Executive Summary / Key Takeaways

• Strategic Reorientation and Growth: Following the Concentra spin-off, Select Medical Holdings Corporation ($SEM) is strategically focused on its three core segments, with an aggressive expansion in its Inpatient Rehabilitation Facilities (IRF) division, projecting a significant increase in beds and double-digit EBITDA growth for the segment in 2026 and 2027.
• Robust IRF Performance: The Rehabilitation Hospital segment consistently exceeds expectations, demonstrating strong revenue and Adjusted EBITDA growth, driven by increased patient days and revenue per patient day. New facilities are expected to reach breakeven within six months and full maturity in approximately three years.
• Outpatient Rehabilitation's Tech-Driven Turnaround: Despite recent headwinds from Medicare reimbursement cuts and payer mix shifts, the Outpatient Rehabilitation segment is poised for a turnaround, with management "very bullish" on future prospects, anticipating double-digit EBITDA growth in 2025 and 2026, fueled by technology investments and productivity improvements.
• Persistent Regulatory Headwinds in Critical Illness Recovery: The Critical Illness Recovery Hospital segment continues to face challenges from increasing high-cost outlier thresholds and complex reimbursement policies, necessitating ongoing advocacy efforts with CMS and legislative bodies.
• Solid Financial Health and Shareholder Returns: Select Medical maintains a stable financial position with a net leverage of 3.4x, healthy cash flow generation, and a commitment to shareholder returns through consistent cash dividends and an extended share repurchase program.

A New Chapter: Select Medical's Strategic Evolution in Post-Acute Care

Select Medical Holdings Corporation, established in 1996, has grown into a prominent provider of specialized healthcare services across the United States. The company operates a vast network of critical illness recovery hospitals, rehabilitation hospitals, and outpatient rehabilitation clinics, extending its reach across 40 states and the District of Columbia. A pivotal strategic move in late 2024, the tax-free distribution of Concentra Group Holdings Parent, Inc. to its stockholders, marked a significant reorientation, allowing Select Medical to sharpen its focus on its remaining three core segments. This strategic pivot positions the company to capitalize on an aging U.S. population and the increasing demand for post-acute care services, which is estimated to grow at a CAGR of 3.0% from 2026 to 2032, reaching $553.35 million by 2032. The U.S. physical therapy market alone was valued at $48.8 billion in 2022 and is projected to grow at a 3.6% CAGR through 2030, with some estimates suggesting a 10.1% CAGR for occupational and physical therapy services from 2025 to 2032, reaching $128.17 billion.

In the competitive landscape, Select Medical operates alongside major players like Encompass Health Corporation (EHC), Universal Health Services (UHS), HCA Healthcare (HCA), and Tenet Healthcare (THC). Select Medical differentiates itself through a diversified yet specialized portfolio and a strong joint venture model, particularly with large academic medical centers. While competitors like EHC focus more narrowly on inpatient rehabilitation, and HCA and UHS offer broader acute care services, Select Medical's integrated care approach across its segments provides a unique value proposition for comprehensive patient care pathways. The company's extensive network of facilities and established brand in specialized care serve as significant competitive advantages, fostering customer loyalty and enabling efficient resource utilization. However, Select Medical, like its peers, faces vulnerabilities stemming from its dependency on government reimbursements and the inherent complexities of its cost structure.

Technological Edge in Operational Efficiency

While Select Medical's differentiation isn't rooted in a unique medical device, its strategic investment in operational technology is a key differentiator, particularly within its Outpatient Rehabilitation segment. The company is actively implementing system upgrades, including a new scheduling module, designed to enhance patient access and improve therapist productivity. This technological focus is expected to drive significant improvements in operational efficiency and, crucially, margin enhancement. Management anticipates that these system enhancements will contribute to the projected double-digit EBITDA growth for the outpatient division in 2025 and 2026. This investment directly addresses the need for streamlined operations in a labor-intensive industry, aiming to mitigate rising costs and optimize service delivery.

Segmental Performance and Strategic Growth Drivers

Select Medical's performance across its three segments reflects a dynamic interplay of strategic growth, operational adjustments, and persistent regulatory challenges. For the nine months ended September 30, 2025, the company reported total revenue of $4.06 billion.

Rehabilitation Hospital Segment: A Growth Engine

The Rehabilitation Hospital segment stands out as a primary growth engine for Select Medical, consistently exceeding internal expectations. For the three months ended September 30, 2025, revenue in this segment surged by 16.20% year-over-year to $328.6 million, contributing to a 16.40% increase for the nine-month period to $949.8 million. This robust growth was primarily driven by an 11.10% increase in patient days and a 4.90% rise in revenue per patient day. Adjusted EBITDA for the quarter increased by 13.00% to $68.0 million, with a year-to-date increase of 14.10% to $209.4 million.

The company's aggressive development pipeline underscores its commitment to this segment. Select Medical expects to add 395 inpatient rehabilitation beds by the first half of 2027 through new openings and strategic bed additions. This includes a 32-bed hospital with Cleveland Clinic, a 45-bed facility in Temple, Texas, and a 32-bed acute rehab unit in Orlando, Florida, by year-end 2025. Plans for 2026 include three new inpatient rehab hospitals, such as a 58-bed facility with Banner Health in Tucson, Arizona, and a 63-bed hospital with Cox Health in Ozark, Missouri. A 76-bed hospital under the Kessler brand in Jersey City, New Jersey, is slated for 2027. New hospitals typically achieve breakeven within approximately six months and reach full maturity (around 85% occupancy) in about three years, with annual start-up losses estimated at $15 million to $20 million. This significant expansion is expected to generate double-digit EBITDA growth for the rehabilitation segment in 2026 and 2027.

