Umnat Seebuaphan/iStock via Getty Images
Umnat Seebuaphan/iStock via Getty Images
The following segment was excerpted from this fund letter.
R1 is a top player in outsourced Revenue Cycle Management for large hospitals and physician groups. Outsourced revenue cycle management is still in the early innings with only about 30% penetration, and we believe R1 has the most complete and scalable independent (i.e., not affiliated with an insurance company) solution in the marketplace, in what could prove to be a "winner take most" industry. With hospital profitability under pressure and coding and regulatory complexity ever increasing, R1 offers substantial savings via regional labor arbitrage and automation technology to customers through more efficient revenue collection.
The current management team came from Cloudmed, which R1 acquired very recently in June of 2022, and has undertaken the challenging task of cultural and technological integration while being relative public market newcomers under immense scrutiny. Cloudmed offers modular or single-point RCM solutions as opposed to a full end-to-end offering, and it counts 95 out of the top 100 hospitals in the US as customers. Cloudmed is a solid business with upwards of 40% EBITDA margins and 117% net revenue retention, and we think they can achieve a mid-teens revenue CAGR over the next few years while opening the door to upselling R1's more robust service offering across the broader customer base.
We believe with Cloudmed's technological focus and vast access to data (they touch over $900 billion of Net Patient Revenue across all hospital EMRs), a bit of a network effect is likely to take hold, as R1's army of engineers (most of their $100 million+ in capex is directed towards software development) are utilizing Machine Learning and, yes, AI, to automate processes to drive further efficiency of economics to be shared with customers. The company recently announced a collaboration with Microsoft (MSFT) to improve billing coding productivity. We believe there is a significant opportunity to both expand margins and expand their technological leadership. The CEO has a technology-oriented background and has been very consistent and outspoken since becoming CEO about the long-term margin enhancing opportunities that Machine Learning and AI could generate for the company.
R1 currently has terrible negative sentiment as evidenced by a massive multiple de-rating and 18% short interest. It is getting hit by both stylistic (floating debt, healthcare IT, SMID) and idiosyncratic factors (accounting concerns, customer loss/bankruptcy, negative estimate revisions). While we cannot dismiss all these negatives as "nothing," it is our variant view that under the covers things at the company are much better than they appear at first glance and most of the bearish arguments miss the forest for the trees.
The level of risk of an investment is in part a function of the valuation paid relative to many outcomes. Waiting for perfect near-term clarity on a situation like RCM would be costly and could negate any chance at outsized alpha. Where we have had big winners is not where we prioritize near-term clarity, but rather precise downside valuation protection under a variety of normal economic outcomes. R1 certainly fits the bill here, with investors overly focused on guidance for the next three months while we are focused on getting comfortable with the cash flow dynamics three years out. We believe there is limited downside over the next few years as there is still latent profitability building that will show up from maturing customers and ongoing Modular (Cloudmed) growth.
Twelve months from now, we think the investment narrative will have transformed significantly as management signs new customers without "paying to play", earnings quality improves substantially, deleveraging begins in earnest, and hospitals become incrementally healthier, leading to what will be viewed as a scarce, high quality healthcare IT asset that could be trading closer to fair value which we peg at 15x 2026 FCF, ~100% higher over the next two years. Although this is certainly an execution story, these numbers do not require much new business to be won as most of the FCF in our Base Case comes from ramping up already signed customers, along with some margin expansion from their AI/Machine learning initiatives. If the "network effect" we are predicting takes hold, we believe the Bull Case below is achievable.
Case Summary | EBITDA-Capex | FCF | Multiple | Price | Up/Down | Implied EBITDA- Capex |
Bear | $725 | $475 | 10x | $9.63 | -10% | 8.5x |
Base | $949 | $666 | 15x | $21.05 | 97% | 12.2x |
Bull | $1,155 | $821 | 20x | $34.58 | 224% | 15.6x |
| Disclosures and Notices Beginning January 1, 2020, all investment activity is conducted by the Voss Value Master Fund, LP (the "Master Fund"), which has two feeder funds, and therefore performance figures from January 1, 2020, onward are calculated based on the Master Fund. All limited partners invest in the Fund through one or more of the following feeder funds: Voss Value Offshore Fund, Ltd. (the "Offshore Fund") and Voss Value Fund, LP (the "Predecessor Fund"), each a "Feeder Fund". Performance figures for the Predecessor Fund are contributable to Travis Cocke as sole portfolio manager. Mr. Cocke maintains the same the position with the Fund and the Fund will employ a similar strategy as the Predecessor Fund. Actual returns are specific to each investor investing through a Feeder Fund. Each Feeder Fund was established at different times and has varying subsets of investors who may have had different fee structures than those currently being offered. 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