Corvel CRVL S
February 08, 2007 - 2:42pm EST by
elke528
2007 2008
Price: 38.34 EPS
Shares Out. (in M): 0 P/E
Market Cap (in M): 540 P/FCF
Net Debt (in M): 0 EBIT 0 0
TEV: 0 TEV/EBIT
Borrow Cost: NA

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Description

Corvel is a stock where the valuation has become disconnected from fundamentals, and even after a 15% drop after their earnings announcement on Thursday (2/8), the stock is overvalued. Absent momentum investors trying to sustain the 200+% increase over the past 52 weeks, downside to the short is minimal due to industry factors, and upside is around 30%, potentially in the short run as momentum investors get out.
 
Background:
Corvel provides cost containment services primarily to workers compensation carriers, TPAs, and self-insured companies.  Business segments include (a) Network Solutions (60% of revenues), which includes medical bill review, PPO networks (400,000 providers, 80% direct), utilization review, independent medical exams, and other ancillary medical cost containment services; and (b) Patient Management Services (40% of revenues; 140 branch offices), which includes case management, vocational rehabilitation (“back to work” programs).  Founded in 1988, Corvel has extensive history in the workers comp market.  Competitors include Concentra, Crawford, Coventry Health, PMSI (subsidiary of Amerisource Bergen), Genex (recently-sold division of UnumProvident), Aetna Workers Comp Access.  Clients include Wal-Mart, Firemen’s Fund, Nationwide, Travelers, St. Paul, Chubb, Utica, Zurich.
 
Why Corvel is overvalued:
·         Ridiculous valuation:  Trading at 13.7x LTM EBITDA and 14.3x Run-Rate EBITDA.  This is for a business that has only recently begun to turn itself around, and the December quarter just announced did not reflect a business that’s taken off like the stock price has over the past 3 months. 
 
($ in millions; FY ends March)
Q106
Q206
Q306
Q406
Q107
Q207
Q307
Revenues
$71
$66
$63
$66
$70
$67
$67
Y/Y Growth
-7%
-8%
-10%
-9%
-1%
1%
6%
Gross Margin
17%
16%
16%
19%
23%
24%
23%
EBITDA
$7
$6
$5
$8
$10
$11
$9
EBITDA Margin
11%
10%
8%
11%
15%
16%
14%
 
Current Valuation (including FQ307 results)
Price (mid-day 2/8)
$38.23
 
Shares Outstanding
                14
 
Market Cap
$545
 
less Cash
$24
 
Enterprise Value
$521
 
 
 
 
 
EBITDA ($M)
Multiple
LTM EBITDA
$38
13.7x
Run Rate Q3 EBITDA
$43
12.1x
Run Rate Q4 EBITDA
$36
14.3x
 
The current valuation is partially based on an…
 
·         Unrealistic rumor in the market:  Valuation spiked due to an unrealistic rumor that Coventry might acquire Corvel.  While it’s possible, it’s highly unlikely at these valuations, and Coventry announced today that it has acquired a big portion of Concentra’s workers comp managed care business.  Some perspective on valuations in the workers comp space:
 
Coventry/Concentra (announced 2/8/07): 1.2x 2006 Revenues
Coventry/First Health (workers comp PPO network, closed 1/2005):  7x LTM EBITDA (on $276m EBITDA!)
 
Based on these comps, and even being generous with run-rates and multiples, Corvel should trade closer $22-$28, which would represent a further drop of 25-40%.
 
Fair Valuation

Reasonable EV/EBITDA Multiple
CVH/ First Health EV/EBITDA Multiple
CVH/ Concentra EV/Revenue Multiple
Multiple

9.0x
7.0x
1.2x
Implied EV (with peak Run-Rate EBITDA/Revenues)

$387
$301
$320
Implied Equity Value

$411
$325
$344
Implied Price

$28.84
$22.80
$24.10
 

 
 
 
Change from current price

-25%
-40%
-37%
 
So if it’s unlikely that a strategic acquirer will buy it, will a private equity firm pay up for it?  Unfortunately for Corvel stockholders…
 
·         Clemons still in control:  In conversations with CEO Gordon Clemons, he gave me the distinct impression that Corvel was not for sale, especially to a financial buyer.  He has disdain for private equity firms and their financial engineering and he will not let the company be taken private.  Since he and his long-time venture partner own 42% of the company, he has some say in the matter.  He considers the company to be his legacy, and as evidence of such, his son is the VP of Business Development.
 
