If you are fortunate enough to land a hedge fund interview, you should always bring a 1-page case study with you. Most candidates do not do this, and it is a great way to stand out. In this chapter, Street of Walls will lay out three real life 1-page hedge fund case studies that have been pitched in interviews by hedge fund analysts.
- A core investment thesis and a clear pathway for the thesis to come to fruition
- Your assessment of the consensus Wall Street opinion of the stock
- Your variant perception, i.e., how your view differs from the Wall Street consensus
- The key catalyst(s) required to make your investment thesis actualize
- Expected returns from upside and downside scenarios
- A brief company overview
- Highlighted acknowledgements of the risks
- Comments (where applicable) on the management team
Example #1
Company: Sabra Health Care REIT (Ticker: SBRA)
Recommendation: Short Equity
Catalyst: U.S. Federated States Balancing Budgets, May 2011
Company Description
Sabra Healthcare REIT (SBRA) is a real estate investment trust (REIT). The Company invests in and provides financing to the long-term care industry.
Situation
States are facing huge budget deficit projections for next year—and Medicaid is at the top of the list to get cut. Since October 2008, states have been getting stimulus monies from the ARRA, mostly in the form of Medicaid and State Stabilization Funds. States were granted $135-140bn and currently have about $40bn to use for 2011 purposes. This ends entirely on June 30, 2011. The states are having a hard enough time balancing their budgets under the current stimulus, and aggregate state Budget Deficits are projected to be $144bn (FY11) and $119bn (FY12) – these are very large holes to fill.
Catalysts
- May 2011: Per the Constitution every state has to balance its budget at the beginning of the year, which takes place during May (for a fiscal year 2011 budget). Medicaid is 21% of the average state’s budget—a large amount. Medicaid is at the top of the list for budget cuts.
- Cuts Similar to CA: Governor Brown is proposing to cut the Medicaid budget by $1.7bn. Other states will likely follow suit.
Risks
- A second extension of the FMAP Medicaid stimulus measures (there does not seem to be political will).
- Larger than expected cuts in Education and Transportation could provide a cushion to Medicaid.
Why SBRA
- Taking a bottom-up approach SBRA has the best risk/reward of the group with significant credit risk to Medicaid cuts.
- SBRA portfolio consists of 80% Skilled Nursing – one of the first groups for Medicaid reimbursement cuts.
- 100% of SBRA’s revenue consists of one Skilled Nursing Provider.
- SBRA’s top two states by revenue, New Hampshire (18%) and Connecticut (15%), are currently facing FY11 state budget shortfalls of $0.3bn and $5.1bn per the Center on Budget and Policy Priorities.
- SBRA has by far the highest exposure to government reimbursement levels – approximately 62% of their revenue comes from Medicare and Medicaid funding, much higher than the group at 39%.
- SBRA is a much smaller REIT with a higher cost of capital than OHI (SBRA raised HY debt at 8.25% last month).
Valuation
SBRA is currently trading at a premium to their closest comp OHI at 12.3x 2011 FFO vs. OHI at 11.8x.
Example #2
Company: Health Care REIT (Ticker: HCN)
Recommendation: Long Equity
Company Description
Health Care REIT (HCN) is a real estate investment trust (REIT) that invests in senior housing and health care real estate. HCN’s current portfolio is comprised of 48% Senior Housing and is currently 75% private pay, with minimal Medicaid exposure.
The Opportunity
The business model has been evolving—HCN is on a massive acquisition strategy, completing $3.2 billion of acquisitions in 2010. The Company sees a $5.5 billion pipeline of off-market acquisitions over the next couple of years. Management is credible, has executed M&A very well, and has had a tendency to low-ball guidance figures in the past. I believe NOI estimates are too low for HCN when taking into account an additional $2-4 billion of acquisitions over the next couple of years.
Catalysts
- January 13th: HCN released 4Q10 acquisition press release which was $1 billion above consensus.
- End of February: HCN will release 4Q10 earnings and 2011 guidance.
- 1Q11 Earnings: 1Q11 numbers will be front-loaded with higher than anticipated NOI growth from 4Q10 acquisitions. HCN announced a huge acquisition beat to guidance (reported $1.43bn of 4Q10 net acquisitions vs. street at $576mm); NOI numbers for 1Q11 will need to move up by at least $75 million.
Valuation
- I am modeling $3.51 for 2011 FFO and $3.84 in 2012.
- My FFO numbers beat street estimates by +6% in 2011 and +9% in 2012, based on higher acquisition volume. Including the announced 4Q10 M&A, I am modeling a +8% beat to 1Q11 FFO estimates.
- HCN is currently trading at 13.4x 2011 FFO and 12.3x 2012 FFO (on street numbers, 14.3x and 13.4x).
- HCN is trading at roughly a 1x discount on both 2011 & 2012 relative to its peers.
Example #3
Company: Omega Healthcare Investors (Ticker: OHI)
Recommendation: Short Equity
Catalyst: U.S. Federated States Balancing Budgets, May 2011
Company Description
OMEGA Healthcare Investors is a real estate investment trust (REIT). The Company invests in and provides financing to the long-term care industry.
Situation
States are facing huge budget gaps next year—Medicaid is at the top of the list to get cut. Since October 2008 states have been getting stimulus monies from the ARRA, mostly in the form of Medicaid and State Stabilization Funds. States were granted $135-140bn and currently have about $40bn to use for 2011. This ends entirely on June 30, 2011. The states are having a hard enough time balancing their budgets under the current stimulus, and aggregate state Budget Deficits are projected to be $144bn (FY11) and $119bn (FY12) – these are very large holes to fill.
Catalyst
- May 2011: Per the Constitution every state has to balance their budget at the beginning of the year, which takes place during May (for fiscal year 2011 budget). Medicaid is 21% of each state’s budget, so it is very large. Industry experts believe that if the economy does not recover, states will have to start cutting budgets next year when state stimulus wears off. Medicaid is at the top of the list for most budget cuts.
Risks
- A second extension of the FMAP Medicaid stimulus measures (there does not seem to be political will).
- RUGS IV Implementation on October 31st, which is expected, could give a quick relief rally signaling an end to the healthcare overhaul (as we’ve seen with the banks and Basel III).
Why OHI?
- Taking a bottom-up approach, OHI has the best risk/reward of the group with significant credit risk to Medicaid cuts.
- OHI portfolio consists of 98% Skilled Nursing – one of the first groups for Medicaid reimbursement cuts.
- 72% of OHI’s revenue consists of ten large Skilled Nursing Providers.
- OHI’s top two states by revenue Florida (21%) and Ohio (15%) are currently facing FY11 state budget shortfalls of $4.7bn and $3.0bn per the Center on Budget and Policy Priorities.
- OHI has by far the highest exposure to government reimbursement levels – approximately 73% of their revenue comes from Medicare and Medicaid funding, much higher than the group at 39%.
Valuation
OHI is currently trading at a discount to the HC REITs at 13.6x current year FFO vs. group at 15.9x.
On EBITDA, OHI is currently trading at 13.9x current year estimates vs. group at 14.6x.
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