AmSurg: A Healing Investment

AmSurg (AMSG) operates a national network of ambulatory surgery centers (ASCs). ASCs are basically places for outpatient surgery. 88% of AMSG's ASCs operate in practice areas of gastroenterology (colonoscopies) and opthalmology. The other most common practice area is orthopaedics. AMSG forms partnerships with physicians to open or purchase these ASCs, always in close proximity to the physician's practice. AMSG usually retains a 51% interest in these partnerships.

Valuation (attributable to AMSG shareholders unless otherwise indicated):

• P/E: 10.08
• P/S (total sales): 0.8
• P/FCF: 6.6
• DCF Valuation: $36.39 (assumes 0% growth)
• Mkt Cap: $540MM

AMSG has very high operating margins (around 27% the last few years) and high CROIC as well (average of 18% over the last 10 years). FCF (even after distributions to noncontrolling partners) was $80MM last year, which exceeded net income. In fact, FCF has exceeded Net Income for at least the past 5 years. FCF has grown by 46% in the last three years. Revenue has gone from $400MM in 2005 to $670MM last year, largely due to the opening of new ASCs. Another of my favorite indicators, management ownership, is also positive; the directors and executive officers own around 7.2% of the company.

AMSG's industry is also a selling point. Approximately 70% of AMSG's ASCs specialized in gastroenterology. With the ageing and growing US population, the demand for these procedures can only increase. As well, ASCs offer a lower-cost alternative to hospital procedures, something that will surely be emphasized as healthcare costs in general continue to increase.

AMSG management estimates that 50% of single-specialty and 25% of multi-specialty ASCs are independently owned, thus giving AMSG the opportunity to grow both by purchasing interests in these currently existing centers and by developing new centers. These factors make the 0% growth assumption quite conservative. It also means that at this current price you are getting any future growth from AMSG for free.

It should also be noted that AMSG's P/E has been as high as 19 in the last 5 years, and even a more conservative 15 would be a 50% gain (or more if EPS were to increase as well). P/FCF was around 10 as recently as 2007. This would represent a similar potential gain.

However, AMSG has been squeezed recently by a tough economic environment. Same-center revenues increased only 1% last year due to a difficult economic environment and the company is expecting flat growth this year. Despite this, AMSG has been able to grow total revenues by 11%, due to opening new ASCs. Debt is also a bit higher than I would like to see normally, but it seems that the company considers this to be a good source of financing, as with over $200MM in FCF in the last year, they could pay down a significant portion if they so desired.

Additionally, about a third of AMSGs revenues are derived from governmental insurance companies, mainly Medicare. I see both positive and negative in this. First, the positive: as the government looks to lower costs, ASCs seem like a great alternative to hospital procedures.

On the other hand, reductions in payment seems to be another method of cost reduction for the government. In 2008 the Centers for Medicare and Medicaid Services in revised its payment system. This resulted in an EPS reduction of $.05 in 2008, $.07 in 2009, and an estimated $.06 in 2010 and 2011, all in addition to the prior year's reduction. This means that in 2011, EPS will be $.24 lower than it would have been under the prior payment methodology.

Beginning in 2012, the payment amounts will stop being decreased and will be adjusted upwards based on the CPI. This is obviously a big deal for AMSG (2009 EPS was $1.73) but the only "risk" here is of future similar reductions in payment; the current reductions and their effects are already known. Presumably, as the population ages, more of AMSG's clients will be covered by Medicare meaning that any future reductions could have a greater impact on profitability.

There are also more remote risks. The company lists certain risk factors involving potential regulatory changes that would effectively shut down ASCs. If this were to happen you could pretty much stick a fork in AMSG. I view the potential for such a regulatory change as extremely remote.

In summary, AMSG is a well run company in a growing industry with very high margins. The risks are either already quantified or extremely remote. Best of all, you're getting any growth for free.

Disclosure: Author long AMSG