Editor's Note: Below is an institutional research note on Allscripts (MDRX) written by Hedgeye Healthcare analysts Tom Tobin and Andrew Freedman on August 5th. Shares of MDRX are down -14.5% since our Healthcare team wrote "Short More." But this short still has juice left. Continue reading to understand why Tobin and Freedman see an additional -35% downside from here. For more information about our institutional research contact sales@hedgeye.com.
DISAPPOINTING SALES GROWTH; 2016 BACK-END LOADED
Allscripts (MDRX) reported 2Q16 Sales of $397 million and Adjusted EBITDA of $69.5 million, with both missing consensus estimates of $403.5 million and $72.7 million, respectively. Driving the miss was a lower revenue contribution from Netsmart of $43 million versus $50 million consensus, and disappointing organic sales growth of +0.6% YoY despite strong bookings performance. The Netsmart joint-venture and financial consolidation masked what would have been a larger miss, with 2Q16 core Allscripts revenue of $353.6 million missing pre-Netsmart consensus sales estimates of $363.0 million, and our estimate of $357.8 million. Note that 1H16 organic revenue growth of +1.8% YoY is below management's guidance for core Allscripts growth of 3-5%, and with guidance left unchanged organic growth will have to accelerate to +6% YoY in 2H16 to hit consensus numbers and management's guidance. This compares to our estimate of +3.5% sales growth in 2H16 and expectations the company will continue to miss estimates like they have for the past 3 quarters.
Non-GAAP EPS of $0.14 was in-line with consensus and slightly above our estimate of $0.13. However, we would highlight that a combination of a higher R&D capitalization rate for Netsmart and an increase in stock-based compensation resulted in Non-GAAP R&D expense that was down sequentially.
ANOMALOUS BOOKINGS STRENGTH; LOTS OF QUESTIONS...
Bookings were the big positive surprise in the quarter, but were somewhat anomalous even considering seasonality. Total bookings excluding Netsmart were +22% YoY with mix favoring higher margin software delivery bookings that were up +44% YoY. Meanwhile, Client Services bookings were down -6% YoY, -26% QoQ and marks a deviation from a 3 quarter trend where the mix shift had favored client services due to cross-selling of hosting and other outsourcing services to existing clients. We have argued that the rate of 2H15 client services bookings was not sustainable as they max out wallet share with their largest clients.
We have a hard time understanding the drivers of the strength in software delivery given reported deal flow compared to previous periods and our assessment of a slowing market, which we believe to be valid. Despite the many questions on the conference call, management would not provide transparency into the number. We question the impact a single deal may have had on the number, specifically the strategic agreement with OptumCare to rollout the Touchworks EHR and Practice Management system across their network of providers. OptumCare was the "commercial partner" tied to the warrant issuance for 4.1 million shares, and while it appears we were wrong to be skeptical about its near-term impact on bookings, we were right in that it was an atypical structure and more strategic in nature.
"It's a long term, it's a strategic deal so you can imagine it doesn't look like a typical agreement. It's not a typical agreement. This is the platform which we expect to, over time, translate to a significant sized relationship between the two entities." -2Q16 Earnings Call
Near-term revenue impact from the deal will likely be modest, and while we have more to learn about OptumCare, it seems there may be hurdles to getting physicians to adopt. Additionally, we place less value on the deal as they had to tradeoff economics in the company to close it.
"...we're going to be methodical and make sure we get it right, get it plugged into the rest of their standardized platform and that they have the time to educate their providers on the benefit of the standard platform too. So they're not — nobody is interested in jamming it down anybody's throat." -2Q16 Earnings Call
TOUCHWORKS; TOO LITTLE TOO LATE
Despite management's positive commentary around improvements in Touchworks and the OptumCare deal, we view it as too little too late, with recent market share losses irreversible, especially at the large IDNs. Additionally, while we appreciate that Black Book "deploys one of the most statistically significant survey techniques in the industry", the results run counter to market trends. We would like to see the characteristics and details of the survey population ourselves.
We spoke to a 30-year CIO at one of the largest IDN's in Michigan who is currently migrating away from a combination of Touchworks and Pro EHR to Paul Black's alma mater who had the following to say about Allscripts:
- "No CIO worth their salt would go with Allscripts"
- "I am not close enough to retirement to make a bad decision like that [Choosing Sunrise]"
- "Everyone in the industry knows they lost so many people because of their instability"
- "No one in their right mind would bet their career on Allscripts"
- "Even if Allscripts was 50% of the money of Cerner or Epic, I wouldn't go with them"
- "I look at their support and it is really poor because of all the employee turnover"
SHORT MORE; DOWNSIDE $8 / UPSIDE $16
We like the risk/reward on the short side given back-end loaded sales guidance, at a time where we face the most difficult bookings comparisons of the year. We don't view strength in software delivery bookings as sustainable, which we believe was confirmed by management's guidance related to bookings mix in future quarters and for a return to normalized software delivery gross margin. Meanwhile, Netsmart JV brings more accounting shenanigans and is a low quality, highly levered, short-term "fix" to management's growth problems.
