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ExamWorks (EXAM) is the largest player in the highly fragmented Independent Medical Examination (IME) industry. The only publicly-traded pure play, EXAM is relatively underfollowed and is in the early innings of a strategy that - when combined with tuck-in acquisitions - should prompt upside vs. Street profit expectations. EXAM recently traded at 11.8x consensus 2014 EBITDA of $98M, which I believe will prove conservative.

Company Background

EXAM is the largest provider of IME's in the country. IME's are conducted to verify the veracity of claims by sick or injured individuals, and are facilitated through the company's national physician network; the company captures a spread between what its clients pay to the company and what EXAM pays out to its contracted physicians.

EXAM was founded in 2007 and has grown rapidly - largely through M&A - to over $400M in domestic revenue. Although EXAM is the industry's largest firm, it captures only a small piece of a large pie; the domestic IME market is highly fragmented and generates an estimated $4B in annual revenue. EXAM's client base is entirely private pay (includes insurers and third party administrators) and as such, the business is attractive in that it is exempt from government reimbursement risk.

EXAM is not heavily followed, as only three brokers publish research on the company: Goldman Sachs, William Blair, and Credit Suisse.

Levered Up In Order to Build National Footprint

From 2008 through 2012, EXAM acquired 40 properties, several of which were overseas, and the largest of which was the domestic acquisition of MES in 2011 ($215M final acquisition price, including $175M in cash). I am not aware of any other IME vendor that approaches EXAM's scale, and there is no other publicly traded pure play. EXAM's debt to EBITDA ratio currently stands at 3.9x, not an unheard of level within healthcare services (and comfortably below the 4.75x ratio required by the company's credit facility). For example, in the first full quarter of Express Scripts results that included Medco Health, the company carried a debt / annualized EBITDA ratio of 3.1x. Catamaran Rx (formerly SXC Health Solutions) had the same 3.1x ratio following its acquisition of Catalyst Health.

Although initially disruptive to EXAM's results, the move to acquire MES was strategic. If another entity had acquired MES (for example, a private equity firm with a stronger balance sheet), EXAM may have faced substantially more competition as it pursued domestic and international acquisition opportunities.

With $40M in operating cash flow expected in 2013 (a welcome improvement over the $25M generated in 2012), the company appears to generate sufficient cash flow to cover its debt obligations, pay down its line of credit, and deploy towards capex requirements (currently a modest 1.1% of revenue). Although EXAM has a negative tangible book value, this is no more or less of a concern than it is for other companies with negative tangible book values (including Coca Cola Enterprises, Western Union, and Hertz).

Adjusted EBITDA Margins Set to Improve in 2013

Given the amount of non-cash expenses impacting EXAM's income statement (largely a result of the company's acquisition-related intangibles), as well as transaction and integration costs, EXAM provides an adjusted EBITDA reconciliation with each quarterly earnings report. This is no different from many other healthcare services companies (including CTRX, ATHN, MDAS, HMSY, PMC, TMH, and MDRX, all of which reconcile adjusted EBITDA or adjusted EPS to reported GAAP figures). After generating EBITDA margins of 15.3% in 2012, EXAM has operated at a 15.7% clip through the first half of 2013 and has guided to a range of 15.5-16.5% for the full year ($93.9M-$101.8M vs. current Street consensus of $91M).

National Account Strategy is Key to the Story

EXAM has estimated that it has 40 larger "national accounts" that average $25M in annual IME spend, distributed across multiple IME vendors. Assuming the company has only 25% penetration within these clients ($6.3M), a significant upsell opportunity remains within EXAM's current customer base ($18.7M per national account). That is to say, EXAM has nearly $748M (40 x $18.7M) in incremental revenue available to it from these accounts vs. its current revenue run rate of $624M. While it is unlikley that EXAM will capture each account at a 100% penetration level, even trimming these assumptions by 50% would paint a compelling picture of the company's upsell potential.

