August 19, 2013 - 3:45pm EST by
2013 2014
Price: 19.40 EPS $0.16 $0.31
Shares Out. (in M): 34 P/E 121.3x 62.6x
Market Cap (in $M): 667 P/FCF 19.3x 21.2x
Net Debt (in $M): 270 EBIT 25 35
TEV (in $M): 934 TEV/EBIT 37.0x 25.8x
Borrow Cost: NA

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  • Healthcare
  • Poor management
  • commoditized product
  • Competitive Threats


I think Healthways (HWAY) is a reasonably timely short with downside to $11 over the next 12 months.  Founded in 1981, HWAY provides wellness and disease mgmt (DM) services (e.g., manage patients to stay on medication, visit doctor, etc.) and wellness offerings (e.g., preventative health risk assessment tools, telephonic coaching, etc.).  Their programs are designed to improve well-being by helping people to adopt or maintain healthy behaviors, reduce health-related risk factors, and optimize care.   In the US, customers include health plans (HPs) [~75% of revenue - ~35% Medicare Advantage (MA), ~20% fully-insured, ~20% ASO], employers (~15%), and integrated healthcare systems (~5%).  HWAY also provides services to international healthcare businesses and/or govt entities in Brazil, Australia and France (~5%).

Here are a couple examples of HWAY's basic disease management services:

-          Commoditized Services:  HWAY has a rather weak business position as there is nothing truly proprietary about its business [e.g., algorithms, websites, alliance with ~15K gyms through their “Silver Sneakers” senior fitness program, etc.].  I believe that HWAY’s services have become heavily commoditized over the years as barriers to entry have fallen which is evident by their customer insourcing (they lost their largest customer – CI at 17% of revenue – in late 2011), increased competition from larger competitors (UNH/Optum, CI, AET) and smaller start-ups, and lack of pricing power as evidenced by their declining margins due to high-margin legacy contracts either leaving or renewing at lower rates.  They have guided to accelerating revenue growth but a further decline in margins, and have given little clarity as to why margins are deteriorating so greatly.

-          Little/No ROI:  If you speak with HWAY management it is very clear that they do not want you to know what they do, which is essentially contracting with small, regional health plans to identify the sickest patients – though biometric screening, health risk assessment questionnaires, etc. – and provide telephonic coaching and online web tools to manage their chronic conditions (i.e. diabetes, congestive heart failure, smoking cessation, etc.).  In addition, ~1/3 of the business is offering gym memberships to Medicare Advantage members through their Silver Sneakers program.  Despite HWAY’s assertion to the contrary, I believe that there is no ROI to their products which is supported by numerous channel checks with current and former customers and industry consultants.  Some health plans simply use their services as a marketing tool to employers, though my customer checks reveal pushback on pricing due to their inability to adequately prove an ROI.

-          Increased Competition:  Historically, HWAY dominated the disease management landscape before the tide turned against disease management’s ROI and demand dissipated.  HWAY has consistently reinvented itself – this time as a “population health management” company; however this time they have been met with more competition as large players (UNH/Optum, CI and AET) have added these ancillary services to their offerings as a means for working with Accountable Care Organizations (“ACOs” – i.e. coordinated hospitals and/or health systems).  HWAY has been slow to add customers here while their large competitors are continuing to build out their ACO infrastructure.  The bottom line is this is a low-barrier-to-entry, low-value-add business.


This is without a doubt a management team that you want to bet against.  Capital deployment has been poor as HWAY bought back 2M shares in April 2008 for ~$36/share and bought back 1.2M shares in 3Q11 for ~$12.40/share just before losing the CI contract and watching the stock get cut in half.  On the M&A front, they made a large acquisition (Axia) in 2006 for $467 at ~3x revenue which created $385M of goodwill.  They built 255K sq ft of office space in early 2009 for ~$35M which is in the shape of a large “H”.  From a transparency perspective, HWAY gives very few financial metrics and provides only minor details on contract wins, losses and renewals.  The CEO, Ben Leedle, consistently uses what one former customer called, “consultant babble” and the former customer told me it is “crazy that he is still there.”  He also said that “HWAY acquired a lot of things but has no talent to put it together” and they “have destroyed a lot of good companies by acquiring them and sucking the life out of them.”  Mgmt also consistently overpromised and under delivered by setting aggressive LT goals (15-20% EBITDA margins), frequently reducing guidance, and losing large contracts which were previously considered highly unlikely.  I met with the CEO in 2010 when they were reaching 38M lives and their goal was to reach 150M lives (half of US population), but today they have grown their reach to a whopping 40M (i.e., +2M in three years)


