Health Catalyst – Looks Cheap But Where Is The Catalyst? (NASDAQ:HCAT)


I covered Health Catalyst (HCAT) when the company went public in the summer of last year. At the time of the offering, I noted that the company seems an interesting play to bet on health care improvements as the company combines data, technology and experts, resulting in rapid growth of the business, although accompanied by big losses. Fast forwarding a year it seems that the company sees stable growth, yet has real work to be done on the margin front, as the situation, that of relative appeal which was apparent at the time of the IPO continues to be the case.

A Look At The Thesis

Little over a year ago I looked at the company which has developed the so-called Health Catalyst Flywheel, a data platform with analytics applications and service expertise. The company believes that all of this should drive measurable improvements in patient outcomes, drive engagement of team members, as the solution is applied in academic medical centers, community hospitals, delivery networks and physician practices. With roughly a fifth of the economy spent on healthcare and the system being full of flawed and ill-thought out incentive plans, the potential to make this segment more efficient is huge.

The company went public last year at $26 per share as the 35 million shares gave the company an equity value of just over $900 million at the time, although valuations dropped to $725 million if we adjust for net cash holdings.

In exchange for this valuation the company delivered on rapid sales growth, although accompanied by fat losses. 2017 sales came in at $73 million on which a $45 million operating loss was reported. Revenues rose 54% in 2018 to $113 million, with losses increasing to $60 million, up in absolute terms, but down a bit on a relative basis.

At the time of the IPO first quarter results for 2019 were known with sales up 70% to $35 million, and losses actually down in absolute terms to $11 million. The company guided for sales of $36.5 million for the second quarter and losses around $10 million, as I noted that the annualized 5 times sales multiple looked compelling given the growth, and the fact that losses were coming down. As shares rose to $39 per share on their opening day, valuations rose to more than 8 times annualised sales which killed some appeal, and while I promised to keep a close eye on the company, interest faded.

What Happened?

By November the third quarter results were released, after second quarter results came in according to expectations, although a touch better than guided for. Reported revenues came in at $39.4 million and while they keep increasing on sequential basis, annualised growth slowed down to 20%. Operating losses ballooned to $20.7 million, mostly cause stock-based compensation increased a factor of about 10 times to about $10 million. With this being the first quarter after the IPO, stock-based compensation typically runs high, as the question is what the real run rate would be.

The company guided for fourth quarter revenues of $40-$43 million and stable results in terms of the losses with shares trading around $35 at the time, as some initial IPO enthusiasm had already faded.

Ahead of Covid-19 the company reported its 2019 results and announced a bolt-on acquisition. Fourth quarter sales rose 21% and came in above the guidance at $43.5 million. Operating losses narrowed to $13.7 million, mostly as stock-based compensation fell back to $4.8 million.

The 2020 guidance looked reasonable with sales seen at $185-$188 million, more or less suggesting 20% revenue growth as (negative) margins are practically stable. By May when the first quarter numbers were released shares were basically flat and back at the IPO price, trading around $28 at the time.

First quarter revenues rose 23% to $45.1 million as operating losses rose a bit again due to higher stock-based compensation expense. For the second quarter the company guided sales of $41-$44 million, a sequential decline mostly due the impact of Covid-19. Over the summer two bolt-on deals were announced, one together with the release of the second quarter results.

Second quarter revenues came in at $43.2 million, still up 18% on the year before as operating losses came in at $15 million, now incorporating approximately $9 million in stock-based compensation. The company continues to muddle through a bit with third quarter sales seen at $43-$46 million and announcing a modest cut in the full year sales guidance. Note that the company can not claim that the business model is to be blamed for modest growth (in the sense that it is moving to a SaaS model) with deferred revenue balances up about $5 million on the year before, creating about 3 points headwind to topline sales.