·         Corvel at structural disadvantage; negative industry trends:  The Patient Management services business consists of 140 branch offices, which are run on a highly decentralized basis.  Lack of central control has resulted in extremely low gross margins in that business which have only now IMPROVED to 10%.  Corvel is fighting the trend of fewer and fewer workers comp claims as the US economy moves away from injury-prone manufacturing.  (Although from the conference calls, Clemons would have you believe that a large portion of the reduction is related to illegal immigrants who don’t file workers comp claims).
 
The Network Solutions business consists largely of revenues generated by a “percentage of savings”, which is being challenged by other companies that offer alternative ways for workers comp payors to save money.  Corvel claims savings by helping its clients direct their injured workers to providers in the Corvel network, or it can reduce out-of-network claims through proprietary bill review and utilization management information systems.  Out-of-network claims generate higher revenue (and profits) since the savings are higher, but Corvel’s clients want the patients to go to the in-network providers, so there’s a constant give-and-take there as network providers change.
 
In the phenomenal FQ2, Corvel revealed that their 9% Network Solutions growth was partially a result of “increase was primarily due to an increase in the volume of out of network bills reviewed which generate greater revenue per bill.”  Since this increase is in direct conflict with Corvel’s clients’ goals, it does not indicate the start of a trend.  Some industry contacts familiar with Corvel have confirmed this dynamic between Corvel and their clients.
 
·         Current shareholder base doesn’t know what this company does:  After years of trading at anemic volumes with consistent top 5 institutional shareholders (Fidelity, Wellington, Wasatch, Kestrel, Royce, Atlanta Capital), volumes have taken off, and stock is now trading over $10m per day!
 
·         Shareholders who DO know what’s going on are selling:  Clemons knows his stock well, buying around $13 last March, and he was selling through November and December, alongside his VC partner (Corstar Holdings) and 2 directors, one of whom sold 40% of his stock (worth $1.2m).
 
Risks:
·         Network Solutions business is scalable:  If Corvel can figure out how to get rid of its Patient Management business, margins could be enormous due to the scalability of the information systems involved in bill review.  However, the Patient Management business is often co-located with Network Solutions locations.  My view of this risk is tempered by the Q3 gross margin, which has paused at 23%, implying that Corvel’s scalable and high-margin solutions are not growing as fast as I had feared.
 
·         Clemons retirement:  Gordon Clemons is in his 60s and could retire, giving someone else with a different perspective on private equity firms a chance to run the company.  Given number of initiatives underway and a recent COO hire, I doubt his retirement will come anytime soon -- and even if he retired tomorrow, it's highly unlikely that any prudent private equity buyer would pay for Corvel at a premium to the current valuation.
 
·         Opportunities in workers comp are large:  Medical cost containment in workers compensation is about 10-15 years behind that in general healthcare.  Innovative companies can be very successful and very profitable by helping inefficient workers comp carriers save money.  However, it also takes workers comp payors a long time to make decisions and change their processes.
 
Catalysts:
·         Momentum investors getting out of the stock (already started today)
·         Lack of strategic buyer in the market (occurred today with Coventry purchase of a portion of Concentra’s business)

Catalyst

Momentum investors getting out of an overvalued stock due to performance and lack of strategic buyer.
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    Description

    Corvel is a stock where the valuation has become disconnected from fundamentals, and even after a 15% drop after their earnings announcement on Thursday (2/8), the stock is overvalued. Absent momentum investors trying to sustain the 200+% increase over the past 52 weeks, downside to the short is minimal due to industry factors, and upside is around 30%, potentially in the short run as momentum investors get out.
     
