Description

High Level View

CIR is a downside protected call option on the European Long-term Care (“LTC”) sector (as CIR has a 371mm euro net cash balance compared to 513mm euro market cap) . Despite 2020 being a horrific year for the LTC industry, I expect most of the Coronavirus-related headwinds to reverse in 2021+ due to the aging European population and critical nature of LTC. I value CIR’s stake in KOS (its LTC business) at ~400mm euros based on a 5% 2022 FCF yield discounted to today. Additionally, CIR is trading at a ~45% discount to NAV (highest in 6 years) despite management taking a notably more shareholder friendly approaching over the last year. I see ~40% upside to CIR based on 20% discount to the sum of 1) its stake in KOS, 2) the value of CIR’s other smaller business investments (18% of NAV) and 3) its net cash position (net of holding company costs). 

Company Overview

CIR is a holding company that currently owns a 1) ~60% stake in KOS, a long-term care facility operator, and 2) a ~57% stake in Sogefi, an auto OEM. As you can see below, CIR's LTC asset and net cash make up ~80% of NAV.

KOS

Historically, KOS has been an Italian LTC operator (~97% of revenues) with 8,510 beds currently. 

• Italian market is highly fragmented and regulated. KOS has been able to grow bed count by 400-500 beds per year with stable EBITDAR margins. 

• KOS owns ~25% of its real estate 

• On October 30, 2019, KOS entered the German LTC market via an acquisition Charleston Holding from EQT for 92mm euros. Charleston has 47 residential facilities/4,050 beds in Germany

• In 2018, Charleston generated 152mm euros of revenue (estimated 30.4mm euros EBITDAR, estimated purchase multiple of ~13x 2018 EBITDAR)

…as you can see below KOS revenue/bed and EBITDAR margins have been expanding over time

Other assets

KOS owns a hodgepodge of other (lower quality) assets. For example, Sogefi supplies filtration systems, air management and engine cooling systems and suspension components to the automotive sector. It’s a low margin (<5% EBIT) business that is highly cyclical. 

CIR also owned a large stake in a publishing company (Gedi). However, CIR sold most of its stake in Gedi to Exor for ~90mm euros (6.5x fwd EBITDA). A 60% premium to the pre-merger share price. 

Net Cash – CIR is trading at a very modest premium to its net cash position today (lowest level in 6 years)

Italian LTC Market has been Highly Attractive

Italian market has incredibly high barriers to entry for private operators. As Korian (a large European LTC operator) notes below, regulatory authorization for new beds is very hard to come by in Italy. KOS is the largest publically traded operator in Italy and grows bed count ~4.5% per year.

KOS is also focused on Northern Italy where demand for LTC per 65+ resident is highest.

Strong Italian LTC fundamentals are also reflected in KOS's financials, which reflect consistently rising revenue/bed, EBITDAR margin and ROE.

…with next 10 years set to be better for Italy LTC than prior 10

Italy’s population is aging faster than almost anywhere else in Europe with bed penetration well below that of peer countries. Therefore, as Korian notes below, waitlists for beds in Northern Italy are long and the Italian government is actively saying it is increasing its share of spend on LTC. 

German Market (which CIR/Korian just entered) is also attractive with lots of high IRR rollup opportunities

All of Europe is set to see dependency ratios rise in coming years and the German market has lots of small, private operators

Korian provided a breakout of its acquired facility EBITDAR margin vs core EBITDAR margin in 2010. You can see private operators in Germany run at ~half the EBITDAR margin of larger players. This is mostly attributed to 1) complex German reimbursement system, 2) frequent government care inspections and 3) tight labor markets.  

I estimate that unlevered IRRs on nursing home rollups exceeds 20%.