Current Thoughts

With a share count of 38 million trading at $31 currently, I peg the equity value at $1.18 billion, which given a net cash position of nearly $200 million works down to a billion operating asset valuation. With annualised sales trending around $180 million, revenue multiples at 5-6 times are the same as they were last year. The reality is that growth has been flattish around 20% which is a touch light if this were to be a great solution, and furthermore no real progress on the bottom line ins made in a huge way.

I must say that I am quite surprised that the market has not picked on this stock as anything relating to healthcare, innovative practices in his sector, and usage of smart technology and telehealth is seeing huge momentum runs these days.

Hence, I have a gut feeling that shares look cheap, but mostly driven by relative comparisons as the reality is that 20% growth is suboptimal if you have a great solutions and lack of progress on the bottom line is somewhat disappointing. Nonetheless, I am happy to pick up a few shares if they revisit the mid-twenties based on the argument above, although I continue to proceed with some caution.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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Tesla’s Q2 sales, impacted by COVID, is catalyst for the stock this week


Tesla Inc. is slated to report its April-June sales in the coming days, with Wall Street hoping to take a measure of just how much the closure of the Silicon Valley car-maker’s sole U.S. car-making factory has affected 2020 sales goals.

Tesla
TSLA,
+6.50%

reports quarterly deliveries, which are its proxy for sales, and production numbers within a few days of the end of a quarter. The Tesla factory in Fremont, Calif., was closed roughly half the quarter under regional shutdown orders designed to slow the spread of the coronavirus.

Analysts polled by FactSet consensus expect deliveries of 72,000 vehicles, of which 61,000 would be Model 3 mass-market sedans and the remainder roughly split between sales of the Model S luxury sedan and the Model X SUV.

Those are heightened expectations from last week’s. Tesla shares surged more than 7% on Tuesday and are poised for another all-time closing record.

Don’t miss:Elon Musk vs. Bay Area officials: These emails show what happened behind the scenes in the Tesla factory fight

Investors are hoping that Tesla’s Shanghai factory, which came on line earlier this year, picked up some of the slack. Tesla’s inventory from the first quarter also could help with sales in the April-June period.

Wall Street also would welcome sales numbers for the Model Y, the compact SUV that is Tesla’s newest vehicle in the lineup.

Tesla has not exactly backed off its goal to sell more than 500,000 vehicles this year, but it has changed its tune somewhat, telling investors in late April it had the “capacity installed” to deliver more than half a million vehicles in 2020 “despite announced production interruptions.”

The electric-car maker said in early April it delivered 88,400 vehicles in the first quarter, a performance the company called its “best ever” first quarter and a number only a tad below Wall Street expectations.

Analysts at Evercore ISI pegged their second-quarter sales expectations at between 80,000 and 84,000 units, with sales in China offsetting a predicted sales decline in North America and a “steep decline” in sales in Europe.

Tesla had between 14,000 and 20,000 vehicles in inventory from the first quarter, the Evercore ISI analysts said.

Read:Michigan-assembled Ford Ranger named ‘most American-made car’ in annual list that includes Tesla for first time

Analysts at Deutsche Bank expect deliveries of 76,000 units, of which 60,000 would be Model 3 sedans.

“We estimate Tesla was able to produce 34,000 Model 3 units out of the Shanghai (factory) and about 21,000 in Fremont,” they said. “But we do not believe Tesla was able to reach full Model Y production levels.”

They estimated Model Y production between 10,000 and 13,000 units in the second quarter, or roughly 300 a day.

Tesla reopened the Fremont factory amid a standoff with local health authorities that included Chief Executive Elon Musk calling the shutdown “fascist” and suing the county where the factory is located. The lawsuit was eventually dropped.

Shares of Tesla have gained 131% this year, and recently cracked $1,000. The gains contrast with losses of 6% and 12% for the S&P 500 index
SPX,
+0.64%

and the Dow Jones Industrial Average
DJIA,
-0.15%

, respectively.



