Athenahealth: Impressive Company, Dangerous Stock

Athenahealth Inc. (ATHN) has quite an impressive business. The company has taken the “Software-As-A-Service” model and applied it to the healthcare industry. While medical technology has advanced significantly over the past decade, Carl Byers (athenahealth CFO) told IBD that few advances have been made in the area of business process.

That’s where athenahealth steps in. The company provides billing, collections and medical record management for physician practices. This service allows doctors to spend more precious time actually treating patients and less time trying to get paid for their service. Since medical billing is such a detailed and specific process, ATHN has a leg up on competition by bringing its expertise to the table.

In September of 2007, the company came public by issuing its IPO at $18. It nearly doubled on its first day of trading. Despite having very little to show in the form of actual earnings, the growth prospects for the company had investors very excited. The stock eventually topped out above $47 and spent the early part of 2008 trading back down nearly to its IPO price. The overall market climate has become somewhat hostile to growth companies and multiples on many strong businesses have contracted.

But over the past month, ATHN has bucked the trend. From a low of $19.19 in late November, the stock has rallied to over $37 - good for more than a 92% gain. Investors are no doubt encouraged by sales growth of 35% or more for the last four quarters and earnings growth of astounding proportions. As the market is so apt to do, the current price seems to anticipate these trends continuing into the foreseeable future.

One of the benefits of working with small numbers is that the percentages look quite impressive. When a small company turns from losing money to making a small profit, growth estimates can distort reality. For instance, if a company earns a grand total of $1,000 in a quarter (barely above break even) and then reports gains of $15,000 in the next quarter, can you really expect 1,500% increases over time? This is a ridiculous assumption, and yet one that the market makes about growth companies time and time again.

So it is with the utmost respect for athenahealth as a company that I suggest extreme caution when investing in the stock. In fact, it seems an aggressive trader could pick a good spot to short this name in the next few months. The fundamental earnings just do not support a stock price in the upper $30’s, and any disappointing news will likely cause a sharp drop in the price multiple. Please tread carefully when trading this stock.

ATHN Notes

Disclosure: Author does not have a position in ATHN.

Comments

[Dan Jacome:]

Interesting to be a contrarian, but you make no mention of what you think ATHN is worth, or the fact that ATHNs software accelerates the billing cycles for docs and that this will be important over the next decade or two as people over the age of 65 increase 50% (by 2020, most estimates) while the primary care physician base will increase by as little as 7% (some est. I have seen say 16%) – in other words, docs will be flooded for demand for services, there will not be enough providing for this demographic, and doctors will want to do whatever they can to get paid faster…rev cycle mgmt and its benefits are more palpable to a doctor, who typically only sees 11% fo the savings accrued through elect health records and ePrescribing. I always like your articles but other than telling us something that applies to all companies (growth off a small base), I don’t see why ATHN is a short

2008 Dec 29 08:22 AM

[Zachary Sch...:]

DAJ - to be quite honest, I didn't include an expected value for the stock because the price would be quite disturbing...

If you assume analysts are correct in expecting $0.77 in earnings next year, and you assign a healthy 20 multiple which accounts for the strong growth that you mention, the stock price could be expected at $15.40

Now I know this is a very rough back of the envelope valuation, but it shows just how vulnerable the stock price could be. In the article I mentioned how I respect the company's growth and the service they provide. But growth at any price makes for some risky investments.

Another issue that has not been brought up yet is that of competition. If the medical software business becomes a very large and profitable sub-sector, you can bet that Salesforce.com (CRM), and many smaller competitors will be on the scene driving margins lower and making for a more efficient market.

So unfortunately, I'm sticking to my assumption of a sharply dropping stock - whether it hits $15 is debatable, but at $35, I believe the risk is very high.

Thanks for the comment!
Zach
zachstocks.com

2008 Dec 29 10:59 AM

[Dan Jacome:]

interesting point, question is whether or not CRM can establish relationships with doc practices, which are very reticent to adopt tech to begin with....

2008 Dec 29 11:23 AM

[TraderMark:]

glad to see your view on this one - It just came up to me today while looking over QSII news - a quick search of SA shows a few articles to give me a quick overview in minutes.

Jan 06 08:46 PM

[Zachary Sch...:]

good deal Mark - always enjoy your opinion as well...

Zach
zachstocks.com

Jan 07 08:41 PM

[Dan Jacome:]

Excellent call, I was wrong and paid for it today....good work, Zach

Feb 27 01:12 PM