PRVA - Privia Health Group: Platform Contribution And Capitated Book Performed Strongly

2023-05-31 18:35:08 ET

Summary

• PRVA had a strong start to the year with solid core operations and expansion into new markets, leading to a reaffirmed FY23 guidance.
• The platform contribution in 1Q23 exceeded expectations, with potential for modest upside surprise to the FY23 guidance, and capitated revenue grew by over 60% YoY, indicating a promising future profit driver.
• I expect the growth of Capitated book to be an upside catalyst once it starts to generate meaning profits.

Thesis

I maintain my bullish view on Privia Health Group ( PRVA ) on the back of a solid start to the year and the reiterated FY23 guidance. In addition to the continued strength of PRVA's core operations, management has noted that the expansion of PRVA's provider network into new markets is proceeding ahead of schedule. Importantly, the credibility of PRVA's FY23 guidance is further enhanced by the fact that PRVA has clear visibility into the implementations of new market providers thanks to the sales pipeline. As I mentioned in my previous pipeline-related post, new market entrants are only expected to make a small contribution to revenue and adjusted EBITDA this year, but I expect that to change in the coming years, especially giving FY24 a solid start. Overall, I think 1Q was a solid start to 2023 and I reiterate my buy rating.

Platform Contribution

In 1Q23, PRVA platform contribution came in at $41.4 million, a significant increase from the previous quarter, and the company reaffirmed its previous forecast for FY23 ($160 million to $168 million). I believe there might be a modest upside surprise to the FY23 guidance. If we look at the cost of platform (-$44.7 million) as a percentage to practice collections ($658.9 million) in 1Q23, it is 6.8%. This is modestly lower than what the FY23 guidance implies at the mid-point. While the difference looks minor using 1Q23 numbers, I believe the actual difference by the year-end might be bigger than expected. Remember that the PRVA platform benefits from scale, which means we should see incremental margin kick in as the business gets bigger. If we assume that the remaining part of FY23 performs better than 1Q23, then it is natural to assume that PRVA will see operating leverage from the cost of platform. In the 1Q23 earnings call, management has also hinted that they will see operating leverage kick in. Specifically, management mentioned that:

“And then from a platform contribution perspective, again, the level of spend is fairly consistent during the course of the year because we are setting up these new states with sales, implementation, leadership teams, and that spend is pretty standard and equally spread throughout the course of the year. But then obviously as topline impact comes in, you start to see some more operating leverage.”

Capitated book update

I think another highlight for the quarter is the strong performance in Capitated revenue which grew by more than 60% y/y from $48 million to $78.2 million. I believe this will be the next up and coming profit driver give its growth rate. Referencing from 1Q23 earnings call , management specifically mentioned that: “there remains a significant embedded opportunity for us to thoughtfully move MA lives into capitated arrangements over the next few years”. As such, I don’t see why this segment will slowdown anytime soon. In terms of profit, while I expect the margins to be lower given the same overall take rate but high risk (cost in this case), management did suggest that over the long term, they should be able to achieve similar to better performance in capitated arrangements as they have been able to achieve in their MSSP arrangements. This also tells me that PRVA will undergo a period with accelerating earnings growth, driven by Capitated revenue becoming a larger mix of total revenue, and Capitated revenue margins slowly expand over time. To put things into perspective, some of PRVA’s most mature MSSP ACOs have achieved savings of 9% to 10% , and I expect a trajectory towards these levels within the capitated book of business over a multi-year period. That said, I don’t think the ramp up in margins will happen at the early stage of this multi-year growth trajectory. In my opinion, PRVA is still new to capitated arrangements, as such, it will take some time for them to understand how to further optimize costs and drive operating leverage.

Valuation

Given the strong start to FY23 and my positive view on PRVA capitated book, I think there is new information to revise my model assumptions . The minor update in revenue assumption (increase of revenue from $1.87 billion to $1.92 billion) is primarily due to the better FY22 and 1Q23 performance. The key update here is that I have a higher belief that its valuation multiple will revert to its mean (vs previous assumption that multiples will stay at 2x). The primary reason for this change is my view on PRVA capitated book, which has shown an impressive performance this past quarter. If PRVA can continue to grow its capitated book and show signs of margin improvement, I think the market will react very positively.

Risks

Regulation

Authorities at all levels—federal, state, and local—keep a close eye on the medical care industry in the U.S., which is subject to stringent regulations. The breadth of these regulations and the scope of the statutory exceptions and safe harbors that are available make it possible that some of PRVA's business activities, notwithstanding the company's efforts to comply with these laws, could be challenged under one or more of these laws. If PRVA fails to accurately anticipate how these laws and regulations will affect its business, the business may be held liable, and its operations may suffer.

Physicians are the critical asset

The success of PRVA's business strategy is heavily dependent on the company's ability to recruit a sufficient number of Privia Physicians for each of its Medical Groups. The number of Privia Physicians working in a certain market affects the company's ability to negotiate competitive reimbursement rates with commercial payers, as well as the number of lives that can be attributed to the company for VBC calculations and the unit cost of providing its services in different geographic markets.

Conclusion

In conclusion, I maintain a bullish view on PRVA based on its solid start to the year and the reiterated FY23 guidance. The company's core operations continue to perform well, and the expansion of its provider network into new markets is progressing ahead of schedule, providing increased confidence in the credibility of PRVA's guidance. The platform contribution in 1Q23 exceeded expectations, and there is a potential for modest upside surprise to the FY23 guidance. The strong performance in capitated revenue, which grew by over 60% year-over-year, also indicates a promising future profit driver for the company.

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