PFMT- Performant Financial

[AgentSmith]

PFMT: Boring Business but a Diamond in the Rough

PFMT- Performant Financial

Overview:

 

PFMT is a technology-based provider of audit, recovery, payment accuracy, coordination of benefits (COB), and outsource services in the United States.  PFMT solutions analyze claims and identify, prevent and correct inaccurate payments. Using their proprietary analytics platform and industry expertise, PFMT helps to reduce losses on billions of dollars worth of improper healthcare payments, state/federal/and treasury tax delinquencies, defaulted student loans and other receivables.  Primary customers include government commercial health plans, CMS, Blues plans, regional Insurers, private/commercial programs, etc that operate in complex and highly regulated environments that rely on PFMT's innovative and disruptive approach. Revenue is generated based on a percentage of validated recoveries for clients. Contracts are negotiated on case by case basis, fees may range from 10-30% of recoveries and the duration of contracts may last 3-5 years+.  These are high margin, recurring revenue contracts, expected to provide multiple years of prolonged double digit growth.

 

This is not a sexy business, quite boring in fact. However, a good investment should be boring. Hopefully you will appreciate the new path management has coursed, and see the potential upside in this turnaround story.

 

Historically, PFMT was known for it's legacy business as a collection agency for student loans, federal/state tax delinquencies and other receivables. Since the taking over of student loan originations by the Federal government a decade ago, PFMTs student loan collections have seen a diminishing contribution to revenues over time. Currently, the student loans collection business accounts for about 22% of revenues. While Other legacy collections still account for about 26% of revenues. Growth in Other legacy collections has remained relatively flat over the years. A smaller business segment derives marginal revenues from first party call centers and licensing of hosted technology solutions to clients.  The diamond in the rough refers to PFMT's up-and-coming healthcare business segment, composed of claims auditing and eligibility reviews. After seeing losses in 2018/19 due to high ramp up costs and standard implementation time lags, this segment  appears to finally be set up for robust growth going forward.  Mgmt has been clear that from 2017-2019, adjusted EBITDA has witnessed a slowdown to reflect a period of transformation in the company to establish itself in the Healthcare space. Management has confidently reiterated their belief in successfully reaching  a 2021 goal of achieving $200M revenue with 20% EBITDA margins, with double digit growth continuing for years to come.

 

Covid-19 Impact:

 

This year was shaping up to be a strong year for PFMT, as Q1 showed promising results that validated the new trajectory of the company. Unfortunately, Q2 and Q3 were impacted by the public health emergency related to Covid-19. The CARES act brought changes that affected the student loans collection segment. Student loan payments, interest accrual and involuntary collection of payments (wage garnishments) were originally suspended till September 30, 2020 but were extended till December 31, 2020. However, PFMT continued to generate student loan revenue for a number of months from existing in-process borrow rehabilitation agreements. Another impact of Covid came from existing healthcare audit customers, that requested a short-term pause on PFMT activities. Mgmt has indicated these pauses have largely ended during the third quarter. To mitigate the impact of this temporary slowdown, mgmt had furloughed more than 500 employees which could result in savings of about $18 million. The company is now aggressively ramping up efforts (including hiring/recruiting). Mgmt anticipates the ramp up efforts to be properly reflected in revenue by Q1 of 2021.

 

 

Healthcare Business:

The healthcare platform has finally reached scale, accounting for the largest (and continually growing) contribution to PFMTs revenue. In Q3, the healthcare business generated $17.6M in revenue  (48.5% of total revenues). That is a 20.5% increase on sequential basis and a 63% increase from the same period last year.

Healthcare revenues over last 11 quarters:

Q3 2020= $17.6M

Q2 2020= $14.6M

Q1 2020= $17.5M

Q4 2019=$14.3M

Q3 2019= $10.8M

Q2 2019= $9.3M

Q1 2019= $9M

Q4 2018= $9.9M

Q3 2018= $6.6M

Q2 2018= $6.1M

Q1 2018= $3.5M

This segment will continue to grow as Mgmt has made it clear this will be a main focus for the company. Soon healthcare will be the primary source of revenue (50%++), leading to a market multiple re-rate.

