Premium-Price athenahealth Leaves Little Room For Error

By Stephen D. Simpson, CFA | June 01, 2012 AAA

athenahealth (Nasdaq:ATHN) offers another example of how it's important to separate a company from its stock. From the perspective of an operating company, there are a lot of positive things going on at this provider of software and services to medical practices. From a stock perspective, though, expectations are already red-hot and success is taken as a given, leaving little on the table for the future and significantly increasing the risk that any future earnings shortfall will be met with a painful sell-off in the shares.

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The Growth Story Remains the Same
The basic story at athenahealth hasn't changed all that much - the company needs to sign up more practices to use its athenaCollector revenue management product, while also increasing its sell-through and cross-selling efforts for platforms like Clinicals and Communicator.

As of the last quarter, the company continues to do well in that respect. Not only did the company post a 4% sequential growth in the number of physicians (22% growth year on year) and providers (21% growth year on year) using Collector, but user growth was considerably stronger in both Clinicals and Communicator. All of that helped to fuel a 38% rise in revenue, a result that was a bit ahead of generally bullish analyst expectations.

But so Does the Profitability Challenge
Although top-line growth looks great, doctors continue to sign up as customers and customer satisfaction and retention numbers remain strong, all is not perfect in athenahealth-land. Like many other software as a-service (SaaS) stories, including salesforce.com (NYSE:CRM), the cost of that growth is a more troublesome story.

Gross margin actually declined from last year on a GAAP basis, while operating income dropped. Although some investors may choose to focus on the non-GAAP measures that show growth (including a 27% growth in adjusted EBITDA), the 40% increase in sales and marketing expenses should not be ignored.

It's not enough to just pull customers away from Allscripts (Nasdaq:MDRX), General Electric (NYSE:GE), Siemens (NYSE:SI) or McKesson (NYSE:MCK), it also has to be a leveragable profit-making opportunity. While it may be unfair to compare SaaS providers across industries, and it is still early in the SaaS story, the ability to really leverage sales and marketing and post the sort of margins that traditional software and healthcare IT companies posted in the past seems like an open question.

SEE: A Look At Corporate Profit Margins

Separating Value and Shareholder Value
I don't argue that athenahealth delivers a good suite of products. The ability to update payor rules in real-time is valuable. Likewise, the ability to better manage the continuum of care, reduce errors, keep up with changes in legislation and improve care are all selling points.

Here again, though, is the difference between a "good company" and a "good stock." Penetrating larger enterprises has remained a challenge and healthcare IT is a ferociously competitive space, with more companies looking to enter the market with their own SaaS model.

The Bottom Line
On some level there's just a basic disconnect between growth and value investors. Accordingly, growth investors may well look at the reported revenue growth, increasing subscriber numbers and improving cross-sell metrics and argue that valuation is beside the point. And, at least for a while, they likely have a valid point.

Sooner or later, though, valuation always matters. Whether that's sooner (in the case of a shortfall in reported results or guidance) or later (as penetration rates reduce prospective growth rates), I do not know. But what I do know is that stocks trading at around a seven times trailing revenue are not buy-and-hold stocks, but rather buy-and-jump stocks that demand the ability to spot the point where the growth curve starts to flatten and get out before the Street and other growth investors turn on the name.

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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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