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QuinStreet: Poised To Grow Margins With QRP Catalyst (NASDAQ:QNST)


Company Overview

QuinStreet (QNST) lays claim to the term ‘pioneer’ of performance marketing. With a history of over 20 years, the company specializes in delivering clicks, leads, inquiries, calls, applications, or customers to its clients. This performance marketing strategy is attractive to QuinStreet’s clients, who pay solely based on tangible execution. QuinStreet operates in financial services, education and home services. M&A is a big part of the business model: the company has acquired three companies since 2018 (AmOne, CCM, and MBT) primarily to increase its number of customer relationships. Although digital ad spend has been down during the pandemic, the macro-shift toward online advertising is resolute. QuinStreet is well-positioned to profit from this transition as long as management can successfully increase margins.

Business Model

QuinStreet’s business model is fairly simple. The company is paid a commission for its marketing performance on a per-quote basis. The variable model runs very few fixed costs as the cost of revenue is largely media-based. When revenue drops, so too does the company’s largest cost. Unfortunately, this low-risk model returns less than favorable margins. The company has TTM gross margins of 11%. Management plans to increase these margins by divesting its unprofitable businesses and rolling out SaaS-like products. Additionally, the company plans to continue its heavy emphasis on growth-oriented acquisitions. On the 2Q 2020 Earnings Call, CEO Doug Valenti remarked:

We plan to narrow our focus to a smaller number of our best-performing businesses and market opportunities and to restructure to align resources and efforts with those areas…We also expect faster margin expansion from top-line leverage on a smaller cost base and a heavier mix of businesses with SaaS-like margins

These plans will need to be monitored by investors over the next few months as the changes begin to be recognized. If the plan is followed through successfully, QuinStreet will prove to be undervalued at its current price.

Financial Highlights

The last few years have been rocky for QuinStreet. After increasing revenue by 35% YoY in 2018, the top line grew just 13% in 2019 and is expected to grow just 7% at the end of the fiscal year in July. This volatility in top-line growth has led to a wavering stock price, as shown below:

Zimlon Insurance Company Analysis

As shown in the graph, QuinStreet’s earnings have been up and down and it is reflected in the steep declines in price. Breaking down its revenue, financial services represented 77% of total revenue in Q3 FY2020. The majority of other revenue comes from the education vertical, representing ~12% of revenue. Financial services grew 15% YoY in the most recent period, while education showed meager 4% growth. The company has struggled to gain ground in education since 2019 when it lost Dream Center Education Holdings, which represented upwards of 20% of revenue. Client diversification remains a risk for QuinStreet as Progressive Corporation (PGR) represents 22% of net revenue. One strong positive for QuinStreet is its balance sheet. The company has upwards of $97 million in cash on hand, representing 17% of its market cap. This gives management a cushion if ad-spend falls off temporarily due to coronavirus. It also may allow management to pursue acquisitions or develop new products to increase margin.

Catalyst

Although the company hasn’t grown its top line favorably over the last few years, it has an exciting catalyst which management expects to grow margins. The QuinStreet Rating Platform (QRP) is an enhanced workflow system designed to vastly improve the sales efficiency of carrier partners and their agents. Carrier partners will get much better workflow management and control, ultimately allowing them to reduce costs. CEO Doug Valenti cited on the Q3 2020 Earnings call that QuinStreet has the most end-to-end integrations with the biggest carriers, allowing them to provide agents with accurate and timely quotes. Although the product has not been completely rolled out, Valenti said the pilot company realized upwards of 40% lift in productivity.

The most exciting part of this catalyst is the SaaS-like margins. Management expects QRP to have 80% gross margins and rise steadily with use. Valenti also noted that the pipeline for the product is extremely deep. In the Q3 2020 Earnings Call, he had this to say regarding QRP:

Launched QRP clients already represent over $6 million dollars in estimated annual revenue opportunity once fully ramped. Signed and near-signed clients (not yet launched) represent $12 million of additional estimated annual revenue opportunity. The balance of clients in the advanced pipeline (not yet at signing stage) represents $36 million more of estimated annual revenue opportunity. That means we believe we already have line-of-sight to over $50 million of estimated annual QRP revenue. We believe the full pipeline and market represent an estimated revenue opportunity of well over $100 million per year.

