I am recommending CorVel (“CRVL” or the “Company”) as a short within a diversified short portfolio.  CRVL was posted to VIC as a short during 2007 at ~$38 and has compounded by almost 13%.  Since that posting, EBITDA has grown by ~7% on a CAGR basis while the EBITDA multiple has tripled to 42x.  During the past one, two, and five years, CRVL has impressively outperformed the NASDAQ.  Although I have not identified the “smoking gun,” I am recommending CRVL as a short based on numerous issues as described below.  At 20% downside, CRVL would still be trading at a questionable valuation (LTM PE 55x, 33x EBITDA, 1.7% EFCF yield)       

·         Priced for perfection

·         During periods of higher unemployment, workers’ compensation claims have typically declined which would likely impact the pace of earnings growth at CorVel

·         A declining ISM index typically indicates a contraction in manufacturing activity which would frequently coincide with less worker injuries and workers’ compensation claims

·         Implementation of industrial injury prevention measures is increasing which could reduce workers’ compensation claims

·         CorVel’s results could be compromised from increased regulatory scrutiny and legal actions based on questionable business practices when unreasonably delaying or denying coverage

·         Technology investments in AI and machine learning do not differentiate CorVel from some of its peers

·         Potential earnings degradation from increased corporate tax rate

·         Suspicions regarding earnings quality

·         Ownership overhang

CorVel provides tools and services for health care business processes such as claims processing, bill review, preferred provider networks, utilization management, pharmacy services, directed care, and Medicare services.  The Company partners with employers, group health and auto insurance providers, third-party administrators (“TPA”), and medical management companies to manage workers’ compensation and liability services.  The focus of the Company’s value proposition to its customers is cost containment by advocating medical management to both reduce the administrative costs and duration of a claimant’s disability. 

Historically, governmental strategies to contain medical costs in the workers’ compensation field have been limited to legislation on a state-by-state basis.  For example, many states have implemented fee schedules that list maximum reimbursement levels for healthcare procedures.  In certain states that have not authorized the use of a fee schedule, CorVel adjusts bills to the usual and customary levels authorized by the payor. 

Healthcare providers are increasingly resistant to the application of cost containment techniques.  Combative issues between healthcare providers and payors are common.  The friction has existed for decades but a recent survey by the American Hospital Association found that 78% said their relationship with payors has deteriorated. 

Payors want to reduce expensive and unnecessary treatment, eliminate fraud and lower financial risk.  Providers want to be able to make decisions regarding their patients’ care without having to navigate the hurdles of medical necessity, prior authorization and complex payor regulations.  There is understandably a need for some oversight and cost containment such that providers are not abusing payors by providing unnecessary services and expense.  However, the legitimate healthcare needs of the patient should take precedence and be appropriately addressed.  Claim denials and delays compromise patient care that might be deemed legitimate and necessary for injured workers. 

CorVel and its peers serve their clients with an objective for finding ways to achieve cost savings for insurance carriers and large, self-funded employers.  There are perverse incentives that the TPA like CorVel has in regards to their own economic benefit to influence healthcare savings that might come at the expense of an injured worker who legitimately needs services.  CorVel’s industry is fraught with issues pertaining to the provision of healthcare services that are unreasonably delayed and/or denied.   Healthcare providers are becoming more active in their efforts to minimize the use of certain cost containment techniques and are increasingly engaging in litigation to avoid the application of certain cost containment practices. 

The industry in which CorVel competes has evolved with technological advancements and consequently there is a growing emphasis on digitization in claims processing and the integration of advanced technologies such as artificial intelligence (“AI”) and machine learning (“ML”).  TPAs are expected to invest in these technologies to enhance efficiency, accuracy and customer experience while complying with evolving regulatory standards.  CorVel is not unique in the application of advanced technologies although the Company’s valuation might suggest otherwise. 

