Health Insurance Innovations: Set Aside Debunked Fraud Claims And Focus On Fundamentals

| About: Health Insurance (HIIQ)

Summary

Management at HIIQ must be prescient as their business model fits like a glove in President Trump’s newly unveiled plan for the future of U.S. healthcare.

Given market size, HIIQ’s rapid growth in revenue and earnings is just the tip of the iceberg of what this company can achieve.

Be aware that allegations of fraud are the mantra of short-term short sellers who are only right a small percentage of the time.

Pearson's claims against HIIQ have now been debunked based on the company’s announcement Monday morning that it achieved an agreement with the State of Florida.

Based on the company's strong earnings growth and pristine balance sheet, HIIQ's fair value is $35.00 per share.

By Paul Lebo, CFA, and Greg Wilkins

Key Drivers For Health Insurance Innovations Inc.

Health Insurance Innovations (NASDAQ:HIIQ) has positioned itself for strong growth due to its proprietary web-based direct-to-consumer technology platform. HIIQ's technology represents a distinct competitive advantage as it reduces the need for customer care agents and reduces the time associated with quoting, billing, underwriting, fulfillment, sales, and marketing. Within seconds HIIQ provides a quote. Moreover, HIIQ maintains relationships with leading carriers in the insurance industry such as Teladoc, Nationwide, and Humana. These relationships allow HIIQ to offer many different types of short-term insurance plans to meet each customer’s individual needs.

Market Opportunity

HIIQ’s sales focus is on the large and under-penetrated segment of the U.S. population who are uninsured or underinsured. Specifically, HIIQ targets individuals who are not covered by employer-sponsored insurance plans, such as (1) the self-employed, small business owners and their employees, (2) individuals who are unable to afford the rising cost of IMM premiums, and (3) underserved “gap populations” that require insurance due to changes caused by life events (i.e. new graduates, divorcees, early retirees, military discharges, the unemployed, part-time and seasonal employees and customers seeking health insurance between the open enrollment periods created under the Patient Protection and Affordable Care Act). HIIQ estimates that the short term medical/health benefit insurance plan market is a $14 billion market and the company currently has 2% of that market. Given the market opportunity and its low penetration, HIIQ has positioned itself well to take advantage of the white space potential.

Strong Growth Over Previous Two and a Half Years

Over the past 2.5 years, HIIQ has seen strong growth in both the top and bottom line. During fiscal year 2015, HIIQ increased revenue 18% from $88.7 million to $104.7 million and EPS from a loss of $(0.06) to a gain of $0.08. During fiscal year 2016, HIIQ increased revenue 76% from $104.7 million to $184.5 million and EPS 637% from $0.08 to $0.59. During the first half of 2017, HIIQ increased revenue 35.3% from $86.9 million to $117.6 million and EPS 177% from $0.36 to $1.00. Thus, due to the scalability, the white space potential, and its competitive advantage, HIIQ is poised to continue its rapid growth.

History of Beating Earnings

In the past 4 quarters, HIIQ has beat street consensus earnings estimates by at least 20% and by as much as 200%. Notably, street consensus estimates increased in each of the past 4 quarters from $0.11 in 3Q16 to $0.34 in 2Q17 but HIIQ continues to beat by a wide margin. In 2017, HIIQ beat by 20% in 1Q and 35% in 2Q. We expect HIIQ to continue to beat for the remainder of 2017 and into 2018.

New Executive Order on Obamacare Subsidies

President Trump’s recent executive order allows consumers to buy short-term policies which are not required to comply with Obamacare’s protections for those with pre-existing conditions. To provide historical context, recall that in June 2016 the Department of Health and Human Services proclaimed that short-term plans from 4 months to 11 months would no longer be permitted, as short-term plans would be limited to just 3 months. In contrast, Trump’s new executive order encourages regulators to end the 3-month cap for short-term plans. While there is still uncertainty as to whether the new rules will be implemented in time for 2018, Trump’s executive order is a significant tailwind for HIIQ as it further legitimizes the HIIQ business model and expands the product portfolio to include lengthier short-term plans. More generally, Trump’s desire to weaken Obamacare will serve to increase the target market for HIIQ’s services as his new order will encourage many relatively healthy customers who earn too much to qualify for subsidies to seek a cheaper alternative.

