eHealth: Less Commission After Reform

A research note out of Oppenheimer & Co. healthcare analyst Carl McDonald claims that the market has “totally misinterpreted the effect of health reform” on eHealth (EHTH). Clearly, this is a troubling prospect for eHealth which has already declined more than 15% in less than seven trading sessions since the bill passed the House. Clearly, the legislation will have a major impact on eHealth as its business is the Internet’s largest health insurance broker. Their technology helps consumers match up with plans that best fit their needs through a system that allows comparison shopping, and it grew revenue by 20.7% in fiscal 2009. Current growth estimates have predicted another year of double digit growth this year, but all bets are off with reforms set to take place.

In the bearish report Mr. McDonald said that he would downgrade EHTH if he could, but he already sees it as underperforming the market. He lowered his price target on the shares from $15 to $12 based on a number of headwinds facing eHealth. Among them is the fact that the healthcare bill will serve to “destroy” the individual market; clearly this is one of eHealth’s target markets. Already eHealth customers make up 4% of the total individual market. The government’s legislation aims to cover all Americans, which could benefit eHealth but there is a really possibility that the mandates lack any real teeth. Mr. McDonald was interviewed on CNBC the day that the bill was approved in the house and said,

“I think the individual [insurance] market in the US is going to be destroyed. I don’t think these companies are going to be able to earn any kind of a margin in that product because of all the adverse selection, ah, mainly because of the fact that there’s just a very weak individual mandate. The penalty in 2014 for not having insurance is $95. Somebody that’s 25 young and health; they’re going to pay that fine as opposed to several thousand dollars for healthcare.” — CNBC 3/22/2010

The research report today focused on another problem for eHealth, the highly likelihood that commissions they are paid by insurance companies will soon fall. One key part of the healthcare bill will be to reduce the amount of premiums that insurers use to pay for anything other than healthcare, such as administrative and commissions expenses. Right now, there are fewer regulations on how much brokers can earn after signing someone up for health insurance, but it is almost a certainty that health insurers will have to cut back where they can in order to meet new requirements. As McDonald points out, the effect will be gradual as renewals will continue to have the higher broker commissions, but all new business will presumably bring in less margin.

At Ockham, we have only covered EHTH since last Fall, but we are maintaining our Fairly Valued or neutral stance. Uncertainties abound for eHealth, as investors have relatively little visibility into the new business model with lower revenue likely. The stock currently trades for a price-to-sales multiple of 2.92x, while during its relatively short history as a public company it has normally ranged between 3.52x to 7.95x. eHealth is not expensive, and the stock has certainly underperformed the broad market indices for the last year because of the threat of healthcare reform. Up to this point its growth in earnings and sales have been impressive but the stock is flat over the last twelve months compared to 60% gain for the NASDAQ. However, we simply cannot recommend this stock until there is more clarity on how it will adapt to the new rules.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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