Description

(skimmer610 beat us to the punch and posted on EHTH on Sept 6th. However, we were already in the process of compiling a 20 page report which we just finished, which we think could still be a value add to the VIC community. So we're deciding to still post, but we will not have this count towards our required two annual membership ideas.)

Write-up on eHealth (EHTH)

In December 2019, we wrote up Benefytt Technologies (BFYT—or formerly Health Insurance Innovations, HIIQ) at $17.40. The company was acquired shortly after that, at $31 by Madison Dearborn in July 2020, generating a 156% IRR for investors. We now believe there is an even more attractive opportunity with one of Benefytt’s superior competitors: eHealth. 

eHealth is the Booking.com of Medicare Advantage (MA) shopping—an electronic brokerage platform that allows senior citizens to comparison shop Medicare Advantage plans on behalf of health insurance carriers. The company works with almost all of the Medicare Advantage insurance carriers such as Humana, UnitedHealth, Aetna, Wellcare, and Blue Cross Blue Shield. eHealth has grown its revenues at a 43% CAGR since 2015. 

Given its high growth rate, eHealth has always traded at 4x-5x revenues. However, its stock recently dropped to around 2x forward sales. Was this because eHealth’s growth rate declined? No. Actually, in July of this year, the company increased its growth targets. The company increased its 4 year revenue guidance to 27%-35% annualized growth till 2024 (which would still give eHealth only 2% market share). 

So what recently caused the ~50% drop in eHealth’s stock? It was simply because the company reported an increase in churn in Q2. Investors panicked and extrapolated that this is a permanent deterioration in eHealth’s economics. We, however—along with company management and our channel checks—think that last quarter’s increase in churn was just a temporary blip, and that the stock sell-off was a massive overreaction.  

We go through the detailed reasons below on why we think that is the case. But if we are right—that eHealth’s Q2 increase in customer churn did not change the earnings power of this business—then its stock should return to its prior level of around $130, which is around 75% upside. Furthermore, given the company expects to continue to grow revenues over 30% per year for the coming years, we think eHealth could be a multi-bagger over time.

Company Overview

eHealth.com is the Booking.com of comparison shopping for Medicare Advantage insurance policies. The company earns commissions from insurance companies for enrolling seniors into Medicare Advantage (MA) insurance plans. Insurance carriers pay eHealth around $300-350 per senior for every year that the senior stays on their MA plan. 

After a senior chooses a Medicare Advantage plan through eHealth, they stay on that policy for an average of around 3 years, at  which point they usually shop again for a new policy to switch to. Seniors shop through two of eHealth’s channels, either online or via phone:

1. Online channel (currently 30% of eHealth's enrollments): This is akin to shopping for your travel plans on OTAs such as Booking.com, Kayak, or Expedia. Seniors visit ehealthinsurance.com or medicare.com (yes, eHealth owns that domain), comparison shop, and then select the Medicare Advantage plan that best fits their needs. 

2. Telephonic channel (currently 70% of eHealth’s enrollments): This is akin to shopping for your travel plans by calling a travel agent by phone. Seniors call and speak with an eHealth sales agent, who helps the senior choose the best Medicare Advantage plan for them. (This is the old-school channel that eHealth’s competitors almost fully rely on, and which we think eHealth will continue to disrupt.) 

eHealth has been generating an increasing amount of its business through its online channel. As can be seen from the chart below, in 2018, 12% of the MA policies that eHealth sold were done through its online channel versus 88% through its telephonic channel. As of Q2 2020, however, eHealth’s mix shifted to 28% online and 72% via phone. eHealth expects this trend to continue and to have its online enrollments reach 50% by 2024. 

Since 2014, eHealth has invested over $230 million in its technology. Not only do we think online enrollment for Medicare Advantage is the future, but the cost for eHealth to enroll a senior online is significantly lower than what it costs to do it over the phone. eHealth’s CAC is 50% lower when a senior enrolls online without the assistance of a sales agent. Meanwhile, eHealth’s competitors have not invested anything near what eHealth has in their technological capabilities, and currently sign up almost 100% of seniors through their telephonic channel.

