Maksim Labkouski
Cano Health, Inc. (NYSE:CANO), which went public via a special purpose acquisition company (“SPAC”) deal two years ago, is one of the largest independent primary care physician networks in the United States, comprising 151 medical centers across 10 states. The company utilizes a technology-powered, value-based care delivery platform to provide care for 295,000 members. CANO predominantly enters into capitated contracts with the nation’s largest health plans to provide comprehensive healthcare.
The company generates predictable, recurring revenue based on a pre-negotiated percentage of the premium that the health plan receives from the Centers for Medicare & Medicaid Services (CMS). CANO’s contracted recurring revenue model rewards it for providing high-quality care rather than driving a high volume of services. CANO also provides practice management and administrative support services to independent physicians and group practices. The company has invested heavily in proprietary technology; its CanoPanorama technology-powered platform facilitates population health management, providing a competitive advantage in delivering superior clinical care. CanoPanorama integrates all member data into one consolidated and centralized repository and helps ensure that members receive the right care and physicians receive the right support using dynamic risk stratification and enhancing member engagement.
Large, integrated, technology enabled, value-based primary care networks are revolutionizing the health care industry, capitalizing on a massive white space, and taking share in a massive $356 billion total addressable market. The majority of the primary care provider landscape is comprised of individual practitioners, small physician groups and independent practice associations, which have a limited ability to invest in technology, preventive medicine and population health management strategies to proactively manage risk and improve care coordination. The U.S. spends more on healthcare per capita than any other country in the world, but its health outcomes are on par with or inferior to those of comparable nations. The current U.S. healthcare model has poor primary care access and experiences, as physicians incentivized to provide high quantities of procedures over quality of care.
In response to rising healthcare spending, commercial, government and other payors are shifting away from fee-for-service payment models towards value-based models that incentivize healthcare providers to improve quality and lower cost of care. The Health Care Payment Learning & Action Network, a group of public and private healthcare leaders, indicated a desire to move 100% of Medicare payments care. Health Care Payment Learning & Action Network, an active group of public and private healthcare leaders, indicated in October of 2019 its desire to move 100% of Medicare payments to value based care by 2025.
Medicare Advantage, a type of Medicare health plan offered by a private company that contracts with Medicare, is the fastest growing market in the healthcare industry serving seniors. The Congressional Budget Office projects that annual Medicare spending will increase from $830 billion in 2021 to $1.26 trillion by 2026. Within Medicare, Medicare Advantage membership is projected to increase its penetration of the Medicare beneficiary population from 42% in 2021 to over 50% by 2026. The shift toward Medicare Advantage is being driven partially by the quality and cost of value-based care relative to original fee-for-service Medicare. While CMS and Medicare Advantage plans seek value-based care providers to deliver care, few providers are able to fulfill this demand. The existing primary care infrastructure was not designed to provide the type of care necessary to provide massive improvements in cost and quality required by the health system. Hence technology enabled value-based primary care networks like CANO’s are thriving, and companies like CVS Health (CVS) and Amazon (AMZN) are scrambling to acquire large players at massive valuations.
The Primary Care M&A Frenzy And CANO’s Opportunity To Be Acquired
M&A activity in the primary care industry is surging. In July 2022, Amazon announced that it was acquiring 1Life Healthcare (ONEM) for approximately $3.9 billion. In September 2022, CVS announced that it is acquiring Signify Health (SGFY) for approximately $8 billion.
There are a plethora of major buyers and virtually no sellers of established primary care operators. On CVS’s Q1 2022 conference call, its CFO indicated, “We’ve evaluated a range of assets in and around the care delivery space. I will remind you most of these assets aren’t out for sale and so that dialogues start to process.” On CVS’s Q2 2022 conference call, CEO Karen Lynch, in response to a question specifically referencing the One Medical deal, stated, “We can’t be in primary care without M&A. We’ve been very clear about that.”
