INNV - InnovAge Holding: Wait For Audit Overhang To Pass Before Investing

Summary

• The US healthcare industry faces issues of rising costs and fragmentation.
• InnovAge platform addresses the needs of dual-eligible seniors.
• Management is confident that they will pass the audits, and operational improvement plans are ongoing as expected.

Thesis highlight

InnovAge Holding ( INNV ) has 16% upside. I believe INNV has found its niche in targeting the most complex part of the healthcare system – dual eligible seniors, and they have certainly gained a strong first mover advantage. I expect INNV to continue growing as the US faces a strong ageing population ahead.

On the other hands, I think it is safer to invest in INNV when the ongoing audit overhang is cleared. While management is confident that they will pass the audit and have already put in place necessary actions, it is still a risk that might impact the stock’s narrative.

Company overview

With a focus on high-cost, dual-eligible seniors, INNV is a comprehensive healthcare delivery platform that offers capitated care for all their medical needs. Each participant's healthcare is coordinated and paid for by INNV. And rather than using other intermediaries, it enters into direct contracts with government payors.

Rising healthcare cost

In 2020, healthcare spending in US reached $4.1 trillion, or 19.7 percent of GDP, a staggering increase from previous years . I think this is just the beginning, and that as the population ages, healthcare costs will rise at an even faster clip. In addition, I expect the government's share (via Medicare and Medicaid) to increase in the coming years as a direct result of the spending increase.

An asymmetrical amount of the money spent on healthcare in the US goes to people who are "dual eligible," a group that includes people who receive benefits from both Medicare and Medicaid. A dual-eligible senior is estimated to cost Medicare and Medicaid 3x as much per capita as a Medicare-only senior, according to management estimates included in the S-1. Consequently, I think a way to slowdown the rapid increase in healthcare spend is by improving care management for seniors who are dual-eligible.

Fragmented healthcare system

Due to the complexity and disjointed nature of the American healthcare system, patients often receive care from a patchwork of different providers who often have a limited understanding of their medical history. In addition, because of this dynamic, patients often find it challenging to find their way around the healthcare system. I think it's important for all care providers to collaborate together in order to better manage a patient's care. And yet, despite the clear benefits of working together, they persist in maintaining separate departments. This disjointed approach to patient care can lead to wrong or inaccurate diagnoses, extra costs, and negative outcomes.

These problems originate from the fact that seniors who are dually eligible are especially vulnerable to being overlooked by the US healthcare system. Few government-sponsored programs, outside of PACE , integrate these individuals' Medicare and Medicaid benefits, which further complicates efforts to provide comprehensive healthcare. Patients who are eligible for both Medicare and Medicaid typically have multiple chronic conditions and use healthcare services frequently. Given the high occurrence of chronic disease and other health problems in this population, poor communication between healthcare providers can have disastrous results.

The InnovAge Platform addresses the needs of dual-eligible seniors

According to S-1, more than 90% of INNV participants are dual-eligible seniors, and the InnovAge Platform was developed by INNV specifically to provide such seniors with comprehensive value-based care [VBC]. With its primary focus on PACE, it has resulted in INNV's having the most members of any in the country. Given its size and history of success in different regions, I believe INNV is in a good position to take advantage of a sizable market potential providing care to seniors who are dually eligible.

The INNV care model was developed with the aim of catering to the most vulnerable and complex members of the dual-eligible elderly population. It gives preference to high-population-density cities and suburbs that are home to many elderly people who are both frail and eligible for the INNV program. By leveraging the InnovAge Platform, INNV is able to provide seniors with comprehensive healthcare that supports their desire to remain in the comfort of their own homes and neighborhoods.

Win-win-win situation for stakeholders in the ecosystem

In my opinion, the InnovAge Platform has allowed INNV to develop a healthcare system in which everyone benefits. For this reason, I believe a powerful virtuous cycle favoring growth and driving INNV's financial results will emerge.

