July 06, 2017 - 8:37pm EST by
2017 2018
Price: 13.40 EPS 0.26 0.27
Shares Out. (in M): 146 P/E 51 49
Market Cap (in $M): 1,945 P/FCF 37 41
Net Debt (in $M): 259 EBIT 45 45
TEV ($): 1,671 TEV/EBIT 37 37
Borrow Cost: Available 0-15% cost

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Company Description

INOV is a Healthcare Services company based in Bowie, MD. The company was founded as MedAssurant by Dr. Keith Dunleavy in 1998. The name was changed to Inovalon in 2012 and the company came public 1Q 2015 at $30 and is now $13. Insiders own 53% of the 146m outstanding shares.


INOV has a $1.9B market cap and $1.6B EV ($260m of debt and $533m of cash). Short interest is 15% of the float.


INOV acquired Avalere, a Healthcare consulting company, for $140m (3x revenue) in September 2015 and Creehan Company, a Specialty Pharmacy PBM platform for $105m (4.2x revenue) and a $25m earn out.


INOV’s end markets include health plans (89%), Pharma (10%), and Medical Device companies (1%). Anthem represents 17% of INOV revenue. No other clients represents more than 10% of revenue as of 2016, but in 2013, BCBS Michigan, EmblemHealth, HealthFirst, and WellCare each represented 11% of company revenue.



If stock charts typically drive your investment process and not fundamental analysis, you won’t want to short this company. However, if you like shorting companies that were benefiting from a temporary surge in earnings whereby they were at the right place at the right time and now competition is pouring in while the government is potentially delegitimizing their business model, you should find INOV an interesting short.


INOV will continue to lose health plan contracts or face significant renewal concessions as their Risk Adjustment practices are no longer accepted by the industry given government scrutiny on the industry and additional competitive pressure.


The combination of a small float, share repurchase program, and investors believing estimates have finally been rebased have caused the stock to rally from a low in December 2016 of $9 up to $13. I believe INOV will miss estimates again in the second half of 2017 due to continued weakness in the Risk Adjustment business and the stock will go to $8-9 based on 10x my 2018 EBITDA estimate for a roughly 35% return.


I think your risk is $14-15 if INOV can hit their 2017 EBITDA guidance and grow another 15% off of that in 2018 and trade at 15x EBITDA which is north of where their much better peer COTV currently trades.



Me compared to the street

INOV has guided for 2017 EBITDA of 105-113m and consensus estimates are comfortably at the midpoint at 107m. While I think 2Q should meet expectations based on the seasonality of their business, 2H 2017 numbers are too high by 10-15% each quarter. My 2017E EBITDA estimate is $96m, or 11% below the midpoint of guidance.


Sell side expectations are not high (no buys) and the stock is 15% short given INOV’s recent past which makes me wary, but I believe at $13-14 the reward to risk is too compelling to ignore. I’m confident the stock wouldn’t be at these levels if it wasn’t for a lack of float, stock buyback, and the first half of the year news vacuum.


Mysterious 4Q 2016 guidance miss

Last year, INOV missed their 4Q 2016 by 40M of revenue and 32M of EBITDA which promptly cut the stock in half. INOV attributed the miss to a contract that did not come to fruition, but that does not seem likely given it would imply something like 30% of revenue on an annual basis in a business that is very people intensive while INOV was not substantially increasing headcount. With some diligence on and provider newsletters, you can find that they closed their Lansing office (BCBS Michigan was 11% of revenue in 2013) and also find a provider newsletter from BCBS Michigan highlighting a new Risk Adjustment vendor for their Medicare Advantage population, Ciox Health.


I pieced together the back story as to how INOV would have lost the contract. BCBS MI acquired a business called Tessellate in 2016 which does the same thing as INOV meaning they were working to take the business internal. Ciox Health is being used as a partner given their expertise in Medical Record retrieval.


