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In recent years, HMS Holdings () has successfully grown its commercial health insurer customer base in order to diversify the company away from an overdependence on government contract revenue. With a healthy and consistent source of revenue from its government contracts, a growing roster of commercial payer clients and strong macro tailwinds, the company is in an excellent position to generate market-beating returns for shareholders in the years ahead.

Though I am not a shareholder at this time, HMS Holdings is one of several companies I am watching closely as I consider additions to my portfolio. For anybody seeking niche healthcare exposure, HMS Holdings is worth a look.

The Business, Past to Present

HMS Holdings’ bread and butter for decades has been its Medicaid coordination of benefits/third party liability business. The company has consistently been the number one vendor in Medicaid COB/TPL, typically maintaining a customer base of at least 40 states at any given time. Unlike Medicare, Medicaid is a state-administered program. Each state represents a potential client to HMS Holdings. The company maintains and continually updates a massive eligibility database with data from more than 1,000 insurers. Medicaid is the payer of last resort. When a Medicaid claim is filed by a provider, HMS Holdings runs a review of the recipient to ensure that the recipient doesn’t already have some other form of health insurance that would be liable for paying the claim. Below is a snapshot from a recent company presentation that touches on COB/TPL:

Source of above graphic: HMS investor presentation, June 2018

Over the last decade, HMS Holdings has diversified its solutions through acquisitions to enter various niche areas such as audits, program integrity, and, most recently, care management.

In concert with the pursuit of diversification beyond COB/TPL, the company has also pursued revenue diversification beyond government. In recent years, the company has aggressively sold COB/TPL, program integrity, and other solutions to commercial insurers (individual market, Medicaid managed care plans, Medicare Advantage plans) in order to improve revenue growth potential and diversify away from dependence on government contracts.

A graphic from a 2013 company presentation illustrated the opportunity beyond government. Though HMS dominated Medicaid COB/TPL, the growth runway in Medicaid was largely limited to expansion in Medicaid Fee For Service rolls. Once you’ve won nearly every state Medicaid contract in the country, who else do you sell to?

HMS Market Reality in 2013:

HMSY 2013 GraphicSource for above graphic: Q4 2013 Company Presentation

The government story for HMS Holdings in 2013 wasn’t just limited to State Medicaid. The company also had a sizable presence at the federal level. In 2013, 22% ($108M) of HMS Holdings’ revenue was attributable to just one contract, a recovery audit (RAC) contract with Medicare. The Feds had divided RAC services into regions and HMS Holdings provided the service for one region. However, this contract vehicle soon became a problem for the company. What had at one time be a rock-solid source of recurring revenue soon became anything but. Due to pushback from Medicare providers, the federal agency that oversees Medicare decided to sharply curtail the audit powers of companies like HMS Holdings. As a result, revenue from this Medicare contract dropped dramatically.

Last year, HMS federal revenue (Medicare RAC + other smaller fed contracts) totaled just $24.9 million, or 5% of total company revenue, vs. $133 million, or 27% of total company revenue, in 2013. This dramatic shift in the company’s federal government revenue is a result of both the decimation of the scope of that Medicare RAC contract and the company’s aggressive pursuit of business with commercial insurer clients.

The Evolution of HMS Holdings’ Revenue Mix Since 2013:

2013 2017 Total % Growth
Total HMS Revenue (millions) $492 $521 6%
State Revenue $212 (43%) $227 (43%) 7%
Commercial Revenue $148 (30%) $269 (52%) 82%
Federal Revenue $133 (27%) $25 (5%) -81%

Company revenue growth took a hit over the last five years as the company adjusted to the new normal of a Medicare RAC contract that is now a fraction of what it used to be while the company built up its commercial presence. Below shows how the stock price has fluctuated over the last five years during the transition, the company underperforming the S&P 500 by a wide margin:

New Care Management Vertical

While commercial has been the clear driver of growth for HMS in recent years, the company recently entered the care management space with two acquisitions, the most recent being Eliza Corp for $170M. Eliza is a cloud-based care management solution that served 70 customers at the time of acquisition in Mar. 2017.

