This month’s Issue of Cabot Small-Cap Confidential features a newly public company that’s trying to do what seems impossible – make the healthcare system work better.
It’s essentially a big data software company for this highly complex market. But it has a services and consulting segment too that’s central to the growth story because so many clients need help getting organized before they can even implement a software system.
Revenue growth tops 30%. And the story remains relatively unknown. All the details are inside the December Issue of Cabot Small-Cap Confidential.
Cabot Small Cap Confidential 247
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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.
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.
Health Catalyst (HCAT)
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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
The market appears to be back in gear and this morning’s U.S. jobs report is giving stocks a little shot in the arm to end the week.
Speaking of shots … have you gotten your flu shot yet? My family did a few weeks ago. Then my wife came down with the flu this week. No matter how far we come with modern medicine, there is always going to be more work to do.
With that backdrop at home, a week of mostly single parenting under my belt, and the December Issue of Cabot Small-Cap Confidential wrapped up, I’m going to keep today’s updates as short as possible!
That said, see below for extended commentary on Domo (DOMO), which is up double digits after reporting last night, and Veracyte (VCYT), which closed an interesting transaction with NanoString (NSTG).
Changes this Week
Veracyte (VCYT) moves from HOLD to BUY
Updates
AppFolio (APPF) was moved to buy last week given the breakout to new highs. No news. BUY
Arena Pharmaceuticals (ARNA) is chopping around and moving sideways. No news. BUY
Avalara (AVLR) is also moving sideways. No news. BUY
Cardlytics (CDLX) has jumped 13% higher since last Wednesday’s close and is now up almost 70% since we got into it in September. No news. Keep holding. HOLD
Construction Partners (ROAD) is up 3% since last Wednesday’s close and is now up 15% since we jumped into it on November 1. Earnings come out next Tuesday. Analysts see revenue up 15% to $248.9 million and EPS up 17% to $0.34. Full-year 2019 revenue growth should be around 18% to $800 million and EPS is seen down around 12% to $0.86. We should get an update on the acquisition pipeline. Keep buying on dips. BUY
Announced earnings date: December 10
Domo (DOMO) released earnings last night that have sparked a nice relief rally. Shares have been up over 20% at times today and are up around 17% as of writing this. The headline is that revenue was up 21.5% to $44.8 million and beat by almost $3 million while adjusted EPS of -$0.85 beat by $0.16. Forward guidance was also better than expected. I listened to the conference call and the takeaway is that many of the deals that were slow to close last quarter have closed, and many deals expected to close in Q3 closed as well. Management remains committed to achieving cash flow positive status with the cash it currently has on the balance sheet but won’t put a date on it. Why? They want the flexibility to hire and press on the growth gas pedal as they see fit without being scrutinized because they put a date out there. Makes sense to me.
There were a lot of questions about the blend of enterprise-scale deals and commercial-scale deals and the punchline is it sounds like Domo is making progress in both markets. Six deals valued at over $500K closed, as well as a couple over $1 million. This is software for big-time operations and as management said on the call it often has to get approval from over a dozen departments in a client’s organization before closing the sale. That makes for a lumpy business.
When management was asked where they see the business tracking relative to their bullish outlook at the beginning of the year (when the stock was racing up toward 47, 50% higher than it is now) they said it’s looking slightly better than they had expected. They also said they think that in a year it will be talking about how many multi-million-dollar customers it has because that’s where they see the business tracking.
In short, some pretty bullish commentary. That’s part of CEO Josh James’ schtick though, so do take it with a grain of salt. That said, a number of analysts, while pointing out that deal lumpiness leads to unpredictability (i.e. what we’ve already seen and why the share price is all over the place) have upgraded the stock.
What do we do? DOMO is up today but we’re still down quite a bit. That means even a 5% or 10% move in the stock, from today’s level, won’t have a huge impact. If DOMO can close above 22.7 (the low from August) there is a much better chance that it can continue to trend higher. That said, this is a stock in which expectations were reset lower, so continued progress is necessary for a “comeback.” I say we continue to hold on and see what develops. HOLD
Everbridge (EVBG) hasn’t done much in the last week or so but management did announce two deal wins. The first is that Goldman Sachs will use Everbridge’s solutions to monitor operational risk, business continuity and employee safety events for people and assets all over the world. And the second is that Peru will deploy Everbridge’s countrywide disaster alerting platform to cover roughly 37 million residents and visitors. Both should be taken as evidence that the company is still executing well. BUY
EverQuote (EVER) was up another 7% since last Wednesday’s close on no news and is now up over 210% since we jumped into the stock in June. It looks like it keeps wanting to climb and if you want to peck away at a few more shares go for it. But I’m content to just sit back, watch and enjoy! So, I’m keeping at hold. HOLD
Goosehead Insurance (GSHD) dipped to the low end of its five-month trading range (near 40) recently, which might be influenced by some insider stock sales. Maybe founders Mark and Robyn Jones are buying a yacht for the family for Christmas? There is still a good chunk of this company that’s not owned by the public. As of the end of September Mark Jones and his family still owned 8%, while other management owned 57%. That leaves 35% for public shareholders, which means trading can by choppy at times. It will even out over time as more shares are distributed (note: insider sales are not dilutive to EPS). BUY
Inspire (INSP) is up 4% over the last week and up 28% since we jumped into it in October. No news. I like that the stock has broken out to new highs above 71. You can start to fill out your half position with additional purchases. BUY
Quanterix (QTRX) is moving sideways in the mid-25 area. No news. HOLD HALF
Q2 Holdings (QTWO) has pulled back a little from the 85 level it hit a couple weeks ago, but still looks good to me. BUY
Rapid7 (RPD) recently announced that its SIEM offering, InsightIDR, is available on Amazon Web Services (AWS) marketplace. No other news. BUY
Repligen (RGEN) keeps grinding higher. No news. BUY
Veracyte (VCYT) recently announced it has acquired an exclusive license from NanoString (NSTG) for the nCounter platform for diagnostic use, which should help Veracyte expand its genomic diagnostic business globally. The nCounter platform provides a simple and cost effective solution for multiplex analysis of up to 800 RNA, DNA or protein targets from samples, and Veracyte will begin by offering its Envisia classifier (for IDP diagnosis) as a kit-based test beginning in 2021. Next up should be the nasal swab classifier (lung cancer diagnosis) in 2022. Veracyte also acquired the NanoString Prosigna breast cancer prognostic test and the LymphMark lymphoma subtyping assay (in development). Key members of NanoString’s global commercial infrastructure team are coming to Veracyte too. The purchase price for all this was $40 million in cash and $10 million in stock, with another $10 million due upon commercial launch. Expected revenue contribution in 2020 is $6 million to $8 million. For context, expected 2019 revenue is $120 million, so this adds roughly 6%. Current consensus for 2020 is for 17% revenue growth, to $140 million, but that will surely change as we learn more about this transaction. On the surface it makes sense to me and should greatly help Veracyte expand. I’m looking forward to hearing more details. The stock has run back up to just shy of 30 with a breakout possible if VCYT jumps above 31.18. Let’s move back to buy and hope to catch that move before it happens. BUY
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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