In December 2020, Encompass Health (EHC) announced it was exploring strategic alternatives for its home health and hospice business with the alternatives including a spinoff, sale, merger, or IPO, among others, recalls Jim Osman, editor of The Edge Spinoff Report Lite.
A year later, Encompass announced in December 2021 it will perform a tax-free spinoff of the Home Health & Hospice Business, to be rebranded as Enhabit Home Health & Hospice.
Enhabit — the spinoff company — is a high quality business. We believe that Enhabit should trade at a premium to its peers Pennant Group (PNTG), LHC Group (LHCG), and Amedisys (AMED), owing to its higher operating margin of around 19% compared to the peer average of around 10.3%.
Post-spinoff, Encompass Health — the parent company — will be the market-leading inpatient rehab franchise (IRF). Due to the non-discretionary nature of several conditions treated in IRFs, EHC’s admission trends tend to be more stable than other sub-sectors of healthcare services, providing valuable revenue visibility and positive free cash flow assurance.
We anticipate potential index selling pressure. EHC is a member of the S&P Midcap 400 Index. To be eligible for the MidCap 400, a company needs to have a market cap in the range of $3.7 billion to $14.6 billion.
If we maintain our assumption of a 1:1 distribution ratio and assume a debt distribution ratio equal to the respective businesses’ EBITDA contributions, we believe Enhabit, the spinoff, will have a market cap of $1.2 billion.
We anticipate potential upside for the combined pre-spin company, EHC, of 27% as a base case, and 52% in a more bullish scenario.