iu

Emdeon Inc. (EM) / (EM-NYSE) / $18.78*

Note to Readers: More details to come; changes are highlighted. Except where noted, and highlighted, no other section of this report has been updated.

Reason for Report: Flash Update: News Update

Prev. Ed.: August 16, 2011; Special Report and 2Q11 Earnings Update; share price & broker material as of Aug. 11

* Although dated September28, 2011, share price is as ofSeptember 27.

Flash Update

On September 27, 2011, Select Data announced a new deal with Emdeon to support the workflow-automation solutions for customers of Select Data. The process enhancements from Emdeon's portfolio of offerings will improve Select Data's efficiency through automation of critical administrative duties. The company will aid Select Data in tailoring claims processing, denial tracking and capturing payer electronic remittance advice (“ERA”). Emdeon will simultaneously aid Select Data improve cash flow and management functions for Select Data customers.

MORE DETAILS WILL COME IN THE IMMINENT EDITIONS OF ZACKS RD REPORTS ON EM.

Executive Summary

Of the 6 firms reporting on the company, 5 provided ratings on the stock. All the five firms with ratings on the stock were neutral.

Emdeon Corporation is the ultimate,or quintessential,middle man in the healthcare business connecting payers with providers. It is primarily regarded as a network provider, which facilitates electronic transactions among payers, providers and pharmacies. The company is also a vendor of revenue and payment cycle management systems for healthcare payers and providers. Emdeon’s business model is mainly based on the paper-to-electronic conversion of claims, payments and prescriptions for providers, payers and pharmacies.

Sales of revenue and payment cycle solutions provide the main growth opportunity for Emdeon. Growth rates in the core clearinghouse, aswell as print and mailsegment, are however, expected to remain somewhat depressed.

Emdeon has evolved from a healthcare transaction processing network to a revenue and payment cycle and clinical information exchange solutions provider. Thus, the company, which was a pure play in network/claims processing in the 1990s, is today a $1 billion (in sales) diversified provider of application (60% of sales), network (20%), services (15%) and analytics (5%).At the Investor Summit, in April 2011, the company envisaged that, in 2015 and beyond, it will metamorphose into a $2 billion company with application, services and analytics each contributing 30% of sales with a mere 10% contribution from network. Also, according to the company, the administrative revenue versus clinical revenue ratio will change from 97% to 3% at present to a ratio of 75% to 25% in 2015.

Bearish: Neutral or equivalent outlook (5/5 firms): Target priceof $19 as provided by 2 firms. Within the universe of healthcare expenditure, 17% ($360 billion) was spent on healthcare administration in 2008. About $150 million was expended by payers and providers on billing and insurance administration functions, which is the segment in which Emdeon operates. The company’s products streamline administrative hassles for payers and providers and can lead to a more efficient healthcare system.

The neutral firms readily concede that Emdeon offers providers, payers and pharmacies revenue and payment cycle solutions that lead to efficiencies compared with traditional cumbersome administrative workflows. Also, on the positive side, a fewfirms believe that Emdeon, driven by cross-selling and new products, is a mid-single-digit organic growth company with acquisitions leading to a mid- to high-single-digit total growth.

The widespread adoption of automated processes, integration of acquisitions and operating leverage are expected to lead to consistent margin expansion.Given the company’s relatively fixed cost structure, Emdeon’s model has the potential to demonstrate margin expansion through operating leverage. Recurring revenue driven by cross-selling, bundled sales and paper-to-electronic conversion also point to margin expansion. On the whole, some firms believe that Emdeon’s adjusted EPS maybe expected to grow in the low- to mid-double-digit rate.

The neutral firms acknowledge that Emdeon’s portfolio of solutions, developed both organically and through acquisitions, is judged to be more comprehensive than its peers. While its competitors offer a handful of solutions in narrowly defined areas, Emdeon, on the other hand, provides cutting-edge capabilities on both an individual modular basis as well as from an expanded revenue/payment cycle management perspective. Such dual capability permits Emdeon’s clients to initiate their relationship with the company with a single solution, which is then expanded with add-on opportunities (these days, however, customers are increasingly seeking bundled solutions from the very start). As a result, the neutral firms expect Emdeon to preserve its market leadership in revenue/payment cycle solutions and healthcare connectivity.