 

Macro:

The macro environment indicates there should be tailwinds for the audit, recovery, payment accuracy and coordination of benefits outsourcing business solutions PFMT provides. According to the CMS, national healthcare expenditures are forecast to grow at 5.4% CAGR for the next 8 years. Reaching  $6.8T by 2028. Despite efforts to reduce the amount of improper payments, error rates in the industry range from 6% in commercial to 14.9% in government plans. Healthcare spending growth is driven primarily by a combination of increasing enrollment and cost inflation. Given the current unemployment environment, we are witnessing a spike in Medicaid enrollment, which should continue to benefit the business via rising utilization and claims volumes. It is useful to note that there can be a lag of several months between Medicaid eligibility and resulting claims volumes. This indicates that a majority of the benefits from the current environment are still to come. Also, as private organizations and state governments are struggling with lower revenues and budget deficits, this could create an increased focus on cost containment strategies where PFMT could play a supporting function. PFMT mgmt sees a $200B+ healthcare TAM growing annually.

 

Healthcare insurance payments explained

 

Claim Submissions (Steps 1 + 2): After treating a patient, the healthcare provider submits a claim for reimbursement to the health insurer. The claim will include information on the diagnosis and treatment/procedure

 

Claim Adjudication (Step 3): The health plan conducts administrative checks (eg. validates provider information and patient eligibility/ coverage) and prices the claim using the providers contract/ fee schedule.

 

Pre-payment Review (Step 4): The payor will leverage internal tools, followed by third party/outsourced solutions (ie. PFMT offerings) to conduct payment accuracy analysis prior to payment. Errors (discrepancies between the submitted claim and the payors payment policies) are identified and corrected.

 

Claim Payment (Step 5 + 6): The health plan will reimburse the provider for the patient care and services rendered

 

Post-payment review (Step 7): The payor will again use internal tools, followed by third party solutions (PFMT) to evaluate prior payments with additional information that has become available (eg. clinical reviews). Payors will correct

 

Competitors:

PFMT differentiates itself with its proprietary technology and customizable approach to each of their customers' needs. The space is mostly dominated by large, slow moving players, that lack flexibility and uniqueness in their approach.  Major competitors include HMS Holdings Corp (HMSY-US, ~~$3B mkt cap) and Cotiviti (acquired in mid-2018 for $4.9B). Contracts in this industry are limited, take time to implement and can last years. PFMT continues to build a moat around it's business by consistently winning, maintaining and being awarded new contracts. An example includes being re-awarded CMS recovery Audit Region 1 and being awarded the newly created Region 5. Thus successfully showcasing PFMTs superior product and path to success in this space. PFMTs will continue to encroach on incumbents' healthcare market share as the market begins to realize the superiority of their technology and approach. 

 

 

Debt:

On Aug 2017, PFMT entered a credit agreement with an existing shareholder and customer, ECMC. As of September 30, 2020 PFMT has about $62M loan outstanding under this credit agreement.  ECMC has been able to accumulate about 5.8M warrants in PFMT as part of the agreement (about 10% of outstanding shares) all at an average exercise price of $1.95.  The effective interest rate was about 13.9% in the 1H 2020. The loan is classified as a current liability, with maturity in August 2021. However, PFMT has two one-year options to extend maturity.

 

PFMT currently (as of Sept 30,2020) has about $17.3M cash and equivalents on hand and is entering a period of FCF generation.

 

The current low interest rate environment offers low hanging fruit for companies looking to refinance their loans at a lower rate. Reducing their loan rate to 5-8% could save up to $5.5M in annual interest expense.

 

Timing/Technicals:

As the calendar approached their earnings announcement date (Nov 11), PFMT stock was trading around recent highs of $2. The stock started selling off aggressively into the earnings and significantly further following earnings (despite a very positive release). The selling pressure appears to have been caused by portfolio management layoffs at Invesco, a top holder. Public disclosure of these layoffs coincides with timing of initial selloff, and a recent 13G filing confirms the exited position. This should quell any fears holders and followers of this stock may have had, as the selling was not based on fundamental flaws in the company or a new short thesis. Invesco owned about 18% of PFMT. Following the recent pressure, it appears the stock is in extremely oversold territory. Since their exit, the average volume profile of the stock has improved significantly, making accumulating a position easier for both retail and institutional demand.

