Providence service corp (PRSC) is the wonderful story of a good company that has been growing at a great pace but has been mismanaged over the years by a distracted CEO but now has the team in place to unlock shareholder value.
The company operates in 2 segments; Outsourced social services and outsourced non emergency transportation (NET). The first business is their legacy business and is now only 30% of sales and dropping every year. The NET business is won on a state by state or county by county basis to service people of Medicaid/care and provide them free transportation to the hospital for regularly scheduled appointments. This saves the state money since PRSC can do it for less, so whole state budgetary pressure is a concern, they are usually the last item to come under attack. The NET business was acquired in 2007 and has been winning tons of new contracts. PRSC took on a lot of debt to buy their NET business and it almost bankrupted them in 2008/9. They managed to pull through that and have now delevered so net debt stands at 90 million, down from 150 million at the end of 2009.
The basic story here is that the social services business has been holding its own, the NET business has been winning tons of new contracts and growing quickly, but margins have suffered. Revenues have grown from 691mm in 2008 to an expected 1.1 billion in 2012, almost entirely from NET. NET keeps winning new contracts, but rolling out these contracts entails on time startup costs. As well, 3 contracts this year were poorly bid. PRSC bids on a contract and gets paid based on the number of people in the geographic area. Thus if more people use the service in that area than they expected, they don’ get extra compensation. Snow storms are actually good for them because people cancel their appointments and stay home (big reason why Q1 this year was so weak vs 2011). So in those 3 contracts, utilization rates came in much higher than management had modeled, ruining the profitability of the entire company.
On many a conference call, management has said they aim for a company wide ebitda margin of 6.5%. From 2008-2010 they managed to surpass this, delivering margins of 6.5%, 8.3%, and 8.3%. However, in 2011 the problems started and they only achieved a 6.2% ebitda margin. This year looks to come in below 5%. That’s a terrible margin obviously, and has been more than offsetting the huge revenue growth.
The former CEO of the company, Fletcher McCuster is the founder of PRSC. He did a decent job growing the company but never worried greatly about profitability and often seemed more concerned with saving downtown Tuscan, AZ than maximizing shareholder value. Here’s a link to a news story on Fletcher after he announced his retirement 2 weeks ago
http://www.insidetucsonbusiness.com/...9bb2963f4.html. As you can see he lacks focus, and owns no shares.
Things got interesting this summer when an activist hedge fund, Coliseum Capital, bought a larger stake in the company (7% at the time). I did some digging on their backround and they take outsized bets on a few companies (150mm AUM and will take stakes up to 35mm) and push for change or ultimately a sale. It worked for them in Benihana and last year as well when they sold Rural/Metro (former symbol rurl) to a private equity firm. RURL is in the EXACT SAME BUSINESS AS THE NET DIVISION. So clearly this hedge fund understands the business and hot to get value from it.
Let me walk you through the timeline on RURL. Coliseum bought a small stake in 2009. In 2010 the increased their stake dramatically over the year by buying shares directly from treasury. In the back half of the year, they fired the CEO, renegotiated the expensive debt from 12.75% to 6% and managed to improve margins on the underlying business. They then sold the business for $17 or 9x ebitda, to PE shop Warburg Pincus. This was in the spring of 2011. Coliseum bought their initial shares around $4 and their big stake at $7.50.
Now stop me when this sounds familiar. Coliseum bought their initial stake in PRSC in spring 2012 around $14. The managing partner of Coliseum, Christopher Shackelton became a director of PRSC in June. In the summer when the shares came under pressure due to bad margins they increased their stake dramatically, buying on the open market to hold 16% of the company. 2 weeks ago Shackelton “retired” the CEO and CFO of PRSC and becomes chairman of the board. A lead director has taken over as interim CEO and a former director from rural/metro has become the new CFO. Coliseum also bought an extra 100k shares the week after announcing the management changed around $12.50.
It is so clear what happens next that I shouldn’t even have to explain it. The turnaround is already occurring, and on the last conference call the COO of the company who runs the NET service said steps have been taken to deal with the 3 contracts that are dragging down the performance of the entire company. One contract has been renegotiated for a higher rate, another will be terminated at no cost to PRSC and the third is being reworked. Shackelton will continue to stress margins when bidding on new contracts. The ebitda margin should improve to at least 6.5% since the company has beat that many times in the past and RURL had higher margins closer to 10%. Then he will sell the company.
If we assume revenues of 1.1 billion and margins of 6.5% we get ebitda of 71.5 million. Like I said RURL sold for 9x in 2011, and a bigger comparable, EMS, sold to a PE firm for 10x in 2010. If we give PRSC 8x, that equates to a 570mm EV. Take off the debt which should be down to 60mm by the end of 2013 and the market cap of equity is $510mm. 13mm shares outstanding and you have $39 a share. The stock is currently trading at $14 and was as low as $10 in august. Even at 5% margins and 7x ebitda you get a takeout price of $25.
There are no big insiders who can block it, old management is already gone, and you have a guy driving the bus who has done the exact same thing only 1 year before. This seems like a pretty obvious buy to me, and is one of my largest holdings.