Short sellers are betting against a high-growth business that’s undervalued
Disclaimer: This is not financial advice. I just work in the Medicare industry and thought I would share some knowledge. I have no affiliation with any of the companies mentioned in this post. I do own shares in CLOV and OSH.
This post will hopefully provide some value to people not familiar with Clover Health (CLOV) and their Medicare Advantage business. CLOV is starting to get a lot of attention because of their high growth rates, the addition to the MSCI index in May, and the high short interest that could lead to a squeeze. I personally invested in CLOV because of the valuation, because I work in Medicare Advantage and the fundamentals support a $20+ share price. I’m happy to hold on to this long-term for that reason.
I’ll start with the valuation, and then work backward to show how I arrived at these numbers and help explain why the stock is trading so far below it. I’ll also highlight the key risks to this company so that everyone can evaluate CLOV objectively and decide if it’s a good investment for them.
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CLOV Valuation
Low End = $20.30 per share
- 70,000 MA patients (end of 2021) x $51,834 per patient = $3.62B
- 70,000 DC patients (end of 2021) x $66,667 per patient = $4.67B
- Total market cap = $8.29B
High End = $27.84 per share
- 70,000 MA patients (end of 2021) x $51,834 per patient = $3.62B
- 100,000 DC patients (end of 2021) x $76,667 per patient = $7.67B
- Total market cap = $11.29B
Medicare Advantage Business Valuation
ALHC is the best comparison for CLOV’s MA business.
- ALHC has a valuation of $51,834 per patient
Growth rate comparison
- ALHC Historical = >30% (source)
- ALHC Projection = >30% (source)
- CLOV Historical = >30% (source)
- CLOV Projection = >30% (source)
Direct Contracting Business Valuation
AGL is the best comparison for CLOV’s DC business
- AGL has a valuation of $66,667 per patient
- Favorable DC model economics (vs MA business) could be as high as $76,667 (15% premium over current AGL patients).
Growth rate comparison (N/A)
- The DC model started April 2021 so there is no historical data, which makes projections unreliable as well
- CLOV currently has 15,000 more DC patients than AGL, indicating they can grow enrollment equal to or faster than AGL
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Full Breakdown of CLOV Valuation
To understand what CLOV should be worth today, look at ALHC, AGL, and OSH. Not only did all four companies go public within the last year, but they are all Direct Contracting Entities (DCE) competing for “lives under management” (Note: you’ll see companies report this number using the term patients, members, or beneficiaries. They’re all equivalent). This term simply means Medicare patients that the company is financially +/- clinically responsible for. Medicare pays $850+ per beneficiary per month for these companies to take on the risk of managing their healthcare costs. You can think of it as a lower margin (5–10% EBITDA) Software-as-a-Service (SaaS) model that generates stable recurring revenue on a monthly basis for each patient being managed.
CLOV started out as a Medicare Advantage (MA) insurance plan, which is pretty similar to Direct Contracting (DC). That’s because the DC model was designed based on the MA model by the Centers for Medicare and Medicaid Services (CMS). CMS launched the DC program in April 2021, and CLOV, OSH, and AGL among the first 53 organizations approved.
OSH does a good job of explaining how the Medicare Advantage market (and similarly the DC market) works:
MA Plans are insurance companies that partner with specific healthcare providers to help manage the cost of their patients. The MA plan gets the $850+ monthly payment, and is required by law to spend at least 85% of it on medical costs. They usually do this by giving 85% of the $850+ monthly payment to the healthcare provider, and thereby transfer the risk of unexpectedly high costs to the provider caring for the patient. The DC model works the same, except Medicare pays the Direct Contracting Entity (DCE) $850+ monthly. What’s interesting about DC is that any type of organization can be a DCE. Here’s a breakdown of how each company participates in the MA market:
- CLOV is an insurance company (MA plan) that creates networks of healthcare providers for their plan members.
- ALHC is also an MA plan (and the most direct comparison for CLOV’s MA business line).
- AGL is a Management Service Organization (MSO) that provides services to healthcare providers that care for Medicare Advantage patients (and the most pure-play company for the DC business model).
- And OSH is a healthcare provider that operates brick-and-mortar clinics focused on Medicare Advantage patients.
Medicare Advantage represents 26 million Americans, accounting for about 36 percent of all Medicare beneficiaries. The DC program was launched by CMS so that Medicare Advantage companies like CLOV, ALHC, AGL, and OSH could help manage the other 46 million Medicare beneficiaries in order to transition away from fee-for-service healthcare. It’s a huge deal.
Below I’ll break down the key numbers driving the valuation of these three companies for their Medicare Advantage business. The DC business is obviously new, but I’ll predict what the valuations will look like in DC afterward. The most important thing to understand here is that the valuation for all four of these companies is the number of lives under management multiplied by a dollar amount. The dollar amount is the market saying how much they believe in the company’s ability to profitably manage those patients.