In the end, however, macro-economic concerns regarding the slowdown of healthcare utilization provide a headwind for the shares.(Yet, the HITECH Act and possibly health care reform provide tailwinds for Emdeon.)Furthermore, Emdeon’s core claims and prescription clearinghouse operations are expected to grow only in the low single-digit range in the medium term. In the meantime, the company has shifted focus toward the data and analytics industry but these businesses have yet to achieve critical mass. While Emdeon provides revenue and payment cycle management services for customers, where the growth rates are solid, these products are not highly rated.On the whole, the neutral firms acknowledge the attractiveness of Emdeon’s largely recurring revenue stream, but they do not find significant catalysts to rejuvenate growth in the medium term.

Also, on the negative side, the neutral firms believe that the claims processing industry will see a shift to direct claims submission as payers shift their administrative hassles to providers. As more and more providers outsource their collection function, centralized billing operations are gathering sufficient economies of scale to justify direct connections with payers. Thus, Emdeon’s core clearinghouse model faces severe impediments over the next few years.(It is expected that Emdeon will evolve into a full health information exchange.) In order to protect its turf, Emdeon must demonstrate value beyond simply routing claims, by curtailing abuse, fraud and waste; in which case payers would think twice before bypassing its clearinghouse.

Ultimately, given industry factors, as well as valuation levels, the neutral firms do not find the risk reward trade-off to be compelling.

August 16, 2011

Background

Emdeon has complicated origins and holding structure. Its roots go way back, to the 1980s, to a public company named Envoy, which processed credit card purchases for the financial services industry. Subsequently, Emdeon entered the health care arena and, by the mid 1990s, it had sold off its credit card wing to focus on the processing of medical claims. In 1996, Envoy merged with the National Electronic Information Clearinghouse, which transformed the company into the biggest healthcare clearinghouse in the nation.

Envoy was taken over by Quintiles, in March 1999, for about $1.7 billion. Quintiles rapidly sold (in January 2000) Envoy to Healtheon (WebMD) for $2.5 billion in cash. Earlier, in 1999, Healtheon had purchased Mede America and it combined Mede and Envoy to form WebMD Business Services. Eventually, Healtheon was renamed Emdeon (in 2005) and WebMD Business Services was renamed Emdeon Business Services.

Emdeon sold a 52% share, in November 2006, to General Atlantic for about $1.2 billion. Emdeon Business Services was renamed Emdeon and the parent company, Healtheon, became HLTH Corp. In February 2008, General Atlantic along with PE firm, Hellman & Friedman, purchased the remaining 48% of Emdeon for $575 million.

Emdeon floated an IPO, in August 2009, in which it sold 10.7 million shares at about $15.50. Besides providing funds for its acquisition spree, the IPO offered a possible exit option for its PE partners, who together held about 67% of the company, post IPO.

Paper to Electronic: About 50% of Emdeon’s sales emanate from paper transactions such as mailing checks or printing statements. As paper-based transactions are digitized, there is a 40% reduction in revenue, which is more than offset by a 90% drop in expenses. This leads to rising levels of absolute profits. Emdeon is also selling higher volumes of software/services to offset the downward pressure on top-line.

Competition: Major competitors with combined services for payers include McKesson, UnitedHealthcare Group and others. It was estimated that Emdeon holds 50% market share for payer related electronic transaction services.

In the arena of healthcare payment services, including e-payment, Emdeon mainly competes against in-house capabilities as well as banks, such as Bank of America and JPMorgan Chase. It was estimated that Emdeon holds 66% market share in this segment.

