Ask Kuppy 12/07/2019
December 8, 2019
No Thesis Creep For Me…
December 20, 2019

…But Kuppy, Isn’t That A Fraud…???

I’ve always wondered why certain false narratives take over in sectors or individual stocks. What makes it so that investors continue to repeat incorrect information when there is an obvious financial incentive to see things for what they are? I don’t really have an answer for you and for the better part of two decades, I’ve seen this as an opportunity—repeatedly going where the hatred was strongest, trying to see what others have missed. As you can guess, this often proves to be unusually successful. I bring this up because I have always been baffled by the strength of these narratives—particularly when the facts start changing and the narrative doesn’t.

Let’s look at Health Insurance Innovations (HIIQ – USA), an insurance broker, which I’m long. For the past three years, the stock has been under a relentless attack by short sellers. It would be inaccurate to say that this was unwarranted. The shorts uncovered a lot that was wrong with HIIQ—plenty of which was questionably legal. As a result of their research, the share price collapsed and shorts earned a rather spectacular victory, culminating with the founder and CEO getting fired and multiple states launching investigations. The shorts clearly won round one.

Now here’s the thing. The company has hired a new CEO, it has settled with most of the states, it eliminated negligent affiliates and it dramatically beefed up internal compliance functions. Are there still some skeletons lurking? Absolutely. Will any of this matter? It’s hard to say. Have the shorts moved on? Nope. Here’s the funny part, they continue to wage war on HIIQ yet they seem to have hopelessly lost the narrative at this point.

Over the years, I’ve invested in hundreds of companies. I’d say that one of the biggest mistakes I’ve made is to engage in “thesis creep.” What’s that? It’s when you go into an investment with one thesis, then as the facts change, you adopt a new thesis to continue justifying your investment. A catalyst trade becomes a value play or a cyclical recovery position becomes a compounder. We’ve all been there and it usually ends badly. When the story changes, you have to exit. While I sometimes struggle with “thesis creep” in my own portfolio, I can always see it in someone else’s. If you want real-time evidence of “thesis creep,” read the dozens of short-seller articles on HIIQ over the past three years and witness for yourself how the bear thesis keeps shifting around.

Why haven’t the shorts moved on? I don’t know. It could be out of laziness or the inability to cover their position given that they are short 70% of the float. Maybe they still have a smoking gun to bring public. Most likely, they have convinced themselves HIIQ is bad and they intend to uncover whatever bad news there is—even as the new “discoveries” become ever more marginal. When you have a company with hundreds of affiliated brokers, will there be an occasional problem? Of course. Will a lot of small fines matter to the bigger picture? Likely not. For shorts, this is all becoming a rather obvious case of “thesis creep.” I see it, they don’t. That’s called opportunity.

Find a bull market and ride it…

I don’t want to get too deeply in the weeds here on HIIQ. If you want to waste a week of your life, start reading all the short-seller posts on Seeking Alpha. For that matter, my friends at Buckley Capital Management posted a solid rebuttal bull thesis here. Rather than re-invent the wheel when the Buckley Capital post is so recent and well done, I want to simply reiterate that I think the shorts have lost the narrative here. Furthermore, they’ve left themselves rather hopelessly exposed to a super-nova squeeze when someone calls their bluff (remember that 70% of the float is short).

That said, I can almost hear the new short thesis coming in a few weeks. The most recent thesis was that HIIQ’s Medicare Advantage business was stillborn. On December 12th, the company reported that they submitted 47,000 policies during the Medicare Annual Election Period (AEP). Clearly, they have a viable business here (despite it only being their first year). Now that this thesis is disproven, the shorts will likely focus on the lack of cash flow at HIIQ. Yes, in a rapidly growing insurance brokerage operation, there is negative cash flow as costs are expensed before the insurance companies pay the insurance broker. The negative cash flow shows that the business is growing fast—this is actually a good thing for longs. If you doubt the value created, look at the contract assets building up on the balance sheet (think of them as commissions receivable). I only wonder what the next short thesis is after the cash flow one—I’m sure there will be another one.

Returning to the story of false narratives, I have a lot of insanely smart friends who follow small companies. I like to reach out to them as I do my due diligence in order to see what I missed as these guys miss very little. Over the past few months, I’ve tried this with HIIQ and learned nothing. Every conversation with my friends starts and ends with, “But Kuppy, isn’t that a fraud…???” The echo-chamber has taken hold here and no one seems capable of thinking critically and analyzing the new facts. To me, that spells opportunity, especially when HIIQ is growing rapidly, the shares trade for less than five times 2019 earnings guidance and a lower multiple on 2020 earnings. Meanwhile, 70% of the float is short, hence any good news here could set off fireworks if just a few of the shorts throw in the towel.

eHealth is effectively the same business, but 2 years further ahead of HIIQ on the pivot to Medicare Advantage…

Over the past few years, I have noticed that the echo-chamber related to certain stocks has drowned out any critical thought. You can blame social media or the extinction event going on in active management for an inability of investors to think as contrarians. Whatever is causing this, companies keep slipping through the cracks and the ability to think critically and ignore the narrative is what has always allowed me to outperform. I feel like my edge is only improving due to the strength of this echo-chamber. Is HIIQ a fraud? I don’t think so. They did some potentially illegal stuff in the past? Sure. Call it a bit scummy today if you want, but that doesn’t make it a fraud. Could the shorts have a smoking gun data-point that they still intend to drop? Possibly and I’ve sized the position accordingly, but if they did, wouldn’t they have used it already? Especially as their most recent attacks seems silly.

Finally, the company is undergoing a “strategic alternatives” process currently. While I don’t expect a sale, it would dramatically increase the IRR on this investment.

If you plug in market multiples from competitors, you get to a share-price that is a few times today’s quote. I suspect it gets there soon as the short thesis has clearly hit an air pocket with Q4 AEP results. I like these sort of situations—especially as the high short interest means I get paid mid-teens in lend-fees to own HIIQ while I wait.

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Disclosure: Funds that I control are long HIIQ and short HIIQ puts