2023-03-16 16:15:57 ET
Summary
- Oscar Health, Inc. looks almost absurdly undervalued at a market cap of ~$620m.
- The company has >$3bn cash and is forecasting revenues of >$6bn in FY23 and losses of <$200m.
- The tech-enabled health insurer may have become something of a laughingstock but has grown to >1m members.
- Oscar needs the ACA market to hold up and to sharpen up most elements of its business - any hint that it can do that ought to drive its valuation back >$1bn.
- The company has made mistakes and its tech startup mindset may not suit the health insurance business - but I would make OSCR shares a fairly strong buy.
Investment Overview
If the market is valuing a listed company that reported $1.6bn of cash and equivalents, and $1.4bn of short term investments as of YE22 at a ~$650m market capitalization, it's probably safe to assume it harbors very serious doubts about that company's business model.
Oscar Health, Inc. (OSCR) joined the New York Stock Exchange ((NYSE)) in March 2021, issuing 31m shares at a value of $36 per share, raising ~$1.2bn. At that time, the stock market valued the company at just over $7bn.
Earlier that year, Google's parent company Alphabet Inc. ( GOOG ) had invested $375m in the company for a 10% stake. Joshua Kushner, brother of Donald Trump's adviser and son-in-law, Jared Kushner, was a co-founder of the business.
Launching at a time of great hope for "virtual care," or "remote healthcare," when the pandemic had convinced the market that "telehealth" was the future after a nationwide lockdown forced consumers to access healthcare virtually, and boasting >500k "users," the future looked bright for Oscar, and for virtual care.
In reality, Oscar Health stock, like several other telemedicine based plays, such as Teladoc Health, Inc. ( TDOC ), Bright Health Group, Inc. ( BHG ), UpHealth, Inc. ( UPH ), and American Well Corporation ( AMWL ), has performed dismally, losing >90% of its value in less than 2 years. Each of the other companies mentioned above have lost >85% of their value across the past 2 years.
There are several reasons to explain the poor performance. Firstly, patients seemingly mistrust "healthtech" and prefer not to engage with it. Secondly, healthtech companies have struggled to find ways to add genuine value to the process of administering healthcare.
Thirdly, healthcare incumbents - and most specifically healthcare insurer giants - have proven to be too experienced, too powerful and too difficult to budge. Fourthly, healthcare companies did not generally feel the need to overlay more bespoke technology platforms over the in-house systems they were already using.
Even taking all of this into account, however, I believe it's possible to make a reasonably strong case that the market has punished Oscar Health stock too heavily. At the end of 4Q22, Oscar's total membership had increased from 598k members, to 1.15m members, a gain of 93%.
Premiums earned in 2022 were $3.87bn, versus $1.8bn in 2021, and although the net loss was $609m in 2022, based on its near term cash position of $3.2bn, the company could run at a similar loss for 5 more years before its funding was exhausted.
Furthermore, management is promising that Oscar has - in the words of CEO Mario Schlosser, speaking with analysts on the Q422 earnings call :
a very clear roadmap for the organization to achieve our goals for the year, which is profitability in insurance business in 2023 and total company profitability in 2024. And we believe we have enough cash to get us there.
In other words, Oscar expects to start 2023 with a likely ~$2.5bn in cash - if losses in 2023 match 2022 - and to be profitable in that year - surely that merits a market cap valuation higher than $620m?
Oscar stock has been on a growth spurt in 2023, rising ~40% so far this year, and hitting highs of $5.5 at the beginning of March - a 57% premium to today's traded price of $3.5.
With that in mind, it is tempting to recommend Oscar Health stock as a very clear buy opportunity with exceptional upside prospects. If Oscar stock was to regain its post IPO high of $35, an investor buying today would realize a 900% gain on their investment.
In the remainder of this post, I'll take a deeper dive look at Oscar's often misunderstood business model, prospects for 2023 and beyond, potential weaknesses and threats, and try to discover if Oscar is absurdly undervalued as a business, or if the business model is unravelling at the seams, as the market seems to think it is.
My research has revealed that Oscar may have made numerous amateurish mistakes, and still has a lot of issues to overcome. I'll begin by highlighting some of these issues, starting with the company's marketing messaging.
