Solskin
Shares of Evolent Health (NYSE:EVH) have seen a huge move higher on the back of a substantial deal. To judge the deal on its merits and figure out what the implications are going forward, I am going back to June when I concluded that Evolent Health saw healthy growth, but that was all about there was.
The value-based care provider is looking to drive benefits to both payers and patients, and while this still look enticing and growth was quite solid, no real profitability was shown by the business. Liking the growth (on a relative basis), I was fearful about the overall valuations given the lack of margins.
Establishing A Thesis
Evolent is a value-based care provider which provides technology-driven solutions for both health plans and providers, by improving health while cutting costs, benefiting all the stakeholders in the process.
The business generated $891 million in revenues in 2021, two thirds from clinical applications and the remainder from its Evolent Health Services, on which the company posted EBITDA of $66 million. The company posted a GAAP loss of $38 million, equal to $0.44 per share, hurt by an increase in the fair value of a contingent deal consideration and prepayment losses on debt. The company made a total of thirteen adjustments to arrive at adjusted profits of $0.02 per share, or a million. I am happy to adjust for quite a few items, but not for a $17 million stock-based compensation expense, among others.
88 million shares worked down to a $2.6 billion equity valuation at $30 per share, as the company operated a flattish net cash position at the time. Valued at around 3 times sales, the company was not really economically profitable, as the company guided for 2022 sales to rise to $1.15 billion with EBITDA seen around $85 million. Following a solid first quarter, the company hiked the full year guidance, now seeing sales at $1.185 billion and EBITDA at around $90 million.
In June, Evolent announced a deal to acquire IPG, a technology company which provides surgical management solutions for musculoskeletal conditions in a deal valued at $375 million, that is excluding an $87 million earn out. With $140 million in revenues, the company is valued at 2.7 times sales (based on the upfront price tag), as 20% revenue growth and $25 million in EBITDA looks quite strong (on a relative basis).
Net debt was set to rise to $465 million, with leverage ratios seen around 3 times, as real earnings were not seen here. The lack of earnings was really my problem with Evolent, as I am not happy to use the adjusted earnings numbers, with realistic earnings still not really existing.
An Update
Since urging a cautious stance at $30 by the end of June, shares actually moved up quite a bit over the past summer as shares hit a high of $40 in September. This was in part driven by M&A speculation in the field, as shares fell all the way to $22 in November, with shares now having moved up to $27 per share.
Momentum in the share price was driven by solid second quarter results, with revenues up 44% to $320 million. Adjusted EBITDA of $22 million was up 80 basis points on the year before to 6.8% of sales as minimal GAAP losses were still reported here. On the back of the IPG deal the company hiked the midpoint of the full year sales guidance to $1.34 billion, indicating that real growth was seen besides the impact of the IPG deal. Full year adjusted EBITDA is seen around $100 million, largely in line with expectations as well.
In November, third quarter results revealed that revenues rose as much as 58% to $353 million, with EBITDA of $28 million translating into margins of 8.0%. Based on the performance, the company essentially reconfirmed the full year guidance with respect to sales and EBITDA. Net debt came in at $255 million following the IPG deal, for a roughly 2.5 times leverage ratio.
With 100 million shares now trading around $25, the company is awarded a $2.7 billion enterprise valuation, equal to roughly 2 times sales of around $1.4 billion. Shares are trading at a huge 27 times EBITDA multiple, with no real earnings reported at the time.
A Huge Deal
By mid-November, Evolent announced that it has reached an agreement to acquire NIA (Magellan Specialty Health), the specialty benefit management company owned by Centene (CNC).
The deal is valued at $650 million, including a $250 million equity issue at $29.50 per share, as a 2023 contingent consideration amounts to a potential other $150 million payment, for a potential $800 million deal tag. NIA generates some $250 million in revenues and $50 million in EBITDA, as the total deal tag amounts to just over 3 times sales and around 16 times EBITDA, fairly in line with Evolent’s own valuation here.
The deal has some added benefits however, as the company expects the deal to generate $85 million in EBITDA through 2024, as the increased relationship with Centene should deliver in another $20 million in EBITDA at that point in time. The $400 million cash component makes that pro forma net debt will rise to $655 million, with pro forma EBITDA seen around $200 million over time, keeping leverage in line (albeit that leverage is higher in the near term) as projected synergies will take time to materialize over time.
With 8.5 million shares to be issued, the pro forma share count comes in around 108 million shares as shares did rise some $4 to $27 per share, adding more than $400 million in value in response to this deal, as the market clearly likes the transaction, and the deepened and more committed relation with Centene.
And Now?
Since June, shares are down some 10% as the company announced another substantial deal, one to which the market reacted in a hugely favorable manner. In the meantime, the company has seen accelerating sales momentum in the second and third quarter, albeit that still no real earnings are reported here.
Amidst all these developments, I see appeal increasing a bit, as the latest deal certainly looks interesting, but the issue is that there are still no real earnings to show for. This is what makes me still cautious here, albeit that I am happy to keep a close eye on the developments going forward from here.
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