Performant has just completed the final stage of its business turnaround, ready to gush cashflows. Curious to hear what people think here. Please help me poke holes in this.
Overview:
Under the radar turnaround story, winning contracts from mega-cap competitors, trading at a ridiculously cheap valuation, with 400% upside in short term, 800%+ long term.
Performant is a technology-based provider of audit and recovery services in the United States with a focus on the healthcare industry. Working with healthcare payers, Performant audits insurance claims to identify, prevent and correct billions worth of improper healthcare payments. A key to their success is the proprietary software that parses data far more efficiently than peers. Primary customers include government commercial health plans, CMS, Blues plans, regional Insurers, and commercial programs that operate in complex and highly regulated environments.
PFMT trades at a ridiculously cheap 1.25X EV/Sales, with potential to be an $8 stock within a few years. It was as high as $5 months ago. Within the last 4 years, all immediate competitors were acquired by PE at 5-7X EV/Sales. PFMT is an ideal private equity takeout candidate, who's largest shareholder is currently Prescott Capital- a well respected SMID investor known for surfacing value of its holdings. PFMT is Prescott's largest holding at over 10% of their fund. Another large sophisticated investor is Mill Road, which also has one of their executives sitting on PFMT's board . There are two large motivated investors in control positions.
Growth:
PFMT continues to grow healthcare revenues, with mgmt targeting $500-$700M of revenue within a few years based only on existing services and noting EBIT margins in the high-20s on a mature basis. Overall profitability has been masked by the need to invest upfront. Given the current EV of $150M and margins in the high-20s, this should be attractive to investors. Mgmt has indicated 2022 target healthcare revenues of $92-96M. 2021 saw record healthcare revenues of $77.5M. Since 2014 Healthcare revenues have come from $3.4M annually to a 2022 revenue guidance of $94M (51% CAGR).
The current revenue model is success-based, fees are generated based on a percentage of validated recoveries for clients. Services do not require significant upfront investments by customers, not reliant on their spending budgets, while offering the opportunity to recover significant funds otherwise lost. 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.
Debt:
On Dec 17, 2021, entered a credit agreement with MUFG Union Bank for a $20M term loan and $15M revolver. The agreement matures at the end of 2026. The $20M was fully drawn as of Dec 31,2021, used together with cash on hand and proceeds from a recent equity raise to refinance an old agreement- yielding savings of $8M in 2022 alone. PFMT currently has $16M cash on hand and $15M of the revolver untapped, thus in a financial position to control their own destiny.
Competition:
The industry is mostly dominated by two independent players with a number of other competitors already rolled up through consolidation. The major competitors, HMS Holdings Corp (HMSY-US, was acquired by PE for $3.4B in Dec 2020) and Cotiviti (acquired by PEin mid-2018 for $4.9B) are huge, lumpy, less integrated players that have grown through acquisitions. PFMT is proving itself as an up and coming, independent contender in the space, more nimble and with a higher audit hit rate than the competition. Over the past few years, PFMT has continuously won contracts away from large peers, establishing itself as a superior product with a sustainable advantage, as evidenced by their ability to dislace well-heeled incumbent providers of sophisticated clients.
Macro:
The macro environment indicates there should be tailwinds for the audit and recovery 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 21.7% in government plans. Healthcare spending growth is driven primarily by a combination of increasing enrollment and cost inflation. 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.
Catalyst:
The recent sell-off was started on the concern that the recently won RAC Region 2 contract would be lost to the incumbent, Cotiviti, following an immediate protest to the decision. First, the ability to win RAC 2 via competitive legal tender is a testament to PFMTs ability to outcompete massive existing players fo government contracts. Second, protests and delays are a common when it comes to government contracts. Especially when an incumbent loses, they almost always protest the award. Occasionally they are succesful and it has to be re-tendered for another round of bidding, but historically they lose the appeal. The time to complete an appeal is often longer than originally anticipated or guided by the government when originally announced. Cotiviti support department claims that the contract has only been extended until Oct 30,2022. The likely scenario is that the contract was extended so that the current incumbent can collect on claims that were frozen during covid/pandemic restrictions. November will see the contract re-awarded to PFMT, relieving this overhang. Lastly, the contract is not meaningful enough in the grande scheme to be worth this much selling pressure, as the real upside for PFMT is in commercial plan growth.
Conclusion:
Historically, Performant Financial was a legacy debt recovery company working on defaulted student loans, federal treasury and state tax receivables and commercial recovery. . As of 2021 mgmt has sold certain non-healthcare recovery contracts (proceeds used to deleverage) and have not renewed existing recovery contracts, nor pursued non-healthcare opportunities. They are now a pure-play healthcare company growing at a rapid rate, it's only a matter of time before they get takenout or get discovered by public markets closing the valuation gap with peers.