The Company derives the majority of its revenues from providing patient management and network solutions services to payors of workers’ compensation benefits, automobile insurance claims and group health insurance benefits.  CorVel segments its business reporting into two different services:  Patient management services and Network solutions services.  Patient management is approximately two-thirds of Company revenue and Network solution is one-third.  During the past two fiscal years (ended March), Patient management services generated a CAGR of 11.8% and Network solutions generated 9.3%.  No single customer represented more than 10% of revenue although one customer accounted for 10% or more of CorVel’s account receivables.  Customers include The Cheesecake Factory, Carhartt, Performance Foods, Edward Jones, R & L Carriers, MSIG North America, and the City of Lakeland.

The Company does not disclose the number of claims it processes but total new claims increased by 4% in the most recent fiscal year; this was lower than the preceding year’s 5% growth.  During FY 2022, total new claims increased by 17% so the rate of change has moderated substantially although CRVL’s valuation fails to discount any moderation of growth but instead the market ascribes a valuation to CRVL that is higher than all the “Mag 7” other than TSLA.

Patient management services include claims administration, utilization review, medical case management, and vocational rehabilitation.  The Company’s patient management services are driven by the number of workplace injuries that become longer-term disability cases.  Through its utilization management services, CorVel recommends the appropriateness of providers’ medical treatment plans for patients, and as a result, could be exposed to claims for adverse medical consequences.  Network solutions include fee schedule auditing, hospital bill auditing, coordination of independent medical examinations, diagnostic imaging review, and preferred provider referral services.  At the end of March, the Company’s PPO network was comprised of more than 1.2M national providers.  Supposedly, in exchange for more patients, these PPO and Network contracts reduce reimbursements to below the amounts established by the state’s workers’ comp fee schedule.

Utilization of early intervention services by healthcare payors is increasing which could impact CorVel’s later-stage network and healthcare management services.  The performance of early intervention services, including injury occupational healthcare, first notice of loss, and telephonic case management services, frequently results in a decrease in the total costs associated with a healthcare claim.

Although CorVel does not specifically identify any of its competitors, the Company’s public filing notes that “primary competitors in the workers’ compensation market include TPAs, MCOs (managed care companies), large insurance carriers and numerous independent companies.”  During my research process, I identified several competitors which include the following:  Conduent’s Casualty Claims Solution business, which is being sold for ~10x EBITDA to MedRisk; Sedgwick which is controlled by Carlyle and is engaged in an exploration process to bring in a minority investor; Broadspire which comprised the largest component, at 40%, of Crawford’s EBIT last year; AJ Gallagher’s Bassett Services; ENLYTE owned by Stone Point and comprised of Mitchell, Genex Services, and Coventry; Aetna’s Meritain Health; Charles Taylor; Liberty Mutual’s Helmsman Management Services; Chubb’s ESIS; Trustmark Health Benefits; Concentra; and Cannon Cochran Management Services. 

CorVel management likes to promote its technology investment in areas such as AI and machine learning but my primary research evidenced similar investments have been made across the competitive peer group.  In fact, some state regulators have demanded that third-party administrators invest in these technologies to enhance efficiency, accuracy, and customer experience while complying with evolving regulatory standards.  One competitor said, “CorVel is a respectable competitor but there’s nothing unique about their technology, there’s no secret AI sauce that any of us has relative to the other, the technology tools today are of great benefit for improving efficiency and mitigating fraud but these investments are necessary for us to make to compete and serve our clients.” 

In an interview conducted by Risk and Insurance pertaining to the Company’s approach to training claims adjusters, the Company’s Chief Claims Officer said, “On the technology side, CorVel utilizes artificial intelligence.  We demonstrate the platform for them so they can see the automation we’ve undertaken to remove that mundane stuff that sometimes gives claims that black eye…we’re using technology to answer questions.  We’re not having technology tell people that they might want to do something.  We’re asking how technology can actually do it for them if it’s repeatable, objective tasks.”  I am sure AI and ML has become an important productivity tool at CorVel but I am dubious that it is redefining their competitive position as the valuation might suggest.

CorVel had 4,870 employees at the end of its recent fiscal year and 75% were characterized as permanent work from home.  Much of CorVel’s employee base is trained as claims adjusters.  Revenue generated per employee is close to $165K.

