Performant Financial Corporation - Long-Term Opportunity After Discount Offering

Aug.12.12 | About: Performant Financial (PFMT)

Shares of Performant Financial Corporation (NASDAQ:PFMT) made its public debut on Friday. Shares of the debt collector agency ended their first day up 18% at $10.60 per share.

The public offering

Performant Financial Corporation, the technology-enabled recovery and analytics service provider for debt collection, sold 9.0 million shares for $9.00 a piece. The firm sold a mere 1.9 million shares in the offering, with selling shareholders selling 7.1 million shares. Performant raised a mere $17 million in gross proceeds in the offering process. Based on the offer price of $9, the firm is valued at $406 million.

The offering is quite a disappointment. Initially the firm and its bankers set an offer price range of $12-$14 per share. Furthermore the firm and selling shareholders planned to sell a total of 11.5 million shares. In total, the firm sold about 20% of its shares outstanding. At Friday's closing price of $10.60, the firm is valued at $478 million. Major banks which brought the company public were Morgan Stanley, Goldman Sachs, Credit Suisse and Wells Fargo.

Valuation

Performant Financial Corporation provides its services for the US government as well as corporate clients. Its technology platform helps to speed up the process of recovering loans which are in default. It focuses on student loans, healthcare payments and delinquent taxes. In 2011, Performant provided recovery services on $8.7 billion in student loans, healthcare payments and other federal and state receivables.

The company reported annual revenues of $162.9 million for its annual year of 2011, up 32% on the year before. The company reported a net profit of $12.4 million, compared to $10.0 million in 2010. Diluted earnings per share came in at $0.13, as the company paid out $6.5 million in preferred stock dividends. Student lending revenues comprise 75% of total revenues, with healthcare and other revenues making up the rest.

For the first three months of 2012, the company generated quarterly revenues of $45.9 million, up 31% compared to 2011. Net income fell from $2.9 million last year to $2.5 million in 2012. Earnigns were depressed as Performant took a $3.7 million debt extinguishment charge. Diluted earnings per share came in at $0.02.

For the second quarter of 2012, Performant expects revenues of $52.0-$56.5 million, up 18% compared to the first quarter of 2012. Net income is estimated at $7.5-$8.5 million, up 218% compared to the first quarter.

The company operates with $12 million in cash and equivalents and roughly $141 million in debt outstanding, as of March 31. This excludes the $17 million in gross proceeds from the offering. Pro-forma, the company has a net debt position of roughly $120 million.

The company is on track to report annual revenues north of $200 million for 2012. This values the firm about 2.4 times annual revenues. Based on the second quarter net margins of around 15%, the company could generate annual profits of $25-30 million for the full year of 2012. Excluding the $6 million in preferred stock dividends, net income for shareholders could come in at $19-$24 million, or roughly $0.50 per share. This values the firm at approximately 20 times earnings.

Investment Thesis

Performant Financial's public offering was quite a disappointment. The public offering took place at a price of $9, revised downwards from an initial price range of $12-$14 per share. Besides lowering the price, the offering volume was also cut back from 11.5 million to 9 million shares. The smaller offering at a discount, did however boost demand and shares showed a nice first day gain on Friday.

The first quarter results of Performant indicate that the business is really scalable, driving future profitability. First quarter revenues were up 31%, while salaries and other benefit expenses only rose 11%.

Performant Financial Corporation trades at reasonably steep values of around 2.5 times annual revenues and 20 times earnings. However future earnings growth could be boosted by economies of scale, as the business model carries lower marginal costs. Furthermore, the company pays almost 10% interest rates on roughly $140 million in its debt outstanding.

Combining all this with strong revenue growth, the company could generate over $250 million in revenues in 2013. Next year it could report net margins of 20% as a result of scale efficiencies and lower interests costs. This would value the firm at less than 2 times annual revenues and 10 times earnings.

For long term investors, Performan Financial Corporation offers an opportunity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.