Since 2015, eHealth has grown all of its key metrics at an exceptionally high growth rate:

The company expects this growth to continue and has set new growth targets through 2024:

Industry Overview / Market Opportunity

This is a gigantic market. There are currently over 55 million seniors in the United States and, over the next 20 years, this population is expected to reach over 80 million seniors (as the baby boom generation begins to retire):

Seniors get enrolled in a government Medicare plan when they reach the age of 65. Medicare Advantage is simply a Medicare plan run by private insurers instead of by the federal government. Medicare Advantage is more efficiently run than standard Medicare, and it comes with lower cost and better service for the senior—a win-win for both the government and seniors. This is what has led the U.S. government to continue to push seniors off of standard Medicare and onto Medicare Advantage plans. 37% of seniors (up from 24% a decade ago) are currently enrolled in Medicare Advantage versus standard Medicare, and the government has predicted Medicare Advantage to reach 40-50% penetration over the next five years. In other words, this massive market is only getting bigger. 

As every category has now proven consumers are willing to shop for it online—from even previously doubted categories such as couches (Wayfair) to used cars (Carvana)—not surprisingly, seniors are also increasingly turning to the internet to purchase their Medicare Advantage plans:

Today, eHealth has only ~1% market share of the total Medicare market—a market that is adding 10,000 new seniors every day, who are more technologically savvy with each year than the prior year :

There are more than 2,700 different types of Medicare Advantage plans. This overwhelming choice and variation is what creates the benefit of a comparison type broker like eHealth—in the same way that Booking.com does when shopping for a hotel—to help a senior decide which plan is best for them: 

Narrowed down, a senior has an average of 28 plans to choose between: 

Market Share Breakdown / Competitive Landscape

Below is the market share breakdown of the four main channels through which Medicare Advantage policies are sold:

As can be seen in the above pie chart, 45% of Medicare Advantage policies are sold directly by the insurers, which we call the carrier channel—think of this channel as akin to airlines directly selling tickets to customers. The remaining 55% of MA policies are sold by 3rd party insurance brokers, called the non-carrier channel—think of this as akin to travel agents or online aggregators selling airline tickets. 

Within this non-carrier channel, 90% of the MA policies sold are through classic insurance brokers (called FMOs), who Medicare Advantage policies to seniors in-person through door-to-door interactions at senior centers, libraries, etc. In other words, 50% of the Medicare Advantage market (90% of the 55% non-carrier channel) is still selling insurance policies through old fashioned methods such as door-to-door sales. Not only should this channel continue to be in secular decline, but its decline should accelerate this year due to Covid-19—as almost all seniors will be reluctant to let strangers into their homes or visit senior centers, libraries, etc.—which should correspondingly increase the tailwinds for eHealth. 

The CEO of eHealth stated on their Q2 2020 call:

Scott Flanders, eHealth CEO: “And the [insurance] carriers are realizing that this [our] channel is very efficient for them in many cases. In most cases, [our channel is] cheaper, even fully loaded with commissions and other advertising revenues that [the insurance carriers] support the channel with, [rather] than their own fully loaded captive sales forces.

In addition, the captive sales forces are facing challenges this year with respect to securing face-to-face appointments with seniors because of their concerns over personal safety, understandably. And so, my discussions with the carriers would suggest that they are investing heavily in the third-party distribution channel as a hedge against their captive channels underperforming. So, we think this is a real positive for us and it's reflected in us increasing in our guidance our expectation for advertising revenue coming from the carriers.”

So what’s this churn situation that recently caused the stock to drop?

As mentioned, the seniors that purchase a Medicare Advantage policy through eHealth stay on their plan for an average of 3 years before they shop around and switch to another MA plan. This leads to an annualized churn of ~34% for eHealth. However, last quarter, eHealth reported a churn of 42%, which was an increase from its average of 34%. The key question is why did this happen? 