The Company’s gross margin, at 21.6%, has eroded by ~200 bps during the past two years.  The Company’s EBIT margin, at ~12%, has eroded by over 100 bps during the past two years.  The premise, if one seeks to rationalize CRVL’s valuation, that the Company has some technology-driven “secret sauce” is not validated by its margin nor the trend.  During the past fifteen years, the Company’s gross margin peaked at 25.4% in 2011.  Broadspire’s gross margin was 24.9% last year and averaged ~23% during the past three years which was higher than the 22.4% average at CorVel.  Some margin degradation is likely ascribed to competitive wages and benefits as was described during the prepared remarks in CRVL’s recent quarterly earnings call. 

I believe there are numerous reasons to be short CRVL including the following:      

Priced for perfection

·         Valuation is not the primary reason to short any stock but CRVL is priced for more than perfection

·         There is no margin of safety from CRVL’s current valuation; the stock skews to the downside on potential fundamental disappointment relative to potential upside ascribed to ongoing fundamental strength

·         On a LTM basis, CRVL is trading at 69x EPS, 53x EBIT, 42x EBITDA, and 1.3% FCF yield

·         For some coincidental context, it’s interesting to highlight that CorVel’s EPS CAGR for its prior two and three fiscal years is very similar to that of Microsoft;  CorVel’s EPS CAGR during the prior two years was 9.6% versus Microsoft at 9.7%; CorVel’s EPS CAGR during the prior three years was 19.9% versus Microsoft at 18.9%; over the prior five fiscal years, Microsoft’s EPS CAGR is almost triple CorVel’s 12.3%; CRVL’s earnings multiple is almost twice that of MSFT

·         One can rationalize any valuation with some narrative and it seems as if CorVel’s valuation might be rationalized by some who follow AI-related momentum stocks as called out, for example, by Investor’s Business Daily; on May 17, IBD highlighted the Company trading at an all-time high pursuant to having announced its first generative-AI initiative for managing and automating claims   

·         It’s interesting to highlight what CorVel’s CEO wrote in the Company’s most recent annual letter to shareholders, “While investment in technology to drive differentiated results is not new at CorVel, 2024 was a year in which the market acknowledged those efforts more.”

·         The CEO’s comment is clearly validated by the 69x LTM PE but CorVel has enjoyed multiple expansion for a few years as evidenced by the 50% premium PE, at 44x, ascribed to its earnings, on an average basis, during the most recent three-year period versus the prior three-year period at 29x

·         If CorVel were to trade at its three-year average PE of 44x, CRVL would be trading at ~$198 which is where the stock traded at the beginning of November in 2023

·         Insiders have sold ~$87M of their stock at an average price of ~$152 during the past four years

·         The CEO must be surprised by the multiple expansion based on his stock sales at an average price of ~$127.50 during the past four years

·         CRVL is one of just 154 companies rated by InsiderScore the lowest score  of “1” among the 15,306 that InsiderScore filters through their algorithm

·         There is no pure-play public comparable to CorVel but the most recent private transaction was valued at ~10x EBITDA; Crawford, Concentra, and AJ Gallagher trade at approximately 8x, 12x, and 20x, respectively; less than 10% of AJ Gallagher’s revenue is derived from workers compensation risk management services and if CRVL were to trade at 25x EBITDA, a 25% premium to AJG’s EBITDA multiple, CRVL would trade at ~$185

·         Neither primary research nor financial results validate that CRVL has created a data-driven healthcare analytics business model that often commands a premium multiple but to the extent that narrative were to be rationalized, the private market has valued such high growth businesses (e.g., Convey Health Solutions, Inovalon, HMS, Cotiviti) at 16-29x EBITDA; at 30x EBITDA, CRVL would trade at ~$221

·         During the 14 years since March 2010, CRVL’s EPS has grown at a 5.6% CAGR but the PE has expanded by seven times

·         If EPS at the Company were to decline for any reason, CRVL’s PE should not expand in a rational market but there is much downside from multiple compression dictated by any change in sentiment or passive-driven investment flows