Interestingly, BCBS Michigan is still using INOV for their HEDIS quality work which is all done in the first half of the year given a June 30th data submission date, so that actually supports the first half of 2017 being less at risk that the back half.


Thesis Details

Typically I like to keep write-ups short and simple, but there is a fair amount of background knowledge needed to understand INOV’s business model so bear with me. It wasn’t so long ago that I was a novice in the Healthcare industry, so I’m hoping this background info can help those that are not as familiar.


Medicare Advantage (MA) Explanation

Americans that are age 65+ can receive healthcare coverage through Traditional Medicare or Medicare Advantage.


Traditional Medicare is commonly known as Fee For Service (FFS) and includes Part A and Part B. The program has a much wider network as most providers in the country will accept Medicare patients. The disadvantage to FFS is that there are no out of pocket maximums and typically a 20% copay. There are ~29m FFS beneficiaries or 67% of the eligible population.


Medicare Advantage (Part C) is a health plan sold by an insurance company and has certain minimum benefits that Traditional Medicare would have. Disadvantages are that the plan will have a narrower network than FFS and you typically need a referral to see a specialist. Advantages are that the plan can often be cheaper all in given the out of pocket max. MA plans have about ~19m members or a 33% penetration rate.


Misleading Business Characterization

INOV portrays themselves to public investors as a Healthcare Technology company addressing the $300-450 BN of waste in the US healthcare system, and as a result, claims their addressable market is $80B and growing while saying that “high 80s to low 90s” percent of revenue is recurring in nature. It’s a classic example of a grossly overestimated TAM to entice investors.


In reality, I estimate (company very cagey about revenue sources) that 55-65% of INOV’s revenue is from a service called Risk Adjustment (RA) they provide to Payers’ Medicare Advantage and Individual or Small Group books. Risk Adjustment is the process of making sure Medical Charts have the proper documentation so the health plans receive the most possible compensation from Centers for Medicare and Medicaid Services (CMS). INOV says their contracts with payers are 3-5 years in length, but I have seen one that was 2 years long and said the client could cancel the contract if INOV did not maintain adequate service levels. There is substantial provider abrasion with Risk Adjustment which payers are always trying to avoid.


The process of performing RA is a body shop business whereby INOV is hiring “coders” that are paid between $15-25 / hour (depending on RN or CNA) to obtain Medical Records from a Doctor’s office and subsequently review them. INOV is compensated by the health plan based on the number of charts they review at ~$21-30 per chart depending on if they could pull the chart straight from the EMR system. Search “Inovalon Triple S Contract” to see an example.


The RA industry has seen a significant increase in revenue since 2011 driven by the Affordable Care Act (ACA) individual market and a new Centers for Medicare and Medicaid (CMS) payment methodology called the Encounter Data System (EDS). Both are discussed below.


ANTM Contract Loss – 8%+ of revenue at risk

I have reason to believe that INOV did not renew their Commercial Risk Adjustment contract with ANTM for 2018. While the industry is very opaque regarding contracts, as an outside party there are some clever ways to find information. One of those is by reading the newsletters that Anthem sends out to their providers which you can find by looking on their website.


The June 2017 newsletter states that Altegra Health, one of the larger INOV competitors, will be performing the RADV audit for the Commercial RA submission. The June 2016 newsletter said that Inovalon would be performing the audit. Best case scenario for INOV is that ANTM chose Altegra to do the RADV audit to give the semblance of checks and balances since DOJ is investigating Risk Adjustment practices. It’s probably a 0.5% revenue impact under that scenario. Worst case is INOV lost the business for 2018 (would not see the impact until 1H 2018) which would be at least an 8% ($35m) by my estimates at a high margin.


June 2017 Newsletter -

June 2016 Newsletter -


I realize that the newsletters are specific to the Colorado region, but you can check the other ANTM regions, and they say the same thing.


