I don’t get Examworks

More accurately, I do understand their business, what I don’t understand is how the company’s stock can trade in the mid-thirties.

And that’s because I do understand the market, their services, and the growth or lack thereof, and I just don’t see the upside investors obviously are banking on. Their stock price makes sense for a high-growth business in a sector with a lot of upside.

That is not how I would describe the IME/peer/MSA business.

EXAM’s primary business is providing Independent Medical Exams to insurance companies – mostly workers comp, some auto, some disability.  Mostly domestic, some in other English-speaking countries.

In their latest earnings call, Chairman Richard Perlman’s comments were totally confusing; here’s a sample (thanks SeekingAlpha):

Starting with the U.S. our largest market, reported revenues grew 12.6% and organic growth was 4.3% compared to the prior year quarter. The organic growth rate was negatively impacted by sales mix with volumes increasing by approximately 10%. National accounts contributed roughly 40% of the growth and the balance coming from singles and doubles. I think it is important to comment on the U.S. growth in greater detail.

The impressive results in the U.S. during 2013 and 2014 reflect a unique confluence of events that resulted from what we believe is an unsustainable sales trajectory [emphasis added] on a quarter-to-quarter basis. The timing of new accounts wins, the initiations of rollouts, the velocity of compliance coupled with the consequential impact of our national account wins and the smaller amount of top competitors allow us the opportunity to have outsized growth for seven quarters in a row. This was a perfect storm.

We believe that we are currently in a period of normal long-term growth which we feel is a pause before the next wave of the positive events I just described. [emphasis added] This is consistent with our repeated guidance of mid to high single-digit sustainable growth in the U.S. for the longer-term.

After puzzling thru those several paragraphs, I still have no idea what he is talking about.  It appears that some big wins, new client rollouts, less competition made for solid growth, but that isn’t going to continue..until it happens again (the “next wave”).

Or, not…?

In the earnings call management cited financials based on “adjusted EBITDA”, a metric foreign to and not understood by most accountants or analysts. Management said this metric amounted to 17.4% of total revenue for the quarter – a rather hefty margin indeed.

A few other items of interest.  CEO Jim Price claimed the Medicare Set Aside Market is $300 to $400 million [!!], with the 30 largest payers only accounting for 30% [!!] of that volume. And while organic growth (same business growth) increased 4.3% in the US, the number of services increased 10%.

It looks like the mix of business changed, with lower-cost services taking a larger slice of the services delivered by Examworks.

So, here’s what’s got me stumped.  My best estimate indicates the US IME and peer review market is less than $2 billion.  Likely a lot less. So, if Exam currently has $450 million in US revenue, how much more can it grow?  And what will that growth cost?

Some growth will be organic – that is, more revenue from the same customers.  But, as almost all payers refuse to single-source their IME and peer business, each additional dollar of revenue is going to be a tougher win than the previous additional dollar of revenue.

Acquisitions are still on tap, and management believes they will be able to pay about the same for new deals as they have historically – 5x earnings.

I don’t think so.  Prices have gone up rather substantially of late, driven by both strategic and financial buyers.  I’d expect prices to be in the mid-to-upper single digits (as a multiple of earnings)…and that’s at the bottom end.

Next, maintaining, much less improving margins (management expects they will get somewhat better in future quarters) depends on lowering cost of goods sold and increasing prices.  At least in the US, the latest quarter shows the price for their average service fell.  I’d expect that to continue, or perhaps level out.  Winning national accounts requires very competitive pricing, as well as, in many cases, payment of “management” or “administrative” fees to the payer customer.

Then there’s the cost end of things.  This is a pretty simple business with relatively low administrative expense and not much opportunity to reduce that expense. While Examworks may try to reduce payment (the biggest component of their cost of goods sold) to IME and Peer Review docs, those docs can just refuse to go along.  As claims adjusters and attorneys on both sides have very definite preferences for docs, those docs do have some pricing power – and if those physicians aren’t in an IME company’s network, than that IME company likely won’t get that adjuster/attorney’s referral.

Finally, workers comp claims volumes across the country continue to decline.  We are in a long-term structural decline of 2-4% every year.  That means there are fewer claims that need IMEs or peer review.

Over the longer term, I expect auto claims involving IMEs to decline markedly as well.  My sense is there aren’t all that many (compared to work comp), and the reduction in bodily injury claims that will result from more vehicle automation bodes well for passengers and pedestrians – but not for auto IME vendors.

All that said, I have no idea why or how equity investors value a stock at a certain level; long ago I came to the realization that I have zero ability to pick stocks.  Then again, a lot of supposedly professional investors do a lousy job despite getting paid to do just that.

What does this mean for you?

It doesn’t mean much to me, as I don’t own the stock nor have any financial position of any kind it it.  You?