 

 

Valuation:

The timing of Covid partially contributes to why the market overlooked this stock, as Q2 and Q3 earnings were impacted. To establish a fair EBITDA estimation for 2020, we will use Q1 results with a conservative bias. Q1 is most appropriate because it will give us the clearest picture of how the company was performing prior to the temporary impacts of Covid. Using Q1, EBITDA was $6.4M (after deducting stock compensation).  Annualizing that amount will give us an EBITDA run rate of $25.6M. This is a conservative measure because we do not account for the impact of any potential interest rate savings or growth in the healthcare segment. Next we need to establish the enterprise value (EV= debt + mkt cap - cash). Which we use to calculate EV/EBITDA.  Calculation below.

 

EBITDA= $25.6M

Enterprise Value (EV)= $62M (debt) + $41 (mkt cap) -$17.3M (Cash) =  $85.7 M

 

EV/EBITDA= 3.3X

Fully diluted share count of 59.7M o/s

Now lets take a look at some Healthcare IT comps. The first 7 are general comps, the bottom 3 are the most similar comps to PFMT. To clarify, HMSY is currently publicly trading and is a direct competitor to PFMT. In December 2019, HMSY acquired Accent (a coordination of benefits/payments accuracy unit of Intrado focused on commercial and Medicare Advantage payers) for $155M. Accent had generated about $50M of revenue during the 12 months ending October 2019 (vs PFMTs $150M revenues in 2019). Based on the transaction price, HMSY paid an estimated 11-12X EV/Ebitda on a TTM basis.  COTV was acquired and taken private in 2018, it continues to be a direct competitor with PFMT. COTV operated in payment integrity and was acquired for $4.9B in mid 2018, an estimated EV/EBITDA multiple of 14-15X based on consensus 2019 estimates.  Also, keep in mind that the average EV/EBITDA for S&P companies in 2020 is about 14.5X.

 

Healthcare IT Peer Trading Comp Table

                        Mkt Cap SHARES O/S                    EV      EV/EBITDA

HMSY             2,793   88.6M                   3,021 16.8X

CHNG             5,581 304.5M                 10,237 11.2X

ACN                   173,423 661.1M               171,554 19X

ADS                     3,466   49.6M                 24,047 30.3X

HQY                     5,013     77M                   5,803 27.2X

IQV                   34,135  191.7M                 45,733 19.5X

CERN           23,727 306.6M                 24,167 14X

 

                                                                        Average: 19.7X

 

PFMT                      40.5   59.7M                         86 3.3X

                                          (fully diluted)

 

Most Similar Comps:

COTV                  4,900 (2019 est)              14.5X

Access                  155 (Acquired by HMSY in 2019)       11-12X

HMSY           2,793 88.6M                   3,021 16.8X

 

                                                                        Average: 14.3X

 

 

Best Case: Applying 14X multiple

EV= 25.6 EBITDA * 14 EV/EBITDA= $358.4M

358.4/59.7(fully diluted)=  $6 per share

 

Base Case: Applying 12X multiple

EV= 25.6 * 12 EV/EBITDA= $307.2 M

307.2/59.7= $5.15 per share

 

Worst Case: Applying 10X multiple

EV= 25.6 * 10 EV/EBITDA= $256M

256/59.7= $4.29 per share

 

 

 

The market still largely views PFMT as a declining student loans collections firm. Yet growing beneath the surface is an attractive healthcare business. As this segment continues to grow the market will recognize the high quality recurring revenue, ability to scale, and increasingly healthcare-focused pure-play as a catalyst for a multiple rerate.  Now using the comps above, I will provide 3 scenarios (best, base, worst case scenario) applying a discount to conservatively account for the micro-cap nature and higher leverage of PFMT. 

 

In the best case scenario, we apply a 14X EV/EBTDA ratio (rounded down from the most similar comparable peer average of 14.3X) which, on a fully diluted share basis, lead to a current price per share of $6.

 

In the base case scenario, we take a couple of notches off the closest peer average and apply a 12X EV/EBITDA ratio. Resulting in a current target price of $5.15/share

 

In the worst case scenario, we further take off two more notches from the most similar peer average to apply a 10X EV/EBITDA ratio. Resulting in a price of $4.29/share.

