NXGN - NextGen Needs To Live Up To Its Name

• NextGen Healthcare offers a wide range of healthcare technology solutions.
• However, competition and underperformance prevent the company from showcasing its namesake qualities.
• Based on provided services, the company should be performing far better, but unfortunately not.

Former Leader, Now Lagger

It has been many years since NextGen Healthcare ( NXGN ) was truly next-generational. The 2000s were a great time for the company as revenue and earnings growth were exponential. Instead, the company has had essentially flat revenue growth for about 10 years, earnings have fallen during the same time period-with occasional losses- and with dilution the total return over 10 years is negative.

This is quite concerning, especially since NextGen's services are useful and remain modern, focusing on electronic, cloud, and wireless applications in healthcare operations. Even so, new management has a renewed focus on developing additional capabilities that allow for growth, and this mostly revolves around data analytics.

The problem with innovative solutions such as "cloud-based" or "paper-less" is that once full market share is obtained, growth stagnates. This is highlighted by the fact that NXGN's revenue growth outlook for enterprise is a meager 4-6%, while their new insights segment is set to see over 25% growth. It is not like enterprise solutions are weak, as the majority of revenues are recurring. Clients just remain resistant, unwilling, or unable to increase their annual payments as a way to drive growth beyond inflation. This can be attributed to many causes, and I believe that competition, managerial hesitation, and the lack of innovation are all potential weak points.

While management expects a return to meeting Rule of 40 expectations within 5 years, improvements across the board are necessary. This will come at a cost, and areas NXGN is attempting to move into are relatively competitive with other analytics and SaaS firms. Work is already underway and the company website lists multiple technology partners including 3M ( MMM ), AWS ( AMZN ), and Citrix ( CTXS ). All three providers offer ways to drive healthcare data online in order to increase operational speed and efficiency. Then, NextGen can provide insights to customers by developing or incorporating analytic processes to further drive optimization. As this comes online over the next few years, I believe NextGen has the opportunity to return to growth.

While the next few years are cloudy, I expect both inconsistent performance and poor returns. I believe it will be best to wait until meaningful progress is being made. This fact is especially clear after the earnings report on July 26th, 2022 which failed to meet both earnings and revenue expectations and the shares fell over 7%. Well, revenues and earnings were in-line but investors wanted more, and low guidance also did not help. As no positive trend is forming, I cannot recommend investing, even if you believe in a turnaround.

Financial Review

Let's look at what has been for NextGen. Starting with revenues, two major patterns can be seen. First, the innovative stage where exponential growth was earned as the platform expanded in the 2000s. But, by the time the company matured in the 2010s, stagnation occurred. This is likely the result of competitors in the healthcare technology and services industries all offering similar solutions. While very slight upward growth now remains, the rate is far below the rest of the market and even inflation.

The business slowdown is even more exaggerated in NXGN's profitability. After a peak of over $30 million in EBITDA and almost $20 million in net income, per quarter, profit margins began to tumble as costs rose faster than revenues. Now, occasional quarters of significant losses are common and there is no concrete reversion in the downward trend for either EBITDA or net income margins. The most recent earnings offered some positivity for EBITDA, but guidance does not reflect the same positivity. The question now is: can the balance sheet support this turnaround period?

Short answer, yes, the balance sheet is fairly strong enough to support reinvestment and reorganization. However, issues with 2% average dilution per year, increasing leverage, and negative cash flows are all risk points to consider. While debt shot up in 2020 in order to survive the pandemic, it has thankfully been paid off for the most part. Management is currently signaling they may be willing to draw more debt, but the most recent quarter has not shown an increase. Therefore, we are in a period of stasis until income performance improves, FCF returns positive, share count stabilizes, and leverage is maintained.

So, as the financial state of NextGen weakens over the years, one would imagine the company is quite cheap. However, this is not quite the case, and is another major reason why one should avoid an investment. Due to the low profit margins and increased leverage, the current EV/EBITDA ratio is quite high compared to periods in the past. In fact, 2022 has seen all-time highs for this metric. Thankfully, the P/S remains low as the price has not moved much over 10 years. However, better buying opportunities come when the price-to-sales ratio is less than ~1.75x. Upon improved financials, look for a higher valuation to be supported, much like during the growth phase from 2000 to 2012.

Conclusion

While the situation around NextGen is evolving, it may be best to remain on the sidelines for the moment. The Q3 earnings was not a positive indicator of a successful turnaround, but increased spending always may pay out later on. I would recommend keeping an eye on performance, but I do not expect much moving forward.

Feel free to share your own thoughts, but I already am quite neutral on the sector after my reviews of Premier ( PINC ) and Phreesia ( PHR ). Also, both offer a better opportunity in my eyes. In terms of the new insights segment of NXGN, I find exposure is better met with an investment in a name such as National Research (NRC) which offers a far better investment profile. Based on the recent performance of those names, it seems that strong names in health care are on the uptrend while NextGen falls.

Let me know if you agree below. Thanks for reading.

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