Infected, Albeit Briefly, with Special Situationitis

Accretive Health (recently changed its name to R1, stock symbol ACHI) is a revenue cycle management company that was de-listed from the stock exchange a few years back and is preparing to come back to the NASDAQ and play with the grown-ups again.

I had originally followed this company before and shortly after it de-listed because I had experience with revenue cycle management companies and understood well the pain point that these companies were trying to solve, namely that health care billing is HARD, really hard (maybe even harder than being the Bard).  

There are endless codes for various “encounters” with a physician.  It’s basically an entire comedy routine.  

“There are 68,000 billing codes under the new ICD-10 system, as opposed to a paltry 13,000 under the current ICD-9. The expansive diagnostic codes, intended to smooth billing processes.”  

This is a joke, right?  

Also, here are some of the most outrageous new codes.  

  • 16. V97.33XD: Sucked into jet engine, subsequent encounter.

  • 14. V00.01XD: Pedestrian on foot injured in collision with roller-skater, subsequent encounter.

  • 11. Y92.146: Swimming-pool of prison as the place of occurrence of the external cause.

  • 9. W55.41XA: Bitten by pig, initial encounter​.

  • 8. W61.62XD: Struck by duck, subsequent encounter.

  • 5. Y93.D: V91.07XD: Burn due to water-skis on fire, subsequent encounter​.

  • 3. W22.02XD: V95.43XS: Spacecraft collision injuring occupant, sequela.

These are real codes.  To clarify, the “subsequent encounter” is the second visit to the doctor, the patient was not sucked into the jet engine a second time (although the new Logan movie is quite good).  

The most recent controversy in coding centered around whether a patient was an inpatient or outpatient (observation status) during his hospital stay, which turned not on time in hospital but a complex combination of acuity, diagnosis and length of stay (and maybe some other things, no one really understands it and that is the problem).  In other words, the patient could stay for 70 hours in the hospital and still be classified at outpatient.  The hospitals have sued Medicare and Medicare has issued updated rules, but it is still a mess.  

In short, there seems to be a viable business opportunity for someone to become an expert in this domain and potentially add value to this complex process, while earning a profit.

However, from a business model standpoint, it does not appear that ACHI had cracked the code a few years back and I don’t know if they have done it this time around.

The basic business model pitch is this.  Ascension is a hospital “collective” with over 130 hospitals in its organization.  Ascension agrees to let R1 manage these hospitals entire revenue cycle management process for a fee.  Ascension calculates that it costs its own hospitals a “large” figure, let’s say $500m (which may be a close estimate to the current contract).  R1 agrees to provide these services for $500m, but thinks it can do it for $450m, thus earnings an operating profit of $50m.  I am simplifying things dramatically, but the general business model is that R1 agrees upfront to a contracted rate, while hoping to provide these services for less than the contracted rate in order to earn a profit.  

The problem that consistently dogs R1 is that the process of medical billing is complex and what R1 thinks it can do for $450m might end up costing them $550m, leaving them upside down.  If you think about your typical law firm, their business model avoids this issue by charging by the hour.  Bill at $500 per hour and pay the associate $250, with $100 “overhead” costs, you are never upside down in your contract.  

Looking back at R1’s financials is basically an impossible endeavor due to the way GAAP reporting treated their pay for performance contracts (old business model).  However, we can basically ignore GAAP financials and look at their cash position.  

Year Cash Position Cash Investment
2011 $196
2016 $181 $176 (new money invested)


Over the past 5 years of operations the company have generated zero cash, but instead burned about $200m of cash, give or take $10-$20m.  

This is not a good business.  Sure, the restatement has cost the company money in the past 5 years, in addition to a lawsuit in Minnesota regarding the company’s debt collection practices, but almost $200m is a lot of money.  That seems like a cash incinerator.  

Here are the company’s future projections with some valuation metrics added by me.  You will notice the share dilution, which was a feature of the recent $200m investment by two parties who now own a large portion of the company.

2017 2020 2020 Post Dilution*
Revenue 400-425 700-900 700-900
Cash $175m $300m $510
Operating Income 0 $105m $105m
Operating Multiple NM 10 10
Shares Outstanding 200m 228m 288m
Valuation (with cash) NM $1.350B $1.560B
Share Price ?? $5.92 $5.42


*Post-Dilution includes majority owners exercise of 60m warrants on a cash basis at $3.50 per share.