During periods of higher unemployment, workers’ compensation claims have typically declined which would likely impact the pace of earnings growth at CorVel

·         During the past few years, a strong labor market led to a struggle to hire and companies incurred increased turnover; this meant employers were compelled to hire employees with less experience which caused a rise to injury frequency

·         40% of workers’ compensation claims resulted from injuries sustained by workers employed for less than a year and employees with less than one year of tenure in a physical labor industry were more than three times as likely to have a claim, according to the Workers’ Compensation Insurance Rating Bureau of California

·         There is clear evidence that employment growth is now slowing and there is much research as early as 1938 that claim frequency declines with reduced economic activity

·         Several factors deemed to affect claim frequency include the following:

1.      Inexperienced workers will typically incur higher injury rates; workers with less than one year of employment have a higher claim rate than the average worker

2.      During a stronger economy, older equipment gets utilized to address strong demand but such equipment is typically less safe than newer equipment but when economic activity is reduced, there are less injuries from utilization of newer equipment

3.      More overtime work which comes with worker fatigue and higher injury rates and claims is driven by a stronger economy but reverses when economic activity is reduced; this is more pronounced in more hazardous industries such as construction and manufacturing

4.      When unemployment is rising, workers have historically deferred filing claims because of fear of losing their jobs

·         Nonfatal working compensation case claims (per the Bureau of Labor Statistics) declined by 12% from 2008-2010

·         CRVL’s management noted in their 2009 annual report, “The volume of workers compensation claims has continued to decline to historic lows.”

·         One can review the earnings degradation at CRVL during the GFC when the Company’s EPS declined by 15% from fiscal year ending March 2008 through March 2009 although CRVL did manage to generate 11% EPS CAGR from March 2008 through March 2010; however, it’s notable that at the end of those fiscal years, CRVL traded at 7-9x EPS

A declining ISM index typically indicates a contraction in manufacturing activity which would frequently coincide with less worker injuries and workers’ compensation claims

·         While higher unemployment typically results in a reduction of workers’ compensation claims, this is more pronounced if unemployment is rising in manufacturing and construction given the higher incidence of work injuries across those occupations

·         After an ongoing run of manufacturing declines continued in June, with output falling for the third consecutive month, the Institute of Supply Management noted in August that U.S. manufacturing activity had dropped to an eight-month low in July

Implementation of industrial injury prevention measures is increasing which could reduce workers’ compensation claims

·         Work-related injuries are declining as employers are more proactive to prevent injuries

·         Companies are driven by government mandates from agencies like OSHA and the Department of Transportation to improve their safety measures

·         As discussed by Mix Telematics/PowerFleet at their Investor Day, “The average cost of a workers’ compensation injury is also quite substantial, which, of course, is going to lead to companies that want to implement safety programs…So really, from a company’s perspective, they have both the government regulations.  They want to make sure they’re improving their brand equity, their brand image.”

·         Employers are increasingly deploying automation, mechanical assistance and other technology to reduce the risk of injury for their employees while improving labor productivity

·         Numerous companies are also adopting industrial injury prevention (“IIP”) measures to improve employee safety and reduce workers’ compensation claims and costs

·         There is increased focus towards reducing workplace accidents and injuries through IIP services offered by firms such as US Physical Therapy (which partnered with Briotix in 2017 and has grown this business segment to ~$80M performing IIP services at over 600 client locations)

·         Utilization by healthcare payors of early intervention services is also increasing which impacts CRVL’s later-stage network and healthcare management services

·         When intervention occurs quickly, the need for additional cost containment services can be reduced

CorVel’s results could be compromised from increased regulatory scrutiny and legal actions based on questionable business practices when unreasonably delaying or denying coverage

·         A review of Better Business Bureau complaints and some legal cases highlights that CorVel’s claims administrators have sometimes engaged in a questionable provision or responsiveness for healthcare services that injured workers likely required

