Summary
- Evolent Health acquires IPG and boosts its full-year guidance.
- On the back of its recent acquisition, the company's leverage returns to 2x.
- Evolent Health is valued at approximately 2x next year's revenues.
- On an EBITDA basis, the company continues to deliver small improvements over time. And its guidance points to further improvements coming over the remainder of 2022.
- This turnaround is gaining traction.
Investment Thesis
Evolent Health ( EVH ) reported a strong Q2 2022 result that points to the making of a "significant turnaround" in its operations.
The one blemish on its progress is that company continues to lean on acquisitions to spur its growth strategy. This has lent itself to its net leverage increasing back to 2x.
That being said, at 2x next year's revenues, I believe that there's a positive risk-reward at hand. Hence, I rate this stock with a tepid buy rating.
Revenue Growth Rates Turnaround
Recall that in 2021 Evolent divested several business units. Adjusting for these divestments, Evolent's adjusted revenues were up 36.7% y/y in 2021.
Consequently, for all intents and purposes, this was a company that was growing in the mid-30%. However, the business now is growing at a significantly faster clip.
Even allowing for slightly easier comparables for Q3, even with that in mind , this new Q3 guidance is certainly compelling.
In my previous article I said ,
IPG [the new acquisition] is assumed to be on a path to $140 million of revenues in 2022. Once IPG's financials are added to Evolent Health's, rather than Evolent growing at $1.2 billion, as it previously guided for, Evolent Health will now most likely guide for approximately $1.3 billion.
And that's very much what we now see for Evolent. Management had been eager to close the IPG deal and upwards revise its full-year guidance. And lo and behold, that's exactly what happened. The IPG deal was closed on the eve of the quarterly results being announced. Just in time for Evolent to raise its full-year guidance.
Why Evolent Health? Why Now?
Evolent is a healthcare administrator platform. Evolent Health describes itself as the " original value-based care company " in the US.
Evolent is the go-between payers and providers. With payers seeking the lowest payouts and providers seeking the highest fees, the two sides are not in alignment with their incentives. Evolent's value proposition is in reducing expenses to payers. Evolent wants to drive value for services, turning the focus away from fees for services.
As noted above, Evolent has acquired IPG recently. With this acquisition in hand, its net debt to EBITDA reached 2x.
What's more, keep in mind that nearly a third of its revenues comes from Medicare within its Clinical Solutions segment. And the growth in this business unit is only clocking up 12% y/y growth.
Consequently, even with the rest of its business units delivering faster growth, it will take a while for those smaller units to be large enough to offset the slower growth being reported within its Medicare business in its Clinical Solutions segment.
Profitability Profile Improving, But There's More
At the midpoint, Evolent is guiding for its adjusted EBITDA margin to reach 7.7% for its full year. That's a minor improvement from the 7.6% it guided for back in Q1 2022.
And a marginal improvement in its adjusted EBITDA profile that was reported for its H1 2022.
Altogether, that takeaway is this, Evolent's profitability profile is going to continue ticking along, improving slowly over time.
Meanwhile, on a cash flow basis, Q2 saw $14 million of cash flows, which was a strong improvement from the negative $57 million reported in the prior quarter.
Does this mean that Evolent could have what it takes to remain a cash flow-positive enterprise? That would be a very welcome ''change of story'' for this company.
On yet the other hand, keep in mind that Evolent's adjusted EBITDA includes a significant amount of add-backs from the usual suspects, such as SBC, acquisition-related costs, depreciation, and a fair amount of interest. Without these add-backs, Evolent's GAAP margin profile is slightly negative.
EVH Stock Valuation - 2x Next Year's Revenues
Looking out to 2023, if we assume that Evolent reverts back to its organic growth rate of 35% to 40% CAGR, that would mean that Evolent's revenues would reach approximately $1.8 billion.
That would put its stock at 2x next year's revenues. Very few investors could rationally argue that this is an extended multiple. In fact, I believe that this is probably a very entry for new investors coming to the stock for the first time.
The Bottom Line
Companies that are adding and divesting many assets at a quick pace, often have a tendency to look for ways to make the numbers good, so investors typically avoid those companies, as suspicious players. I don't believe that's what's happening here
On the other hand, keep in mind that the biggest stockholder here was the previous CEO Frank Williams. And Williams has now resigned from his position and left his position of Chair earlier this year. There's no other large significant executive shareholder.
That being said, that hasn't stopped investors from bidding up the share price in the past year. All considered, there are more positives than negatives and the valuation makes sense. Hence, I'm asserting a tepid buy rating.
For further details see:
Evolent Health: Improving Financials, But There's More