Description

After a multi-year industry reset, we think now is the time to own EHTH. The Medicare Advantage e-broker industry is in the late innings of rationalization. Two large competitors have exited the market this year. EHTH is the best company in the space with the strongest technological infrastructure and balance sheet. The company is on the cusp of returning to cash profitability which could drive a large rerating of the stock.

Sentiment in the industry is at a trough. EHTH is trading far below its liquidation value. Our price target requires no heroic assumptions. Simply a return to zero TEV would imply a share price of $13.70/sh, or ~200% up from the current share price.

Company Overview

EHTH is an electronic brokerage platform that allows senior citizens to comparison shop Medicare Advantage (MA) plans. Booking.com for MA plans is an apt analogy.

EHTH derives the majority of its revenue from commission payments from health insurance carriers. For each MA policy enrollment, EHTH earns ~$600 in upfront commission, and ~$300 each year upon renewal. Under ASC 606, EHTH books the LTV of commission streams as revenues upfront. Churn is the key assumption in projecting LTV. Under prior management, low quality cohorts in 2019/2020/2021 led to higher realized churn than assumed, leading to large revenue write downs (more on this later).

Seniors can shop for Medicare Advantage plans with EHTH either online (ehealth.com) or telephonically. 58% of EHTH sales occur through the online channel, up from 29% in 2019. EHTH is the only e-broker with a built-out online sales platform and the reason why we prefer EHTH over competitors. Competitors GOCO/SLQT still enroll 99% of seniors telephonically. The average telephonic enrollment takes 45 minutes to 1 hour with an agent. We view EHTH as a secular winner as younger boomers are increasingly comfortable shopping for healthcare online, as most are already accustomed to online healthcare enrollment with their current employers.

Industry Overview

We estimate industry growth to be around 10%. Drivers of growth include:

·         An aging boomer population. There are 65mm Americans eligible for Medicare Advantage, growing by 5-6% per year

·         Increased penetration of Medicare Advantage over Medicare FFS (1-2% growth)

·         Commission rate growth of 2-6%. Commission rate is set by CMS and determined annually

Additionally, we think e-brokers are share gainers versus traditional brokers.

The e-broker channel currently accounts for less than 10% of policy enrollments. About 50% of seniors enroll in MA plans directly with carriers (akin to booking flights directly at Delta.com). The remaining 40%+ of enrollments are done with traditional brokers.

Traditional brokers are mom and pop independent insurance agents that typically service only their local communities. The majority of sales are done door-to-door or via community events such as seminars. Traditional brokers do not offer the same breadth of offering as e-brokers. The average senior has over 60+ MA plans to choose from in a particular geography. A typical traditional broker will learn 3-5 plans from one or two carriers, and only sell those plans, even if they are not the most suitable plan for the consumer. Traditional brokers have the benefit of lower overhead and higher retention rates due to a more personal relationship with the enrollee. But we expect this channel to continue ceding share to e-brokers as each cohort of younger boomers are increasingly comfortable shopping online or telephonically.

Brief History

Prior to 2018, EHTH was a small but profitable business. Starting in 2018, EHTH adopted the ASC 606 revenue recognition standard. Under ASC 606, the company recognized the LTV of commission streams as revenues upfront. High optical growth rates drove up the stock price of the company as growth investors piled in, and set off the “growth at all cost” phase of the industry. All cost discipline was thrown out the door, as sales compensation and executive compensation were changed to drive growth and growth only. At its peak, EHTH was trading at 7x revenue.

Competitors chased a similar valuation, aggressively expanding headcount and overpaying for low-quality leads. CAC increased dramatically. Marketing reached a fever pitch, with many aggressive ads dangling a whole array of incentives to lure seniors to switch plans.

Increased plan switching drove up churn dramatically. Investors realized that previously assumed LTVs were grossly overstated. EHTH and competitors were forced to take massive revenue write-downs. Unit economics were shown to be negative (LTV < CAC) and the whole industry was rendered uninvestable.

We think now is an opportune time to own EHTH

We think now is an opportune time to own EHTH. The industry has gone through a reset since the heady days of 2020/2021. We are 2.5 years into rationalizing and we think the industry has reset enough for investors to once again consider an investment. New management teams have come in and cleaned out the skeletons (i.e. large revenue write-downs). Executive compensation is now based on profitability and cash flow. Salesforces have been downsized to include mostly tenured agents who are 2x+ more productive. Advertising spend has been cut dramatically.

Policy churn is ticking down. Cash flow is approaching breakeven, ahead of management targets set during the investor day in May 2023.

Exit of two large competitors in 1H 2024 should accelerate industry rationalization

Over the past 6 months, two major competitors, AssuranceIQ and Benefytt Technologies (formerly Health Insurance Innovations) have shut down. After two years of incremental rationalization, we think this is a large step for the industry in re-establishing sustainable unit economics.