Coronavirus likely to cut EBITDAR in half for LTC in 2020…but I expect most of this to reverse in 2021+

Occupancy (30% EBITDAR reduction in 2020)- likely down ~2-3% per month based on commentary from US operators (CSU, Welltower, Healthpeak). This makes sense given the 30 month average stay of a LTC occupant (so you lose 3.33% of your occupants every month assuming no new check ins). If you expect this quarantine lasts from March thru June, you come out to around an 8% decline in occupancy assuming we hold occupancy at June levels). Notably, the European operators have been a bit more bullish. Orpea (reported 3/17/2020) actually reaffirmed their 8% YoY 2020 revenue growth guidance. 

• I broadly expect a near complete reversal of this occupancy loss…Nursing homes are not hotels or casinos. They provide an essential service (Orpea grew volumes organically during the GFC) and occupancy in Europe was already incredibly high going into the Coronavirus.

Costs (20% EBITDAR reduction in 2020)- There are two buckets of cost inflation. 1) PPE, which Healthpeak says is 2% of LTC facility costs, has tripled in price and 2) Labor, which is 50% of a nursing home costs, has gone up 5-15% in the US according to Healthpeak. 

• I expect PPE inflation to completely reverse given commoditized nature of the product. 

• Labor cost inflation could be stickier (maybe nursing homes are less attractive to work at than in the past). However, I expect the European market to be less impacted than the US market given 1) labor markets in the US are a lot tigher than in places like Italy and 2) KOS average staff cost is ~35k/year (compared to US nursing assistant average salary of $19k)

• Notably, Korian/Orpea have both noted limited employee absenteeism and have soft guided to only a 1-2% increase in labor pay. 

I use Korian’s income statement to illustrate impact of Corona (tho Orpea has near identical cost structure…KOS doesn’t provide granular cost buckets). I only expect ~11% reduction in EBITDAR from staff costs to potentially be sticky into 2021+ as discussed above

KOS Valuation 

KOS FCF in 2019 was 45mm euros. Note: they acquired Charleston (Germany LTC business) at end of October 2019 (in 2018, that business did 152mm euros of revenue/~30mm euros of EBITDAR).

• I model 1) a reversal in occupancy declines from 2020 over 2021/2022, 2) a reversal in PPE cost inflation by mid 2021 and 3) German margin improvement from 20% EBITDAR margins to 25% EBITDAR margins by 2024 (in line with Korian/Orpea). 

• I don’t think my numbers are particularly aggressive. I still have 2022E FCF at $38mm euros (WITH Charleston), which is below their Italy-only FCF in 2019.

I value KOS at end of 2021 at a 5% Fwd FCF yield and then discount back to today. This values CIR’s stake in KOS at ~400mm euros

Company appears to be doing more for its shareholders and simplifying its corp structure

• In February 2020, CIR merged into Cofide with the new company named CIR S.p.A. – Compagnie Industriali Riunite

• This obviously simplified their corp structure and dramatically improved the float of the business (went from trading 60k euros/day to 600k euros/day)

• In April 2020, CIR sold its 45.8% publishing business stake to EXOR for euro 102.4mm

• Further simplifies the company and gives them ~92mm euros of cash (post 5% reinvestment) 

• Sold secularly declining business at a 60% premium to its trading price prior to acquisition (sold at 6.5x Fwd EBITDA…when US advertising centered companies like PUB and MDP trade at 5x fwd EBITDA)

• Rodolfo De Benedetti took over as Chairman of CIR in April 2013. He and his two brothers are controlling stakeholders of CIR

• While Rodolfo has said he will not use the excess cash for dividends (said before CIR shares sold off on Corona), he is likely to reinvest in KOS (high returns business)

While SOTP stories are always seductive, this one seems interesting given most of the value comes from either KOS (secularly attractive business) or net cash (which is likely to get reinvested into KOS). I see 40% upside to the stock given my value of KOS, public market values for other notable investments and a 20% conglomerate discount. 

• Note: to get hurt on this investment, you really need to believe either 1) KOS is a zero (which I strongly do not believe) or 2) the company will do something reckless with their cash…which is possible but seems unlikely given the shareholder friendly actions taken to date

Catalyst

Sale of noncore assets

Recovery in Italian LTC care space

German LTC cost cutting