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THE BIG IDEA
How psyched would you be if you went to your healthcare provider and they said the following:
“I can make a health optimization recommendation for you, informed not only by the latest clinical trials, but also by local and regional data about patients like you, the real-world health outcomes over time of every patient like you, and the level of your interest and ability to engage in your own care. In turn, I can tell you within a specified range of confidence, which treatment or health management plan is best suited for a patient specifically like you and how much that will cost.”
I’m pretty sure your response would be, “Sign me up!”
It’s a good pitch, right? Especially in a field as complicated as healthcare where most of us don’t have the time or expertise to understand how it all works, or the desire to figure it out.
We just want the best care for ourselves and loved ones at a reasonable price.
The good news is there is a company offering that value proposition I just quoted. It’s the company I’m profiling today. It’s newly public, early-stage, and has a lot of growth in front of it.
The bad news is it’s a small company and its solutions haven’t yet been widely adopted, so there’s a decent chance your healthcare provider is not benefiting from their expertise (yet).
The other bad news is that it’s a pretty boring company to talk about. I mean, it’s essentially a big data and analytics company for healthcare clients. I can sense your eyelids are drooping already.
But perk up because, while this isn’t cocktail party material it’s a pretty darn good investment opportunity, in my view. And that’s what we’re here for.
The big idea behind the company is simple.
The U.S. healthcare industry wastes almost one-third of the $3.6 trillion that’s spent on healthcare annually. That’s over $1 trillion—one Apple (APPL), or one Microsoft (MSFT), just tossed in the gutter every year (their market caps are over $1 trillion each right now). It’s obscene.
At the same time private and public payers are cutting fee-for-service reimbursement rates and providers are shifting from volume to value-based payment models. This has profit margin implications, and it dramatically increases the complexity of these organizations.
The proverbial “silver bullet” solution is to use clean data and purpose-built analytics to better manage healthcare organizations. This is getting easier to do as recent laws and regulations are promoting the free exchange of health information, much of which has been digitized in the form of electronic health records.
It used to be that a dearth of healthcare data was the issue. Now there is too much data! It’s not just patient data, it’s best practices and co-morbidities data too, just to name two examples.
In arguably the most complex industry in the world, there is a massive opportunity for innovative companies to develop technology to unify this data to drive better financial results for healthcare providers and better care for patients.
That’s what today’s opportunity is all about.
THE COMPANY
Health Catalyst (HCAT) is a $1.4 billion market cap company that provides cloud-based data and analytics technologies (55% of revenue) and professional services (45% of revenue) to healthcare organizations.
The founders, Steve Barlow and Tom Burton, had a vision that all healthcare decisions will become data informed. To that end, they founded Health Catalyst in 2008 and developed a data platform along with analytics software that clients can use to manage their data, derive analytical insights to operate their organization, and produce measurable clinical, financial, and operational improvements.
They also began to train staff to provide services to clients to help them get the most out of their Health Catalyst platform and application investments.
Taken together, the company estimates the current addressable markets for its platform technology, applications and services tops $8 billion.
While their vision of where the healthcare industry needs to go was developed early on, the solution to the immense challenges wasn’t immediately apparent. They started by building their own data warehouse, but soon realized it couldn’t execute the fundamental changes clients needed.
They needed a solution to help clients spot trends, map out rational plans and implement new processes that would drive sustainable improvements.
With lofty goals they pioneered a new data warehousing architecture and analytics apps that use a just-in-time approach to data binding. This fixed many of the problems encountered when using traditional data warehousing methods.
It’s catching on. Health Catalyst currently has over 120 customers, including large academic medical centers, health information exchanges, ACOs, community hospitals and physician practices. The network of organizations using the company’s solutions is greater than 250 hospitals and 3,000 clinics, which collectively care for over 70 million Americans a year.
The internal numbers are good too.
Organic revenue growth has topped 30% since the beginning of 2018. Dollar-based retention is around 107%, showing that customers increase their spend with the company over time. Over 90% of revenue is recurring, showing that it’s a relatively stable business with high revenue visibility (a plus of the subscription business model). And gross margin has improved by more than 10% over the last two years, to just over 50%. Health Catalyst isn’t yet profitable, but it’s moving in the right direction.
