OSCR - Oscar Health Inc.: On Path To Profitability Through Strategic Margins And Unique Technology

2023-11-16 00:30:52 ET

Summary

• Consider buying Oscar Health before it achieves consistent positive earnings, as higher valuation will limit potential future gains.
• While yet to turn a profit, recent positive adjusted EBITDA and management focus on profitability and faster growth signal potential for positive net income in the next 1-2 years.
• Margin Improvement Focus: Oscar Health's strategy of pricing above peers, leveraging Medicaid redeterminations, and targeting lower Medical Loss Ratio, aims to boost margins.
• A strong management team positions Oscar Health for fast growth and a stronger competitive position.

Company Description

Oscar Health (NYSE: OSCR) is a health insurer currently focused on the ACA Exchange coverage for individuals but rapidly scaling into other business lines such as Medicare Advantage, Small Group, and Healthcare IT. OSCR leverages its proprietary technology, called +Oscar, to lower costs and improve outcomes by engaging consumers directly through telehealth, automated doctor, pharmacy, and diagnostic referrals, and other in-app health tools to close gaps in care. At any time, a member can use the app to list a condition and then will be offered a free phone call from a doctor or a visit with a primary care physician or a specialist with an estimated price. If a customer wants to talk to a doctor at 3 am, they can request a call through Virtual Urgent Care in the app and they will be on the phone with a doctor or provider, in as little as 30 minutes.

This technology platform is also offered separately to businesses (other carriers) that want to drive better efficiency, growth, and superior engagement with their members and patients. The service allows Oscar Health to monetize this technology, as well as attract cost-effective, high-quality providers.

The market OSCR operates in is highly competitive, with many national and regional carriers, local Blue Cross plans, start-up carriers, original Medicare plans managed by the federal government, and more participants. Additionally, there is significant competition for personnel. However, because of leveraging the technology platform, +Oscar, and focusing on financially sound pricing and networking decisions, the OSCR has been one of the fastest-growing companies in the Healthcare IT sector. For example, revenue nearly tripled in 2021, increased again by 115% in 2022, and by nearly 50% in the 3 quarters of 2023. At present, Oscar Health has not yet achieved a positive net income but is on the way to do so in the next 2 years. We will discuss the financials further in the story.

Funding track record

OSCR's funding journey is a testament to its management's exceptional ability to consistently secure substantial capital despite facing challenges in generating positive net income. Through a series of strategic funding rounds, over the course of a decade, the company successfully attracted investments from renowned names in the venture capital sphere. Investors include Thrive Capital, CapitalG (a growth equity investment fund under Alphabet Inc), Fidelity Investments, and more. Notably, in 2014, Peter Thiel's Founders Fund spearheaded a $30 million investment during the Series A round, propelling the company's valuation to $800 million. Subsequent rounds in 2015 and 2016 saw an influx of capital from prestigious entities like Google Ventures, Google Capital, Alphabet, pushing the valuation higher, reaching $3.2 billion by 2019. The ability to continuously raise substantial funds, leveraging an extensive personal contact network, showcases one of the company's great assets - the management's skills in fundraising to sustain growth despite operational challenges.

Financials: path to positive adjusted EBITDA and breakeven net profit level.

Oscar Health's earnings trajectory has seen significant shifts and challenges. Although the company has had a steady growth in subscribers from the time it was founded in 2012, to over a million members today, illustrating a promising ascent, OSCR is yet to reach profitability.

The revenue, driven primarily by earned policy premiums, has been growing consistently, as shown in the following chart.

Source: SEC fillings linked on company website

However, the company is yet to reach profitability. In fact, net loss has been increasing year-over-year as the scale of operation and associated expenses and investments increase, as illustrated below.

Notably though, during the first 2 quarters of 2023, Q1 and Q2, Oscar Health finally achieved a positive adjusted EBITDA, a potential precursor to a positive net income in the next couple of years. (See the last bar of the chart above and table below). While the path to profitability has been lengthy, the recent 124% increase in adjusted EBITDA year-over-year paints a promising picture for potential investors.

The most recent quarter has had a negative adjusted EBITDA once again (due to seasonality), but the overall dynamic is an exciting development for the investors keeping an eye on the stock. A potentially good opportunity to invest is sometime before cash flows turn consistently positive, as valuation will change significantly at that milestone. The stock will have lower risk and consequently, a lower risk premium (and lower potential reward) for holding it.

(Note regarding earnings announcement : "The Company has not provided a quantitative reconciliation of forecasted … Adjusted EBITDA to the appropriate forecasted GAAP metric within this press release because the Company is unable, without making unreasonable efforts, to calculate certain reconciling items with confidence.")

Per management's comments during the earnings call and in SEC filings, new strategies and pricing aimed at margin expansion, are intended to move the company towards a more stable and lucrative trajectory.

