Catasys (NASDAQ:CATS) is an emerging growth healthcare services company that is at the forefront of addressing the enormous behavioral health market. Today over 1 in 5 adults suffer from some sort of mental health or behavioral health disorder or addiction. CATS has developed an outpatient program that provides coaching and on-going support to patients in a highly attractive, high margin recurring revenue program. The company works directly with the national health insurers who have eagerly embraced the CATS program as a result of the significant savings it provides. The company offers a differentiated model in which they work directly with health insurers and clinics to manage reimbursement and recovery for the affected patient. CATS generates north of $8,000 a year per customer and has an addressable market of over ~200,000 potential customers. The company is already nearing breakeven cash flow at ~1,000 customers. I think they can easily accelerate current growth (which is north of 90%) given that they already have relationships with Humana, CATS, and Coventry. Management has also stated that they expect to sign another Top 5 national health plan before year end. Based on my belief that the company can achieve the below levels of client penetration over the next 24 months and given the 30 percent EBITDA margins this business can achieve at scale, I think that with sound execution, investors could be looking at a 5-10 bagger over the next several years.
Health plans continue to be under pressure to reduce costs due to health care reform, even as premiums have increased 100% over the last 10 years. To capitalize on this pressure in the reimbursement environment, CATS developed a system called OnTRAK to provide a solution for treatment for the highest costing substance abusers: alcoholics, cocaine, methamphetamine, and opiate users. Combined, these users cost health insurers over $21b in annual medical expenses. On a per case basis, these members typically cost a health insurer over $25,500 annually vs. non high cost substance abusers that typically incur $3,250 in costs. What CATS has been able to do with its OnTRAKsystem is reduce this cost to a more manageable $12,750 per year, or 50% lower than what health insurers are paying. CATS then charges the health plans $8,500 per user, resulting in a savings of $4,250 for the health plan per member enrolled. CATS is able to do this because they employ a network of nurses that oversee each patient and coordinate with clinics to provide residency and services for each member (typically a year at a time)
CATS currently has approximately 1.1m members enrolled in the system, consisting primarily of members from the Humana network (as well as members from Coventry and Centene, among others). Of these 1.1m members, approximately 10 basis points will be enrolled in the program, or 1,100 members. These 1,100 enrolled members generate approximately $9m in revenues a year, all paid by the health insurers.
The company has stated that breakeven on a cash flow basis is about 1.5m total members. However, these economics are only on the commercial side - if you look at the Medicare side, CATS typically enrolls 25 basis points of total members, and generates slightly higher revenues of $9,300 per user. If they are able to secure 1m Medicare members, resulting revenues are closer to $23m a year.
There is significant leverage in the business model. The Humana relationship has just begun, and as the program ramps up, I would expect CATS to go from the 1.1m members now to an eventual ~10m members (which is the total membership of Humana). Although I don't have data on margins, 10m members generates approx. 85m of revenues per year and should be incrementally profitable (they will profitable at a 16-18m run rate). What's more exciting about this opportunity is that CATS is actively signing the other large health plans as well. They've announced a recent contract with a national health plan that is expected to be their largest contract, and given that they already have Coventry as a customer, I would expect that this national health plan to be Aetna (who acquired Coventry last year). Aetna adds another 20m in members, as that begins to scale, I would expect the other national health plans (United, Wellpoint, CIGNA) to soon follow as well.
So why isn't anyone else doing this? First, most high cost members are never identified. CATS uses claims data, substance abuse research, and its nurse network to continually discover and contact eligible members. They find these abusers early, rather than after multiple and costly hospital visits. Their nurses are assigned cases that they are responsible for throughout the entire program and provide very high touch care for each member. The programs typically last a full year, delivering continual treatment and support, instead of a typical week long rehab stint. These programs range from medical evaluation in the very beginning to community based programs at the end. No other company had the foresight to develop this given that it is a nascent market, but it's obvious that there is already significant traction since they were able to sign a national health insurer. The proprietary data, nurse network, and clinics are not built overnight; CATS has a significant first-mover advantage here.
There are also other long term growth drivers that the company can tap into down the line. For example, the OnTRAK system can be expanded to other high cost under-managed populations with behavioral health issues, such as depression and anxiety, both which have seen increased diagnosis in the last few years. These opportunities are much bigger than the substance abuse market, and could double or triple the available opportunity.
Management also has a significant stake in the company. The CEO and Chairman, Terren Peizer, has been adding shares as recently as two months ago and currently owns 69% of the company.
Assuming that CATS gets to 5,000 customers by year end, the revenue run rate for 2015 will be 42-45m. At that rate, the company would be generating 18m in pretax income, which would value the current company at a 2x pre-tax income. Given the growth rate of 100%, this company could be generating more than its market cap in pretax income by 2016. This estimate assumes 10m members, which I don't think is unreasonable given that their current customer, Humana, can fill this demand by themselves. If CATS was able to sign 2 or 3 more national health networks, this opportunity potentially could grow into a TAM of 50 million plus members. Once again, I want to reiterate that the company will break even at 1.5m members, which they should achieve shortly, if not already there.
I believe the stock is current mispriced because CATS is a 30m microcap with zero sell-side coverage. Since insiders own such a significant portion of the company, large and medium sized institutional investors cannot invest, and therefore do not bother to dig more deeply and understand the fundamentals underlying the company. The company has just begun going to conferences and roadshows, and is still relatively undiscovered. Investors waiting to get in on an eventual secondary will likely be disappointed as the company needs very little incremental capital to grow its business. Mr. Peizer has done a nice job of funding the business in a very efficient manner, which will allow investors to harvest the benefits as the company scales.
I believe that CATS can do $2/share in revenues in 2015 and $4/share in 2016. At a 5x sales multiple, (given the 100% growth rate), the company is worth $10 in 2015 and $20 in 2016. With a more conservative multiple of 3x, the company is worth $6 in 2015 and $12 in 2016, at least 3-4x the current stock price. From an EBITDA perspective, the company should be able to do close to $1/share in 2015 and $2/share in 2016. You can make your own EBITDA multiple assumptions, but in my opinion, 10x is at the very minimum of what should be appropriate.
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