Surgical Center Development, Inc. (THC) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Tenet Healthcare Business Update Call. I'll now turn the call over to your host, Regina Nethery, Vice President of Investor Relations. Please go ahead.

Thank you. We're pleased to have you join us on short notice for a discussion of the SCD transaction Tenet announced this afternoon. Tenet's senior management participating in today's call will be Ron Rittenmeyer, Executive Chairman; Dr. Saum Sutaria, Chief Executive Officer; Dan Cancelmi, Executive Vice President and Chief Financial Officer; and Brett Brodnax, President and Chief Executive Officer of USPI. Our webcast this evening includes an accompanying slide presentation, which has been posted to the Investor Relations section of our website, tenethealth.com. Listeners to this call are advised that certain statements made during our discussion today are forward-looking and represent Tenet management's expectations based on currently available information. Actual results and plans could differ materially. Tenet is under no obligation to update any forward-looking statements based on subsequent information. Investors should take note of the cautionary statement slide included in today's presentation as well as the risk factors discussed in our most recent Form 10-K and other filings with the Securities and Exchange Commission. With that, I'll turn the call over to Ron.

Thank you, Regina, and thank you, everyone, for joining us. Look, we realized it was a very short notice. We apologize for that. But as you can imagine, with some of these situations, it takes a lot of steps to get all the details done and closed and signed, and we've been working at this diligently. And unfortunately, time slipped a little bit, but we felt it was important to get out publicly and announce it. And because, again, it involves so many different centers, we didn't want this to dribble out inappropriately. So hopefully, we can provide you with the most important things. We're sorry if we've inconvenienced some of you. We -- certainly, that was not our intent. And then, of course, we can be available after this for follow-up accordingly. So I just want to start out by clearing the air a little bit on that. We realized it was not the most convenient. And again, we apologize. But it's a very important situation, and we're obviously incredibly pleased with the way this transaction has developed. The announcement clearly has built off our success of our previous portfolio transaction with SCD, and it's really a natural evolution of the working relationship, which we cemented this past year. We really have great respect for the leadership of SCD, and we are really looking forward to our future partnership. This is another major step in our continued strategy to materially expand the U.S. portfolio with high-quality assets and service lines, which serve our communities and employ world-class physicians and staff. It further solidifies USPI as the leader in the ambulatory space with the momentum to continue to expand based on its service, quality and support of the physicians and staff of its centers. Additionally, it's a testament to the operating success of USPI through the pandemic and its ability to rebound both quickly and effectively. The strategic rationale in the financials of this deal are equally compelling. And I think you'll see why we believe this is such a value-creating opportunity for Tenet, USPI and, overall, our shareholders. So let me now turn it over to Saum, who's going to go into details of the transaction. Saum?

All right. Thank you, Ron. We are pleased to announce that we've come to a definitive agreement with SurgCenter development in a bold transaction and a new partnership that brings the rest of the SCD portfolio fully into USPI and Tenet. The scope of this transaction is broader, and it's different than our very successful deal from a year ago. At that time, we acquired 45 centers from SCD in December of 2020, and we added 4 additional facilities this year to make it a total of 49. All of those centers were mature in their first stage of physician partnership and had ramped up patient care. As we have noted in prior earnings calls, we've been pleased with our ability to bring synergies to that portfolio and anticipate successful reduction of the effective acquisition multiple over time. Today's unique transaction is based upon our proven success in working with SCD, the high-quality centers they develop and the credibility built with the physicians. We have entered into an agreement to acquire SCD's ownership interest in a portfolio of 92 centers, of which 65 are mature centers, similar to last year, and 27 have either been opened less than a year or have fully syndicated partnerships in place and will open within the next year. In addition to that, we are also establishing a new 5-year development partnership that gives USPI access to invest upfront and a right to buy out SCD's interest within 18 months in a target number of 50 additional centers or more over the life of the development agreement. This is in addition to the initial 92 centers. The transaction also includes some acquisition of ambulatory support services that are provided to the majority of the centers. This partnership further scales USPI's national platform and complements USPI's existing development capabilities with a shared commitment to empower physician leaders and deliver high-quality experiences for patients. Brett will unpack the elements of the deal a bit further.

