This article by Ryan O’Connor is excerpted from a letter of Crossroads Capital. The following case study was written prior to the Intermedix acquisition announcement, which Ryan estimates may increase intrinsic value by $15+ per share.
Given our mandate and focused approach, we can aggressively pursue compelling investment opportunities whenever and wherever they arrive. It’s with this in mind that we’d like to introduce you to R1 RCM, or just “R1” for short – a resilient, non-cyclical, high-quality business that’s been undergoing a value-unlocking transformation since we initiated our position in the low $2’s in late 2016.
R1 is a leading provider of revenue cycle management services to hospital networks. That means it handles their front- and back-office needs, aiming to streamline operations, cut out unnecessary costs, and reduce billing errors, all in a bid to maximize revenues and profits. With hospitals facing tight 1-to-2 percent margins, R1 can make a big contribution, often doubling or even tripling their profitability over time.
To deliver those extra profits, R1 plugs directly into its clients’ operations, tying its own differentiated IT and systems into hospital networks and working hand-in-hand with employees to eliminate margin-sapping inefficiency. With R1 on the scene, hospitals label patient visits more accurately, find more insurance options, and make sure everything gets properly billed. Moreover, by rationalizing vendors, moving hospitals to an offshore shared service platform (to benefit from labor arbitrage), and taking other cost-cutting measures, R1 is in a prime position to enhance its partners’ – and its own – bottom line.
While it’s a solid business today, R1 has a complicated history. In fact, R1 wasn’t even always called R1 – it was originally known as Accretive Health, a spinoff of Ascension Health, the second-largest hospital system in the US. As Accretive, its troubles included:
— being charged with abusive billing practices by the state of Minnesota,
— being charged with failing to protect consumers’ personal information by the FTC, and
— a full-blown SEC investigation into aggressive revenue recognition from 2011 through 2013.
To make matters worse, in 2014 Accretive was delisted from the NYSE and banished to the OTC netherworld after missing a deadline to restate 2011-2013 results. Of course, problems like these did pretty much what one would expect for the share price: From above $30 in 2011, it crashed to below $10 in 2012, slumped below $5 in 2015, and even dipped below $2 for part of 2016. Then Ascension, the company’s largest customer, smelled blood in the water – ultimately making a lowball bid to reacquire Accretive at roughly 50% below market value, threatening to pull its business if Accretive didn’t fall in line.
Yet while the stock was tanking, the company itself was healing. First, in 2012, Accretive settled with the state of Minnesota while admitting no wrongdoing. Then, in 2013, it settled with the FTC and leadership changes were enacted, including the CEO and Chairman. Next, at the end of 2014, it filed restated earnings for the 2011-2013 period. Finally, in early 2016, it concluded a new agreement with Ascension that killed the take-under bid. Instead, Ascension bought $200 million worth of 8% convertible preferred shares in Accretive and got warrants for another 60 million in common shares. In exchange, it gave Accretive a new 10-year exclusive service contract and an enormous amount of new business. It was this new symbiotic arrangement that sparked our initial interest in a name that, at the time, was nothing short of despised. We pulled the trigger.
Fast forward to the start of 2017, and the company took further steps to dissociate itself from its difficult past, changing its name to R1 RCM and up-listing to the Nasdaq. Of course, we invested well ahead of these value-unlocking events in order to profit as R1’s respectability rose phoenix-like from its own ashes. And that respectability recently reached new heights as management nailed down another highly accretive deal with another highly reputable client: Intermountain Healthcare.
R1’s deal with Intermountain resembled the one with Ascension: Intermountain bought $20 million worth of R1 shares north of $4, with warrants for 1.5 million additional shares at $6 thrown in. In exchange, R1 got a 10-year exclusive service renewal and contract extension, plus rights to serve hospitals Intermountain might acquire later on. And by this point, the Ascension deal had been modified to grant R1 similar rights to serve hospitals Ascension might itself acquire down the road.
So where does all this leave R1 today?
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