Athenahealth (ticker: ATHN), ever since its 2007 IPO, has been hyped as a SaaS company with a federal stimulus story on top.  The company earns substantially all of its revenue from its revenue cycle management (RCM) software, yet the street values them as if they will garner significant market share in the electronic health records (EHR) space as the government begins to pay out "meaningful use" bonuses.  We think the street is egregiously overestimating the part that ATHN will play in the EHR narrative.  ATHN has managed to grow their physician client base nicely over the past 3 years (although that growth has slowed), nonetheless, we believe they are targeting the wrong market as it will be hospitals that drive the adoption of EHR going forward.  Once investors realize that, as far as athenahealth is concerned, the EHR story is just a bunch of hot air, its earnings multiple will be cut in half and consensus estimates will come down, resulting in a per share price in the $15-$20 range.

Business

ATHN provides internet-based services for physician practices.  The company's principal offering is athenaCollector, a revenue cycle management (RCM) system that automates and manages billing-related functions for physician practices.  ATHN's other offerings are athenaClinicals, a service that automates and manages medical record-related functions for physicians practices and includes an electronic health record (EHR) platform; and athenaCommunicator, a patient cycle management (PCM) service suite that includes an automated messaging and reminder system, live operator services and a patient web portal.

ATHN makes most of its money via its athenaCollector product which brings in around 95-97% of the company's revenue.  Again, athenaCollector is a revenue cycle management product which is a fancy way of saying it is a "help-doctors-get-paid-by-insurance-companies" product.  ATHN charges doctors a small fee for system implementation and training, typically around $4,000 for a small practice (Implementation Revenues) and then they charge 4-5% of collections for athenaCollector (and an incremental 2-3% for athenaClinicals and another ~1.5% for athenaCommunicator if these products are purchased as well) once the system is up and running (Business Services Revenues).   Make no mistake, athenaCollector is an effective RCM product that is attractive to small practices as there is a very small up front capital commitment.  In addition, the method by which ATHN provides this RCM system via the internet using its athenaNet "rules engine" appears to be a very efficient way to provide such a product.  ATHN is using the success it has had with athenaCollector to leverage its way into the Electronic Health Records (EHR) business by up-selling its athenaClinicals and athenaCommunicator products to those doctors either currently using, or interested in purchasing, athenaCollector.  This is where we think the ATHN story weakens.

Background

On July 13 of this year the Center for Medicare and Medicaid Services (CMS) issued its rules for "meaningful use" (MU) of electronic health records (EHR).  Doctors and hospitals will be required to meet 20 and 19 practical objectives, respectively, in order to qualify for bonus funds allocated to them in the Health Information Technology for Economic and Clinical Health (HITECH) Act, a portion of the 2009 American Reinvestment and Recovery Act (ARRA) federal stimulus bill.  This program is completely separate from the health reform bill (H.R. 3590 - Patient Protection and Affordable Care Act) signed in late March 2010; the billions of dollars in funding for EHR bonus payments has already been allocated.  Over the next 5 years, physicians can earn up to $44,000 and $63,750 in Medicare and Medicaid incentive payments, respectively, should they prove meaningful use of EHR as early as 2011.  Beginning in 2015, eligible professionals that do not comply with the meaningful use requirements will see their Medicare payments docked by up to 1%, and up to 2% in 2016.  This legislation has effectively created a gold rush in the world of healthcare IT which is one of the reasons why ATHN trades at such an obscene PE of nearly 60x 2010 estimated EPS.  What remains to be seen, however, is precisely how this legislation will be put to use in the private world.  Currently there are dozens of companies offering EHR systems, most of them private, and each one of them fighting for that federal stimulus dollar.  The key to the legislation being considered a success will be uniformity; a single patient record that can be accessed and maintained by doctors, dentists, hospitals, and long-term care facilities alike.  Case in point, the recent merger of Allscripts (ticker: MDRX) and Eclipsys.  Allscripts and Eclipsys, leaders in EHR offerings to the ambulatory and inpatient segments, respectively, took a look at the trends in medical care developing today and decided they would be best positioned to profit from the implementation of a national health information exchange by joining forces.  On the merger conference call Glen Tullman, Allscripts' CEO, cited an important trend in medicine today: "It is about the shift that we see and more and more physicians becoming employed by hospitals. And those hospitals using the Stark safe harbor exemption are actually starting to organize the market and drive adoption, and that is really the reason for this [merger]."  In October 2006, congress enacted the Stark Safe Harbor legislation that allows hospitals to donate EHR related hardware, software, internet connectivity, implementation and training, and support services to physicians.  The hospital benefits from this arrangement as there will be greater name recognition among physicians with admitting privileges, greater recognition of the hospital in the community, and the potential to have better integration of data between doctors' offices and the hospital.  As detailed in a September 2009 article in the New York Times, big hospitals are subsidizing their affiliated physicians' cost of EHR adoption in order to "share data among doctors' offices, labs and hospitals to coordinate patient care, reduce unnecessary tests and cut down on medical mistakes."  For example, the North Shore-LIJ health System in New York has a program underway that offers its 7,000 affiliated doctors subsidies of up to $40,000 over 5 years to adopt EHR in addition to the HITECH bonus money.  The North Shore program happens to use Allscripts.  According to the article, many hospitals are even offering assistance to unaffiliated doctors in hopes that physicians with privileges at multiple hospitals will develop an allegiance to the one that helps them into the digital age.

