April 07, 2010 - 9:38pm EST by
2010 2011
Price: 19.80 EPS $0.15 $0.42
Shares Out. (in M): 58 P/E 131.6x 47.1x
Market Cap (in $M): 1,140 P/FCF N/A N/A
Net Debt (in $M): -231 EBIT 15 40
TEV ($): 909 TEV/EBIT 61.2x 23.0x
Borrow Cost: NA

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Eclipsys is priced for near perfection at over 19x TTM EBITDA and 50x fully taxed (at 40%) EPS (after backing out net cash and the present value of its NOL). At ~$20 I believe shorting ECLP has a reward/risk of ~3x with a potential return of ~50% over the next 2 years. Eclipsys currently operates in a very sexy business, healthcare IT systems. Thanks to the Obama administration's future subsidies (based on demonstrating meaningful use beginning in 2011) to hospitals and doctor's offices, the time-frame to upgrade existing or implement new systems capable of managing electronic health records has been moved up a few years. This has pushed Eclipsys' stock up very nicely as well as other healthcare IT plays such as Cerner (CERN), McKesson (MCK) and Allscripts-Misys (MDRX).

Accounting Issues Likely Overstates EPS: Since 1997, ECLP has not generated a dime of annual free cash flow (before taxes) based on my definition of EBITDA - purchases of PP&E - capitalized software development costs--and has burned almost $300M from 1997-2009. Over that same time period, purchases of PP&E and capitalized software development costs have averaged 1.9x that of D&A. Also, its allowance for doubtful accounts has declined to 2.6% vs. a 13-year average of 5.6%. This jibes with its allowance addition charged to expenses in 2009 as a % of revenue of just 0.6% vs. its 13-year average of 1.2%. Thus its paltry reported EPS has likely been overstated, making the valuation even more stretched than it already is. Nevertheless, the street prefers to look at EBITDA excluding stock compensation, which in 2009 represented a whopping 27.9% of EBITDA before stock comp expense. This is a real expense that should not be ignored.

Market Share Break-down of Tier 1 Hospitals
Company # Market Share
Meditech 327 22.2%
Cerner 263 17.9%
McKesson 242 16.4%
Epic 148 10.0%
Siemens 132 9.0%
Eclipsys 113 7.7%
GE 77 5.2%
Homegrown 93 6.3%
No System 78 5.3%
Max Target Market 614  

Bull Case:
1) There is a large target market of 614 Tier 1 (largest in the U.S. with the means to spend to implement an ECLP system) hospitals in the U.S. that either have no system (78 hospitals) or could switch (536 hospitals) from its current provider (Meditech, Siemens or GE) since Epic (private company), CERN, MCK, and ECLP have a much stronger offering. If ECLP gets ~15% of that target market at $15M per client then ECLP will generate a ton of cash over the next 5 years from systems implementations and then have a growing recurring revenue business. This assumes ECLP won't lose any existing clients to any of its competitors. Also, while 150 of its 250 clients have everything they already need, 100 of its existing clients need to purchase system upgrades to qualify for meaningful use. It is estimated that the average hospital will spend about $3-$4M for this upgrade.

2) New CEO who bought stock: The new CEO, Philip Pead, bought $1M of stock on 5/29/09 at $14.33. He became CEO on 5/14/09. Previously, he was managing partner at Beacon Point Partners LLC, a healthcare consulting from 2007-May, 2009. Prior to that he was CEO of Per-Se Technologies, a provider of acute care solutions, claims processing services, as well as physician outsourcing services and practice management solutions, from 2000 until its acquisition by McKesson in 2007.

Bear Case:
1) The target market isn't as large as the market believes it to be. While, Meditech (327 Tier 1 clients) is 1.0-1.25 years behind the stronger competitors, it doesn't mean all of its customers are going to switch to a new system because it likely costs more and could cause more logistical headaches. At the same time Siemens (132 Tier 1 clients) is supposedly winning new business. Thus the Tier 1 target market could be as low as 385 hospitals--based on 50% of Meditech's and Siemen's existing clients plus GE and hospitals with no system.

