Trading: short this sickly looking health insurance broker

eHealth’s accounting seems too optimistic and regulators are circling, says Matthew Prtridge.

America’s S&P 500 index plunged by a third when the coronavirus crisis struck. But it has since rallied and is back to where it was at the beginning of the year. The remarkable rebound suggests that this may be a good time to consider some short-selling ideas. One company that looks a prime target for short-selling is health insurance broker eHealth (Nasdaq: EHTH). The group is in a sector beset by continual regulatory scrutiny, but has nonetheless been on a tremendous tear over the past two years, rising from under $25 a share in June 2018 to around $120 today.

The reason for this surge is that between 2017 and 2019 sales more than doubled, while they are projected to increase by another 50% between 2019 and 2021. The company, previously loss-making, is now making a large profit. It says this is due to the rising popularity of its platform, which allows Americans to compare health-insurance plans online. 

Just as online brokers have revolutionised real estate, eHealth aims to do the same for American healthcare, helping consumers reduce the cost and complexity of what is generally deemed one of the most complicated and expensive health systems in the world.

How secure are sales? 

However, the firm has attracted increasing attention from activist short-sellers, who argue that most of eHealth’s increase in revenue comes from changes to accounting rules a few years ago. The company uses the “mark to model” accounting technique, which lets it book expected sales and profits over the lifetime of a client. 

Crucially, these expected sales and profits are based on eHealth’s own assumptions about how long people will remain customers, so if they cancel their plans, or stay with eHealth for a shorter period than expected, then the anticipated commissions could fail to materialise. They also argue that eHealth’s assumptions may be overly optimistic in that they depend on customers who have traditionally changed their plans regularly sticking with their provider.

It is always possible that eHealth’s projections could be proved correct and the short-sellers proved wrong. Still, there are several reasons why I think that the company is overvalued. Firstly, the mark to model technique has a terrible reputation, so I would be sceptical about any company that used it. The fact that the company is currently burning through large amounts of cash isn’t a good sign either. What’s more, I think that the current valuation of 24.6 times 2021 earnings is very high for a company in an industry under increasing political scrutiny.

I therefore suggest that you short eHealth at the current price of $118. Given how volatile the stock can be, stake £20 per $1 (a lower level than I’d normally recommend, with a wider stop-loss), covering your position if it rises above $168. This gives you a total downside of £1,000.

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