 

Also, considering the existing ownership of the company. Parthenon investors, Prescott Group, Mill Road Capital are all large shareholders. It is not unreasonable to think that they pursue a more aggressive activist role in the company and set it up for sale at a premium. It is also possible that competitors recognize the massive discount of this up-and-coming threat, and decide to acquire PFMT before other market participants drive up the price making such a strategic acquisition far more expensive. All of which offer upside to existing shareholders.

 

As we approach future quarters and results continue to support this positive narrative we should start to see investor appetite pick up for this name. Average daily volumes have quadrupled since Invesco's recent exiting has added to the freely trading shares, improving the liquidity profile of PFMT.  These signals will start appearing on investor screens as they (professional small cap investors, value investors, quant investors, generalists, hedge funds, etc) look for new ideas. There is virtually zero sell-side coverage of this stock at the moment, this will likely change in the future. Accumulating a position now, presents an opportunity for entry at basement level prices in a stock that has the potential to provide 500-700% upside.

 

 

 

 

Thank you for taking the time to read my idea. Full disclosure, I am long PFMT, i do not hold employment with the issuer.

 

Feedback and criticism of this idea are encouraged. Always do your own due diligence. Ive included the sources used for this analysis in the links below.

 

 

Sources:

https://www.performantcorp.com/investors/events-and-presentations/default.aspx

 

https://www.sec.gov/cgi-bin/browse-edgar?CIK=1550695&owner=exclude

 

https://www.cms.gov/Research-Statistics-Data-and-Systems/Monitoring-Programs/Medicare-FFS-Compliance-Programs/Recovery-Audit-Program

 

https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccountsHistorical

 

[DooDiligence]

Nice writeup.

 

I always wondered why many hospital bills are super inflated & then get resolved at significantly lower values.

 

Seems like it could be either the hospital billing department not knowing what the contracted rates are (unlikely) or an attempt to get more than the contracted rates through inefficiencies with payers.

 

Are these guys getting a slice off the difference between initial billing in the adjudication process? Or are the bills the public sees significantly higher than the ones that are actually sent to the payer?

 

What are the chances that payers start requiring billing departments to submit claims that more accurately reflect contracted rates?

 

Would this be a threat to claims adjudication recovery fee growth?

Not saying they'd go away, just maybe shrink a bit.

Could still make them a candidate for integration with a payer.

 

Keep in mind that I'm probably one of the least qualified individuals on CoBF to analyze a business and my questions have a high likelihood of being nothing.

 

I ask because this does seem interesting.

[WideMoat]

Thanks for the write-up.  The debt situation is the piece I would like more clarity on; they will need to refinance in the next year or two, what will the likely terms be?  If they could replace with longer term financing, that material risk dissipates.  Given that capital seems available now at attractive rates, why would management not sprint to lock it up?

[Cigarbutt]

Interesting idea. Thanks for sharing.

i am familiar with the area (healthcare related) through private ventures. The area i'm most comfortable with is related to utilization and bill review related to workers comp cases. The percentage of cost recovery shared with the client is potentially a very profitable area when dealing with inefficient systems. But i would say this is a people-to-people business and you have to understand the peculiarities and dynamics of specific markets. Also, a firm may have to adjust to various state or other jurisdictional levels of regulation. That may be some kind of barrier to entry (complexity) but it may not scale very well. So you have to understand the markets or have to be comfortable delegating this understanding to management. These markets may be 'boring' but are also fluid, tend to be very competitive (capital will eventually try to destroy pockets of profitability) and the ‘technology’-related barrier to entry tends to be very relative.

So, how do you assess the CEO and the healthcare VP? Wasn’t the CEO around during the time when legacy businesses did not really show impressive results over the span of a few years? Where’s the moat here? Is it only hoping that present trends continue without competition adjusting? Also, the potential for cost recovery tends to be more important in private commercial contracts vs CMS-related contracts. What’s the strategy there?

It’s potentially a good idea. If they can report a reasonably positive trend in cashflows, they could become a candidate for private equity which involvement, in this sector, has often resulted in short-term excessive cost cutting (and low investment in future maintenance of moat) in exchange for a short-term spurt in further ‘profitability’ before another exit.

