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CFA Research Challenge 2013-2014 Belmont University, Nashville, TN. 11% Increase in Sales in 2014 40% Increase in EBITDA EBITDA Margin Widens by 250bps over 2013E Economies of Scale $0.29 Forward EPS BUY Rating $19 Price Target. Summary NASDAQ: HWAY. $19.00. BUY. 18.60 % Upside. - PowerPoint PPT Presentation
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CFA Research Challenge 2013-2014Belmont University, Nashville, TN
11% Increase in Sales in 2014 40% Increase in EBITDA EBITDA Margin Widens by 250bps
over 2013E Economies of Scale $0.29 Forward EPS
BUY Rating– $19 Price Target
Market Profile (As of January 31, 2014)52 Week Range $9.59 –
$22.201 Year Return 45.5%Average Volume 502,154Market Capitalization
$ 572.8M
Inst. Ownership 94.5%Insider Ownership 3.9%Summary
Business &
Industry Financial Analysis Valuation Risks
SummaryNASDAQ: HWAY
Oct-13 Nov-13 Dec-13 Jan-14 Feb-14$8
$10
$12
$14
$16
$18
$20HWAY
18.60 % Upside$16.0
2
$19.00 BU
Y
Key Target Drivers
Economic
Increasing demand for Population Health Management
Shift towards value-based healthcare payment models
Continued demand for SilverSneakers® Program
Political
Formation of Accountable Care Organizations
Affordable Care Act subsidized insurance premiums
Global healthcare legislation encouraging Population Health Management
InternalEconomies of scale creating value for shareholders
Steady expansion into international markets
Business & Industry
Largest independent global provider of specialized population health management solutions for health related cost bearing entities
Scaled proprietary technology infrastructure and delivery capabilities serving >30M people on 4 continents
Return to growth and strengthening financial profile post 2011 customer transition
Healthways OverviewNASDAQ: HWAY
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
MedicareAdvantag
e
Blue&
Regional
Health Systems
Employers
Customer BreakoutNASDAQ: HWAY
Revenue BreakdownNASDAQ: HWAY
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
$-
$150,000,000
$300,000,000
$450,000,000
$600,000,000
$750,000,000
$900,000,000
-
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
Revenue Lives
Rev
enue
in M
illio
ns
Live
s U
nder
Man
agem
ent
(Mill
ions
)35%
35%
15%
10% 5%Revenue Segments
Medicare Blues/RegionalSelf-Insured Employers Health SystemsInternational
Lives Under Management vs. Revenue (5% increase in lives leads to appx. 4% increase
in EBITDA)
Competitive AnalysisNASDAQ: HWAY
Advantages First-Mover Experience Wide array of services Individualized
programs
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
Disadvantages High fixed costs Dependency on large
contracts
0 3 6 9 12 15 18 21 240%
25%
50%
75%VRSK
AETCRVL
HWAY
Industry Relative Value
Current Price to Q3 Sales
Q3
Gro
ss M
argi
n
Public
Comps
PINC
VRSK
CRVL
AET
Financial Analysis
Congressional Budget Office Actuary Data
Non-Partisan Healthcare Analytics Surveys of Hospital Executives Revenue Sensitivity Analysis
Growth StrategyNASDAQ: HWAY
Increasing Demand for Pop. Health ManagementEconomies of Scale
Sector Shift to Value-Based Payment Models
The ACA incentivizes the formation of ACOs
Healthcare sector moving from volume to value-based payment
Shifting trend in the global healthcare landscape
High expected revenues will widen gross margin
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
Healthcare ReformNASDAQ: HWAY
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
Accountable Care Organizations
Premier SurveyAlready enrolled in an ACO 18.30
%Expected to participate by the end of 2013
5.20%
By the end of 2014 26.10%
By the end of 2015 13.90%
After 2015 13.00%
Will not participate 23.50%
Q1 201
1
Q4 201
1
Q3 201
2
Q2 201
3
Q1 201
4F
Q4 201
4F
Q3 201
5F
Q2 201
6F
Q1 201
7F
Q4 201
7F
Q3 201
8F -
500
1,000
1,500
2,000
2,500
Historical and Projected ACO Growth
Historical ACOs Projected ACOs
Num
ber
of A
CO
s
Healthcare ReformNASDAQ: HWAY
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
Coverage Projections Post-ACA Historical and Projected Revenue vs. LUM
$500
$550
$600
$650
$700
$750
$800
28
30
32
34
36
38
RevenueLives Under Management
Mill
ions
of
USD
Mill
ions
of
LUM
2012A2013A
2014F2015F
2016F2017F
2018F2019F
2020F2021F
2022F2023F
-
50
100