UNH Whistleblower Case – Negative implications for INOV

Benjamin Poehling, an ex UnitedHealth Group employee, filed a lawsuit in 2011 that alleges UNH and other Medicare Advantage plans were deliberately defrauding the government by claiming patients were sicker than they really were. MedAssurant, INOV’s former name as a private company, was mentioned in the suit as being one of the players engaged in the systemic fraud.


This is important because the DOJ is now investigating UNH under the False Claims Act which would require repayments if the DOJ did deem they were committing fraud (potentially in the billions of dollars). This is the DOJ’s first time getting involved in Medicare Advantage on a False Claims basis. MedAssurant (INOV) is not named in the suit which means they would not be held accountable. It’s the health plan that is held accountable for the data that INOV submits to CMS.


Very good NYT article highlighting the issues here


Lawsuit found here


There are some damning remarks made about MedAssurant in the lawsuit. Here are a couple excerpts.

“MedAssurant promises significant return-on-investment (“ROI”) from its CARA solution. The company claims in its promotional material that many plans achieve reimbursement gains in excess of $3,200 per confirmed CEDI. MedAssurant is so confident in the profitability of its services that it allows client health plans to set “ROI thresholds” requiring the achievement of specified financial gains. Overall, MedAssurant reports that ROI typically ranges from 7:1 to 12:1, but can be in excess of 27:1.”


“Among the experience and knowledge Relator relies upon is his belief that no health plan would hire MedAssurant to perform risk adjustment-related services unless that plan intended to, and as a general practice did, fraudulently increase its risk adjustment claims. After reviewing MedAssurant’s data analysis algorithms and chart review practice, Relator believes that MedAssurant’s processes are so obviously designed to fraudulently inflate risk scores (and offer no mechanism to correct errors found) that a health plan would not hire MedAssurant unless the plan itself was already applying or planning to apply that approach to all of its MA business.”


While I’m not claiming there will be any direct monetary impact to INOV based on the lawsuit and will acknowledge the whistleblower’s bias, I believe the industry is going to be much more careful regarding their aggressiveness with up coding patients now that the DOJ is involved. I spoke to someone at Optum that confirmed health plans are being more conservative now in their up coding.


I have also been told that INOV’s solution is much more of a “black box” where they do not share the algorithms they are running to identify the target patients while they also charge more than competitors for their service. The lawsuit will likely cause additional pushback from clients and pressure INOV when it comes to contract renewals.


Affordable Care Act (ACA) Benefit - Don’t mistake this as an ACA repeal play

Beginning in 2014, The ACA created a guaranteed issue (not medically underwritten) exchange population that would be insured by the existing market participants. Because this market was not medically underwritten, health plans were concerned they would exposed to adverse selection and potentially extreme losses if the plan was not priced appropriately which was difficult due to lack of medical history and the fact that the Government limited the difference in premiums between the healthy and unhealthy population.


To get the health plans on board, CMS introduced the 3Rs: Risk Adjustment, Reinsurance, and Risk Corridors. Each R was designed to be budget neutral and stabilize the Exchange risk pool, but I am going to focus on Risk Adjustment given relevance to INOV. There is a great and detailed explanation of the program here.


Risk Adjustment – The program is not a novel idea from CMS as the same program exists in the Medicare Advantage (MA) market to ensure that health plans are not incentivized to cherry pick healthy members (strong operators like HUM were getting good at finding the healthy members by doing things like only getting members with a gym membership and other creative methods). This works by paying healthy plans more for their members that are sicker as measured by Hierarchical Condition Categories (HCC) like Diabetes or High Blood Pressure.


Plans are responsible for ensuring that their members have the proper codes associated with them so they get paid the appropriate amount. The process consists of health plans querying their data for the areas that typically have the most errors and then pulling Medical Records from their providers to correct them. Besides the internal staff, INOV was basically the only company of scale around at that time, and they receive sweetheart pricing deals because of this.


