Bright Health Group: Going Concern Risk (Rating Downgrade)

Summary

Long story short, I made a mistake in going long Bright Health Group (NYSE:BHG), with the hopes of catching the falling knife – which represented what I thought was a huge upside if everything turns out well as sentiments were horrific back then. I was wrong, and the recent performance has changed my mind to a sell rating.

Thesis update

In case you missed it, the biggest news is that the BHG 10-K now includes a "going concern" qualification, which questions the company's ability to continue operating for the next year with its current cash reserves. There are 13 results from a ‘going concern’ keyword search in the latest 10K vs last year’s. This is the dealbreaker for me. My original thesis was that with time, BHG should be able to grow and convince the market that its business value proposition was still sound. With that, the market would eventually re-rate the business. However, with the going concern issue today, there is a risk that time is no longer on BHG side. There is now a real risk that BHG equity value be worth zero if it not able to fund its business. According to the most recent filing, BHG had $150mn in unrestricted cash and cash equivalents, which was below the minimum level of $200mn required under its fully drawn credit facility. The minimum liquidity threshold for BHG has been reduced and the liquidity covenant has been waived until the end of April 2023. In order to continue running this year, management has said it is consulting with the Board and other advisors to secure the necessary additional funding.

Despite BHG's reiteration of its 2023 adj. EBITDA profitability target, I believe there is a very high execution risk. Management, in my opinion, is under significant pressure to successfully achieve EBITDA and cash flow break-even. The 2023 projections account for things like higher margins for MA plans, higher profits for Consumer Care per member under new shared-risk contracts with third-party payors, and lower overall corporate costs. I think execution risk is high for another reason, which is that the company's ability to reach EBITDA break-even hinges on its effective management of the cost of care for members covered by its new payor contracts, as well as achieving a margin improvement of around 500 basis points in its MA plans.

Financing updates

BHG's current credit facility expires early next year and the company is exploring options to replace it. However, management has declined to comment on whether or not BHG will need to raise additional capital. I think it was a mistake not to be more forthcoming with information. BHG's management has failed to allay the fears of investors and would-be investors who are examining the company's finances. Could BHG be considering an equity offering? Debt? Preferred? Or to be sold in its entirety? There are simply too many unknowns. I think this was a major factor in the precipitous drop in share price. Because of this, I'm beginning to doubt that management really does have a good plan in place. It would have been widely disseminated if it existed. Therefore, in my opinion, the announcement was especially disheartening considering that the company obtained more funds in the fourth quarter of 2022 and stated that its financial flexibility would be adequate to finance its operations until it became profitable.

CFO sold shares

On top of everything, the fact that Smith Cathy (the CFO) sold half her stake in the company 2 weeks after the earnings was not helpful either. If I were to infer literally, are insiders telling us that there is no hope left?

Conclusion

In conclusion, my initial thesis on BHG stock has changed, and I am now recommending a sell rating. The recent "going concern" qualification in the company's 10-K report is a dealbreaker for me, as it questions BHG's ability to continue operating with its current cash reserves. There is now a real risk that BHG's equity value could be worth zero if it is unable to fund its business. Despite BHG's reiteration of its 2023 adj. EBITDA profitability target, I believe there is a very high execution risk, and management is under significant pressure to achieve it. BHG's financing situation is also uncertain, and management has failed to provide enough information to allay investors' fears. Finally, the CFO selling half her stake in the company two weeks after the earnings announcement is not a good sign. Therefore, I believe it's time to cut losses and sell BHG shares.

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