The care management platform is a source of recurring revenue and will be a growth driver for the company, Lucia said. Care management accounted for 10% of revenue in Q2, but saw 35% growth YOY.

In Q1-17, following the Eliza acquisition, CEO Bill Lucia explained the company’s care management strategy as follows:

The company expects to generate $120 million in annual revenue from its care management vertical by 2020.

Total Addressable Market

The company views the future as nothing but opportunity. In a recent investor presentation, CEO Bill Lucia noted that a highly inefficient healthcare system presented a $1 trillion market opportunity. Company revenue last year of $521 million is expected to hit $585 million this year.

Source of above graphic: HMS investor presentation, June 2018

The company cites multiple macro tailwinds that will help drive growth. In the coming years, market shifts could benefit the company’s sales prospects.

Source of above graphic: HMS investor presentation, June 2018

To this point, the market has responded favorably to the inclusion of the care management vertical, the recent uptick in commercial growth, and the overall growth potential that the company foresees. Below is a chart of stock performance this calendar year:


On a free cash flow basis, the company looks undervalued when I apply a 3% discount rate (US Treasury) and 3% perpetuity growth after year 10. The company has grown free cash flow at an annual average rate of 12% over the last decade. But, FCF growth has been flat the last five years and an assumed 12% FCF growth rate going forward may be overly presumptuous. The company noted earlier this year that this was the first Q1 in four years where the company was FCF-positive.

The price to free cash flow ratio is in the 30s whereas it was under 10 a few years ago when the company was struggling to recover from the government’s neutering of the Medicare RAC contract. The stock has gone on a run this year after three successive quarterly revenue growth spurts of 16%, 24%, and 10%. On a current FCF valuation basis, one could argue that the stock price has gotten ahead of itself as a result of the great revenue growth this year.

HMS doesn’t really have a direct apples-to-apples competitor. It competes with a variety of companies large and small that also offer some of the services HMS sells.

Maximus () isn’t really a competitor, but the bulk of Maximus’ revenue is through State Medicaid contract vehicles (like HMS). Maximus has a price/free cash flow in the mid-teens. Conduent () is a BPO conglomerate that has exposure to government healthcare and commercial healthcare clients, among other verticals unrelated to healthcare. Conduent’s price/free cash flow is in the low teens.


HMS is a dominant player in Medicaid and has limited competition for its COB/TPL solution, as the company had maintained a strong market position for decades. In other areas, like analytics and care management, the competition picture changes dramatically. There are dozens, if not hundreds of companies in the care management space – analytics as well – and larger health plans themselves have in-house solutions that they also market to other health plans. See UnitedHealth’s (NYSE:) Optum as an example of this.

Policy Risk

While the growth drivers for a bright future appear to be in place, HMS has also benefited from policy decisions, notably the Affordable Care Act, which resulted in a massive uptick in the number of people covered by Medicaid and health insurers in general. If the healthcare industry experienced another major policy shift, say to single payer, for example, many of the solutions sold by HMS would become largely irrelevant. For example, there would likely be no need for coordination of benefits/third party liability because there would be just one payer in the country – the federal government. HMS operates in an industry that could be altered dramatically based on policy shifts.


HMS Holdings is a company to watch as it pursues continued growth in the commercial insurance space. I have a hard time believing the single payer threat will be a reality anytime soon. If anything, future policy shifts in healthcare will probably further expand coverage (Medicaid specifically) and simply further expand the market opportunity for HMS Holdings (Medicaid contracts, Medicaid managed care clients).

The executive team has done a great job in recent years of diversifying the company away from a government focus by aggressively pursuing a commercial strategy that has enabled strong growth and helped the company nearly double its stock price this year. I will continue to monitor the company and its free cash flow growth in the coming quarters before I consider investing.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


Post Author: Orion Mitchell

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