Seeking Alpha

eHealth Stock Has More Room To Rebound

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About: eHealth, Inc. (EHTH)
by: Vince Martin
Vince Martin
Long/short equity, value, gambling
Summary

EHTH stock fell by half in a matter of months, apparently due to worries about competition and churn.

But the Q3 report should calm investor fears - and already has, as EHTH has bounced off the lows.

There are risks here in terms of the political and regulatory environments, and the stock isn't necessarily cheap.

Still, incremental margins are enormously attractive, and there's a nice path here for EHTH to challenge past highs.

One of the odd aspects of trading in online health insurance exchange eHealth (EHTH) is that the stock has made huge swings during the middle of the year. In theory, EHTH stock should be relatively quiet. Particularly with its Medicare business driving current results and long-term growth, what would seem to matter most would be the OEPs (Open Enrollment Periods) for Medicare, which runs October 15-December 7, and Medicare Advantage, which covers the calendar financial quarter.

Yet year after year, EHTH seems to go on a wild ride in the middle of the year, outside of those periods. 2019 has been no different:

EHTH stock quote

Source: finviz.com

To be fair, the volatility does make some sense. eHealth is a bit of an "eye of the beholder" stock, as impressive revenue growth also drives persistently negative operating cash flow. The company has significant political and regulatory risk. Even purely from a financial standpoint, the story here is somewhat complicated - eHealth actually has to estimate its revenue and membership, for instance - and the bull case is based on incremental margins on out-year commission revenues.

That said, this pullback looks like too much. I recommended EHTH at $102 at the beginning of August, and while I acknowledged the potential for volatility (though obviously not this much volatility), I believe the case made then holds, particularly after a solid Q3. Near-term trading may see more movement, particularly with the 2020 U.S. presidential election almost exactly one year out, but even with the recent bounce, a price 36% below the highs still leaves an attractive mid-term opportunity.

Why Did EHTH Fall So Far?

Again, I certainly didn't predict the steep decline that began in early August, and I struggled to understand exactly why it was happening. It's possible that a sell-off in high-growth momentum names (the likes of Shopify (SHOP) and Roku (ROKU) turned south at roughly the same time) was at play, though one wonders if EHTH would have been lumped in with those larger, more widely-held names.

But the Q3 conference call seemed to offer some clues. In his prepared remarks, CFO Derek Yung said he would "address our membership metrics in the context of customer retention, a topic that's been [on] top of investors' and analysts' [minds] over the past few months". He noted that approved Medicare Advantage members convert to paying members at a 92% clip, which CEO Scott Flanders noted later had remained reasonably consistent. Yung also noted that churn diminishes as members persist - and eHealth appears to have added a new slide to its earnings presentation to highlight that fact:

EHTH stock quote

Source: eHealth Q3 earnings presentation

Analyst questions, meanwhile, suggest competitive concerns were another factor in the sell-off. The federal government's CMS (Centers for Medicare & Medicaid Services) announced in late August that it had upgraded its Medicare Plan Finder site for the first time in a decade, and that site was a focus of two different questions. Raymond James analyst Greg Peters prefaced his question by noting that "there seems to be a new player or strategic coming into the market almost on a daily basis". That includes Health Insurance Innovations (HIIQ), which acquired 65+ marketer TogetherHealth for $70 million in June.

So far, competition doesn't seem to be an issue. Q3 results were strong (more on this in a moment). Flanders was asked if eHealth had seen any impact from Plan Finder and answered with a succinct "no". At another point in the call, Flanders predicted no impact on gross margins or to revenue growth from competition.

To be sure, management may not be necessarily correct in dismissing competitive effects. But eHealth has a multi-year head start on its newer rivals. As COO Dave Francis noted in response to a SunTrust analyst, the front-end experience of offering quotes over the Internet is replicable. But it's on the back end where the competitive advantage lies. eHealth has significant long-standing relationships with the likes of Humana (HUM), UnitedHealth (UNH), and CVS Health (CVS) unit Aetna; the three companies combined drove 55% of 2018 revenue, per the 10-K. The moat may not be impenetrable, but it will take time and significant resources for competitors, particularly new competitors, to slow eHealth's growth. The federal government, meanwhile, already has been a competitor, yet eHealth has posted impressive growth in its Medicare business for years now.