Emdeon competes with players such as Athenahealth, MedAssets, CareMedic and RelayHealth in the arena of revenue cycle management. Emdeon was placed at number 2, behind Surescripts, in the area of pharmacy and e-prescribing services.

Acquisitions: Acquisitions have traditionally played a critical role in the Emdeon growth story and the company has a historical preference for spurring growth through small acquisitions. The most sizeable transaction occurred, in 4Q10, when Emdeon took over Chamberlin Edmonds (with $100 million in annualized revenue) for $260 million in cash. Chamberlin Edmonds provides tech-enabled services to determine government payer eligibility. In other words, it specializes in qualifying uninsured or under-insured patients for government funded programs (Medicaid) or charity care.

The other sizeable deal took place, in 3Q09, when Emdeon took over eRX Network, an electronic pharmacy healthcare solution provider, for about $100 million.

Also, in 2009, Emdeon acquired TheSentinel Group. The Sentinel Group uses human investigators and data analytics to identify fraudulent claims.

The company’s acquisitions have mostly been in the realm of provider services. Emdeon has rapidly widened its services by targeting four critical areas: revenue cycle management through the Chapin and Chamberlin Edmonds acquisitions; payment automation by taking over FV Tech; payment integrity via Sentinel acquisition; and finally, exchange of clinical data through FVTech.

Overview

The analysts identified the following factors for evaluating the investment merits of EM:

Key Positive Arguments / Key Negative Arguments
  • Emdeon’s core network asset comprises all domestic payers, 90% of providers and all pharmacies. Such high level of connectivity is a vital attribute for a revenue and payment cycle service provider. The company’s network strength is unmatched in the sense that it processed about 5.3 billion healthcare transactions and 1 out of 2 electronically delivered commercial healthcare claim, in the U.S., in 2009.
  • The size of Emdeon’s network is unique and it therefore offers a competitive advantage.Competitive advantage arises from network scale and connectivity. (Emdeon’s network scalability is a major competitive barrier.)
  • Emdeon’s huge network is well placed to take advantage of headwinds arising from federal legislation and transition from paper to electronic payments.
  • Development of clinical information exchange services, including Emdeon Clinician, and five-year agreement with IBM Initiate Patient to be the tech provider for the clinical information exchange, are exciting growth areas for the company.
  • Emdeon has entered into managed gateway agreement (MGA) with 400 payers (25% of all US payers) in which it is the exclusive vendor of services.
  • Emdeon has leveraged acquisitions to transform itself from a plain transaction processing company to one that offers value-added services.
  • The company has a track record of cross-selling new solutions to existing customers.Further, as per Emdeon, its existing client base represents a $3.8 billion sales opportunity for its current solutions (i.e., huge potential sales from cross-selling).Underpenetrated areas include RCM, electronic payment and strategic consulting.
  • Emdeon benefits from low client concentration.
  • 95% of Emdeon’s revenue is recurring in nature.
  • The company’s revenue base is well diversified with no client comprising more than 5% of sales in 2009.
  • Brokerage firms are consistently impressed with the free cash flow of the company.
  • Emdeon is expected to attract investor interest as the focus shifts toward cost containment.
  • Emdeon trades at a discount to its group.
/
  • Emdeon is overly exposed to medical transaction volumes.
  • Consolidation among hospitals and physician practices increases their negotiating power, which could lead to loss of pricing ability for Emdeon. Also, the consolidation among clients, both providers and payers, has the potential to reduce demand for services in the near term.
  • The company must ensure data security to comply with stringent regulations.
  • Emdeon has traditionally relied on acquisitions for growth. Each deal is accompanied by execution and integration risk.
  • Financial leverage from debt burden exposes the company to covenant risk. The interest outgo has, however, fallen in recent years.
  • The company suffers from ownership concentration, as its current owners General Atlantic and Hellman & Friedman have the ability to set the agenda of the company.
  • Some large business segments, such as Patient Statements, have recorded negative growth.
  • Emdeon’s Clinician product is a Stage 1 certified EHR. Clinician’s lack of a clinical decision support is its main difference from a fully functional EHR. Further, it does not enjoy a trajectory for meeting Stages 2 and 3 meaningful use criteria. This low cost (Clinician) product is not expected to be a major revenue driver in future.
  • Emdeon does well in a complex healthcare environment with a multitude of participants. Should the US shift to a single payor system, it would severely hurt the company.
  • Emdeon’s core clearinghouse model faces a challenge from direct claims submission, as centralized billing operations gather sufficient scale to justify direct submission of claims.

