Description

In recent months SPACs have cracked under the weight of extreme negative revisions and incinerated investor confidence. The group is indicative of the worst excesses of the equity capital markets in the last year, but SPACs don’t have a monopoly on broken businesses. We believe there are several recent IPOs that are of SPAC-like quality and due for bursting of their own, our favorite short that meets that description is Signify Health (SGFY).  Signify meets all the criteria of the businesses that have gone belly up recently.  Buzzy business model (value-based care), PE sponsor (New Mountain Capital), insane valuation and a commodity product.  We believe there are several impending catalysts for SGFY to realize 50%+ downside.

Signify was formed by New Mountain Capital bolting together four small healthcare players in the Medicare space.  The business operates in two segments: Home and Community Services (~75% of revenue and EBITDA) and Episodes of Care Services. 

HCS conducts in-home evaluations (IHEs) on behalf of Medicare Advantage plans to establish risk scores (critical input to MA capitated payments) for patients who cannot come in to see a provider.  These services are provided by gig workers and are highly commoditized.  The way the business works is that SGFY is provided a target master list (TML) of patients in late December and spends the rest of the year chasing down leads.  Believe it or not management calls out seasonality in their results as they run out of patients in the second half of the year.  This segment also competes with their own customers, as UNH and HUM (38% of SGFY revenue) operate their own IHE services (via Optum and YourHomeSerivces). There is also a great deal of pricing pressure as virtual IHE’s are 25% cheaper and have taken share through COVID (~33% of evaluations).

The other 25% of the business is Episodes of Care Services which serves as a convener in the Bundled Payment for Care Initiative Advanced (BPCI-A), a trial program from the Center for Medicare and Medicaid Innovation (CMMI). The goal of BPCI-A is to push hospital systems to value-based arrangements by setting a benchmark for a procedure (97% of average fee-for-service cost) and allowing providers to share in the upside if they can deliver care below that target price.  Providers also share in downside if they miss the target price but this is a voluntary program, so presumably those who choose to participate are confident they can create savings.  As a convener, SGFY steps into the middle of this transaction and handles administration and coordination while taking a portion of the upside/downside on behalf of the provider.  Providers can choose whether they want to work with a convener or not.  SGFY is paid an administrative fee (1.5%) and a share of the upside/downside (generally 50/50%).  

Quite simply, our thesis is that both sides of this business are commodity products and no one would miss this business if it went away. We believe there are red flags on both sides of the business that could serve as catalysts in the next 12 months. 

BPCI-A is a flawed program with a shrinking profit pool- While BPCI-A has a noble mission, the program is fundamentally flawed. A multi year review by CBO revealed that BPCI-A actually ended up costing CMS more money than simply paying traditional Medicare rates would have, to the tune of a $160M net loss in 2019. BPCI-A is trial program set to expire in 2023, any tightening of its terms or an outright cancellation would be devastating to SGFY. Additionally, even if the program is renewed, it is designed so that the savings target will move down over time. BPCI-A reimbursement is benchmarked against a rolling three year time frame, as years where providers were incentivized to deliver care cheaply roll into the comparison period, the savings hurdle will raise.  Finally, hospitals that have opted into BPCI-A have little need for a convener. They have decided to take part in the program because they think they can drive savings and can leave at any time. Those who choose to stay have presumably demonstrated an ability to consistently create savings, and sharing that upside is irrational. This is already playing out- in June of 2020 SGFY terminated a contract with an ECS customer over renegotiated terms- that customer was 5% of total revenue, on a 25% of revenue segment that means 20% of the business walked out of the door. Putting those together we believe this is a business with secular price pressure, high customer flight risk, and existential pen-stroke risk. 

IHE’s are a commodity and SGFY has been paying their customers to rout them business- IHEs are very simple to carry out and health plans only outsource them to accelerate time to completion and get to hard to reach customers. HCS was formed by smushing together three businesses that did this previously, and it remains a terrible business. There are also severe agency problems- MA plans will use third parties to create the appearance of impartiality in risk scoring, but SGFY is equivalent to a ratings agency in 2008- captive to much more powerful customers. In the last 5 years CMS and OIG have both recommended that in-home evaluations be further reviewed or outright abolished and shares have recently been weak as these risks have bubbled up in another OIG report. Most importantly, I believe there are signs that UNH (17% of segment revenue) is considering pulling their business from SGFY. In December 2019 and September 2020 SGFY agreed to two separate equity appreciation rights agreements (EAR) with UNH. In the first they agreed to give UNH 3.5% of equity appreciation above a $2.7B market cap, and in the second UNH can receive 4.5% of appreciation above a $4.0B market cap.  In a change of control the two contracts will pay out the EAR amount or $55M if below the market cap hurdles. In exchange for this UNH got non-binding three year targets on IHEs routed to SGFY. If they miss targets the EAR is reduced but not eliminated. Based on the set up I believe these EARs were part of contract renegotiation and New Mountain sold the business out from under them to keep revenue growth up through IPO. With another round coming up this fall it remains to be seen whether the company will give away more equity, or lose their third largest customer.

Other concerns

• SGFY is an emerging growth company with reduced disclosure and had material weaknesses in both 2018 and 2019

• ECS revenue recognition is based on estimates. SGFY is paid a share of savings so they need to estimate how much savings their partners will be able to create.  CMS only reconciles BPCI-A actual vs targets twice a year which means SGFY recognizes revenue and builds receivables in 2Q and 4Q at a complete disconnect from cash, which only comes in twice a year

Valuation

This business has been swept up in the value care craze and is currently trading at 4.5x ‘22 sales and 21x ‘22 EBITDA. We believe a business with this risk profile deserves a sub-market multiple, at 12x EBITDA on ‘22 estimates we see 50%+ downside with potential for extreme downward revision of estimates due to customer loss, program cancellation, or accounting issues across the business.

Catalyst

• Loss of customers in either business
• Termination of BPCI-A program
• Further investigation into IHE's