for the period.
Why EV-to-EBITDA?
The hospital industry is capital intensive in nature. These businesses have higher debt on their balance sheets along with higher provisions for doubtful accounts. Hospitals incur continuously higher capital expenditures to support growth through expansion. To measure the operating efficiency of such businesses, EBITDA is a good valuation metric.
Enterprise value is a metric that makes comparisons capital structure neutral.
How will LifePoint’s valuation multiple improve?
A hospital’s EBITDA margin represents its operating efficiency. During 3Q15, Acadia Healthcare operated at an EBITDA margin of 21.5%, whereas the EBITDA margins for Community Health Systems and Universal Health stood at 13.4% and 16.8%, respectively. The EBITDA margin for LifePoint was 12.2% during 4Q15.
Acadia operates at the most efficient operating level, as it has the highest EBITDA margin, which justifies the higher valuation multiple for the company. The operating margin for LifePoint is expected to be in a similar range until 2Q16. Hence, its current discounted valuation seems to be justified.
To align LifePoint’s recently acquired companies’ margins with its own will take another two to three years. The combined EBITDA margin for these recently-acquired companies is less than 5%. As a result, there will be a 1.7% dilutive effect on LifePoint’s consolidated EBITDA margin during 2016.
Following integration, the margin should gradually improve by 1% in 2017 and another 100 basis points in 2018. As a result, by 2018, there could be operating margin expansion of 2%. So, with a long-term horizon of two years, the valuation multiple of LifePoint could improve, leading to a surge in its share price.