Premier Inc.: An Undervalued Swan On The Surface Of The Healthcare Industry

Summary

• Premier is a $4bn market cap provider of services to the healthcare industry via its Supply Chain Services and Performance Services divisions.
• Shares currently trade at $33.8 - a discount to recent highs of $38 and 2018 highs of $45.
• Premier has forecast revenues of ~$1.63bn in fiscal year 2021, up 25% year-on-year, and EPS of ~$2.3.
• Long-term, management is targeting mid-to-high single digit percentage top line and bottom line growth.
• My contention is that shares are undervalued by as much as 40% at current price. Premier operates in a tricky space but it is an experienced operator and a decent bet in the current uncertain markets.
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Investment Thesis

When the stock market is buoyant, investors are often prepared to accept a higher level of risk - for example, by backing a loss making or pre-revenue company - but when trading conditions become adverse, strong fundamentals become more important.

As such, I think that Premier Inc. (NASDAQ:PINC) - a $4bn market cap company focused on providing integrated data services and analytics to the managed healthcare industry - looks like an attractive opportunity in the current bear market.

Premier's shares have traded in a range between $28 and $40 for the best part of 5 years - except a short spike to a price of $46 between August and November 2018 - and currently trade at $32.7 as of this writing.

Premier released its fiscal Q221 results at the beginning of February. Net revenue increased 32% on a GAAP basis, to $422.8m, from $319.6m in the prior year period. Net income fell from $91.6m to $44.9m, but EPS was $0.36 per share versus -$6.88 in the prior year period (owing to an adjustment to redeemable limited partners' capital). The company also declared a quarterly dividend payment of $0.19 per share, for a yield of 2.3% based on current share price.

Long-term, management says it is targeting "multi-year compound annual growth rates in the mid-to-high single digits for consolidated net revenue, adjusted EBITDA, and adjusted earnings per share".

That would indicate that management is targeting increasing revenues to >$2bn per annum by FY25, and a basic DCF analysis therefore suggests that Premier's shares are currently undervalued. The consensus analyst target price for Premier's shares is ~$39.3, but I believe the present day value of Premier's shares is >$45, a premium of >40% to current price.

Things at Premier are not quite as clear cut as they might appear based on fundamentals - the company has a complex ownership structure and its business model is challenging, with uncertain margins, and occasionally under threat due to the work it does negotiating the pricing of products and services between suppliers and healthcare organisations.

In this article I will provide a company overview, comment on recent performance, provide a ballpark company valuation, address some of the risks the company faces, and look at the current dynamics of the healthcare intelligence and data analytics market. Overall, I maintain that Premier's shares may be undervalued even when considering the underlying risks.

Company Overview

Premier Inc. describes its core activities as follows:

We partner with hospitals, health systems, physicians and other healthcare providers with the common goal of improving and innovating in the clinical, financial and operational areas of their businesses to meet the demands of a rapidly evolving healthcare industry.

According to its Q221 10-Q submission, Premier works with an alliance of 4,100 US hospitals and health systems, plus ~200,000 other providers and organisations, leveraging a technology platform that offers:

...critical supply chain services, clinical, financial, operational and value-based care software-as-a-service (“SaaS”) and licensed-based clinical analytics products, consulting services and performance improvement collaborative programs.

Premier has a complex but beneficial ownership structure whereby its 4,100 alliance members own 41% of the company's outstanding share capital through their ownership of Class B common stock, whilst the remaining 59% of the company is publicly owned by Class A shareholders - including institutional shareholders like Vanguard Group, which reportedly owns an 8% stake in Premier, River Road Asset Management (5% stake), Neuberger Berman (5% stake) and Renaissance Technologies (3% stake).

That means that Premier has developed its products, services and long-term growth strategy alongside its members/clients, giving the company access to valuable proprietary data and insight into, and perhaps influence over the changing face of the healthcare industry and the innovations within it. Over 400 individuals from its member organisations sit on 28 of Premier's strategic and sourcing committees, whilst 6 Senior Executives sit on Premier's Board of Directors.