·         Undoubtedly it is more likely that negative reviews get posted but the magnitude and substance of such manifest to me some questionable business practices; these issues are inherently motivated by CorVel’s focus on cost containment but if unreasonable delay or denial of healthcare services is at the detriment of injured workers, this could escalate into a broader industry-wide area of focus for regulators or legislators

·         Linked here is a recent example of the challenge of an injured worker in California:

o    https://blog.daisybill.com/adjuster-attorney-behavior-bad-look-for-corvel-part-1

o   https://blog.daisybill.com/adjuster-attorney-behavior-bad-look-for-corvel-part-2

·         As described some within this link, the issues at CorVel are not necessarily isolated to CRVL but perhaps a broader industry-related set of issues that might arouse increased regulatory scrutiny; an example of issues at CorVel’s peer Sedgwick can be reviewed in the following link:  https://blog.daisybill.com/sedgwick-getting-worse

·         The workers’ compensation industry is more profitable than ever, employer costs are at a 40-year low, but there are concerns for whether the workers’ compensation system is fulfilling its obligation to those injured on the job

·         Healthcare providers are more active in their efforts to minimize the use of cost containment techniques; increased visibility from providers or workers of unreasonable delays and denials of necessary healthcare services could arouse regulatory or legislative action

·         Recent litigation between healthcare providers and insurers has challenged certain insurers’ claims adjudication and reimbursement decisions; this could result in less cost containment business for CorVel if insurers reset their business approach

·         The U.S. Department of Labor filed a suit against UMR (a subsidiary of UnitedHealth) last year for routinely denying healthcare claims for ER services and urinary drug screening for over 2,000 self-funded employee welfare benefit plans

·         It should be noted that CorVel makes recommendations about the appropriateness of providers’ proposed medical treatment plans for patients and that could subject the Company to claims arising from adverse medical consequences; however, as described by the Company, “plaintiffs have not, to date, subjected CorVel to any claims or litigation relating to the granting or denial of claims for payment of benefits or allegations”

·         I am not at all asserting that CorVel has ever engaged in questionable business practices akin to those reported by Chris Hamby regarding publicly-traded MultiPlan (“MPLN”) in the New York Times; however, it’s worth reading those articles which have raised the visibility about troubling health insurance tactics at MPLN

·         The investigative reporting has led to some lawmakers recently calling for regulatory scrutiny; Congressman in leadership positions on a House committee overseeing employer-based insurance highlighted MultiPlan as an example of “opaque fee structures and alleged self-dealing”

·         MPLN emphasizes its technology-enabled solutions and data analytics for reducing medical costs and improving payment accuracy

·         AdventHealth filed a lawsuit against MPLN, alleging the company works with health insurers to underpay medical claims; AdventHealth alleged providers have lost at least $19B per annum as a result of MPLN’s agreements with UnitedHealth, Aetna, Elevance, Centene, Cigna, Humana

·         Both CRVL and MPLN operate in the managed care and healthcare cost containment space but CRVL is more focused on workers compensation and MPLN on general healthcare

·         I found some evidence (as linked here https://blog.daisybill.com/corvel-disguises-ppo-discounts-version-for-publishing) of a collaborative relationship between CRVL and MPLN in 2020 when CRVL applied its own bill review reductions and MPLN’s to medical bills but I have not developed a well-informed perspective regarding the extent of their past or current collaboration towards their common goal of reducing medical costs for payors

·         MPLN trading at ~8x LTM EBITDA with 7.5x leverage has declined by over 80% YTD

 Technology investments in AI and machine learning do not differentiate CorVel from some of its peers

·         While CRVL’s valuation seems to have greatly benefitted from the market premium ascribed to AI-related companies, the Company’s AI and machine learning investments are not unique to CorVel

·         As evidenced from primary research, similar investments have been made across the peer group; in fact, these investments are expected by regulatory authorities

·         Sedgwick’s Managing Director of IT said last year that they are using AI to detect claims oddities and discrepancies that could potentially signal insurance fraud; she said, “AI is not going to replace someone’s job.  What it’s going to do is take the red tape and the busy work off someone’s desk so that you change the story about the person’s job.”

