Spinoff or Merger: Making Sense of Encompass Health’s Options

Activist investment firm Jana Partners is reportedly urging Encompass Health Corporation (NYSE: NYSE) to reconsider plans to spin off its home health and hospice segment into a new public entity. Instead, Jana wants the Birmingham, Alabama-based company to circle back to a potential third-party merger.

There are hypothetical advantages and disadvantages to both a public spinoff and merger with another organization, according to market experts.

One of those strategies is likely more realistic than the other, however.

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“[With a spinoff], you’re not at the mercy of a bidding process, and you’re not waiting for buyers to show up,” Jefferies health care services analyst Brian Tanquilut told Home Health Care News. “It’s an easy, surefire way to affect the separation of the two businesses and, hopefully, realize some of the trapped value in the fact that they’re together.”

Encompass Health’s home health and hospice segment is made up of nearly 350 locations in 34 states, with the bulk of those being on the home health side. Overall, the segment does about $1.1 billion in annual revenue, with roughly 158,300 home health admissions per year and about 13,200 hospice admissions per year.

In addition to the home health and hospice segment, Encompass has a network of 145 in-patient rehabilitation hospitals. With about $3.9 billion in annual revenue, that makes the company the largest owner and operator of such facilities in the U.S.

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In 2020, Encompass Health executives said they were exploring strategic alternatives to maximize the value of its home health and hospice segment. In October, they said a public spinoff was the best course of action to do that.

It’s not an infrequently used strategy, with another recent example being The Ensign Group (Nasdaq: ENSG) spinning off its home health, hospice and senior living segment into The Pennant Group (Nasdaq: PNTG).

“Executing a spinoff is not a unique strategy, as many companies that are somewhat diversified, with large caps have executed spinoffs,” Les Levinson, co-chair of the transactional health care practice at Robinson & Cole LLP, told HHCN. “The primary reason for doing it is that you’re feeling there’s value that’s locked into the larger corporate structure. And by spinning that off and having it trade on its own, that value is going to be appreciated more as a pure-play versus being mixed in with other business lines.”

Indeed, an advantage of the spinoff is not having to find a third-party buyer or merger partner. Another benefit is bypassing the integration process – and any personnel hurdles that may arise.

A spinoff typically comes with more control, leaving the fate of the separated company in the hands of its existing decision-makers, who are intimately familiar with all of the challenges and inner workings of the business.

Encompass Health began making leadership appointments for its home health and hospice segment in June, announcing Barb Jacobsmeyer and Crissy Carlisle as incoming CEO and CFO, respectively.

“They’ve already set up a new management team for the business, so that certainly helps,” Tanquilut said.

A downside of a potential spinoff: The separated company just doesn’t perform as expected, or the investor community simply doesn’t rally behind it.

Another drawback is missing out on synergistic benefits associated with a merger or combination, Levinson explained.

Jana, according to Reuters, is pro-merger because it sees a combination with another industry player as a way to better manage challenging operational conditions, including a shortage of nurses.

“By either aligning with or combining with another entity who is also in your space, you may create certain synergies,” Levinson said. “Market penetration, other intangibles that might not be fully appreciated if you’re just doing it on your own as a standalone, kind of competing with the rest of the universe.”

As far as a third-party merger or sale, those options could create more instant value for Encompass Health shareholders – if there’s an interested buyer that’s making an attractive deal.

The problem with that scenario, though, is there aren’t many home health players that could swing a deal for an asset that’s the size of the Encompass Health home health and hospice segment. And similar to Encompass Health, most of the home health publicly traded companies have seen their stock prices go somewhat depressed.

“Everyone has seen their stocks pulled back quite significantly,” Tanquilut added. “Their ability to acquire an asset like Encompass, that evaluation that would be compelling to the board has been impaired in a way, because of the pullback in the respective stocks. I think it’s just harder to get a sale process done, an evaluation that the board would want.”

Last April, reports surfaced that Encompass Health representatives had been spotted in Rhode Island, the home of CVS Health (NYSE: CVS), which led some to think CVS was positioning itself for a home health move.

There have been no further Encompass Health-CVS reports since.

Encompass Health has said it expects to execute a spinoff in the first half of 2022.