OSCR - Oscar Health Shares Quadrupled But They Are Still Cheap

2023-07-03 01:38:00 ET

Summary

• Even with a (most likely temporary) halt in two important markets, Florida and California producing a small retreat in membership growth, Oscar Health is still making considerable progress.
• It had its first AEBITDA profitable quarter, and although it will still produce losses for the year, its cash burn will decline, and profitability is in sight next year.
• Even after having quadrupled in just under 6 months, the shares are still dirt cheap if that progress continues according to plan.
• But keep in mind, there are many moving parts that, while unlikely to completely derail the progress, can still dent it in unexpected ways.

Oscar Health ( OSCR ) provides a digital AI-driven health insurance platform that matches policy seekers to the best health plans, mostly on the ACA (the Affordable Care Act).

The company claims that it is reinventing the industry with its AI-based digital approach, enhanced by care teams. It purports to act as a family doctor. These are strong claims but there is some data to back that up:

• The rapid rise in membership in the past couple of years (although stalling this year to special circumstances in Florida and to a lesser extent California).
• An industry-leading NPS ( Net Promotor Score ) score of 50 where competitors score zero.

Management also argues that their data and platform enables them to benefit from large language model type "across every aspect of healthcare" and believe this is a competitive advantage, but we assume competitors also have large amounts of data so we're not overly convinced here.

We introduced the company to our members a couple of months ago arguing that it could surge. Surge it did, although recently it has fallen back a bit:

It isn't the easiest company to get a grip on all the moving parts, which is why we didn't have the confidence to add it to the portfolio as that was the first time we acquainted ourselves with the company.

What went right?

• Premiums +50% to $1.4B
• Efforts to reduce cost and reduce losses, resulting in the first AEBITDA quarterly profit with bottom line improvements (AEBITDA +$88.1M, net loss +37.7M to -$39.6M y/y).
• Both MLR and Administrative ratios improved.
• High single-digit premium increases.
• Sold +Oscar module Campaign Builder to another customer.

The company's near-term objectives are threefold:

• Achieve insurance company profitability in 2023.
• Target total company adjusted EBITDA profitability for 2024.
• Continue to enhance the value of the +Oscar business.

Growth

The main growth drivers:

• Market tailwinds
• Gaining members
• Entering new markets
• +Oscar

The company largely serves the ACA, benefiting from its tailwinds (Q1CC):

As we look to the future, we continue to see many tailwinds for the ACA, specifically, growth due to the resumption of Medicaid redeterminations, the proposed new role to expand marketplace coverage to DACA recipients and the continued shift of employers in the market through individual coverage HRAs.

There could be a problem though as roughly 85% are supported by APTCs ( Advanced Premium Tax Credits), which are only guaranteed until 2025. Other individual markets (like state-based marketplaces ) also offer opportunities, as do the small group market.

The company has also embarked on selling modules of its platform +Oscar , and has managed to sell its campaign builder module to a second customer and went live with their first customer (Q1CC):

Since launch, our client has seen an approximately 60% engagement rate with English speakers and a 65% engagement rate with Spanish speakers, which shows the power of provider led communication. We're also excited about signing another campaign builder customer, a large value based primary care group that serves hundreds of thousands of patients across commercial, Medicare Advantage and Medicaid segments. We will partner with this group to drive primary care utilization to owned and affiliated PCPs, close process caps and streamline operations. Campaign builder is just one example of the technology tools that we expect to bring to market over the next several years.

Revenue growth , while not nearly as high as in the recent past, is still very high at 45% in Q1:

Management argues it has three main levers for increasing growth:

1. Total cost of care
2. Administrative cost
3. Portfolio sculpting

On the cost of care, the company is making progress (Q1CC):

We're seeing strong performance across several areas including payment integrity, network optimization and savings from vendor contracts. However, I see pockets of opportunities for improved financial performance in areas where we are underperforming against our potential. Specifically, there are many traditional scale processes for payers where I see opportunities to drive the bottom line.

But management argues that these are merely the starting point so there is more to come. One element here is a renewed agreement with PBM (Pharmacy Benefit Manager) CVS Caremark at improved terms.

Another element is the shift in the membership mix toward the average ACA population (Q1CC):

We also have a more subsidized membership with a very modest shift from silver to bronze. Similar to trends we saw last year, we expect this updated mix will result in a higher morbidity population and therefore a lower risk transfer as a% of premiums... Given the morbidity of the population and our expected risk scores, as we stated, we expect less risk transfer this year. This will have an impact on the numerator denominator of our [indiscernible], but not the overall underwriting dollars.

That last sentence isn't clear to us but it seems to suggest lower risk adjustment payments, but these are nevertheless highly variable (see the 10-Q for a larger treatment).