HWAY has a very weak balance sheet as they are highly levered at 3.2x debt / EBITDA and had to raise their debt covenants twice over the past year to avoid breaching them.  Even after the large GW write down in 4Q11 of $183M ($5.35/share), GW + intangibles is still 59% of assets and 77% of their gross PP&E is computer equipment and software.  HWAY also holds very little cash ($2.3M as of 2Q13) and net debt / LTM EBITDA is expected to reach ~3.8x in 3Q13.  While the company has generated $19M of FCF in 1H13, most of that is seasonal as they had taken down working capital from lost contracts which resulted in a non-recurring $13M working capital inflow.


Revenue has been roughly flat from 2010 through 2013, with some dip from the loss of Cigna in late 2011.  HWAY likes to talk about revenue growth excluding contract losses, which doesn't make much sense to me. Nonetheless, my model conservatively assumes continued market growth (with no major contract losses) and natural margin expansion from G&A leverage. I think the picture could be quite a bit less rosy given the aforementioned insourcing/commoditization/pricing risks.

FYE 12/31; $M 2010A 2011A 2012A 2013E 2014E 2015E 2016E CAGR ('12-'16)
Revenue $696.6 $688.8 $677.2 $702.9 $781.9 $821.0 $862.0 6%
EBITDA 130.0 113.2 82.4 77.6 88.4 98.5 103.4 6%
Op Income 77.3 63.3 30.7 25.0 35.4 43.9 47.2 11%
OCF 72.9 76.3 40.7 78.2 81.4 88.7 92.6 23%
FCF 28.5 27.0 (8.2) 34.6 31.4 38.7 42.6 n/m
EPS - Cont Ops $1.11 $0.83 $0.27 $0.16 $0.31 $0.47 $0.53  
EPS - GAAP $1.36 ($4.61) $0.24 $0.16 $0.31 $0.47 $0.53  
EV / Revenue 1.3x 1.3x 1.4x 1.3x 1.2x 1.2x 1.1x  
EV / EBITDA 7.0x 8.1x 11.1x 12.0x 10.6x 9.5x 8.9x  
P / E 17.2x 23.0x 69.1x 121.3x 62.6x 41.3x 36.6  
P / B 1.6x 1.9x 2.4x 2.3x 2.3x 2.1x 2.0x  
P TB n/m n/m n/m n/m n/m n/m n/m  
FCF / Market cap (%) 4.4% 4.1% -1.3% 5.2% 4.7% 5.8% 6.4%  
ROE (%) 9.6% 8.1% 3.4% 1.9% 3.6% 5.0% 5.3%  
ROIC (%) 6.4% 6.0% 2.7% 2.3% 3.5% 4.3% 4.7%  

-          Historical Trading:  5-year average: NTM EV/EBITDA of 6x (low of 3x, high of 11x)

  • 2.0% ROE and 2.5% ROIC

-          1-Year Price Target (Base Case / Downside):  $11 / $23

  • Base:  7x EBITDA / Downside:  12x EBITDA
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.



