Athenahealth Can't Maintain Its Sky-High Valuation

| About: athenahealth, Inc. (ATHN)

The market is full of misunderstood companies, as well as perhaps three times that number of companies where management believes Wall Street just doesn't understand the business or the proper value for it. With health IT provider athenahealth (NASDAQ:ATHN) being one of the relatively rare companies where a majority of analysts are not positive on the stock and where the current price is above the average price target, it seems like there's some disconnect in this name.

While the top-line growth at athenahealth is indeed impressive, and the growth runway would seem to be long and wide indeed, this is not a stock where investors can afford to be complacent. The stock's valuation already assumes that the company emerges as a major player in healthcare IT, but investors may want to ask whether the company's progress with enterprise-scale customers and sales leverage merits such a lofty expectation.

The Third Quarter In Review

Revenue rose 33% in the third quarter, to just under $84 million, while the company's collections grew just under 27%. Utilization of athenaCollector rose more than 20%, while athenaClinicals saw slightly greater growth at 21%. Bears, though, are going to bark about the fact that these are decelerating rates of growth and that athenahealth is beating numbers by a decreasing margin.

Profitability, and operating leverage more specifically, remain areas of concern. The company's gross profitability is fine, and rose nearly a full point. In fact, athenahealth can stand right beside much larger companies like Allscripts (NASDAQ:MDRX), McKesson (NYSE:MCK), Quality Systems (NASDAQ:QSII), and Computer Programs & Systems (NASDAQ:CPSI), with no shame in that regard.

Operating leverage is a different story, though. Due in large part to soaring sales and marketing expenses (up 58%), operating leverage is all but nonexistent, and athenahealth saw operating income rise just 13% this quarter. Simply put, athenahealth is seeing its IRR on incremental marketing expenditures fall, and fall at an accelerating rate.

Now, it's true that it takes money to make money, it's true that the company needs a large sales effort to penetrate enterprise customers, and it's true that high marketing spends are not uncommon with companies trying to advance cloud-based models, including non-healthcare names like Red Hat (NYSE:RHT) and (NYSE:CRM). Still, it's ultimately not a sustainable model.

The Wall Of Worry In Enterprise

Many of the sell-side analysts following athenahealth have hammered on the company's difficulties in penetrating enterprise customers (basically, large clinical practices and hospitals). An alliance with Microsoft (NASDAQ:MSFT) and the acquisition of Proxsys have yet to help that much, though the Proxsys deal was quite recent.

Ultimately this is will be an issue. There are plenty of smaller practices that athenahealth can still target, but the company has to start signing up big players and reaping the operating leverage that comes with that if it truly wants to be a threat to the aforementioned Allscripts, McKesson, or Cerner (NASDAQ:CERN). Likewise, a future acquisition by one of the larger players would be easier to contemplate if athenahealth could demonstrate that it can sell itself to these big-practice CIOs. If it can't, the idea that athenahealth offers a seemingly valuable cloud-based suite of products falls flat.

Still Plenty Of Potential

It is not so hard to see why there is plenty of optimism around this name. AthenaCollector has shown strong retention rates, and there is still ample cross-selling opportunity with athenaClinicals (though the progress in that effort is another chew-toy for some bears). Moreover, payor rules are only getting more complex, and there is a substantial value proposition in a system that updates virtually in real-time, saves labor for the medical practice, and can deliver reimbursement more quickly and more successfully (that is, a higher percentage of the requested reimbursement amount).

This is not lost on Allscripts, Quality Systems, et al. While these larger players are generally more interested in the larger clients, they have succeeded with top-down integrated IT packages that may not be as good as athenahealth's specifically in revenue cycle management, but answer multiple other IT needs for the customer. Moreover, with the ongoing pace of consolidation in health care services, a lot of small practices are being folded into these larger enterprise customers.

The Bottom Line

Bulls on athenahealth may want to argue that the company should be valued more as a cloud computing/Software-as-a-Service provider and less as a healthcare IT company. Either way, though, the discounted cash flow model doesn't change, and that model says that athenahealth has to produce truly Olympian growth to justify its current valuation.

The pace of growth makes this a risky stock to short (overvalued stocks often go to “outrageously overvalued” before falling, and that can be excruciating), but just as risky to buy. While the products do seem to offer real value, and the federal government has actively encouraged healthcare providers to migrate to electronic record-keeping, investors with an inclination towards value or GARP investing should wait for a pullback before giving serious thought to athenahealth's stock.

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

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