There have also been considerable efforts to control administrative costs (Q1CC):

We have solidified the majority of our efficiency efforts at this point in the year. For example, we successfully executed our distribution optimization efforts during open enrollment and expect these savings to continue throughout the year. We're also achieving scale benefits in our cost structure. As another example, we recently negotiated a new multi-year agreement with a large risk adjustment vendor, allowing us to realize significant savings going forward. Our technology is also having an impact on our efficiency.

Scale is of course an important factor in reducing cost as the platform is largely fixed cost.

The third bucket is their ' portfolio sculpting ' approach, which involves a shift towards emphasizing profitability rather than just growth, stripping out activities that aren't producing profits or even (supposedly temporarily) getting out of whole states, like Florida and now California.

Indeed this shift in emphasis even produced a reverse in growth as the company had 1M+ members (down sequentially from 1.15M), which is a stark contrast from the near triple-digit membership gains in FY22.

We dealt with why the company retreated from Florida, which was by far its biggest market, in our previous article.

Compared to that the withdrawal from California was less dramatic as it represented less than 5% of its portfolio and the company is still serving existing (35K) members (producing $200M in gross premium), just as in Florida.

The reason for the withdrawal was simple, its business there had an MLR ( Medical Loss Ratio ) in excess of 100%. They will revisit the situation and will probably back in 2024.

Just as the Florida situation, this halt in California is likely to be temporary and will not dent its longer-term growth perspective (although this year it will lower growth).

Finances

While revenue grew at 45.2% most of this came from the significant amount of ceded premiums in Q1/22 ($359K) which wasn't repeated in Q1/23. Premiums before ceded reinsurance grew 8% y/y to $1.4B.

The GAAP net income is still ugly:

But the company already sprung into adjusted EBITDA profitability, although as will be clear from the graph above, this is mostly a seasonal phenomenon (albeit the $51.1M Q1/23 AEBITDA is still a whopping improvement of $88.1M compared to Q1/22).

Investors have to realize that the company still envisions a considerable AEBITDA loss (between -$175M and -$75M) for FY23.

The MLR improved 110bp to 76.3% and the InsuranceCo Administrative Expense Ratio improved 120bp to 18.6, producing an InsuranceCo Combined Ratio of 94.9%, a 230bp improvement.

The MLR will increase during the rest of the year as it's guided to 82%-84% for the year, but that's not as steep a rise during the year as last year as this would imply a 250+bp decline y/y.

$3.6B of cash and investments at the end of Q1 including $260M at the parent should be plenty to keep them going for a long while although one might keep in mind that there are regulatory requirements for cash holdings (which was the reason they voluntarily and temporarily retreated from Florida, see our previous article ). The company gained $28.78M in interest income and paid $5.72M in interest expense.

Guidance

From the earnings PR:

Oscar is reaffirming its full year 2023 outlook across all metrics as provided in its financial results press release dated February 9, 2023, including anticipated MLR range between 82% and 84%, and Adjusted EBITDA1 loss of ($175) million to ($75) million.

Valuation

There are 218.35M shares outstanding to which we have to add:

So that's a fully diluted share count of 316.9M for a market cap (at $8) of $2.54B Since the debt (convertible notes) are already included in the dilution count this means the company still has a negative EV (of $845M). Pretty unbelievable the shares sold at $2 at the start of the year.

Analysts estimate revenue at $5.48B this year rising to $6.33B next year so the shares also sell under 0.5x sales. We think this is way too cheap. Analysts also expect a still large loss of $1.41 per share falling to $0.48 in 2024.

Risk

There are quite a few moving parts and they can move in unexpected ways, at least we don't have a firm enough grip on them to be able to make comfortable predictions. Things like risk scores and adjustments, developments at the state level (leading to an unexpected withdrawal from California, for instance) and all kinds of regulations and market developments make this a difficult stock to handicap years out.

Conclusion

It's not easy to get a firm grip on the moving parts of the company, which is why we couldn't firmly recommend them after our first effort a couple of months ago.

What we know now after a second effort is that metrics are more firmly moving in the right direction and what we also know is that things have to derail quite spectacularly for the company (and the shares) to become unstuck as two factors provide a large margin for error:

• The massive cash (and equivalents) balance of $3.6B
• The still cheap valuation of the shares. Despite the strong rally in H1 with the shares quadrupling, they still trade below cash.

Do we think the company can derail spectacularly? We're not 100% sure but it seems quite unlikely. The new CEO is an experienced guy who ran Aetna and things are moving in the right, rather than the wrong direction.

If that continues, and we don't see any compelling reason to assume otherwise, the shares are still dirt cheap, as surprising as that may be for a stock that quadrupled in a little over 5 months.

For further details see: