Value Investors Club / Health Innovations (HIIQ)

Description

Health Insurance Innovations (HIIQ) is one of the most maligned publicly traded companies on the

planet. The company has been hit with short-selling campaigns from at least four short-sellers. This has

left the stock trading at incredibly cheap levels, considering that it’s a high growth company trading for

under 6X 2019 EPS. We disagree completely with the short’s view on the company and its product and

find it quite surprising that the stock price has returned to these levels after passing through a 42 state

investigation that was the basis of the earlier more potent short selling attacks.

Consensus:

• Short-term (STM) health Insurance is a bogus product promising real health insurance for a

fraction of the price, taking advantage of poor unsuspecting customers leaving them in a

potentially precarious position without health insurance.

• It is only amount of time before the government bans short-term health insurance as the

Obamacare market spirals out of control. The democrats have already spoken out against the

industry and as soon as they are in power they will shut-down the industry.

• The company faces large liabilities from a former distributor facing lawsuits.

Variant Perception:

• Short-term health insurance is a great product for healthy individuals who do not have their

healthcare paid for by an employer.

• The Obamacare market is actually functioning and fairly stable, counter to public headlines.

While politicians may express outrage against short-term health insurance, as it is politically

convenient to do so, they are highly unlikely to ban a product that would leave people

uninsured and directly affect millions of voters.

• HIIQ has greatly improved its compliance over the years and any claims of liability are likely to

result in zero or minimal damages to the company. We believe that past regulatory actions

have colored certain short-sellers against the company, causing them to dramatically overstate

the risk of certain situations despite being wrong in the past.

The Business:

HIIQ provides insurance products and software to third parties (primarily call centers). The software

enables sellers to sell multiple products with just one online form from policy holders. This enables

sellers to sell many policies such as dental, Teladoc, vision and life beyond the primary policy which is

usually some form of healthcare. The additional policies tend to have higher commissions, and it is our

understanding that the software will allow a seller to double the commissions they would have gotten if

they had to push the products one by one to consumers. HIIQ also gives access to smaller firms to

insurance products by having relationships and scale with insurance providers along with licenses. HIIQ

may also provide or help procure leads for call centers. Lastly HIIQ will also provide some form of

financing for call centers in the form of advanced commissions. We view the company as a technology

and relationship oriented business with its primary product being short-term health insurance. The

company also sells directly to consumers online which is under 20% of the business.

Short-term Health Insurance is a great product!:

The basic crux of the short argument is that short-term health insurance is (pardon my French) a bullshit

product that rips off stupid poor people. This stems from the basic assessment over how can something

that costs about a quarter of regular health insurance (not even including the higher commission rates)

provide the same coverage? When we first talked to our Washington intelligence firm, we got a similar

view. But then we spoke with a number of people who actually are in the business of selling the

product. While these people might seem biased and self-serving for sales, one person with whom we

spoke had bought short-term insurance for his family, and we would describe this person as likely easily

able to afford Obamacare. The intelligent shopper picked HIIQ’s product.

Short-term health insurance can provide pretty much what is in the Obamacare “silver plan” for a

fraction of the price by essentially restricting and eliminating unhealthy people from the pool it insures.

Over 80% of the costs of healthcare stem from the people who are unhealthy, such as people who have

chronic conditions like heart disease. Additionally costs are cut since care is only provided short-term,

so if a subscriber gets cancer, it covers him/her for the subscription period, but once the period is up, it

will not renew your policy. Short-term health insurance will not sell to people with pre-existing

conditions or will void coverage of those conditions. It also does not cover things such as psychiatric care

or pregnancy.

So why would people want a policy that would dump them as soon as they get sick and need it? Let me

explain how smart people use short-term health. They buy a policy for a fraction of the price of

Obamacare and if they end up getting hit with a temporary or chronic condition, then they are covered

for a while. If unable to renew their policy, they will move on to Obamacare which does not reject

preexisting conditions. A health care consumer is worried about three things: 1) getting health care, 2)

avoiding financial ruin and 3) the price of health care. This combo of short-term to Obamacare if

necessary solves or wins on all three counts. Consider the two alternatives for consumers: 1) they can

pay for Obamacare from the start and pay more for basically the same coverage, a clearly inferior

option, or 2) they can run the risk of going without insurance, a decidedly undesirable and extremely

risky option.

The Government Will Put an End to Short-term Health Insurance as soon as the Democrats come into

Power:

This stems from two mistaken beliefs that the product is a rip-off, which we show is not true above and

that the Obamacare market was going onto a death spiral and was being severely impacted by short-

term health insurance.

The Obamacare market is actually stable though that is the case for unintended reasons. The fear is that

if STM grows, it will drive up prices in the ACA market. The market was supposed to guarantee health

insurance to all and provide for that by coercing all to join (by using the now individual mandate), so the

healthy would subsidize the sick.

However, this is not how the ACA market is working. Instead, the pool consists primarily of low income

households who are getting substantial subsidies and are generally healthy and has a sprinkling of

wealthy households who buy insurance to avoid the penalties under the mandate and middle income

households who have high medical costs (ie sick people). Interestingly, this is a perfectly stable system

and is not subject to the “death spiral” concerns that many think is or at least was happening.

The ACA offers some subsidy for those earning between 250% and 400% of the federal poverty level,

compelling subsidies for those earning less than 250% of the FPL. Based on this set of incentives, you

would expect that healthy individuals who receive big subsidies or are subject to big penalties and sick

individuals who receive neither would sign up for the plans. This, by and large, is exactly what

happened.

Apologies for having not having more recent numbers in the following paragraphs. My numbers are

from when we first investigated the short-term space, but I am sure the numbers don’t look much

different for 2017 & 18.

The ACA market had 17 million participants in 2016. 9 million of these participants received subsidies in

2016. 81% of these participants earned less than 250% of the FPL and thus received substantial

subsidies. Unsurprisingly, participation rates were much higher among those who were eligible for

larger subsidies.

Additionally, according to HHS, among the unsubsidized buyers of insurance were 2.5 million who were

eligible for a subsidy (including 1.1 million who earn less than 250% of the FPL) and 1.9 million

individuals who were eligible for Medicaid. It is generally thought that most of the participants who

didn’t receive the subsidy for which they were otherwise eligible did so because they made the mistake

of buying the plans off exchange where the subsidies are not available and didn’t know that they were

eligible for a subsidy.

Since the subsidies are set to cap the cost of insurance at a certain percentage of income, as insurance

prices rise, the subsidies rise to offset. Thus two thirds of the ACA’s participants either received a

subsidy or were eligible to receive a subsidy and thus should be largely not impacted by price changes.

Among the remaining 5 million or so covered lives who were not eligible for the subsidy, there are some

number of sick/ expensive individuals, some number of wealthy individuals who needed to buy

insurance to avoid the penalty, and some number of healthy individuals who would be better served by

an STM plan. It is difficult to know precisely what the mix is. However, if 2 million or so of those

individuals were to move over to STM plans from the ACA market, they would roughly increase the price

of insurance for the remaining unsubsidized purchasers by ~10% and the price from there would be

stable.

This analysis is not particularly sensitive to exactly how many of the nonsubsidized lives leave. If it is 1

million or 3 million the equilibrium price of insurance on the exchanges should remain fairly stable as

the large population of 11 million subsidy eligible lives would likely participate regardless.

So the market is stable, with very little to gain by forcing a few million people off STM plans, that could

knock 10% to 15% at most off prices. To do this all you have to do is kick a few million people off their

plans. You would have then either cost these people around $4,000 per year for an individual and

possibly $10K or more for a family. I am no political expert, but it seems to me a good reason for these

people to vote Republican. So it seems to me this is just politically unfeasible.

Now socialized medicine is intriguing and could happen eventually, but it is likely decades away if it ever

happens. Many democrats are backing Medicare for everyone, but that won’t likely happen till they

have the presidency and filibuster proof majorities in both houses. We are pretty confident that is at

least 10 years away.

A compromise is easy to see here if it gets that far. Under Obama, STM plans were limited to 3 months

in duration, and this made using them as a long-term solution a little tougher. However, HIIQ had huge

growth under these regulations as they were able to push Hospital Indemnity plans (very similar to STM

but not quite as good). Democrats could claim victory with totally alienating a large number of voters

and Republicans could accept this as reasonable, meanwhile HIIQ would still prosper. It seems that just

the press of changing healthcare laws may drive sales for HIIQ.

HIIQ is far Better than Perceived Compliance:

Much of the perception of HIIQ’s compliance is derived from the misperception of the product. If you

believe that the product is a total rip-off, how would they sell it without lying? But when speaking to

many call center and industry execs, we found that the product basically sells itself and lying would

probably make it worse. After all, if you tell someone this is an Obamacare plan they would naturally

question why it is 75% cheaper, but if you tell them it has the same coverage as an Obamacare plan and

is cheaper because it does not allow preexisting conditions, they can understand and trust that.

The vision that the bears have of a call center probably looks like the movie Boiler Room with some

young jerk riding off in a Ferrari as he lies to poor people about health insurance. In fact, it is much

different picture--more of a customer service center environment with the average pay of about $40K

and the top employee getting $100K. The calls are scripted, and this not exactly the environment that

attracts a lot of get rich quick schemers. So are there calls that are not compliant, of course there are.

But the cause of this is not greed, it is likely more laziness than anything else. There are innumerable

permutations to people’s healthcare issues and while preexisting conditions are not covered, not all will

make you ineligible. So sometimes a call-center worker doesn’t know and answers incorrectly, and

sometimes they just take a lazy yes instead of investigating or explaining. This is a high turnover

industry, and the bad apples are eventually found. Ineffective salesman often are let go, but mistakes

do happen. We tested the product sales process as a pretend shopper. We asked a very difficult

question while posing as a person who had bipolar disorder and was on medication. The correct answer

is that we would be allowed to get STM but the medication is not covered. About half got it wrong but

erred on the cautious side, saying that we could not get STM. Only one out of seven said it would be

covered. So for the hardest question we could think of one out of seven would have a compliance issue

that would quickly be caught within weeks even if it made it to an actual policy. We did not buy policy

or head down that road and give this person a chance to correct his mistake.

What we have found with HIIQ is that the company in compliance was kind of faking it till they made it,

as they were lax in the early years when compliance was too much of a luxury. However, we have

spoken with multiple former compliance people, company insiders and call center execs and found a

growing culture of compliance that is fairly robust at least in legal terms and has only gotten stronger

since CEO Gavin Southwell took over. We do not believe compliance will be an issue going forward, and

we view the resolution of the 42 multi-state agreement as proof that HIIQ’s compliance was sufficient in

the past.

Now I will cover the shorts argument that HIIQ will be responsible for damages in the case against

Stephen Drorfman’s call center operations. This case stems from Dorfman subpoenaing HIIQ

employees, along the misperception of the product and where Dorfman likely went afoul of rules. First

off the FTC has already stated that they are not investigating HIIQ on this case. From our talks with a call

center exec, the scuttlebutt in the industry is that Dorfman got in trouble for soliciting leads for non-

STM products than converting those leads to STM. This makes sense--we know after speaking with a

former Drorfman company exec that this company at least in part generated its own leads and had an

advantage in doing so. It would make sense to try to get leads from Obamacare sites, since those don’t

reward brokers much they are less highly valued than STM leads, so a potential arbitrage for Mr.

