Value Investing Great Businesses/Warren Buffett |
| Great Businesses/Warren Buffett Posted: 28 Jun 2019 01:17 PM PDT I was listening to the Berkshire Hathaway annual meetings in podcast form and the following quote from Buffett caught my attention: "The really great business is one that doesn't require great management. The poor business is one that can only succeed or even survive with great management." How do you guys think about what makes a great business? [link] [comments]  | |||||||||||||||||||||||||||||||||||||||||||||||||
| Let's have a conversation about HealthEquity(HQY) Posted: 28 Jun 2019 12:59 PM PDT I personally would like to see more original discussion on individual stocks/businesses so let's have a conversation about HealthEquity (HQY)!
Why? To my knowledge, there have been no adequately articulated bull theses anywhere on the internet (save seeking alpha BS), one short thesis on VIC, and one short for a competitor WAGE (which somewhat translates into a bull thesis for HQY) on VIC. Over the last year I have become very bullish on this stock and business and it is one of my top holdings. Their latest announcement to acquire WAGE re-affirms my confidence in the management team/future growth/capital allocation of the business and I can't help but pound the table on this stock. This will be very verbose so feel free to jump around but I'd like to get a discussion going regardless.
TLDR: HQY is the early-mid innings of what will be one of the best, most stable, highest-ROIC businesses in the world. At a 4B market capitalization it's trading at a fraction of intrinsic value. I estimate a 5-year 20%+ IRR from purchasing the stock at its current ($65) price.
The Industry
The Problem with US Healthcare and need for HSAs News flash: there's a healthcare spending crisis in the US. From ~6% of GDP in 1965, national healthcare expenditures total ~18% of GDP today and are projected to continue to eat more of the GDP pie. Healthcare quality has not improved proportionally. You could point to a multitude of causes but many congressmen/healthcare experts highlight the arcane, esoteric cost structure of the industry. Now there are 1,000 page volumes on why this is/how it works but long story short a major flaw is lack of agency on the part of Healthcare consumers (see Consumer-driven healthcare). I'll give an abridged version of this phenomenon. Identical healthcare procedures can fluctuate in cost 100-600%, with the same level of quality. I.e. if I'm getting a colonoscopy you can quote it out to 5 different places and receive prices for virtually the same operation for $800-$5000 (these are real numbers, svc charges include differing prep kits, diagnoses, sedation techniques, pathology, facility etc). The way many insurance policies are structured disincentivize consumers from shopping healthcare costs and actually making a price/quality decision, causing costs to balloon and providers/insurance co's to make out like bandits (just look at ROIC of those businesses). So, there has been a big push to put cost/healthcare decisions back in the hands of consumers and make them more responsible for their healthcare choices.
How does an HSA help? Enter Health Savings Accounts (HSA). An HSA is a savings account offering triple tax-deductibility (tax-free contribution, growth, and withdrawal) for qualified medical expenses. HSAs and similar devices enable consumers to pay routine medical expenses/save for future costs while falling back on a High-Deductible Health Plan for large expenses. So now when I go and shop around for that operation, I'm going to have costs in mind (as the balance will fall into my pocket) and the idea is this should help control costs in the long-run for the country. HSAs were created in 2003 and grew rapidly to 4.5m accounts in 2007, 9m in 2013, and 25m in 2018. The rise in popularity of HSA/HDHP and similar plans demonstrate the efficacy/potential of this model. Arguably there is a secular shift which will increase the portion of ~190M under-age 65 consumers to adopt the HSA/HDHP or similar model.
The Business
Overview HQY is a mission-driven first-mover and innovator/pioneer of the industry itself, with founder/CEO dynamics, offering HSAs coupled with health plans since 2005. Stephen Neeleman (VP/Founder, prior CEO) is an HSA expert and aggressively lobbies for HQY/HSAs in congress. Jon Kessler (CEO) previously founded WageWorks (NYSE: WAGE) a $2B company which offers competing products. It's interesting that Kessler left WAGE (which focuses on inferior FSAs, being cannibalized by HSAs) to lead HQY and now is essentially pulling a Steve Jobs and acquiring his old company (more on that later). To say HQY is dominating this industry is an understatement. They have sustained growth for years higher than their second and third largest competitors combined. It's a combination of astute management, industry know-how, aggressive marketing/sales/account tactics, strong company culture, and exceptional customer service.
