Beyond the Bottom Line: Why M&A Isn’t Just About EBITDA for The Pennant Group

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Over two years after spinning off from The Ensign Group (Nasdaq: ENSG), Eagle, Idaho-based The Pennant Group (Nasdaq: PNTG) stands at 87 home health and hospice agencies, plus 54 senior living communities. The company has locations throughout 14 states overall.

The Pennant Group is, no doubt, a large-scale provider with plenty of resources at its disposal. It’s this scale and reach that the company uses to back the small and mid-sized local home health agencies it often acquires.

That’s because, for Pennant CEO Danny Walker, health care is a local business. The company thrives by purchasing community-driven agencies with strong ties to their specific markets. Once these companies are part of Pennant, the leaders are given the space to remain decisionmakers.

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So while it’s a major publicly traded enterprise, Pennant is made of agencies that have the feel of mom-and-pop businesses.

This year alone, Pennant has announced the completion of at least five deals. The company’s leadership team remains bullish as ever moving into 2022 as well.

Home Health Care News sat down with Walker to learn more about Pennant’s acquisition strategy, in addition to the challenges and red flags on the M&A front.

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HHCN: Ensign completed the spinoff of Pennant slightly over two years ago. Looking back, how has this overall journey gone?

Walker: I think overall, it has gone very well. We didn’t plan to end up in the middle of a global pandemic, six months after we spun off. But the reasons for spinning off were sound, and we’ve seen that prove out.

We’ve been able to maintain a high degree of coordination and a unique relationship with Ensign. We’ve also been able to create more space for our leaders inside of Pennant to really experience the opportunities that they came here for, and that’s really gratifying. The operating environment has been challenging for everybody, but I think the adversity you face as a company reveals where you’re at. I think that’s been good for us.

Overall, I feel like it’s been a significant success. We’re now completely finished with the transition services agreement that we had with Ensign. This means we have completed the separation of all of our systems, IT, accounting, payroll, AP, banking, EMRs. All of those things have been moved over safely, carefully, and really flawlessly in a challenging environment. We’re really pleased with where we’re at. We’re even more excited about the coming years.

The Pennant Group has home health, hospice and senior living communities under its belt. What is your strategy when it comes to the home health segment of your business? How are you looking to grow this segment specifically?

I would say our strategy is best understood by having a strong emphasis on being an employer of choice — and provider of choice — for the local health care community.

One of the things that is uniquely strong about our business model is that our leaders at the local operational level control the entire profit and loss statement, just like a mom-and-pop operator would. This is a very common thing in home health care. The fragmentation is so significant in home health that many caregivers, nurses and other practitioners are used to having the owner and the decisionmaker right there in the office with them. Our emphasis is on that local leadership-driven model, then coupling that with the resources, flexibility and sophistication of a large corporate operator.

We’ve become a really interesting place for families, individual owners and smaller operators who have built something based on a high quality of care, a strong local culture and that care about their legacy. They entrust their legacy to us. We’ve seen that small and regional operators who are really deeply ingrained in the community have a preference for working with us as a buyer. We preserve the name and the identity of the business when we purchase it.

We aren’t a group that has ever been highly focused on one particular niche. We have generally taken care of whoever our health care partners in the community have had to care for. This leads us to have a really diverse operational structure, where we’re highly competent in a range of health care services, and that served us really well in the transition to the Patient-Driven Groupings Model (PDGM).

PDGM rebalanced the reimbursement structure away from certain niches and made sure that high nursing acuity patients were appropriately reimbursed. And our strategy was rewarded quite well under this.

On your August earnings call, you noted home health revenue for The Pennant Group increased by nearly 70% year over year, from $20.8 million to $35.3 million. What’s behind this performance and why has home health been a success for the company, in your view?

I mentioned PDGM. We executed really well on that.

Also, the vast majority of this is organic growth, as our operators build local teams that can move the market to them. Health care, in our view, is a local business. Obviously, it has national impacts, but when you’re in a local community of physicians, families and discharge planners, they refer to partners in the health care community that they know and trust. This has nothing to do with national branding. It has everything to do with being excellent on the ground, in the local community that you serve. That accounts for 80% or more of our growth.

The rest of it is our acquisitions. Our strategy doesn’t involve purchasing existing performing assets very often. It’s really rare for us. We typically take culturally and clinically sound operations that aren’t producing a lot of EBITDA. We take that, layer it into our system and set those local teams free to have better access to resources. The goal is to help them do what they’ve dreamed about doing in the local communities.

What have been the key challenges on the home health front? And what challenges do you still see coming down the road?

It has everything to do with our team members.

The pandemic, in and of itself, is another infection. Our home health providers know how to handle infection control. I mean, we’re surveyed on it on a regular basis. We’re constantly training on it. There are other nasty bugs out there that we’ve had to deal with, but COVID was new and a little uncertain at first. The biggest impact, in my view, is just how it’s affected our workforce, our team members.

As I look into the future, that’s the biggest challenge that I see.

