athenahealth Not Yet a Compelling Valuation

| About: athenahealth, Inc. (ATHN)

Recently I wrote an article about athenahealth (NASDAQ:ATHN), a hyped SaaS healthcare information technology stock. Following full year 2007 results, my bearish thesis turned out correct, even sooner than I anticipated.

The stock’s lofty valuation did not justify realistic growth prospects. When the recent Q4 2007 results were announced, the stock plummeted from the low 30s to around 25 dollars per share. Despite meeting expectations with a healthy 35% revenue growth, investors wanted more.

My Response to the Critics

After my initial publication, a few readers have pointed out that I am too skeptical about the growth prospects for athenaHealth’s EMR system for practitioners. I agree with the criticism – that medical record systems conducted over the Internet are inevitable. After all, we trade stock and do banking online these days.

However, I still back my claim that this process will be a gradual implementation, quite possibly slower than Wall Street would like. I think the fourth quarter disappointment is a good demonstration of the Street’s unreasonably high expectations. It will most likely take the next generation of medical professionals to usher in this new era for health care IT.


Now that athenaHealth stock is nearly 30% lower since my last writing, does valuation look attractive at this level? After delving into the Q4 results and reconsidering its strengths, I am starting to see value in some respects:

  • The company has a unique marketing angle. I think they have a unique strategy by appealing to individual practitioners, in contrast to other firms that focus on bigger contracts with larger institutions.
  • Near the end of 2007, the company paid down nearly all of its debt. With the remaining debt maturing over the next 3 years, this company will be almost pure equity. This is advantageous because it removes the burden of interest payments and lowers the near term possibility of bankruptcy.

    Without interest, more cash flow is available to shareholders. In the upcoming years, I see the potential for the company to generate a strong free cash flow, assuming operating margins can improve or stay level.

  • The athenaNet Rules Engine is their most valuable proprietary asset. If there is any incentive for athenaHealth to become an acquisition target, it would be for their massive rules database for processing insurance codes. This database puts athenaHealth in unique position to help doctors by allowing them to easily untangle the complicated insurance codes and deliver optimal reimbursement.

Unfortunately, after considering these strengths and being a fan of the athenaHealth story, I still dislike the equity. Here are the reasons on why the stock is a bad investment:

  • Unreasonably high PE ratio. Based on analyst earnings consensus of 0.42 for 2008, at 23 dollars per share it is trading at a 54 PE ratio. My estimate is on the low end, 0.30, which would place it near a 75 PE. Most of the peer group trades between 18 and 25 PE.

    Even though critics would justify that a 35% growth rate gives the stock a PEG ratio just above 1.5 (somewhat reasonable for a quality growth stock), I still don’t believe that is enough reason to go long.

  • Equity dilution. On March 20th, the lockup date for nearly 25 million shares expired. This places nearly three quarters of the company’s stock available for sale on the open market. Already, several insiders have disposed of close to 3 million shares. No doubt there is more to come.

    In addition, I still contend that management will follow through with a planned secondary stock offering that was postponed in January due to market conditions.

  • My updated DCF model indicates that this stock may have more to fall. Below is a link to the Excel spreadsheet, which runs several scenarios of varying growth levels through 2015. Updated from my last article, the model includes full 2007 figures and a few tweaks on valuation calculations.

    According to my model, valuation looks more attractive in the low 20s. However, I still think this stock has more to fall and would not recommend going long until the mid-teens.

I really believe that athenahealth has a compelling business model and I’m rooting for them. Unfortunately, based on equity valuation this stock does not seem to be a good investment quite yet!

ATHN DCF Model (Excel Spreadsheet)

click to enlarge

Disclosure: None