Recall that eHealth currently enrolls 30% of its seniors online and 70% by phone. eHealth’s telephonic channel (currently 70% of its enrollments) can be further divided into two. eHealth’s telephonic channel uses both its in-house call center (internal sales agents) and an outsourced call center (external sales agents). eHealth’s internal sales agents are obviously better trained and more productive, leading to lower customer churn for eHealth. Conversely, its external sales agents are the opposite, and lead to higher customer churn versus eHealth’s internal agents. Policies enrolled through external agents experience 20% higher first-year churn versus eHealth’s internal agents. So here is the key point: eHealth’s recent increase in churn stemmed largely from these external agents. 

So why does eHealth use external agents if it's negatively impacting their churn numbers? This is because eHealth experienced such rapid growth that it’s own internal agents could not handle the call volume coming into their call centers, and so eHealth had to supplement its business with outsourced sales agents. 

Most seniors enroll into Medicare Advantage policies during what’s called an Annual Enrollment Period (AEP) which occurs the last 2 months of each year, November and December. In 2018, before eHealth started to rely on external agents, in just 8 weeks during the AEP, eHealth left 136,000 calls unanswered as their internal agents could not handle that much volume:

At eHealth’s conversion rate of 20%+, that is a lot of applications and easy money left on the table. This continued into 2018 and 2019, as the magnitude of calls coming into eHealth’s call centers outpaced its headcount. When eHealth experienced faster than expected growth during the AEP, the only way for it to expand its telesales capacity was by tapping outside external resources quickly. For example, in 2019, the company grew approved senior customers by 88% when it was only expecting to grow 60%.

This forced eHealth’s management to lean more heavily on the external sales force than it otherwise would have. Looking at the magnitude of the company’s sales beats versus their prior guidance is a good proxy for actual approved members versus initial company plans:

One can see that eHealth’s actual results have been beating the company’s guidance at an accelerating pace over the last three years, which forced the company to lean more heavily on an external sales force. 

What investors need to understand, however, is that even though external sales agents increase eHealth’s churn metric, their LTV is still greater than its CAC. In other words, volume sent to eHealth’s outsourced call center does come with higher churn (since those sales agents are not as effective in helping seniors choose the most optimal plan for them), but nevertheless, it is all still incrementally profitable for eHealth.

The company has been growing its internal sales force to catch up with its top line growth. In 2020, eHealth is reversing the trend, and will go from having 30%/70% internal/external sales agents to 45%/55% internal/external. And the company expects this to reach 50%/50% by 2021. 

The company just announced on September 10th that it has already achieved its goal of 45% internal/55% external for this year’s AEP happening in November and December:

https://ir.ehealthinsurance.com/news-releases/news-release-details/ehealth-achieves-its-internal-medicare-sales-agent-hiring-goals

Bigger picture and longer-term, however, eHealth’s DNA and objective is to be an online portal like Booking.com, and not a call center. Recall more and more of their seniors are enrolling through eHealth’s online channel instead of via its telephonic channel. Seniors that enroll through ehealth.com or medicare.com have a churn that is 25%-30% lower than the seniors that enroll through eHealth’s call centers.

So as more of eHealth’s business continues to move to its lower churning channels (online and internal sales agents), churn should naturally decrease. Aside from that, eHealth is also implementing several new initiatives that focus on decreasing churn:

1. eHealth is changing the compensation structure of its sales agents. Instead of compensating an agent simply based on a senior’s “approved” Medicare Advantage application, the company will now pay sales agents only 65% of their commission upon approval and 35% after the first 100 days, the time period when the majority of eHealth’s churn occurs. This will incentivize their agents to enroll customers into the most appropriate plans and care more about customer retention, instead of just sign-ups. 

2. eHealth is hiring a team of 30 people (hourly employees who are coming on at minimal incremental expense) that will focus on nothing but customer churn, and are assigned to monitor that seniors are consistently enrolled in the best MA plan for them as their life circumstances change. Currently, eHealth only retains 10% of the seniors who decide to switch Medicare Advantage policies, and the company believes it as an easy hurdle to get that number to at least 25%.

Churn Is Not the Key Metric Either Way (It’s All About Your LTV to CAC Ratio)

Putting aside this one quarter of eHealth’s churn metric and why we think the change was a temporary blip, we more importantly believe that the market is overly concerned with churn and overlooking a more important metric: LTV to CAC. We know that if the marginal profit of a customer is higher than zero—i.e., your customer LTV is higher than CAC—that customer is incrementally positive to eHealth, regardless if that customer churns sooner than the average.