·         Gallagher’s Bassett Services’ SVP for data and analytics noted that new technologies such as AI have “tremendous promise for our industry but if misused could be certainly damaging and counterproductive”

·         Mitchell Casualty Solutions Group SVP for product delivery noted that AI can benefit back-office claims management as well as customer service and document digitization tasks; he said, “You really need to understand what you’re trying to get out of tools like this, because they’re tools right now.  I wouldn’t throw generative AI at the most complicated problem…I’d use it to automate tasks…”

·         Last week, Effective Health Systems, a LA-based insurance software development company released BaseLine.RPT, an AI-powered platform designed to streamline efficiency in workers compensation claims processing; according to Effective Health’s CEO, “BaseLine is being used by carriers representing over 20% of the workers compensation premium market to maximize the value of their human capital and cut through the obstacles, noise and clutter that prevent claims managers from dealing with the real issues driving claims.”

·         CorVel’s capitalized software costs amounted to ~$37M recently, or 8% of the Company’s total assets; at Crawford, these costs amounted to ~$97M, or ~12% of assets, and increased by almost 17% from the preceding year versus just 10% at CRVL

·         CorVel’s median employee compensation is ~$58,450 which is ~10% more than at Crawford but for context, at United Healthcare, median employee compensation is ~$67,000, at Dell, it is ~$73,000, and at Microsoft it is ~$194,000

·         According to Dice.com, the average tech salary in 2023 was ~$111,000; CRVL’s employee base is primarily trained as claims specialists who are equipped and enabled by CorVel’s technology platform but that does not make the Company a technology company as reinforced by CRVL’s revenue per employee, median compensation, and margin trends

·         Less than 3% of job openings at CRVL are currently listed for software development; if technology leadership is as relevant as management seeks to position, I would think the magnitude of job openings for software would be substantially higher but instead almost 70% of CRVL’s job openings are for job categories encompassing case management, claims, and bill review

·         CorVel’s $37M of capitalized software costs is a necessary investment dictated by both regulatory authorities and the competitive landscape; the fact that the market ascribes a multiple of more than 140x CRVL’s software investment compared to MSFT at 40x is simply absurd

Potential earnings degradation from increased corporate tax rate

·         There is a some likelihood for an increase to the corporate tax rate

·         Since FY 2020, CRVL’s average effective tax rate was ~21% which added substantial earnings relative to the five-year period from FY 2013 when the average effective tax rate was ~38%

·         In 2025, federal lawmakers will confront major tax policy expirations, the majority of which stem from the Tax Cuts and Jobs Act of 2017 which lowered the corporate income tax rate to 21% from 35%

·         If CRVL’s tax rate were to increase to 25% and without any change to CRVL’s premium earnings multiple, EPS would erode by almost $0.30 and the stock would decline by over $20

·         If CRVL’s tax rate were to increase to 30% and without any change to CRVL’s premium earnings multiple, EPS would erode by over $0.55 and the stock would decline by ~$38

Additional issues to highlight, some of which make me suspicious regarding the quality of CRVL’s earnings, would cause me significant concern if I were long CRVL and reinforces why I am short

·         Unbilled receivables grew by 59% from the previous year and have grown in aggregate by 147% during the past three years; unbilled receivables comprised 44% of total receivables last year which is double the composition from three years ago; unbilled receivables comprised 5.3% of CRVL’s revenue which was up from 3.7% in last year and up from 3.1% three years ago; total receivables grew by ~20% in the past fiscal year, almost double the pace of CRVL’s revenue growth

·         Auditor’s opinion includes a “Critical Audit Matter” regarding Revenue Recognition and how the critical matter was addressed in the Audit; as described by the Company’s auditor Haskell & White, “Revenues that are most significantly impacted by management’s estimates and judgments include (i) bill review services that contain contractual provisions that allow the customer to compensate the Company only for services that it utilizes and (ii) directed care services at period-end for which the Company has not been billed by the related providers.”