150
200
250
300
350
Medicaid & CHIP Employer-BasedNongroup & Medicare Insurance Exchanges
Mill
ions
of
Amer
ican
s
Sensitivity AnalysisNASDAQ: HWAY
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
2006
2008
2010
2012
2014
F20
16F
2018
F $650
$680
$710
$740
$770
$800
$830
$860
Push
Historical Revenue
Bull Case
Bear Case
Base Case
Consensus
Mill
ions
of
USD
Bull Base Bear5% of ACO Market
3% of ACO Market
1% of ACO Market
15% Growth in Blue/Regional
10% Growth in Blue/Regional
5% Growth in Blue/Regional
8% Growth in Medicare
4% Growth in Medicare
2% Growth in Medicare
0% Growth in Employer Segment
-3% Growth in Employer Segment
-5% Growth in Employer Segment
10% International Growth
5% International Growth
2% International Growth
$2350% Upside
$1924% Upside
$1315% Upside
Revenue Sensitivity Analysis
Valuation Price Target:
EV/EBITDA Free Cash Flow to Equity Free Cash Flow to Firm
supports BUY
Enterprise Value / EBITDANASDAQ: HWAY
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
$19Targ
et price:
Premium to the five-year average: Increased market presence Wider gross margins Additional lives under
management
5-Year Average Industry Average
7.33 10.40
2013E 2014F 2015F 2016F 2017F 2018F $-
$20,000,000
$40,000,000
$60,000,000
$80,000,000
$100,000,000
$120,000,000
$140,000,000
$160,000,000
0%
5%
10%
15%
20%
25%
30%
$63,262,243
$88,690,351 $99,660,914
$110,199,655 $122,142,256
$133,647,489
10%12% 13% 15% 16% 17%
EBITDA EBITDA Margin
Mill
ions
of
USD
EBIT
DA
% o
f R
even
ue
(Amounts in millions) EV / EBITDA Valuation
Multiple 10.4x FY14E EBITDA $88.7 Implied Enterprise Value 922.4
Less: Debt (246.9)Plus: Cash 1.5
Equity Value $677.0 Shares Outstanding 35.1
Free Cash Flow to EquityNASDAQ: HWAY
FCFE Model
2014
20 Year Treasury
3.54%
Beta 1.07Market Risk Premium
8.00%
Cost of Equity
12.10%
Shares Outstanding
35,060,000
Current Price
$15.31
PV of FCFE (2014-2018)
$5.99
Terminal Growth Rate
3.00%
Terminal Value
$23.49
PV of Terminal Value
$13.27
Value Per Share
$ 19.26
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
Value Per Share: $19.26 Reaffir
ms BUY25.77% Upside
Potential
(Dollars in Thousands, Except per Share)
Free Cash Flow to Equity Valuation2014F 2015F 2016F 2017F 2018F
Net Income $10,224 $13,832 $17,157 $21,308 $25,153 Plus: Depreciation & Amortization 60,228 65,821 71,478 77,207 83,024 Plus: Net Borrowing 24,596 3,970 2,180 5,075 3,376 Less: Investment in Fixed Capital (34,957) (37,181) (37,614) (38,084) (38,672)Less: Change in Net Working Capial (897) (136) (75) (174) (116)
Free Cash Flow to Equity $59,194 $46,306 $53,126 $65,332 $72,765
Free Cash Flow to Equity per Share $1.69 $1.32 $1.52 $1.86 $2.08
Free Cash Flow to FirmNASDAQ: HWAY
FCFF Model
2014
Cost of Equity
12.10%
Weight of Equity
68.49%
Cost of Debt 5.08%
Tax Rate 30%
Weight of Debt
31.51%
WACC 9.40%
Terminal Growth Rate
3.00%
Firm Value $1,046,282
Less: Debt $(246,926)
Equity Value $799,356
Per Share Value
$ 22.80Summary
Business &
Industry Financial Analysis Valuation Risks
Value Per Share: $22.80 Reaffir
ms BUY48.92% Upside
Potential
(Dollars in Thousands, Except per Share)
Free Cash Flow to Firm Valuation2014F 2015F 2016F 2017F 2018F
Net Income $10,224 $13,832 $17,157 $21,308 $25,153 Plus: Depreciation & Amortization 60,228 65,821 71,478 77,207 83,024 Plus: After-Tax Interest Expense 9,613 9,754 9,831 10,011 10,130 Less: Investment in Fixed Capital (34,957) (37,181) (37,614) (38,084) (38,672)Less: Change in Net Working Capial (897) (136) (75) (174) (116)
Free Cash Flow to Firm $44,211 $52,090 $60,777 $70,268 $79,519
Risk Analysis
Prob
abi
lity
Lo wM
oder
ate
Hi
gh
Impact
Insignificant
Moderate
Severe
Slower than expected international growth
Changing heath plan market
Shareholder activism
Cost reduction pressure
Delayed implementation of the ACA
Vertical integration of healthcare services
Failure to properly hedge against foreign exchange risk
Inability to receive customers’ data timely and efficiently
Loss of Humana contract
Risk AnalysisNASDAQ: HWAY
SummaryBusiness
& Industry
Financial Analysis Valuation Risks
Questions
Presentation Slides
• Summary• Overview• Customer Breakout• Revenue Breakdown• Competitive Analysis• Growth Strategy• Healthcare Reform (ACO)• Healthcare Reform (CBO)• Sensitivity Analysis• EV/EBITDA• Free Cash Flow to Equity• Free Cash Flow to Firm• Risk Analysis
