HealthSouth Corporation (HLS) operates in the post-acute care sector, specifically in inpatient rehabilitation facilities (IRFs). The company faces potential regulatory risks and reforms in the industry. CEO Jay Grinney has expressed concerns about rate cuts, the introduction of the 75% rule, changes to qualifying conditions, and site neutral payments. Despite these challenges, HLS appears well-positioned to navigate them. The company has strong margins, a good balance sheet, and is prepared to adapt to new reimbursement models such as ACOs or bundled payments. HLS also has a competitive advantage over its competitors, with better average length of stay and lower readmission rates. If these changes are implemented, competitors may struggle to function under the new normal, potentially leading them to seek joint ventures with HLS or exit the market. This could result in HLS gaining market share, although it may be less profitable.
While the regulatory risks pose headline risk and may cause a temporary stock sell-off, HLS management is prepared to mitigate these challenges. They have shown a proactive approach by aggressively buying back stock and potentially lobbying to slow down implementation. Despite the uncertainties, HLS management believes that the company can handle the impact of regulatory changes and even turn them into opportunities. With an aging population and HLS’s dominant position in the industry, the company is likely to benefit in the long run. Furthermore, HLS has a capable management team that has demonstrated its ability to allocate capital effectively. Although valuing HLS shares is challenging due to shifting cap structures, large NOLs, and regulatory risks, the company’s intrinsic value is expected to grow steadily. Therefore, it is not necessary for the valuation gap to close for HLS to be a successful investment.
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