There’s plenty of money to be made in the healthcare cost recovery (identification and actual recovery), at least for a while, but it’s an awfully competitive landscape at least in the pockets i know or understand. It may be different for PFMT but turnarounds are difficult.

I would spend more time on this if able to assess management’s ability to turn this around in a sustainable way.

-----

@DooDiligence

If you can stand more anecdotal stuff. Your questions are really relevant. When a different individual, i was involved in self-regulatory creative-billing control activities and that gave inspiration for profit-motivated private ideas as human nature tends to trespass natural rules, especially if allowed to, duality helping. In order to self-regulate, the ‘job’ was typically initiated and supplemented by the major payer. Given the nature of the ‘nationalized’ payment system (i’m not saying it’s better; this topic is left for the constructive political threads), no sophisticated analytical skills or advanced artificial intelligence were necessary (it was kind of obvious who was at risk anyways) and only basic statistical tools to detect deviance did the job. It was a high NPV proposition for the payer and it seems this is why it may be a reason to outsource at times. Also, on average about 2 to 5 times a year, i did not outsource to clerical staff (for a variety of reasons including an interest to try to understand the American health insurance system) the billing activity related to Americans with insurance visiting our soil and unexpectedly needing urgent attention. While communicating with commercial insurers, fees were progressively increased but never reached a ceiling..until a colleague eventually suggested to charge 10x the basic fee and to accept a 10% reduction or something and this worked quite well but I reckoned that there was a your-margin-is-my-opportunity moment there somewhere. The fee structure and system in place in your great country are not sustainable but have survived much longer than thought possible. And there seems to be very little appetite for meaningful reform so it may happen with a bang!                                                                                                                       

 

[keerthiprasad]

I recently exited my position in this company around $2 and have been adding on the way back down.  Definitely nice to see some increased liquidity.

 

Definitely a few levers to pull. Refinancing the debt should be #1. Divesting the legacy businesses would be nice, but doubtful it can happen at a reasonable valuation.

 

I can confirm that their RAC audit business is no longer stopped by COVID.

 

thanks for sharing your thoughts.

[AgentSmith]

As much as I would like to think that the prior write-up was a catalyst for PFMTs recent performance, the reality is that there have been some significant industry developments driving the recent movement in price.  This will be a short follow up summarizing the recent event and why I think it is important to the underlying thesis. Also, I will try to answer some of the recent questions that have been posed to me. Thank you to all who have engaged me. Hopefully we can continue this constructive dialogue around this investment idea.

 

On Monday morning (Dec 21), HMSY (a direct competitor of PFMT) announced it had agreed to be acquired by Gainwell Technologies for $3.4B. Gainwell is owned by the private equity firm Veritas Capital. In March 2020, DXC Technologies announced the sale of their Government Healthcare business segment for $5B in cash to Veritas which renamed this new segment: Gainwell Technologies. Prior to acquiring this segment from DXC, this healthcare business was generating $1.5B in annual revenues, growing double digits year over year with 20% margins (inline with industry standard and PFMTs 2021 margin goal). The transaction values HMSY at 16-17X forward 2021 EV/EBITDA.  From what I gather, this is above most consensus estimates but still seems to be a fair price. A reminder that Veritas also acquired Cotiviti (COTV) in 2018 at a slightly lower valuation of 14-16X EV/EBITDA. The willingness to pay a premium relative to their COTV recent transaction indicates growing opportunity in the space.

 

Veritas intends on breaking up the various HMSY segments and redistributing them among its portfolio companies COTV and Gainwell. COTV will take on the payment integrity and population health management business while Gainwell will take on the Medicade, Coordination of benefits/third party liability services business. Strategically, Veritas is able to secure HMSY's valuable set of data assets in the Medicaid market, and gaining exposure to the potentially higher EBITDA in 2021 due to the positive recent Medicaid enrollment trend. However, HMSY has been under pressure for failing to deliver predictable results and underperformance in some segments (particularly their population health management business). This inherent volatility in the revenue model is a burden on these companies (including PFMT) as it masks longer term growth and margin expansion potential.

