Healthcare claims processing is soul-crushingly complex. Recently the number of "codes" used went up 5x to over 68,000. At the same time there is tremendous cost pressure so every insurer wants to ensure claims are accurate and enforce payment policies.

Cotiviti (NYSE:COTV) is one of the dominant companies in medical billing and payments space. They have tweaked their positioning to be more data-savvy and call themselves an "analytics-driven payment accuracy" company. The company serves the majority of the top insurance companies and processes claims for over 190 million people.

The company had revenues last year of $541M with 62% gross margins and $200M of EBITDA. Cotiviti customers pay a portion of what they save so ROI is very high. For example in 2015 it's estimated that customers saved $2.7B out of which they paid Cotiviti about 20%.

The nature of this business means that it would be very very hard for an existing customer to switch vendors. So the revenue is basically recurring in nature.

So what are the "ugly" parts?

1. This company was bought by private equity firm Advent and is the result of a recent merger between Connolly and iHealth. That creates a fragile culture that could change after the IPO. We'd expect high turnover during the first year or two post IPO.
2. The public company will be left with little cash saddled with $840M in debt (pro-forma). To add insult to injury they are paying a large "special cash dividend" to Advent. Now I need to shower again!
3. Post-IPO Advent will still be in control and own over 60% of the shares outstanding. As a public company their interests should be aligned with other shareholders but you never know.
4. They company has a declining business that has been a drag on growth. It is now about $100M per year and management expects it to stay at the level but it's still a risk/distraction.
5. For the past two years the company has achieved operating income with substantial "impairment charges" of $74M in 2014 and $27M in 2015. Depreciation and amortization are also very high in this company which makes the books a little suspect in our view, at least in terms of judgement.

Having said all that the facts remain:

1. This is a large, recurring business with high margins and a pretty good "moat" to protect the company from direct competition.
2. There is substantial market opportunity for the company to meet their 10% to 12% revenue growth targets. The chart below breaks it out and it's well grounded. Our rough IV model has them reaching $1B in revenues in 2020/21 versus their estimate of a $5B opportunity.

The valuation at the IPO price looks attractive. Our IV suggests a $25 share price this year versus the current $18 mid-point. If they execute and generate strong results it can be a $32 stock in 2017. We've included what we'd call a "rough" IV model given the limited disclosure of the company thanks to the "JOBS" act.

Exhibits:

(Click on image to enlarge)

(Click on image to enlarge)