THE PRODUCT & SERVICES
The Health Catalyst system helps customers run a data-informed business that drives measurable clinical, financial and operational improvements. There are three layers of its comprehensive solution:
A cloud-based Data Operating System (DOS): This is a healthcare-specific and flexible data platform that integrates and organizes data from disparate software systems to make it easier for clients to see what is going on. DOS represents one of the largest data assets of its kind and delivers unique insights to clients.
Analytics applications: Software apps are built on top of the DOS data platform and allow customers to analyze the most common challenges they face. Analytics make it possible to pinpoint opportunities for measurable improvements (clinical, financial, and operational) and are used by everyone from executives to the clinicians that provide care to patients. Also available are analytics accelerators, which are pre-built data modules and visualizations that can be customized to individual client needs. This is an area for growth; as Health Catalyst grows it will develop and release more applications.
A team of analytics and domain experts: These individuals help clients leverage Health Catalyst technologies to shorten time-to-value and achieve sustainable measurable improvements. Analytics experts are typically data analysts, engineers and scientists, whereas domain experts include physicians, nurses and administrators.
This slide from Health Catalyst lays out their solution. Study it for a minute. As you can see it is relatively complex. That should help illustrate the need for this type of solution in healthcare, and the value it provides to clients.
The Business Model
Health Catalyst does business through two different operating segments: technology and professional services.
The technology segment (55% of revenue, 67% gross margin) includes the data platform, analytics applications and support services, and mostly generates revenue from cloud-based subscriptions. Licenses, maintenance and support fees make up a smaller portion of technology segment revenue. Most subscription contracts are for three years.
The professional services segment (45% of revenue, 37% gross margin) combines data and analytics, domain expertise, outsourcing, and implementation services. These services help clients configure and maximize use of their technology offerings. Fees are based on full-time equivalent (FTE) services that the client needs and typically include a blend of analytic engineers, analysts, and data scientists.
The company has two basic subscription plans: All-Access, or Limited-Access/Modular. All-Access means the customer gets the Data Operating System (DOS) and all Analytics Apps, whereas the Limited-Access means DOS plus just whatever Analytics Apps the client selects.
Growth Initiatives: Where Is Health Catalyst Going and How Will it Get There?
New Customer Growth: The biggest driver of this business is customer growth. Health Catalyst is in the early stages of business development and customers are in the early stages of adopting its solutions. Only around 5% of the 1,200 potential buyers of its platform (DOS) are current customers. There remains a large untapped market out there, worth approximately $8 billion, that can be expanded through strategic M&A and expansion into adjacent markets, such as life sciences and internationally.
New Product and Services Offerings: As is the case with many software companies, Health Catalyst’s second growth opportunity is to sell more solutions into its existing customer base. This is the hallmark of a successful company and management is actively developing applications to seize the day. Since 2015 it has developed CORUS, Touchstone, Patient Safety Monitor, Population Builder and others, which have helped drive 107% net revenue retention. It is early in its product development curve but I expect continued progress in this department over time.
Cross Selling into Medicity Customers: Health Catalyst’s new Medicity acquisition, completed in July 2018, was not done because it was a growth business (it is actually in decline) but for strategic reasons; it has over 60 customers (health systems and regional healthcare information exchanges) that are potential buyers of Health Catalyst’s other solutions. The major effort to sell into this customer base has not happened yet. Management is being strategic and instead focused on helping these customers prepare their organizations for the more significant change that Health Catalyst can help them achieve, and which should drive meaningful revenue growth. Expect the cross-selling effort to begin in earnest in 2020 and for more details to come on this important strategic initiative.
How Are Customers Doing?
Allina Health: Allina is a non-profit healthcare system in Minnesota. It is saving up to $125 million a year by using Health Catalyst solutions across many clinical, financial and operational improvement projects. In one specific example Allina saved over $1 million and reduced severe sepsis and septic shock mortality by over 30% by driving higher adherence to sepsis treatment best practices.
University of Pittsburgh Medical Center (UPMC): UPMC Health Plan realized $38 million in clinical, financial and operational improvements over several years using Health Catalyst solutions. Around $15 million alone was saved in supply, drug and pharmaceutical ordering and protocol development.
