Evolent Health Stock: Healthy Growth, But That Is About It (NYSE:EVH)

Shares of Evolent Health (NYSE:EVH) have been doing quite alright in a tumultuous market here. Since its IPO in 2015, the company has not been seeing that much attraction from investors, so let’s establish a thesis following resilient performance and a recent deal.

The Business

Evolent Health is a so-called value based care provider which provides technology-driven solutions for health plans and providers, to simultaneously improve health while cutting costs, being beneficial for all the stakeholders in the system. The company has a generic focus, providing these solutions across all lines of care including Medicare, Medicaid and commercial markets.

The company generated $891 million in revenues in 2021, two thirds of which were generated from clinical applications and the remainder from what it calls Evolent Health Services. Overall EBITDA came in at $66 million with segment EBITDA reported at $100 million. This works down to nearly 14% margins for the largest clinical applications business and just over 5% margins for the smaller EHS unit, with a +$33 million corporate cost allocation reducing the reported EBITDA down the line to $66 million.

A Look Into The Numbers

in February of this year, Evolent posted its 2021 results as revenues actually fell 2% to $908 million, with the small discrepancy from the $891 million number above stemming from a difference in GAAP and non-GAAP accounting.

Earnings numbers were notoriously hard to read into as a GAAP loss of $38 million, or $0.44 per share was reported with results hampered by an increase in the fair value of a contingent consideration and losses on repayments of debt, partially offset by gains on equity method investees and gain on transfer of membership. No less than 13 adjustments were made to arrive at adjusted profits of $0.02 per share, or just over a million, among others a very real and substantial stock-based compensation expense of $17 million.

The 88 million shares outstanding value equity at just over $2.6 billion at $30 per share, as the company operated with a rather flattish net debt load by year’s end. This reveals that the company is valued at around 3 times sales, as the company is not yet economically profitable of course. For 2022, the company guided for revenues at a midpoint of $1.15 billion with EBITDA seen at a midpoint of $85 million.

In May, the company posted strong first quarter sales with revenues up a massive 38% to $297 million, driven by continued contract wins. This drove a strong increase in operating leverage with EBITDA margins up 130 basis points to 8.2% of sales. Despite the rapid increase in EBITDA as a profitability metric, the company still posted a net loss of $5 million and while it might be fair to adjust for some GAAP losses, the company is more or less just breaking even here.

With dilution increasing the share count to 90 million shares, for a $2.7 billion valuation, we see the valuation increase to nearly $2.8 billion if we factor in net debt of around $70 million, at least that was the count per the end of the first quarter. Following the strong start to the year, the company hiked the midpoint of the revenue guidance to $1.185 billion with the EBITDA guidance hiked by $5 million to $90 million.

A Bolt-on Deal

In the final days of June, Evolent announced that it has reached a deal to acquire IPG, a leading technology company which provides surgical management solutions for musculoskeletal conditions in a deal valued at $375 million, with earn-outs having the potential to increase the price tag by another $87 million.

With revenues seen at $140 million this year, IPG is acquired at a 2.7 times sales multiple (excluding earn-outs). This is a fairly similar multiple at which the company trades itself, yet 20% sales growth and $25 million in EBITDA look quite interesting I must say, certainly on a relative basis. Net debt will jump to $465 million overnight as the company anticipates leverage ratios around 3 times upon closing, quite steep as the business is not really economical here, with EBITDA being quite adjusted.

That is exactly the problem with Evolent in my book. The strong growth and positioning seem good, but the company is not really economically profitable. Even if one were to believe the adjusted earnings multiples, this results in a high earnings multiple, yet the reality is that the adjustments are so plentiful and sizeable that the company is really not profitable at all, making it very hard to value. Given the pace of growth sales multiples might look reasonable, yet at some point some margins are required as it is hard to see to which level they might get.

While the latest deal looks relatively compelling, (on a relative basis) I feel that the risk-reward situation is not compelling enough here, certainly as margins are appearing at various aspects of the market nowadays.