Competitive Advantage / "Moat" Other HSA Plan Providers: HSA Authority; Fifth Third, Optum, UMB Bank, BenefitWallet, HSA Bank, Further, HealthSavings Administrators, Bank of America
As already stated HQY is dominating the competition. The fact that their fees charged are more-or-less in the middle of the pack demonstrate that lower fee is not what drives the competitive dynamic. Administrators can differentiate based on investment options offered, quality of those investment options, transparency of service/options, customer-service, robustness of technological platform, eligibility/compatibility with investment managers/health plans, ability of the admin to sell into company plans, etc. Long-story short… it's not simply a race to the bottom on fees (ala retirement/trading accounts, which bears have pointed to). It's much more complicated and based on a multitude of complex dynamics/relationships that lie at the center of the byzantine American healthcare system. HQY's business provides:
1) A liaison between consumers, healthcare plans (employers, etc), healthcare providers, investment managers, us govt (to continue to lobby new plans/savings vehicles) 2) A robust technological platform integrating saving/spending decisions, healthcare bills, cost comparison, investment comparison, benefit information, wellness incentives 3) Education and transparency to all parties, especially consumers
Additionally, HQY is one of the few (and only major) competitors that made the business decision to solely focus on HSAs. In addition, as much of this business is network-based, there are inherent scale/network-effect benefits. It's not an industry with a low barrier to entry and speaks to the large gap between HQY and the competition.
Revenue HQY had 3.5M accounts on their platform as of FY '18, adding ~700K accounts each year since 2016. HQY generates revenue via 1) Custodial: cash assets deposited with custodial bank partners/annuities with insurance partners (48%) 2) Service: fees charged for monthly account services (31%) 3) Interchange: fees charged on physical/virtual payment cards (21%) Note the vast majority of revenue growth is coming from Custodial segment – tied to what is basically the "AuM" of the business/prevailing rates, and the long-term business strategy is to reduce other fees as a benefit to the consumer. As these three revenue sources are virtually disconnected from any consumer supply/demand dynamics, management has highlighted the unusual amount of stability/foreseeability ("90% visibility") in all three sources.
WAGE acquisition So as I'll highlight in the next section HQY is a cash machine. They have sustained 100%+ ROIC and have just stockpiled cash/investments on the B/S with virtually no liabilities. So a huge question is capital allocation… and the newly announced WAGE acquisition reaffirms my confidence in that department. The acquisition will consist of total cash outlays of ~2.3B, funded by ~600M of cash and ~1.7B of new debt. They plan to rapidly deleverage with the high, stable, cash flow of the combined businesses. I'm not going to go into the details on WAGE's business model, please see VIC short idea post for that, it's a great writeup. Long-story short their margins are inferior, their products are inferior, and HQY is cannibalizing their business. The general idea is to convert a large portion of WAGE's customers to the better-serving, fiscally constructive HSA/HDHP model.
The Numbers
Metric Definitions Cash Flow: OCF – Special Items – Maintenance Capex/Dev Costs Net Liquid Assets: Short-Term/Long-Term Liquid Assets(Cash/Investments) – All Liabilities [included to show how HQY just stockpiles cash] ROIC: Cash Flow / Operating Assets (Assets less mainly intangibles and cash)
HQY Financials ($mn)
2019 HQY cash flow (40% growth assumed, vs 80% last year) = (FY2018 CF) 81 * 1.4 = 113 2019 WAGE cash flow (15% contraction assumed) = (FY2018 CF) 127 * .85 = 108 2019 PF Combined cash flow = 221 2019 PF Combined Net Income = 671.4 (HQY) + 26.85 (WAGE) = 116 (Tentative) Interest Expense = 3.5% (Libor + 120 bps) * 1.7B = 60
The cash margins speak to the scalability here… their incremental margins is in the range of 70%+. They've compounded net income growth at 50%+ since their IPO. Anyone who has studied ROIC of businesses will immediately recognize how ridiculously lucrative this franchise is. You can argue against those adjustments (intangibles/cash) but it's perfectly sound practice on the street/many shops. It's a cash machine. Also realize there's a thousand ways to calculate all these metrics but don't get bogged down to lose the big picture here…
Risks/Bears The way I see it risk could be bucketed into three major categories which I will briefly address (and maybe leave some to you guys!) Note there is a lot I did not cover about this stock, leaving the nitty-gritty for Q&A:
1) Regulatory Risk It goes without saying, one stroke of a pen in congress can destroy most US healthcare businesses. It's always a risk in this industry. HSAs have always had bi-partisan support and I personally believe cooler heads will prevail. Spiraling healthcare costs are one of the hottest issues the US faces and I think responsible decision-makers know CDHP is a solution not a cause of the problems.
2) Competition I have touched on this briefly in the writeup above.
3) Valuation Many investors get scared off by a 40x+ P/E valuation but you miss a lot of great investment opportunities with this mindset. I also go back to this quote from Buffett:
The Bottom Line So you're looking at a business with a strong "moat", high ROIC, reinvestment opportunity, recurring revenue, low churn, strong mgmt., industry-leader, that has sustained net income/cash flow growth of 50%+ trading at ~20x cash flow and ~40x net income. Those multiples assume no synergies whatsoever on revenue/cost from the acquisition, which really are inevitable. I predict HQY will manage to sustain net income growth of 25%+ over the next five years, and pay down a significant portion of the debt resulting in a net income figure of ~350mn, a ~10B market capitalization with a 30x P/E multiple, justifiable given the robustness of the business. At the current share price of $65, a 5-year holding period would generate an IRR of 20%. [link] [comments]  |
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