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When Privia Health Group (NASDAQ:PRVA) went public in May of last year, I concluded that good intentions do not necessarily make a good investment. The company witnessed a successful public offering with shares nearly doubling from the preliminary price range, as investors like the disruptive growth model, but that unfortunately has not been accompanied by disruptive actual sales growth.
The IPO - The Initial Take
Privia was one of the latest players in 2021 to go public, aiming to disrupt an inefficient and traditional US healthcare system by providing value-based care, focusing on patient experience and efficient operations.
The company is a so-called national physician enablement company which works together with medical groups, health plans and health systems to optimize physician practices, patient experiences and creating right incentives in the system.
The market is huge, with the physician enablement markets totaling some $2 trillion, as companies with the right incentives have great potential in this industry with a long runway for growth. The company´s solutions impact 3 million patients through 650 care centers, with greater ambitions targeted of course.
After pricing took place at $23, a full five dollar ahead of the midpoint of the preliminary offering range, Privia commanded a $2.5 billion equity valuation, which includes a net cash position of around a hundred million. This valuation was applied to a business which posted 19% revenue growth in 2019, with sales reported at $786 million, as operating profits improved to $16 million.
Despite the disruptive business model, or at least ambitions, revenues were up just 4% in 2020 to $817 million as operating profit improved further to $25 million, still resulting in a 100 times operating earnings multiple. That felt like a rich multiple, certainly as first quarter sales in 2021 were down 4% on an annual basis, and certainly as shares rallied to $36 on the first day of trading, pushing up the enterprise valuation to $3.7 billion. After all, here the value has risen to 4.5 times sales, yet the operating earnings multiple far exceeds the 100 times mark, as this entirely is, or should be a lower margin business.
While the valuation actually looked somewhat compelling to some other recent high-fliers at the time, the valuation gap with traditional names has been huge, making me very cautious.
What Happened?
Fast forwarding since May 2021, shares have been seeing quite some volatility. Shares rallied to the $50 mark in the summer, but ever since have come under quite some pressure, with shares now down to the $20 mark, essentially trading at their lows.
In May the company posted first quarter results with revenues flat on the year before at $213 million, with operating earnings coming in at nearly $8 million. Second quarter results were a mixed bag, with spectacular growth driven by easier comparables and bottom line results impacted by charges related to the IPO and related stock-based compensation expenses. It was telling that selling shareholders offered a big block of shares at $29 in the autumn, even as shares were 40% from the highs already, but of course were up still significantly from the IPO price.
Third quarter sales of $251 million were up more than 21% on the year before and indicate a billion run rate, yet the modest operating profits turned into a loss of $12.8, seemingly driven by new and structural stock-based compensation expense. With shares down to $20 now, the 106 million shares still represent a $2.1 billion equity valuation, as net cash balances actually still surpass the $300 million mark, for a $1.8 billion enterprise valuation. This results in a mere 1.8 times sales multiple, a significant pullback from the IPO price.
Worrying is that modest operating profits of 3-4% have turned into a loss of around 5% of sales, which given the nature of the business is a huge amount with so many billable hours involved. The exact explanation behind this driver is the fact that stock-based compensation for the third quarter totaled $25 million, after the company incurred a >$200 million charge alongside the IPO already. And while all of this is adjusted for in EBITDA calculations, it is a real expense to investors and a dilutive one, so it should not be adjusted for (only in the sense of cash flow purpose calculation)
Despite this bad news show, there was actually some good news as well as the start of 2022. The company reached an agreement with a subsidiary of Humana (HUM) on which it expects to recognize $230 million in collections this year, equal to a quarter of the total revenue base!
What Now?
Modeling a 5% operating margin to be quite decent over time, the company is likely stuck posting operating earnings around $50 million at this pace. Accounting for interest and applying a 25% cut for taxes, I peg net earnings potential at $35-$40 million in such a scenario, which at $1.8 billion valuation still works down to a 50 times multiple.
Of course, there is potential here in the revenue base, given the run rate and recent contract wins, but in all likelihood, margins will not be achieved this year either. Even if I kindly double the operating earnings potential to a hundred million, which is equal to 5% margins on a $2 billion revenue rate, only then are we seeing fair to still slightly higher valuation levels. In the meantime, there is so much heavy lifting to be done, both in terms of sales and margins, as all of this makes me still quite cautious here.
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