Additional Slides
• RIM Valuation• Free Cash Flow 2-Way Tabl
es• EV/EBITDA Sensitivity• Management• Bear Price Justification• Global Legislation
• SWOT Analysis• Comparable Firms• Pro-Forma Financials & As
sumptions• CBO Projections• ACO & Pop. Health Manag
ement• Leavitt Partners Data• Bull, Base, Bear Sensitivity• LUM Estimates• EV/EBITDA• Beta Regression• Free Cash Flow Assumptio
ns• FCFE• FCFF
Largest independent global provider of well-being improvement solutions
30+ years of experience improving health and well-being for health plans, employers and health systems
Operator of the SilverSneakers program, the nation's leading exercise program designed exclusively for older adults
Dependency on large contracts Level of indebtedness could
adversely affect future financial conditions
Growing demand for population health management
Changing macroeconomic trends and company specific-trends
Continued growth in international markets
Vertical integration of population health management services
Short-term pressures to reduce costs from increased competition, decreasing revenues from governmental and private revenue sources, increasing medical costs, and overall market conditions
Expansion into international markets brings additional business,
regulatory, and financial risks
O
S W
T
SWOT AnalysisNASDAQ: HWAY
Comparable CompaniesNASDAQ: HWAY
(Dollars in Millions, Except per Share)
Healthways Comparable Companies - 1/31/14
Company Price - 1/31
Market Cap EV Revenue
EBITDA Margin
EV / EBITDA EPS
Debt / Equity
TTM TTM (x) TTMLast
ReportedHealthways (Nasdaq:HWAY) $15.31 $357.0 $651.2 $669.2 9.9% 12.3x $(0.02) 85.9
Corvel (Nasdaq:CVRL) 47.36 513.5 492.7 470.5 15.3% 14.4 1.92 - Aetna (NYSE:AET) 68.33 16,132.9 18,111.5 47,290.0 8.6% 8.1 5.86 60.5 Verisk (Nasdaq:VRSK) 63.86 9,962.2 11,328.9 1,680.0 45.1% 15.7 2.09 271.4 Premier (Nasdaq:PINC) 34.69 1,122.9 1,070.0 806.3 39.9% 3.3 1.16 3.9
Mean 45.91 5,617.7 6,330.9 10,183.2 23.7% 10.8 2.20 84.3 Median 47.36 1,122.9 1,070.0 806.3 15.3% 12.3 1.92 60.5
Historical and Pro-Forma Income Statement
(Dollars in Millions, Except per Share)
Source: Company Financials and Team Estimates.
For the Historical Fiscal Year Ended Dec. 31, For the Projected Fiscal Year Ending Dec. 31,
2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018ERevenues $720.3 $688.8 $677.2 $658.7 $728.8 $739.5 $745.4 $759.0 $768.0
Cost of Goods Sold 493.7 510.7 533.9 536.8 574.6 573.4 568.1 568.6 565.3 Selling G&A Expense 72.8 64.8 60.9 58.7 65.5 66.5 67.0 68.2 69.1 Impairment Loss - 183.3 - - - - - - - Restructuring and Related Charges 10.3 9.0 1.8 - - - - - -
EBITDA 143.5 (79.1) 80.6 63.3 88.7 99.7 110.2 122.1 133.6 Depreciation/Amoritization 52.8 50.0 51.7 52.5 60.2 65.8 71.5 77.2 83.0
Operating Income (EBIT) 90.8 (129.1) 28.9 10.8 28.5 33.8 38.7 44.9 50.6 Gain on Sale of Investments (1.2) - - - - - - - - Interest Expense 14.2 13.2 14.1 12.5 13.8 14.0 14.1 14.4 14.5
Pre-Tax Income 77.8 (142.3) 14.7 (1.7) 14.7 19.8 24.6 30.6 36.1 Income Tax Expense 30.4 15.4 6.7 (0.5) 4.4 6.0 7.5 9.3 10.9
Net Income 47.3 (157.7) 8.0 (1.2) 10.2 13.8 17.2 21.3 25.2
Basic EPS (GAAP) $1.36 $(4.68) $0.24 $(0.03) $0.29 $0.39 $0.49 $0.61 $0.72
Growth Rates:Revenue --- (4.4%) (1.7%) (2.7%) 10.6% 1.5% 0.8% 1.8% 1.2% EBITDA --- NM NM NM 40.2% 12.4% 10.6% 10.8% 9.4% Net Income --- NM NM NM NM 35.3% 24.0% 24.2% 18.0%
Margins:Gross 31.5% 25.8% 21.2% 18.5% 21.2% 22.5% 23.8% 25.1% 26.4% EBITDA 19.9% (11.5%) 11.9% 9.6% 12.2% 13.5% 14.8% 16.1% 17.4% EBIT 12.6% (18.7%) 4.3% 1.6% 3.9% 4.6% 5.2% 5.9% 6.6% Net Income 6.6% (22.9%) 1.2% (0.2%) 1.4% 1.9% 2.3% 2.8% 3.3%
Income Statement Assumptions
Depreciation Expense: Expected to remain at a constant percentage of PPECost of Goods Sold: Remains at the 2012 percent of sales (78.84%) until 2015 at
which time it declines by 1% per year until 2018, returning to the pre-Cigna-loss average of 73.61% of sales
SG&A Expense: Expected to remain at 9% of salesInterest Expense: Expected to remain at 5% of Long Term DebtEffective Tax Rate: Expected to remain at the historical average of 30%Share Count: Forecasted EPS assumes constant share count of 35.06M
Historical and Pro-Forma Balance SheetAssets
Source: Company Financials and Team Estimates.