Dorfman. This is outside of the purview of what HIIQ is responsible for and our guess is that the vast

majority of the supposedly duped clients of Dorfman are thankful that they didn’t end up buying

Obamacare. Either way we believe that HIIQ will have no or at worst minimal liability. The risk that

others operating the same way Dorfman did is low and the way HIIQ operated some brokers popping up

while others go down, does not affect the company’s bottom line much.

Valuation:

We believe that HIIQ should do roughly $3.75 in EPS in 2019, so the stock trades for under 6X and is

growing greater than 20%, buying back shares. Of course this is higher than the $3.29 currently

projected by analysts as we believe the company has a history of giving very conservative guidance and

the buyback at low prices has not fully been reflected in those estimates. They also mentioned that they

are being very conservative with their implementation of ASC 606, and we expect numbers will go up

throughout the year as they beat and raise each quarter. We note this happened to Ehealth (EHTH) in

2018, and the stock tripled as investors began to better understand ASC 606. EHTH currently trades for

33X 2019E EPS. Additionally, the STM market is expected to grow between 50-100% this year, so 20%

growth for HIIQ seems conservative. A simple back of the envelope calculation on adjusted 2018 EPS of

$2.60X 25% growth gets you $3.25 with the company buying back 10% plus of their shares that takes

you over $3.60. We think growth will be higher than 25%, ASC 606 will benefit EPS, and margins will

show some improvement, making our estimate conservative. At 15x 2019E EPS 3.75, HIIQ would trade

at $56/share or 155% upside from current prices. HIIQ has historically traded between 10-22x forward

earnings, so you can pick your multiple, but the stock should be much higher than it is today.

Risks:

Our major concern is a rise in competition. While HIIQ has an early lead, coupled with relationships in

both the call center and insurance space and with exclusive agreements in both. Gret economics attacts

competition. We have found former company employees founded a competitor a few years ago and

have taken share with a very similar offering to call centers. We have also found other less direct

competitors. The rise in competition is what makes this difficult to forecast long-term and thus more of

a trading position.

Long-term the business may go more direct online, as consumers become more familiar with STM

products.

This industry is populated with largely what we could call characters. This does not mean they are

incompetent. The person who was pillared in a short report for hocking a product called the butt

bobble online we found to be so revered in the industry that a competitor tried to copy his whole

operation as much as he could simply due to reputation. A more negative example is that this is the

only time that I know of where we were knowingly lied to an expert network call. While the lie was for

competitive reasons, it was unnecessary and clearly unethical. You also don’t have to look hard to find

people in the industry who have run into legal trouble. This may cause a little more difficulty in

analyzing the industry and could cause some trouble for a corporation who does play by the book.

Other Tidbits:

At least as of year ago, the CEO of EHealth owned shares of HIIQ, we were told by someone from EHTH..

I imagine you think judging by the side I am on with HIIQ that I am a Conservative. I am actually a fairly

liberal lifelong Democrat.

Catalysts:

The short interest is an incredible 95.13% of the stock, with the buyback that only increases. We also

have heard some scuttlebutt that the number is even higher since some major shareholders don’t lend

their shares out.

We believe that 2019 earnings will come in above consensus.

The company passes through the Dorfman lawsuit with no liability

Regulatory risk eases--a Trump 2020 win would be huge, but indications of that will do. However, given

that health care is sort of always in play politically, we see this as sort of a more melt up situation than a

large price jump, at least for this issue.

At current valuation levels the company could be an acquisition target for private equity or some

strategic acquirers.

Any success from a non-STM product HIIQ is currently working on a Medicare Advantage product and a

Spanish speaking product, both of which could be meaningful

If the company is able to tap into the association market for STM products, we could see a meaningful

increase in earnings.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Sorry this isn't pasting properly, please see above.

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			2019	2020
Price:	22.34	EPS	3.75	0
Shares Out. (in M):	14	P/E	6	0
Market Cap (in $M):	313	P/FCF	0	0
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0