 

Though FTC concerns don’t appear to be an issue. It is uncertain to me what this new Veritas combination will mean for their Medicare RAC regions. As HMSY has one region and COTV has two. I believe there is a program limit of two regions per vendor. This could prove to be an obstacle for the new entity.  Also the inherent culture clash in executing large mergers typically leads to significant employee turnover and loss of talent. In such a niche industry, I would imagine the labor market is tight and any brain drain could hurt the new entity. In fact, a basic linkedin search of these companies indicates a recent influx of talent from large competitors into PFMT. If industry incumbents, particularly experienced sales people, are realizing PFMT has a superior platform relative to the large slow moving competition then this should be another positive signal reinforcing PFMTs trajectory. Discount this as anecdotal investigative evidence but I think it has merit.

 

The continuing theme of consolidation in this particular area of Healthcare IT highlights the large market opportunity across cost-containment and solutions services.

Recent transactions:

Access acquired by HMSY in 2018 at 11-12X EV/EBITDA

DXC HC segment acquired by Veritas/Gainwell

COTV acquired by Veritas at 14-15X

HMSY acquired by Veritas at 16-17X

 

This all bodes well for PFMT, as it solidifies my view that this turnaround story is not being valued as an appropriate comp to its peers. If TODAY the market determines that HMSY is worth 16-17X EV/EBITDA, this supports my Base and Best Case Scenario of valuing PFMT using a 12X ($5.15/share) and 14X ($6/share) multiple, respectively (accounting for microcap nature and leverage by reducing the multiple by a few notches).  The recent price improvement in PFMT appears to be driven by a recognition of PFMT being undervalued on a comparable basis. Volumes have improved in the last few sessions but the stock is still extremely undervalued. Likely some retail investors accumulating entry positions. Imagine if a small fund of $100 AUM identifies this stock as an ideal investment, decides to initiate a small 200 basis point position. It would require 2-3M shares. The stock was up 20% today after trading only 1M shares, accumulating supply for a single fund position will require a significant movement in price. Given the current valuation, this opportunity could soon hit the radar screens of multiple funds. The recent string of transactions will continue to attract attention to this space. Sooner or later someone will start kicking the tires on PFMT...

 

 

Responses to recent questions and comments:

1. Is it possible that customers build/improve their internal tools to the point where they become threats to PFMT?

Good question. Customers may marginally improve their ability to audit claims internally but not to the point of being a threat. It's important to understand that the solutions/services offered by PFMT, HMSY, COTV, etc require technology- heavy platforms that require significant amount of resources (financial and intellectual) to develop, once developed there are minimal incremental costs for higher volumes. These types of commitments are not usually within the realm of possibilities among the customer base.  The ever-changing complexity around these types of industries makes in-house billing departments ill-equipped to maximize value relative to specialists like PFMT. An example to illustrate such complexity would be the ongoing changes in the International Classification of Disease codes (ICD). When the WHO decided to change the medical classification codes of ICD9 to ICD10, it increased the number of procedure codes from 13,000 to 68,000. This is just one example of the type of nuance that will always provide opportunity for specialist support from a PFMT.

2. Terms of the credit agreement and Why hasn’t mgmt refinanced the Debt?

For anyone eager to learn more about the terms of the Credit Agreement, i would advise you read the latest 10k (link posted in my original report). The 10-k is helpful in clearly outlining all details.

 

I think mgmt is working towards refinancing the debt. But these are not things that can be negotiated or arranged immediately. It is possible that mgmt wants/needs to have a certain number of consistent quarter over quarter improvement before they can renegotiate terms. In the current interest rate environment and following their recent turnaround progress, this low hanging fruit should be picked soon enough.

3.  Divesting legacy business?

I would not be surprised to see parts of the legacy business sold off as the focus turns toward the growing health care business. I will continue monitoring mgmt discussion on next earnings call for any evidence to support this.

4. PFMT is transitioning to focus on its healthcare business.

Some commentators have referred to PFMT as a pure-play student loans collection firm which would be a false description. Student loans do not account for a majority of their revenues and mgmt has made it clear their focus has changed towards a constantly growing healthcare industry.