Mission Health: Mission Health is a Medicare Accountable Care Organization (ACO) and one of North Carolina’s largest health systems. It used Health Catalyst solutions to optimize performance against its ACO’s Medicare Shared Savings Program measures, saving over $11 million and achieving 100% of all at-risk dollars.
The Bottom Line
Health Catalyst grew revenue by 54% (37% organically) to $112.6 million in 2018. Of that, $12.5 million came from the acquisition of Medicity (acquired in July 2018). In the first nine months of 2019 total revenue has grown by 45.7%. In Q3 2019, which is the first quarter that laps the Medicity acquisition, revenue growth was 20%, to $39.4 million. The adjusted EPS loss over the first nine months of 2019 is -$0.73. In Q3 2019 the adjusted EPS loss was -$0.27, which represented a 43% improvement over Q3 2018. Health Catalyst beat Q3 analyst expectations on both the top and bottom lines.
Analysts expect full-year 2019 revenue will grow by 33% to $150 million and that 2020 revenue will grow by 27% to $190 million. Consensus estimates are lower than management guidance, which is for revenue of $151.4 million to $154.4 million (up 34.4% to 37%). Adjusted EPS loss in 2019 is expected to be -$1.11, then improve to -$0.95 in 2020.
Health Catalyst ended Q3 2019 with $241.4 million in cash and equivalents (it raised $195 million in the IPO in July), $47.9 million in long-term debt and 36 million diluted shares outstanding.
RISK
Constantly Shifting Landscape: Healthcare is ever evolving. On the one hand, that raises a lot of questions about the sustainability of businesses in the healthcare data area. On the other, it’s that very change that means they need to exist. Those that are forward thinking and develop solutions that help clients achieve stability in a shifting landscape should thrive. That’s what Health Catalyst looks like today, but it could change.
Insider Lockup Expiration: HCAT just came public this past summer and lockup expiration is January 21, 2020, at which point around 7 million shares could be sold by insiders. While lockup expiration is seen by some investors as a risk because of the idea that insiders will dump all their stock and drive down the share price, the actual data shows this isn’t accurate. While every situation is different stocks often rise in the weeks ahead of, and after, lockup expiration.
Medicity Acquisition: In July 2018 Health Catalyst acquired Medicity, one of the nation’s largest population health management companies, for total consideration of $17.3 million. The acquisition included over 100 clients (health systems, health plans, employers, etc.), which care for over 75 million patients. The acquisition was completed for strategic purposes, namely to capture a customer base to sell Health Catalyst products into, not because Medicity was a growing business. This strategy may not work out as planned.
Transition to Cloud Hosting Provider: Health Catalyst is transitioning from company-owned cloud hosting environments to Microsoft Azure. This new cloud environment offers better functionality and future proofing but comes with a higher cost. While this seems to be the way the world is going, it may not prove to be the right strategic move.
COMPETITION
Health Catalyst competes in a diverse market of healthcare data analytics, technology platforms, information exchanges, population management and consulting firms. The players, regulations, customer requirements and client expectations are constantly changing, which requires agility and forward-thinking businesses leaders that gain and maintain credibility in the marketplace. At the same time, clients may look to larger, established players that might be less nimble, but have been around for longer. Significant competitors include Epic Systems, Cerner, Optum Analytics and IBM.
THE STOCK
Trading Volume: Health Catalyst has a market cap of $1.4 billion and trades an average of 264,000 shares daily. That means roughly $10.3 million worth of stock trades each day. Our subscriber group shouldn’t move this stock.
Historical Price: HCAT went public on July 25, 2019 at 26 and jumped 50% in its first day. Shares peaked at 49.85 in mid-August then pulled back into October, when they bottomed at their IPO price of 26. Since then the stock has been making a series of mostly higher highs and higher lows on its journey back to 39, where it sits today.
Valuation & Projected Price Target: HCAT trades with a 2020 EV/Sales multiple of 6.3 using consensus estimates (2020 revenue of $190 million, which is probably low). As it grows and operating losses are reduced shares could easily trade up to a higher valuation. In the near term (within 12 months) a multiple of 8.2 or so is entirely feasible, implying the stock could rise 30% before being fully valued. A higher growth rate, or lower EPS losses, could push that multiple even higher.
