Spruce Point Capital Management Releases A Strong Sell Research Opinion On Hill-Rom Holdings, Inc. (NYSE: HRC)
NEW YORK, Oct. 29, 2019 /PRNewswire/ -- Report entitled "Over The Hill" outlines how Hill-Rom Holdings, Inc. faces 25-55% downside risk to approximately $45 to $75 per share. The full contents of the report can be reviewed at www.sprucepointcap.com. Spruce Point believes that Hill-Rom ("HRC") is a low-quality medical equipment roll-up whose recent "core" financial performance has been underpinned by accounting machinations and temporary business segment pruning. We believe HRC is now rapidly approaching the end of its current growth cycle as it faces slowing growth from new products, limits to M&A, and the end of its recent divestment campaign. We believe that HRC management has few, if any, credible alternatives to sustain future growth and that it is being forced to "pitch" a new financial outlook a year ahead of schedule.
- Non-Stop M&A And Confusing Math Masks A Slow-Growing Business: In an attempt to make up for slow top-line growth driven by low demand for low-tech hospital furniture, management has spent ~$3.5B on M&A since FY09 on businesses across numerous sub-sectors and geographies. However, it has subsequently exited or divested of many of these businesses, usually at a loss after experiencing material top-line contraction. While the sell side has cheered such activity, Spruce Point sees them as evidence of management treading water as it burns cash to acquire businesses which it subsequently drives into the ground, and which, in our view, require further goodwill impairments.
As management exits failing acquisitions, it instructs analysts to evaluate growth using its proprietary "core growth" metric, which adjusts growth for the negative impact of planned divestitures even before they occur. Management conveniently "re-bases" core growth every few quarters by adding new slow-growth business lines to non-core revenue, supporting consistent mid-single-digit core growth even as these ring-fenced verticals drag on total sales. Management has been able to present top-line growth of almost 300 bps greater than total growth in some quarters by selectively adjusting the many puts and takes which make up "core growth."
- Slowing Revenue Growth From New Products Likely To Expose True Underlying Growth: New product releases such as its Centrella "smart" bed have prevented Hill-Rom from showing dramatic core sales contraction over the last two years: these new products have grown from generating zero revenue prior to 2017 to over $400M in FY19 (expected). Management claims that it has accelerated the hospital bed repurchasing cycle by transforming the bed from a mere piece of furniture into a vital piece of hospital room technology. However, former employees and industry experts suggest that new product revenue will quickly normalize after a brief initial period of sales uptake. After adjusting for M&A and incremental sales contributed by new products, Spruce Point believes that Hill-Rom's underlying sales growth has been effectively flat at best, versus management's reported "core growth" of 2%-6% through the past two years.
- Time To Reset Expectations: As the recent plateau in sequential growth from new products is set to become visible in annual growth starting this quarter, we believe that Hill-Rom may be set up to post disappointing growth in Q4 and in subsequent years as Company growth reverts closer to its ex-new product sales growth rate of ~0%. Almost all EBITDA margin expansion since FY16 can be attributed to divestitures of lower-margin business and acquisitions of higher-margin businesses. Price increases, endless restructuring, and supposed post-acquisition synergies appear to have had almost no positive impact on profitability. The sell side continues to see room for close to 250 bps of margin expansion through FY21, but, with divestitures set to cease next year and with limited capacity for further M&A, Hill-Rom will likely achieve less than half the sell-side's expected level of margin expansion.
- Fleeing Executives And Insider Sales Are Indicative Of An Unattractive Risk/Reward: Over the past two years, HRC has lost its CEO, CFO, CIO, and two of its three division heads. It is currently on its fifth CFO since 2010. Executives frequently leave after having spent just one or two years (or fewer) at the Company, sometimes with little forewarning and to the surprise of peers, per our research. When accompanied by significant insider net selling, we find this level of executive turnover concerning given that those most knowledgeable about the business and its plans are choosing to leave the Company rather than see the recent shift in strategy to completion.
Spruce Point believes that the Street overestimates Hill-Rom's forward sales growth due to its focus on the "core growth" metric and its lack of appreciation for slowing new product sales. We believe that investors will be disappointed by slower-than-expected sales growth and stagnating margins as the recent round of divestments is set to end. We also believe that investors should not give management credit for earnings growth achieved through dubious adjustments and reserve reductions, which have boosted earnings materially through the past four years. Spruce Point sees 25-55% downside in HRC shares when each of these factors is taken into account.
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
Spruce Point Capital has a short position in Hill-Rom Holdings, Inc. (HRC) and stands to benefit if its share price falls.
