Cerner Well-Positioned in Promising Category
The market for medical software is white hot and our favorite player is Cerner Systems (CERN), which was upgraded today by Caris & Co (the same people who said Google was going to $2,000, regrettably).Medical errors are unfortunately still running rampant in America, so the need for clinical /administrative data automation in the health care industry is greater than ever. According to IDC, hospital-related IT spending is expected to rise considerably within the next 3-5 years as health care providers look to implement safey metrics across the board. The Center for Information Technology Leadership (CITL) says the health-care system could save more than $77 billion annually if it gets its act together. Cerner's brand visibility is a competitive advantage we think the firm enjoys.
Cerner's revenue streams come from software sales and the ancillary/follow up services it provides for its clients. Clients include large hospitals, but Cerner has recently penetrated the tighter, smaller private physician space in order to diversify it client base and augment its long term contractual agreements.
Currently, Cerner lacks the scale its rivals enjoy, and as a result, Cerner has to spend more in order to develop content solutions and haul clients through the door. Nevertheless, Cerner has done an exceptional job turning the orders it has received into recurring revenues.
Should hospital budgets loosen up -- and the firm carve out an inpenetrable niche in this terribly fragmented category -- we think Cerner could see great upside.
But now may not be the best time for investors to get in. Cerner trades at 25x forward earnings and 12x EBITDA. Although rival McKesson (MCK) carries more debt, it trades at 20X next year's results. Valuation concerns could explain why 30% of Cerner's float is currently being shorted (which upsets our risk-reward).
There is more reason for investors to be wary -- Cerner's balance sheet is far from perfect, and the company has already announced much higher R & D expenses going forward as it tries to grapple with increasing competition from the likes of formidable stalwarts like IBM (IBM) and Accenture (ACN), who could arguably blow Cerner out the water if they decided to leverage their name and deploy cash on acquisitions. Record-keeping software maker Quality Systems (QSII) must also be watched closely. A small but powerful player, Quality Systems is cash flow positive and growing at a torrid pace.
Amidst the skepticism, analysts are still enamoured with Cerner -- there are no sells on the Street. As for us, we'll take the road most travelled: we're initiating coverage on the stock with a nuetral rating.
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