Great. Thanks, Saum. And to echo yours and Ron's thoughts related to the next generation of our relationship with SCD, it simply would not have been possible to put together this type of forward-looking partnership without the mutual respect and trust between the organizations. The portfolio of 92 centers we're partnering in will expand USPI's leadership in musculoskeletal care, along with other attractive specialties with high-quality leading physicians from around the country. And a byproduct of the partnership with SCD will be that these facilities will have the advantage of accessing both USPI and SCD's development and operating expertise as these facilities grow and mature. Among the 92 centers, 65 of them have been opened for greater than a year and on a trailing basis have just shy of $480 million in center level revenue and approximately $170 million in EBITDA. In terms of maturity and performance, I think you can compare these centers to the 49 centers we acquired from SCD last year. In addition, USPI anticipates acquiring a portion the physician ownership interest such that many of these centers will be majority owned and consolidated by us, therefore, can benefit from USPI's ability to deliver operational synergies. Additionally, there are 27 centers that are currently under development or that have been opened for less than a year. Again, these facilities will benefit by leveraging the capabilities and synergies of both SCD and USPI earlier in the development, therefore, avoiding later costs related to deployment of different technologies or systems and processes. We anticipate these centers at run rate will generate about $225 million in revenue and approximately $90 million in EBITDA. Turning to Slide 7. Strategically, USPI will expand in high-growth states such as Florida, Texas and Arizona. And we'll solidify our presence in recently entered markets like Ohio, Indiana, Wisconsin and Maryland. Also, similar to how we entered Maryland at scale through the previous SCD transaction, we have a similar opportunity in Michigan to enter the state with 8 ASCs. Turning to Slide 8. The second pillar of this transaction is very exciting. It's a very exciting partnership for USPI with SCD principles who have a proven track record of developing over 200, some of the most successful ASCs in the country with leading physicians. We're entering into a development partnership for 5 years that provides USPI with an exclusive option to invest in a minimum target of 50 centers over that period of time. USPI will invest in an equity stake at the time of the development and then will have the ability to acquire the SCD partner share of the equity 18 months after the ASCs open. And as you would expect, all of this de novo development activity with SCD will be additive to USPI's very active development team that will continue to execute on a very robust pipeline of de novos and acquisitions with other premiere physicians across multiple specialties throughout the country. In short, this is not just a transaction to us but a very unique partnership that brings together the talent, expertise and capabilities of 2 organizations that have a common objective of developing and operating highly efficient, safe and successful ASCs with leading physicians and communities across the U.S. The nature of this relationship, to Ron's point, is another significant step in our stated strategy of materially expanding the USPI portfolio of high-quality surgical facilities. So with that, I'll pass the call to Dan for more details on the transaction.

Thanks, Brett. Let's turn to Slide 9. In consideration for these assets, we will pay SCD approximately $1.2 billion for their full ownership interest in the 92 centers. SCD owns a minority interest of approximately 39% on average in 86 of the ASCs and a majority interest of approximately 55% on average in 6 of the ASCs. In addition, we anticipate investing another approximately $250 million to acquire a portion of the physician's ownership interest so that we own a majority interest and can consolidate many of the centers. We are expecting to drive consolidated adjusted EBITDA of roughly $175 million by the end of year 1 from these centers with the completion of certain physician buy-ups for the mature centers. As we integrate the centers within USPI, we conservatively estimate $45 million to $55 million in annual synergies by between years 3 and 4. This will be about 15% to 20% of consolidated adjusted EBITDA from this portfolio and consistent with the synergies expected from the previous portfolio transaction with SCD. And importantly, we anticipate the effective adjusted EBITDA minus NCI multiple will be about 7x between years 3 and 4 when the new centers are fully ramped, and this does not include the value of the centers to be developed under our 5-year development arrangement with SCD. Let's now flip to Slide 10. The financial profile of this transaction is very attractive but different than the previous SCD transaction. We are acquiring interest in 27 development centers that do not generate meaningful earnings yet. As those centers ramp up in synergies from USPI management ramp-up, we anticipate at least $200 million in consolidated adjusted EBITDA less NCI. This represents more than a 50% increase from year 1. Let's now look at Slide 11. The anticipated financial return from this transaction are compelling, including 2021 pro forma EPS accretion of about 16% and consolidated adjusted EBITDA margin improvement of approximately 55 basis points by the end of year 1. We also anticipate delivering a 9% ROIC by year 3. On Slide 12, I want to point out that we plan on financing this transaction through the issuance of first lien secured notes later this month. There will be a small initial impact on our leverage after completion of the transaction due to various centers that recently opened or will be opened within next year. However, it is important to highlight that as the development centers and synergies ramp up, this will make the transaction essentially leverage neutral over time. With that, I'll pass the call back to Saum to close.

