Benefitfocus Will Continue To Have Difficulties This Year

Summary

• The company recently announced U.S. layoff of 17% of employees plus executive salary cuts.
• Guidance for FY20 has been reduced substantially, with original revenue guidance of $310-$310M reduced to $250-$270M.
• The company has negative total common equity which tends to produce substandard stock performance.
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Benefitfocus, Inc. (BNFT) is a stock that has been pummelled over the last year and a half. In February 2019 the stock price touched $60. Today it trades for little more than $10.

(Source: Yahoo Finance/MS Paint)

Benefitfocus is likely to experience further discomfort due to workforce reductions as a result of mandated shutdowns due to the pandemic. The company operates in the HCM industry with more than 18% market share of the benefits administration niche.

(Source: Apps Run The World)

Benefitfocus is definitely hurting in this economic climate, evidenced by the company's decrease in guidance for FY20 with expected revenue of $250-$270M down from $310-$310M. It is also cutting costs, including executive pay, and is reducing its U.S. workforce by 17%.

Community Resource Center

The Community Resource Center is a recent initiative by Benefitfocus that assists companies through all work stages. The solution will have:

• An automated off-boarding experience that connects affected individuals to affordable medical plan alternatives and voluntary benefit products
• The ability to reactivate staff when business circumstances allow for return-to-normal business operations
• Guidance on workforce changes through information, education and communication tools on available options that impact the business and the individual
• Ability to easily change eligibility status of employees through various categories and back.

Hats off to Benefitfocus as this appears to be a very useful initiative during this time of crisis.

Benefitplace.com

Benefitfocus has also announced an initiative that allows employees of customers that have been affected by the current economic conditions to have access to a variety of affordable individual and family health plans:

for employees who have been offered COBRA by their employers and are seeking lower-cost alternatives, as well as a variety of other products and services to support the well-being of displaced workers through this time of crisis and beyond.

Unfortunately, at the present time, I cannot assess whether the Community Resource Center or Benefitplace.com will have a positive effect on the company's financials. These initiatives are provided for information only.

Total Common Equity

One of the striking fundamental factors that I find interesting about Benefitfocus is that it has negative total common equity.

(Source: Portfolio123/MS Paint)

This is a situation that I don't normally run across so I decided to run a backtest of the stock performance of companies with negative common equity. Using the Russell3000 as the base stock universe, I determined that stocks with negative total common equity have underperformed the Russell3000 fairly significantly over the last 10 years.

(Source: Portfolio123/MS Paint)

The Rule Of 40

One industry metric that is often used for software companies is the Rule of 40. The metric sidesteps the valuation dilemma for high-growth companies that generally don't show profits. The Rule of 40 allows for both revenue growth and profitability (expressed as a margin) in combination such that they must add up to at least 40%. Analysts use various figures for profitability. I use the free cash flow margin.

The rationale for the Rule of 40 is as follows. If a company grows by more than 40% annually, then you can turn a blind eye to negative free cash flow to some extent. On the other hand, if a company grows by less than 40%, then it should have a positive free cash flow to make up for the less-than-ideal growth.

This rule accommodates both young, high-growth companies as well as mature, moderate-growth companies. Young companies tend to have high revenue growth but are burning cash. Mature companies have lower revenue growth, but they make up in terms of free cash flow. The 40% threshold is somewhat arbitrary but typically divides the digital transformation stock universe in half, separating the best stocks from the so-so.

For a description of how to compute the Rule of 40, please refer to one of my previous articles.

(Source: Portfolio123/MS Paint)

In Benefitfocus's case the Rule of 40 calculation is as follows:

Revenue Growth + FCF margin = 14% - 10% = 4%

Benefitfocus scores well below the 40% needed to fulfill the Rule of 40, meaning that Benefitfocus is having difficulty achieving a healthy balance between growth and profitability.

Stock Valuation

There are numerous techniques for valuing stocks. Some analysts use fundamental ratios such as P/E, P/S, EV/P, or EV/S. I believe that one should not employ a simple ratio, and the reason is simple. Higher growth stocks are valued more than lower growth stocks and rightly so. Growth is a significant parameter in discounted cash flow valuation.

Therefore, I employ a technique that uses a scatter plot to determine relative valuation for the stock of interest versus the remaining 152 stocks in my digital transformation stock universe. The Y-axis represents the enterprise value/forward sales, while the X-axis is the estimated forward Y-o-Y sales growth.

The plot below illustrates how Benefitfocus stacks up against the other stocks on a relative basis.

(Source: Portfolio123/private software)

A best-fit line is drawn in red and represents an average valuation based on next year's sales growth. The higher the anticipated revenue growth, the higher the valuation. In this instance, Benefitfocus is situated well below the best-fit line. This suggests that Benefitfocus is extremely undervalued on a relative basis.

Another way to look at relative valuation is to substitute forward earnings estimate for forward sales estimate in the Y-Axis of the scatter plot shown above.

(Source: Portfolio123/private software)

With this new scatter plot, Beneftifocus appears to be extremely overvalued.

Summary and Conclusions

Benefitfocus is the industry leader benefits administration in the U.S. with an 18% market share. This company is expecting to take a significant hit during the pandemic and has announced a layoff of 17% of U.S. staff as well as executive salary cuts. The company has a high debt level of ~$285 million, has a negative total common equity, and fails on the Rule of 40. I expect that 2020 will be a difficult year for this company. Therefore, I am giving Benefitfocus a neutral rating.

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