(Dollars in Millions)
As of the Historical and Projected Fiscal Year Ending,2012A 2013E 2014F 2015F 2016F 2017F 2018F
AssetsCash & Equivalents $1.8 $2.6 $1.7 $1.7 $1.7 $1.7 $1.8 Accounts Receivable, net 108.3 93.4 103.4 104.9 105.7 107.7 108.9 Prepaid Expenses 9.7 8.4 9.3 9.4 9.5 9.7 9.8 Other Current Assets 7.2 6.2 6.9 7.0 7.1 7.2 7.3 Income Taxes Receivable 5.9 5.1 5.6 5.7 5.8 5.9 6.0 Defrred Tax Asset 8.8 7.6 8.4 8.6 8.6 8.8 8.9 Total Current Assets 141.8 123.3 135.3 137.3 138.4 140.9 142.6
Net PPE 156.5 177.3 204.5 236.1 268.0 300.4 333.2 Other Assets 21.0 21.0 21.0 21.0 21.0 21.0 21.0 Net Intangibles 90.2 90.2 90.2 90.2 90.2 90.2 90.2 Goodwill 338.7 338.7 338.7 338.7 338.7 338.7 338.7
Total Assets $748.3 $750.6 $789.7 $823.3 $856.4 $891.2 $925.8
Current Assets:• Expected to remain at a constant percentage of sales Leasehold Improvements:• Held constant over the forecast period Computer Equipment:• Expected to increase by 5% of sales from year to yearFurniture & Office Equipment:• Held constant over the forecast periodCapital Projects in Progress:• Expected to remain at a constant percentage of sales
Historical and Pro-Forma Balance SheetAssumptions – Asset Side
Historical and Pro-Forma Balance SheetLiabilities, Stockholders’ Equity & Metrics
Source: Company Financials and Team Estimates.
(Dollars in Millions)
As of the Historical and Projected Fiscal Year Ending,2012A 2013E 2014F 2015F 2016F 2017F 2018F
LiabilitiesAccounts Payable $26.3 $23.4 $25.9 $26.3 $26.5 $26.9 $27.3 Acrued Salaries & Benefits 24.9 22.1 24.5 24.8 25.0 25.5 25.8 Accrued Liabilities 39.2 34.8 38.5 39.1 39.4 40.1 40.6 Deferred Revenue 5.6 5.0 5.5 5.6 5.7 5.8 5.8 Contract Billings in Excess of Earned Revenue 14.8 13.1 14.5 14.7 14.9 15.1 15.3 Current Portion of Long-Term Debt 11.8 10.5 11.6 11.8 11.9 12.1 12.2 Current Portion of Long-Term Liabilities 5.5 4.9 5.4 5.5 5.6 5.7 5.7
Total Current Liabilities 128.3 113.9 126.0 127.8 128.8 131.2 132.8
Long-Term Debt 278.5 246.9 271.5 275.5 277.7 282.7 286.1 Long-Term Deferred Tax Liability 36.1 36.1 36.1 36.1 36.1 36.1 36.1 Other Long-Term Liabilities 26.6 26.6 26.6 26.6 26.6 26.6 26.6
Total Liabilities 469.4 423.4 460.2 466.0 469.2 476.6 481.5
Total Stockholder's Equity 278.8 327.2 329.6 357.4 387.2 414.7 444.3
Total Liabilities and Stockholder's Equity $748.3 $750.6 $789.8 $823.4 $856.4 $891.3 $925.8
Balance Sheet Metrics:Working Capital $13.6 $8.4 $9.3 $9.5 $9.5 $9.7 $9.8 Investment in Fixed Assets 18.4 21.5 35.0 37.2 37.6 38.1 38.7 Investment in Working Capital 4.8 (5.1) 0.9 0.1 0.1 0.2 0.1
Current Liabilities: Expected to remain at a constant percentage of sales Long-Term Debt: Expected to remain at a constant percentage of sales
Historical and Pro-Forma Balance SheetAssumptions – Liabilities and Stockholder’s Equity
Congressional Budget Office Projections(Millions of Americans)
*Non-elderlySource: CBO’s May 2013 Estimate of the Effects of the Affordable Care Act on Health Insurance Coverage
2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023ECoverage without ACAMedicaid & CHIP 34 35 34 34 33 33 33 33 34 34 34 34 Employer-Based 154 156 157 159 161 164 165 166 167 167 168 169 Total Medicare & Non Group 50 52 53 55 57 58 60 62 63 65 67 69 Uninsured 55 57 57 57 56 56 55 55 56 56 56 56
Total 293 300 301 305 307 311 313 316 320 322 325 328
PercentagesMedicaid & CHIP 11.6% 11.7% 11.3% 11.1% 10.7% 10.6% 10.5% 10.4% 10.6% 10.6% 10.5% 10.4% Employer-Based 52.6% 52.0% 52.2% 52.1% 52.4% 52.7% 52.7% 52.5% 52.2% 51.9% 51.7% 51.5% Total Medicare & Non Group 17.1% 17.3% 17.6% 18.0% 18.6% 18.6% 19.2% 19.6% 19.7% 20.2% 20.6% 21.0% Uninsured 18.8% 19.0% 18.9% 18.7% 18.2% 18.0% 17.6% 17.4% 17.5% 17.4% 17.2% 17.1%
Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Coverage Changes per Year
Medicaid & CHIP - 1 9 12 12 12 12 12 13 13 13 13 Employer-Based - 2 - (2) (6) (6) (7) (7) (7) (7) (7) (7)Nongroup & Medicare - - (2) (3) (4) (5) (5) (5) (5) (5) (5) (5)Insurance Exchanges - - 7 13 22 24 25 25 24 25 24 24 Uninsured - (2) (14) (20) (25) (25) (25) (25) (25) (25) (25) (25)
Coverage with ACAMedicaid & CHIP* 34 36 43 46 45 45 45 45 47 47 47 47 Employer-Based 154 158 157 157 155 158 158 159 160 160 161 162 Nongroup & Medicare 50 52 51 52 53 53 55 57 58 60 62 64 Insurance Exchanges - - 7 13 22 24 25 25 24 25 24 24 Uninsured 55 55 43 37 31 31 30 30 31 31 31 31
Totals 293 301 301 305 306 311 313 316 320 323 325 328
PercentagesMedicaid & CHIP* 11.6% 12.0% 14.3% 15.1% 14.7% 14.5% 14.4% 14.2% 14.7% 14.6% 14.5% 14.3% Employer-Based 52.6% 52.5% 52.2% 51.5% 50.7% 50.8% 50.5% 50.3% 50.0% 49.5% 49.5% 49.4% Nongroup & Medicare 17.1% 17.3% 16.9% 17.0% 17.3% 17.0% 17.6% 18.0% 18.1% 18.6% 19.1% 19.5% Insurance Exchanges 0.0% 0.0% 2.3% 4.3% 7.2% 7.7% 8.0% 7.9% 7.5% 7.7% 7.4% 7.3% Uninsured 18.8% 18.3% 14.3% 12.1% 10.1% 10.0% 9.6% 9.5% 9.7% 9.6% 9.5% 9.5%