Premier has 2 reporting segments - Supply Chain Services, which operates one of the largest nationwide Group Purchasing Organisations ("GPOs") covering ~2,800 contracts with ~1,370 suppliers and encompassing areas from medical and surgical product procurement, to laboratory supplies, IT and construction services, and Performance Services, which is primarily concerned with information technology analytics and workflow automation through its PremierConnect cloud-based platform, and consulting services provision via initiatives such as Premier Performance Partners, focused on value based care, and QUEST Collaborative, focused on performance improvement.

Last month, Premier announced that its long-time CEO, Susan DeVore, would retire after 12 years at the helm, being replaced by current company President, Michael Alkore, who has been at the company since 2003. DeVore is expected to remain at the company for a 24-month period as a consultant, so the transition seems likely to be a seamless one.

Recent Performance

Premier H121 revenues by business reporting sector. Source: company 10-Q submission.

As we can see above, revenues across the second half of 2020 increased by $147.7m, or 24% overall - and by 32% between Q220 and Q221, suggesting that the growth trend has momentum - with Supply Chain Services accounting for ~76% of all revenues, and Performance Services ~24%.

Adjusted EBITDA in Supply Chain Services fell by 20% across the 6-month period however, from $298m to $222m (and by 26% in the most recent quarter), due mainly to a $190m increase in cost of revenue, which management put down to the costs of procuring PPE equipment during the pandemic, which was in high demand.

Going forward, management expects demand for PPE to stabilise, and cost of revenue to correspondingly decrease, whilst remaining higher overall than previously due to the sale of additional direct-sourced products to new and existing customers.

Adjusted EBITDA in Performance Services increased by 46% across the 6 months to December 2020, from $50.3m to $73.7m, thanks to new enterprise license agreements and clinical analytics products whilst both cost of revenue and OPEX decreased marginally.

As such Premier's results can be viewed as satisfactory, albeit disrupted by changing purchasing trends owing to the pandemic. Looking ahead, Premier's FY21 forecast were also positive.

Looking Ahead

Premier Inc FY21 forward guidance. Source: Premier earnings press release Q221.

Total net revenue in FY21 is forecast to be $1.63bn at the midpoint of expectations - up by 25% year-on-year from $1.3bn in FY20 - suggesting that both Supply Chain Services and Performance Services will outperform marginally in the second half of the year over the first, whilst FY EBITDA of $455m at the midpoint of expectations suggests that operating costs are likely to remain higher than usual.

EBITDA across FY20, FY19 and FY18 respectively was $564m, $561m and $540m, on an adjusted basis, and net income $337m, $349m, and $315m, for EPS of $2.73, $2.66, and $2.3. It is worth noting that these figures are heavily adjusted after accounting for non-controlling interests, discontinued operations and redeemable limited partner's capital, but, assuming that these adjustments are all above board and related to the complex ownership structure, we can see that Premier is growing its top line revenues without necessarily becoming more profitable.

That does not overly concern me at this stage however, partly because of the pandemic headwinds in FY20, partly due to management's stated ambition to grow EBITDA and EPS as well as revenues in the mid-to-high single digits, and partly due to recent acquisitions made by the company which indicate it plans to grow both organically and inorganically.

Market and Strategy

In my view, Premier's status as a company serving an alliance of healthcare members who also partly dictate how the company should operate and grow is both advantageous and constrictive.

It is advantageous because Premier has the inside track on how the industry is developing, as well as gaining access to an invested and loyal client base, and constrictive because, reading between the lines - like Pharmacy Benefit Managers (PBMs) in the health insurance and pharmaceutical industries - Premier appears to take on much of the healthcare industry's "dirty work", negotiating pricing deals between health care centres and their suppliers, sharing market intelligence, and arguably, attempting to help the healthcare industry outmanoeuvre governments and regulatory bodies.

It is unusual for example to hear major healthcare organisations discuss government policy, but on Premier's Q221 earnings call, management spoke quite candidly about the impact of the Biden administration on the industry.

Given the Democrats extremely narrow margins of control of government and the need to unite the nation by avoiding extreme polarisation, we believe that many of the sweeping changes proposed during the campaign may not be achievable. This includes proposals like Medicare for all, a public option and direct drug pricing negotiations among others.

In this regard, key health care themes and trends will more likely stay the same, rather than change. Moreover, we believe this more stabilised policy environment will create an opportunity for continued innovation and investment in healthcare overall.