Valuation

HIIQ currently trades at just 12.60x P/E, which is at a 26.9% discount compared to the larger insurance companies that focus on long-term insurance. This peer group (UNH, AEL, MFC, RGA, ATH, AVVIY, and LFC) has an average P/E of 17.23x. Due to its strong current growth and future growth prospects, HIIQ should be trading at a higher P/E than the larger insurance companies as investors typically pay a premium for growth, especially within the healthcare sector. Using a P/E of 20x, which we deem to be relatively conservative, we calculate a fair value estimate for HIIQ of $35.00/share. We also note this valuation is in line with the range of valuations suggested by sell side analysts that cover HIIQ.

Financial Statement Analysis

Income Statement

HIIQ has seen significant sales growth ranging from 18% in 2015 to 76% in 2016. 2017 sales growth is anticipated to continue at the double-digit level with all indications pointing to 30-40% range. Additionally, due to operating leverage, the company has seen a significant increase in profitability over the years as EPS increased from $(0.06) in 2014 to $0.08 in 2015 to $0.59 in 2016. For the first three quarters of 2017, HIIQ has already logged an EPS of approximately $1.45, and this does not take into account Q4 EPS. The primary expenses of the company are Third-party commissions and SG&A expenses.

Balance Sheet

HIIQ has a healthy balance sheet with significant room to finance new opportunities. The company rarely takes on debt and as of year-end 2016 was debt-free. Additionally, HIIQ requires very little in PPE as less than 4% of assets are PPE. The largest liability the company has is ‘accounts payable and accrued expenses.’ Importantly, the majority of the right side of the balance sheet is equity as the company does not have many liabilities. A review of the unaudited June 30, 2017 financial statements similarly reveals a pristine balance sheet with a more than doubling of the cash balance and no long-term debt.

Cash Flow Statement

As HIIQ grows and operates more efficiently, the cash flow statement continues strengthening. In 2016, the company saw a sharp increase in net income as well as an increase in cash from accounts payable, accrued expenses and other liabilities. HIIQ used these funds to pay off all long-term debt while most other line items remained relatively constant. Despite paying off its long-term debt of $15 million, HIIQ saw cash increase by $4.5 million to $12.2 million in 2016. A review of the unaudited June 30, 2017 financial statements shows that similar trends have continued except for the fact that the company no longer has long-term debt, and was thus able to more rapidly build up its cash balance to $27.5 million.

Analyst Coverage

Lake Street, Canaccord, and Cantor Fitzgerald have all ranked HIIQ as a BUY with as much as 78% upside. In addition, these analysts have all upheld their ratings in the past several weeks in the wake of startling accusations leveled at HIIQ by short seller Richard Pearson on September 11. Moreover, yesterday Zacks Research increased its rating from a Hold to a Strong Buy following HIIQ’s strong pre-earnings announcement. In fact, the recent pullback in price has created a significant buying opportunity as the stock is down over 40% since its peak of $37.38 achieved in late August.

Refuting Pearson’s Claims

In his article, Mr. Pearson claimed that fraud penalties were expected to reach $100 million or more from fraud investigations in 42 states which would cripple HIIQ. The key claim in Pearson’s article was that HIIQ had been denied a TPA (Third-Party Insurance Administrator) license by the State of Florida in June 2017 which would trigger a “domino effect” by which licensing denials would spread to other states. Due to recent developments, this prediction was proved incorrect as HIIQ reached an agreement with the Florida Office of Insurance Regulation (OIR) which appears to provide a path for HIIQ to receive its Florida TPA license in the near future. This decision effectively prevents the “domino effect” that was predicted by Mr. Pearson. If the State of Florida was indeed investigating HIIQ for fraud as claimed, it would not have reached an agreement for a path forward on the TPA license.

Another key claim made by Mr. Pearson was related to management selling $50 million in shares. Mr. Pearson believed that shares were about to drop below $1.00 or even get delisted. However, the company announced on Monday morning a $50 million share repurchase plan which indicates management believes the shares are currently undervalued and shows there is no risk of a decline to $1.00 a share.

Preliminary Q3 Numbers

On Monday morning, HIIQ announced record preliminary 3Q numbers, as well as a stock buyback program of up to $50 million. The strong preliminary performance in 3Q, in combination with the stock buyback plan, further validates our hypothesis that HIIQ is primed for a rebound. HIIQ expects to announce that revenue for the third quarter will be in the range of $62.3 million to $63.3 million, an increase of 35% to 37% over third quarter 2016. Additionally, adjusted earnings per share are expected to be in the range of $0.44 to $0.46, an increase of 33% to 39% over third quarter 2016. Street consensus earnings per share were $0.35, so HIIQ beat earnings again by 25% to 31%.

Disclosure: I am/we are long HIIQ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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