Buy Range (next two months): Buying between 36 and 42 is the most attractive buy range in the near term. We could see some resistance at the 44 level (12% above where the stock is now), and there should be some support in the 32 to 34 range (roughly 15% below where the stock is now), if HCAT gets down that low.
The Next Event: Management will announce official Q4 2019 results and host a conference call around January 28. Insider lockup expiration is January 21, 2020.
UPDATE THESE CHARTS AND EVERYTHING BELOW:
Construction Partners Inc. (ROAD) |
UPDATES ON CURRENT RECOMMENDATIONS
Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.
Back On Track
This was the most encouraging week in a long time. On the back of big tech earnings from companies like Microsoft (MSFT), Apple (AAPL), Salesforce.com (CRM), Amazon (AMZN), etc., we’ve seen the broad market hit all-time highs and pockets of growth stocks come back to life.
Concurrently, I’ve seen many strong bounces in good stocks that had previously been taken out to the woodshed in this software correction. Not that these stocks look beautiful or anything right now. But check out Tenable (TENB), Zendesk (ZEN) and Instructure (INST) as just three examples of stocks that look a heck of a lot better after reporting.
The message? Software stocks are likely oversold. I expect significant action in our software names over the next two weeks as they report. I can’t guarantee all moves will be in the right direction. That depends on how companies have executed over the last three months. But provided they have done their jobs and not run into any roadblocks, we should see many of these stocks trading higher a week from now.
At the same time, we have a third rate cut, a flurry of articles and blog posts detailing how well stocks do with three cuts (but not 4!!) and modest optimism on the China-U.S. trade war. That all means a greater sense that there’s potential here for an end-of-year rally in growth. Oh, I almost forgot: GDP was up 1.9%. That’s better than the 1.6% expected. Another modest positive.
The punchline here is we can lean a little more bullish.
As evidenced by this month’s new stock, Construction Partners (ROAD), I am starting to spread my research around a little and see what else we can add to the portfolio beyond software and MedTech. I’m not saying I’m going to stay on that track. But I’m not saying I won’t. It all depends on what looks good as of the first Friday of every month!We have a big week of earnings on tap. Look for the “EVERs”—Everbridge (EVBG) and EverQuote (EVER) – to report on Monday.
We will hear from Rapid7 (RPD), Avalara (AVLR) and Inspire (INSP) on Tuesday. Then on Wednesday the “Qs,” Quanterix (QTRX) and Q2 Holdings (QTWO), step up to the plate. And Arena Pharmaceuticals (ARNA) closes things down on Thursday.
Buckle up!
Changes this week
None
Updates
AppFolio (APPF) reported Monday, beat expectations and the stock popped. We enjoyed a little follow through, and shares are now 11% off all-time highs. Let’s keep holding. HOLD
Earnings: Done
Arena Pharmaceuticals (ARNA) was essentially flat this week despite news that it began dosing patients in the ADVISE phase 2 trial evaluating etrasimod in atopic dermatitis (AD). This wasn’t a huge surprise. Management will issue earnings (not that Arena really has any) next Friday. I’ve had at buy and am keeping there. BUY
Announced earnings date: Tuesday, November 5
Avalara (AVLR) was staging a little rally, until Friday. There’s no news here as management is keeping a lid on things until earnings, which come out on Tuesday. We’re looking for revenue to jump 34% to $93.1 million and for the EPS loss to decline 29% to -$0.10. This should put Avalara on track to grow revenue by 37% in 2019 and deliver an EPS loss of -$0.22. If you want to gamble ahead of earnings my expectation is that Avalara will beat and the stock will jump. Officially, I’ll keep at hold until we see a bit more of an uptrend though. HOLD
Announced earnings date: Tuesday, November 5
Bandwidth (BAND) was sold a few weeks ago. No news. This will be the last mention of the stock unless I decide to add it back to the portfolio. SOLD
Announced earnings date: Wednesday, November 6
Cardlytics (CDLX) hit a new 52-week high near 42 yesterday and looks amazing. Earnings are due out a week from Tuesday. There’s been no news in the past week. Analysts see revenue up 45% to $50.1 million in Q3 while EPS should stay flat at -$0.15. For the full year, revenue is seen rising 27%. BUY
