Activist sets sights on another health-care company with break-up potential

• Business: Evolent is a health-care delivery and payment company. It supports health systems and physician organizations in their migration from fee-for-services reimbursement to value-based care and population health management payment models. The company has two segments — services and True Health. The services segment includes clinical and administrative solutions designed to help payers and providers administer value-based reimbursements. This segment includes Identifi, a proprietary technology system that aggregates and analyzes data, manages care workflows and engages patients. The services segment also offers specialty care management solutions that support a range of specialty care delivery stakeholders during their transition from fee-for-service to value-based care. The True Health segment is a physician-led health plan in New Mexico available through the commercial market for employer-sponsored health coverage. True Health manages full health plans and acquires RFP to run health plans in different geographies.
• Stock Market Value: $1.2 billion ($13.35 per share)

• Percentage Ownership:  9.99%
• Average Cost: $12.76 per share
• Activist Commentary: Engaged Capital was founded by Glenn W. Welling, a former principal and managing director at Relational Investors. Engaged makes concentrated investments in small and mid-cap undervalued public companies with a two-to-five-year investment horizon. Its style is holding managements and boards accountable behind closed doors.

Engaged intends to review its investment in the company on a continuing basis and to communicate with the company’s management and board regarding potential steps to unlock the intrinsic value of the company’s core business, including, but not limited to, improving capital allocation, divesting non-core assets and/or exploring a sale of the entire company.

The services business is the company’s core business, accounting for 80% of its revenue. This business had grown historically at a 40% CAGR and 2020 guidance has 30% growth. On the contrary, the True Health business is very capital intensive and has not performed well. The company has written off $47 million on its acquisition of an Oklahoma health plan and failed to grow its Kentucky health plan, leaving it with just a New Mexico plan. Despite this, by refinancing its convertible debt on less favorable terms instead of redeeming it with cash the company expects to receive from its arrangement with Passport Health, management is indicating that it plans on continuing to invest in the True Health segment and its sub-par ROI business.

The health-care sector has been making a move away from fee-for-service to value-based care and Evolent is the largest and best player in the industry. There is opportunity here to rapidly scale the services business and significantly increase the number of lives on the system from the current 7.5 million, particularly if that business is sold to a strategic investor. Evolent has been a coveted asset by a number of strategic players, including large managed care plans like United, Anthem and CVS and other healthcare IT players like Epix.

This is a textbook activist opportunity where a company spends the money from its profitable, growing core business and spends it on a money-losing, non-core business. Engaged will urge the board to first and foremost exit the True Health business, allowing management to focus its time and resources on the services business.  This should close some of the gap between where Evolent trades (1.5x revenue) and its peers trade (3-4 x revenue). Then, Engaged will request the board to explore its strategic alternatives, including a sale of the company. In 2018, Cerner made a minority investment in Evolent’s smaller peer, Lumeris, at 6x revenue.

If Engaged is not able to constructively engage with the company by Jan. 10 when the nomination window opens, we would expect them to nominate a full slate of directors for the 2021 class. The 2021 class of directors has three filled board seats and one vacancy, so Engaged stands a chance to win four of ten seats. Moreover, the company’s founder and CEO, Frank Williams, is in this director class. As he has already announced that he will be stepping down as CEO to become Executive Chairman on October 1, losing his board seat will leave him with no role in management. Engaged would also have another tailwind to a proxy fight in that for the past two years ISS has made recommendations against all directors due to unfriendly shareholder provisions in the Company’s charter and bylaws.

Engaged has had three other exited health-care investments — Aratana Therapeutics, Volcano Corp and HeartWare International. While their returns are somewhat mixed in those investments, in each one they ultimately were able to get the board to sell the Company at a healthy premium to the prior day’s stock price (Aratana – 40%, Volcano – 57% and HeartWare – 93%). 

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Squire owns Evolent Health in the fund.