To be sure, I wouldn't discount competitive risks and churn issues entirely, even at the cheaper price. And it's far from certain that those worries were what drove the 50% decline from August highs to October lows. That said, there is some evidence in Q3 that specific worries about long-term growth drove at least a portion of the selling - and there's some evidence on the Q3 call that those worries were overblown.

Q3 Supports the Bull Case for EHTH

Share price movements aside, Q3 looks positive for eHealth stock, which indeed has rallied since the report despite declining 6% the following day. Headline growth on the top line looks impressive, with overall revenue climbing 72% and Medicare revenue climbing 75%. The Individual & Family Plans segment, which a few quarters ago looked like it was potentially going to be dissolved, has bounced back in a big way, with revenue up 59% and segment earnings returning to a profit.

There was some help to the top-line performance from so-called "tail revenue". Under ASC 606, in both the Medicare and I&FP segments eHealth calculates revenue by estimating the "total expected commissions we expect to receive over the life of the underlying policies," as it wrote in the 10-K. The company then applies a "constraint" to ensure conservatism.

As policies age, the actual cash received can either be more (residual revenue) or (impairment of commissions receivable) less than estimated. In Q3, eHealth booked $11.5 million in tail revenue (which is residual revenue less impairments), which accounted for almost 40% of its year-over-year growth.

Still, revenue booked from members approved during the quarter increased 54%, which shows strong underlying performance. And the jump in tail revenue from the year-prior $2.35 million certainly isn't a bad thing. The higher tail revenue itself calms some of the worries about churn: many more policy holders are lasting longer than modeled, rather than shorter. It suggests that, contrary to some simplistic bear cases, eHealth isn't at risk of some sort of revenue write-down due to inaccurate modeling.

eHealth also improved its guidance for lifetime values in Q4 from a "mid-single-digit" decline y/y to a 1-2% reduction. That, too, came from lower-than-expected churn, as the loss rate of members brought on during last year's OEP has slowed. Flanders said in the Q&A while discussing that improvement that churns overall was flat year-over-year.

On the top line, then, eHealth still seems to be in excellent shape. It's bringing on new members, with applications up 66% in Medicare and 163% in I&FP. It's monetizing those new members as well, and for as long, as it has in the past. And below the top line, the news is either good or better than it appears.

One key data point in the quarter was the company's online penetration. Moving to online enrollment has been a goal of eHealth for some time, for obvious reasons. Online enrollment both lowers the company's costs and increases the likelihood of conversion. Online applications for Medicare products soared in Q3, jumping to 21% of the total from 9% the year before. That suggests a nearly 4x increase in online applications year-over-year. Higher online marketing spend has helped, as customers acquired online often apply online as well. The shift in applications provides another long-term driver for margin expansion here.

One potential source of worry in the quarter is that losses expanded markedly, even on an adjusted basis. Adjusted EBITDA, for instance, was a loss of $18.8 million against $6.9 million the year before. But the expanded loss came primarily from one area: customer care and enrollment spending. That expense increased 133% year-over-year on a non-GAAP basis as, per the call, eHealth more than doubled its headcount.

But eHealth expects to easily leverage that spend thanks to growth in the fourth quarter. Full-year guidance still projects $65-$70 million in Adjusted EBITDA, roughly double last year's $33.7 million. And it certainly sounds like that guidance can be beaten. In the Q&A, Flanders was asked to explain why the company was doubling call center capacity at the same time it was seeing higher online application penetration. His answer was simple: "I would just say our guidance is conservative." COO Francis said elsewhere in the Q&A that the decision not to raise full-year guidance (which excludes non-GAAP EPS, which was raised for what appear to be tax reasons relative to an earnout liability) was made before the quarter and was "irrespective of where we came in [in] Q3".

