Description

Quadramed has been posted twice before on VIC (at the beginning of the year by puma4180 and in 2004 by lindsay790).  Given the latest developments and progress made at the company, I believe it warrants being written up a third time as there is material upside from the current stock price and numerous catalysts that will unlock that value.  I won’t go into much background on the name given the historical posts (which give excellent detail) but heres a quick recap….

QD is a healthcare IT company, similar to a Cerner (CERN), Eclipsys (ECLP) and Allscripts (MDRX). They provide software products that enable hospitals, multi-facility care delivery organizations/networks, physicians and other health care associations to manage health information. The company had a troubled history prior to 2005.  QD had SEC investigations, financial restatements, expensive re-financings due to a technical default in their bond issue, significant employee turnover, numerous lawsuits, a dearth of new sales, enormous net income losses and was de-listed from NASDAQ.  Despite the mess of negative issues it had to deal with, QD continued to win industry awards for its products and didn’t lose any significant customers. 

In the past two years, new management has been brought in and all of these issues have been resolved.  The company has gone from one facing a potential Chapter 11 filing to one with robust sales momentum, net income positive results and decent cash flow.  QD is now in a healthy excess cash position.  That being said, the progress hasn’t fully shown up in the valuation and the sales momentum has yet to meaningfully impact the P&L. This may be due to the fact that there is still no analyst coverage and management doesn’t provide any guidance.

During the gloom and doom years, it was challenging for QD to win any new business – a CFO at a hospital would look at QD’s P&L and see massive net income losses ($40MM in 2004) and the sales person would have to face the “are you going to be around?” issue – it was a tough hurdle to overcome.  Its also a long sales cycle (18-24 months), so it takes time to turn it around once you clean everything up.  QD no longer faces the “are you going to be around” issue and has finally started to benefit from the strength of its products and the terrific tailwinds for healthcare IT.  The progress is just starting to show up in sales wins and will soon more favorably hit the P&L.    

In Q1, QD sold their first enterprise platform (Affinity) in a couple of years.  They sold another in Q3 while announcing many decent sized contracts (some of which are much bigger than affinity products) along the way.  In talking with management, sales for next year will definitely be higher than this year - its just a question of how much.  The pipeline is robust and the sales force is making progress.  Also note that 67% of the revenues are recurring. 

There are 46 million shares outstanding (excluding the convertible preferred stock). The stock is at $2.79 so roughly a $128 million market cap.  There is $100 million of convertible preferred stock that converts at $3.10 and there is $42 million in cash, so a $186 million TEV.  There should be around $125 million in revenue for ’06.  QD is trading at 1.5x this year’s sales.  The M&A deals in the space have been done at 2.0x to 10.0x revenue multiples.  Public comps are trading at 2.6x trailing revenue.  I’m using 5.0% revenue growth for ’07 (this is conservative given announced wins and the ’08 ramp could be well into the double digits). If you use a 2x revenue multiple off of the $131.5MM implied ’07 revenue figure plus the cash they will have a year from now ($56MM), then you get a $4.07 stock (46% upside).  This price converts all the convertible preferred stock. 

Looking at QD on a FCF basis, I expect the company to generate $12.5 million in cash next year after paying the preferred dividend of $5.5 million.  This implies roughly a 10% FCF yield off of today’s current market cap.

After Q3 results (which were terrific), the stock went as high as $3.25 but since retreated as people got confused by a subsequent registration of shares.  The shares were not a big secondary or a new overhang on the stock as some message boards alluded to.  The registration was simply a contractual obligation the company had relating to the preferred stock and was already accounted for if you used the fully diluted share count (78.2 million shares).  Given the coupon on the preferred is 5.5% and the cash flow and excess cash on the balance sheet, the convertible preferred is an extremely attractive piece of paper – in my view its basically risk free and has significant upside.  Thus, I don’t expect much sell pressure from the registration.  The overhang is not new as these shares were always there in the first place and the preferred stock has also traded sporadically over the past two years.

As far as catalysts, outside of more sales wins and the P&L impact of recent sales wins there are many.  The company has been unable to provide guidance because the management (given its past issues) has a consent decree with the SEC which excluded them from safe harbor protection on forward statements - this expires in May 2007 and the company may give annual guidance at that time.  At a minimum, I would expect a management roadshow and the company is likely to finally have some analyst coverage in the near term.

The company is also in a healthy excess cash position and is at the beginning stages of analyzing what to do with it (announced on the Q3 call).  I believe they have a bulge bracket type investment bank advising them.  They are exploring buybacks and accretive acquisitions.  Management said its unlikely (given the storied history) that they do anything silly with the cash or do anything but small slam dunk accretive acquisitions. 

I also believe that after proving 2 or 3 more quarters of positive financial results, the company may look to sell itself.  Potential buyers are either competitors looking to pick up an incremental installed base of sticky customers or other healthcare related companies looking to enter the healthcare IT space.

The company’s cash and results can fluctuate quarter to quarter but the progress is real and the value creation is just starting to take shape.  The risk reward is extremely compelling at these levels.

Catalyst