Einhorn Says Athenahealth May Crash 80%. Is He Right?

Greenlight Capital President David Einhorn is never shy about his opinions, and that was the case again at the high-profile Sohn hedge fund conference in Manhattan this week.

At that conference, Einhorn predicted that shares of health-care information technology provider athenahealth  (NASDAQ: ATHN  )  will tumble 80%.

Given that scary prospect, let's look at athenahealth and whether Einhorn may be right.

ATHN Chart

ATHN data by YCharts.

First, a bit of background
The business of health care IT has never been better. The arrival of the Affordable Care Act has increased adoption of next-generation technology designed to break down the industry's decades-old reliance on paper and pencil.

That is most evident in doctor's offices, which maintained rows of metal file cabinets long after most industries discarded them.

However, that reliance is quickly becoming ancient history thanks to Obamacare's meaningful use provision, a carrot-based approach that rewards physicians with Medicare and Medicaid bonuses when they achieve technology-based targets.

The rush to meet those targets has been a boon to health-care software providers including athenahealth, a company laser-focused on software designed to break down barriers between specialists, primary care, and patients.

Previously, the market for that kind of software, which covers both record management and practice management systems that help doctors better code, track, and collect payments, was fractured and included a host of small regional players.

Today, those small players are being overrun by athenahealth and competitors Quality Systems (NASDAQ: QSII  ) and Allscripts  (NASDAQ: MDRX  ) .

Those three large companies have far greater resources that enable them to quickly adapt to significant changes, including the implementation of ICD-10, a new medical coding system that dramatically increases the number of diagnosis and medical procedure codes for doctors to use when documenting (and billing) for service. 

As a result, athenahealth's revenue grew from $70 million in 2006 to $595 million last year. That momentum continued into the first quarter, with sales growing 30% to $163 million.

Einhorn's argument
Investors need only look at the treacherous path taken by cloud health-care analytics company Castlight Health  (NYSE: CSLT  ) to see the type of damage to share prices that can happen in a short time once shareholders sour on a highly valued company.

Castlight roared onto the exchanges in March at nearly $40 per share; however, increasingly nervous investors worried over its reliance on potential competition from third parties that supply Castlight's data have sent shares tumbling nearly 65%.

Einhorn argued that athenahealth may be similarly overvalued. And he wouldn't be incorrect in saying the company has been priced at lofty levels.

The company has a forward P/E ratio of nearly 100. That's a lot higher than competitors Quality Systems, which trades at 20 times earnings, and Allscripts, which has a P/E of 28 and triple the electronic health records, or EHR, market share of athenahealth.

Einhorn is also right in reminding investors that athenahealth isn't the industry leader. That designation is held by Epic Systems, a private Wisconsin company that has 11% market share in the EHR market and is a goliath across health-care IT software categories, including practice management. According to industry research firm KLAS, 33% of U.S. patients will receive health care at providers using Epic's electronic medical record software.

Investors also shouldn't ignore that athenahealth is a cost-heavy company with an operating margin of just 5.4%.

A great company, with great management, that's simply too pricey
Einhorn doesn't think the company is mismanaged, and arguably doesn't believe that there isn't revenue to be made by disrupting the health care IT industry. He simply believes investors have driven shares to untenable, bubble-like highs.

During his presentation at the conference, Einhorn made the distinction between athenahealth's business opportunity and its mispriced shares. He not only said the company has a great CEO in Jonathan Bush, but that he didn't want to see athenahealth fail in its business mission.

"The world may be a better place if it succeeds and even though we're short I'm not rooting for it to fail ... the stock is simply at the wrong price," said Einhorn, according to Business Insider's blog coverage of the Sohn event.

Fool-worthy final thoughts
Growth companies often sacrifice short-term earnings for market share, and athenahealth is clearly focusing more on product than profit. Last quarter, it spent nearly 10% of its sales on research and development.

Since the company posts a healthy gross margin near 60%, there would seem to be plenty of earnings-friendly room to squeeze out costs; however, it's unlikely that will happen soon given the ongoing investments in product and significant opportunity to capture market share. After all, athenahealth's EHR market share is still in the low single digits.

That means there's still a great deal of opportunity for revenue growth. The company expects its sales will expand around 18% to between $725 and $755 million this year. That's a stark contrast to Quality Systems, which saw its sales slump 5% year over year in the most recently reported quarter ended in December, and Allscripts, which reported that its sales were essentially unchanged in 2013 from 2012.

But earnings remain the gold standard of valuation, and with athenahealth guiding for earnings of just $0.98 to $1.10 per share in 2014, below last year's levels, there's little to argue with Einhorn about valuation. Instead, athenahealth's investors will need to focus on the long-term potential and hope that once the company achieves scale it will eventually deliver those shareholder-friendly earnings.

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