Computer Programs and Systems, Inc. (CPSI): Moat
CPSI has a superior product and value proposition evidenced by their market share, ROE, margins, and through CUSH’s independent channel checks. CPSI has taken more hospitals to Meaningful Use than its next five direct competitors combined. Implementation of the CPSI’s EHR system is typically one to two months compared with the six to twelve months of some of its competitors. Their hardware is sold and supported by CPSI, and they handle all of the training on-site. Most of their competitors use third parties to sell their hardware.
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Contracts are typically five years in length, and switching costs are astronomically high. When asked about conversions, CFO David Dye responded, “It’s a tremendous nightmare that they (healthcare facilities) avoid as much as possible. I’m not even talking about the cost which is tremendous as well.”1 In doing our channels checks with healthcare facilities and other EHR vendors, the nightmare of conversion that Mr. Dye noted was confirmed. Back to an earlier point of CPSI receiving Requests for Proposal (RFPs) from healthcare facilities that currently have an EHR vendor other than CPSI. These hospitals are looking to get to Meaningful Use; and, with the nightmare of doing a conversion, the winning of this business speaks to CPSI’s track record and leadership in getting facilities to Meaningful Use. While the specific number of competitive replacements done by CPSI has not been disclosed, we do know from conversations with management and through our channel checks that this data point is very significant.
The five-year contracts for services from CPSI create nice stable cash flows. Recurring revenues represent 60% to 65% of top line, and CPSI is expanding into business consulting with TruBridge. The threat of new entrants is present, but the successful EHR vendors are the ones that have been doing it for 30 years (companies such as CPSI, Cerner, and Epic). The billing and clinical requirements are so complex that you simply cannot jump in, drop a ton of money, and write a system from scratch. Companies like Microsoft, Oracle, and GE have tried to get into this market by doing just that, and it has not gone well for any of them.
Mis-pricing and valuation
Much of the mis-pricing comes from the so-called Street expert’s displeasure with CPSI falling short of quarterly earnings estimates by a penny or so. The reason for this has to do with CPSI’s strategy for getting hospitals to Stage 1 Meaningful Use. In 2012, CPSI began offering its systems at almost no upfront cost to clients; they just pay a monthly fee until they receive their stimulus check. Once they receive the stimulus check, they then pay for the system in full. What the Street does not like about this strategy is that instead of receiving the revenue from this in Q2, it might not be until Q3 or Q4 that CPSI receives the revenue due to the lag between attestation and receiving the stimulus from the government. Attestation happens when a healthcare facility proves to the government that they are using the electronic records system, meeting the standards set for the various stages of Meaningful Use. The strategy creates a window of time where costs are greater than revenues, but once the revenue is received, it is at a very high margin. CPSI is able to do this because of its exceptionally strong balance sheet. Companies like Prognosis Health Information Systems have similar strategies but not the financial backing to support them so they are struggling. This strategy is slowing down, though, as the bulk of the contracts CPSI is signing currently are for Stage 2 Meaningful Use. Long-term investors will be best served, as they will be able to better recognize the gains from this strategy.
This implementation strategy aside, CPSI has grown top-line revenues at more than 12% over the last three years, and ROE is at a high of 53%. This is likely to accelerate given ARRA legislation and the launch of TruBridge. However, valuation multiples—price/earnings, EV/EBITDA, and price/book—are below historical levels and that of peers. Free cash flow yield is 3.39% (which is understated for the reasons listed above), and with the most recent dividend increase, CPSI is yielding about 4% at its current price.
Inside its existing customer base, CPSI has an internal market opportunity of 168 hospitals needing to get to Stage 1 Meaningful Use (based on 75% of current base being Stage 1), and an outside market opportunity of 100 hospitals for Stage 1 sales. Using $800 thousand (the midpoint between $1 million and $600 thousand) for a Stage 1 sales estimate, that equates to $214 million in revenue over the next two years, as the deadline for Meaningful Use Stage 1 is October 1, 2015. For simplicity, you could assume that number will be spread evenly at $107 million a year. We expect recurring revenues to grow in the 5% range. For 2013, we estimate top-line revenue to be $216 million. Holding margins constant gives us an EPS estimate of $3.00. In our model, for conservatism, we did not give CPSI any credit for margin expansion—which is likely over time, as a greater percentage of revenues come from services. Nor did we include sales numbers for Stage 2 and Stage 3 Meaningful Use or potential revenues from Trubridge. Also, it is worth noting that there are indications of continuing stages of Meaningful Use after Stage 3, for which we did not model.
CPSI has a niche in an industry that is growing nicely with near-term catalysts. Based on our DCF model, which forecasts top-line growth of 15% until 2015 and a WACC (weighted average cost of capital) of 15%, we set a price target of $62.00 and recommend buying under $52.00 for an appropriate margin of safety.
The Market Realist Take
During the six months ended June 30, 2013, the company generated revenues of $102.8 million selling its products and services, compared to $90.2 million in the six months ended June 30, 2012. This is an increase of 14.0% that we can mostly attribute to the discontinuation of First Generation Meaningful Use Installment Plans. It installed its core financial and patient accounting system in 17 new hospitals in the first six months of 2013, compared to 18 in the first six months of 2012. Plus, its expanding customer base resulted in continued growth in support and maintenance revenues and business management, consulting, and managed IT services revenues. Its net income for the six months ended June 30, 2013, increased 10.9% from the first six months of 2012, while cash flow from operations decreased 41.3%—primarily as a result of increases in its financing receivables.
Net cash provided by operating activities for the six months ended June 30, 2013, was $6.8 million, compared to $11.5 million for the six months ended June 30, 2012. This decrease in net cash provided by operating activities mostly results from a major increase in the company’s financing receivables. It said it continued to experience increased levels of customers seeking financing arrangements for system installations during the year. This was due to challenging economic conditions, the unavailability of third-party credit, and its new system installation customers’ increasing preference to minimize the near-term impact that purchasing its system will have on their current cash resources. It expects this trend of increased levels of customers seeking financing arrangements for system installations to continue during the next 12 months. This should result in further increases in its financing receivables. The expected increase in financing receivables—although offset by periodic collections of previously outstanding amounts—could temporarily have a negative impact on CPSI’s net cash provided by operating activities.
CPSI’s competitors include Cerner Corporation (CERN), Quality Systems Inc. (QSII), McKesson Corporation (MCK), Veeva Systems (VEEV), and Quadramed Corp (formerly QD, which was recently purchased and went private in June).