The market has been iffy since Fed Chair Jerome Powell’s “prepare for pain” speech at Jackson Hole last Friday.

With interest rates up and (most) stocks down since I’m going with a high-quality name this month.

This healthcare specialist just posted 44% growth in Q2 and has grown its covered lives by 80% over the last 12 months. It’s profitable, and with a bucket of new contracts in the first half of 2022 the business looks set up for a terrific 2023.

Enjoy!

Cabot Small-Cap Confidential Issue: September 1, 2022

The Big Idea
The U.S. healthcare system is broken.
That’s the gist of a now famous book by well-known strategy guru and Harvard Professor Michael Porter.

In 2006 Porter and Elizabeth O. Teisberg co-authored, “Redefining Health Care Creating Value-Based Competition on Results”. That book is reshaping how healthcare is delivered in the U.S. today. And it lays out the foundational concept and solutions that gave rise to the company we’re adding to our portfolio today.

The point of the book is that the U.S. healthcare system, which is based on traditional fee-for-service (FFS) reimbursement models, is dysfunctional.

Providers compete on the wrong things at the wrong level. As a result, the U.S. spends more per citizen than any other nation, and gets worse health outcomes in many areas.

Porter and Teisberg argued for a new, simplified delivery model that would do away with the expensive, complex and failing system that has evolved since the middle of the last century.

They suggested a much simpler and seemingly obvious model: restructure healthcare to deliver value for the patient.

To do this they argued healthcare delivery must be organized around medical conditions, must accurately measure outcomes that matter to patients, and should measure the cost to achieve those outcomes.

Payment rates should be a function of value, not volume.

And healthcare networks need to deliver the right services at the right location and with the right professionals.

To make this new value-based care model possible an integrated information technology platform is needed.

Porter and Teisberg’s vision has gained a loyal following. It’s estimated that 20% of the $4.1 billion spent in the U.S. healthcare market in 2020 was tied to value-based care models.

And it’s continuing to grow due to price pressures from the failing FFS reimbursement model and from support from the Centers for Medicare & Medicaid Services (CMS).

That said, the transition is only possible because of innovations in technology, software and data. This infrastructure powers the integrated technology platforms that tie a value-based healthcare network together.

Today’s portfolio addition is one of the leading providers of this type of technology infrastructure.

The Company
Evolent Health (EVH) develops clinical and administrative software solutions that help healthcare providers (health systems and physician organizations) and health plans (payers) shift to a value-based healthcare model.

Its solutions help providers and payers integrate healthcare delivery and financial responsibility. The end result is they’re better able to streamline operations, lower costs, improve quality and increase patient satisfaction.

Evolent was founded in 2011 and has been growing organically as well as through acquisitions. In 2020 the company began a modest reorganization campaign to shed non-strategic health plan businesses (i.e. True Health), refresh management and refocus on what it does best.

This reset appears to be paying dividends.

In just the first half of 2022 Evolent has announced 10 significant deals, worth over $110 million in 2023 revenue. That puts the company ahead of its full-year target of six to eight deals, with half the year still to go. Evolent has also closed a significant acquisition that should add another $170 million or so to next year’s revenue.

With revenue up 44% in Q2 and covered lives up 80% to 21.9 million, the trends are very strong. Revenue growth could approach 50% this year, and close to 30% next year.

There are likely to be more deals and/or acquisitions announced in the back half of the year too, implying that forward revenue could come in well ahead of expectations.

Moreover, there could be considerable upside in future years as these customers ramp up spending with Evolent.

The Platform
Evolent Health has three primary solutions: Evolent Health Services (EVH), New Century Health and Evolent Care Partners. The latter two are housed in the Clinical Solutions segment.

Evolent Health Services (EVH): EVH generates around 30% of revenue. It is an integrated platform for health plan administration and population health management. EVH helps providers and payers deliver better care in a cost-efficient manner. Solutions include health plan management (enrollment, billing, payment, sales, marketing, compliance, etc.), pharmacy benefit management, risk management, analytics, reporting and more.