Announced earnings date: Tuesday, November 12
Domo (DOMO) is moving sideways on no news. HOLD
Estimated earnings date: December 6
Everbridge (EVBG) reports Monday and we’ll keep the stock at hold into the event. That said, with shares 33% off their highs and a little more appetite for growth, this one could move. This could be a good place to start buying if you’ve been waiting for a window. For those who have a big gain already and have seen it whittled away somewhat over the past four months, it’s safer just to hold through earnings. Revenue is seen rising 32% in Q3 while EPS loss should be chopped in half, to -$0.05. In 2019, revenue is expected to jump 33% and EPS should be -$0.25. HOLD
Announced earnings date: Monday, November 4
EverQuote (EVER) will also report Monday and my advice is the same as it is for Everbridge: OK to buy a little if you don’t have any and are risk tolerant, but safer to hold through the event if you’re already in the stock and don’t want to risk any more capital. It’s going to be very interesting to see how the new verticals are doing. Analysts see revenue up 40% in Q3 and up 40% in 2019. The company’s still losing money, in part because of investments in the aforementioned new verticals (renters’ insurance, health insurance, etc.). EPS should be -$0.47 this year. HOLD
Announced earnings date: Monday, November 4
Goosehead Insurance (GSHD) reported this morning and will host a conference call at 8:30 am. I sent out a Special Bulletin earlier detailing the results and will follow up with insights from the conference call later. BUY
Earnings: Done
Inspire (INSP) will report on Tuesday. Revenue should be up around 60% this year, with 47% growth (to $19.2 million) expected in Q3. Earnings are seen coming in at -$0.48 in Q3, and -$1.50 for the full year. I’ve had a buy a half rating and am keeping it there. BUY A HALF
Announced earnings date: Tuesday, November 5
Quanterix (QTRX) will report on Wednesday and we’re hoping the event will inject some life back into this stock, which has pulled back mightily from its June high of 36. Analysts see Q3 revenue up 19% and an EPS loss of -$0.46. For the full year revenue is seen up 25%, to $50 million, and an EPS loss of -$1.78 is expected. As I said last week, Quanterix is underfollowed, and management sees revenue growing closer to 40% for the next couple of years! So there’s a little disconnect between consensus estimates and what management has said. It’s a great story, just nobody knows about it (yet). HOLD HALF
Announced earnings date: Wednesday, November 6
Q2 Holdings (QTWO) reports next Wednesday. I’ve had the stock at buy since it’s more than 20% off its highs and I see revenue growth accelerating. With the addition of the commercial lending solution Precision Lender acquired recently (the biggest acquisition in Q2’s history) forward growth estimates should go up. In terms of consensus, revenue is seen up almost 30% this year and 23% in 2020, with EPS dipping this year (to -$0.13) before bouncing back to $0.38 in 2020 (up 192%). On the call we’ll be looking for more insight into Precision and other thoughts from management on broader M&A activities. BUY
Announced earnings date: Wednesday, November 6
Rapid7 (RPD) clawed back to near its October high this week. We’ll get a report on Tuesday. Analysts see revenue up 29% to $80.2 million and EPS of -$0.02. For 2019 look for revenue to climb 33% and for the first year of positive profits (EPS of $0.05 expected). Hold into the event. HOLD
Announced earnings date: Tuesday, November 5
Repligen’s (RGEN) reported yesterday morning and I detailed the report in a Special Bulletin. It was good, and Repligen stays at buy. BUY
Earnings: Done
Veracyte (VCYT) reported last week and was moved to hold after the event given that the stock fell down below 22. The report wasn’t awful, and shares have bounced back a little this week. It should be fine long term, but we don’t have a lot of room to play with here so I’m keeping Veracyte at hold until it gets back into the mid-20s. HOLD
Earnings: Done
Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.
The next Cabot Small-Cap Confidential issue is scheduled for January 3, 2020.
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