Disclaimer: I’m not saying all four companies should be valued exactly the same. I am arguing that the dollar amount per managed life should be within a much tighter window because the gross margin for managing a Medicare life (MA or DC) will always end up in a very tight window (5–10% of revenue) no matter what model you deploy.
OSH = $14.3B market cap (6/4)
OSH is obviously liked the most by the market based on their valuation. It’s partly because they run the clinics so they can keep more of the Medicare dollar (instead of splitting it with the healthcare provider that takes on the risk). Employing clinicians also allows them to theoretically do more to improve health outcomes and control costs. In this model, the MA Plan takes 15% off the top, and the rest goes to OSH.
- 2020 gross margin = 6.7% (source)
- 75,500 total managed lives growing to 112,000 this year (source)
- That’s a valuation of $125,000 per patient
AGL = $14.3B market cap (6/4)
AGL holds the contract with the MA plan and then pays the contracted (not employed) healthcare provider. In this model, the MA Plan takes 15% of the premium off the top, and the rest is split between AGL and the provider practices.
- 2020 gross margin = 7% (source)
- 165,300 total managed lives growing to 210,000 this year (source)
- That’s a valuation of $66,667 per patient
ALHC = $4.38B market cap (6/4)
ALHC has historically been just a MA plan, taking the 15% of the premium off the top and paying the rest to cover the patient’s costs (source). MA plans have an average profit margin of 4.3% after all their admin and sales expenses are accounted for (source).
- 2020 gross margin = 1.37% (source)
- 83,500 total managed lives growing to 84,500 this year (source)
- That’s a valuation of $51,834 per patient
CLOV = $3.65B market cap (6/4)
CLOV has historically been just a MA plan, taking the 15% of the premium off the top and paying the rest to cover the patient’s costs (source). MA plans have an average profit margin of 4.3% after all their admin and sales expenses are accounted for (source).
- CLOV historical gross margin (before COVID effect) = 2.5–4.1 % (source)
- 132,000 total risk-based patients growing to 160,000 this year (source)
- That’s a valuation of $22,800 per patient
AGL is a good preview of how the DC market could be valued per Medicare patient, except the DC model could be even better. There is no MA plan taking 15% off the top in between the risk-bearer (Direct Contracting Entity: CLOV, AGL, or OSH) and Medicare. Direct Contracting patients could be valued as high as $76,667 (15% premium over current AGL patients).
The CEO of OSH was recently quoted “the per-patient economics of that program will potentially be better than the company had initially estimated” (source).
CLOV also believes the margins will be better in the DC model (source):
Here are the number of Medicare patients enrolled by each DCE (since the program launched in April 2021):
- ALHC: 1,500 managed lives (source)
- OSH: 6,500 managed lives (source)
- AGL: 50,000 managed lives (source)
- CLOV: 65,000 managed lives (source)
Hopefully now those valuation ranges I presented at the top make a little more sense to you.
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Why is CLOV Undervalued?
Part 1: Hindenburg Report (February 2021)
Hindenburg does research for short hedge funds. The report revealed a DOJ investigation into CLOV that was previously undisclosed. The day after the report was released, an SEC investigation was initiated into CLOV based on the report. The report had a number of unrelated claims on shady marketing practices, undisclosed business relationships, and “upcoding”.
Probably the most serious accusation of them all is the one about “upcoding”. If this is true, it’s Medicare fraud. The number one rule in the Medicare industry is DON’T OVERBILL MEDICARE. In the case of CLOV, I seriously doubt there is any upcoding going on based on how their software works. The Clover Assistant (CA) software doesn’t have the ability to change any codes. It just makes recommendations. The doctor has to manually do it for regulatory and patient safety reasons. There are other population health tools out there that do this exact thing. Often times when upcoding is being investigated, it’s because the Medicare fee-for-service claims suggest a much lower risk score. However, that’s because providers don’t document most codes in fee-for-service claims because they don’t get paid to spend the extra time. When the patient then enrolls in a MA plan or DC program, all of a sudden their risk score shoots up because the MA/DC organization and provider get paid based on risk.
Regarding the other accusations, CLOV released a point-by-point response the day after the report came out. I thought they addressed everything sufficiently. From an investor’s perspective, it all comes down to what the DOJ finds. I’d be very surprised if Chamath’s counsel and the third-party counsel involved in the SPAC ignored or did not look into illegal practices during due diligence. This was one of Chamath’s first SPACs and he knew was launching many more. If you mess up due diligence once, the rest of your SPACs become worthless.
Part 2: DC Enrollment Numbers (May 2021)
CLOV announced their initial Direct Contracting (DC) enrollment numbers in their most recent quarterly report. The 65,000 DC patients were far below the 200,000 that the market was expecting. There was obviously a miscommunication between CLOV and the market. CLOV stated they had access to 200,000 Medicare patients through their network of 1,800 providers using their software. Analysts took that as a projection of enrollment. They still have access to all those patients and will enroll them over time. My guess is they were able to do claims-based alignment for much of the initial 65,000 DC patients, which is automatic. Now they have to market this program to the other $135,000 DC patients to get them enrolled via voluntary alignment (i.e. consent). They could also market the MA plan which has more benefits. That’s the power of CLOV having a network of providers contracted with its DCE and MA plan.