Thanks, Dan. This transaction accelerates the path of our portfolio mix targets we originally set forth for the end of 2023. Ambulatory in USPI as a percentage of Tenet's EBITDA will now reach approximately 42% on a 2021 pro forma basis inclusive of Conifer and 46% excluding Conifer. USPI will have over 490 centers with this transaction alone with further growth from other development activities planned as described. Today's announcement reinforces Tenet's strategic focus across our entire care delivery business to further our leadership in surgical care and higher acuity services. USPI has a track record for delivering synergies in high-quality care that will be extended to this portfolio as well as the new centers to be developed under the development agreement. Indeed, the diversification of our business and continued strength in our hospital and Conifer segments will continue to be substantially value-creating for Tenet shareholders. Thank you for your time. And Regina, we'll be happy to take questions.

Hector, if you could go ahead and give the instructions, that would be great.

[Operator Instructions] Our first question comes from the line of John Ransom with Raymond James.

Just wanted to go through a couple of these numbers. So the $175 million of EBITDA by the end of year 1, that is pre-NCI?

That's correct, John. It's Dan.

What would be the NCI associated with that $175 million?

It would be approximately $130 million -- $125 million to $130 million.

So the real asset's EBITDA is only like $30 million or $40 million in year 1. Is that right?

I'm sorry?

So the EBITDA less NCI is only like $30 million in year 1?

No, the consolidated EBITDA minus NCI would be about $128 million, somewhere in that territory.

Oh, I thought you said NCI was $125 million.

No, no, no.

All right. And so if we were to add this $250 million -- I'm just trying to think about how that plays with the NCI. So it would be $1.5 billion for roughly $125 million of EBITDA? Or are we getting less NCI? How much does that $250 million reduce that pro forma NCI? So I'm trying to figure out the multiple, just the interplay of timing and that extra $250 million and what's the real first year EBITDA will be.

Yes. I think, John, once everything is ramped up, the consolidated EBITDA will be roughly $275 million, okay? And EBITDA minus NCI would be -- we have it on the slide, $200 million to $210 million.

Our next question comes from the line of A.J. Rice with Crédit Suisse.

Maybe just to ask about the operating model of these properties. You obviously bought the ones last year, and you're now taking these second ones on. Two things that strike me. I wonder, is there managed care contracting dynamics materially different than what we see with USPI? Is that part of the synergy? Or do they maybe get better for some reason rates? And then it seems like they have a lot of properties that they own the minority interest on. Does that in the early years allow them to get somehow a stronger physician group in their mind? What is the thinking there? Because it sounds like you're now going to be able to buy out a number of these so at least you get to a majority position. So I'm just trying to figure out what that dynamic is all about.

A.J., it's Dan. I'll start off, and then I'll flip it over to Brett. In terms of the synergies, as you can imagine, it's not only contracting synergies related to the revenue side, but also on the supply chain side as well as obviously our capabilities to manage these centers based on our past experience acquiring a particular facility. So the synergies that I called out, $45 million to $55 million, it's really a combination of managed care synergies, supply chain synergies and then management, other type of synergies down the road.

