A few updates and thoughts to share with you on this fine May Friday, starting with a more detailed look a the new healthcare-related stock that I added to my portfolio a little while ago and haven’t discussed much yet.
That stock is Premier, Inc. (PINC), a truly generic name for a pretty interesting company. It came to my attention thanks to the presentation by Allan MacDonald at the Value Investing Conference hosted by the Ben Graham Centre a couple weeks ago. It was not a hard sell, by any means, but the argument from MacDonald was that there are opportunities to be found in new business models or in structures that the market just doesn’t think about properly or understand.
He gave the example of the 407 toll road creating huge value for SNC-Lavalin shareholders even though it was thought of as an expensive boondoggle and Wall Street had little patience for toll roads, with much of the value coming only if you looked more closely and saw that they had the right to raise toll prices almost at will. And the Madison Square Garden (MSG) example came up, a longtime favorite story for value investors because most investors failed to recognize the value not only of the regional sports network, but of the actual arena, the air rights above it, and the Knicks and Rangers, which were undervalued until the tech billionaires started buying up franchises.
These opportunities are harder to find, he says, because they’re not showing up in screens and they’re not easy — they require thought. But one area where he has consistently found interesting ideas is in demutualization — the process of turning businesses that are owned by their partners into private and independent companies. That includes most amazingly the exchanges, companies like CBOE and CME and the Nasdaq that used to be owned by their participants but are now public, a list that now includes most of the major stock and derivative exchanges in the world, as well as some insurance companies, realtor groups, and others that he says have often had very strong annualized returns, sometimes quite quietly. The poster child for this is the best performer, Mastercard (MA), previously owned by its card-issuing banks but now boasting 37% annualized returns since it went public in 2006, but many of them have been around much longer.
Premier is much newer as a public company. It is a Group Purchasing Organization (GPO) for health care providers, and it’s the only one that has gone public, with a 2013 IPO and a continuing provision of liquidity from owners (mostly hospital groups) who can gradually sell down their stakes.
Here’s how MacDonald summed up Premier (his powerpoint is currently publicly available if you’d like to see the whole thing):
Controls $56 billion of healthcare spending for 3,900 member hopsitals
Has a rich database of mission critical information
60% owned by its members hospitals
Market cap: $4,436 million
Net Debt: $44 million
Pre-Tax ROIC 2017: 96%
Operating Profit Margin 2017: 30%
EV/EBITA 2018 estimates: 8.0x
PE Ratio 2018 est.: 12.5X
So that was enough to get me interested and send me, after a bit of work, to my brokerage account to buy a small position. Since then, I’ve been reading up a little more and becoming more comfortable with the company, and as of today I’ve added a bit more to my Premier holdings. This is not likely to be a barn-burner anytime soon — it has had its ups and downs in almost five years as a public company and is currently trading at about the same price it garnered back in 2013… but it’s very reasonably priced and growing at a good clip, and I think there’s a good chance that the health care world will provide more opportunities for them to grow income in the years to come — particularly if the regulatory environment becomes a little bit clearer and allows hospitals to have a little more visibility on which projects are worth investment.
The strength of the company, and the reason that the shares have never really had a terrible year or dipped much below $27, is probably the high retention and high revenue visibility… which should mean surprises are pretty rare.
They say that between 89-94% of their revenue guidance range is “available under contract,” so doesn’t make a lot of assumptions about future growth or opportunities… and they have 95% renewal rates on their services and 99% renewal rate and long-contracts — 93% of their administrative fee revenue currently has extended beyond 2018, and most of their members signed five year renewals in October of last year.
So that gives some idea of the level of stability — how about growth?
Most of the revenue has come from their supply chain services — mostly shared pharmacy service, aggregated purchasing power for members, and things like that, and that is still more than 3/4 of their revenue now. But they’ve been focusing on growing their data and analytics and consulting resources and relationships with those members, collecting information about outcomes and helping their members to migrate to “value based” and “outcome based” payment models that are likely to be of increasing interest to insurers and the government these days, and that area, until recently, has growing more quickly (average growth of about 20% a year over the past five years, versus 11% for the supply chain services).
And yes, there is a wave of panic about Amazon entering the healthcare business — that’s arguably a big reason for the weakness in Premier shares back in October, when there was a lot of chatter about Amazon getting pharmacy licenses in 10 states.
But as MacDonald said, Amazon can’t build this kind of business in a hurry — if they want to get big into healthcare distribution, they should just buy Premier (he was half joking, at least).
Amazon is not going to immediately get into these thousands of hospitals and get their outcomes data and be able to offer consulting services… and, frankly, Amazon’s retail pricing for healthcare products, which seems to be the first wave of their interest in the business, is more of a threat to retailers and drug distributors than it is to an aggregated purchasing organization like Premier. They said they did a study in 2017 and the online retailers, including Amazon, had pricing that was, on average, 72 to 121% above the prices that Premier got for their members on the top 100 products Premier’s members most frequently buy. I’m sure that study was probably slanted in their favor, but Premier gets good prices from providers because they aggregate and commit to huge purchases, and they earn a contracted fee on the purchases instead of adding a fat second layer of profit margin.
The member owners of Premier still have a controlling stake in the company, they own about 60% of the outstanding equity and have the right to exchange (sell) their shares quarterly, which they’ve done quite gradually over the past five years since the IPO (it was more like 78% at the IPO) — over time, each partner has the right to sell one seventh of their shares each year over seven years, though they have not sold that many at this point.
For this year, which is now 3/4 complete for Premier, they expect 14-17% growth in supply chain services and a more modest 0-2% growth in what had been their faster growing segment, performance services (consulting, data and the like). That should end up bringing $1.6 billion in revenue, 12% growth over last year, which turns into $535 million in adjusted EBITDA and something like $2.26 in earnings per share, which would be earnings growth of roughly 20%. At $32, that’s a very reasonable current year PE of 14, and if there’s any added push for more an