Pethealth

This is a company that appears expensive on an earnings and asset valuation, but is actually quite cheap. I was first intrigued by PTZ.TO when it hit a new 52-week low earlier in summer. Here is a 1o year chart of PTZ. Every time it dips under $1 it looks like a decent entry point.

From their website:

Pethealth Inc. (“Pethealth” or the “Company”) is North America’s second largest provider of medical insurance for dogs and cats to pet owners operating in Canada, the United States and the United Kingdom. It sells its policies under several different brand names using a model which includes co-branding, white labelling and private labelling programs with distribution partners. In addition, the Company is a leading provider of pet recovery database services in North America, a market it entered in February 2003 under the brand 24PetWatch™. Furthermore, the Company, through its web-based product, PetPoint™, has become the leading provider of management software to animal welfare organisations in North America, a market it entered in 2005.

What it really means is there is the insurance segment and the non-insurance segment. The non-insurance segment is actually a few different pieces lumped in as one.

Insurance

The insurance segment is easy enough to understand. Through an MGA (managing general agreement) with some insurance providers PTZ earns a small amount of income for marketing, claims adjustment, premium collection, etc. They do have some underwriting risk in their US and UK operations, but none in Canada. I think the best way to value this segment is to average out some of the peaks and troughs and put a conservative multiple on it.

As you can see, revenue took off due to an acquisition to enter the UK market. Though the Canadian market is not necessarily strong, the US and UK market is really soft at the moment. A prolonged soft market is a risk to the insurance segment. I think that the insurance segment should be worth more than 4x EV/EBITDA. So at if I average the insurance EBITDA over the last several years and put a 4x multiple on it, I get around $0.70 as fair value. This tells me that there is little value being ascribed to the non-insurance segment.

Before I move onto the non-insurance segment, let’s take a look at the last 5 years from a valuation perspective.

Since the insurance segment has turned EBITDA positive, the stock has slowly had a valuation adjustment downward. The revenue is on a consolidated basis. As you can see the company has never been cheaper. Looking back to the first chart, it appears that the company would have been too expensive to warrant investment as it was barely earnings positive. But that didn’t stop the market from building in high expectations.

Obviously there is a risk here. The non-insurance operations could be bleeding cash and/or the insurance segment will look dramatically different going forward. I will try to disprove this notion.

The insurance market is commoditized. However, there are unlikely to be many new entrants at this point in the cycle.

Non-insurance

The non-insurance is made up of a few different businesses.

The microchip business which is really 24PetWatch RFID chips and database management. This is a low barrier to entry business, but the fact that the database is managed by Pethealth’s software is were they seem to have an advantage. Petpoint is offered for free to animal welfare organizations that purchase the RFID chips from Pethealth. This application is cloud based and allows for organizations to easily track any animal that has a Pethealth chip in it. PTZ is likely to represent 50% of the total adoptions in North America that come from welfare organizations. A fee based version will be available shortly with increased IT efficiency and agility. With the recent roll out of a new ERP, there has also been temporary margin pressure.

The other part of the non-insurance segment is petango. Petango.com is an online store that allows visitors to view real time data on adoptable animals. As PTZ expands their geographical reach they will be able to scale better with this business. Margins are also depressed from all the up-front costs associated with the website launch.

Obviously, all the different parts can be marketed to customers from its own unique value proposition.

The segment is about to break even on an EBITDA basis. Though there have been a few times where it almost broke even, but nothing that was sustainable. I believe that the segment has enough synergies and traction to actually turn to a profit in 2012. The ceo feels that 2012 will finally be the year that they make money on the non-insurance side. There has been a huge increase in expenses and intangible assets on this side of the business that is now winding down, this should support margins going forward.

As you can the downward trend in expenses. This combined with increased revenue will drive profitability in 2012.

Risks

You didn’t think there wasn’t any did you? Of course there are risks here. If you buy PTZ, you are buying a premium to book. And lots of that book value is in the form of goodwill and intangibles. It may not be worthless, but it is tougher to value than hard assets.

You could also get an extended period of tough insurance environment that will eat into the margin of safety. The non-insurance side could also not execute as planned. Though the stock may not drop precipitously, it could end up being dead money.

In 2002, the ceo was loaned money from the company to buy shares in the open market. He did indeed buy them, but at a poor time. The loan was a 10 year loan that is will be due soon. Since the shares are under water and the company is just starting to gain traction, I think the terms will just be extended.