    Background:
    Corvel provides cost containment services primarily to workers compensation carriers, TPAs, and self-insured companies.  Business segments include (a) Network Solutions (60% of revenues), which includes medical bill review, PPO networks (400,000 providers, 80% direct), utilization review, independent medical exams, and other ancillary medical cost containment services; and (b) Patient Management Services (40% of revenues; 140 branch offices), which includes case management, vocational rehabilitation (“back to work” programs).  Founded in 1988, Corvel has extensive history in the workers comp market.  Competitors include Concentra, Crawford, Coventry Health, PMSI (subsidiary of Amerisource Bergen), Genex (recently-sold division of UnumProvident), Aetna Workers Comp Access.  Clients include Wal-Mart, Firemen’s Fund, Nationwide, Travelers, St. Paul, Chubb, Utica, Zurich.
     
    Why Corvel is overvalued:
    ·         Ridiculous valuation:  Trading at 13.7x LTM EBITDA and 14.3x Run-Rate EBITDA.  This is for a business that has only recently begun to turn itself around, and the December quarter just announced did not reflect a business that’s taken off like the stock price has over the past 3 months. 
     
    ($ in millions; FY ends March)
    Q106
    Q206
    Q306
    Q406
    Q107
    Q207
    Q307
    Revenues
    $71
    $66
    $63
    $66
    $70
    $67
    $67
    Y/Y Growth
    -7%
    -8%
    -10%
    -9%
    -1%
    1%
    6%
    Gross Margin
    17%
    16%
    16%
    19%
    23%
    24%
    23%
    EBITDA
    $7
    $6
    $5
    $8
    $10
    $11
    $9
    EBITDA Margin
    11%
    10%
    8%
    11%
    15%
    16%
    14%
     
    Current Valuation (including FQ307 results)
    Price (mid-day 2/8)
    $38.23
     
    Shares Outstanding
                    14
     
    Market Cap
    $545
     
    less Cash
    $24
     
    Enterprise Value
    $521
     
     
     
     
     
    EBITDA ($M)
    Multiple
    LTM EBITDA
    $38
    13.7x
    Run Rate Q3 EBITDA
    $43
    12.1x
    Run Rate Q4 EBITDA
    $36
    14.3x
     
    The current valuation is partially based on an…
     
    ·         Unrealistic rumor in the market:  Valuation spiked due to an unrealistic rumor that Coventry might acquire Corvel.  While it’s possible, it’s highly unlikely at these valuations, and Coventry announced today that it has acquired a big portion of Concentra’s workers comp managed care business.  Some perspective on valuations in the workers comp space:
     
    Coventry/Concentra (announced 2/8/07): 1.2x 2006 Revenues
    Coventry/First Health (workers comp PPO network, closed 1/2005):  7x LTM EBITDA (on $276m EBITDA!)
     
    Based on these comps, and even being generous with run-rates and multiples, Corvel should trade closer $22-$28, which would represent a further drop of 25-40%.
     
    Fair Valuation

    Reasonable EV/EBITDA Multiple
    CVH/ First Health EV/EBITDA Multiple
    CVH/ Concentra EV/Revenue Multiple
    Multiple

    9.0x
    7.0x
    1.2x
    Implied EV (with peak Run-Rate EBITDA/Revenues)

    $387
    $301
    $320
    Implied Equity Value

    $411
    $325
    $344
    Implied Price

    $28.84
    $22.80
    $24.10
     

     
     
     
    Change from current price

    -25%
    -40%
    -37%
     
    So if it’s unlikely that a strategic acquirer will buy it, will a private equity firm pay up for it?  Unfortunately for Corvel stockholders…
     
    ·         Clemons still in control:  In conversations with CEO Gordon Clemons, he gave me the distinct impression that Corvel was not for sale, especially to a financial buyer.  He has disdain for private equity firms and their financial engineering and he will not let the company be taken private.  Since he and his long-time venture partner own 42% of the company, he has some say in the matter.  He considers the company to be his legacy, and as evidence of such, his son is the VP of Business Development.
     
