HealthStream Already In The Rapids

By Stephen D. Simpson, CFA | February 27, 2012 AAA

Figure out a way to automate and simplify a mundane (and non-core) task and you have a good shot at creating a successful business. In the case of HealthStream (Nasdaq:HSTM), this small healthcare IT firm gives hospitals an option for training employees that is less costly and less cumbersome, but keeps them in compliance with an ever-changing set of rules and regulations. While HealthStream is hardly undervalued, growth investors may like what they find here.
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A Good End to the Year
HealthStream did really blow the doors off with its earnings relative to prior expectations, but it was still a strong quarter and Wall Street definitely liked what it heard. Revenue rose 24% for the quarter, with revenue from the Learning business up 31% and revenue from Research up 9% on a 15% increase in patient discharge surveys.


Gross margins were slightly soft (down two full points), but operating income nevertheless rose 85% from last year on surprisingly flat product development and administrative costs. Marketing costs were likewise held in check, growing only 16% from last year's level. (To know more about income statements, read Understanding The Income Statement.)

A Strong Foothold in a Big Market
HealthStream's core business is built around offering continuing education, training and compliance to healthcare workers. HealthStream presently focuses on the U.S. hospital market, where it believes it serves almost half of the workforce.

HealthStream charges a base annual fee per worker and then additional fees based on the specific courses that the worker needs to complete. As the platform is internet-based, it can be kept up to date easily and is far less burdensome for the hospitals.

As time goes on, HealthStream could find itself addressing a multi-billion dollar market. It's not just hospitals that have ongoing training requirements; nursing homes, home care facilities, dentists and labs all have various regulations and requirements concerning annual training.

What's more, this isn't just about checking boxes to comply with OSHA and HIPAA. There are numerous licensing and certifying bodies out there, all requiring examinations and continuing education, to say nothing of the possibilities of using the HealthStream platform for more customized training.

Co-opting the Competition
The good, and bad, news about the HealthStream approach is that there is very little that is proprietary about what they offer. HealthStream has instead approached potential competitors (companies that produce/own data) and incorporated them as partners.

While what HealthStream offers may not be proprietary, which does not mean that there's no value in how they offer it. HealthStream has set up a convenient-to-use SaaS platform that hospitals clearly like. Renewal rates run close to 100% and satisfied customers will be hard to dislodge; any interruptions in training/continuing education are a "must never happen" event for hospitals, so administrators are going to be reticent to mess with a system that works well so long as the pricing stays reasonable.

That's not to say that others aren't targeting this market as well. Reed Elsevier (NYSE:RUK) is a huge company in its own right and already tied into to many healthcare facilities through its medical publishing business. Other companies could also look at this market as a potential growth opportunity - SaaS-based HR companies like Saba (Nasdaq:SABA) or Taleo (Nasdaq:TLEO) (which is being acquired by Oracle (Nasdaq:ORCL)) could see this market as a reasonable extension of its capabilities. Others, too, like Advisory Board (Nasdaq:ABCO) could try to enter the business.

The Bottom Line
With 20%+ revenue growth today and billions of dollars of potential business out there, it's no great surprise that this stock already carries hefty multiples. What's more, the process of building this business means that near-term free cash flow growth is not going to look all that explosive. In other words, building a financial model that makes HealthStream look cheap is not an easy task.

All of that said, it's not hard to see how this could become a business with multiple hundreds of millions of dollars in annual revenue and very appealing free cash flow. That hope means that it's a worthwhile stock to think about for growth investors; while value investors will almost certainly walk away, shaking their heads at the "unreasonable" multiples HealthStream already carries. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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