2023-04-23 02:05:08 ET
Summary
- Evolent began life as a software developer but 2018 acquisition of New Century Health has seen it shift into specialty care provision.
- The company drove revenues of $1.35bn last year, also becoming profitable for the first time. Guidance for 2023 is for ~$1.94bn and EBITDA of ~$900m.
- The growth of the Medicare Advantage industry has driven Evolent's growth, as the company can help administer better quality healthcare at a cheaper rate.
- Evolent has grown rapidly via acquisitions and prospects for long-term growth look very strong.
- The business model is not yet 100% proven but I'd be optimistic Evolent can thrive in the prevailing Value Based Care environment which is replacing fee-for-service.
Investment Overview - Buoyant Medicare Advantage Market - & Evolent's Role Within It
This week I have been researching listed companies providing services within the newly emergent "Value Based Care" industry, a sub sector of the healthcare / health insurance industry that is viewed as a potential long-term replacement for the "fee-for-service model.
The mantra of Value Based Care is administering a higher quality of healthcare at a lower price, and it is becoming increasingly popular partly as a result of the rise of consumer-focused health insurance programs - most notably Medicare Advantage, the fastest growing form of healthcare insurance for seniors.
According to the Kaiser Family Foundation ("KFF"):
In 2022, more than 28 million people are enrolled in a Medicare Advantage plan, accounting for nearly half or 48 percent of the eligible Medicare population, and $427 billion (or 55%) of total federal Medicare spending (net of premiums). The average Medicare beneficiary in 2022 has access to 39 Medicare Advantage plans, the largest number of options available in more than a decade.
According to the Better Medicare Alliance :
Medicare Advantage is built on a value-based system in which Medicare Advantage health plans receive a per-member, per-month payment for each beneficiary's care, and are tasked with using those dollars most effectively - incentivizing high quality, high-value care for the 24.2 million enrollees who trust Medicare Advantage with their health care needs.
In 2023, Original Medicare enrollment shrunk by 1.3m members, according to Chartis , while Medicare Advantage programs added 2.7m members, and with ~10k members of the "baby boomer" generation becoming eligible every day in the US, and analysts expecting Medicare Advantage to achieve 60% - 70% penetration between 2030 and 2040, within an industry that will likely reach $1 trillion dollars in size, this is a growing, lucrative industry.
In order to achieve a profit from its Medicare Advantage plans, health insurers - the 3 with the largest Medicare Advantage exposure being UnitedHealth ( UNH ), Humana (HUM) and CVS ( CVS ) (thanks to its acquisition of Aetna) - must find a way to keep patients as healthy as possible - star ratings are awarded for all plans and the highest rated plans receive additional bonuses - whilst spending the smallest amount possible, and that often means attempting to try to circumvent fee-for-service procedures.
Instead of a patient visiting a physician for example, whose hourly rate is extremely high, health insurers may direct their patients to a nurse instead for an initial evaluation, saving hundreds of dollars. Rather than being treated at a hospital, Medicare Advantage members may be treated at a private clinic which offers the same procedure at a much more reasonable rate.
This is where Evolent Health ( EVH ) comes in. The company has 2 reportable segments as follows (as per its 2022 10K submission ).
Clinical Solutions, which includes our specialty care management and physician-oriented total cost of care solutions, along with the New Century Health, Vital Decisions, IPG, NIA and Evolent Care Partners brands; and
Evolent Health Services ("EHS"), focused on administrative simplification solution and supporting value-based business infrastructure.
The key focus for Evolent going forward is changing however, as per a further statement in the 10K:
The Company anticipates its focus in the future will be primarily on maximizing the market opportunity it believes it has in the management of complex specialty conditions, which constituted approximately 70% of corporate revenue for the year ended December 31, 2022, prior to the acquisition of NIA which will increase this proportion further.
Acquisition of New Century Health & Specialty Care Business
Evolent Health joined the Nasdaq through its 2015 IPO , which raised ~$195.5m via the issuance of ~11.5m shares prices at $17 per share. The company was originally founded in 2011 and its initial focus was developing software for hospitals transitioning to new fee systems.
