|Shares Out. (in M):||48||P/E||0.0x||0.0x|
|Market Cap (in $M):||381||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||51||EBIT||0||0|
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As a result of a number of issues that arose in 2013, Performant wasn’t much of a performer. The stock is currently trading near all-time lows due to very negative sentiment and weak 2014 earnings expectations which were recently confirmed by management on PFMT’s fourth quarter 2013 earnings conference call. In addition, some of the confidence that investors had in the stock has been shaken by the numerous regulatory and budgetary surprises that occurred over the course of the last year. While these issues, and their impact on earnings, are real, we do not believe that PFMT’s earnings power is permanently impaired. Over the course of 2014 most of the issues that have impacted the stock should resolve at which point we think that PFMT will be back on track to generating $80-$90mln in EBITDA and $0.90-$1.00 in EPS in the 2016 – 2017 time frame which should put the stock in the $11-$14 range in a year or so.
What does PFMT do?
PFMT is a defaulted asset and improper payment recovery contractor. PFMT operates for the most part in the student lending and healthcare industries. Its clients in the student lending industry are the Department of Education (“DOE”) and 11 of the 31 guaranty agencies (“GA”) which are the public sector participants in the student lending industry. On the healthcare side, PFMT is one of four companies that contracts with The Centers for Medicare & Medicaid Services (“CMS”) to recover improper Medicare payments and has begun to contract with private payers in the healthcare industry improper payment recovery as well. Finally, PFMT generates some revenues from the Department of the Treasury as well as other state and local taxing authorities. I’ve included a portion of the PFMT business description from the 2012 10-K below with my own emphasis added. The 10-K does a pretty good job of explaining exactly what the company does, how it does it and who it does it for.
We provide technology-enabled recovery and related analytics services in the United States. Our services help identify and recover delinquent or defaulted assets and improper payments for both government and private clients in a broad range of markets. Our clients typically operate in complex and regulated environments and outsource their recovery needs in order to reduce losses on billions of dollars of defaulted student loans, improper healthcare payments and delinquent state tax and federal treasury receivables. We generally provide our services on an outsourced basis, where we handle many or all aspects of our clients’ recovery processes.
We utilize our technology platform to efficiently provide recovery and analytics services in the markets we serve. We have continuously developed and refined our technology platform for almost two decades by using our extensive domain and data processing expertise. Our technology platform allows us to disaggregate otherwise complex recovery processes into a series of simple, efficient and consistent component steps, which we refer to as workflows, for our recovery and healthcare claims review specialists. This approach enables us to continuously refine our recovery processes to achieve higher rates of recovery with greater efficiency. By optimizing what traditionally have been manually-intensive processes, we believe we achieve higher workforce productivity versus more traditional labor-intensive outsourcing business models. For example, we generated in excess of $150,000 of revenues per employee during 2012, based on the average number of employees during the year.
We believe that our platform is easily adaptable to new markets and processes. Over the past several years, we have successfully extended our platform into additional markets with significant recovery opportunities. For example, we utilized the same basic platform previously used primarily for student loan recovery activities to enter the healthcare market. We have enhanced our platform through investment in new data and analytics capabilities, which we believe will enable us to provide additional services such as services relating to the detection of fraud, waste and abuse.
Our revenue model is generally success-based as we earn fees based on a percentage of the aggregate amount of funds that we enable our clients to recover. Our services do not require any significant upfront investments by our clients and we offer our clients the opportunity to recover significant funds otherwise lost. Because our model is based upon the success of our efforts and the dollars we enable for our clients to recover, our business objectives are aligned with those of our clients and we are generally not reliant on their spending budgets. Further, our business model does not require significant capital expenditures and we do not purchase loans or obligations.
As discussed below, we think that most if not all of the issues discussed above are not only already reflected PFMT’s share price but they are temporary transitional issues that will largely dissipate upon the award of a new RAC contract. In addition, the core positive aspects to the PFMT thesis like growing student loan defaults, massive Medicare improper spending TAM, largely untapped private payer contracting opportunity, and low capital intensity business model still exist.
We don’t see why PFMT can’t get back to 2013 revenue and EBITDA levels by 2016 and grow from there especially when accounting for PIP provider audits and the removal of PRGX as a subcontractor. If you assume $250mln in revenue in 2016 at a 34% EBITDA margin (PFMT put up a 35% EBITDA margin in 2013) that puts EBITDA at $85mln (just below the reported 2013 number). Applying a 9x one-year forward multiple (average of 8-10x) to that EBITDA number puts the EV at $765mln in 2015. Add in $82mln of cash and take out $133mln of debt and conservatively give the company zero credit for FCF generation between now and then (even though the company generated between $40-$50mln in FCF in 2013, depending on how you want to calculate it) and the equity should be valued at around $715mln which would put the stock at around $14.25 in around a year from now assuming 50mln shares outstanding. That is nearly a double in a year. Discount that valuation by 25% to be conservative and you still have a stock at around $11 in a year or so vs $7.91 as of Feb 28, 2014.
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