The exact financial implications remain to be seen, but as with any industry going from six players down to four, we think the impact will be significant. Fewer competitors should further rationalize the marketing environment. The Company has indicated to us they are already seeing cost per lead down come down y-o-y (though they didn’t quantify).

EHTH has also been proactive in hiring the top quartile of agents from AssuranceIQ. Hiring and retaining good agents has been a pain point over the past few years in a tight labor market. New agents are expensive to onboard (about $25k per head for training + certification), and are less productive than agents who have gone through at least one AEP. During the peak 20/21 mania, new agents were costing the company more than the commissions they generated, as inexperienced agents burned through expensive leads with low conversion rates.

Sales productivity metrics are not disclosed but we know that experienced agents convert leads at much higher rates. Based on a discussion with the former CMO of a competitor:

“Well, so [agents with] two-plus AEPs, they were converting leads at 35% to 40%. An agent that had just one AEP under their belt, was going to be in that 20% to 22% up, and an agent that had not yet been through an AEP was about 10% or 12%.”

Furthermore, the exit of two competitors leaves a large whitespace for the remaining e-brokers.

Importantly, none of this is currently baked into the current guidance given by the public players. We don’t expect major revisions in guidance, as all three (EHTH/SLQT/GOCO) understand the importance of re-establishing credibility and setting the bar low.

We temper our enthusiasm a bit given the 2024 election which will crowd out marketing in swing states during the first three weeks of AEP. But the competitive environment has never been more favorable, and sets up well for a strong upcoming AEP. We would not be surprised to see a large beat on both the top and bottom line. An imminent return to profitability should drive a re-rating of the stock.

EHTH is currently trading significantly below liquidation value

EHTH is currently trading significantly below its liquidation value. The company has $845mm in commission receivables on its balance sheet, more than covering its entire TEV.

Applying a 25% discount to the contract assets still gets us to a liquidation value of $13.70/sh for EHTH, or up ~200% from the current share price. This is our initial price target.

Longer term we think the business can be worth substantially more. We are entering a multi-year demographic bulge of boomers turning 65. We also think the e-brokers continue taking share from traditional brokers, who do not have the technological and compliance infrastructure to scale effectively. Management has guided to a 8-10% EBITDA margin by 2025, implying Adj. EBITDA of $40-$50mm. What is the right multiple for a profitable, asset-light distribution business gaining share in a 10% growth industry? We have some thoughts, but that is a debate for later date. For now, we are playing for a return to zero TEV.

After the large write downs across the industry in 2021/2022, investors are understandably skeptical in ascribing value to contract assets. Management teams (we have spoken to EHTH/SLQT/GOCO) understand the credibility problem they inherited from their predecessors and have baked in added conservatism to these numbers. Contract assets have also since been heavily scrutinized by lenders which adds to our confidence that these numbers are solid. In fact, EHTH has written UP their revenue for the past 7 quarters as cash collections exceeded previously assumed LTVs.

Given the large disconnect between EHTH’s market cap and its asset value, management has been looking for ways to monetize its commission receivables balance ($845mm).

SLQT stock is up 400% since May when it discussed an illustrative securitization structure that would pull forward cash flows from commission receivables. Under this structure, cash flows would be positive upon the initial sale of a MA policy, while future commission streams from renewals would be reduced.

We spoke to GOCO last week and they too are exploring options to monetize their contract assets.

The timing of securitization efforts is uncertain, but we expect to hear something within the next 12 months. There is urgency for SLQT in particular to get something done given its upcoming debt maturities. We think a transaction by any of the three would be a huge catalyst for the industry to rerate, as it would crystallize the value of the large contract assets on the balance sheet.

Conclusion

The bet here is that after a multi-year reset, the industry will emerge structurally more rational. Recent financial performance and industry developments give us confidence that rationalization is happening and accelerating. New management teams have come in and restructured companies to focus on profitability instead of growth. All the secular trends that made the industry attractive in the first place are still in play – demographic bulge of retiring boomers, the shift from in-person sales to telephonic and online sales.

Risks

Competitors re-engage in unsustainable growth policies – We are comfortable with this risk, particularly in the near-term, as SLQT and GOCO are both straddled with debt and focused on cash flow.

Regulatory risk – Medicare Advantage is a heavily regulated industry with annual changes. We think the larger e-brokers are better suited than traditional brokers to handle the associated compliance risk.  EHTH takes no underwriting risk but is still exposed to regulation of consumer marketing and broker commissions. Additionally, Medicare for All would be an existential threat, but the likelihood of legislation passing is near zero even with a Democrat sweep in November.

More revenue write-downs – As detailed in the write-up, we feel confident in the level of conservatism baked into LTV and commissions receivable numbers. Management has also indicated repeatedly that these numbers are solid. An unexpected revenue write-down would call into question management credibility and our entire thesis.

Catalyst

Upcoming 2024 AEP

Securitization of contract assets

Re-inclusion in the Russell 2000 index next June (EHTH was on the wrong side of the cutoff this year)