*Stock Idea Alert* PFMT - BUY
Performant Financial Corp (PFMT)
PFMT is a $2.34 stock with 73.8 million shares outstanding making it a micro-cap stock at a market cap of just $173 million. There is $22 million of debt on the balance sheet and $16 million of cash making the Enterprise Value $179 million.
There are a few things that make PFMT likely to be an undiscovered and misunderstood company ripe for making high investment returns.
It’s small market cap & less than $5 stock price.
A business turnaround/transformation
Hedge-fund ownership
History
Historically, Performant Financial was a legacy debt recovery business working on defaulted student loans, federal treasury and state tax receivables and commercial recovery.
As their debt recovery business began to struggle, they decided to exit and instead transform into a much more profitable and quickly growing healthcare payment integrity company.
As PFMT began to exit their legacy business, naturally they experienced a dwindling of overall company revenue. The lower revenue came as a result of their legacy business being smaller than the then new healthcare business.
A business that was in the process of pivoting out of a low quality industry and transforming into a high growth high margin, recurring revenue, business, on paper looked like it was experiencing dwindling revenue.
Fast forward a few years to the current day and PFMT is now officially a pure-play healthcare company with essentially zero exposure to their legacy debt recovery business.
Now, PFMT works with healthcare payers to audit and then correct incorrect claims. For example, if a hospital charges an insurance company too much (example - a double charge, or incorrect characterization of a procedure) PFMT will find these mistakes, correct them, and keep a percentage of the money that they recover for the insurance companies. In this way their business model is a win, win. PFMT saves the healthcare payers money, and gets to make money themselves on whatever they save.
Full year Guidance
On the last earnings call management guided to achieve in the full year of 2022…$92 million to $96 million in revenue.
In 2019, health care revenues were $43.3 million
In 2020, health care revenues were $68.5 million. 58% YOY growth.
In 2021 they achieved revenues of $77.5 million in the healthcare business. 13% YOY growth.
If they achieve the low end of their guidance at $92 million they will have grown 18.7% growth.
Right now the business is in a high growth/spending mode and is not yet optimizing for margins so it is hard to get a sense of what the true earnings power is. Contract wins take a year or two to fully integrate, but the business has to spend money up front before the and during the integration process. This pre-investment in human capital makes margins lower in the short term.
Management has guided to mid 20s operating margins in the future and this can be confirmed by taking a look at the margins of one of their closest peers called Cotiviti.
Cotiviti does what PFMT does, but is a private company and is much larger. In 2013 Cotiviti had more than double the revenue PFMT will achieve in 2022, and was able to achieve 30% matings on that revenue. This makes me feel comfortable assuming 20% margins for PFMT.
If PFMT were able to achieve 20% margins in 2022 on their $92 million in revenue, that would equate to $18.4 million in earnings. That would mean that PFMT is currently trading at about 9.4x what PFMT would be capable of producing if they decided to stop spending money in order to grow at a rapid pace.
I believe a company growing at this kind of pace deserves higher than a 9.4x’s multiple and something closer to a 12-15.
If PFMT traded at 12x’s that would lead to upside of 27.6% and at 15 x's an upside of 59%.
3. Hedge-Fund Ownership
PRESCOTT GROUP CAPITAL MANAGEMENT
This hedge fund runs about half a billion dollars with their biggest position being a $40 million investment in PFMT. That $40m investment is double the size of their next biggest position so it seems that they are quite bullish on this company. When a hedge fund running that much money is invested in such a small company like this, it would be very hard for them to liquidate their position without crushing the stock price. What that means to me is that they’re stuck in this position and need it to work out.
It’s comforting to know that a large fund is both bullish and dependent on this position working out for them.
Most recently, in January of this year they bought about $4 million worth of stock at an average price of over $2/share…. so they clearly like it around these prices.