Overall, you can see that eHealth’s LTV / CAC over time has been relatively stable, even though churn has moved around, which is what makes churn a misleading metric to focus on. Here is year-over-year chart comparing eHealth’s churn with their LTV/CAC:

And here is a quarter-over-quarter comparison:

Having higher churn does not mean that the LTV / CAC of acquiring a marginal customer is unprofitable. The company tells you that the LTV / CAC across all three channels (online, internal sales agents, and external sales agents) is above 1. So even though its outsourced external agents have higher churn and, therefore, lift the overall churn number for the company, the business from that channel is still all incremental profit for eHealth. 

The CFO of eHealth stated on their Q2 2020 call:

Derek Yung, eHealth CFO: “We currently project for MA LTVs to decline up to 10% in the fourth quarter of 2020 and by mid-single digits for the full year, which has been reflected in our revised 2020 annual guidance [due to an increase in churn stemming from increased business sent to external sales agents]. At the same time, our acquisition costs per approved Medicare member is forecasted to decline by approximately 13% in the fourth quarter of 2020 and 10% for the full year 2020 compared to 2019.

As a result, our Medicare member profitability, as reflected by the LTV to total acquisition cost per member ratio, is expected to remain favorable and could actually improve for the full year 2020 compared to a year ago, which will have a positive impact on our overall profitability.”

Rounding out our point here, if we highlight below the math from which we can deduce that all three channels that eHealth uses to acquire a customer have a LTV / CAC ≥ 1 (meaning they are all incrementally profitable for the company):

Lastly, we thought it might be interesting to compare Booking.com’s historical LTV ratio with that of eHealth’s:

One can clearly see Booking.com’s historical LTV to Expense ratio dipped in certain years. To have sold or not invested in Booking.com when that slight deviation occurred would have been a missed investment opportunity. We hope the above chart encourages a longer-term view.

Barriers to Entry

Marketing to senior citizens is a highly regulated process and, therefore, creates a compliance barrier to entry. As an example, Cigna was banned from marketing their MA product for a couple of years because of misleading marketing. It is clear that a company the size of Cigna does not want to risk its highly lucrative MA license by partnering with a small startup broker with no scale, when large, compliant players such as eHealth can get the job done. (In the same way you don’t see airlines partnering up with new aggregators that compete with the likes of Expedia and Booking.com.)

http://www.maturehealthcenter.com/resources/blog/medicare-solutions/what-the-latest-medicare-insurer-sanctions-mean-to-you/#.X0R_ochKhPY

As a result, insurance carriers are careful who they select to be partners for marketing their products and have chosen only a handful of companies to work with, which is why there have been little new entrants in the past decade. We think that as with the OTA industry (such as Expedia and Booking), insurance carriers will continue to only work with the scaled players.

The only other main competitors to eHealth are SelectQuote and GoHeath. (Benefytt is a small competitor with a still unproven Medicare business model to date.) These three players have been in this business for the past decade and there have been no major new entrants during this time period. From our channel checks, it would appear that piecing the various aspects of the business together from scratch is quite difficult: the new entrant needs to be well capitalized—as the cash flow breakeven point only happens after year 2—and it is difficult to build and retain a quality sales force and have the appropriate TV and digital marketing capabilities simultaneously. We also believe that given the regulated nature of the business, insurance carriers prefer working with a handful of well-reputed players, as they will be banned from the Medicare market if they are deceptively marketing to seniors (as Cigna was a couple years ago). Finally, we believe that over time, the market will shift online, and over the past ~5 years, eHealth has invested about $230mm into their technology capabilities, far higher than its peers, which will be an advantage for them as this transition to online accelerates.

In terms of operating metrics, eHealth is the largest player amongst them:

The company has used its size and scale to invest in its technology versus peers:

SelectQuote and GoHealth operate almost entirely only through call centers and do not have the online presence of eHealth. Each of these players has a slightly different model. eHealth’s two competitors—SelectQuote and GoHealth—enroll seniors almost entirely over the phone. 