The excitement for this catalyst is evident in the management’s rhetoric. The company has yet to recognize revenue for the product, but expect to do so sometime in the next few months. Until then, investors can rely on the testimonial of Tom Lyons, Chief Operations Officer of Plymouth Rock Management Company of New Jersey:

QRP will help us improve response time to client inquiries while preparing the most competitive insurance quotes possible. We view QRP as a mission-critical enterprise workflow management application that should significantly drive our business value to customers and help us expand sales.

It should be clear to investors that QRP is a great opportunity for QuinStreet in the near future. The product offers great reward to carriers and their agents, and will allow QuinStreet to improve upon its poor margins. Management expects to see 8-digit revenue from QRP in FY2021 which is just shy of 15 months from now.

Risk

Aside from the bright future surrounding QRP, the company has a few risks. As mentioned earlier, 22% of its revenue is derived from Progressive Corporation. Although no other companies represent more than 10% of revenue, this heavy reliance on a single company could be reason to worry. Progressive currently has a strong balance sheet, but further virus implications could force the company to reduce ad-spend. Doing some simple math, a 50% reduction in ad-spend would wipe more than 10% of QuinStreet’s revenue. This is a very real risk and deserves to be recognized in any financial projections.

Another risk lies in the company’s business model. Management has promised to continue to pursue acquisitions. While the company certainly has enough cash to do so, the underlying principle is cause for concern. One bad acquisition could prove costly to a growth company like QuinStreet. Investors will be putting their trust in management, relying on them to choose the right acquisitions at the right cost.

Valuation

Given the risk of decreased ad-spend from Progressive and/or other carriers, any valuation deserves two scenarios. A DCF model captured both scenarios. The following table shows the inputs and assumptions of the model:

5-Year CAGR

QRP Revenue Growth

50%

Other Revenue Growth

10%

QRP Gross Profit Margin

80%

Other Gross Profit Margin

11%

Operating Expenses (% of Revenue)

10%

Tax Rate

20%

Growth rate in perpetuity

2%

WACC

7%

Beta

1.25

Risk-free Rate

2%

Market return

6%

The above assumptions were present in both scenarios. In the first scenario, FY2021 revenue (consisting of Financial services/Education/Other) decreased by 10% from FY2020. The effect of the loss on earnings is somewhat diminished by QRP revenue which represented $10M in 2021, in line with management guidance. Discounting the 2025 value back to present, the model returns a price target of $12.25. This should be viewed as a baseline price target.

In scenario 2, FY2021 revenue has no growth, followed by 10% growth in subsequent periods. This results in a price target of $13.83, representing 35% upside from the current price. It should be noted that both models incorporated QRP revenue as management guided, forecasting for 8-digit revenue in FY2021. QRP revenue tops out around $50M in 2025 in the model, although management foresees revenue reaching $100M in the future. As seen in the chart below, profit margins will steadily increase as QRP gains ground in the market.

Zimlon Insurance Company Analysis

As the company becomes more profitable with QRP and other SaaS-like products, the stock price is sure to follow. Both of these scenarios were relatively conservative and thus clearly exhibit a considerable margin of upside for investors.

Conclusion

To sum up, QuinStreet is an undervalued company with room to grow. Revenue growth has been up and down in recent years, but the impending QRP product will rejuvenate the company’s earnings. Keen investors will notice QuinStreet trading at an absurd 38 P/E ratio. Normally this high of a ratio would be cause for concern. However, QRP promises to lift earnings over the next few years and management remains focused on growth-oriented acquisitions. The successful combination of these two will result in a profitable business worth more than 35% of its current share price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.





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