Problems with the Athena Story

• Hospitals are driving EHR adoption, not doctors. The future of digital medicine will require a common infrastructure that facilitates the seamless sharing of information and it will be the large enterprises that define that infrastructure. Athena does not focus on the "hubs" of the US healthcare system, the inpatient facilities (e.g. hospitals, nursing homes, rehab facilities), instead they focus on the "spokes", the independent doctors in private practice, which, as we discuss below, is a shrinking part of the healthcare landscape. This is quite clear from ATHN's ratio of providers per client account which was 14.8 as of Q109 and has dropped to 14.1 as of Q210. If ATHN were successfully tapping the enterprise market, then this ratio would be increasing not declining. Regardless of the company's efforts to "Intensify efforts to expand the enterprise sales pipeline", the numbers speak for themselves. ATHN, in their 2Q10 earnings release, discusses how they plan to add 30 salespeople, "In terms of our sales force, we have added 12 new quota-carrying sales representatives year-to-date, and we currently plan to add approximately 18 quota-carrying sales representatives by year-end. Most of these reps will join our small practice sales force." Another example of how the company is barking up the wrong tree as far as EHR goes. Hospital systems have launched programs to drive the adoption of EHR among their affiliated physicians. This will "coordinate patient care, reduce unnecessary tests and cut down on medical mistakes", thereby lowering costs at hospitals and helping them to meet Pay-for-Performance (P4P) quality metrics included in the health reform legislation; ATHN is missing the boat here, marketing directly to doctors, essentially competing with hospitals which will also be pushing their choice of EHR on the doctors. The recent merger of Allscripts and Eclipsys emphasizes this trend as was discussed on their conference call, "It is about the shift that we see and more and more physicians becoming employed by hospitals. And those hospitals using the Stark safe harbor exemption are actually starting to organize the market and drive adoption, and that is really the reason for this [merger]."
• The number of independent doctors' offices, and thus ATHN's core market, is shrinking. ATHN makes the following statement in their 10-K: "We believe that the market opportunity for our services is, in large part, currently driven by physician practice collections in the United States." The problem with this statement is that the owners of private physician practices are rapidly approaching retirement and more likely to sell their practices (often to a hospital) than put money into them. According to the AAMC (Association of American Medical Colleges), 250,000 doctors are over age 55. Physicians will have until 2015 to demonstrate meaningful use of EHR before being penalized with lower Medicare reimbursement, and until 2017 before that penalty is more than 2% of Medicare collections. By that time, one third of U.S. doctors will be around 70 years old and likely retired. Older physicians will be required to undertake an extensive cost-benefit analysis in order to determine if the capital expenditure and opportunity cost required to implement and learn an EHR system is worthwhile. The younger generation of physicians is not starting or even joining independent practices, they are joining hospital-based practices or just opting for employment at a hospital. According to a 2009 article out of the American Academy of Orthopedic Surgeons (AAOS) emphasizes this point: "From their perspectives, hospital-employed physicians are looking for stable work hours, less administrative work, and reduced handling of malpractice issues. Hospital employment also eliminates concerns about practice expenses, because salaries and supply purchases are no longer under the physician's control. The salary arrangement also reduces concerns about decreasing physician reimbursements." This trend has been in place since earlier in the decade. Most new doctors are coming out of school with massive amounts of debt and just don't have the desire to open a risky private practice especially in light of the weak economy and the uncertainty created by the health reform legislation. In addition, a rising number of older doctors are selling their practices and moving into salaried jobs at hospitals as well. According to the Medical Group Management Association, as of 2008, approximately 48% of medical practices in the United States were owned by doctors and approximately 50% were owned by hospitals. The percentage owned by doctors has declined from over 70% in 2002 and as high as 68% in 2005 while the percentage owned by hospitals has gone from around 25% in 2002 and 2005 to 50% in 2008, thus the trend has accelerated in the last five years. If this trend continues, the market that is ATHN's bread and butter will continue to shrink.
• The EHR competition is fierce. ATHN's user base is only around 27,000 providers; contrast that with Allscripts' base of 180,000 physicians and 1,500 hospitals, McKesson (ticker: MCK), the giant drug and medical supply distributor that has a technology solutions group of its own that services more than 50% of U.S. hospitals and 100,000+ physician practices, Cerner (ticker: CERN) whose healthcare IT solutions can be found in 2,300 hospitals; each of which has their own EHR offering, or Ingenix, a subsidiary of United Healthcare, with 200,000+ physicians and 6,000 hospitals as clients. There are dozens of other companies both public and private that are competing in the EHR space, not to mention the RCM space. Combine the fact that there are numerous large well-funded aggressive competitors in the EHR space with the fact that the HITECH stimulus money will only help to subsidize traditional healthcare software and you have a situation where, according to ATHN CEO Jonathan Bush, the big vendors like GE, Allscripts and Cerner stand to gain more than the web-based companies like Athena and others.
