GOCO - GoHealth: Evaluating The Buyout Offer

2023-06-18 21:07:00 ET

Summary

• GoHealth, an insurance broker, has seen its market value nearly double since the start of the year.
• An over-weighted portion of GOCO's assets is long-term commissions receivable.
• The crux of the question is just how reliable are the future cash flows.
• The $20 per share buyout offer is a serious starting point for valuation discussion based on discounted book value.

GoHealth ( GOCO ), the insurance broker helping consumers get matched to insurance products like Medicare Advantage plans, has seen its shares pop on the announcement of an offer from a group of investors to acquire the rest of the company for $20 per share.

GoHealth's market value has nearly doubled since the start of the year, although it has been a volatile ride for shareholders. With the shares now sitting at just a minimal discount to the buyout offer, it is worth attempting to determine if the offer is a fair one for shareholders. In this article, I will not be delving into the company's operating results, expectations for the future, or parsing statements by management. Instead, I am solely focused on the question of valuation, and just as importantly (in my opinion), thinking through one particular framework for coming to an estimate of what the equity is worth.

The GoHealth Business Model

GoHealth is one of a handful of companies that function as brokers of insurance plans on a large scale; peers would include SelectQuote ( SLQT ) and eHealth ( EHTH ). The business model is built around helping consumers find an insurance plan that works well for their needs, specifically in the Medicare Advantage space. GoHealth will have a wide range of such plans available from different insurers, like Cigna ( CI ), Humana ( HUM ), Aetna ( CVS ), etc., and as consumers use the GoHealth platform for comparing, choosing and ultimately purchasing a policy, GoHealth receives a stream of income in the form of commissions back from the insurance companies for the life of the policy.

In a sort of best-case scenario, those commissions back to GoHealth continue to flow in year after year as the policy holder renews the same policy. However, all sorts of things can interrupt the flow of those commissions. With the aged Medicare population, there would be a higher amount of expected loss from the death of policy holders relative to the general population, but other factors are just general churn caused by making different policy elections from year to year, whether changing insurers, or going from Medicare Advantage to the traditional Medicare program. Alternatively, a consumer might do some comparison shopping on one of the other similar broker platforms and make a switch or find a way to purchase the plan directly from the insurer rather than going through a broker. In other words, the life-time value to GoHealth of a single Medicare Advantage enrollment is the sum of the expected commissions, which is a tricky estimation to make for all of the brokers, as I have covered before with eHealth.

This leads to an over-weighted portion of the company's assets being long-term commissions receivable; in the meantime there are upfront cash expenses for customer acquisition - paying agents, advertising, and general & administrative expenses. On the one hand, the value of those long-term commissions receivable is readily measurable as predicted future cash flows, as opposed to a set depreciating fixed assets. However, just how reliable those future cash flows really are is the crux of the question, since so much of GoHealth's equity value is derived from these assets.

As of 3/31/2023, the asset side of GoHealth's balance sheet was dominated by the commissions, with current commissions receivable of $292.9 million, and an additional $643.9 million in long-term commissions, for a total of $936.8 million. GoHealth's total assets are $1,543.5 million, and total tangible assets are $1,066.4 million, so respectively the total commissions make up 60.6% of total assets and 87.9% of total tangible assets.

Getting to a Fair Value

With the market valuing the company's shares in-line with the offer for $20 per share, it certainly behooves shareholders to consider if the offer is a fair and realistic representation of the company's value. My original starting point for this experiment was simply considering what the book value and tangible book value of the shares are, since the balance sheet with these commissions is a substantial driver of the value story here. Unfortunately, this was less helpful than I had hoped at first.

In the case of GoHealth, the book value per share at 3/31/2023 is $29.34, so already there could be question around the difference between the offer at $20 versus the book value. However, this is potentially mitigated by the negative tangible book value of GoHealth, since its net intangible value was $477.1 million is greater than the book value of equity attributable to the common shareholders of $263.5 million. If its intangible value (i.e. goodwill) should really be that high might be questionable, but nevertheless, there would be minimal tangible book value no matter how you slice it, short of a massive write-down of goodwill while growing other assets, or a turn-around that can increase the book value of the shareholders' equity. On tangible book basis, the $20 per share offer is an extremely generous premium.

While superficially it doesn't look promising to evaluate this way, I come back to the same approach I've taken with eHealth at times, which is to try and consider the long-term commissions receivable on a discounted basis, as they are essentially a form of future cash flows, and then working with a discounted, or adjusted, book value. In a certain this is very handy, as we do not have to make some speculative guesses about future cash flows - this is key information sitting right in plain sight.

While this is all very rough and approximate math, the logic goes like this: the current portion of the commissions receivables is approximately one-third of the total, and I treat those as having a present value equal to their book value for simplicity. Since the current receivables are about one-third of the total, I take the remaining balance and divide them in half, giving me three periods with roughly equal book values ($292.9 million, $321.9 million and another of $321.9 million). I discount the two halves of the long-term commissions, the first by one period and the second by two periods. Obviously, making different assumptions on how to split up the long-term commissions will affect the results, as will the discount rate.

I picked two scenarios for the discount rate, 15% and 20%, for comparison, based on a risk-free rate of ~5% assumption and wanting a return hurdle well above that. The results start to make the $20 offer make more sense to me:

Discounted at 15%, the adjusted book value per share comes out to $16, and at 20% comes to $12. Now the $20 per share offer is in a reasonable range, being a premium to the values derived from this methodology, but not an outlandish premium, and perhaps insufficiently generous to get the green light; that will be up to shareholders to determine. Nevertheless, I can see why $20 is the sort of opening bid here.

Obviously, there are certainly other approaches that could be used. For example, GoHealth has been free-cash flow positive on a trailing 12-month basis for the past two quarters, and currently sports a price to free cash flow multiple of just 4.50x on a forward basis, which looks potentially undervalued at $20 per share. In comparison, peer eHealth has a P/FCF multiple over 8x, so shareholders could argue that the offer should be closer to $35 or $40 to be fair.

Conclusion

GoHealth has been around for more than two decades, but only became a public company in July 2020. At the time, it was the largest healthcare segment IPO of the year, and shares were offered for between $18 and $20. However, shareholders went through a 1 for 15 reverse stock split in November of last year as shares had toiled and the company struggled, so understandably the current offer for $20 likely does not sit well with those holding at much higher cost basis. However, based on an evaluation of the primary source of the company's book value for equity being in the commissions, the $20 offer is fair in at least one sense, in my opinion: it sets a minimum bar for consideration. Whether or not the process continues with some negotiation that results in a higher offer, the offer was a reasonable and serious place for a bidder to start from, though I expect this is just the start of the discussion.

I do not have buy or sell recommendation to make at this time, so on a neutral view I consider the shares to be a hold.

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