Medical Loss Ratio improvement supports profitability effort

Q3 earnings reporting showed strong results in a number of areas. One of the key indicators, MLR (Medical Loss Ratio) exceeded the projections by 2% and improved year/over-year by 3.6%

Note: MLR stands for Medical Loss Ratio. It's a financial metric used to evaluate the efficiency of an insurance company in managing its medical costs versus its income from premiums. The MLR is calculated by dividing the insurer's total expenses on healthcare claims and quality improvement activities by the total premium revenue.

Insurance regulators often set a minimum MLR that insurance companies must meet. For instance, in the United States, under the Affordable Care Act, health insurance companies in the individual and small group markets are required to have an MLR of at least 80%. If an insurer's MLR falls below this threshold, they might be required to issue rebates to policyholders or make adjustments to improve their efficiency in managing medical costs.

Health insurers typically aim to keep MLR just above the annual legal minimum limits, which are 80% for the individual and small group markets (usually companies with up to 50 full-time employees), in which Oscar Health currently operates. Keeping MLR as close as possible to the minimum directly affects profitability. Oscar's trajectory shows a successful attempt to lower MLR each quarter compared to the same quarter of the previous year.

Targeting higher margins through pricing

Oscar Health's pursuit of higher margins is supported by the company's strategy of raising prices above industry peers for the second year in a row, leveraging Medicaid redeterminations, to bolster overall market growth. When assessing pricing strategies, a key method is to compare weighted average pricing against peers. If a managed care organization ((MCO)) prices above this benchmark, it often indicates a focus on margin rather than membership. Oscar Health's +6.8% year-over-year price increase into 2024, against the -6.9% market average, positions them +13.7% higher than the market, suggesting deliberate pricing for margin rather than sheer membership acquisition.

Medicaid redeterminations - effect on margins

A significant contributor to margin growth is the impact of Medicaid redeterminations.

Note: Continuous enrollment in Medicaid was originally mandated because of COVID-19, which caused a Medicaid enrollment surge. However, the Consolidated Appropriations Act, 2023, delinked this provision from the emergency, ending continuous enrollment by March 31, 2023, and phasing out enhanced federal Medicaid funds by December 2023. Disenrollment began after March, causing some to lose Medicaid coverage and either become uninsured or find insurance through the ACA Exchange.

Approximately 19% of net Medicaid disenrollment has transitioned into exchange membership. As a result, an estimated ~15 million members are expected to shift from Medicaid and translate into nearly 3 million new members to the exchange pool by the end of 2024, representing a 17% surge from the outset of 2023. The gradual addition of these members through 2024 will inflate year-over-year membership growth and revenue growth. Growth.

Other catalysts for profitability include strong execution from a newly installed and highly regarded management team of former Aetna executives (new CEO Mark Bertolini brings a proven track record of execution at Aetna and other companies in the healthcare industry. He is also the co-CEO of Bridgewater Associates, one of the world's largest hedge funds). That coupled with the streamlining of earnings disclosures signifies more catalysts to allow Oscar Health to improve market positioning and stronger margins.

PBM contract renegotiation

Another metric on track to continue improving is Pharmacy Benefit Manager contract renegotiations.

PBMs act as intermediaries between health insurance companies or employers and pharmacies. They handle the administration of prescription drug programs. PBM contract renegotiations refer to the process of re-evaluating and potentially modifying the terms and agreements between the PBM and the insurance company. The primary reason is often to control or reduce the costs associated with providing prescription drugs. This can involve negotiating better prices for medications or adjusting administrative fees charged by the PBM.

Along with conservative pricing, automation, and other value creation initiatives underway, the company is set to continue margin expansion in the future years.

Price Objective

The current price is $7.11, and the Bloomberg estimate for price target is around $9.0, with the following actual and estimated EPS values:

The price target of $9 is based on roughly 10.0x 2025E EV/EBITDA estimate, which is a slight premium to where peers have traded during their periods of growth (7-8x EBITDA) due to significantly higher near-term growth potential. This price objective implies a 26% upside potential. We believe the price objective will be reached soon after the next quarter earnings are announced and confirm management guidance for the first full EBITDA-positive year.

The downside risks associated with investing in Oscar Health include potential challenges related to Medicaid redeterminations (not onboarding new patients at expected rates). Another concern pertains to inability to consistently improve margins over time. These factors pose potential obstacles that could impact the company's growth and financial performance.

Summary

Oscar Health offers an interesting investment opportunity for those looking for exposure to health insurers at the brink of profitability. The company, driven by proprietary tech, is expanding its subscription base and revenue, as a path toward a net profit. Upside potential lies in growing subscriptions and market expansion, and the key drivers include technological advancements and strategic pricing for margin growth.

Supported by a strong management team, OSCR may appreciate towards what we believe is a fair value around $9.0, implying a 26% upside potential. The company's growth trajectory and management focus position it as an attractive prospect in the healthcare industry.

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