Investment thesis
I recommended going long Accolade (NASDAQ:ACCD) in January when the stock was trading at $9.55, and that recommendation played out well, with the stock going as high as $17. I believe ACCD’s value proposition remains strong as the challenges faced by individuals navigating the healthcare system still exist. ACCD is well-positioned to address these issues by utilizing its proprietary technology and health assistants. I am reiterating my Buy rating on the stock after the company reported a strong 4Q23 profit and upgraded its FY25 margin target (during the Analyst day). While the stock has fallen steeply after the earnings, I believe it is not warranted, and hence, presents another opportunity for investors to buy the stock with a better fundamental outlook today.
Demand trend
The results for 4Q23 show that the demand trend for ACCD has remained high. As a result of commercial account membership growth that has been relatively immune to the macro environment, revenue increased by 5.6% to $90 million. Although margins were slightly lower than normal, this was primarily due to ACCD recognizing a larger number of performance guarantees [PG] in Q1, Q2, and Q3 of FY23 than usual, which reduced the number of high-margin contributions made in Q4 of FY23. The 33% increase in ARR bookings was the highlight, as it demonstrated the strong demand trend that ACCD is enjoying. In addition, management has stated that there is no sign of a slowdown in the current demand environment for navigation and advocacy solutions. The fact that expansion was seen across commercial, government, and consumer channels is even more promising. I don’t think ACCD’s expansion was a fluke; rather, I attribute it to the company’s diversified product line-up and streamlined business processes, which encouraged a greater number of customers to sign up for more than one service. Given that one contract usually lasts three years, ACCD’s FY25 target was further de-risked by this excellent performance. As the size of ACCD’s customer base grows, I believe it will become easier for the company to increase its ARR through up- and cross-selling.
FY25 margin
During the analyst day, ACCD shared optimistic projections for FY25 and a long-term revenue goal of more than $1 billion. Investors’ concerns about a possible slowdown in growth for FY25 were apparently allayed by management’s show of confidence at the analyst day. In particular, management has stated their conviction in reaching $500 million in sales. To achieve this, I expect to see ACCD’s leverage its virtual primary care services, along with the adoption of additional trusted partner ecosystem applications, to further extend its business model (i.e., greater reach with minimal additional cost) in the near future. Management also emphasized an enhanced margin profile, with an expected adj EBITDA margin of 2-4%. In my opinion, this is a significant improvement, as the projected increase in profitability from the previous guidance (1.5%) is now 3% (double). This increase in margin target, driven by successful restructuring efforts that contributed to improved operational efficiency, is likely to be structural and sustainable. Long-term, management has set an ambitious goal of exceeding $1 billion in revenue by FY29 and aiming for adj EBITDA margins of 10% to 15% (implied EBITDA of $125 million). Taking a look at the top-line target, I wouldn’t say it’s impossible because management has several options for generating expansion. For instance, it could expand into adjacent markets by focusing on them, expanding its existing market share by upselling and cross-selling to existing customers, and developing new products. However, it’s important to note that, assuming $500 million in revenue in FY25, this goal will only be reached if the company maintains a 19% CAGR in the years between FY25 and FY29. All in all, I believe the analyst day has shed a lot of information about the long-term targets of the firm, and if management meets these targets consistently, I think the stock will do very well from here. If we assume ACCD trades at the S&P forward EV/EBITDA multiple of 12x at FY29. The business will be worth $1.5 billion in enterprise value (vs the $821 million today), which implies nearly a double from today.
Competitive advantage
ACCD’s secret sauce is its custom-built platform, which is backed by a mountain of data and designed with the care team, members, and customer in mind. The Clinical Foundation Score [CFS], which takes into account a wide variety of factors, is a key part of what makes this platform so attractive to me. The CFS also takes into account social risk factors and the member’s healthcare relationship when determining the most effective method of member engagement with the goal of increasing conversion. I think there are many benefits for the care team when costs can be predicted more precisely. One advantage is that they can see more clearly how to systematically increase profits. ACCD introduced a new improvement at the analyst day, which I think will increase the care team’s efficiency even more. The True Health Dashboard, which evaluates the effectiveness of referrals and member engagement within a closed-loop reporting framework, is one such improvement that will help the care team more clearly illustrate and measure cost savings for employers.
Partner ecosystem
In the context of the rapidly developing digital health ecosystem, I see great value in ACCD’s trusted partner ecosystem. In the current macro environment, businesses are looking to stay ahead of the competition by providing attractive benefits packages, but they need help evaluating the wide variety of digital health point solutions available. Here is where ACCD comes into play. Accolade’s approach to their partner ecosystem is quality-driven; they prioritize working with the market’s top-tier providers. By streamlining the procurement and implementation process, ACCD helps customers save time and money while also benefiting its point solution partners through improved distribution, and higher member utilization. For ACCD, I see this as a promising and potentially profitable growth driver over the next few years because of the margin-accretive nature of increasing the partner network (cost little to extend ACCD reach).
Valuation
I believe ACCD is now trading relatively cheap compared to its history as well. ACCD used to trade in the range of 8x to 10x forward revenue back in 2021 when it was growing 20+%. Today, ACCD trades at just 2x forward revenue but is expected to grow at ~20% (using management guidance). Even if we adjust for the higher interest rates today (which I expect to come down to a more normalized level), this discount seems to be too steep. I would also note that the profit margin outlook today is much better as well (management did raise their margin guide by 2x, as mentioned above).
Risks
The problem with ACCD stock, in my opinion, is the lack of profits, and if one were to look at the LTM figures, operating losses is >100%. While the increase in margin guidance is good, I believe a lot of investors are very skeptical about the stock, and most will shun it until profitability is within reach (less than 2 years in my view). The stock is unlikely to screen well, as it falls into the realm of decent growth but huge losses. This is unlike those high-growth software companies that are growing at >30% and pass the rule of 40. If rates were to increase further, growth slows down further, or management misses any part of its profit outlook, my worry is that the market will punish the stock by re-rating the valuation downwards. The stock might work in FY29, but the path to FY29 might be a very painful one.
Conclusion
The demand trend for ACCD remains high, as evidenced by the strong growth in commercial account memberships and increased revenue. The company’s diverse product line-up and streamlined business processes have led to successful expansions across commercial, government, and consumer channels. Management’s optimistic projections for FY25, including an improved margin profile and a revenue target of $500 million, instill confidence in ACCD growth trajectory. The trusted partner ecosystem further enhances the company’s competitive advantage and offers potential for margin accretive growth in the future. Considering these factors, I maintain a positive outlook on ACCD and believe that the recent decline in stock price presents a favorable opportunity for investors to capitalize on its better fundamental outlook.
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