Greystone Capital new idea Q3,2023 newsletterMedical Facilities Corp. (MFCSF)
Medical Facilities Corp. found its way into the portfolio this quarter as an under-the-radar microcap that
owns minority interests in a group of surgical hospitals in various geographies. The company’s four core
facilities are located in South Dakota, Oklahoma and Arkansas and provide services ranging from
orthopedics to spinal care to various inpatient and outpatient procedures. Medical Facilities partners with
physicians for ownership of these hospitals, and operates the facilities from an administrative, billing and
back-office standpoint, while generating revenue by collecting a facility fee for their services. This model
is a beneficial partnership for both the company and its physician owners, as doctors are free to provide
medical care while MFC takes care of management of the facilities.
I wouldn’t typically be interested in this business or industry, as there is no shortage of bad examples of
private equity surgical hospital rollups where scaled players who took on too much debt collapsed under
the weight of a high fixed cost model. MFC is not a rollup, and when run well, surgical hospitals are licenses
to print money. Furthermore, there are elements of this story that I believe have allowed us to purchase
shares at bargain basement prices. Following years of mismanagement, recent activist involvement led to
a management and board change, strategy shift, dividend cut, and operational improvements that were
executed with the sole focus of driving shareholder value. The dividend cut and strategy shift caused the
stock to sell off, which hasn’t quite recovered despite the positive improvements that have taken place.
Furthermore, MFC has some of the best performing hospitals in their geographies, carry less leverage than
their peers, and have been in operation between 20-40 years, earning very high-quality scores among
patients and staff. MFC will also benefit from favorable trends in the US healthcare market including an
aging population and strong demand for orthopedic services moving forward. Despite this being a
competitive space, MFC has some aspects of a soft moat, that have allowed the facilities to grow their
patient volumes and revenues at mid-single digit rates for the past decade plus.
These include:
- High levels of patient satisfaction are driven by convenience, high standards of care and a less
bureaucratic environment than a traditional hospital. This allows for more convenient intake and
discharge as well as better scheduling availability
- Physicians practicing at MFC facilities can drive their procedure volumes higher than a traditional
hospital setting, thereby increasing earnings potential which leads to surgeon loyalty over time
- The scale of each facility means that MFC can offer a wider range of procedures and patient
choice, providing an equal alternative to a traditional hospital
- Given the choices available, MFC can lead with billing transparency and avoid surprise medical
bills for hospital visits
I like our chances to do well here as the mandate for management is simple. Manage the hospitals
efficiently, sell off non-core assets, and return capital to shareholders. MFC has been executing on all
three initiatives, by divesting five of six non-core Ambulatory Surgery Centers, restoring hospital level
margins, and returning a significant amount of capital by repurchasing nearly 20% of shares outstanding
last year alone. It is likely the business will continue to divest both non-core assets and potentially surgical
hospital assets over time.
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Greystone Capital Management | adam@greystonevalue.com | www.greystonevalue.com
Selling into strength will benefit MFC. Significant consolidation is taking place across the industry, with
the last 12-18 months representing one of the most active periods for M&A in industry history. The rise
of physician owned hospitals, outpatient care, the need for market share gains and significant scale mean
that MFCs assets are very attractive and could fetch strong valuations in a sale scenario. The closest public
company comps, as well as every relevant M&A transaction I could find point to a sale scenario being one
path to strong returns. Absent that, mid-single digit top line growth, even on a slightly elevated cost base,
means that MFC should be able to generate $1.5 - $2.0 dollars in FCF/share within the next few years. The
current share price is $6.75 USD. With the continued divesting of assets, more share buybacks, and
potential margin expansion, our upside could approach 100% over time.