Healthcare IT is a fragmented, low margin, and low-growth industry (based on research experience at least) since the industry appears oddly resistant to change - the disruption of healthcare services through data-driven technology has never really succeeded in the way it has within other industries.
Evolent Health (Seeking Alpha )
As we can see above, Evolent did a reasonably good job of growing its business in its first years after listing, although it was not profitable, and by the end of 2017 its share price had slipped in value to ~$12.
In 2018, however, Evolent completed the acquisition of New Century Health, in a deal worth $217m. In its 10K Evolent calls New Century:
a national population health leader in managing specialty care for Medicare, commercial and Medicaid members under performance-based arrangements, focused primarily on oncology and cardiovascular care
The acquisition led to "Evolent's current primary strategy to pursue solutions for managing high prevalence, complex specialty care" the 10K goes on to say, and the main thrust of Evolent's business now goes through the New Century business model, which has been bolstered by 2 further acquisitions discussed as follows:
in October 2021, we acquired Vital Decisions, a leading provider of technology-enabled advance care planning services. In August 2022, we acquired IPG, a leader in providing surgical management solutions for musculoskeletal conditions.
Essentially, Evolent's main business is handling the specialty care requirements of Medicaid and Medicare Advantage healthcare plans on behalf of health insurers and primary care providers, using its high-performance provider networks, which have the following key features:
- Direct contracts with specialists facilitate ease of care.
- Comprehensive specialty networks include multiple downstream subspecialists.
- Incentivizes financial payment for quality and cost-efficient utilization.
- Minimizes "buy and bill" incentives through shared savings methodologies.
- Dedicated provider operations provide staff to support practices.
- Clinical response team provides clinical education on-site to practice staff.
- Dedicated central call center facilitates referrals and helps to resolve claims issues.
- Provides established system of ongoing provider education and training.
- Increases the frequency of utilization and value of advance care planning.
Evolent revenues breakdown (10K submission)
As we can see above the Clinical Solutions business now accounts for the lion's share of Evolent's business, and it is growing rapidly - management's guidance for FY23 revenues is $1.92bn - $1.96bn, and adjusted EBITDA of $180 - $200m.
Although Evolent's share price hit an all-time low of just $5.5. shortly after the pandemic induced market selloff in March 2020, it has been climbing ever since, reaching an all-time price of $36 last week, which values the business at a market cap of $4bn. Based on that valuation, forward price to sales ratio is currently 2x, and forward EBITDA per share ~21x - very reasonable metrics, which ought to improve further based on current growth rates, particularly on the profitability side.
Looking Ahead - Tripling Adjusted EBITDA Over Next 2 Years Thanks To NIA Acquisition
Having discovered its optimal business model - looking after Medicaid, Medicare and Commercial plan members specialty needs via a sophisticated network of relationships with key stakeholders - Evolent has no intention of resting on its laurels.
Evolent plans to triple adjusted EBITDA (Evolent Presentation)
As we can see above Evolent has ambitious plans to grow EBITDA, and not just through organic growth - which is very encouraging in itself - but also through its newly acquired IPG business, and even more recently (in January this year) acquired NIA, which was acquired for an initial $650m upfront plus additional contingent consideration of up to $150 million based on 2023 performance.
NIA is, according to a press release , a:
specialty benefit management organization owned by Centene Corporation ( CNC ) that focuses on managing cost and quality in the areas of radiology, musculoskeletal, physical medicine, and genetics.
NIA drove revenues of $250m and EBITDA of $50m last year, so Evolent has certainly not paid over the odds for the company, and crucially, it adds another blue-chip client to Evolent's roster in Centene, a health insurer that has ~5% of the Medicare Advantage market, according to KFF, with ~1.5m members. Other major health insurers the company works with includes Humana, Molina Healthcare ( MOH ), Oak Street Health ( OSH ) - recently acquired by CVS in a $10.6bn deal - and Blue Cross / Blue Shield. Chief Executive Seth Blackley told analysts on the company's Q422 earnings call that:
Last year, we sized the total Performance Suite opportunity at our top 5 customers as over $16 billion of new annual revenue.