Critical Illness Recovery Hospital Segment: Navigating Regulatory Complexities

The Critical Illness Recovery Hospital segment, while facing significant regulatory headwinds, demonstrated resilience. Revenue increased by 4.60% to $609.9 million for the three months ended September 30, 2025, with a modest 0.20% increase for the nine-month period to $1.85 billion. Adjusted EBITDA for the quarter rose by 10.50% to $56.1 million, though year-to-date Adjusted EBITDA declined by 16.60% to $199.0 million.

A key factor influencing performance was the deferral of the "20% transmittal rule" by CMS, which resulted in a favorable revenue adjustment of $12 million to $15 million for Q3 2025 EBITDA. However, the segment continues to grapple with increasing high-cost outlier thresholds, which have nearly doubled over two years, reaching $78,936 for fiscal year 2026. This makes it challenging to accommodate very acutely ill patients, impacting average daily census. Management is actively engaged in advocacy efforts with CMS and legislative bodies, seeking policy reforms to support the treatment of high-acuity patients. Robert Ortenzio, Executive Chairman and Co-Founder, noted that the regulatory environment is "mind-numbingly complicated" due to various levers like the fixed-loss threshold and the 8% outlier pool mandate. Despite these challenges, the supply-demand dynamics for critical illness recovery hospitals remain strong, driven by demographics, medical technology advancements, and the need to decompress crowded ICUs.

Outpatient Rehabilitation Segment: Focused on Efficiency and Recovery

The Outpatient Rehabilitation segment experienced mixed results but shows promising signs of recovery driven by strategic initiatives. Revenue increased by 4.30% to $325.4 million for the three months ended September 30, 2025, and by 3.20% for the nine-month period to $960.3 million. However, Adjusted EBITDA for the quarter decreased by 14.60% to $24.2 million, leading to a year-to-date decline of 3.70% to $79.0 million. This decline was primarily attributed to a reduction in Medicare reimbursement and an unfavorable shift in payer mix, compounded by severe weather events in Q1 2025.

Management remains "very bullish" on the segment's future, anticipating double-digit EBITDA growth in 2025 and 2026. This optimism is fueled by expected improvements in commercial managed care rates and enhanced therapist productivity from investments in technology, specifically a new scheduling module. A modest Medicare rate increase of approximately 1.75% to 1.8% is also anticipated for 2026, reversing a multi-year headwind. The company is actively streamlining its portfolio by consolidating or closing clinics with limited growth potential to optimize resources.

Financial Health and Capital Allocation

Select Medical maintains a solid financial foundation. As of September 30, 2025, the company reported $60.1 million in cash and cash equivalents and $419.1 million of availability under its revolving facilities. Net working capital increased to $80.9 million from $42.1 million at December 31, 2024, primarily due to decreases in accrued other liabilities and accrued payroll. The company's net leverage under its senior secured credit agreement stood at 3.4x at quarter-end.

Capital allocation priorities emphasize development, particularly in the high-growth inpatient rehabilitation segment, followed by shareholder returns through dividends and opportunistic share repurchases, and debt reduction. The Board of Directors declared a cash dividend of $0.06 per share on October 29, 2025. The common stock repurchase program was extended to December 31, 2027, authorizing up to $1 billion in repurchases. Labor costs, a significant expense in the healthcare industry, have stabilized, with nursing agency rates returning to pre-COVID levels and full-time employee wage increases moderating to under 3%. This stability is crucial for managing operating expenses and supporting profitability.

Outlook and Key Risks

Select Medical has reaffirmed its 2025 business outlook, projecting revenue in the range of $5.3 billion to $5.5 billion and Adjusted EBITDA between $510 million and $530 million. The company has increased its estimate for earnings per common share to a range of $1.14 to $1.24. Capital expenditures, excluding those for non-consolidating joint ventures, are expected to be between $180 million and $200 million. This guidance reflects the anticipated growth in the rehabilitation segment, the expected recovery in outpatient, and the ongoing management of regulatory pressures in critical illness recovery.

Despite the positive outlook, several risks warrant investor attention. The company faces ongoing legal actions and governmental audits, including qui tam lawsuits, which could result in significant penalties. Regulatory changes, such as the One Big Beautiful Bill Act (OBBBA), could reduce federal Medicaid funding by an estimated $1 trillion over the next decade, potentially leading to decreased reimbursement. The OBBBA could also trigger Pay-As-You-Go (PAYGO) Act cuts to Medicare spending, potentially a 4% reduction for fiscal year 2026 without Congressional relief. Changes to LTCH outlier reconciliation criteria are expected to increase recoupments by Medicare Administrative Contractors, potentially delaying reimbursement appeals. The labor-intensive nature of the healthcare industry means inflationary pressures and competitive labor markets could continue to impact costs, and the company's ability to pass these on to customers remains uncertain.

Conclusion

Select Medical Holdings Corporation is embarking on a transformative phase, strategically leveraging its robust Inpatient Rehabilitation Facilities segment as a primary growth driver while enhancing operational efficiencies in Outpatient Rehabilitation through targeted technology investments. The company's disciplined capital allocation, coupled with a more stable labor environment, underpins its resilient financial health. While the Critical Illness Recovery Hospital segment continues to contend with complex and evolving reimbursement policies, Select Medical's proactive advocacy and diversified service offerings provide a buffer against these headwinds. The company's commitment to expanding its high-margin rehabilitation footprint, alongside its focus on operational excellence and shareholder returns, presents a compelling investment thesis for discerning investors seeking exposure to the specialized post-acute care market. The successful execution of its IRF development pipeline and the continued optimization of its outpatient services will be critical indicators of its long-term value creation.