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A Higher-Margin Small Cap Spinoff Breaks the Norm

The Ensign Group, Inc. (ENSG) will complete the Spinoff of a uniquely positioned senior living and home hospice business (to be called The Pennant Group, Inc. (PNTG)) at the beginning of October, following the same playbook as a previous REIT Spin back in 2014. While PNTG will experience some initial index selling pressure as it leaves the S&P SmallCap 600 Index, it will also be a high-margin, low leverage, and asset-light business prime for a mid-term takeover in a competitive space.

What's Happening?
The Ensign Group, Inc. (ENSG) has outperformed the S&P SmallCap 600 Index since its 2014 Spinoff of CareTrust REIT, Inc. (CTRE) by +212%, and is now looking to perform another break-up by October 1, 2019. This time, it is separating its senior living and home health & hospice operations from its core skilled nursing assets. This Spinoff is structured similarly to the CTRE separation and was announced on the back of higher investor interest in non-nursing assets like senior housing and hospice services than in the skilled nursing space. In a reflection of these sentiments, the average EV/EBITDA multiple for skilled nursing companies is 9.3x (EHC: 9.7x and NHC: 8.9x) compared to the much higher non-nursing companies’ 15.8x (AMED: 18.9x, BKD: 10.9x and LHCG: 17.5x), a significant premium of 69.1% on FY20E, which is a strong positive for The Pennant Group, Inc. (PNTG, Spinoff).

The Edge View (ENSG, Parent Ex-Spin)...
Following the Spinoff, ENSG (ex-Spin) will be a skilled nursing company with a revenue of $2.3bn from its two segments: Skilled Nursing ($2.2bn, 98.1% of the total) and Senior Living ($58m, 2.6% of the total). We expect ENSG (ex-Spin) to continue its growth momentum on the back of selective acquisitions and a favorable leverage position of FY20E: 0.9x (including lease 4x) compared to its closest peer EHC’s leverage of 3.4x (including lease 3.7x). Furthermore, the simplification of the Medicare reimbursement process is expected to increase realization rates by 2.4% for ENSG, thereby supporting its EBITDA margins toward FY20E at 10.6% from the current levels of 9.5% in FY18.

The Edge View (PNTG, Spinoff)...
PNTG (Spinoff) operates into the non-nursing space, which has seen higher investor interest building compared to the skilled nursing space (particularly due to the asset-light model typically found in these companies). Due to the increase in M&A activity (driven primarily by private equity), we believe PNTG is a potential medium-term takeover target. Having said this, we anticipate some initial index selling pressure on PNTG of 2.7% (0.8m shares) due to its size as it leaves the SmallCap 600 Index.

Management Shuffle at Both Companies...
After the announcement of the Spinoff, it was determined that Christopher Christensen (former CEO of ENSG for 13 years until May 2019) will be elevated to become the Executive Chairman of ENSG (ex-Spin), and Barry Port (formerly the head of Skilled Nursing Facilities from 2012) will be appointed CEO of ENSG (ex-Spin). Meanwhile, Daniel Walker (President of Home Health & Hospice at ENSG since 2010) will be appointed Chairman, President and CEO of PNTG (Spinoff). Christensen will also be appointed to the Spinoff’s board of directors. Therefore, Christensen will be on both companies’ boards and the respective presidents of the Skilled Nursing and Home & Hospice businesses will be appointed as respective CEOs.