If you take the company’s projections at face value, buying stock today around $2.45 gives you an annual return of 23%.  This is not a return you would completely ignore, but you have to make some massive and venture capital type projections to assume this company can all of a sudden become cash flow profitable.  That is not something I am willing to do at this point.  I put it in my Dust Bin List to check back on it in six months.  

(Part of the reason, I wrote the “theory” post on special situationitis is I hear these “set-up” stories constantly and I wanted to cement in my own mind to be highly skeptical of such pitches and to focus on the business).

However, here is the special situation pitch for R1:

R1’s de-listing has caused forced and indiscriminate selling because the previous holders could not hold a stock that was de-listed or not current in filing its financials.  Wall Street analysts have left the company for dead, but now with the re-listing, the company is going to re-engage the Street through its attendance at multiple industry conferences.  Analyst coverage will increase and the related ownership ability of mutual and index funds will in turn create a forced-buying set-up.  R1 has the potential to announce a string of new contract wins causing further upward momentum to the stock price.  Not to mention, the GAAP financials with the new fee-based business model will be much cleaner allowing broader exposure to potential owners of the stock.  

This italics language is value investing jargon.  The first question should be: How has the business model changed such that the company will be able to earn a profit in the future whereas it could not in the past? If you can’t answer that question, run for the hills.

John and I both enjoy writing here because it helps us clarify our thinking.  I spent way too much time on this idea because I didn’t fully recognize how jargon-y the jargon was.  It was meaningless.  

One of the things that kept me writing about this company was sharing the following story.  Revenue cycle management is not just data entry, it’s logistics, communications and constantly pushing the ball forward.  This sort of work is hard to estimate the costs. R1’s revenue projections might be on target, but I have no faith in their cost projections.  

In this particular story (this just happened last month), the Veteran Affair’s claims processing unit was being transferred from Arizona to Minnesota, but during this process paper claims were being processed at the Arizona location as a stop gap until the Minnesota location was fully functional.  The RCM company (this is a large one and a potential competitor to R1) had sent a boxes of paper claims to the VA location in Tucson.  However, there is not just one building at the Tucson location, instead over 50 and the individual sending the boxes only addressed the boxes to the first name of the intended recipient, “Olga.”  It turns out that the person accepting the package did not want to spend time looking for Olga among the 50 buildings at the VA campus and let the boxes sit there for quite some time (as of now, the boxes have not been found).  I have removed most of the information below for privacy reasons, but I assure you this all happened. Real life medical claims processing is often funnier than fiction.  

A batch of claims was delivered via Fedex attention Olga. Can you confirm you have received and they are in process for XXXX?

Your package has been delivered
Tracking # XXXXXXXX

 

Delivered
Delivery date:
Olga

Regards, XXXX

| Revenue Cycle Specialis

The email chain regarding this shipment and confusion is Home Alone type humor.  I have cut and paste one such email.  This email is from the CEO of the healthcare company (and my source for this hysterical piece of scuttlebutt), who hired the revenue cycle management company.  

Guys,
Who is this Kristin XXXX? [This is the individual who sent the boxes of claims to the VA] Does she usually send letters to “Santa, North Pole”. Someone should help her with her tax return, she might send it to “John, IRS”.  Really? she sent the boxes to “Olga, VA”. I am in awe, we’re talking about $500k. You should think about sending her paycheck to “Kristin, wherever she lives”.  I’m floored, does she think the VA is the corner store? There is no way they will find those boxes.

The RCM company will have to figure out how to track down these claims, perhaps find the boxes, perhaps re-do the claims, but the point is that there are going to be cost overruns on their side of things.  Sure, this could be done more efficiently.  And, of course, it is hard and there will there always be complications.  Do I want a 23% projected return if the company hits all their numbers?  I think there are probably better options out there.  

___________________________________________

Matt Brice is the portfolio manager of The Sova Group, LLC.  The Sova Group maintains a bat on the shoulder waiting for one-foot hurdles portfolio approach.  Simple, concentrated and patient value investing.  

Matt can be reached at matt@thesovagroup.com  

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