Corvel provides cost containment services primarily to workers compensation carriers, TPAs, and self-insured companies.  Business segments include (a) Network Solutions (60% of revenues), which includes medical bill review, PPO networks (400,000 providers, 80% direct), utilization review, independent medical exams, and other ancillary medical cost containment services; and (b) Patient Management Services (40% of revenues; 140 branch offices), which includes case management, vocational rehabilitation (“back to work” programs).  Founded in 1988, Corvel has extensive history in the workers comp market.  Competitors include Concentra, Crawford, Coventry Health, PMSI (subsidiary of Amerisource Bergen), Genex (recently-sold division of UnumProvident), Aetna Workers Comp Access.  Clients include Wal-Mart, Firemen’s Fund, Nationwide, Travelers, St. Paul, Chubb, Utica, Zurich.

 

·         Ridiculous valuation:  Trading at 13.7x LTM EBITDA and 14.3x Run-Rate EBITDA.  This is for a business that has only recently begun to turn itself around, and the December quarter just announced did not reflect a business that’s taken off like the stock price has over the past 3 months. 

 

 

 

The current valuation is partially based on an…

 

·         Unrealistic rumor in the market:  Valuation spiked due to an unrealistic rumor that Coventry might acquire Corvel.  While it’s possible, it’s highly unlikely at these valuations, and Coventry announced today that it has acquired a big portion of Concentra’s workers comp managed care business.  Some perspective on valuations in the workers comp space:

 

Coventry/Concentra (announced 2/8/07): 1.2x 2006 Revenues

Coventry/First Health (workers comp PPO network, closed 1/2005):  7x LTM EBITDA (on $276m EBITDA!)

 

Based on these comps, and even being generous with run-rates and multiples, Corvel should trade closer $22-$28, which would represent a further drop of 25-40%.

 

 

So if it’s unlikely that a strategic acquirer will buy it, will a private equity firm pay up for it?  Unfortunately for Corvel stockholders…

 

·         Clemons still in control:  In conversations with CEO Gordon Clemons, he gave me the distinct impression that Corvel was not for sale, especially to a financial buyer.  He has disdain for private equity firms and their financial engineering and he will not let the company be taken private.  Since he and his long-time venture partner own 42% of the company, he has some say in the matter.  He considers the company to be his legacy, and as evidence of such, his son is the VP of Business Development.

 

·         Corvel at structural disadvantage; negative industry trends:  The Patient Management services business consists of 140 branch offices, which are run on a highly decentralized basis.  Lack of central control has resulted in extremely low gross margins in that business which have only now IMPROVED to 10%.  Corvel is fighting the trend of fewer and fewer workers comp claims as the US economy moves away from injury-prone manufacturing.  (Although from the conference calls, Clemons would have you believe that a large portion of the reduction is related to illegal immigrants who don’t file workers comp claims).

 

The Network Solutions business consists largely of revenues generated by a “percentage of savings”, which is being challenged by other companies that offer alternative ways for workers comp payors to save money.  Corvel claims savings by helping its clients direct their injured workers to providers in the Corvel network, or it can reduce out-of-network claims through proprietary bill review and utilization management information systems.  Out-of-network claims generate higher revenue (and profits) since the savings are higher, but Corvel’s clients want the patients to go to the in-network providers, so there’s a constant give-and-take there as network providers change.

 

In the phenomenal FQ2, Corvel revealed that their 9% Network Solutions growth was partially a result of “increase was primarily due to an increase in the volume of out of network bills reviewed which generate greater revenue per bill.”  Since this increase is in direct conflict with Corvel’s clients’ goals, it does not indicate the start of a trend.  Some industry contacts familiar with Corvel have confirmed this dynamic between Corvel and their clients.

 

·         Current shareholder base doesn’t know what this company does:  After years of trading at anemic volumes with consistent top 5 institutional shareholders (Fidelity, Wellington, Wasatch, Kestrel, Royce, Atlanta Capital), volumes have taken off, and stock is now trading over $10m per day!

·         Shareholders who DO know what’s going on are selling:  Clemons knows his stock well, buying around $13 last March, and he was selling through November and December, alongside his VC partner (Corstar Holdings) and 2 directors, one of whom sold 40% of his stock (worth $1.2m).

 

·         Network Solutions business is scalable:  If Corvel can figure out how to get rid of its Patient Management business, margins could be enormous due to the scalability of the information systems involved in bill review.  However, the Patient Management business is often co-located with Network Solutions locations.  My view of this risk is tempered by the Q3 gross margin, which has paused at 23%, implying that Corvel’s scalable and high-margin solutions are not growing as fast as I had feared.

 

·         Clemons retirement:  Gordon Clemons is in his 60s and could retire, giving someone else with a different perspective on private equity firms a chance to run the company.  Given number of initiatives underway and a recent COO hire, I doubt his retirement will come anytime soon -- and even if he retired tomorrow, it's highly unlikely that any prudent private equity buyer would pay for Corvel at a premium to the current valuation.

 

·         Opportunities in workers comp are large:  Medical cost containment in workers compensation is about 10-15 years behind that in general healthcare.  Innovative companies can be very successful and very profitable by helping inefficient workers comp carriers save money.  However, it also takes workers comp payors a long time to make decisions and change their processes.

 

·         Momentum investors getting out of the stock (already started today)

·         Lack of strategic buyer in the market (occurred today with Coventry purchase of a portion of Concentra’s business)