    ·         Corvel at structural disadvantage; negative industry trends:  The Patient Management services business consists of 140 branch offices, which are run on a highly decentralized basis.  Lack of central control has resulted in extremely low gross margins in that business which have only now IMPROVED to 10%.  Corvel is fighting the trend of fewer and fewer workers comp claims as the US economy moves away from injury-prone manufacturing.  (Although from the conference calls, Clemons would have you believe that a large portion of the reduction is related to illegal immigrants who don’t file workers comp claims).
     
    The Network Solutions business consists largely of revenues generated by a “percentage of savings”, which is being challenged by other companies that offer alternative ways for workers comp payors to save money.  Corvel claims savings by helping its clients direct their injured workers to providers in the Corvel network, or it can reduce out-of-network claims through proprietary bill review and utilization management information systems.  Out-of-network claims generate higher revenue (and profits) since the savings are higher, but Corvel’s clients want the patients to go to the in-network providers, so there’s a constant give-and-take there as network providers change.
     
    In the phenomenal FQ2, Corvel revealed that their 9% Network Solutions growth was partially a result of “increase was primarily due to an increase in the volume of out of network bills reviewed which generate greater revenue per bill.”  Since this increase is in direct conflict with Corvel’s clients’ goals, it does not indicate the start of a trend.  Some industry contacts familiar with Corvel have confirmed this dynamic between Corvel and their clients.
     
    ·         Current shareholder base doesn’t know what this company does:  After years of trading at anemic volumes with consistent top 5 institutional shareholders (Fidelity, Wellington, Wasatch, Kestrel, Royce, Atlanta Capital), volumes have taken off, and stock is now trading over $10m per day!
     
    ·         Shareholders who DO know what’s going on are selling:  Clemons knows his stock well, buying around $13 last March, and he was selling through November and December, alongside his VC partner (Corstar Holdings) and 2 directors, one of whom sold 40% of his stock (worth $1.2m).
     
    Risks:
    ·         Network Solutions business is scalable:  If Corvel can figure out how to get rid of its Patient Management business, margins could be enormous due to the scalability of the information systems involved in bill review.  However, the Patient Management business is often co-located with Network Solutions locations.  My view of this risk is tempered by the Q3 gross margin, which has paused at 23%, implying that Corvel’s scalable and high-margin solutions are not growing as fast as I had feared.
     
    ·         Clemons retirement:  Gordon Clemons is in his 60s and could retire, giving someone else with a different perspective on private equity firms a chance to run the company.  Given number of initiatives underway and a recent COO hire, I doubt his retirement will come anytime soon -- and even if he retired tomorrow, it's highly unlikely that any prudent private equity buyer would pay for Corvel at a premium to the current valuation.
     
    ·         Opportunities in workers comp are large:  Medical cost containment in workers compensation is about 10-15 years behind that in general healthcare.  Innovative companies can be very successful and very profitable by helping inefficient workers comp carriers save money.  However, it also takes workers comp payors a long time to make decisions and change their processes.
     
    Catalysts:
    ·         Momentum investors getting out of the stock (already started today)
    ·         Lack of strategic buyer in the market (occurred today with Coventry purchase of a portion of Concentra’s business)

    Catalyst

    Momentum investors getting out of an overvalued stock due to performance and lack of strategic buyer.

    Messages


    Subjectre: Software sales
    Entry02/22/2007 09:43 AM
    Memberelke528
    Corvel bundles many, many things into its Network Solutions business, so while it's possible that they have a small amount of traditional software sales, that's not the big driver of their revenues. Their business, however, is shifting more towards software-as-a-service (ASP) or as they call it, "portals" (this is the CareMC product).

    This shift should result in more automation and less labor (both because of the increased reliance on electronic tranmission of claims and because the clients' claims adjusters are doing the manual labor) and should result in higher margins. This is the main threat to my short thesis, as I mentioned in the posting.

    But insurance companies, especially workers comp insurers, are slow to change, and gross margins in the Network Solutions business have flattened out after some good performance in FQ1 (35%) and FQ2 (34%). FQ3 came in at 33%, which makes me confident that their progress in implementing CareMC is slower than the bulls out there had hoped (if they understood this at all).
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