In December 2020, Encompass Health (EHC) announced it was exploring strategic alternatives for its home health and hospice business with the alternatives including a spinoff, sale, merger, or IPO, among others. A year later, Encompass announced in December 2021 it will perform a tax-free spinoff of the Home Health & Hospice Business, to be rebranded as Enhabit, Inc. (EHAB).

Enhabit — the spinoff company — is a high quality business. We believe that Enhabit should trade at a premium to its peers Pennant Group (PNTG), LHC Group (LHCG), and Amedisys (AMED), owing to its higher operating margin of around 19% compared to the peer average of around 10.3%. Post-spinoff, Encompass Health — the parent company — will be the market-leading inpatient rehab franchise (IRF). Due to the non-discretionary nature of several conditions treated in IRFs, EHC’s admission trends tend to be more stable than other sub-sectors of healthcare services, providing valuable revenue visibility and positive free cash flow assurance.

If we maintain our assumption of a 1:1 distribution ratio and assume a debt distribution ratio equal to the respective businesses’ EBITDA contributions, we believe Enhabit, the spinoff, will have a market cap of $1.2 billion. We anticipate potential upside for the combined pre-spin company, EHC, of 27% as a base case, and 52% in a more bullish scenario.

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