Totals 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
“In an ACO, providers take responsibility for the health of a defined population, coordinate care across settings and are held to benchmark levels of quality and cost. Unlike some previous delivery system reforms, ACOs seek to balance cost control with efforts to improve outcomes and enhance people’s satisfaction.”
“[ACO] participation [is] projected to double by the end of 2014 to 50 percent. Overall, 3 out of 4 respondents say their hospitals have future ACO participation plans.”
Excerpt from Premier Fall 2013 Economic Outlook
Excerpt from Premier Fall 2013 Economic OutlookContinued
Source: Premier Fall 2013 Outlook, Published December 2013
Levitt Partners ACO Registration Data
“The current trajectory shows that providers and payers are recognizing the need to shift toward accountable care arrangements, or at the very least to shift away from fee-for-service care.”
“The shift to population health management, which will require an entirely different way of looking at health care.”
“In an ACO practice, however, attention must shift to the management of all patients in a practice across the entire spectrum of health, from those who are well to those with the most complex conditions, including individuals at the end of life.”
This will be a major transformation for providers and the healthcare systems they are associated with. Making the transition even more challenging, the Patient Protection and Affordable Care Act of 2011 will extend health insurance to an additional 32 million people and require enhanced coverage for preventative care. At the same time, the aging and growth of the U.S. population will increase the number of patients who need chronic care management.”
Excerpt from American Medical Group Association
“In the ACO population health model, it is the aggregate results across all patients that matter – even if some individuals are not cooperative or engaged, their results still count in the world of accountable care.”
“ ‘Practice-based population health’ which refers to the responsibility of primary care groups and networks for the health of their patient populations.”
“This would also be the level at which risk-bearing ACOs would stand or fall on a financial basis.”
PBPH, by definition, must address the health needs of a total patient population. Thus, ACOs must proactively reach out, not only to patients who have visited their doctors recently, but to every individual who has a relationship with an ACO physician”
Excerpt from American Medical Group Association
As discussed in the Investment Risks section of the report, unexpected developments in ACO growth, ACA mandate implementation, or internal lives under management growth will generate revenues outside of our base projection. To compensate for unforeseen events, be they positive or negative, we ran our valuation models with three different sets of assumptions briefly mentioned in the Valuation section of the report. Base Case:Our base case growth projections are based on a close analysis of ACO growth, macroeconomic shifts in the healthcare sector, international demand, and our estimates of Healthways’ potential for organic growth. These assumptions drive our $19 price target and buy decision for the stock. We expect HWAY can reasonably capture 3% of the new ACO demand for population health management and grow lives under management in the regional health plan, Medicare, and international segments by 10%, 4%, and 5% respectively. The base case also assumes -3% year-over-year decline in sales from the employer segment as described in the report.
Business Segment Sales and Sensitivity AnalysisBase Case BASE CASE
3% of ACO Market
10% Growth in
Blue/Regional
4% Growth in Medicare
-3% Growth in Employer Segment
5% International
Growth
$ 19
Bull & Bear Case:Our bull and bear case projections give us best case and worse case scenarios for company growth. The bull price of $23 represents a 50.23% upside from the January 31 closing price while the $13 bear price constitutes a 15.09% downside. The assumptions for each of these scenarios are listed in the figures on the right. Running the revenue projections with bull assumptions gives us the forecast of $839.41M by the end of 2018 while the bear case assumptions project $735.38M. We expect actual reported revenues to fall somewhere between these two numbers for the next five years. The chart below displays these three set of assumptions, our revenue projection range, and the Street consensus as provided by FactSet.
