A couple of weeks ago, Cotiviti Holdings went public breaking a long enterprise software and services IPO drought.  Never heard of Cotiviti?  Me neither, until the IPO.  But once I looked into Cotiviti I realized the company is involved in businesses many of you follow.

Cotiviti:  Managing Complex Invoices

Here’s how Cotiviti describes their business in their prospectus:

Cotiviti is a leading provider of analytics-driven payment accuracy solutions, focused primarily on the healthcare sector. Our integrated solutions help clients enhance payment accuracy in an increasingly complex healthcare environment. We leverage our robust technology platform, configurable analytics, proprietary information assets and expertise in healthcare reimbursement to help our clients enhance their claims payment accuracy. We help our healthcare clients identify and correct payment inaccuracies, which resulted in over $2.7 billion in savings in 2015. We work with over 40 healthcare organizations, including eight of the ten largest U.S. commercial, Medicare and Medicaid managed health plans, as well as CMS. We are also a leading provider of payment accuracy solutions to over 40 retail clients, including eight of the ten largest retailers in the United States.

In short, Cotiviti is a specialized invoice/claim audit recovery company.  That is, the company helps clients inspect the invoices/claims the clients receive and Cotiviti shares in the savings they find for their clients.  This type of solution is found in retail, healthcare, energy, telecom, freight and other complex billing areas.  I have written about this field before in a blog entitled “There’s money in them thar complex invoices“.  Like most companies in this market, Cotiviti appears to be a combination of technology and managed service.

Cotiviti describes their business model in the following two charts from their prospectus:

  • one shows the business process associated with healthcare payments and
  • the other professes to demonstrate Cotiviti’s large Total Addressable Market (TAM).

Healthcare Payment Complexity

Cotiviti Health Care

Cotiviti TAM

Cotiviti TAM

Cotiviti “Gain Share”

The most interesting aspect of the prospectus is Cotiviti discussion of its business model:

Aligned financial model that delivers measureable return.    Our financial performance is directly tied to the savings we deliver to our clients. The majority of our contracts are structured such that we receive a percentage of the savings that we help our clients achieve. We have consistently generated a high return on investment for our clients of approximately 4 to 1 as a result of our aligned financial model. The savings we deliver are incremental to our clients’ internal payment accuracy capabilities. As a result, we can provide a substantial contribution to our clients’ earnings and create strong alignment and durability in our client relationships. In 2015 and 2014, our commercial healthcare clients realized over $2.5 billion and over $2.0 billion, respectively, in savings using our solutions.

Like other companies in this general space (e.g., PRGX), the company shares in the savings it produces for its clients.  It cites two figures in this regards:

  • $2.5 Billion in client savings in 2015 and $541 million in Cotiviti revenue (hence the 4:1 savings to cost claim)
  • $35 Billion in TAM which will generate approximately $5B in revenue

So, Cotiviti receives about 15-20% of savings generated for their clients.  Gain-share based businesses are really attractive to sell because they offer hard ROI and “pay for themselves”.  There are several issues with these businesses however:

  • Over time, automation and business process improvement tend to drive out the savings from post-hoc or, retrospective recovery, as Cotiviti calls it.  Clients will pay gain share for an issue the first time the vendor finds it, but they expect a good vendor to help find ways to keep it from recurring!  (Cotiviti also offers “prospective claims accuracy”, but it is a much smaller part of their business).
  • Clients have a lot of negotiating leverage in these contracts, after all it is the client’s spend.  Over time, clients wonder why the provider cannot quote a fixed price per document, contract, or even FTE deployed, rather than share the savings with the provider. Whether it is sourcing, supply chain finance, or a variety of other areas, gain share contracts often evolve into fixed costs contracts as the market matures–and buyers capture much of that upside.

Summary

Some PE firms love tech-enabled managed service providers.  These businesses can provide stable, recurring revenue sources. Since the healthcare market is 16% of the economy, this business is no exception.  Advent is the PE firm that assembled the companies comprising Cotiviti and its sizeable debt load.  I’m not familiar enough with the competition in the healthcare market to opine on Cotiviti as an investment.  (I do know that the historical leader in retail audit recovery, PRGX seems to have struggled.) In “gain share” markets, if the competition is strong, the buyers will eventually capture all of the savings.  The e-sourcing market is a great example.  It started as gain share, moved to traditional consulting and finally became commoditized software in 10 years.  The big winners were the buyers, the losers were suppliers and the suppliers of the software!

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