Yes. A.J., this is Brett. And related to the ownership structure, as long as I've known and worked with SCD folks over the last almost 2 decades now, their ownership structure has been very similar. They've typically owned anywhere from 30% of the center to, in this case, about 38% on average, about 38% of the operating entities and the physicians on the rest. So their business model has been pretty consistent for a long period of time.

Yes. And A.J., this is Saum. That's no different than the centers that we had last year. It's exactly the same in terms of how the partnerships were developed and then the buy-ups that happened.

Our next question comes from the line of Josh Raskin with Nephron Research.

I guess, are there characteristics that differentiate these facilities, especially the mature ones that you spoke to, the majority of them versus the 65 last year? Sort of how did you pick and choose? And maybe why were the first 65 included last year? And again, what differentiates these?

Josh, it's Brett. So I would say the portfolio of 92 facilities that we're going to be partnering in this time around is very similar and consistent with the -- what ended up being 49 facilities we acquired in the -- partnered in, in the first SCD transaction. So very musculoskeletal focus, in this case. About 80% of the revenue is related to musculoskeletal business, and there's some other high-end specialties such as ENT that also is part of that case mix. But in general terms, very consistent ownership structure, very consistent selection of premiere leading physicians in great markets with good demographics and good reimbursement characteristics. So all in all, very consistent portfolio.

So is it really just a financial decision, just sort of a sizing in terms of the December transaction last year versus coming back with another $1.2 billion this time?

Yes. Josh, I would say it's very different transaction. Last time around, we -- of course, we acquired the 49 facilities or partnered in those 49 facilities. This time around, of course, there's a larger portfolio of centers. But don't miss probably the more important aspect of this transaction, and that is the partnership going forward, where we'll be able to leverage both the SCD and USPI operating and development expertise for not only in the facilities that will be partnered in initially but ongoing for the next 5 years as SCD continues to execute against their own development pipeline.

And I apologize, just for clarification, what's left of SCD post this transaction?

What's left is essentially a very strong and capable development engine that will continue to develop centers across the company -- I'm sorry, across the country. So there'll be no facilities left in SCD after this transaction.

And we have that relationship for...

Yes. And again, we'll have the development relationship with SCD going forward.

For 5 years, right, Brett?

For 5 years.

It gives us first call on everything they do at a preset. Or no? Did I say that correctly?

Yes, yes.

Our next question comes from the line of Kevin Fischbeck with Bank of America.

This is actually Courtney on for Kevin. So I guess just some -- if you could add some extra color on the new development that you mentioned as part of this 5-year continued partnership. So I guess, how will these investments be funded? What percent stake will USPI have? Are you guys going to go for majority interest? And then I guess just any color on timing you have in purchasing out the physician stake?

Yes. I'll try to answer both of those. So related to the ownership structure, we'll have the opportunity to invest side by side with SCD when the syndication is done for each of the individual development centers on a per pursuit basis. And again, as I mentioned in the commentary, we'll also have the option to acquire SCD partners, the SCD partners' ownership interest, the remaining portion of their ownership interest 18 months after the facility opens. So that's going to be the ownership structure for all of the -- what we believe is going to be a minimum of 50 facilities going forward in the development agreement. As it relates to the buy-ups, we plan to start having conversations with the physicians actually in the mature centers next week, and we hope that we'll have success in being able to buy up in many of those facilities before the end of the year. And then some, of course, will slip into 2022.

Okay. And then I'd like to just clarify one thing. Is this specifically on facilities that you're breaking ground on in the next 5 years or facilities that are going to be open in the next 5 years by the SCD development engine?

Yes. These are going to be facilities that are currently not in development today. Everything that SCD has historically been working on or is operating, those facilities are coming over. So these will be new facilities that the SCD principles will begin to develop post transaction.

We have everything else ahead.

That's right.

Our next question comes from the line of Brian Tanquilut with Jefferies.

Congrats on the deal. I guess just a quick question. Slide -- that slide where you show the improvement, I think Slide 10 in EBITDA and the valuation, does that assume the buy-up in those fully ramped multiple targets?

Yes.