Before Signify Health was acquired by CVS, the WSJ reported that Amazon, UnitedHealth (UNH) and Option Care Health (OPCH) appeared to be in a bidding war for the primary care target. While the number of large acquirers in the space already vastly exceeds the scant number of established primary care operators for sale, the dwindling list of potential acquirees got even smaller last week when Oak Street Health (OSH) CMO Ali Khan, responding to takeover rumors, indicated that the company has no interest in a takeover. Khan expressed extreme optimism about the primary care industry and Oak Street’s growth potential. He said, “We’ve got a model that works, that replicates, that scales. We think we’ve got something really special on our hands. So we want to see that through.” Oak Street’s unwillingness to entertain a potential acquisition likely will further bolster acquirers’ interest in taking over CANO.
Activist funds have been salivating over the prospect of CANO being acquired given the massive disparity between its public market value and its value to a well capitalized acquirer. In August, Owl Creek Asset Management, L.P. wrote a public letter urging CANO to pursue a sale to a strategic buyer. Owl Creek argued that:
“CANO has consistently traded at a discount to its peers due to its SPAC heritage, its hybrid model (owned and operated medical centers along with affiliates), and heavy concentration in the South Florida market. One could argue for some discount due to one or more of these factors, but the valuation discrepancy between CANO and peers is highly punitive.”
The fund concluded that:
“If CANO had an enterprise value equal to three times this year’s expected revenue like Oak Street Health and agilon (AGL) do, or one similar to what Amazon is paying for One Medical, that would increase the valuation by more than $4.5 billion, equating to a share price of approximately $14.”
On September 22, the Wall Street Journal reported that Humana (HUM) and CVS were circling CANO, as “healthcare heavyweights scramble to snap up primary-care providers.” The Journal indicated that “the talks are serious and a deal to purchase CANO could be struck in the next several weeks, assuming the negotiations don’t fall apart.” CANO’s stock price surged to almost $10 by early October, when it was reported that CVS was in exclusive talks to buy the company. CVS was reportedly among several potential buyers, which also included Humana, weighing bids for CANO. In mid-October, however, Dealreporter leaked that CVS decided against pursuing a deal with CANO, causing the stock price to plunge.
CANO is arguably the most compelling acquisition target in the primary care space. Its valuation is orders of magnitude below those of its peers, it generates positive EBITDA, which will ramp significantly in 2023 as its rapidly growing centers generate strong comps and yield contribution margins that are far above its current 6.4% margin, it has a powerful technology and data platform that yields superior patient outcomes and satisfaction, and it has a fatigued shareholder base that is pressuring the company to sell.
So why did CVS back out of the deal? We believe that CANO was seeking an unrealistically high valuation. In the second half of 2021, Dr. Marlow Hernandez, CANO’s CEO, purchased well over 1 million shares of the company’s stock at prices as high as $11.99 in the open market. Since then, the company has grown revenue by 33%, membership by 40% and EBITDA by more than 200%. There has also been a frenzy of M&A activity in 2022, valuing companies in the space as high as 7X – 8X EV/Sales (which would imply a valuation for CANO of more than $35 per share). Hence it’s likely that Dr. Hernandez was seeking a massive premium to the $11.99 that he paid for shares in the open market. The plunge in CANO’s stock to $1.65 could ironically be the greatest gift to shareholders, as it may force management and the board to negotiate a price at which acquirers would bite. Even at an unjustifiable 20% discount to the price at which Amazon purchased EBITDA-negative 1Life Healthcare, CANO would be valued at almost $13 per share.
The following table demonstrates the degree to which CANO, which unlike most of its peers generates positive EBITDA, is undervalued.
| PRIMARY CARE COMP ANALYSIS | ||||
| CANO | OSH | ONEM | SGFY | |
| Market Cap ($bn) | 0.81 | 4.91 | 3.50 | 7.20 |
| Net Debt ($bn) | 0.89 | 0.43 | 0.04 | (0.13) |
| EV ($bn) | 1.70 | 5.35 | 3.54 | 7.07 |
| 2022 Revenue (E) ($bn) | 2.73 | 2.15 | 1.08 | 0.96 |
| EV/Revenue | 0.62 | 2.48 | 3.30 | 7.37 |
| 2022 EBITDA (E) ($bn) | 0.16 | (0.29) | (0.12) | 0.22 |
CANO’s Third Quarter Earnings Were Sorely Misconstrued
On November 9, CANO reported its Q3 earnings. While EBITDA for the quarter was up 211% year-over-year to $42 million, revenue was lower than expected, 2022 revenue guidance was trimmed to $2.7 – $2.75 billion from previous guidance of $2.85 – 2.90 billion, and 2022 EBITDA guidance was cut from $200 million to $150 – 160 million. The stock has since plunged by 51% after already having plunged by 65% in the month prior to the earnings release.