All told, this seems like a quarter that buttresses the bull case here. Top-line performance continues to impress. Online application increases help the longer-term margin and profit outlook. The spike in spending is driving growth, not a case of the company underinvesting in the past (though eHealth apparently did leave sales on the table last year). EHTH admittedly isn't cheap, but it's increasingly difficult to argue that it should be.

Valuation and Risks

Back at $71, EHTH admittedly still looks expensive. The midpoints of guidance suggest EV/EBITDA of about 26x and adjusted P/E around 37x. Operating cash flow, meanwhile, remains negative.

But EHTH is in line with LendingTree (TREE) on an EBITDA basis and cheaper in terms of P/E. And the negative cash flow is a feature of the business model. eHealth is booking revenue up front under ASC 606 - but it actually receives the cash over time. That creates an increasing commission receivable, which totaled $358 million at the end of the quarter. But it also means that near-term growth actually hurts free cash flow, as the company spends more (as it did on customer care in Q3) to bring in cash that may not arrive until 2020 or beyond.

Relative valuation aside, there's a clear path to grow into the current multiples. As I detailed in August, the company's 2023 targets given with its Investor Day presentation in May suggest a share price above $180 at a P/E above 30x (EV/EBITDA ~22x). Those projections suggest the company would have nearly $1 billion in commissions receivable that year - and just 2% market share in Medicare. The seemingly resurrected IF&P business, if it can get back to creating material value, can drive further earnings growth and upside.

Even taking a broader approach, 40x earnings or 26x EBITDA are not aggressive multiples (particularly in this market) for a business posting 58% revenue growth with solid incremental margins. Even with the bounce from $50 to $71, and even understanding the complexity in modeling this business (whose own management, again, has to estimate revenue and current membership), the core of the bull case here is intact and simple. If eHealth keeps doing what it's doing and taking share in a Medicare Advantage market that by a CMS forecast is supposed to grow 10% in 2020, EHTH stock is going to gain. And it may well gain big.

That said, the risks need to be monitored. Competition is real. Churn can be a factor. Volatility will persist: again, big moves in EHTH are not limited to just 2019 trading.

The political environment may impact trading as well. I'm somewhat skeptical of the idea that EHTH is significantly exposed to the 2020 U.S. presidential election, particularly with Elizabeth Warren floating a "Medicare for all" proposal. Anything short of single-payer likely leaves the business intact, and whoever is in the Oval Office in January 2021 is going to face heavy resistance to changing the program.

Indeed, it's possible, if not likely, that a Democratic win and some change to existing programs may push beneficiaries to review their plans more carefully and/or use a third-party provider like eHealth to choose their plans. (Relative to knee-jerk assumptions that a Democratic win would be negative, it's worth remembering that eHealth once was thought to be "Obamacare's biggest winner". The stock wound up falling ~90% from 2014 peaks. Health care politics and policy are complex; understanding and predicting either is not a simple task that lends itself to blunt red/blue analysis.)

That said, not all investors will agree, and political developments may impact EHTH trading if only from a broad sense that the status quo is good for the company while any change is not. (From that standpoint, it's possible impeachment drama was another factor in the recent sell-off.) And there is the risk that eHealth stumbles. Incremental margins are a big part of the bull case, but those margins are a double-edged sword if the revenue outlook disappoints at all.

Still, the risks here look worth taking. I don't see valuation as anywhere close to prohibitive. Even performance short of Investor Day targets still suggests a path to ~100% returns in 4-5 years. Medicare and Medicare Advantage both have years of demographic tailwinds left, and I'm highly skeptical of any significant changes to either program no matter who wins the 2020 election. Simply put, the sell-off here went too far. To invert a snarky investor saying, I did like EHTH above $100 - and I do love it above $70.

Disclosure: I am/we are long EHTH. 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.