Business Segment Sales and Sensitivity AnalysisBull & Bear Case
BEAR CASE
1% of ACO Market
5% Growth in Blue/Regional
2% Growth in Medicare
-5% Growth in Employer Segment
2% International
Growth
$ 13
BULL CASE
5% of ACO Market
15% Growth in
Blue/Regional
8% Growth in Medicare
0% Growth in Employer Segment
10% International
Growth
$ 23
2006 2007 2008 2009 2010 2011 2012 2013E2014F2015F2016F2017F2018F$400
$500
$600
$700
$800
$900
Revenue Sensitivity Analysis
PushHistorical RevenueBull CaseBear CaseBase CaseConsensus
Mill
ions
of
USD
Business Segment Sales and Sensitivity AnalysisBull & Bear Case
The year 2006 presented several significant changes to Healthways business model. The acquisition of Axia represented a shift from high-risk case management to total population health management with emphasis on prevention. As displayed in the table below, revenue per life since the acquisition has been constant relative to the years before the business model shift. Healthways has not reported total lives under management since 2009, to estimate this number; we took an average of the 2007-2009 revenue per life figures ($21.86) and divided reported revenue into this number. Our forecasting method maintains this $21.86 revenue per life to predict total future sales.
Year Lives Revenue Revenue Per Life
2001 260,000 $75,121,000 $288.93
2002 579,000 $122,762,000
$212.02
2003 852,000 $165,471,000
$194.21
2004 1,335,000 $245,410,000
$183.83
2005 1,883,000 $312,504,000
$165.96
2006 2,426,000 $412,308,000
$169.95
2007 27,446,000 $615,586,000
$22.43
2008 31,700,000 $736,243,000
$23.23
2009 36,000,000 $717,426,000
$19.93
2010 32,950,688 $720,333,000
$21.86
2011 31,506,651 $688,765,000
$21.86
2012 30,976,253 $677,170,000
$21.86
Source: HWAY Annual Reports, Team Estimates in Yellow
Estimated Lives Under Management Calculation
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 $-
$150,000,000
$300,000,000
$450,000,000
$600,000,000
$750,000,000
$900,000,000
-
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
Lives Under Management vs. Revenue
RevenueLivesLives (estimate)
Tota
l Rev
enue
Lives
Und
er M
anag
emen
t
Lives Under Management
Company Ticker EV/EBITDA (ttm)CorVel CRVL 14.35Aetna AET 8.13Verisk VRSK 15.71Premier PINC 3.31*
Average 10.40*Estimate Provided by Capital IQSource: Bloomberg
EV/EBITDA Pricing Model
EV / EBITDA Valuation Multiple 10.4x FY14E EBITDA $88.7 Implied Enterprise Value 922.4
Less: Debt (246.9)Plus: Cash 1.5
Equity Value $677.0 Shares Outstanding 35.1 Target Price $ 19
Free Cash Flow Valuation AssumptionsBeta
-15% -10% -5% 0% 5% 10% 15%
-60%
-40%
-20%
0%
20%
40%
60%
f(x) = 1.07192334640998 x − 0.000113671368359679R² = 0.0848007707797231
S&P Monthly Returns
HWAY
Mon
thly
Ret
urns
We arrived at a beta of 1.07 by running a 60 observation regression of S&P monthly returns against those of HWAY.
Risk Free Rate Our free cash flow models assume a risk free rate of 3.54%, consistent with
the 20 year treasury rate in January 2014Terminal Growth Rate We assumed a terminal growth rate of 3% based on a combination of
company expectations and estimates for GDP growth. A sensitivity analysis is conducted on the terminal growth rate via our two way tables
Tax Rate Our assumed tax rate of 30% is a 2006-2012 average of income tax expense
divided by taxable income
Free Cash Flow Valuation AssumptionsContinued
(Dollars in Thousands)For the Historical Fiscal Year Ended Dec. 31,
2006 2007 2008 2009 2010 2011 2012Income Tax Expense $24,009 $30,163 $37,740 $10,137 $30,445 $15,386 $6,722
Operating Income 62,213 93,469 113,482 73,603 90,776
(129,114) 28,895 Interest Expense 1,053 18,185 20,927 15,717 14,164 13,193 14,149
Pre-Tax Income 61,160 75,284 92,555 57,886 76,612
(142,307) 14,746
Effective Tax Rate 39.3% 40.1% 40.8% 17.5% 39.7% (10.8%) 45.6%
Average Tax Rate 30.3%
Risk Free Rate Our free cash flow models assume a risk free rate of 3.54%, consistent
with the 20 year treasury rate in January 2014.Terminal Growth Rate We assumed a terminal growth rate of 3% based on a combination of
company expectations and estimates for GDP growth. A sensitivity analysis is conducted on the terminal growth rate via our two way tables.
Free Cash Flow Valuation AssumptionsContinued
Weights of Debt & Equity Our Free Cash Flow to Firm valuation discounts using WACC rather than
cost of equity. Calculations for debt & equity weights are shown below.
Price per
Share
Shares Market Total Firm Weight of
Weight of
Outstanding Cap Debt Value Debt Equity
HWAY $15.31 35.1 $537.0 $247.0 $784.0 31.5% 68.5%
Free Cash Flow to Equity Pricing ModelOur free cash flow to equity model supports our price target of $19 proposed by the EV/EBITDA valuation.
