Markets & Finance

Marcial: Is a Spin-Off in Chemed's Future?


Chemed's Vitas hospice care and Roto-Rooter units are strange bedfellows. But they're doing well despite calls to split up, which management is resisting

For New York Stock Exchange-listed Chemed (CHE), breaking up may be hard to do, although that is what some major shareholders are clamoring for. Leading such a move is asset manager MMI Investments, which has accumulated a stake of nearly 4%.

Chemed finds itself in this pickle primarily because it runs two disparate businesses. One of its two units is Vitas Healthcare, the country's largest provider of end-of-life care through its hospice operations. The other division is Roto-Rooter, the nation's No. 1 provider of commercial and residential plumbing and drain cleaning services.

The combination of the two businesses under the same corporate umbrella makes "little strategic and economic sense," says Clay Lifflander, MMI's president. The two should be separated by means of a tax-free spin-off that would allow shareholders to benefit from each company's value as a separate entity, he adds. Splitting the company would unlock the real value of each unit, he maintains.

solid earnings outlook

MMI put its money where its mouth was by formally filing a proposal with Chemed's board of directors on Feb. 12. Based on the valuation of comparable public companies and prices paid in previous deals, MMI estimates that a spin-off could potentially yield a 40% to 75% increase in Chemed's Feb. 11 closing price of 39.81 a share.

As of Feb. 17, the stock had risen to 41 a share, driven partly by MMI's proposal and also by solid fourth-quarter financial results reported on Feb. 16.

At a conference call for analysts on Feb. 17, Chemed CEO Kevin McNamara acknowledged that the company had received a letter from a shareholder requesting that the Vitas and Roto-Rooter businesses be separated. "Chemed will carefully evaluate this shareholder's recommendation and respond appropriately," he said.

Indeed, fourth-quarter results were in line with analysts' expectations. And to bolster its argument that the company was doing well, management provided a solid outlook for 2009, with projected earnings of $3.70 to $3.95 a share—higher than most forecasts. In 2008, Chemed earned $3.38 a share.

Analyst Michael Wiederhorn of Oppenheimer (OPY), who rates Chemed's stock outperform, estimates the company will earn $3.71 a share in 2009 and $4.02 in 2010. He says the stock remains attractively valued, trading at 11 times the midpoint of management's expected 2009 earnings of $3.70 to $3.95 a share. Wiederhorn has a 12-month price target of 52 for the company as it currently exists.

Persistent Call for a Spin-Off

According to MMI, Lifflander had been talking informally with Chemed's top executives about the spin-off proposal, but they didn't indicate they would consider it. He isn't giving up, however.

In a letter to the company's board, Lifflander said that despite public statements by Chemed's management arguing against a spin-off, "Chemed has presented no compelling reason for its view … . Chemed's current structure is denying shareholders the ability to recognize maximum value for their investment."

Lifflander says Chemed's two divisions generate significant cash flow—the only characteristic the two share. Vitas and Roto-Rooter have distinct businesses that can operate successfully independent of each other, he says.

According to MMI's analysis, the stock of each company would be worth 55 to nearly 62 a share if each traded independently. And once on their own, either one—or both—could be the target of a takeover by larger companies, says Lifflander. On a takeover basis each could fetch prices of more than 68 a share, according to MMI's calculations. Lifflander says the firm has researched each of Chemed management's objections, including problems of capital structure and taxation, and "we have concluded that there appear to be no insurmountable obstacles." Management did not return phone calls to BusinessWeek seeking comment.

Mixed Ratings on Stock

A spin-off of one of Chemed's units, he says, would be relatively simple given the company's discrete operating structure and minimal shared resources. "A split would produce two viable, self-funding, pure-play independent public companies, each with critical mass in today's stock market," argues Lifflander.

That doesn't mean, however, that every analyst agrees with MMI that a split would improve Chemed's profitability. One who preferred not to be identified says the combination of Vitas and Roto-Rooter hasn't been a drag on Chemed's earnings. Roto-Rooter, specifically, is a robust cash cow, says this analyst. However, Chemed as it now stands hasn't been widely favored on the Street. Of the eight analysts who follow the company, only three rate it a buy. Four tag it a hold and one recommends selling the stock.

MMI has always been an active investor looking for companies whose intrinsic worth isn't reflected in their share prices. One recent victory was its campaign in 2007 for Brinks Home Security Holdings (CFL) to spin off its home security and armored car businesses. Brinks initially rejected the idea, but last year the company did spin off its security business. Now both are doing well—and, to the benefit of the company's original shareholders, trading independently.

MMI's proposal would probably fare better if Chemed's stock was doing poorly. It isn't. The stock has climbed from a 52-week low of 32 in mid-October to 45 on Feb. 17.

Still, MMI could remain steadfast in its calls for the breakup of Chemed. If management resists, expect the firm's entreaties to grow more forceful. Judging from its experience with Brinks, MMI isn't one to give up easily.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.


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