About two weeks ago, I had the opportunity to sit down with the management team at Catasys for a corporate update. I left the meeting more excited than ever about both the near-term and long-term prospects of Catasys. The Company is clicking on all cylinders and, unlike the overall market, the stock has yet to make a big move. In my opinion, there exists a disconnect between the strength of the Company’s business and the low valuation of the shares.
In this report, I’ll discuss my three key takeaways from the meeting. I’ll also address what I believe are investors’ main questions…questions that are keeping shares of Catasys trading below last year’s deal price, and that will be addressed in the coming weeks.
1. Business is strong and management is exuding confidence. This was one of those meetings in which the body language said, “yeah, we got this one.” I’ve spoken with this team many times and had several face to face meetings; this meeting was the most telling ever in terms of the strength of the message they are sending.
Management is justifiably confident when you look at how business is progressing. On last quarter’s call, they stated that October billings were well over $1M. This put them on pace for a large sequential growth in billings in Q4. There is some seasonality, due to holidays, in their business, but I’m confident they came close to $3M in the Q, which would be a great sequential increase in billings.
Besides the strength in their existing book of business, management remained committed to their guidance from the earnings call for closing on significant new contracts in Q1; all of which would be incremental to their 2018 guidance. Since our meeting, we have seen Catasys announce deals with Cigna and Blue Cross/Blue Shield of Illinois (with ongoing discussions about other states). These are big partners and should add substantially to their forecasts. However, they are not the only ones expected to occur in Q1 and I believe we’ll see more deals soon.
2. There exists a moat around this business and it’s getting larger. By the time Catasys got their first partner, they had invested well over $100M into developing the Ontrack. Part of this was spent running a trial during which they proved that they generate cost savings for their insurance partners. These savings are quantifiable and, as part of their contracts, they guarantee ROI for insurers whose patients they enroll. This is a big barrier to competition as no one else has proven this level of success.
To put this in context, for a competitor to win this business from Catasys, they would need to run a 5,000 patient trial that demonstrates savings of over 50%. This would take significant time and money. In a recent press release, Catasys proved 54% cost savings on enrollees. This is a huge barrier to competition.
Even more importantly, over time the barrier is growing. There are two ways in which this is occurring. The first increase in the barrier to entry is their artificial intelligence (AI) program.
Catasys is developing an AI platform in which every patient that is in the system is tracked closely. Each interaction will be detailed, including down to the recordings of the caregiver calls, which are analyzed by their AI program. The thing about AI is, as you get more usage data, especially with outcomes, it learns and improves upon itself. Thus, the longer Catasys is in business, the more its business becomes smarter than any other potential competitor. This will allow them to generate better outcomes for patients, higher savings for insurers, and, potentially, better economics for themselves. As they build out their AI platform, Catasys’ moat around their business will grow daily.
Secondly, almost ignored in their last press release was the announcement of their own “proprietary Catasys network”. While investors were, justifiably, excited about signing the Blues, the fact that they have established their own credentialed network will likely be of much more significance in the long-term.
What does it mean that they have their own network? Well, in the past, they have had to use an insurers network of providers. This limited their access to providers and impacted their ability to use their AI to match patients with the perfect counterpart. By establishing their own credentialed network, Catasys is better able to provide high quality care in the proper geographies. At this time, they have several thousand providers in their growing network, and that number should expand greatly over time.
All of which means that, with a combination of AI and their own network, Catasys will be offering an ever-increasing quality of care and service that is unmatched by the competition. And, over time, it will be harder and harder for anyone to try to emulate them.
3. In an age of big data, Catasys will become a leader in healthcare. Think about this for a minute. If Catasys signs 7 of the 8 largest health insurers as clients, which they are well on their way to doing…and, if these clients continue to roll out Ontrak across their network…Catasys could, theoretically, have the patient healthcare data for well over half of all Americans.
The implications of this are incredibly broad and extend well beyond their Ontrak program and its effectiveness. With more data on patients, including outcomes, Catasys will be able to create many different programs to offer to insurers. The potential of Ontrak is huge; the longer term potential inherent in them having the most healthcare data on the planet is much bigger.
Catasys’ CEO, Terren Peizer, has said repeatedly that investors seem to miss the importance of having 7 of the 8 largest health insurers sharing data with them. These partners don’t randomly give this access away. You not only need to earn their trust and offer an ROI, but you need to build a secure system to protect the data.
Catasys told me their data network infrastructure gets audited very frequently by the insurers. It’s truly a big deal to have access to this data. With potential access to more data than anyone else, Catasys is positioned to make themselves into a really big deal in the healthcare industry.
What’s keeping a lid on the stock?
In April of 2017, Catasys raised $15M at $4.80 per share. Yesterday the stock closed at $4.70; this during a time when the market has set continual records. Something is keeping Catasys’ stock down. I believe there are two things weighing on CATS and that Q1 will see the weight lifted.
The first issue is the lack of growth in billings. Around the time of the financing, billings were running slight more than $2M per quarter. In their Q3 2017 numbers, Catasys reported slightly more than $2M in billings. Unfortunately, the market had been expecting a ramp in billings and investors were not happy.
Now, however, it appears that things are picking up. As previously mentioned, October billings were well over $1M. If they report near $3M in billings for Q4, which I think is likely to happen, investors will have their first tangible clue that business is improving as forecasted.
The Company has given very strong guidance for billings of over $20M in 2018. I don’t think investors necessarily believe this will happen, due to zero growth in the last few Q’s reported. CATS is due to report their earnings in early March. When they do so, the issue of no growth will be a thing of the past. Taking it one step further, growth in Q4 will not only make 2018’s numbers seem more likely, it will also allow investors to start quantifying upside based on the recently announced new contracts. Bottom line, this issue should be put to bed in the next few weeks as investors start pondering the very real scenario of billings coming in over guidance for 2018..
The second thing weighing on CATS are concerns over another financing. On the last conference call, management did say that, if they hit their goals of significant new customer launches, they would require additional capital. This is a first class problem to have, but, obviously, a share issuance would be a negative overhang for the stock.
I believe this concern is misplaced. We addressed this point specifically in the meeting with management, at which time they said they believed the Company could be financed through non-dilutive means. This would imply some sort of debt or bank financing would become available to the Company.
It’s important to note that the CEO has invested more than $22M into this Company and is by far the largest shareholder. Believe me when I say, he’s not likely to dilute himself at a time when the Company is just turning the corner on significant revenue growth and can start seeing free cash flow coming down the pike.
After meeting with management and hearing their statements, and reading their body language, I’m quite comfortable that a share issuance is unlikely at best. Instead, I expect them to announce plans for some non-dilutive financing on their next earnings call, which should remove this issue from the marketplace.
Thus, what I perceive as the two biggest question marks in investors’ minds could very well be answered by the end of Q1. When the Company announces Q4, revenue growth will become very real. And, an announcement about non-dilutive financing would encourage investors to step in sooner rather than later.
CATS shares are up by about 20% year to date. However, they remain below year ago levels and represent a compelling opportunity. Once the questions are answered, expect investors to focus more on the upside opportunities. This is a Company with a well-protected niche product that could grow into the billions over time. And, with their AI at work, more products should be coming into view. The future for CATS is very bright indeed.
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