LifeStance Health: Several Hurdles To Overcome To Re-Rate

Investment summary

As the prevalence of mental health statistics continues to rise, there’s good scope to explore the range of selective opportunities operating in the space. Here we turned to LifeStance Health (NASDAQ:LFST) to investigate its prospects of a turnaround in share price following a fairly abysmal year on the charts. The stock is trading 54% to the downside across the past 12 months of trade, despite the broad market’s several relief rallies across this time. Here, I’ll be discussing our findings from the LFST investment debate, demonstrating that the company still has several hurdles to overcome before commanding a re-rating to the upside, or justifying its inclusion into equity-focused portfolios. Net-net, we rate LFST a hold on a $4.22 valuation.

LFST 18-month price evolution (weekly bars, log scale)

Potential mid-term growth lever – CEO change

Effective from September 7th, LFST appointed a new CEO and Chairman, Ken Burdick. With over four decades of experience in the healthcare industry, Burdick has the potential to bring a wealth of knowledge and expertise to the company. Previously, he served as Executive Vice President of National Markets and Products at Centene (CNC), leading all health plans before retiring in 2021.

Prior to that, he held the position of President and CEO at WellCare, eventually overseeing its acquisition by Centene in 2020. Burdick has also held various leadership roles at UnitedHealth Group (UNH) and Cigna, including serving as CEO of UnitedHealthcare. In addition to his work with LifeStance, Burdick currently sits on the boards of several healthcare companies and recently concluded his term as national Board Chair for Big Brothers Big Sisters of America.

Burdick was active on the Q3 earnings call. In his opening address, he mentioned several focus areas for improvement. In particular, he noted:

“It is clear to me that we’re not performing to our full potential. In taking on leadership of LifeStance, I am laser-focused on execution, profitability and operational excellence. This will be our formula for long-term value creation. Since joining the company in September, the leadership team and I have been working through our strategic planning process. We will provide an update on our multiyear targets and deliver guidance for 2023 during our fourth quarter earnings call.”

Looking at LFTS’s balance sheet, it reported total shareholder equity of $1.53Bn in Q3. However, a bulk of the gross asset value making up the value of equity is from non-tangible sources. Specifically, $1.25Bn in goodwill (a non-cash, non-amortizable ‘asset’) and another $272mm in intangibles. Alas, tangible book value of equity for shareholders is a meager $14.6mm ($0.04/share). As to what impact Burdick will have directly on the LFST share price remains to be seen, however, we’d opine this is a meaningful step forward to create additional tangible book value for the company moving forward.

Q3 financial results indicative of areas needed for change

Switching to the company’s latest set of numbers (reported in November), we’d note there were mixed results throughout the P&L. We saw that it reported revenue of $218mm, a 25% YoY increase, underscored by a 24% growth in clinician numbers. However, this was lower than expected.

Center margin of $60mm rose 16% YoY, due to revenue growth, but was offset by increased center occupancy costs. We’d also note the company saw a 70bps impact to center margin due to the lower-than-expected revenue clip and surge in labor costs experienced in the broad healthcare sector. In spite of this, it saw some leverage at the G&A line of ~95bps YoY on adjusted EBITDA growth of 44% YoY to $15mm.

The company exited the quarter with $90mm in cash and net long-term debt of $212mm, but only generated $6mm in quarterly CFFO. It also realized a free cash outflow of $9mm, although this is an improvement of $9mm sequentially. The savings stemmed from lower CapEx that resulted from planned moderation of its de novo center openings. However, it’s the return on invested capital that counts with FCF, and LFST has yet to demonstrate profitability at this level.

Looking backwards, you’ll note that LFST’s quarterly revenue clip has continued on a steady ramp, and this is something to factor into the investment debate. It provides a reasonable bedrock from which the company can work from, whilst core EBITDA has been tracking higher since FY21. Should LFST keep this ramp on revenue growth at the current pace, it will be one reason to remain constructive on the stock.

Exhibit 1. LFST quarterly operating walk-through since IPO (revenue, core EBITDA)

In our opinion, it wasn’t too much of a surprise to see management downgrade both Q4 and FY22 guidance following its Q3 results. It now expects revenue to range between $215mm-$220mm, and center margin of $55mm-$58mm on adjusted EBITDA of $7.5mm-$10.5mm. For the full year, it narrowed guidance to $850mm at the upper end of the range, projecting adjusted EBITDA of ~$53mm on that amount.

The tighter growth assumptions are built on LFST’s expectations for lower predicted visit volume and further labor inflation into the new year. You can see the list of consensus bottom line estimates for LFST into FY24 in the chart below. Whilst there’s notable growth projected over the coming 2-years, we’d also advise that LFST has a large hurdle to overcome in order to regain investor attractiveness, and EPS upsides mightn’t be enough to get there.

Exhibit 2. LFST consensus EPS assumptions FY22-24′ (quarterly)

Valuation and conclusion

It’s first worth noting that consensus also has LFST priced at 37x forward EBITDA and 2.3x forward EV/sales.

Moreover, the stock trades at 1.16x book value. However, as mentioned, a large portion of LFST’s asset value is tied up in goodwill and intangibles. Plus, at negative 18% trailing return on equity (“ROE”), this doesn’t appear as attractive on face value.

We also have downside targets to $3.60 on our point and figure studies, as seen below (Exhibit 3). LFST recently took out the $4.60 downside target shown below as well.

Exhibit 3. Downside targets to $3.60

Looking at market positioning in LFST, we noted the option chain for contracts expiring April FY23′ is stacked on the calls side, with strike depth ranging from $2.50 to $17.50. Curiously, the bulk of open interest is skewed to the $17.50 strike volume. This could mean investors are speculating on a rally to this level, or it could mean investors are hedging their short exposure to the stock. Noteworthy is that short interest is currently at 12.5% for this name.

Exhibit 4. LFST options chain stacked towards calls

Meanwhile, the stock is rated at an average grade using Seeking Alpha’s quantitative factor grading system. Where it is most attractive on face value is in the growth segment, which is a point for consideration. Rolling the company’s FY22 adjusted EBITDA assumptions of $53mm to the consensus forward EV/EBITDA multiple of 37x derives a price target of $5.22 apiece, a negligible portion of upside potential from the current market price. This also confirms our neutral view.

Exhibit 5. LFST Seeking Alpha quantitative factor grading