·         Haskell & White has been CRVL’s auditor since 2006 but the “Critical Audit Matter” described above has been included in Haskell & White’s 10K since 2020 which was pursuant to the Company’s receipt of a comment letter from the SEC; although I do not know how to frame the probability of the matter being a quantifiable risk, if I were long, and especially at CRVL’s lofty valuation, I would find the matter to be disconcerting

·         I am not at all questioning the integrity of the Board, management nor Haskell & White but I wonder why a company with almost $5.5B market cap would not work with at least a top 100 (as defined by size) accounting firm; according to Inside Public Accounting, Haskell & White generated $23M of revenue last year and was ranked #215, by revenue, across CPA firms.  The 100^th largest auditor did more than twice that and a review of Haskell & White’s clients demonstrates that a majority of the firm’s publicly-traded clients are sub-$100M market caps. 

·         CRVL’s auditor was in fact a top 100 firm that preceded Haskell & White but CorVel dismissed Grant Thornton as its Auditor in 2006 pursuant to Grant Thornton describing questionable internal control issues at CorVel

·         In 2006, Grant Thornton noted some material weaknesses in the Company’s financial reporting  which included the following:  did not maintain a sufficient number of personnel and appropriate depth of experience for its accounting and finance departments; did not maintain adequate segregation of duties; did not maintain effective controls over the preparation of account analyses, account summaries and account reconciliations; did not maintain effective controls related to expenditure processing; did not maintain effective controls related to revenue and receivables reporting, including the complete and timely review of revenue entries and the collection and application of payments and credits to accounts receivable; the Company does not maintain effective controls over payroll processing; the Company did not maintain effective monitoring of third party controls supporting financial reporting

·         One should infer that all material weaknesses described by Grant Thornton were reconciled accordingly; however, I do think it’s interesting that none of the CFOs pursuant to those disclosed material weaknesses came from outside the Company; the current CFO (age 44), whose sales of CRVL are at ~$150, was appointed in 2018 and has been with CRVL since 2003

·         Although CorVel is headquartered in Fort Worth, TX, none of the eighteen named executives on CRVL’s website lists Texas as their location on their LinkedIn profile

Ownership overhang

·         The founder (Jeffrey Michael through Corstar Holdings) and Chairman (Gordon Clemons) own ~45% of CorVel; Kayne Anderson Rudnick which initiated their position during Q2 of 2020 owns ~11%

·         It should come as no surprise that each of these shareholders has trimmed their ownership to some extent as each has accumulated enormous gains and even in the absence of any fundamental or valuation concern for their investment, some reduction might simply be motivated by a pursuit of risk management and diversification

·         During the past two years, Clemons has reduced his position by 12% while both Corstar and Kayne have trimmed 2% of their position; during the past three years, Clemons has reduced his position by almost 22% and Clemons’ estate planning objectives could be a source of additional selling since he is 80

·         CRVL’s three-month average volume is ~41K shares and although admittedly the 355K shares sold by Corstar, Clemons, and Kayne during the past two years is insignificant, if I were long I would find this magnitude of overhang, especially at CRVL’s current valuation, to be very disconcerting

·         It’s interesting to highlight that Corstar’s 10b5-1 trading plan evidenced their largest number of shares being sold during a recent Form 4 filing since 2016 when Corstar sold stock at $46-49

·         Kayne is the second largest shareholder at ~11%; their team clearly seized upon a great investment return with CRVL which traded below $50 during Q2 of 2020 when they initiated their position and a review of their historical holdings demonstrates they roughly-sized it to its current size through Q3 of 2021 although with some tweaks up and down since then

·         Kayne’s investment strategy is premised on the longer-term focusing on what they perceive as well-positioned companies operating a durable business model with strong balance sheets and a relatively attractive valuation, and one can review their Q2 2024 portfolio characteristics for their Small Cap Core portfolio in which CorVel was their fifth largest holding at 4.6% as of Q2; it’s notable to me that Kayne highlights ~25x PE and 5% FCF yield for their Small Cap portfolio although CRVL trades at almost triple that PE and its FCF yield is approximately one-fourth

·         During a recent podcast between Ben Falcone, a Managing Director at Kayne, and Julie Biel, a chief market strategist and PM at Kayne, Julie said, “If we drill down to the Magnificent Seven more specifically, this group has definitely seen multiple expansion…So, while we understand investor positioning to go where the growth is, we do believe that valuations could be a bit full here…And I think this is why investors are piling into relatively few ideas that have really clear earnings visibility and that valuation has kind of taken a backseat when it comes to those companies.”