FCFE Model 2014 20 year Treasury 3.54% Beta 1.07 Market Risk Premium 8.00% Cost of Equity 12.10%
Shares Outstanding
35,060,0
00 Current Price $15.31 Abnormal FCFE $5.99 Terminal Growth Rate 3.00% Terminal Value $23.49 PV of Terminal Value $13.27 Value Per Share $19.26 Upside Potential 25.77%
Free Cash Flow to Equity Valuation2014F 2015F 2016F 2017F 2018F
Net Income $10,224 $13,832 $17,157 $21,308 $25,153 Plus: Depreciation & Amortization 60,228 65,821 71,478 77,207 83,024 Plus: Net Borrowing 24,596 3,970 2,180 5,075 3,376 Less: Investment in Fixed Capital (34,957) (37,181) (37,614) (38,084) (38,672)Less: Change in Net Working Capial (897) (136) (75) (174) (116)
Free Cash Flow to Equity $59,194 $46,306 $53,126 $65,332 $72,765
Free Cash Flow to Equity per Share $1.69 $1.32 $1.52 $1.86 $2.08
Free Cash Flow to Firm Pricing Model
We valued HWAY equity with an EV/EBITDA model, a Free Cash Flow to Equity model, and a Free Cash Flow to Firm model. The price target using free cash flow to firm is not as consistent with the other two valuation methods, and hence is not mentioned in the report, but it does confirm our upside expectations for the stock.
Free Cash Flow to Firm Valuation2014F 2015F 2016F 2017F 2018F
Net Income $10,224 $13,832 $17,157 $21,308 $25,153 Plus: Depreciation & Amortization 60,228 65,821 71,478 77,207 83,024 Plus: After-Tax Interest Expense 9,613 9,754 9,831 10,011 10,130 Less: Investment in Fixed Capital (34,957) (37,181) (37,614) (38,084) (38,672)Less: Change in Net Working Capial (897) (136) (75) (174) (116)
Free Cash Flow to Firm $44,211 $52,090 $60,777 $70,268 $79,519
Free Cash Flow to Firm Pricing ModelContinued
FCFF Model 2014 20 year Treasury 3.54% Beta 1.07 Market Risk Premium 8.00% Cost of Equity 12.10%
Shares Outstanding
35,060,000 Current Price $15.31
Total Equity
$536,768,6
00 Weight of Equity 68.49%
Debt Outstanding
$246,926,0
00 Tax Rate 30% After Tax Cost of Debt 3.54% Weight of Debt 31.51% WACC 9.40% Abnormal FCFF $230,132 Terminal Growth Rate 3.00%
Terminal Value
$1,279,139 PV of Terminal Value $816,151
Total Firm Value
$1,046,282 Minus Debt $(246,926) Value of Equity $799,356 Value Per Share $22.80 Upside Potential 48.92%
We valued Healthways’ equity share price 6 different ways including the buy-out prices discussed in Appendix 15. Of those 6, we discredited price to earnings and residual income valuations for the following reasons. Price to Earnings ModelThere were several issues with P/E ratios industry wide. Healthways currently has no P/E multiple because EPS ttm is negative. Premier, one of the closest competitors for ACO business, is a new firm with no earnings. Our earnings per share forecasts for Healthways are too low to rely on industry average P/E multiples for share valuation, and hence this model is discredited and does not contribute to our target price.
Residual Income ModelForecasted earnings per share for Healthways were less than the 12.10% cost of equity multiplied by the book value per share, hence residual income is a negative number. Earnings per share is too low for residual income valuation and we discredit the model as a valid contributor to our target price.
2014F 2015F 2016F 2017F 2018FBeginning Book Value Per Share $ 8.76 $ 9.05 $ 9.45 $ 9.94 $ 10.55
EPS $ 0.29 $ 0.39 $ 0.49 $ 0.61 $ 0.72
Dividend Per Share $ -
$ - $ -
$ -
$ -
Change in Retained Earnings (EPS - dividend) $ 0.29 $ 0.39 $ 0.49 $ 0.61 $ 0.72
Ending Book Value Per Share $ 9.05 $ 9.45 $ 9.94 $ 10.55 $ 11.26
EPS $ 0.29 $ 0.39 $ 0.49 $ 0.61 $ 0.72 Per Share Equity Charge (12.10% Cost of Equity × Beginning Book Value Per Share) $ 1.06 $ 1.10 $ 1.14 $ 1.20 $ 1.28
Residual Income (EPS – Per Share Equity Charge) $(0.77) $ (0.70) $ (0.65) $ (0.59) $(0.56)
Discounted Residual Income $ (2.40)
Value Per Share RIM $ 6.36 (Discounted RI + Beginning Book Value)
Price to Earning and Residual Income Valuations
Discount Rate and Terminal Growth SensitivityTwo-Way Tables
Buy Sell Hold
FCFF 2 way table Terminal Growth Rate 2.00% 2.50% 3.00% 3.50% 4.00%
WACC
8.00% $25.41 $27.79 $30.65 $34.14 $38.519.00% $20.70 $22.37 $24.32 $26.61 $29.37
10.00% $17.18 $18.40 $19.79 $21.40 $23.2711.00% $14.44 $15.36 $16.40 $17.57 $18.9212.00% $12.25 $12.97 $13.76 $14.65 $15.6513.00% $10.46 $11.03 $11.65 $12.34 $13.11
FCFE 2 way table Terminal Growth Rate 2.00% 2.50% 3.00% 3.50% 4.00%
Cost of Equity
10.00% $22.76 $23.94 $25.29 $26.85 $28.6611.00% $20.12 $21.01 $22.02 $23.16 $24.4612.00% $18.01 $18.71 $19.48 $20.34 $21.3113.00% $16.29 $16.84 $17.45 $18.12 $18.8614.00% $14.86 $15.31 $15.79 $16.33 $16.9115.00% $13.66 $14.02 $14.42 $14.85 $15.3216.00% $12.62 $12.93 $13.25 $13.61 $13.99
EV/EBITDA SensitivityTwo-Way Tables
Buy Sell Hold
EV/EBITDA 2 way table
EV/EBITDA Multiple
Market-Cap Weighted
Industry Average6.28
HWAY 5-Year Average
7.33
Simple Industry Average
10.40HWAY 2013 EV/EBITDA
12.34
Simple Industry Average ex PINC12.76
EBITDA (millions)
Bear 66.95 $5.03 $7.03 $12.90 $16.60 $17.4075.00 $6.47 $8.72 $15.28 $19.43 $20.33