EXAM has begun efforts to attempt to capture an increasing percentage of this client spend, and has been rolling out its national account strategy to two early adopters (with a third recently announced on the company's 2Q conference call). To support these efforts, EXAM has maintained the MES brand separately, so that national accounts can contract with EXAM and yet still drive volume to two vendors (avoiding a perceived conflict of interest by contracting with a single vendor).

Assuming that the company can execute on this strategy, a case for upside can be made vs. street expectations. Specifically, I assume that by 2015, EXAM will have re-contracted with 7 of its 40 national accounts. Further, I conservatively assume that EXAM will only capturing two-thirds ($17M per account, or an incremental $11M of IME spend) of the potential IME opportunity through its ExamWorks and MES brands. Modestly growing the rest of the base at a low single digit clip - and assuming no additional acquisitions - I estimate $715M in 2015 revenue, $34M above Street consensus. Little SG&A spend should be required to capture incremental volume from existing national account strategies (EXAM is not going out an acquiring new customers); as such, this can be compelling from an EBITDA and cash flow perspective.

aAvg Spend on IME per Year per Lg Account $M$25$25$25$25 
b# National Account Clients40404040 
c# Re-contracted with natl strategy (avg in year)0247 
d# Under legacy contract (AVG)37383633 
ePenetration Level - recontracted Natl Accts 30%55%66% 
fPenetration Level - legacy national accts25%25%25%25% 
gRecontracted - revenue per (a x e) $M $7.5$13.8$16.5 
hLegacy - revenue per (a x f) $M $6.3$6.3$6.3 
jRevenue from recontracted natl accts $M (g x c) $M$0$15$55$116 
kRevenue from legacy national accts $M (h x d) $M$231$238$225$206 
mTotal natl acct revenue (j + k) $M$231$253$280$322 
nOther US revenue $M$90$124$131$136assume 5% growth
oTOTAL US Revenue (m + n) $M$321$376$411$458 
pCanada $M$28$30$33$36 
qUK $M$131$138$142$146 
tAustralia $M$22$67$71$75 
vTOTAL International Revenue (p + q + t) $M$181$235$246$257assume 5% growth
 TOTAL REVENUE (o + v) $M$502$611$657$715 
 Street consensus estimates $M $608$644$681 
 +/- Street $M $3$13$34 

Given the significant amount of noncash, non-recurring expenses that impact reported EPS, I prefer to value EXAM on an EV/EBITDA basis (rather than P/E). EXAM currently trades at 12.7x and 11.8x consensus 2013 and 2014 EBITDA estimates, respectively; since its 2010 IPO, EXAM has traded between 7.5x and 24.6x EBITDA, at an average multiple of 10.9x (according to Bloomberg). Although EXAM trades above its average 3 year EBITDA multiple, I view this as warranted, given its reduced reliance upon large M&A transactions, lack of government reimbursement risk, accelerating organic growth rates, and the company's continued share gain opportunities at the expense of subscale competitors. Additionally, management credibility suffered in the quarters that followed the completion of the MES acquisition, as the company struggled to execute as it digested its acquisitions, thereby compressing EXAM's multiple.

EXAM's 2013 EBITDA multiple is also below the 13.1x median multiple commanded by a peer group of 11 healthcare services companies. Assuming that EXAM can command a 12.5x EBITDA multiple against my 2015 EBITDA estimate of $117M as it exits 2014, and assuming net debt of $311M at the end of 2014 (I assume that the majority of FCF is deployed towards debt repayment), this equates to a share price of $33, or 43% above the August 16 closing price of $22.86.

Valuation Comps (as of August 16, 2013)

(Data sourced from Bloomberg; I normalized adjusted EBITDA when necessary to add-back stock compensation and unusual expenses).

 Mkt CapEV20122013201413-14 Growth201220132014
MEDIAN      14.5x13.1x11.3x
Source: ExamWorks: The Case For Upside