1 Main Capital, an investment management firm, published its second-quarter 2021 investor letter – a copy of which can be downloaded here. A quarterly net return of 18.6% was delivered by the fund for the Q2 of 2021, ahead of its S&P 500 and Russell 2000 benchmark that delivered a 15.2% and 17.5% return respectively for the same period. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
In the Q2 2021 investor letter of 1 Main Capital, the fund mentioned ATI Physical Therapy, Inc. (NYSE: ATIP) and discussed its stance on the firm. ATI Physical Therapy, Inc. is a Bolingbrook, Illinois-based physical therapy services provider with an $849.4 million market capitalization. ATIP delivered a -59.73% return since the beginning of the year, and it closed at $4.3 per share on August 31, 2021.
Here is what 1 Main Capital has to say about ATI Physical Therapy, Inc. in its Q2 2021 investor letter:
“In the Q3’20 letter I wrote about how SPACs were being used to help companies circumvent the traditional IPO process when coming public. In the letter, I noted how the number of SPACs was exploding and how some sponsors were recklessly pursuing increasingly speculative deals at unreasonable valuations to cater to retail speculators. However, not all sponsors were acting in this manner; in fact, some SPAC sponsors announced mergers with good businesses at reasonable valuations.
Recently, the SPAC bubble has started to deflate. One of the byproducts of this deflation, along with the sheer number of vehicles created is that, in some cases, the baby has been thrown out with the bath water, creating some interesting opportunities in de-SPAC’d companies.
One such example: the warrants of ATI Physical Therapy (ATIP), which came public by merging with a Fortress sponsored SPAC this past June. ATIP is the largest independent outpatient physical therapy (OPT) provider in the United States with over 800 clinics in 24 states.
OPT is an attractive end market to participate in given the strong unit economics of clinics as well as the strong outlook for demand. Specifically, an aging demographic, an emphasis on preventative care and a more active population are providing strong secular volume tailwinds, while new OPT clinics have rapid paybacks of around 13 months, on average. Typically, new units require around $250k of capex, $100k of upfront startup loss absorption and then deliver around $175k of annual EBITDA at maturity – not bad. Better yet, OPT has low per-visit costs, and therapists can diagnose and treat over 70% of musculoskeletal conditions without any other provider. This leads to the prevention of worsening conditions as well as the avoidance of unnecessary higher-cost medical visits, medications and surgical procedures. As such, it makes more sense for payors to focus on shifting volume to OPT clinics rather than trying to reduce the amount they pay to them.
Given the compelling unit economics and growing demand, it makes sense to heavily reinvest in the business to pursue greenfield growth as well as the occasional attractive M&A opportunities. However, due to its private equity ownership the business has historically operated with high leverage, an issue that COVID exacerbated even further, preventing it from pursuing attractive reinvestment. Since completing the SPAC merger in June, ATIP announced that it now has net debt of approximately $460 million, or only 2.6x 2022E EBITDA, which should allow it to invest more aggressively going forward.
Additionally, unlike many SPACs targets, Fortress has been following ATIP for nearly a decade as a lender to the company. Investors should take note of the fact that Fortress not only sponsored the deal but also committed $75 million of its own capital into the deal via a PIPE and importantly agreed to restructure its promote as an earn-out that doesn’t fully vest until the stock hits $16 per share.
Currently, ATIP is selling for less than 12x 2022 consensus EBITDA, well below its closest peer (USPH), which sells for more than 20x 2022 consensus EBITDA. As public markets become more comfortable with ATIP, as the company’s PE sponsor sells down its stake and as ATIP grows EBITDA by opening new clinics and making accretive acquisitions, I expect the stock to increase significantly from current levels. If this were to happen, our warrants will be worth many multiples of our average cost, which is below $2 per unit.”
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Based on our calculations, ATI Physical Therapy, Inc. (NYSE: ATIP) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. ATIP was in 30 hedge fund portfolios at the end of the first half of 2021. ATI Physical Therapy, Inc. (NYSE: ATIP) delivered a -56.80% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.