Business Breakdowns
· Zack Fuss, Chadd Garcia
[00:00:00] S0: And what's the margin profile of Roto-Rooter overall and how has that trended? [00:00:00] S1: It's about 25% EBITDA margins in any given year, and it kind of goes up and down in any one quarter, any two quarters, but about 25% EBITDA margins. The one interesting thing from the call today was that their branches are performing remarkably well. And that makes sense because the corporate's got a lot more control over the branches than they do the franchises and independent contractors. Revenue grew overall, but leads coming in were down 7-8%. And so what that tells me is that they're probably being less aggressive on the search engine optimization and competing in that manner, which may have lowered their leads, but the leads that they get, they are converting those to sales at a higher rate. [00:00:00] S0: So they're seeing higher quality leads. I guess just to make sure that we have a good understanding: It looks like around two-thirds of their EBITDA is from their branches, whereas the remaining third are split between contractors and franchisee fees, with the franchisee fees being a smaller proportion of that. Can you just walk us through the basics of the three models and how they're different?
· Zack Fuss, Chadd Garcia
[00:00:00] S0: So they're seeing higher quality leads. I guess just to make sure that we have a good understanding: It looks like around two-thirds of their EBITDA is from their branches, whereas the remaining third are split between contractors and franchisee fees, with the franchisee fees being a smaller proportion of that. Can you just walk us through the basics of the three models and how they're different? [00:00:00] S1: With respect to the branches, you own the whole business. So it's a normal corporate income statement. With respect to the franchise fees, they have 360 franchises. So if you look at, maybe they have $7 million in franchise fees a year. So you divide that out, that's probably $15,000 per franchise. They'll tell you that what the franchises pay is determined on the population base that they serve, but they're not getting much money from the franchises and they don't spend any money on them. So that should be the highest margin business, if it's close to 100% margin, but it's small, 6% of their overall earnings. And then 21% of their EBITDA comes from their contractors. And so that's the 28% royalty that they get from their contractors. But they supply a lot of the marketing services and the back-office functions. So that's going to be higher margin than their branches, but less than the franchises. [00:00:00] S0: And then how has it been evolving over time in terms of mix? [00:00:00] S1: They've been slowly acquiring franchises and converting them either into independent contractors or branches.
· Chadd Garcia, Zack Fuss
[00:00:00] S1: They've been slowly acquiring franchises and converting them either into independent contractors or branches. [00:00:00] S0: And then, you know, you haven't made a lot of mentions to management, although typically in stories where capital allocation is a primary driver of value creation, management's important. I know the CEO of the business is a lifer. What's your experience with the management of this company and what does succession look like there?
· Chadd Garcia
[00:00:00] S1: Well, most of my experience has been with the CFOs, primarily the former CFO over the course of several years. Since I invested in this in the 2000s, I've recently started spending a lot of time with the current CFO. But they are hard to get in front of. They are covered by one, two, three sell-side firms at any given time. These sell-side firms tend to be on the smaller side. So it's hard to get to some of the conferences that these guys go to and get in front of them. Back to the CEO, Kevin McNamara. He started out at the pharmaceutical services business Omnicare. He became general counsel of Chemed in the '80s. He became Chemed's president in the '90s. In the early 2000s, he became the CEO. He's 70 years old and doesn't seem to be stopping yet, but given his age, it's good to be looking at who's next in line. Nicholas Westfall, the current CEO of VITAS. He's been with the company, I believe, since he graduated from business school in '09. He's been a long-time participant of the quarterly calls. It would be my guess that he's probably next in line for the CEO job, given his age and VITAS's relative size to their overall business. Regarding the company's culture, I see it in their actions. Like how do they allocate capital? Are they consistent with what they said they would do? Are they consistent with what they've communicated to me that they exist to grow their free cash flow per share in the business units, like at VITAS? How do they treat their patients? Do they go above the Medicare cap for high-acuity patients from time to time? From time to time they do. It costs the company money, but it's the right thing to do for the patients. When you go back to the fine that they paid for the False Claims Act charges, it seemed to me that in that situation they were treating high-need patients when the reimbursement rates were too low. A lot of the other industry players weren't doing that. In my mind, that shows the integrity that the team has and management's culture. Do they treat their employees well? During the post-COVID healthcare-worker crunch and high inflation, they implemented a substantial retention program in their business, and they were able to recruit employees from other firms. Are they good spokespeople for the industry? During that same time, their margins were lower than usual, but their margins were still satisfactory.
· Chadd Garcia, Zack Fuss
For the bottom 50% of the industry, whose margins are materially lower, these firms were at jeopardy of going out of business. VITAS was reaching out to the government to advocate that they up the reimbursement rates sooner than the government normally would. That was done to save the industry, not protect their margins, which were lower for a period of time, but still fine. [00:00:00] S0: I think that's a robust summary on the Roto-Rooter business. Tough to find an easy segue over to hospice care from a business characteristic perspective. Maybe just start on the similarities you see between the businesses, and then we'll follow up with what exactly the hospice business does, how it's grown, and the strengths, weaknesses, and challenges facing that business. [00:00:00] S1: Well, to start, both of the businesses are highly fragmented industries. And so, if you look at Roto-Rooter, they're probably 2% to 3% of the overall plumbing market and 15% of the drain cleaning market. If you look at VITAS, VITAS is probably 12% of the hospice market. Neither of them require many assets, but they are people-intensive. They don't require much capital to grow, but they generate high returns on capital and spit off a lot of free cash flow. And then both of them are fairly acyclical. [00:00:00] S0: The hospice business itself was interestingly acquired a few decades ago through a prior financing. How has that business evolved? What does it do? Why do you like the hospice business?
· Chadd Garcia
[00:00:00] S1: The business has compounded its revenue at 6%. They really didn't utilize acquisitions as a way to grow it. So that's all, for the most part, organic and greenfielding. The earnings have grown at a faster rate as they expanded their margins. The EBITDA margins for this business range between 15% and 22%. They were able to do a large acquisition recently. When I look at this business, aside from the high returns on capital that it generates and the massive free cash flow, I look at the tailwinds that this thing has coming up, and I think it's massive. Right before COVID, there were two and a half million Americans who passed away every year. Presently, we have about 3 million that pass away. Fast forward in the 2000s, that number should rise to just under 4.5 million people every year and plateau for a long time. There's definitely going to be a rising demand for palliative care services. And then if you look at one of the other major players in the business, it's the government. The government pays for 96% of the bills for palliative care services, and 93% of that is Medicare. What service does the industry and VITAS provide to the government? 30% of Medicare's expense comes in the form of paying for healthcare in the last year of a person's life. And most of that is within the last six weeks. And it usually comes in two forms: First, paying for curative care that's not effective and could do more harm than good. Or, dealing with episodic events via emergency room visits, ambulance transportation, and hospital visits. There are episodic events that can happen in the final days of a person's life that are quite scary for their caregivers, who are mainly their family members. That often leads to expensive hospital visits. The hospice industry and VITAS train these caregivers on how to deal with episodic events so their patients don't end up in hospitals to be stabilized and then shortly after return back to their house. This industry saves Medicare an ample amount of money, and so that's something that the government should want to support and continue.