 

5. Comparables mentioned are 100X larger than PFMT, why is that a fair comparison?

This is a reasonable observation. The answer to which is a function of numerous factors. The current market cap is significantly depressed as the popularity contest that IS the stock market is not identifying the value of this name. The stock was depressed further as a large holder just sold their 18% position, pushing the price near all-time lows. The huge gap in public market valuation is one of the reasons why this is a table pounding buy in my opinion. As this gap closes the difference in market cap will seem more acceptable.

Also, despite being small, the fact that PFMT is able to compete on the same level with these giants is a testament to its superior product and team: evidenced by their ability to secure two Medicare RAC region contracts (competing directly with COTV and HMSY), among other contacts won from incumbents.

6. What is the moat/"secret sauce"?

PFMT's disruptive technology in this context refers its ability to differentiate itself over the competition. Competitors have been using a "one-size-fits-all approach" to their customers. PFMT uses their proprietary software to scrape data and yield higher rates of potential recoverable claims. Their solutions are more client-centric than the competition. As a smaller player they can be nimble, providing customized solutions to fulfill each client’s needs. For this reason they continue to be rewarded with new contracts taken from large incumbents. See the recent presentations (on their website) for quantitative case study examples.

 

These contracts are difficult to win, have long term time horizons.  The technology to service customers is unique and initially capital intensive to establish. Barriers to entry are significant.

 

 

 

 

 

 

[AgentSmith]

More industry developments supporting $PFMT thesis:

 

Yesterday (January 6) United Health ($UNH) announced the acquisition of Change Healthcare ($CHNG). The transaction value of $13.8B, values CHNG at a 13X forward EV/EBITDA multiple, a 41% premium to the previous days close and a 98% premium relative to their recent IPO price of $13 in 2019. CHNG mgmt noted that the company was not up for sale, they only IPO'd in 2019 and were in near the end of an 18 month process of  restructuring their business, exiting underperforming assets/segments and repositioning their focus on long term growing segments (similar to PFMT's strategic turnaround story). However, the UNH offer was too compelling to turn down.  UNH recognizes the value of CHNG complicated businesses such as Payment Integrity, Cost Containment, Payment Networks, Data assets, among others.  So here we have another Healthcare IT firm being acquired in less than a month. We can compare the 13X multiple paid for CHNG to the recent HMSY acquisition (on Dec 21,2020) where Veritas paid a 16-17X multiple. The difference may be due to the complexity and diverse nature of CHNG's product offerings as well as $5 billion of debt on their balance sheet that weighed on the valuation relative to the HMSY transaction (no debt).  Given the list of recent HealthCare IT transactions, the market is telling us that a low-mid double digit EV/EBITDA multiple is the standard for companies in this space.  The frequency of transactions in this space over the last 18 months indicates that market participants see undervalued companies and are capitalizing on the opportunity through business combinations and takeouts.

 

Performant continues to grow it's healthcare business, quarterly releases in recent past have evidenced this trajectory. Future releases will prove to be catalysts confirming PFMT is a healthcare IT firm operating in the same industry and competing in similar segments as the firms mentioned above. Some critics point to PFMTs $62 M debt as a weakness. But as we read the terms of the credit agreement and look at the macro environment, it is easy to see that the terms are flexible and the opportunity to refinance more favorable terms is low hanging fruit. If CHNG with a massive $5B debt can be acquired at 13X multiple, then it is not unreasonable to apply a conservative base-case scenario of 12X EV/EBITDA to PFMT. Such a multiple equates to a $5.15/share price target (565% upside from current prices).

 

In a market where TSLA and bitcoin continue to make ludicrous all time highs, lacking any rational fundamental reason, PFMT continues to offer a compelling deep discount opportunity to participate in a budding Healthcare IT turnaround story that is backed by fundamentally sound operations poised to succeed within a growing industry.

[Samson]

First and foremost, I'm an noobie and still learning.  I've been trying to look for objective information regarding how Performant stacks up against its competitors, we are often told they do well by management.  I found information regarding RAC's on the CMS website.  Looking through the CMS Report to congress for 2018, it appears they do alright.  Has anyone else looked at this?  Information is obviously slightly dated.