This lower DC patient enrollment has now been priced in with analysts adjusting down to an average price target of $9.33. These price targets are based on extremely conservative enrollment projections and revenue projections from CLOV for their DC business.
They set forecasts at 70,000 to 100,000 by end of 2021. They already have 65,000 enrolled in April. They intentionally set expectations extremely low to absorb the negative market reaction upfront and then outperform going forward. They also reported extremely low revenue projections for the DC patients. They’re only projecting $20M — $30M for the year.
I would guess that their profits from the DC market this year could be $25M+ (5% margin x 65,000 patients x $850 x 9 months). Revenue should be similar to Medicare Advantage at $850+ per patient per month. That’s at least $55M in Medicare payments per month for 65,000 DC patients.
They did state that “GAAP revenue estimates for Direct Contracting are dependent on the finalization of accounting treatment, which we expect will be completed by the end of the second quarter of 2021”.
Part 3: Differentiation
CLOV does have a virtuous cycle built into its business. It’s all based on their relationship with their provider network. When they contract with a healthcare provider, they give them access to the Clover Assistant (CA) for free. CA is a software platform that analyzes electronic health record (EHR) and claims data to provide decision support back to the provider at the point of care.
The CA platform is a population health tool. There are competing software solutions in the market. The difference here is that the provider has to pay for access to those tools. CLOV pays the provider to use the CA platform. CLOV pays $200 per visit, which is much higher than the average $121.45 that other MA plans pay.
The reason that CLOV pays the provider to use it is because it improves the top and bottom line for CLOV. CA helps providers make better treatment decisions and document risk scores more accurately, which results in higher Medicare payments (to CLOV and the provider). Higher Medicare payments directly increases the top line revenue. Better treatment decisions lead to lower costs, which allows CLOV (MA plan or DCE) to keep more Medicare dollars. If you’re interested in how CA works, I’ll include some bulletpoints at the bottom of the post.
Happy providers are key to increasing the number of lives managed long-term. Providers are directly involved in the “alignment” process for DC enrollment, and their opinion is highly respected when making a recommendation around which MA plan a patient should choose. As CLOV grows its provider network, it will increase enrollment for both MA and DC. It will also lead to more CA software users, more software users usually leads to better experience and insights, which could reinforce itself and bring more providers onboard.
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Risks to CLOV
Below are the biggest risks I see for CLOV, in order of importance:
1. DOJ Investigation
As I mentioned above, I don’t think there were illegal practices going on at CLOV that management, Chamath, or the third-party counsel were aware of. It’s still possible the DOJ investigation finds something. This happens all the time in the Medicare industry, including to the biggest names (UnitedHealth, Humana, Cigna, etc.).
All the MA plans learn from each other’s missteps. CLOV has been operating an MA plan for over 5 years now. They were fined $106,095 in 2016 for ‘misleading’ marketing tactics. They haven’t been fined since. They have also gone through multiple rounds of funding from top venture capitalists and Google. There’s been no shortage of due diligence on this company.
Yet, there is always the risk that someone somewhere was doing something illegal this time. If that is the case, it will likely end up in a lawsuit. I’ve seen many cases get to this stage and then get dismissed by a federal judge (UnitedHealth 1, UnitedHealth 2, ). Worst case scenario for the company, there is a settlement. Here are examples of MA plans paying settlements for “upcoding” fraud cases:
No matter how cynical a view you want to take on the DOJ investigation, CLOV has no debt and $700M in cash from the SPAC proceeds, so a settlement should not significantly impact them.
2. SEC Investigation
The SEC investigation was announced the day after the Hindenburg report came out. The SEC is investigating whether the DOJ inquiries were material enough to require disclosure to the market. The investigation may not be closed until the DOJ inquiries have been resolved. If the SEC determines there should have been a disclosure, there will likely be a fine. I’m not an expert on SEC enforcement. The only thing I could point to would be the $20M fine Elon Musk paid for announcing a fake acquisition at a much higher price at the time. He picked $420 as the fake number, not sure why…
3. Market Multiple
Valuations based on profitability could be hurt in the short term. Medical costs are higher this year due to delayed care during COVID-19, so all companies in this space will have compressed margins in the short-term. I believe growth is more important than profitability in this market when you’re looking at <1% of DC patients enrolled. CLOV has proven to be exceptional at growth and has proven it both in MA and now DC.
There could also be a general downturn in market sentiment, and these growth stocks with low margins would be affected the most. However, Medicare is a very stable business and these companies will continue to grow independent of economic conditions.
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