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Mean health (NYSE: SGFY) recently announcement The winding down of its Episodes of Care (ECS) business segment, including the Bundled Payments for Care Improvement-Advanced (BPCI-A) program, will be good news for investors. The ECS segment consistently disappointed after the IPO, taking away the shine of outperformance of the HCS segment (already on track for ~2.4 million home health assessments this year) as well as its exposure to secular tailwinds. The outlook for ECS was also not improving – a recent reconciliation update from the Centers for Medicare and Medicaid Services (CMS) lowering the target price of ECS would have significantly limited savings opportunities for SGFY and providers. in the future. With SGFY stayco now trading at an implied rate of around 11x EV/EBITDA despite its position for continued double-digit revenue growth and EBITDA margin expansion, I think the risk/reward ratio has become favorable for the title.

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DHW Segment Reduction

After more than a year of resistance, Signify has finally announced the end of its ECS segment (including a complete exit from the BPCI-A program). By management, the latest CMS reconciliation update lowering the target price for episodes of care was the straw that broke the camel’s back, limiting long-term financial opportunities for SGFY and providers. For context, retrospective trend adjustments were first introduced to BPCI-A in 2021 (or model year 4), with CMS delivering SGFY’s 2021 retrospective trend adjustment report at the end of June/beginning of July this year.

Indeed, BPCI-A 2021 benchmark rates will see a downward revision – despite inflationary pressures from labor and supply chain disruptions over the period. Thus, the proposed trend adjustment for 2021 will further reduce the savings attributable to organizing participants such as SGFY and, in turn, will distort the risk/reward ratio of the ECS segment. Given that the BPCI-A business had already recorded losses at the EBITDA level for five consecutive quarters (negative contribution of approximately $24 million to EBITDA in 2021), the exit of ECS was at my notice the only rational outcome.

Signify Healthcare ECS Profitability

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A clear strategic and financial positive

The overall business of SGFY has undergone a massive change since the acquisition of Caravan Health in March of this year – recall that prior to the acquisition, BPCI-A accounted for ~90% of ECS segment revenue, with the commercial packages business contributing the remaining ~10%. Given that ECS segment revenue had also declined to ~$120m in 2021 (vs. ~$160m in 2020) amid COVID pressure on case volumes, diversification was a welcome move. .

Mean health revenues

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Over the past few months, the industry backdrop for ECS has deteriorated significantly, driven by ongoing changes to the terms of participation. As a result, with many BPCI-A vendors rushing to exit, vendor participation in BPCI-A has declined, leading to significant pressure on program size, administration costs, and vendor revenue. shared savings from SGFY. With the decline in supplier participation looking more structural than transitory, ECS revenue headwinds would likely have persisted for the rest of the BPCI-A model, and therefore SGFY’s decision to cut its losses here makes a lot of sense.

On a positive note, the exit of ECS will not impact the state of the recently acquired Caravan Health business, which will continue to operate on a stand-alone basis. From a cost perspective, SGFY guided between $25 million and $35 million in post-exit restructuring charges as well as non-cash impairment of goodwill and intangible assets of $450 million to $530 million. These fees will eliminate approximately $85 million in annualized ECS costs and $30-35 million in shared cost savings (out of $60-65 million in total shared costs) by the end of 2022. Thus, the reduction (expected to be completed by the end of 2022) is expected to prove earnings accretive as early as next year – showing an advantage over the current consensus EBITDA estimate of around $275 million and resulting in a stronger free cash flow generation in the future.

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Consensus EBITDA (before liquidation)

275

(+) 2023 losses attributable to the old ECS (pre-exit)

32.5

Midpoint of forecast to eliminate $30-35 million (out of $60-65 million shared spend with ECS)

(-) Caravan intake 2023 (Pre-Release)

20

Caravan contribution to HCS standalone Adjusted EBITDA at >20m (100% YoY growth forecast)

= Implied EBITDA of HCS segment 2023e (pre-exit)

288

(-) Annual shared costs retained

27.5

Midpoint of forecast to retain $25-30M (out of $60-65M shared spend with ECS)

(+) 2023 Caravan Contribution (Post-Release)

20

Adjusted EBITDA growth > 100% year-over-year

2023e total adjusted EBITDA (post-exit)

280

Remainco Implied Adjusted EBITDA Margin

27%

Sources: author, Signify Health Disclosures

ECS Wind Down Highlights Remainco’s Compelling Valuation

Net, SGFY’s decision to wind down the ECS segment is clearly positive for the long-term investment case, improving the operating consistency, revenue growth trajectory and margin profile of the entire business. company. Although the exit from ECS may result in lower revenue in the short term, the business has long been a drag on EBITDA, and so the termination of the program presents SGFY with an opportunity to reduce costs and increase still its EBITDA margins over time. Additionally, the stock trades at ~11x stayco’s 2023 EBITDA – a compelling valuation given that its >20% revenue growth and potential for EBITDA margin expansion remain intact. The upcoming Q2 2022 earnings report in August could be a potential upside catalyst, with management ready to provide further insight into the status of the ECS win after the ECS win.