Demographically, we are just beginning the process of caring for sick and aging baby boomers. That silver tsunami is just barely starting to hit. Making sure that we have the nursing capacity, the caregiver capacity, the therapy capacity and the office infrastructure to care for larger volumes of patients in a highly effective way is probably the biggest area of concern for me. It’s not just a matter of getting staffing; it’s making sure that those staff members are really happy and engaged in our work environment. Health care is not an easy job, and we want to make sure that we provide a robust support system for these heroes on the front line.

On that front, I am hopeful that the federal government and states will continue to look carefully at reimbursing home health providers appropriately for the essential work that is being done.

The Pennant Group has always been a prolific acquirer. What makes a home health agency an attractive acquisition target?

They have a solid local reputation in the community. They have a history of operating in that local community. And they have an assembled team that is loyal to the brand. If that’s in place, we’ll look hard at their financial position and look at their trailing financial results. Again, we aren’t trying to go acquire someone else’s EBITDA. We value these businesses for what they are currently — and what they have the potential to become.

We’ll often lead with, “Why do you do what you do?” If a home health company is built just for a particular financial purpose, you get a different answer to that question of why. What we find is that local mom-and-pop businesses where people are doing it because of a desire to help the community, a love for home health, a love for the patients, the staff members, that’s an ideal situation for us.

On the flip side, what qualities have made you decide a company isn’t right for The Pennant Group?

If the purpose of building the home health business has been largely just a remote financial transaction and there’s not really a strong local leadership team in place, that’s a red flag for us.

Of course, there are sometimes significant regulatory or compliance concerns. We have not moved forward on a number of transactions if, upon audit, we’ve identified significant weakness in the documentation related to face-to-face or eligibility for homebound status. There could be other kinds of concerns that obviously are a big focus for contractors. Even a business that’s having financial stress is not a concern for us, because we understand that there’s value beyond just the EBITDA that has been produced. We can still find our way through a deal.

But if there are big red flags in the compliance arena, or if it’s just a remote financial play in a market that seems attractive and you don’t have that local connection to the community, those two things make a deal not feasible.

Has M&A been more or less difficult in 2021 compared to 2020?

It’s been more difficult in our experience. In both 2020 and 2021, there has been a lot of uncertainty in the marketplace. There has been a lot of difficulty for different operators to kind of figure out, “How is this all going to play out?”

All the government stimulus has affected some of the transactions. All of a sudden, some of the providers that would contemplate exiting have been given a longer lease on things. Volumes changed significantly. One particular provider that we’ve worked really closely with was contemplating a sale, then all of a sudden elective surgeries were canceled in their marketplace. Their census went down significantly, which had a ripple effect through their financials and how you might value that business. We worked carefully with them and let things build back up, then we proceeded.

There have also been challenges around getting on-site to visit safely. There have been challenges with travel. There have been disruptions with staff members being either quarantined or battling the virus themselves. Overall, the environment has not been as static and predictable. We’re pleased that we’ve been able to continue our acquisition pattern as we have done in the past. We look forward to things settling down, so we can continue the growth pattern that we’ve demonstrated we’re capable of.

What’s something that Pennant is doing in the home health space that sets it apart, in your view?

I think the Ensign-Pennant care continuum is highly unique. That process is taking post-acute providers and keeping every provider in the network healthy, finding ways to make it work for upstream hospital systems and payer sources. I think it will increasingly differentiate us from others. We’re also doing joint ventures with hospitals. We have a great joint venture relationship with Scripps Health, for instance.

How much of a role will traditional acquisitions continue to play in your growth strategy moving forward. Will we see The Pennant Group try de novos or a merger in the future?

We do have a practice of doing de novos. We just do them on a targeted, market-specific basis. You won’t see us look across the country and do 200 de novos. When our local operators identify an optimal location for a de novo they can support from an adjacent market, we’ve done eight to 10 of those already, in our history. We have four or five of them in the works right now at various stages of growth and development.

The bread and butter for us will be small to medium-sized acquisitions. The likelihood of us doing a large-scale merger is pretty low. We built our whole business on a predictable, sustainable growth approach. Looking to do a larger transformational deal is not really something that we’re particularly interested in. We’re always open to things that might make sense, so we don’t ever shut those things down. What you’ll see from us is a methodical growth rate through acquisition, with a really strong and compelling organic growth rate, as we execute on our strategy in local markets in states we’re in. Then we’ll strategically explore new states, as the right opportunities present themselves.

As CEO, what goal do you have for the remainder of this year? What will be your main area of focus for 2022, apart from M&A, which we’ve talked about?

I want us to finish the year strong. With the Delta variant, we’ve been hit hard. The biggest challenge is not the financial headwinds or the disruption in the day-to-day workplace, it’s actually the human element of it. Our leaders and our staff members have experienced loss. My deepest concern is for the people who are involved. They’re still experiencing uncertainty and challenges.

I think on a relative basis, we’ve thrived and we’ve done really well on a lot of fronts, but I want us to finish strong.

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