This Heath Care Software Provider Could Fall Ill

One of the by-products of the Affordable HealthCare Act was to be a push towards electronic platforms to create cost efficiencies in tracking data and billing for procedures. But after being an initial beneficiary of the explosion of spending on health care management software this company could become collateral damage.

This bearish option strategy provides a flexible low cost way to profit from either a sudden or steady decline in the share price in coming months.

Too my mind Athenahealth’s (ATHN) founder and CEO is Jonathon Bush comes under a lot of unwarranted criticism for his relations to Presidents Bush (he’s a cousin of George W and nephew to H. W) and his manic style. I couldn’t less about the former and actually like the latter; the man brings passion in attempt to bring positive change to broken healthcare system. I found his book, Where Does It Hurt?: An Entrepreneur’s Guide to Fixing Health Care filled great insights and ideas.

But for some investors his style and business plan seem outlandish and profitability out of reach. The most notable takedown came from hedge fund honcho David Einhorn, head of Greenlight Capital, in a 65 page presentation he gave last May explaining why he’s shorting the AthenaHealth shares.

This caused the stock to drop nearly 20% over the next two days to a 52-week low of $97 a share. Bush did the media rounds defending himself and his claims that Athena (oh wait, Bush insists the company uses a lower case “a”) could be the Google, Amazon and Facebook health management services.  It’s that type of hyperbole, and the spending trying to achieve that goal, which gives one pause.

Shares eventually climbed back as high as $150 by the end of 2014. But brief spike following its February 6th earnings report, which touched that $150 making a double top, shares quickly retreated and the chart forming a bearish flag.

ATHN 022615

Combined the weak technical picture with numbers coming from earning report suggests the fundamentals can’t support the still lofty valuation. Unfortunately, as much as I’m rooting for Bush and his company I think the stock could sink back below the $100 level.

My main two main concerns is that athena’s is spending and costs are increasing at much greater rate than its revenue or earnings growth. Which might be fine in the early stages of company trying to grab market share in a relatively new field with a lack of incumbents. But based on the numbers and anecdotal evidence is that it’s failing to make inroads against competitors such as Cerner (CERN) and Allscripts (MDRX) or even larger general data management company’s like Oracle (ORCL).

In 2015 revenue is expected to grow by some 20% to $919 million but earnings just 2% to $1.17 per share giving shares a lofty forward p/e of 107x at its current $128 a share. The growth rate just doesn’t justify the valuation.

Athenahealth doubled its employee headcount 2014 and plans adding another 1,000 to over 4,500 in 2015.   Most of these will be sales and marketing related jobs in attempt to sign up doctors and hospitals for its core electronic payment and billing service. There have also been a host acquisitions and expansion into tangential services such as social platforms with thus far disappointing results.

Its acquisition of Epocrates division saw sales actually decline by 25% and the 2014 launch of Coordinator Enterprise inpatient service is now not expected to contribute meaningful revenue until late 2016; well behind the company’s original projections.

All told, at 17 years old, athenahealth has moved passed the untapped potential stage and into the “show me” phase of its business life. I think it will have a hard time delivering on its early promises. I’m establishing a bearish position.

The Trade:

I’m using a diagonal put calendar spread which consists of buying a long term put with a near the money strike and selling a shorter term put with a further out of the money strike.   Specifically;

-I’m buying the September $130 put and selling the March $125 put for a $12 net debit for the spread 

This position will benefit from both time decay as the March puts

value erodes at an accelerated rate versus the September puts we purchased. It will also benefit from a decline in price as the Sep. puts have a closer to the money strike.

If shares drop below $125 prior to the March 20th expiration we can close the entire position for an approximate $4 or 25% profit in less than a month. If shares are above $125 we can sell April puts to further reduce our cost.

The ultimately goal would be to eventually bring the cost basis of the log September puts down towards zero and have a “free” outright put position.   Depending on price behavior this could be accomplished with four monthly rolls, March, April, May and June. Profits could be taken at any point the shares slumped below strike sold short.

The ultimate downside would be the 52-week low at $95 a share. If the position worked out perfectly we could be looking at over a $30 or 2,000% profit. That probably won’t be achieved but we are setting up situation with a high probability for 25% to 100% return over the next six months.

 

— Steve Smith

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About the Author: Steve Smith