2) ECLP has ~8% market share of Tier 1 hospitals. The stock is pricing in a much higher win share of the maximum potential clients up for grabs. However, in 2009 ECLP only had 4 client wins compared to CERN's 80+; and it had just 2 new client wins in 2008. ECLP's 2009 new hardware revenue declined by -49.7% YoY while its implementation and software revenue declined by -7.7% YoY. While its business improved in Q4'09, new hardware revenue was still down -6.8% YoY and implementation and software revenue was down -0.7% YoY. The reality is that ECLP has a win share that is lower than its existing market share. This is because its offering is inferior to Epic's, CERN's, and MCK's.

Channel Check: This statement is from a CIO in charge of implementing one of the largest, major metropolitan U.S. hospital's new IT systems. Previously, he/she worked as the CIO for a different Tier 1 hospital implementing Eclipsys' IT system there. This time around he/she is using Epic, which he/she believes is far superior. I recently caught up with him/her a month ago after he/she attended the largest industry conference, HIMSS, and this what he/she had to say: "Epic continues to rock on...I know of 3 major existing customers that are in the midst of switching from Eclipsys to Epic. Their (Epic) double digit growth while impossible to keep going safe at least for another couple of years. The Eclipsys booth was busy with foot traffic, in my opinion that is because they have excellent marketing, excellent technology...the problem is it is all based on average or below average clinical software. I do not believe Eclipsys is well positioned to take advantage of the HCIT initiative as they basically have no private MD application, they are hospital software focused and since hospital systems can cost 10s of millions - the incentive of $2 million or so for hospitals won't move the needle much."

Eclipsys is known for having a good inpatient computerized physician order entry system. Where it falls relatively short is that its system does not have good surgery software to keep track of what tools, etc. were used in the case. It does not have a good scheduling system for surgeries. It has no program to archive medical images. It does not have a good lab program to track test requests and the results of those tests. Lastly, it does not have a good physician office offering.

Estimate of ECLP's intrinsic value:

Initial Contract Sales (2010-2013E)        
  Low Base High Assumptions
Incremental Revenue from Client Base          300.0          350.0          400.0 100 existing clients, $3-$4M per upgrade
New Client Revenue          253.3          434.5          921.0 22-100 new clients over 4 years, $10-$15M each
Total Revenue          553.3          784.5       1,321.0  
Incremental operating margin 20.0% 25.0% 30.0%  
Operating profit          110.7          196.1          396.3  
Net Income (40% tax rate)            66.4          117.7          237.8  
Present Value            57.9          102.6          207.3  Discounted at 10% per annum for 4 years 
Value per share  $        1.01  $        1.78  $        3.60  
Incremental Recurring Maintenance/Software Revenues (2017E)    
  Low Base High  
Existing Client Base            60.0            87.5          120.0 20-30% of initial contract value
New Clients            50.7          108.6          276.3 20-30% of initial contract value
Total Revenue          110.7          196.1          396.3  
Incremental operating margin 40.0% 45.0% 50.0%  
Operating profit            44.3            88.3          198.2  
Net Income (40% tax rate)            26.6            53.0          118.9  
Present Value            15.0            29.9            67.1  Discounted at 10% per annum for 6 years 
EPS  $        0.11  $        0.23  $        0.51  
P/E Multiple 12 16 20  
Value per share  $        1.37  $        3.63  $      10.20  
TTM Recurring Cash EPS  $        0.26  $        0.26  $        0.26  
P/E Multiple 12 16 20  
Value per share  $        3.14  $        4.18  $        5.23  
TTM Contract Sales EPS  $        0.05  $        0.05  $        0.05  
Present Value  $        0.21  $        0.24  $        0.27 Lasts 5-7 years, discounted at 10% per year
Net Cash per share  $        4.01  $        4.01  $        4.01  
Total ECLP Value  $        9.72  $      13.84  $      23.30  
    % change from current price -50.9% -30.1% 17.7%  


ECLP doesn't get the new client wins (and associated revenues) the street is expecting over the next couple of years, which forces the street to re-rate the P/E multiple on lower than expected EPS. 

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