Description

• Growth of the healthcare technology business is being obscured by businesses that are being shut down or sold.

• While there are close to ten companies in PFMT’s space, the nature of the business really makes it closer to an oligopoly or even monopoly.  There are also real barriers to entry in the healthcare technology space.

• The company trades at under 3X 2021 healthcare revenue for a business that is profitable, growing rapidly and expected to generate long-term EBITDA margins in the 20-30% range (and possibly much higher).  We believe the stock should trade up 100% over the next 12 months with tremendous upside after that.

• Due to a combination of long-lead implementation times, a ramp-up period, and a business that contains natural momentum, growth over the next 2-3 years is likely locked in.

Obscured healthcare technology business:

Performant (PFMT) specializes in auditing payments. This is a technology and software driven process.  It has done this historically in three areas: student loans, taxes and healthcare.  

The IRS business is getting tougher and much more regulated.  (While it amazes me that the government would want to make it harder to collect money it is owed and thus easier for people who cheat on their taxes, but that’s the case.)  The regulators are not really going after the hedge fund manager using offshore vehicles to avoid millions in taxes, it’s more like the waitress who owes $2K.  

While the tax tool would appear to have some general synergies with healthcare, the company believes that the negative regulator outlook could contaminate its healthcare business, so it has decided to exit the tax space.  It will be selling its tax business off in pieces, likely for low multiples around 3X EBITDA.  

Performant’she student loan business essentially went to zero after Covid hit and student loan payments could be skipped for the time being.  This was a competitive space,  the company believes that this student loan area can also contaminate its healthcare business from a regulatory and contract competition perspective.   PFMT has decided to use the pandemic pause on student loan collection as a way to shut this business down.There will likely be some smallrevenues trickling in as it is being wound down.  

That leaves its healthcare business.PFMT specializes in payment integrity in healthcare.  Essentially this is auditing payments for insurers or the government to different healthcare providers and looking for errors, which given the size of the space there are a tremendous amount of errors.  PFMT estimates that between commercial, Medicare and Medicaid there are over $240bln of inaccurate payments annually.  The healthcare segment grew revenue from $43.3 mln in 2019 to $68.5 mln in 2020, and we believe it is currently more profitable than the other segments.  In the meantime total revenue declined over $5 mln to $150.4 mln in 2020.

There are other issues that may be obscuring the value of Performant in the short-term.  PFMT is over 22% owned by private equity sponsor Parthenon, who first acquired Performant in 2004. The position is miniscule for it, and the fund it was part of has likely been nearly fully dissolved by now.  Parthenon has been cutting its stake and sold a few percent recently.  Another issue is that PFMT has fairly punitive debt that also has warrants as a form of payment attached to it.  The company will likely exit this debt financing by next year.  After years of a lagging stock price, Performant no longer has any sell side analyst coverage. 

The Industry is much less Competitive than it Appears:

While close to ten companies operate in the same space as PFMT, the competition is less than that number could suggest.  Even a small operator will hire at least two companies, and a major insurance companies will hire six or more companies.  So one company will take the first cut, another the second, and so on, until hopefully there are very few errors.  The companies also have specialties that differentiate them and give them little niches.  So if there are eight companies to choose from and you have to hire six, it becomes more like a very tight oligopoly, and given the specialization, it’s even better than that.  It’s also very hard to break into the industry given the heavily regulated nature of it. Performant was able to get a large CMS contract that is essentially a license to get into the rest of the business including commercial.  It’s likely that the company’s background in other government work enabled it to get the original contract.

PFMT Trades at a fraction of the price of other healthcare tech companies:

Performant is expecting $83-90 mln in2021 healthcare revenues.  The current EV is just $163 mln so it trade for less than 2X revenue before the other businesses.  We believe long-term margins should be at least 25%, thus a fairer multiple would be around 4-5X revenue though if you look at what other companies trade at today 6X+ sounds quite reasonable.  We believe that by 2024 or earlier that PFMT could generate $150 mln in revenue $40 mln of EBITDA and $25 mln of net income, and should easily trade for 20X earnings, thus a $500 mln market cap with a fair amount of cash generated along the way, so there is upside of 3X or more in a few years!  However, this may be light as we have heard from various sources that margins could be much higher as maturity and growth could be stronger. It would not be crazy to see a multiple twice as high and a 7 bagger is a definite possibility.

Growth is Locked in:

Due to the nature of the business, revenues are highly predictable and have a good amount of momentum.  It takes about 12 months for implementation on a new client, and it’s probably another 3- 6 months before one is  fully up and running and collecting revenues. Additionally the sales process takes another about 12 months. Thus the company has nearly perfect vision into near-term growth and very good vision nearly three years out.  The business also has natural momentum--as one moves up in the ranking of providers, for example Performant gains a client and starts out getting the fourth crack at the records, the company performs well  and moves up to the third position, which increases your sales to that client.  

PFMT is clearly growing.The growth is a mix of new clients and increased business from existing contracts.  When we asked industry insiders why PFMT is taking share, we got a mix of answers from that it is more aggressive in collections to that other companies have had problems implementing software changes over time.The exact reason for taking share is unclear, but it does appear that PFMT has a superior product and the company does give examples of its results in its presentation.  It certainly appears that PFMT is highly likely to continue growing over the next few years and potentially beyond.  Additionally, the pandemic may have slowed down PFMT as it was likely tougher to get new clients signed up with a lack of in person meetings, which could mean a bump in growth in another year.    Indeed, the company has said investments made over the past year will start paying off in 2022.  

Catalyst

Catalyst:

Return to companywide revenue growth by 2023 or even 2022.

Raising guidance, as initial guidance only contains fully contracted sales, we believe there is room for upside.

Analyst coverage resumes.

Refinancing of debt.

Company is acquired, there have been a lot of deals at very high prices (last transaction at 17X EBITDA) in this space.