 -          2H13 Numbers Are Way Too Aggressive:  Despite weak 1H13 results, HWAY maintained its 2013 revenue and EPS guidance.  Given the high P/E multiple on the stock, I believe it’s trading on expectations for accelerating revenue growth which I do not believe will occur.  HWAY did $162M in 2Q13 revenue, down from $165M in Q1.  Both quarters had the same amount of revenue from 2 lost contracts ($1.3-1.4M each quarter), so you can still make an apples-to-apples comparison when excluding those contracts since the lost contract revenue is a wash.  So revenue still fell $3M sequentially.  However, they recognized MORE performance fees in Q2 than they were expecting (~$3M which is ~100% margin) and they also blamed the Q2 revenue miss on the fact that new contracts were slower to ramp than expected.  That being said, if the contracts were ramping AT ALL from Q1 to Q2, new contract revenue should have been higher in Q2.  So despite more revenue from new contracts and greater performance fees in Q2, revenue still fell Q/Q.  Therefore, either the base business is declining and/or these new contracts have not started to contribute to revenue at all.  Even if the latter is true, the base business must still be declining.  [The sell-side is totally clueless on the stock, and many sell-side analysts seem to not even understand what the company does); the Piper analyst has the company growing EBITDA >$28M next year ('14) on $89M higher sales (i.e., 31% incremental margins), despite the company having generated 16.1% gross margins in 1H13.]

-          Another Bad Acquisition:  HWAY recently issued a convertible bond – taking advantage of the run in the stock price – and expects to use the proceeds to repay some debt – as they recently had to change their bank covenants (second time in ~1 year) to avoid breaching them – and mentioned making selective acquisitions.  The second part would be positive for the short and likely put the company at further risk as management has a poor track of making small, roughly pre-revenue acquisitions.  For example, from 2009-2012, they spent $35M on acquisitions although revenue has declined $40M during that timeframe.  Most notably, they wrote of $183M of goodwill in 4Q11.

-          Large Contract Loss:  As we saw with CI in 2011, large customers have the potential to move their services in-house.  HWAY is currently or about to start renegotiation on their UNH contract which is slightly <10% of revenue.  While we think that it is unlikely that UNH drops HWAY as a customer, I believe that they will push back on price, as UNH uses HWAY for their Silver Sneakers (gym memberships for MA members) program, and MA pricing/margins are coming under pressure next year due to lower govt reimbursement.


-          Rising Tide Lifts All Boats:  As we saw with disease management a decade ago, these fads can last a while and create “story stocks.”  HWAY first characterized itself as a “disease management” company then a “wellness” company then a “well-being” company and currently it is a “population health management” company.  However, the latest version is a buzz word that HCIT vendors, ACOs and MCOs are throwing around as well.  There seems to have been an increase in RFP activity and it is too early to see if HWAY is losing share or not, but our channel checks have suggested HWAY is getting increasingly aggressive on pricing.

-          Large Contract Win:  To HWAY's credit, they have announced several contract wins – most recently with state of GA for 650K employees.  Despite never providing any financial metrics on their contract wins, investors bid up the stock on contract announcements.  Given the increase in RFP activity and HWAY’s focus on revenue growth over profitability, more contract wins is a clear risk.

-          Acquisition Target:  This is usually a risk for any short but there has been an uptick in M&A activity in the space (CERN/PureWellness) as the new “population health management” buzzword makes the rounds.  Given that most of the recent M&A has focused on an HCIT angle – versus HWAY with a traditional, high capex, hands-on (i.e. call centers with nurses, telephonic coaching) approach – I believe it is unlikely.  Furthermore, former HWAY customers have revealed that their IT systems are in shambles as they had to outsource everything to HPQ after having issues managing it internally.  Several former customers cited this as a reason for dropping HWAY.

-          Tough To Value a Black Box:  HWAY gives very few operating metrics and very little financial disclosure which makes understanding the business trends very difficult – and makes all of the sell-side analysts simply take management at their word despite a consistent history of overpromising and underdelivering.  I rely on constant channel checks and hear a very different tune from what management speaks.  For example, management recently touted two ACO agreements with Carondolet and Texas Health Resources.  However, based upon our channel checks, no revenue has even exchanged hands yet.  However, maintaining a “black box” allows management to continue to fool investors into betting on the “to come” and makes disproving the bull case more difficult as HWAY can keep kicking the can down the road.

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