Nevertheless, Premier is responsible for its own fate and for attempting to grow the business on behalf of shareholders, and did that in the first half of 2020, acquiring Health Design Plus - a third-party administrator that arranges care for employees - in May for $23.8m, renaming it Contigo Health and adding it to the Performance Services division, and earlier in the year, completing the $291.5m acquisition of Acurity, Inc. and Nexera, Inc., both indirect wholly owned subsidiaries of Greater New York Hospital Association (“GYNHA”).

Acurity - a regional group purchasing organisation - has been a partner of Premier's for 24 years, and Nexara - a hospital financial improvement consulting firm - is highly complementary to Premier's existing business operations.

In H121 Premier increased the number of managed lives under its auspices by 25%, and its future growth strategy is based around expanding its capabilities - with a particular focus on artificial intelligence - to provide more and better data insights and intelligence, capturing a greater proportion of membership spend, and instigating more joint ventures and alliances - a recent example being the development of a customised GPO portfolio for long-time member Yankee Alliance to drive incremental savings for its $800m purchased services spend.

In its 2020 Annual Report, Premier quotes research from the Centers for Medicare and Medicaid suggesting that healthcare expenditure will represent 19.7% of GDP in the US by 2028, growing at a CAGR of 5.4%, and total hospital services spend in the US will rise to $1.3 trillion, or ~33% of total healthcare expenditures, in 2020.

As well as being a large market, the healthcare services industry has high barriers to entry, where incumbents have a significant advantage over new market entrants, as has been proven over and again in recent years. Even giants in other industries have shied away from the healthcare battleground - witness the disintegration of Amazon (AMZN), Berkshire Hathaway (BRK.A) (BRK.B) and JPMorgan's (JPM) combined efforts to establish a foothold in the market.

Premier lists its competitors as rival GPOs such as HealthTrust Purchasing Group, Intalere Inc., Managed Health Care Associates, Inc. and Vizient, Inc, healthcare product sourcing companies such as Cardinal Health (CAH), McKesson Corporation (MCK), and Medline Industries, and in Performance Services, Allscripts Healthcare Solutions (MDRX), Cerner Corporation (CERN), Change Healthcare (CHNG), Health Catalyst (HCAT), IBM (IBM) and Oracle (ORCL) on the software services side, and consultancies such as Deloitte, and Optum Health, a subsidiary of UnitedHealth (UNH).

That makes for a crowded, if finite, market but as mentioned, Premier is protected to an extent by its membership alliance, and its market cap of $4bn is smaller than most of the rivals mentioned above, which ought to make Premier stock more volatile and capable of growing faster, provided management continue to provide continuity, good stewardship, and are able to capitalise on the market insight gained from members with innovative new products and technology-driven initiatives.

Valuation

One drawback of the healthcare services market is that growth across the industry is relatively flat, which might indicate that in spite of all the talk of innovative technologies and new trends such as Population Health Management, the industry is still fundamentally based around relationships and something of a zero sum game. Another way of looking at it is that the increased efficiencies the industry is able to drive through technology reduces the amounts that companies can charge for their services.

Either way, Premier's growth has been broadly flat over the past few years, but my feeling is that managements' mid-to-high single digit percentage growth targets are achievable, due to the scalability of new technologies, and the fact that the migration of healthcare services from manual to digital is still in its infancy. Long-term, the possibilities of telemedicine and virtual doctor visits may mature from the "what if" stage to become a staple of everyday healthcare.

Short-term, Premier is likely to be buoyed by the decreasing severity of the pandemic and a return to BAU, which ought to increase margins.

For my DCF analysis, I have therefore used the company's FY21 estimates, taking the midpoint of revenues, $1.63bn, and calculating COGS and OPEX as $1.1bn, which assumes that both reduce slightly in the second half of fiscal year 2021.

I increase revenues by a CAGR of 6.9% until FY25, so that they reach $2.125bn in that year - this can be considered conservative when we think about the 25% growth between 2020 and 2021 (albeit partly due to increased demand for PPE which does not necessarily translate to profitability) - and increase total operating expenses by 7.8% per annum - a higher rate based on management's guidance, discussed above - to $1.6bn by FY25.