1. For participants: INNV uses its unique approach to enhance the wellbeing of its members and reduce the need for costly medical interventions like hospitalizations and nursing home stays. For participants, INNV means they can age in place without having to move out of their homes. Unlike some care models, INNV caters to the individual requirements of each patient. In my opinion, this strategy results in happy, engaged participants.
2. For families: Caregiving obligations are greatly lightened thanks to INNV. Transit to and from clinical and center visits, assistance with activities of daily living, and the development of social outlets to combat social isolation are all taken care of under the INNV model. Most importantly, I think INNV gives participants' loved ones the assurance that their complex needs will be met.
3. For providers: The clinical and administrative support offered by INNV allows them to concentrate on patient care. By incentivizing excellence rather than quantity of care, INNV relieves the burden of maximizing the number of patient visits.
4. For government payors: Through capitated payment arrangements, INNV is able to reduce the overall cost of care for dual-eligible seniors.

First mover advantage

Barriers to entry are high in INNV's industry due to the complexity of regulations, the complexity of operating models, and the capital required for opening a new centre. Additionally, regulators commonly limit the number of providers allowed to serve a given MSA to a single entity. I think this structure generates substantial advantage for the first player that enters in new markets. Because of this, INNV has put forth considerable effort into developing partnerships with local, state, and federal governments in order to expand its operations into new territories. In my opinion, INNV's competitive edge improves with every new program it creates because of the economies of scale it achieves.

Track record of scaling business model nationwide

The success of INNV's central operations in a variety of markets is evidence of the company's ability to scale its business model internationally. The prospectus discloses that, across all INNV markets, recently opened mature centers have achieved positive unit-level Contribution Margins in a matter of months. These results demonstrate the reliability of the INNV model, and they give me faith that INNV will be able to carry out its expansion plans.

Audit / Validation process

The 1Q update was encouraging for INNV as it continues to focus on the path to sanctions relief. During the quarter, the company attested to CMS and state regulators that it was prepared for validation audits in Sacramento and Colorado because it had achieved 95% or more compliance with key performance measures using an internal tracker. Since INNV has already requested the final review and validation and is performing at a 95%+ threshold against criteria set out by the CMS, I believe they are quite confident in their ability to pass the audits. Successful completion of the audit would result in the lifting of sanctions in about half of the company's markets. However, I will reserve judgment until the freezes are lifted formally and a plan for resuming the census is established.

Operational improvement plans are well in progress

Management's progress on the operational initiatives they outlined remains steady, and it appears that they will finish these enhancements by the end of the year as originally planned. INNV has also sped up hiring by 76% by eliminating vacancies in key positions. Interestingly, management has decided to increase staff in Colorado and Sacramento ahead of time to absorb capacity in those markets once the sanctions are lifted, despite the fact that the population in those areas is actually decreasing. They are getting ready for this by standardizing their care model and implementing Epic software at their Virginia centers; they plan to do this at all of their centers within the next year. Management is also spending money on compliance processes like a routine internal audit. The commitment to operations improvement is inspiring, and it is obvious that it is driving measurable development.

Valuation

My model suggests that INNV is worth $8.80 in FY24. The core part of my thesis is INNV can continue to capture share in this complex, large, and niche market within the US healthcare industry. Given that it has already established a large presence with a proven playbook for success, I believe there should be no issues. The obvious hurdle here is the audit process, should it fail, then there will significant near-term headwinds in terms of performance and expectations.

Suppose management manages to pass the audit and continue to grow, using consensus estimates, INNV should generate around $950 million in revenue in FY25. Attaching the current revenue multiple of 1.4x in FY24 would translate to $1.2 billion in market cap, or $8.80 per share.

Risks

Ongoing audit

Due to the audits, CMS has put a hold on some operations at the Sacramento center, and this hold will remain in place until the issues are fixed. An extended period of freezing temperatures could disrupt business activities.

Low penetration rate despite decades of operations

PACE has been around for about 30 years, but only a minority of people who are eligible for both Medicare and Medicaid are enrolled in it. This makes me nervous about the program's ability to expand and attract more participants in the future. In addition, the healthcare system as a whole may be hesitant due to the lack of action from the major insurers.

Conclusion

I think INNV has found its sweet spot by going after the most convoluted part of the healthcare system (dual eligible seniors), and they've certainly gained a significant head start as a result. Considering the massive increase in the US's elderly population, I believe INNV can continue to grow.

If the current audit cloud can be lifted, however, I believe INNV will be a safer investment. In spite of management's assurance that they will pass the audit and their having taken all appropriate measures, this is still a potential risk that could affect the stock's story.

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