Taking a closer look at Q1/24
WELL reported revenues ahead of estimates with strong outperformance in CDN Patient Services. WELL reported Q1/24 revenues of $231.6MM (flat q/q; +37% y/y), ~0.6% above RBCe ($230.2MM) and ~1.9% above consensus ($227.3MM). The revenue strength vs. RBCe was led by better-than-expected performance in CDN Patient Services (aided by strong organic growth and a one-time positive reimbursement payment in the Dx segment) partially offset by weaker-than-expected SaaS and Tech Services (usual lumpiness) and the USA Patient Services segment. CDN Patient Services revenue of $75.7MM (+49% y/y) was ~6% ahead of RBCe ($71.3MM) and ~5% ahead of consensus ($71.8MM). USA Patient and Provider Services revenue of $140.4MM (+42% y/y) was marginally (~0.6%) below RBCe ($141.3MM) and largely in-line with consensus ($140.1MM). SaaS and Technology revenue of $15.4MM (-20% y/y) was ~12% below RBCe ($17.6MM) and ~11% below consensus ($17.3MM). Management noted that excluding the lumpy cybersecurity revenues, SaaS and Tech segment revenues were flat y/y as the organic growth in the segment was offset by the sale of IntraHealth to HEALWELL on 01-Feb. Management noted organic growth of ~13.5% y/y, which included ~3.5% y/y contribution from absorptions (acquisitions with nominal considerations).
Updates on the clinic digitization and transformation program. Management noted that at the time of absorption or acquisition of primary care clinics in Canada, these clinics generally operate in the 1-3% EBITDA margin range (some of the recent acquisitions have been loss making with negative EBITDA margins). After implementing the clinic transformation process, the company targets ~5-10% EBITDA margin within the first year and 10+% margins within 18 to 24 months. The clinic transformation program includes several technology solutions and processes, including online booking, waiting room automation, workflow optimization, accounting shared services, virtual care, billing improvements, as well as AI suite of products.
The initial original cohort of 18 clinics in B.C. (acquired in 2018) is currently operating at 13+% EBITDA margins. The 2022 cohort achieved 10+% EBITDA margins within 18 months and the clinics are now operating at 12+% EBITDA margins. For the 2023 cohort (which included loss making large clinics acquired from MCI and the Manitoba clinic), management noted that the digitization and transformation efforts at these clinics is running ahead of plan, and both Manitoba and MCI Ontario are now running at positive adj. EBITDA. Management expects continued improvement in adj. EBITDA margins at these clinics over the next year.
As it relates to the recently acquired clinics from Shoppers Drug Mart (here), management noted that the acquisition will have a temporary negative impact on the P&L as WELL implements the clinic transformation program at the acquired 10 clinics. The company expects the acquired clinics to turn profitable later in 2024.
In our view, the market is currently underappreciating the long-term value creation opportunity in transforming CDN primary/ Dx care, as underscored by our strong forecasted ROIC and IRR metrics for recent acquisitions. Previously, WELL has added >500bps in EBITDA margin, on average, to primary/Dx clinics post purchase, leading to strong ROIC metrics. Our work suggests the recent MCI/Manitoba clinic acquisitions could generate ROIC of >30% in aggregate over time and an IRR of ~30%. For additional details, please see our recent initiation report on WELL Health (see pages 20-21, here).
M&A pipeline – 40 clinics with 10 absorption candidates. WELL’s pipeline of new clinic opportunities consists of ~40 clinics under LOI agreement of which ~10 would be actionable under the clinic absorption model (clinics are absorbed into the WELL network with minimal upfront payment) and the remaining 30 clinics are under the regular M&A bolt-on program. Under the clinic absorption model, WELL acquires clinics for nominal cash costs in the range of <0.02x revenue multiple, whereas for the regular M&A program, WELL pays up to ~0.5x revenue or ~3-5x EBITDA. Management reiterated its conviction of the significant inorganic growth opportunity for the company, which despite being the largest owner of primary care and Dx clinics in Canada, still has <1% share of the ~$35B physician spending market reflecting the highly fragmented nature of the CDN clinic market.
Targeting lower dilution and improvement in per share metrics. Management noted the company has reached an inflection point where it can significantly reduce share issuances (including stock-based compensation) and instead leverage its cash flow from operations. Management expects a double-digit decline in share issuances in 2024 after ~4% dilution in 2023 and ~10% dilution in 2022. The company has also initiated a NCIB, which may be increased over time depending on any significant improvements to cash flows and/or if the company is successful in unlocking value from US digital assets (Circle Medical, Wisp). As of May 7, WELL has bought back 75,300 shares under its NCIB. The company is also switching its employee incentive programs to be more cash-based versus share-based, which is expected to result in a significant reduction in new share incentive grants in 2024 vs. 2023. With expected improvement in cash flows (aided by organic growth and cost optimization programs) and lower share issuances, WELL expects greater improvement in per share metrics.