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Investment Thesis
Semler Scientific (NASDAQ:SMLR) is a wonderful company that faces near-term risks. Cautious guidance by a top customer along with the lack of consumer activity in December and the Omicron case surge don't seem to be factored into consensus estimates and I believe that there's a high probability that Semler disappoints. I'm on the sidelines for now looking for a better price.
Fourth Quarter Could Bring Further Weakness
There's been a significant pullback in Semler shares following its third-quarter results where the company recorded its first revenue miss in 10 quarters. The weakness then went on for the rest of November. Shares seem to offer an amazing opportunity as they're 42% below their late October highs. But what seems won't be the case in my opinion, at least not so for the coming quarter.
The source of the mid-November weakness was very important and went missing on SA. I believe that the underlying reason will be material to near-term price action and investors that value tactical opportunities and risks should pay close attention.
One of Semler's key customers highlighted weakening demand to which some on the street took notice. Signify Health, which is Semler's second-largest customer, reported an expected decrease in IHEs (In-Home Evaluations) for the fourth quarter. The company had conducted 437k IHEs in 4Q 20 (963k for the first 9 months and 1.4mn for the full year as disclosed) but announced that it expected to only do 388k in 4Q (at the midpoint of the 1.815-1.855mn guidance range and 1.447mn for the first 9 months). The 11% drop in Signify's IHEs will be a headwind for Semler.
Signify accounted for 27.9% of Semler's third-quarter revenues per Semler's 10-Q. The loss of Signify YoY would imply a negative growth headwind of more than 3.1% (27.9% times 11.21%). This could make Semler's 8.1% 4Q YoY growth guidance difficult to reach.
The Weakness Doesn't Seem to be Fully Priced in
What's perhaps more important is what Signify's announcement implies. We're seeing what we say earlier in the pandemic; patients are delaying procedures. Semler's FY20 10-K acutely highlighted this with the words "we experienced decreased test volumes due to COVID-19". What Signify is experiencing is most likely a broader phenomenon that Semler will, unfortunately, see with its other customers.
It's important to pay attention to patient behavior as well. We saw a pick-up in cases in the rest of November and December following the announcements with the spread of the Omicron variant. I'm guessing that with Christmas around the corner, many patients decided to delay any socializing activity for the majority of December to have safe holidays. Many people (like me) distanced for most of the time leading up to the Christmas period to be able to travel safely and not infect any family members. This will show up in fourth-quarter results.
While we saw a significant pullback in Semler's 4Q revenue estimates, down from $16.44mn to $14.54mn following the company's announcements, the rest of the revisions don't seem to reflect what happened following the call. Signify's announcement only brought the consensus down by ~$1mn to $13.55mn. Signify contributed ~$4mn to Semler's third-quarter revenues and could account for all of the decreases in consensus solely by itself. Furthermore, Omicron came about at the end of November, after both Semler's and Signify's results, and will have a significant impact on Semler's 4Q revenues compared to what one would've expected them to be mid-November. The consensus estimate drop of ~$1.5mn down to the current $13.05 doesn't reflect the potential risk in my opinion.
Source: Capital IQ
Moreover, we've only seen the COVID situation get worse since the November announcement. Omicron has been causing a storm with the US printing record case counts day after day as we head deeper into January. This is bound to affect 1Q numbers. 1Q estimates, however, have not moved since the recent surge in caseloads and have significantly increased since the second week of November. FY22 numbers also haven't moved since Omicron after falling significantly after Semler's announcement and less after Signify's.
Source: Capital IQ
Source: Capital IQ
The price action doesn't seem to reflect something that the consensus missed either. If you look at the stock price chart at the top of the article, most of the losses came before the Omicron spike. Further disappointments seem likely to me.
With no immediate relief in the US COVID situation, I think that Semler missing 4Q estimates and downward revisions to 1Q numbers is very likely. I will be staying away from Semler until the market reflects this outcome. Purchasing put options or replacing common equity with calls could be wise choices for current holders of the stock.
While the Tactical Opportunity is to the Downside, Strategic Allocators Must Stay Bullish
I always want to present a balanced view and give my full opinion. I do think that 4Q is a significant risk to Semler's current price even though the stock is below the levels it was when its NASDAQ listing was announced.
However, long term, I'm confident that the stock will trade above its current levels. Semler is positioned very favorably with its highly scalable business model, large and growing TAM, leading product, low penetration, underlying drivers in Medicare Advantage, and low competitive pressures. The company has one of the most attractive financial profiles with extremely attractive margins and cash generation. There may be a downside to near-term consensus but I see upside to medium to long term numbers which I don't think factor in potential new products that are likely to come given the management commentary regarding new products and the company's continued R&D spend and the international opportunity. And all of this comes at an undemanding valuation. Semler is truly a wonderful business.
Many will call my cautious view myopic and they may be right. But I cannot buy a company where I see a clear downside to current estimates. If the revenue impact isn't worse than I fear I'm happy buying Semler at a higher price as I see significant room for appreciation over the long term. I'm on the sidelines for now.
