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Bear of the Day: athenahealth (ATHN)

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athenahealth (ATHN - Free Report) is a $5.5 billion provider of software and services for physicians and hospitals. Their web-based business services for medical groups and institutions are based on proprietary practice management and electronic health records (EHR) software, a continuously updated payer knowledge-base, and integrated back-office service operations.

One of their specialty services helps doctors with billing and collections using a revenue calculator that shows medical professionals how they can increase payment amounts and timeliness using data pulled from a 99,000-provider network.

The company claims that their patented Billing Rules Engine and expert service teams are proven to get more claims paid on first submission, reduce days in accounts receivable, and dramatically reduce patient no-shows.

Since the end of 2012 through the first quarter of this year, athenahealth grew annual revenues at a 27% CAGR from $422 million to $1.112 billion.

The company, whose CEO Jonathan Bush is cousin to George W. #43, is based in Watertown, MA and has recently become the target of activist investor Paul Singer who runs the $33 billion hedge fund group Elliott Management.

More on that story after we discuss why the stock is a Zacks #5 Rank (Strong Sell).

Earnings Disappointment Brings Estimates Down

On April 27, athenahealth reported adjusted earnings of 10 cents per share in the first quarter of fiscal 2017, missing the Zacks Consensus Estimate by a penny and declining almost 9% on a year-over-year basis.

The company posted revenues of $285.4 million, which also missed the Zacks Consensus Estimate of $297 million but increased 11.3% on a year-over-year basis.

athenahealth registered operating margin of 7.7% in the first quarter compared with 9.4% in the year-ago quarter.

For fiscal 2017, the company expects revenues in the band of $1,210–$1,250 million. Adjusted operating income is projected in the range of $120–$140 million with annual bookings expected at around $350–$400 million.

In response to this report and outlook, analysts took the 2017 full-year EPS consensus down 29% from $1.18 to $0.84, representing negative 18% "growth."

And the 2018 profit projection slipped an unhealthy 31.45% from $1.59 to $1.09.

Per management, the company expanded its network across ambulatory, hospital and population health platforms. The company’s network has grown to over 99,000 providers, 88 million patient records and 2.8 million covered lives at the end of the first quarter.

And buoyed by strong network expansion, athenahealth is expected to see revenue and earnings growth over the long haul. But not everyone is so patient with this growth outlook.

The Man Who Sells Your Company -- Whether You Like It Or Not

Paul Singer is a New York hedge fund manager infamous for taking activist positions in companies to reorganize management, revive growth, sell assets, or even sell the company itself. His determination and success in this regard is remarkable.

According to a recent CNBC article by Leslie Picker, "In the last seven years, Elliott has engaged in 38 campaigns, of which 20 have been sold, according to data compiled by Bloom berg, cited by an Evercore analyst."

On May 18 investors learned that one of Paul Singer's hedge funds, the $13.3 billion Elliott Associates, had acquired a 9.2% stake in ATHN shares. Whenever an institutional investor amasses anything greater than 5% of a company's shares, they must report their position to the SEC within 10 days.

Looking over the SEC 13D filing (the "D" indicates an "Activist" classification of the investor's position, as opposed to a 13G which is "Passive"), I found that it showed the dates for the purchase of 375,000 shares at an average cost somewhere below $110.

The buying began on April 17 and continued through April 21 at prices between $110 and $118. Then shares gapped down $20 on April 28 after the company's disappointing report and Elliott funds bought more until May 5, at which point they must have crossed over the 5% ownership threshold for reporting to the SEC.

But 375K shares would only be a 1% stake in the approximately 40 million shares outstanding.

Purportedly, Singer also used "derivatives" to amass the 9.2% stake. Doing some rough math, another 8.2%, or 3.25 million shares, could have been assembled using 32,500 standard, exchange-traded call option contracts. That was my first guess. But I could find no mention of options anywhere.

So I decided to dig deeper into the filing because I knew that this had to be reported somewhere within the small type on hundreds of lines of text. Sure enough, Items 5 and 6 described cash-settled swaps that were transacted with, of course, an off-shore Bermuda-based financial entity. Here's a key descriptive line from the filing...

Elliott, both directly and through The Liverpool Limited Partnership, a Bermuda limited partnership and a wholly-owned subsidiary of Elliott ("Liverpool"), and Elliott International have entered into notional principal amount derivative agreements (the "Derivative Agreements") in the form of cash settled swaps with respect to 1,055,471 and 2,242,880 shares of Common Stock of the Issuer, respectively (representing economic exposure comparable to 2.6% and 5.6% of the shares of Common Stock of the Issuer, respectively).   

The good news is that even off-exchange, non-standard, off-shore derivatives contracts like this are held accountable by the SEC if constructed using real shares of stock.

Spotlight on the Activist

Singer said of athenahealth that it "operates in a highly strategic area at the intersection of technology and health care." The Elliott team believes ATHN is substantially undervalued and it may propose changes to the company’s operations, board and dividend policy, as well as a potential sale.

Part of this effort may be inspired by controversial public statements and business communications from the outspoken CEO Jonathan Bush.

"Companies like this – good businesses with good products but a somewhat unstable management, are viewed as un-investable by many investors but good opportunities for activists," said Kenneth Squire, chief investment strategist of the 13D Activist Fund. "There is an excellent opportunity to cut costs and focus on operations with the right management team."

Writing in Barron's on May 26, Squire offered this keen and concise analysis...

Behind the Scenes: Elliott is a very successful and astute activist, particularly in the technology sector. In the past, it has often offered to acquire its portfolio companies as a catalyst to enhance shareholder value. But unlike many other activist investors, Elliott has demonstrated its willingness to actually own its portfolio companies -- at the right price. This willingness to buy has become even more of a reality since Elliott launched a tech-focused private equity fund that is run by Jesse Cohn, who also runs U.S. activism for Elliott.

Athenahealth is managed by Jonathan Bush, a cousin of former president George W. Bush. At the company's heart is a cloud-based software platform containing 88 million patient records. The company's margins have been steadily shrinking, leading to a decline in share price after each of its six past earnings reports. There is an excellent opportunity to cut costs and focus on operations with the right management team. There are two ways to accomplish this: by bringing in a new management team; or by selling Athenahealth to a company with its own management team. Based on Elliott's history, it will likely push for the latter.

Citi Raises ATHN Price Target to $163

On June 5, Citi analyst Garen Sarafia raised his price target on athenahealth saying Elliott Associates' recently disclosed stake in the company reinforces his favorable view and likely provides a support level for shares. Here was a key summary of that report, courtesy of

The analyst said potential acquirers of athenahealth would include tech companies aiming to build a healthcare presence, including IBM (IBM - Free Report) , which has made several recent acquisitions to bolster its healthcare network. He added that Aetna (AET - Free Report) and UnitedHealth (UNH - Free Report) , through its Optum business, may also be potential suitors, although UnitedHealth is currently under agreement to use Allscripts (MDRX - Free Report) software.

While the earnings picture is cloudy for ATHN, the activist one is crystal clear. Paul Singer intends to shine some light on the matter and, given his track record, Wall Street analysts and other large investors will give him the benefit of any doubts.

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