• Operating metrics are showing signs of deterioration. Growth of providers on athenaCollector has slowed in recent quarters. Year over year growth in providers using athenaCollector was 55.1% in Q109, 49.9% in Q209, 27.8% in Q309, 24.4% in Q409, 21.5% in Q110 and 21.9% in Q210. Another way to look at it would be the 1H athenaCollector provider numbers which are also showing decelerating year over year growth: 1H08 vs 1H07=29.2%, 1H09 vs 1H08=52.5% and 1H10 vs 1H09=21.7%. Not the kind of revenue trajectory an investor wants to see for a 60PE stock. While the athenaClinicals (the company's EHR product) is showing very strong provider growth, it is also showing deceleration on a year over year basis: 1H09 vs 1H08: 118.9% and 1H10 vs 1H09: 107%. The price as a % of collections from the athenaClinicals business is lower than the athenaCollector business and thus regardless of its significant growth, average business services revenue per provider has pretty much gone nowhere since Q208 when it was approximately $2,294 vs the 2Q10 number of $2,133. You might argue that I am double counting somewhat by using total providers, but the numbers are not much better when using just the providers on athenaCollector which have also gone nowhere since Q208 when it was approximately $2,374 vs Q210 at $2,313. Again, not the kind of numbers you want to see for such a high PE stock. As a matter of fact, one would expect to see an increase in the revenue per average provider on athenaCollector because the total revenue numbers include revenues from athenaClinicals collections as well which likely implies that there has been a decrease in athenaCollector revenues per provider. Some of the decline in revenue per average provider is due to the weak economy impacting the number of doctor visits by the public as more people are having to do without insurance and those that have insurance don't want to take a day off of work to go to the doctor and they also don't want to pay the ever-increasing co-pays. So, one might argue that these numbers will improve with the economy. Well, the employment situation in the US could take years to recover so these types of revenue numbers may be around for a while. The deteriorating top line has impacted the company's outlook; from the Q2 2010 earnings release, "As a result, while we currently expect that Q3 2010 annual revenue growth will be 30% or better, due in part to Medicare claims collections shifting into that period, we do not believe Q4 2010 annual revenue growth will reach our prior 30% target."
• EBIT margins have deteriorated. First half EBIT margins going back to 2007 are as follows: 1H2007=(4.1%), 1H2008=3.6%, 1H2009=7.7%, 1H2010=3.3%. The company has had to kick up marketing spend as well as G&A and R&D each of which has grown at a faster rate than revenues in the 1H2010 vs 1H2009.
• Valuation. Athena has, by far, the premium multiple in the EHR space at close to 60x 2010 estimated EPS and close to 40x 2011 estimated EPS. Competitors trade in the 20x 2011 estimated EPS range which, given the possibility that ATHN is not as properly positioned to benefit from EHR adoption as the market seems to believe, we think is a more appropriate multiple. Taking the point one step further, if ATHN turns out to only be a revenue cycle management story, then it should trade more in line with MedAssets (MDAS) and Emdeon (EM) that trade with high teens 2011 earnings multiples which would put the stock at around $15 per share.
• Sundry Items. 1) There is speculation that Methodist Hospital System in Houston is transitioning off of ATHN's systems to those of NextGen Healthcare, a subsidiary of Quality Systems Inc (ticker: QSII). According to the Methodist Hospital website, the hospital is subsidizing EHR technology for Methodist's 2,300 affiliated physicians who want to use NextGen's integrated EHR in their practice to "streamline all phases of patient care, improving patient safety, reducing costs and creating efficiencies." 2) there is also speculation that CVS may also be transitioning off of ATHN's systems. 3) while having EHR and RCM systems functioning in the cloud certainly has its advantages, there will be a percentage of potential clients that will shy away from the SaaS system out of fear of lack of availability, denial of service attacks, privacy concerns, etc. 4) The original three-year marketing and sales arrangement with PSSI expired in May 2010 and apparently it renews automatically for successive one-years periods unless PSSI gives notice of termination 60-days prior to the expiration of the then current term. If that is the case then the PSSI deal is still in effect, if that is the case then what was meant by Jonathan Bush when he said on the Q210 call, "I think we're just batting back and forth and expect to have something done with them pretty soon. I absolutely kind of thought we would be done by now..." Given that PSSI is a major channel partner for ATHN, this would not be a positive if they lost PSSI.