The ACA uplift is short term in nature as health plans had an influx of new members with potentially limited historical data given lack of previous coverage. Health Plans tend to do RA work internally as its mission critical work, but vendors like INOV are used as flex labor whenever there is a temporary surplus of work for a plan due to membership growth over a short period of time. While we are now reading about the underwriting spiral occurring in the ACA exchange market due to guaranteed coverage, health plans and others knowledge of how the health insurance industry works knew that there was a good chance this could happen. As a result, health plans used INOV for their ACA members and likely had plans to staff internally in the event the market stabilized.

New Payment Methodology for MA Plans - Encounter Data System (EDS)

CMS currently compensates health plans primarily based on the Risk Adjustment Payment System (RAPS) under which the plans are paid more money based on the severity of the claim. CMS allows the health plans to submit their own data under RAPS which is validated by CMS after the fact based on sampling called a Risk Adjustment Data Validation (RADV) audit.


In 2008, CMS introduced the Encounter Data Payment System transition which would be complete in 2020. Under EDS, plans transfer all the raw claims data to CMS and they would internally calculate the Risk Adjustment scores based on the patient’s medical record data. The problem here is that the medical charts currently do not contain all the data that CMS is planning on using for their scores, so payers must dedicate resources to provider outreach and updating patient charts if they do not want to their payment rates to drop. INOV did a sample for some of the health plans they serve and estimated that payments could be reduced by 2%-28% depending on the enrollees.


CMS plans to fully compensate plans based on the EDS by 2020 with the mix of RAPS and EDS in the meantime. EDS weightings were slated to go from 10%, 25%, 50%, 75%, and 100% from 2016 to 2020.


As part of the CMS CY2018 Medicare Advantage Rate announcement, CMS actually walked back the EDS weight from 50% to 15% given payer push back to the program. While it’s not possible to know the total impact, this will cause plans to utilize less of INOV’s chart chasing services as their reimbursement rates will not be impacted as much.



Risk Adjustment was previously a very fragmented industry with INOV, United’s Optum, and Verisk Health (sold to Veritas Capital in 2016 for 10.6x trailing EBITDA) being the only real scale players.


Recently, a company called Ciox health acquired a Blue Cross Blue Shield funded company called ArroHealth that provided the same services as INOV. I believe Ciox-ArroHealth will be the most significant new competitor to INOV as Ciox manages the Electronic Medical Record departments of 3 of every 5 healthcare providers in the US. This will allow them to be much more efficient than INOV when it comes to obtaining charts for reviewing.


Another recent deal was in July 2015 when Change Healthcare (combination of MCK Healthcare IT business and Blackstone’s Emdeon) acquired Altegra Health, one of INOV’s larger competitors, for $910m.


Verscend is another player of scale that was created when Veritas Capital acquired Verisk’s Healthcare business. Verisk Healthcare itself was created from the acquisition of MediConnect Global and Health Risk Partners.


Valuation and Comps

INOV currently trades at 50x 2017 Non-GAAP EPS, 17x EV / 2017E EBITDA, 36x 2017 FCF, and 3.9x 2017E revenue. EBITDA isn’t the greatest metric to use for INOV vs other Healthcare Services companies as they capitalize a meaningful portion of R&D (5% of revenue).


While there are no perfect comps, Cotiviti (COTV), HMS Holdings (HMSY), are somewhat comparable although they probably wouldn’t agree. COTV is the best business out the group and currently trades at 13.7x 2018E EBITDA while HMSY trades at 10.1x 2018E EBITDA given investor fears around their Medicaid business. To illustrate the importance of the capitalized software, on 2017 numbers, COTV trades at 15.5x EV / EBITDA compared to INOV at 17.1x and COTV trades at 23x FCF compared to INOV at 36x.

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


3Q or 4Q 2017 earnings. INOV's guidance implies a step up in revenue for Q3 over Q2 which has never happened given the seasonality caused by HEDIS data submissions.

~70% of Risk Adjustment chart chasing is done in second half of the year given the January data submission deadline. Pressures in this business will cause INOV to miss their guidance.

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