In Q3, capitated revenues per member per month, or PMPM, declined nearly 9% sequentially, driving most of the shortfall. This was primarily a result of revenue pressures from new members, who yielded lower revenue PMPM. Although the market perceived this as an ominous development, it’s a transient issue that is partially a function of CANO’s hypergrowth since 2021 and seasonality. New members pose a headwind to margins since they initially lack adequate medical encounters to advance risk score adjustments. Moreover, there was a lagged impact from lower encounter rates for new members in 2021 as a result of COVID-19. Also, Medicare Advantage PMPM generally declines over the course of the year, as new members join with less complete or accurate documentation. Seasonality will revert positively in early 2023, just as medical costs are coming down. It would be logical for an acquirer of CANO to consummate a transaction before this impending surge in EBITDA.
Importantly, retention rates and engagement scores are performing in line with historical trends and existing members are performing as expected, driving confidence that new patient risk score adjustments in the coming quarters will result in increased margins. Medical costs are coming down, and the massive cohort of new members since 2021 will yield much higher PMPM. At the same time, the company is slowing new center growth, cutting poorly performing affiliates for Medicare Advantage and Medicaid, and negotiating more favorable payer contracts. All of these factors are likely to contribute to a surge in 2023 EBITDA. CANO’s operating leverage is extraordinary, as the company’s hypergrowth in new centers since 2021 mean that membership can more than double without a single additional exam room. Since maintenance CAPEX per existing center is only $50,000 annually, the impending surge in EBITDA will yield material positive free cash flow.
The market is also misconstruing CANO’s liquidity position, yielding illogical concerns that the company may have to consider a dilutive equity offering. CANO’s Q3 10Q, however, states:
“We believe that our cash, cash equivalents and restricted cash along with our expected cash generation through operations and revolving line of credit will be sufficient to fund our operating and capital needs for at least the next 12 months.”
While investors and analysts have expressed concern about CANO’s meager $24 million cash balance, they are missing a hoard of additional sources of non-dilutive liquidity. CANO has $92 million of net receivables and a $120 million available balance on its revolving line of credit, implying available near-term capital of well over $200 million. Moreover, approximately 97% of CANO’s long-term debt matures in 2027 and beyond. Without any material risk of a liquidity crunch or a dilutive equity offering, CANO has become a nonsensically cheap, long-duration call option at its current share price.
Risk Factors
CANO has been shunned by Wall Street, and there is the potential for this paradigm to continue. As Owl Creek Asset Management indicated in its August letter, the company’s SPAC heritage, hybrid model and heavy geographic concentration have resulted in the stock trading at a significant discount to peers. With the recent disappointment in Q3 earnings and 2022 guidance, CANO is in the doghouse, and the burden of proof is on the company to disprove the market’s skepticism. The management team is perceived as an impediment to shareholder value creation despite having consistently crushed the expectations set forth when the company went public.
Conclusion
Given the plethora of acquirers in the primary care space and the dearth of sellers, in conjunction with management’s openness to exploring strategic options to create shareholder value, we believe it is likely that CANO will soon be acquired at a massive premium to its current share price. Humana is arguably the most likely acquirer, as the health insurance company is accelerating its investments in primary care centers and already has an established partnership with CANO. We believe that CANO could be valued at more than $16 per share in a sale (implying a comparable multiple to that paid by Amazon for 1Life Healthcare). Though Dr. Hernandez likely has a more ambitious price tag in mind given his aggressive open market purchases near $12 per share, CANO’s sagging share price and building activist pressure from funds like Third Point Management and Owl Creek will likely either force him out of the company (opening the door to an expedient sale) or coerce Cano Health, Inc. to accept the highest offer in this unique window of exploding primary care M&A activity.
Be the first to comment