The company's debt is hard to quantify, since it could be subject to restructuring and its obligations to members are not clear to an outsider, but Premier has a revolving credit facility through which it can borrow up to $1bn - current borrowing stands at ~$100m - and according to its Q221 10-Q statement there is a current portion of notes payable to members of $95m, and a long term portion of $347m. Premier's CAPEX across 2021 is expected to be ~$100m, which seems high, so I kept the figure, but have not increased it over the 5-year period.

Premier Inc.: ballpark DCF analysis. Source: my table and assumptions using company historical financials, forward guidance.

That is broadly how I have come up with the above table. I have used a depreciation figure of 3% of revenues, tax rate of 24% (the current rate quoted by management), expected market return of 9% and risk free rate of 1.6%. As we can see, I therefore calculate the present day value of Premier to be ~$5.7bn, or $46.5 per share - a premium of 38% to the current share price.

The above valuation is for discussion purposes only and it's unlikely that Premier's growth will be so linear - it doesn't necessarily follow that if a company is profitable and growing revenues, its share price will go up. In my view however Premier's solid business model and network of partners makes the company a more straightforward investment opportunity than most, that can potentially provide a good upside yield in uncertain times.

Risks

I will briefly outline the 5 main risks that I associate with Premier and its business model after reviewing the company's risk factors section and conducting my own research.

Relations and reputation - Much of Premier's business is relational and although the company's fortunes are tied to those of its partners, there is no guarantee that Premier will hold onto its existing contracts if is no longer able to compete on price, for example, or lacks technical expertise or scalability, or damages its reputation somehow. Many of its competitors are better-resourced.

Strength of competition squeezes margins - Premier does not have too much reason to fear new market entrants, but the number of industry incumbents makes the competition fierce, and as a go-between, negotiating deals between suppliers and healthcare companies, Premier is under continual pressure and may struggle to make margins for itself given it is partly judged on the margins it makes for its clients.

Regulators and government - As discussed above, the threat of wholesale changes to the way that healthcare is administered in the US is continual. Medicare For All could be particularly damaging to companies with business models like Premier's, creating further pricing pressures and challenging the role that Premier plays in pricing decisions.

Reduced Activity - Particularly within its GPO business, Premier needs its partners / members to be spending, or there is no spread to be made. During the pandemic this problem was averted owing to increased demand for PPE equipment, but if members are forced to reduce spending owing to reduced budgets or delay spending due to market uncertainty, Premier's revenues will come under pressure.

Third Party Payors - Often the products and to a lesser extent the services that Premier provides are subject to reimbursement by third party payors, including Medicare and Medicaid, and by extension, the government via CMS, and again these arrangements are fluid and subject to constant change. The burden generally falls on Premier to protect itself, and its bargaining power is subjugated to the larger industry and the regulatory powers that it serves.

Conclusion - A Tricky, Tight Market But Premier's Insider Status Is Hard Won & Valuable

To conclude this note, from the outside Premier looks like an uncomplicated growth stock whose shares may be undervalued given the company's profitability, earnings per share, price to earnings ratio, and management's growth targets which, in the current market, look attractive rather than moderate and imply a higher present day share price value based on forward earnings projections. Plus there is a dividend payment thrown in, and protection offered by the non-controlling ownership which is comprised of Premier's partners and clients.

Digging a little deeper, it is possible to see how Premier's business model is under continual pressure from competitors, and from the need to earn a spread from its healthcare and supplier clients, whilst finding new technological innovations to deliver scalability and cost efficiency, and trying to hold onto the margins it makes there too.

It is clearly not an easy task but Premier has been doing it for a long time and has a strong track record and history of delivering fundamental value - it is hard to extricate Premier from its owners and clients and that can only be a good thing for its business.

Business models like Premier's do not generally generate good publicity but management has done a good job involving itself in policy decisions in the past - incoming CEO Mike Alkire has testified before the U.S. House of Representatives on issues such as gray market price gouging, resulting in two pieces of bipartisan legislation, according to his company bio.

Despite the knife-edge nature of some of the work Premier does, I conclude that the company's shares offer value at the current price. Although not bulletproof, Premier's business model has always proven exceptionally hard to improve upon, despite external and internal pressures, and if the company can deliver a few more solid growth quarters, I think shares can challenge 2018 highs of ~$45.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PINC over 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.