Surgery Partners Inc [NASDAQ: SGRY]

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1/21/19

Surgery Partners (SGRY) reiterated the 2018 guidance they presented in November during Q3 earnings. In July of 2018, Hedgeye reported that SGRY’s EBITDA estimate was too high, believing that management would cut their guidance making a great catalyst for the short side. Timing and the thesis have played out accordingly since then, but EBITDA estimates for 2019 are still too high and many elements of the original short thesis on SGRY are still in play such as low-quality assets / poor case mix and overleveraged balance sheet.

The company has shown a remarkable inability to generate free cash flow as they continue to take on more debt to fund their acquisition strategy. At the current rate they will have to tap capital markets again later in 2019. From a valuation perspective, we can get to an $8 stock or 30% downside from here in 2019 if we are right on the fundamentals and catalyst. In Hedgeye’s bear case scenario, there is a change of the stock going to $0. Stay tuned for Q4 earnings and 2019 guidance in February.

1/19/19

This will make it hard for the company to fuel the roll-up strategy and hit consensus numbers. The cash burn also makes it difficult for the company to do enough acquisitions to close on the pipeline and meet quarterly earnings estimates. They need to spend about $150-$200 million in acquisitions to hit 2019 estimates. At the end of 1Q’19, at the current pace, they would only have $122 million so there’s a gap that’s emerging.

The “phase-shift” took place after the preliminary 3Q’18 release and news of incremental capital raise (which was successful). High-beta, high-leverage, no cash flow makes for a great Quad 4 (i.e. U.S. growth and inflation slowing) short, and the stock remains significantly overvalued.

Surgery Partners pre-announced saying that they’re going to raise additional capital to fund acquisitions going forward. This is not what you want to see as an equity holder when TheCYCLe is signaling the best course of action is to deleverage.

We think what’s really fascinating about the Surgery Partners pre-announcement is that in the press release the company said Same Store Revenues were 9-11%. That’s significant same-store growth particularly with where the company has been trending, in the low single digits. At the same time, the company isn’t generating any type of operating leverage or free cash flow so their margins are continuing to come under pressure.

If Same Store growth was going to save the day this would have been the quarter we were going to see it. That’s part of the reason why the stock has traded down since the announcement.

Bottom Line: Margin expansion is going to be very difficult for Surgery Partners (SGRY), but the core of any balances sheet short is that this company is not earning its cost of capital. It continues to burn cash which means that they’re going to have to raise capital at a time where they’re already significantly levered by the tune of 9X leveraged.

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