Why I Have A Small Problem With Oscar's Sales Pitch & Messaging
The age of technology companies claiming that they intend to "disrupt" or "reimagine" entire industries may be coming to an end, perhaps due to the market's loss of patience with capital intensive technology platforms that consume vast quantities of cash and deliver mediocre outcomes, as opposed to vice versa. With that said, you could equally argue that the market's lack of patience is the problem, not the technology.
Either way there is no denying that the U.S. healthcare system is plagued by inefficiencies. According to TheStrategyStory.com , U.S. consumers have given health insurers the lowest rating of any sector of the healthcare system, and less than 4% of Americans are able to accurately describe the four tenets of healthcare insurance: deductible, co-insurance, co-pay, and out-of-pocket.
Oscar's language in its latest 10K submission is reminiscent of the classic tech startup. Oscar is apparently "the first health insurance company built around a full stack technology platform and a relentless focus on serving our members," and behaves "like a doctor in the family."
This where the company needs to be careful from a marketing and PR perspective, in my view, because it is dangerous to claim that you are more caring and personalized than all of the established health insurers, that serve >95% of all those with medical insurance, unless you are absolutely capable of proving it beyond any reasonable doubt.
In reality, the likelihood is that a company new to the industry will struggle more than the incumbents, so this kind of messaging may ultimately prove unhelpful and quickly turn the public against it.
It's also worth bearing in mind that a health insurer's target market is an older one, since the more elderly we become, the more we tend to need healthcare. The baby-boomer generation - the most populous of any generation and the key target market for health insurers - is not tech savvy and may actually dislike tech.
Baby-boomers may even enjoy the process of researching different healthcare options for themselves as opposed to being spoon-fed by a computer. That would certainly help to explain the rising popularity of Medicare Advantage - an absolutely critical market for health insurers and one that Oscar has already been badly burned by.
Oscar Health - Business Model & Recent Performance
Nevertheless, at the end of 2022 we can see that Oscar Health, Inc. had >1m members.
The vast majority of Oscar's members are from "individual and small group", a market that is likely to be overlooked by the major healthcare insurers, e.g., UnitedHealth Group Incorporated ( UNH ), CVS Health Corporation ( CVS ), Humana Inc. ( HUM ), Elevance Health, Inc. ( ELV ), Centene Corporation ( CNC ), The Cigna Group ( CI ), Molina Healthcare, Inc. ( MOH ), who are focused on employer, Medicare and Medicare Advantage plans primarily.
The vast majority - 685k - of Oscar's members are based in Florida, with Texas - 148k members - Georgia - 104k members - and California - 72k members - making up the top four, and being the only other states to have >25 members.
Around 99% of all Oscar's revenue is derived from sales of health plans regulated by the Affordable Care Act, and 85% are supported by advanced premium tax credits ("APTCs") which are only guaranteed until 2025 - making Oscar quite susceptible to future policy changes that could significantly impact its revenues to the downside.
It's important to note that Oscar does not forecast membership growth in 2023, and has stopped accepting new members in Florida, apparently due to regulatory requirements around "capital and surplus requirements, escrows, or contingency guaranties" according to its 2022 10K submission.
Clearly, not being able to grow in the one state where you are capable of growing due to the risk of falling foul of the regulations is the kind of rookie mistake that makes the market doubt if Oscar has what it takes to succeed in an industry as demanding as health insurance.
Another area of concern I'd highlight is Oscar's use of reinsurance agreements. A statement in the 10K submission reads:
reinsurance is a financial arrangement under which the reinsurer agrees to cover a portion of our medical claims (ceded claims) in return for a portion of the premium (premiums ceded).
Essentially, Oscar is paying substantial sums to reinsurers to cover patients who become more ill than Oscar expects. In 2022, according to the company, 29% of its premiums were ceded under its reinsurance programs
As we can see above, out of $5.33bn collected from members in 2022, $1.46bn went to reinsurance. If Oscar wants to turn net losses of >$600m into profits going forward, reinsurance strikes me as an area the company may need to address.
On a more positive note, Oscar has been improving its medical loss ratio, a key measure of performance for a health insurer. The medical loss ratio represents medical costs as a percentage of premium revenue, i.e., what an insurer pays for administration of healthcare to all of its members versus the premiums it collects.
As we can above, the MLR reduced by 360 basis points in 2022, even as membership increased dramatically - a positive sign.