Note: The company’s fiscal year coincides with the calendar year.

August 16, 2011

Long-Term Growth

The average long-term growth rate, quoted by two analysts, is 17%, ranging from 16% to 18%.

The healthcare industry will continue to evolve from paper-based transactions to electronic forms and automated processes. The changes emanating from HIPAA 5010 and ICD-10, healthcare reform, ARRA and e-prescribing programs are expected to ensure directional momentum. As the largest medical clearinghouse, Emdeon is well positioned to transition its clients to ICD-10 and HIPPA 5010.The promotion of health information by Health Information Exchanges (HIE) isalso expected to provide a tailwind to electronic transaction volumes. This trend is expected to benefit clearinghouses, such as Emdeon, who run on a per transaction fee basis.

Emdeon is dedicated to pursuing cost cuts, timeliness and cash flow management for its clients (i.e.,payers, providers and pharmacies) through its broad range of revenue and payment cycle management solutions. The company is capable of delivering its value proposition through transaction-based and recurring processes that promote automation of administrative duties.

The company is perceived to have the critical competitive advantage of scale. It is empowered by its scalable and expansive network, which reaches out to all U.S. payers and about 88% of physicians and hospitals. Scalability comes from both its network connecting almost all payers and pharmacies as well as the comprehensiveness of its solutions, which span revenue and payment cycles.

As Emdeon takes advantage of the scale of its infrastructure, consolidates costs, integrates acquisitions and implements paper-to-electronic process conversion within its provider and payer client bases, it will generate margin expansion.

The potential for healthcare utilization levels to stagnate poses a potential dampener for Emdeon’s growth outlook.While revenue and payment cycle solutions are the company’s primary growth drivers, growth in its core clearinghouse operations is likely to remain under pressure. It is true that Emdeon’s nascent data and analytic products may enjoy good long-term opportunities, but it is too early to judge them. E-prescribing is possibly the most rapidly growing of Emdeon’s businesses. About 18% of the nation’s prescriptions are currently processed electronically and this figure is expected to gradually ramp up as providers are required to e-prescribe to qualify for Stimulus-oriented meaningful use funds.

At present, more than 80% of claims are submitted electronically by providers but only a handful of payments are sent electronically by payers. It is expected that, in the end, payers will switch from paper to electronic submission.Brokerage firms expect Emdeon (barring the revenue cycle management solutions in the payer segment) to grow in tandem with electronic transaction growth, which should be moderate in the medium term.

At the Investor Summit, in early April 2011, Emdeon highlighted a long-term vision of its revenue mix beyond 2015. The company foresees potential revenue of $2 billion or more, with higher weightage for services and analytics than at present. One brokerage firm observed that combined contribution from applications and network would remain flat whilecombined revenue from services and analytics would zoom 500% from current levels.

In other words, while FY10 company-wide revenue was about $1 billion, the company’s vision for 2015 suggests sales of $2 billion driven by growth in services and analytics. The services segment, which contributed about 15% of total sales ($150 million), in FY10, is expected to grow 4x, at a CAGR of 32%, to $600 million in FY15. The analytics segment, which formed less than 5% of sales in FY10, is also expected to contribute another $600 million to the top-line in FY15. The core combined applications and network businesses are, however, expected to stagnate at $800 million. One brokerage firm believes that the envisaged mix shift in favor of services and analytics may be too bold.

Hence, it may be concluded that the ongoing development of services and analytics segments is a vital component for the successful execution of Emdeon’s strategic plan.