Okay. Got it. And then I guess my follow-up just to the point that Brett made earlier. So is this basically like a way -- in a way to outsource development partially and then kind of going parallel with your internal development strategy? Is that a good way to think about this?

Yes, let me -- this is Saum. Let me make a couple of points about that. I would characterize it slightly differently than outsourcing development. If you think about what Brett said, the history with SCD is long. I mean the transaction last year happened to be a big chunk, but the success of USPI and SCD partnerships goes back many, many years. And so number one, the balance of operational and to be operational facilities within SCD now land within USPI. They're all coming over. It's important because this is probably -- well, it's certainly the largest and only actionable platform out in the marketplace today available for a transaction like this. The second thing is, based upon the relationship with the physicians and the integration over the last year and the ability to drive synergies, we have a lot of confidence in taking on the initial 92 centers, some of which we indicated are like last year's. And a subset of which are still going to ramp up, but we believe they'll ramp up faster and more effectively working together. Then in addition to that, you have this development agreement around the 50 new centers, which they will play a role in. Those principles will play a role in starting up with our typically 2-way partnership, de novo, musculoskeletal-focused centers, around the country, fully complementary to the work that Brett's USPI development team does today, which is a mix of 3-way and 2-way partnerships with often larger -- on average, larger centers than the typical center that SCD develops. So I would think of it as a broadening of the development aperture for USPI as we look forward in addition to ramping up the amount of investment that we'll be putting into the business to grow the number of centers over time.

Yes. No, thanks, Saum. Yes, the only thing I was going to say is -- and Saum alluded to this, this is going to -- think about the SCD principles working in parallel with the USPI development team. We're going to be working on our own separate deals, our own separate acquisitions and de novos. But at the end of the day, they're all going to be coming together and the overall USPI portfolio.

Our next question comes from the line of Whit Mayo with SVB Leerink.

Maybe just a follow-up on that. I didn't hear this. So what is the overlap of these assets look like with USPI's current hospital partners? And I presume you have an opportunity in some of these situations to bring in a hospital partner, so I just wanted to sort of understand that dynamic. And then as we think about where you have hospital partners, does it influence where SCD will focus on some of their de novo activity? I guess I'm trying to think about how they may pivot their own development pipeline just given the partnership now.

Yes. Whit, this is Brett. So on the latter point, SCD has a proven track record and very successful. I suspect that they're going to continue to use their historical pattern of developing facilities with kind of leading physicians across the country where they think it makes sense. Obviously, we'll do that or they'll do that in coordination with us, but we're not going to want to get in their way in terms of how they have historically develop facilities just because they've been so successful at it. As it relates to the overlap between this portfolio and our health system partners, there's a little bit of overlap in a few markets. So in those situations, we'll certainly be offering those facilities that end up in those markets with health system partners to the JVs with those health systems. And you're right that there's going to be some other facilities where we don't have health system partners today. That may result in new health system partnerships going forward, if there's an opportunity to work with those health systems to create a nice joint venture relationship for the entire marketplace where it be accretive to the health systems and accretive to us.

And with a chance to grow.

And with, absolutely, a chance to grow.

Your final question is a follow-up from John Ransom at Raymond James.

Dan, just to go back to my question on multiple. The multiples that you cite, the 7x kind of terminal multiple, does that include the $250 million additional consideration for the doctors? Or is that based on the $1.2 billion?

No, it includes the $250 million, John.

And just kind of talk, if you would, about how this is going to work. Is this just literally going out and doing a gazillion meetings with individual doctors and trying to talk them into selling? Or is there some structure by which you could make this happen in a more structured way?

Yes. John, well, we've gotten pretty good at it just simply because we ended up having a bunch of Zoom calls during COVID with the first group of physicians through the initial SCD transaction. So we're going to go through the same process this time around. We already have it. We already have a plan. We already have a schedule. And we're going to be -- now that we've announced it, we're going to be contacting each of those physician groups to schedule Zoom calls with each and every one of them over the next 30 days. So a lot of work to do. And you're right, it's going to be a lot of Zoom calls. But we have confidence that we'll make them happen, and we'll ultimately end up with quite a few opportunities to buy up in these facilities and make this transaction look good and profitable for everyone.