The bottom line here is that for a ~60PE stock (~40x 2011) there better not be any chinks in the armor.  The problem with ATHN is that there are quite a few and as such, we think that the stock is priced for a perfection that may not materialize.

Risks to our Short Thesis

• The company's RCM product, athenaCollector, is highly regarded among those physicians that are using it. This could help the company maintain or increase top line growth which would allow the company to continue to grow earnings at a rapid rate which could keep the valuation at high levels.
• The success of the company's RCM product could lead to significant growth in athenaClinicals, the company's EHR product.
• The stock could simply trade higher as a result of excitement and hype over HITECH stimulus payments driving EHR adoption as we approach the 2011 demonstration of "meaningful use" of an EHR system approaches.
• The company could be taken over, yes, even at these obscene multiples if their technology proves to the "killer app" that some think it is.
• Our thesis could take a long time to play out and in the mean time the stock could rise in the absence of a negative catalyst.
• The short interest in the stock is in the 33% range which could create a short squeeze if the company releases good news. The high short interest is also creating a hard-to-borrow situation.
• The company is holding an analyst day in December 2010. The stock could trade up into this event as investors and trading believe that the company will say positive things at the analyst day.
• The company recently announced a collaborative agreement with Humana where Humana will incent physicians in its provider network to use ATHN's EHR with per-patient bonuses and up to $4,000 in EHR implementation subsidies. Deals like this could help drive athenaClinicals adoption.
• Todd Park, the company's co-founder, sold all of his stock and went to work for the Obama administration as the Chief Technology Officer of the Department of Health and Human Services. This political connection could help the firm.