EVH also includes the company’s proprietary Identifi technology system, which handles data digestion and EMR integration between Evolent and its customers/partners. Identifi is a cloud-based suite of applications that evolves to meet clinical, financial and operational requirements to deliver a value-based care model.

EVH is growing in the mid-20% range and covers 2.1 million lives.

Clinical Solutions: Clinical Solutions generates around 70% of revenue, covers 19.8 million lives and grew by more than 50% in Q2. The segment offers two solutions: (1) New Century Health (a.k.a. specialty care management solutions) and (2) Evolent Care Partners (a.k.a. total cost of care management).

New Century Health solutions were acquired in 2018 and have been expanded in the years since. It is a national population health business servicing Medicare, Medicaid and commercial members and helps them transition from an FFS model to a value-based model. NCH is largely focused on the oncology and cardiology markets. That said, recent investments (such as the Vital Health acquisition) are helping to diversify the segment. This is the fastest growing area of Evolent’s business.

Evolent Care Partners solution helps providers manage populations they are accountable for under value-based contracts with payers or ACO contracts with the CMS. This is mainly a performance-based service and seeks to reduce costs by identifying and managing high-cost patients through preventative care and other interventions.

Growth Initiatives
Add Covered Lives to the Platform: At the end of the day, more covered lives means more healthcare spend running through Evolent’s platform, and means more and larger contracts. At the end of Q2 2021, the company had roughly 21.9 million covered lives, an 80% increase over a year ago.

Add New Partnerships: In 2022 alone Evolent has already announced 10 new operating partnership worth roughly $116 million in 2023. This brings total partnership up to around 44. There should be more announced this year and into next year as well.

Acquisitions: Evolent is an active acquirer. The IPG acquisition (2022, surgical management solutions for musculoskeletal conditions) should add around $170 million in revenue next year while the Vital Decisions acquisition (2021, specialty care focused on end of life) should add around $40 million. Expect more acquisitions in the future.

Expand with Current Customers and Cross-Sell New Solutions: Current customers have more lives in geographic regions not covered with current contracts. These lives represent future potential revenue. Evolent also has the opportunity to develop new solutions that current customers need. A recent example is the expansion with Molina to cover three states with Evolent’s New Century Health Oncology Performance Suite.

Capture Value of Risk-Based Arrangements: The entire idea of value-based care is to reduce costs in healthcare and offer better care to patients. Evolent has the opportunity to capture some of that cost reduction by entering into risk-sharing arrangements.

Government-Driven Program Growth: Medicare beneficiaries have grown by 11% over the last five years. The trends indicate that government-managed lives will continue to grow and Evolent stands to benefit given significant exposure to Medicaid.

The Business Model
Evolent generates revenue from recurring, multi-year contracts, which give a good degree of visibility into the future. Over time the business should gain revenue leverage from fixed investments as more covered lives and revenue under management are added to the platform. Evolent should also gain profit leverage as new performance-based contracts in the Clinical Solutions segment begin with lower margins (mid-single-digit percentages) then mature closer to mid-teens percentages (for New Century Health) and roughly 35% (for Evolent Care Partners).

The Bottom Line
Evolent was hit by the pandemic and the sale of Passport health in 2020 obscured an otherwise solid business. In 2019 revenue grew 35% to $846 million but then grew by only 9% in 2020. In 2021 revenue shrank by 2% to $908 million (Passport had driven almost 20% of revenue).

The business is a lot cleaner in 2022. Revenue grew by 38% in Q1 and by 44% to $320 million in Q2, during which Clinical Solutions grew 57% to $228 million (71% of revenue) while Evolent Health Services grew by 23% to $92 million (29% of revenue). At the end of Q2 covered lives totaled 21.9 million, 80% more than a year ago.

At the current pace, and factoring in acquisitions, revenue should grow by nearly 50% to $1.35 billion this year. EPS has also begun to ramp as the business scales. EPS of just $0.02 in 2021 is seen improving to $0.35 this year.