Oscar's member retention rates also appear to be quite strong and the company's FY23 guidance is more robust than in previous years.
As we can see, losses are expected to narrow to $(75m) - $(175m), and the medical loss ratio is expected to improve slightly, whilst policy premiums will also grow.
A final point about Oscar is that the company is hoping to monetize its +Oscar technology platform alongside its health insurance business. This is an area of the business that I would have some reservations about, purely because the barriers to entry in this market do not seem to be very high.
The idea is that +Oscar can be used to store, and then slice and dice data to figure out, for example, where a member's nearest physician may be, or what level of care may be required, or to send out mass communications to members, which can be tailored to each individual based on the data collected about them.
There is nothing wrong with the idea and I can see how Oscar can use this platform to streamline its own business, but in terms of who the platform could be sold to, I can only think of other health insurance companies, and I would be staggered if they do not already have these kinds of analytics systems in place.
After all, these companies have decades of experience more than Oscar and the assumption that they simply would never have thought to set up a database is simplistic in my view, and underscores one of the areas where I believe Oscar may be going wrong - underestimating the competition.
Summarizing The Investment Opportunity
Summarizing the performance of Oscar since its IPO, we can point to a lot of areas where the company may have made errors or underperformed.
For example, the company appears to have failed to capitalize on growth in its key market of Florida, and, therefore, will not grow membership in 2023. Even though it is an insurer, it spends >25% of its revenues on insuring itself.
It has announced that it is withdrawing from the Medicare Advantage market - the fastest growing market in healthcare - and is instead focused on the ACA market, where the majority of members are reliant on tax credits, and where there is uncertainty around regulation beyond 2025.
Finally, Oscar seems to believe it is a more caring organization with better technology than its rivals, but it has not yet demonstrated that in any meaningful way, and its +Oscar platform does not look like something rival health insurers would want to buy.
There are plenty of negatives to help to explain why Oscar's valuation has collapsed since its IPO, but as discussed, my bull thesis is derived more from the market's overly negative take on Oscar, than Oscar's performance to date. I believe performance can and will improve.
It is understandable that a new market entrant with little experience would struggle in a market as competitive as health insurance, dominated by giant companies that know their members much better than Oscar seems to think they do.
But nevertheless there are positives. The ACA market is very large - according to a 2022 Oscar investor day presentation the total addressable market is ~29m lives. Oscar has good retention rates - 80% in 2022 according to the same presentation. The company may have tripped itself up regarding growth in 2023 but premiums are still forecast to grow and losses are narrowing, meaning management could achieve its goal of profitability by 2024.
Oscar also still has plenty of cash - there is >$3bn to burn through, so the business is in no danger of bankruptcy, even if the potential changes to the ACA market after 2025 do concern me.
The technology platform is a likely non-starter for me, and Oscar's marketing strategy may need some work, but ultimately I believe the company is right to assume there are millions of people in the U.S. who would consider changing the way they access healthcare - especially the younger generation, who will one day become the older generation.
I must admit that when I first considered Oscar as an exciting contrarian trade, and began researching the company, I did not expect to find as many potential problems as I did, so I can understand the market's skepticism and low valuation of the company.
The key element of the investment proposition for me, however, is that Oscar still has time on its side, and plenty of cash. I am not expecting great things from the company in 2023 in terms of member growth or profitability but equally it seems clear that any company forecasting for annual revenues of >$6bn, with >$3bn cash, and losses <$200m cannot be anything other than severely undervalued at a market cap valuation of >$650m.
Things can - and will - only get better for Oscar Health and its beleaguered shareholders in 2023. I can't see how the company can end 2023 with a valuation <$1bn, and as such I see at least 30% upside in the short term, and provided the ACA market proves robust enough over a 5-year period, potentially much more to come.
If I were Oscar Health, Inc. management, I would attempt to take a leaf out of the Molina Healthcare playbook. Molina began as a family owned business catering for low income health insurance payers in 1980, and has grown its business over the years from $6bn revenues in 2013, to >$30bn in FY23. It has done so by focusing on its end users as opposed to its tech platforms, and has shown what it takes to take market share away from larger incumbents. Its share price is +250% over a 5-year period.
For further details see:
Oscar Health: So Many Issues, But Hard To Ignore The Upside Potential