And again, we did it in the past. So I think we're pretty confident we can pull it off. We have a very good plan.

We do have 2 additional questions that came through. The first is from Ralph Giacobbe with Citi.

Great. My only was the one that John just asked, but just a follow up to that in terms of going and kind of the individual sort of those conversations in those Zoom calls. Is the buy-up up to 51% to consolidate? Because I know you talked about a 55% interest in the 6 centers. Just trying to get a sense of, is it just to get it over to the sort of 51% threshold? And then just the $250 million, like what is that based off of? I guess I'm still unclear. If you haven't had those conversations, how do you come up with the $250 million to acquire to consolidate those centers?

Ralph, it's Brett. To answer your second question first, the $250 million was just based on an assumption that we would ultimately end up getting 80% of the, we'll call it, mature facilities to agree to allow us to buy up in those facilities. So that's an assumption we made. We feel good about the assumption. But to your point, we haven't had those individual conversations with the physician partners at this point. To answer your first question, very similar or exactly like we did in the first SCD transaction, we'll be offering to buy anywhere from -- up to anywhere from 50.1% to 60% in each underlying asset. So the doctors will have the option to, one, participate it all. And then two, if they decide to participate, then they'll have the option to sell us to get -- sell us enough ownership to get to 50.1% or anywhere between 50.1% and 60%.

Your final question comes from the line of Andrew Mok with UBS.

The slides indicate 38% EBITDA margins even though 27 ASCs are in developmental stages. Can you give us a sense for the margins of the mature 65 facilities and how that compares to the 27 in development?

It's comparable. It's comparable.

So is there very little revenue contribution from those 27 facilities?

Well, there's none right now. They're just -- they're very -- there's some of -- 16 of them have opened, then there's 11 that haven't opened yet. So I mean there is some revenue associated with it but -- for the ones that have been opened, but those centers are still essentially in development.

So Andrew, maybe to make sure I answer or understood your question correctly. So the 38% is for the mature centers. It does not take into consideration the margin of the centers that are less than 1 year old and/or the de novo facilities.

No further questions at this time, and we've reached the end of the question-and-answer session. And I would like to turn the call back over to...

No, we could extend it slightly if there were other people that had other questions. That's all I'm saying.

Okay. Yes. At the moment, there are no further questions at this time.

All right. Then we can -- Saum, you want to...

All right. So let me just summarize. Look, I couldn't be -- as Ron said, to begin with, I couldn't be more pleased with the way this transaction has come together. If you think about what we had accomplished last year, which ended up being 49 centers. Here, we have 66 centers that look very similar, high quality, high margin, nicely ramped centers with post-synergy multiples that are going to be back in that range in the low 7s that we talked about. And what really took some time to work through in this transaction was earning the trust of the SCD principles to do 2 things. One is bring centers on board before they were mature, which also have a similar growth and performance profile associated with them but working together with the USPI operations team to really ramp those up and see the benefit of those synergies early on. And then obviously having put together a partnership that will now take SCD's incredibly productive development engine and put it alongside USPI's development engine gives us a runway of further growth over the next 5 years as described that ought to be unrivaled in this industry. Our leadership in musculoskeletal -- broadly speaking, musculoskeletal, ambulatory care is, at this point, truly unparalleled when this deal closes, which is terrific because that is, by far, the most rapid area of growth. So we're very excited about the deal. We think that the things that we need to do that we've talked about over the last 45 minutes that will successfully ramp these centers to what we've described, in particular on the financials on Page 10, are things that we have been doing with the current facilities from SCD very successfully, which gives us confidence in our ability to execute. So I'd like to thank Brett and the team and everybody involved in bringing this transaction together. Regina, I'll turn it back over to you.

That's all for the saving. If you have any follow-up questions, obviously, of a nonmaterial nature, feel free to give me a call. I think you all have my contact information. Have a great evening, everyone.

Thank you.

This concludes today's conference. You may now disconnect. Thank you all for your participation.