·         The “Mag 7” are trading at an average and median 2024E PE of ~42x and 34x, respectively; excluding TSLA, the average and median is ~33x; the average and median EPS growth projected in 2024 for the Mag 7 is ~39% and 32%, respectively, and excluding TSLA which is projected by consensus to decline, the average and median is ~49% and 37%, respectively; I am not positioned across the Mag 7, albeit I own one of those names, but I understand the ongoing narrative for the crowded positioning based on closet-indexing and perceived growth from the Mag 7 since the average and median PE is roughly 1.1x EPS growth estimated for the past year and much less when TSLA is excluded

·         CRVL grew earnings by 17% this past fiscal year (i.e., 47% below the estimated Mag 7 median) and is now trading at 70x LTM EPS; if CRVL were to trade at 3.3x its recent EPS growth (i.e., 3x that of the Mag 7), that 56x PE would imply CRVL should trade at ~$252.50 

·         Kayne’s Biel is frequently on CNBC’s Fast Money and on August 16^th she noted that valuation does matter which demonstrates consistency in some of her messaging I have read, as described above, and heard from her but is totally inconsistent with where CRVL is trading; if she or anyone else at Kayne were to influence reducing CRVL, their firm’s overall 21^st largest position, by just 25%, that’s over 115 days of overhang if Kayne were to represent 10% of CRVL’s daily trading volume

·         CRVL does not have any sell-side research that is currently “enlisted” to support the stock if motivated selling pressure were to occur; CRVL has traded over 100K shares just four times in the past year

·         A tightly-held stock comes with strong benefits when those concentrated owners are not selling, and the benefits are amplified by passive ownership composition with positive flows; however, if anything were to cause those concentrated owners to reduce their positions more significantly, that will likely be a catalyst for the stock to decline or, at the very least, underperform the market

·         Excluding the Chairman, management insiders own less than 0.50% of stock according to the most recent proxy but there are 2.85M outstanding options at a weighted average exercise price of $129.42; that’s a lot of additional overhang, albeit issued over time, for an equity with 17.3M outstanding shares

·         At CRVL’s current valuation, insider selling coupled with institutional selling given significant embedded gains should not be a surprise but that selling, albeit prudently motivated, is an overhang that might limit CRVL from generating much appreciation from its current level in a rational market

Selected Risk Considerations to CRVL Short

·         AI-related hype continues to arouse investors despite no compelling evidence from research that the Company’s AI-related activities differentiate CRVL within its competitive landscape

·         Buyback authorization to repurchase over $280M; since 2023, CRVL has repurchased 2.3% of its stock, albeit ~36% repurchased was sold by insiders during that period

·         Passive investing:  over 17% of CRVL is owned by passive-driven funds BlackRock, Vanguard, and State Street; I do not know what motivates their selling which would assist the short thesis working but indiscriminate buying from passive investors could be a risk to the short working from a timing perspective at the very least

·         Short interest is ~5.5% of the float and 9 days to cover; this makes the short slightly crowded which comes with inherent risks

·         Algo-driven investment strategies indiscriminately “buy price, not value”:  favorable technical charts could challenge the short thesis working until chart reverses (i.e., support is broken again which one can see in late May and early April when the 50 DMA was breached)

·         Favorably screens for ROIC; at a three year average of 27.5% (for context, MSFT at 30%) and only FY 2020 (at 19.8%) and 2021 (at 16.6%) were below 20% in the past decade

·         Strong balance sheet, virtually no interest-bearing debt for the past 33 years

·         Overvalued stock as potential tuck-in currency, if sellers are convinced to accept CRVL equity as form of consideration, would most likely be accretive