R1 RCM Is A Rare Health Tech Winner

R1 RCM Inc. (NASDAQ: RCM), a provider of ‘revenue cycle management’ services, i.e. services ranging from patient registration to bill collection, to healthcare providers, is one of the beneficiaries of healthcare providers outsourcing front-end services.

Usually, the healthcare industry, in general, is one of the slowest adopters of technology and outsourcing services, which is one of reasons space doesn’t either grow or command the trading multiple like high-growth tech niches, e.g. Cloud, but RCM seems to be making the right moves in terms of both revenue growth and profitability, shrugging off the legacy issues.

The negative impact of Covid-19 on the business was short-lived and the company has reinstated guidance, thanks to increased visibility. Macro tailwinds, including Covid-19, are encouraging healthcare providers to look for service providers like R1 RCM to drive operational efficiencies for profitability.

In the meantime, R1 RCM is stepping on the gas to improve sales growth, both organically and using acquisitions. Even though margins have been improving for the company for a while now, the business is finally at a scale where improved margins will result in earnings per share that can highlight the inherent value in the stock at current levels.

This is the first time that R1 RCM was included in our weekly list of favorite ideas for the week.

The macro argument for the service

More and more healthcare providers are under pressure to reduce costs, including that of revenue cycle operations, and one of the proven ways is to increase automation, creating a sweet spot for R1 RCM.

During good times, R1 RCM allows them to turn their cost structure from fixed to variable in nature thereby freeing balance sheet that healthcare providers can use for growth whereas, during a lean phase, healthcare providers find it easier when companies like R1 RCM can provide upgraded revenue cycle infrastructure, helping them save resources otherwise spent on technology investments or managing third-party vendors.

No wonder, business for R1 RCM is recovering faster than what the company forecasted at the beginning of the lockdown. Geographically, the business for the company recovered fastest in hard-hit states like Florida, Alabama, and Texas, where healthcare providers were inundated with managing the influx of patients.

Strong near-term momentum as the company monetize the opportunity

Even though Covid-19 has been tough on the cash collections side of the business, revenue for the company grew 6.7% last quarter, with help from new customer wins and organic growth at existing customers.

The majority of the second quarter net operating fees, which grew 14% over the previous year, was based on customer cash collections. The company has reintroduced guidance, after withdrawing it earlier in the year, but the same may still prove to be conservative.

R1 RCM expects revenue of $1.22-1.25 billion in revenue and adjusted EBITDA of $230-240 million, which doesn’t include any EBITDA contribution from the recently acquired RevWorks that will be integrated this year but bakes in EMS divestiture.

The company has already raised performance targets for billings to cash conversion rates, volumes have continued to rise every successive month since April and the pace of recovery has been faster than previously expected.

Catalysts that can help maintain this growth trajectory

There are three major catalysts, deployment at new customers, recent acquisitions, and traction of new services and technologies. 

Deployments

New customer deployments seem to suggest a strong end to the year. Penn State Health, a new customer, onboarding for which was initiated in May, is expected to be fully on board by the first quarter of 2021. Another customer that was signed in the third quarter of 2019, the $700 million NPR Physician account is also expected to be fully on board by the first quarter of 2021.

Rush University system is expected to be fully on board by the end of the current year. Deployment at Quorum Health is already complete and the focus is on performance optimization now.

Acquisitions and a strong pipeline

The company acquired SCI Solutions and Cerner’s RevWork business and announced the divestiture of the EMS business. Revenues should benefit as the company’s technology suite and automation tools are deployed across RevWork, acquired earlier last month, especially to RevWork’s transactional processes. SCI Solution’s platform is already helping with its scheduling functionality, with volumes growing.

Pipeline for both end-to-end and modular deals has been growing steadily, with increased activity from health systems with $5 billion-plus in NPR, in addition to existing strength in $1-5 billion NPR deals. Given the fragmented vendor landscape, there are limited players with scale who can serve large physician groups.

New services and technologies

More than 18 months ago, R1 RCM launched a program to digitize the front office, i.e. scheduling, contactless patient intake, financial clearance, and other services for the healthcare provider’s front office. 

New services like Patient Experience Platform, which includes SCI Solution’s scheduling functionality, and Robotic Process Automation, which automates more than a dozen routine services, should fit perfectly in the current demand scenario. 

Margin expansion, good execution leading to profitability

R1 RCM Inc.       
        
As % of revenue201420152016201720182019Q2 2020
Gross profit13%-44%66%7%11%17%21%
Selling, general and admin33%37%8%10%9%7%8%
Operating margin-19.9%-81.1%58.5%-2.7%2.1%9.5%13.3%

Transformation of the last few years have resulted in improved margins as well, if anything, recent efforts to automate and digitize should offer a further boost to the margins. 

With $445 million of net debt, enterprise value for the business is close to $3.2 billion, not egregious in today’s environment for a business expected to generate $240-250 million of EBITDA and requiring $60-70 million of capital expenditure.

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