Base 88.69 $8.92 $11.58 $19.35 $24.25 $25.3295.00 $10.05 $12.90 $21.22 $26.47 $27.61
Bull 102.74 $11.44 $14.52 $23.51 $29.20 $30.43
Note on Vertical Integration
It may be the case that Healthways becomes a viable enough ACO contractor that the Company presents an enticing buying opportunity to a larger healthcare conglomerate. Mergers are common in the healthcare sector, and our analysis of recent acquisitions has led us to conclude that when smaller health services providers are bought out, the acquirer typically pays a premium between 20% and 40%. Wellpoint, for example, paid an estimated 20% premium for 1-800-CONTACTS in 2012 in an effort to raise its MLR to comply with new federal regulations. Later that year the company also acquired Amerigroup for 43% above its equity value at the time. We estimate that HWAY’s probability of being bought out before 2018 is 10%. Applying this data to our price targets gives us the value of shares weighted according to buy-out probability. Probability of Buy-
Out 10% Industry Premiums 20% 40%
FCFF Buy-out Price $27.36 $31.92
FCFF Weighted Price $23.26 $23.71
FCFE Buy-out Price $23.11 $26.96
FCFE Weighted Price $19.64 $20.03
Current Management TeamUnder the direction of current CEO Ben Leedle, Healthways revenue has grown by over 300%. Approximately half of that growth was organic, meaning that it doesn’t include revenue captured simply as a result of the 2006 acquisitions of SilverSneakers® and Axia. Leedle has been CEO since 2003, but has been with the Company since 1985. The current upper-level management team has a combined total of 116 years of experience in health care and a combined 58 years with Healthways. While management has been criticized in the years following the loss of the Cigna contract, we are not convinced by the accusations that the firm is not being run in the best interest of shareholders. Our analysis attributes declining revenues to shrinking gross margins after the Cigna loss and slower than expected implementation of Affordable Care Act mandates. The dependency on Cigna before 2011 was a huge weakness and the loss of the contract had an enormous adverse effect on revenue, but our analysis has led us to believe that Healthways will recover, adding lives under management in a more diversified array of contracts thereby securing a more profitable future.
North Tide Capital, LLCNorth Tide Capital, LLC is a Boston-based hedge fund that currently owns approximately 10% of HWAY shares, making the fund the second largest shareholder. In December 2013, North Tide began raising its position in HWAY stock, taking an activist position and calling for the immediate removal of CEO Ben Leedle. The fund claimed that Leedle was harming the value of Healthways stock by missing attractive trends in the domestic healthcare marketplace. Along with the removal of Leedle, North Tide also called for Healthways to discontinue its international expansion efforts and focus on shorter-term trends centered in the United States. Healthways’ board of directors issued a statement defending Leedle and claimed that it had no plans to seek a replacement for the CEO position. We are not convinced that outing a CEO who’s been with the firm for almost 30 years in the midst of a critical macroeconomic healthcare shift would create value for shareholders. We believe that there is value in Leedle’s experience with the firm and the level respect paid to him by the board of directors. However, if North Tide manages to bring in a new CEO its obvious that this new executive would run the company in favor of the hedge fund, most likely by shifting focus away from global expansion and implementing a short-term capital restructuring plan to pay off debt and increase the value of equity. The situation should be monitored closely as it develops; for now, it is not factored into our valuation models.
Note on Management and North Tide Capital
Ben R. Leedle, Jr.• President & CEO• Joined in 1985, CEO since 2003• Steered HWAY towards Population Health Management• HWAY revenues have grown by over 300% under his
leadership
Current Executive Team
Combined 116 years of experience in Health Care
Combined 58 years at HWAY
Average of 5 years as executive
ManagementNASDAQ: HWAY
2009 2010 2011 2012 2013-$0.20
$0.00
$0.20
$0.40
$0.60
$0.80
$0.46
$0.72
$0.50 $0.55 $0.61
$0.24 $0.24 $0.18 $0.23 $0.24
-$0.02-$0.06 -$0.04
$0.10 $0.24
Strassmann’s Return on Management 2009 to 2013
HWAY CRVL VRSK
Ret
urn
on M
anag
emen
t
Bear Price JustificationNASDAQ: HWAY
Feb. 14 Price Movement
Source: Bloomberg
Global LegislationNASDAQ: HWAY
Country Date Legislation Goal
China 2009 Healthy China 2020
Provide universal healthcare by 2020
UK 2012 Health & Social Care Act of 2012
Abolish primary care trusts & establish smaller clinical commission groups run by general practitioners
Germany 2012 GKV Require all Germans to hold health insurance & make payment a percentage of income
US 2010 Affordable Care Act
Provide healthcare for all Americans by subsidizing premiums & reforming payment systems