Examworks’ stock – a sudden dose of reality?

For those who have been following Examworks, yesterday’s collapse in the company’s stock price is a mystery indeed – why did it take so long for investors to realize reality is kinda important?

As I noted in a post a couple months ago:

… I don’t understand 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.

I hasten to add that I am about as far from a credible stock picker as there is.  For several years I’ve been mystified by the steady rise of Exam’s stock price to stratospheric levels – it just made no sense. Yet increase it did, up to and over the $44 mark.

(as proof, here’s my quite skeptical review five plus years ago…)

After yesterday’s earnings announcement, Exam has a value less than half what it was just six months ago.

While I have no idea what finally caused investors to extract their heads from their nether regions, it may have been due to the earnings call itself.

Among the notable statements were these:

• “constant currency organic revenue is expected to be flat within an expected range of negative 1% to positive 1%”
• Total leverage on a net basis was approximately 2.95 times
• we really look at this as a pause that’s a temporary phenomenon frankly [talking about the annual growth rate].

First, it’s never a good sign when the Chairman starts off the call reminding investors of the “unique characteristics of our Company..The industry is approximately 40 years only [sic] and over the course of that time has grown in good times and bad times with little correlation to the general economy.”

Well, no.  As in, if you actually believe that, you clearly don’t understand your business. 

In fact, that’s pretty much totally wrong.  The workers’ comp industry (which is the primary buyer of Exam’s services) tracks the overall economic cycles pretty closely, albeit belatedly. That’s what you would expect from a business based on employment.

Moreover, as the US has moved away from high injury-jobs towards a service-based economy, the injury rate has declined rather dramatically – over 55% over the last 20 years.  So, if anything, Exam’s business – evaluating injured workers – is concentrated in a market that has structural declines baked in for the foreseeable future.

Which is particularly concerning when you read Chairman Perlman’s next remarks, to wit:

“As we understand it, healthcare is suffering from declining volumes as well as reimbursement pressures, neither of which apply to our industry.“[emphasis added]

Wait…did he actually say that?

Yup. If anything, his business – evaluating injured workers and people in a hyper-competitive industry – epitomizes that description. And, btw, healthcare is NOT “experiencing declining volumes”, at least health insurers, health plans, health care providers, and pharma aren’t.  How could they be, with the huge decline in the number of uninsured?

The IME (independent medical exam) business is brutally competitive.  Driven in no small part by Exam, prices have been slowly if steadily declining for some time. The reasons are simple; again noted a couple months ago:

…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 [Q2 2015] 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.

What’s happened of late – as evidenced by the lower net revenue per service reported by Exam over the last two quarters – is this decline in pricing has affected their “mix of business”.  Fortunately word is pricing has stabilized somewhat – good news for Exam’s competitors.

There’s a lot of other fluff in the earnings call, fluff that I’ve described in detail in earlier posts (just type “exam” in the search box up there to the right), but the net is this.

These guys have no clue about their business, or they do have a clue and hope investors don’t.

Ok, I can’t resist.  Perlman does say “We have secured six of the 40 national accounts in the US and expect to continue to grow the national account business.”

That means the nice, well-dressed, smiling Examworks field reps have a “license to hunt.” It does NOT mean Exam is going to get all the business from those national accounts, far from it.  It means the Examworks field reps get to try to get into claims offices (an increasingly difficult thing to do as more and more payers are refusing to admit vendor staff) and schmooze Jane and Jack adjuster in hopes J&J will refer files to them.

Instead of the myriad other IME companies knocking on their cubicle “doors”.

Sorry, one more thing just begs to be addressed.

Exam makes a very big deal of their purchase of a Buffalo NY-based IME firm – First Choice.  This $24 million company with earnings in the $1 million range sold for 7-8x earnings.  Perlman said, and I quote, that this is a price “in line with what we have paid historically for businesses of this size and regional significance.”

Historically, EXAM bought smaller, regional companies for around 4x.  Unless my math is pretty bad, prices are going up, despite what Mr Perlman says. First Choice is somewhat larger than previous acquisitions, but the doubling of the multiple is NOT “in line” with previous purchases.

OK, I’m done.  For now…

What does this mean for you?

I don’t own the stock, although I wish I’d short-sold it a couple weeks back. You?

Note – I have nothing against Exam, don’t know Mr Perlman, and have no financial stake in this industry.  I do find equity analysts’ understanding of core business issues sometimes don’t have any grounding in reality.