Looking out into 2022, revenue is seen growing around 27% to $1.71 billion while EPS is expected to jump 83% to $0.64.

Evolent ended Q2 with $193 million in cash and cash equivalents.

Risk
Support for Value-Based Model Evaporates: The single biggest risk (while unlikely) is that the value-based reimbursement model begins to falter or support stalls.

Competitor Pressures: There are tons of players in the healthcare space and solutions are constantly evolving. Evolent will have to keep fighting to gain market share.

Loss of a Significant Customer: In 2021 Cook County Health and Hospitals represented 28% of revenue. Florida Blue Medicare and Blue Cross Blue Shield of North Carolina are significant customers as well. Losing any significant customer would represent a growth headwind.

Data Breach: Healthcare data is particularly sensitive and any loss of data and/or conviction in the reliability of Evolent’s platform could do significant reputational damage.

Competition
Evolent competes with both large and small companies that provide population health and data analytics, Accountable Care Organization (ACO) solutions and specialty benefit management solutions (especially in the oncology and cardiology markets).

The Stock
Trading Volume: EVH trades an average of 1 million shares daily.

Historical Price: EVH came public in 2015 at 17 and has been up and down in the years since. There were runs to around 27 in both 2016 and 2017 and shares almost touched 30 in 2018 but then the stock retreated into the single digits and was pummeled by the pandemic-induced crash. At the low in March 2020 EVH was a 3.5 stock. Shares have recovered to make new highs over the last two and a half years. The 2021 high of 34.6 was struck in October then EVH lost 38% as the market softened. A rally to 33 in February and March was followed by another 20% drawdown this spring. But EVH has been more resilient than most stocks and grinded higher in June and July as the broad market made its low. The all-time high of 39 was an intra-day, post-earnings pop on August 3. Since then the stock has drifted as low as 32.5 but for the most part has held up very well in the mid-30s.

Valuation: EVH trades with an EV/EBITDA (2024 estimated) multiple of around 18.5. That could get closer to a 22x to 25x multiple as we move into 2023.

Buy Range: Expect to buy in the 32 to 38 range in the near-term. We will likely keep at buy should the stock drift down to 30 (which would seem like a screaming buy), depending on broad market conditions.

The Next Event: Q3 earnings in early November

Updates on Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary
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.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for October 6, 2022.

About the Analyst

Tyler Laundon

Tyler Laundon is chief analyst of the limited-subscription advisory, Cabot Small-Cap Confidential and grand slam advisory Cabot Early Opportunities. He has spent his entire career managing, consulting and analyzing start-up and small-cap companies. His hands-on experience has taught Tyler that the development of a superior business model is the biggest factor in determining a company’s long-term success. Accordingly, his research focuses on assessing the viability of management’s growth strategies, trends in addressable markets and achievement of major developmental milestones.

Tyler’s small-cap portfolios favor a high allocation to stable, high growth companies, upon which he layers strategic purchases of higher risk, event-driven investments. He first began publishing his analysis of small-cap opportunities in 2009. Since 2012, he has led his subscribers into 10 doubles. Between 2012 and September, 2015 his small-cap recommendations generated cumulative returns of over 2,300%, including both winners and losers, and outperformed the Russell 2000 Index by an average of 28% per year.

Prior to joining Cabot, Tyler founded and operated a small business for 15 years. He then worked as a consultant for start-up technology companies, as well as Vermont’s largest health care institution. From 2009 to 2015, he was the chief analyst of growth stocks at Wyatt Investment Research, where his research spanned the full spectrum of the growth stock universe, from micro-cap start-ups to multi-national mega-caps.

Tyler holds a B.S. and MBA from The University of Vermont, where he graduated Valedictorian. He has been a long-time contributor to the Wall Street’s Best Investments, has been quoted by U.S. News & World Report, and has presented investing ideas and strategies for The Money Show and Bloomberg Markets LiveINSIGHTS.