Valuation

We believe that eHealth is cheap on a number of different metrics:

Expected 2021 earnings for eHealth is around $5/share, which means eHealth currently trades at 15x EPS. We believe that this is unusually cheap for a stock that has compounded its MA revenues at 43% since 2015 and expects to continue to grow 27-35% over the next 4 years. Businesses with similar growth rates tend to trade at or greater than 30x earnings, which would value eHealth at $150/share today. 

On a revenue multiple basis, eHealth has historically traded at 4-5x revenues:

We think that once the market recognizes that it had an overblown reaction to one churn metric in one quarter, eHealth’s stock will revert back to its historical revenue multiple of 4-5x, which is what most companies growing over 25% per year get valued at. 

We also believe that the company’s 2024 guidance of $1.5 billion in sales at a 35% EBITDA margin is achievable. eHealth has expanded its operating margins every year as they gain scale: 2017 was -4%, 2018 was 8%, and 2019 was 20%.

The company's targets imply it will do at least $525 million of EBITDA by 2024. At a 10-12x EBITDA multiple, that is a $5-6 billion versus today’s ~$2 billion enterprise value—a potential 3 bagger in 3 years.

Over time, given the company’s similarity to online travel agencies like Booking.com, we think it is possible eHealth may get a similar multiple, as a greater amount of the large Medicare Advantage market moves online and away from phone and in-person sales agents (the way travel moved online, away from travel agents). Booking.com has traded at an EV / NTM sales multiple of 6x over the past decade: 

Furthermore, old-fashioned insurance brokers such as Marsh and McClennan and Aon also trade at 4x-5x revenues, today, while only growing their top line at 3% versus +30% for eHealth.

Given all of the above, we think eHealth’s ~2x forward revenue multiple and 15x earnings multiple is too low.

eHealth trades at a discount relative to its peer group today, despite our view that it is the most structurally advantaged business long-term, given its investment in technology relative to peers. (We remind you that eHealth will soon enroll 50% of seniors through its online channel versus around 0% for its peers). 

Comps / Margin of Safety / Strategic Value

We also believe that the platform has tremendous strategic value that limits downside risk at this price. eHealth trades below the valuation of traditional brokers and the price at which its very small peer, Benefytt Technologies, was acquired at just a couple of months ago—at 4x its Medicare Advantage revenues—even though eHealth is in a substantially superior position. 

July 2020: Madison Dearborn acquires Benefytt Technologies for $700mm at 4x medicare revenues

(https://www.globenewswire.com/news-release/2020/07/13/2061108/0/en/Benefytt-Technologies-Inc-to-be-Acquired-by-Madison-Dearborn-Partners.html) 

There was significant strategic interest. You can read about the transaction here: https://www.sec.gov/Archives/edgar/data/1561387/000119312520198599/d148056dsc14d9.htm#toc148056_4, but essentially:

• 60 counterparties were contacted

• 20 confidentiality agreements signed

• 7 initial indications of interest

• 5 parties invited to second round bids

We further believe there is significant downside protection (and obviously significant upside potential) given that eHealth now trades way below its call-center only peers, SelectQuote and GoHealth:

Note: Benefytt’s non-Medicare revenue is in runoff. Company is using the proceeds to fund the $175mm medicare revenue for 2020 so EV / Medicare revenue is the most appropriate metric.

eHealth CEO Insider Purchase

The CEO of eHealth just personally bought $3.5 million of stock in the open market:

https://www.sec.gov/Archives/edgar/data/1327337/000133349320000154/xslF345X03/wf-form4_159666585401471.xml

Biden Win / Dem Sweep

Biden has proposed decreasing the Medicare eligible age from 65 to 60. Should this happen, it could potentially increase eHealth’s TAM overnight by 20 million people or ~36%.

Catalyst

• eHealth's focus on improving customer retention, by moving more of its business to its online portal and internal sales agents (versus outsourced sales agents).
• eHealth's expanding operating margins, as the business continues to grow top-line at ~30%.
• Investors better understanding churn is not the important metric to focus on, but incremental LTV/CAC ratio is what's key to continued growth in profitability.
• Biden election win / Dem sweep.