The CEO also fleshed details of a new collaboration with Humana covering its members impacted by a cancer diagnosis, an arrangement which Blackley believes will add $250m of revenue to the top line in 2024.
Some Risks To Be Aware Of
In this article I have discussed the strong growth of the Medicare Advantage industry, and Evolent's role within it, and its impressive acquisition led growth which has transformed the company from a software developer into a manger of important specialty care to a fast growing number of patients via relationships with a wide selection of blue chip clients.
To summarize, I feel quite bullish about the progress Evolent can make in the coming years, and the prospects for its share price, given the company's 2x price to sales ratio and the fact the business is starting to show increasing levels of profitability.
There are some risks to consider however. It has not escaped the Centers for Medicaid and Medicare Services ("CMS") attention that Medicare is proving an extremely profitable business for health insurers, and CMS has begun the process of pushing back against some of the more generous aspects of the system in order claw back some of the billions it believes it may have paid out to health insurers unnecessarily.
Health insurers stand accused of "gaming the system" by categorizing patients as higher risk than they really are, in order to gain more generous payouts, or not providing plan members with sufficient access to physicians, instead funneling them through companies such as Evolent, who attempt to find a cheaper alternative than e.g. a hospital visit.
The CMS and health insurers clashed earlier this year over plan payment rate adjustments, which health insurers believed represent a cut of >2.5%, whilst the CMS suggested the changes represented a 1% increase.
These disputes will affect businesses like Evolent's downstream, given their reliance on health insurer clients to keep sending them patients. Admittedly, it would take a lot of anti-Medicare Advantage legislation to reverse the current tide, but Evolent may find it needs to focus on driving scale rapidly as profit margins narrow somewhat going forward.
Evolent is not an especially cash rich company. Cash position at the end of 2022 was $188m, and current assets totaled $478m, whilst current liabilities stood at $433m, and there is $413m of long term debt also to consider.
Evolent, being an acquisition led company, is not necessarily experienced at knitting together multiple businesses so there is some pressure on management to prove it can execute at scale, and its industry is becoming more and more competitive with new market entrants attracted by the rewards on offer.
Conclusion - From A Software Developer To A Specialty Care Provider - The New Business Direction Can Usher In Long Term Share Price Growth In My View
Despite these risks I have highlighted above - namely a potential backlash against Medicare Advantage, a lack of funding, and inexperience, I think Evolent has done exceptionally well to identify in which direction the market was headed, where the profitability lay - not in healthcare IT, but in administering patient care - and to make the necessary acquisitions to pivot into these spaces.
After a slow start to listed life, Evolent's shares now trade at twice their IPO price, and this could be just the beginning for the company, given its forward P/S ratio of just 2x - a rule of thumb average for a listed company would be closer to 4x, and its growing profitability.
Because Value Based Care and Medicare Advantage are relatively new phenomena, and complex ones at that, arguably companies like Evolent do not attract as much attention as they should, but investors should take note - Oak Street Health, which runs clinics designed to help health insurers administer care to MA plan members - was acquired by CVS in January for >$10bn.
Health Insurers like this way of doing business as it helps them avoid the heftier reimbursement bills that come from hospitals and the traditional fee-for-service model, therefore I would not be surprised if a Centene or a Humana were to make a bid for Evolent's business, and that could be a very significant premium to current traded price.
M&A is yet another reason to consider Evolent as an investment opportunity. Naturally there are some risks to consider, and upside is never guaranteed but Evolent stock has returned +28% so far this year, and I think it could return as much again before the end of the year as the NIA acquisition adds substantially to top and bottom line earnings.
When we start to see real profitability - likely after 2024 - I could see Evolent really starting to push on as a business, and who knows, perhaps challenging a double digit billion valuation by the end of this decade.
For further details see:
Evolent Health: Another Beneficiary Of Explosive Medicare Advantage Growth