 

https://www.cms.gov/Research-Statistics-Data-and-Systems/Monitoring-Programs/Medicare-FFS-Compliance-Programs/Recovery-Audit-Program/Resources

 

Key Points I see are

1) Appendix K, in 2018 they had a high rate of Improper payment identification

2) Appendix L, in 2018 looks like they had a hiccup in accuracy score for Region 1, but previously were very accurate

3) Appendix N, in 2018 they were middle of the pack regarding cases that were appealed (27.1% vs Covtiviti 24.5% and HMS 30.9%

 

Thanks for the discussion

 

[5xEBITDA]

How come your downside case is a 3.5x return?

[AgentSmith]

With Performant about to release earnings mid-March, I think now is a good opportunity to discuss the company again. This update is to emphasize the importance of PFMTs growing medical reimbursement business by clarifying the reimbursement process. Keep in mind as you read this that US healthcare spending was about $4 trillion in 2020 and is expected to be $6 trillion by 2027. Also, consider how quickly medical technologies are advancing. Imagine how digital multi-sensor contact lenses, 3D medical prosthetic/drug/organ printing, robotic surgery, new imaging tech, faster clinical trials, robot assistance, brain-computer interface and DNA customization will redefine our lives. The mass of adoption of such technologies will no doubt shock the bureaucratic coding, claiming and reimbursement processes of the world thus requiring companies like PFMT to provide dedicated expertise that in-house tools cannot handle alone. With ever rising healthcare costs in the US, reimbursement is only likely to increase in importance with the potential for a faster pace of change as well. Understanding reimbursement is a critical part of medical tech/IT investing. There are and always will be changing pressures on healthcare so it is safe to assume there will be ongoing change and nuance to this process. The US process is complex and the triggers that cause commercial/government payors to implement change are not well understood by in-house teams. Successful navigation of the reimbursement process in the US requires interactions with multiple large organizations including government regulators (CMS), large physician run societies and commercial insurers. All of which PFMT has existing contracts and relationships with. And like any other process that demands interaction with multiple large organizations: focus, persistence and having proper strategy is what matters significantly.

The first step in attaining reimbursement for medical service is to ensure appropriate coding. Coding is the standard cost identification system used by MCS, healthcare providers and third party payors and is the link between coverage an payment. The existence of an official code facilitated the entire process as it is a formal recognition system. A code does not guarantee reimbursement from a payor but it is a critical step in the standardized process. Coverage and payment for non-coded services is possible but that process is far more difficult, manual and time-consuming. Given the broad range of health-related events that might happen to a given patient, there are a vast array of codes and types of codes that exist to describe everything from where a procedure was performed (inpatient/outpatient setting or at home), who performs it (physician, nurse, tech) and the type of equipment/procedure involved (equipment, consumables or medical technologies). By analyzing these codes, payors are able to make informed reimbursement decisions based on symptoms of patient and procedures performed.

These codes can be broken down further into multiple categories, each with more complexity. For the sake of this piece, it is only important to understand that with such a complicated coding system doctors may be hesitant to use certain codes or simply may not be familiar with all the nuance, this raises concerns over whether or not they will be paid for the services provided. These concerns and natural ambiguity provides opportunity for PFMT to reclaim improperly coded services and collect a fee in the process.

In theory, you would expect experienced teams of large payors to understand all codes and handle them accordingly. In practice, payors can often be so inundated with new applications that they cannot fully and appropriately give fair and full reviews of claims so there is tremendous amount of leakage in the system.

Side note: This stock always starts to run higher into earnings releases. The last quarter had the unfortunate timing coinciding with layoffs and fund closures at top shareholder (filings confirm this). Hence there was selling pressure but not due to any fundamental reason related to PFMT operations. The stock is still trading at extremely depressed prices. In this market it should be trading at the best case scenario $5.15 per share. Investors will start to see the potential in this name and accumulate positions. Not only that, but from a broad market perspective, many sectors and particular names are getting to be at very overvalued frothy levels. It is not unreasonable to see a rotation out of growthy large cap tech names into deep value. Anyone shorting PFMT will get squeezed. It is still a relatively unknown name, this is a great entry point.

 

Please comment with questions and thoughts!

 

[AndreG]

Thank you for your presentation.

No questions have been asked in earnings calls since Q4 2019.

Therefore, we have no insight on the progress of the debt refinancing.

Do you have any insights on that?

Or is it possible for you to ask relevant questions in upcoming earnings call?

Thank you