A high Canadian dollar is also bad as it hurts the US and UK profitability when operations are translated back to Canadian dollars.

Other notes

The ceo bought 100,000 shares at $0.70 a few months back. This is a vote of confidence.

The company is raising chip prices in 2012 for some customers.

The company has the ability to to pre-fund some of its expansion plans with PetPoint. It collaborates with shelters to show them the benefits of Pethealth’s program. This first tranche of expansion included 55-65 organizations. It bodes well for future expansion plans.

PTZ has the ability to sell some of the massive amounts of data it has gathered from its partners.

There isn’t a close competitor that services all the different points of the pet ownership market, so I don’t have any company that I can use for relative valuation.

The ceo and chair own 20% of the company together. This should help align incentives between shareholders and management. Though compensation is a little high for my taste, but where isn’t it?

There is also two investment funds that own quite a bit of stock. Burgundy Asset Management owns about 15% of the company, and have owned since 2010. Goodman & Company own about 12% of the company, and have owned since 2007.

Summary

I have a hard trigger at $0.75. At that price I don’t think you are paying anything for the non-insurance segment. With a near term catalyst, I think I can find room in my portfolio for PTZ.

Dean

Disclosure: The author is long PTZ at time of writing.

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9 Comments

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9 responses to “Pethealth

  1. Pingback: Pethealth - Petty Cash - B-Hive - WAGGLE

  2. Pingback: Pethealth Update | Petty Cash

  3. Jeremy

    Time to get on board all pethealths ducks are finally perfectly In a row. They just bought back 260,000 of their shares on the repurchase program. Non insurance side is doing exceptional. Insurance side has picked up.

    • Hey Jeremy,

      I think the thesis is still intact. That being normalized insurance earnings power coupled with positive EBITDA in non-insurance should lead to a higher valuation. I am glad to see the buy back. Though not a core holding (but still higher than 5%), I did pick up some more shares under 0.80. Hind sight says I should have sold above 1.30, but I think we get there again if there are a few quarters of positive EBITDA from non-insurance. I do think that the insurance segment has or is about to bottom.

      Dean

  4. Michael Doumet

    How would you guys value this stock? What’s your mid-term target?

    Thanks.

    • I don’t have a good clean answer for you, but I’ll take a stab at it…

      I give the insurance segment a value of $1 or so. This is based on some more normalized profit from where we are today. Let’s say about 6 million in EBITDA for a run rate. At 6x EBITDA we get 36 million fair value.

      The non insurance side is thrown in for free. I don’t believe that there is much need to split up the non-insurance business and value each individual piece (though you need to track each part of non-insurance to measure success). With the major spend trending down as % and in absolute terms for non-insurance I think you can just ride the run is revenue and allow some scale to come into this side of the business.

      I have tried to put a value on the non-insurance business, but I can’t really until I truly understand its earning power. They have some pretty unique synergies and ideas, so based on what some competitors trade at as a multiple of revenue and a basic book value, I get $0.30(ish). This gives me a total value of $1.30 (as a minimum).

      An added potential is data sales. The growth initiatives and customer captivity give me some comfort as well. As does the recent buybacks.

      Hope this helps.

      Dean

  5. Quentin Oppoq

    PTZ just touched $1.80. I would be very interested in your thoughts about the current valuation…

    • Hey Quentin,

      I don’t have a huge amount of insight into the name. I have trimmed my position once the $1.60 mark was breached. I continue to hold a 3% position as they are executing on the business. Non-insurance has gained some scale and shown EBITDA positive results of 1.1mil for TTM. Given the momentum in the top line, margins should expand. I am actually impressed how many organizations are involved in the PetPoint build-out.

      Having said that, Mr. Market has now taken notice of PTZ given recent news from FFH and business conditions improving. The upside over the short to medium term seems limited and I have been hunting in different grounds rather than adding to PTZ.

      I know I kind of danced around your question about valuation, but I struggle to put a hard number on what a “fair” value given that I have yet to truly identify what the business could earn on a run rate basis. With shares up 125% YTD, and things feeling frothy, I continue to hold. Without a change in the business, I would add below $1.20 and sell into (even more) strength about $2.00.

      Dean

      • Quentin Oppoq

        Thanks for your thoughtful reply. I have done pretty well over the last several months on this one and I am tempted to lock in my profits. But I also have a bad habit of selling my winners too early! My problem is that I loose confidence when a play turns from “value” to “momentum” or “growth”…

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