CodeSmart Holdings Inc (ITEN): CodeSmart's Dramatic …

(Editors’ Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

We are about 10 months away from the point when all health care providers in the USA are forced by federal law to use the so called ICD-10 coding. This is a super big transition with such enormous implications that it is to create a multi billion dollar industry on itself. Scouting for interesting investment opportunities in the stock market, we discovered CodeSmart (OTCQB:ITEN). This is a tiny under-the-radar micro-cap that went public last May. CodeSmart is positioning itself as a leader in servicing the transition to ICD-10 and after some research, we found out the upside potential is very large, and argue that the company is, given the risks, tiny market cap and recent developments, dramatically undervalued. It could be one of the most undervalued health care plays in the stock market as of today. We believe this is another classic example of Wall Street severely mispricing micro-caps and have therefore recently established a long position.

What is ICD-10?

ICD-10 is the 10th edition of the International Classification of Diseases (hence, the ICD), the common system of codes that classifies every disease or health problem. The ninth edition of the ICD classification (ICD-9) has been used in the United States since 1979. But ICD-10 is coming, ready or not, and it isn’t just an update to the old version. ICD-10 is a completely new edition, with all codes rearranged and placed in different areas. ICD-9 is the old-school coding classification system, while ICD-10 is the new kid in town, and the differences between the two are fairly significant. For starters, ICD-9 has just over 14,000 diagnosis codes and almost 4,000 procedural codes. In contrast, ICD-10 contains more than 68,000 diagnosis codes and more than 72,000 procedural codes. Other differences involve how the codes are presented (the number of characters, for example) and how you interpret them (deciphering the characters to know what particular groupings mean).

As of this writing, all healthcare providers are obligated to be ICD-10-ready by October 1, 2014. Because getting everyone the world over on the same page, so to speak, is such a gargantuan job, ICD-10 is being implemented in phases for just about anyone who has anything to do with using it. Also good to know is the fact that the Affordable Care Act (also known as Obamacare) will not have any impact on the adoption of ICD-10.

About CodeSmart

As mentioned, CodeSmart Holdings is a first-mover in servicing the transition, focusing on providing on-line education services for medical coding and billing to healthcare professionals in the United States. Many experts indicate CodeSmart is outflanking the competition on product quality and broad mix of services. It offers CodeSmart University, see codesmartuniversity.org, an on-line training program. This program is the leading and top ranked on-line education program for ICD-10 in the country. With more endorsements than anyone in the industry, this interactive education program is poised to provide training to the millions of healthcare professionals who need to be trained for ICD-10. It’s a complete package, from an interactive learning platform to live professors. We like the fact the platform has unlimited capacity to handle as many students as possible. Adding students does not involve material costs, so more revenue almost directly adds to profit. The company also provides a range of consulting services, including training and education, ICD-10 preparation for healthcare providers, outsourced coding/auditing, placement service for trainers and coders, and clinical documentation improvement programs and training. Its customers include physicians, hospitals, coders and everybody else that has anything to do with ICD-10.

The Market Potential Is Very Large

CodeSmart is operating in a soon to be multi billion dollar addressable market. Experts indicate the transition will take years and even perhaps decades, akin to ICD-9, as whole business processes and people in the health care sector must be aligned with the new law. To give you an idea: many health care provides are still struggling with the 34 year old ICD-9 coding. Imagine the business opportunities as these providers have to cope with the much larger ICD-10. The next picture provides more information about this matter.

(click to enlarge)

Current strategic planning is to focus on forming partnerships with as many large healthcare networks and educational institutions as possible and to position the company for the long haul. CodeSmart is already the exclusive provider of ICD-10 services to over 60 colleges and universities. If CodeSmart manages to capture just a fraction of the market, its tiny market cap of just $13 million could easily balloon to a whole new level. What also adds to the bull thesis is the context in which this is all taking place; the healthcare sector is one of the fastest growing sectors in the country as the Bureau of Labor Statistics projects that healthcare and the professional and business services sector are to account for half of the projected job growth from 2010-2020.

Revenue is picking up steam

We are still in 2013 and the ICD-10 deadline is looming. As a start-up, CodeSmart has just begun rolling out its business model, and while revenue projections may have been overly optimistic during its IPO, revenue is picking up steam now. Let’s check out revenue growth and projections throughout 2013 and 2014.

The projections are very conservative, as we halved the estimates provided by Umbrella Research, a leading small cap investment capital firm. Even so, it becomes clear CodeSmart is on the path of growing at a rapid pace, and soon to be profitable. The revenue numbers are realistic, as the sales department has been on a tear over the course of the last weeks. To give you an overview:

(click to enlarge)

We assume these sign-ups won’t be the last and expect CodeSmart to add a lot of new customers further on, so the conservative revenue estimates may even be outdated very soon. But let’s use those numbers anyway to come with a share price target. With about 20 million revenue in 2014 and a 3X price/sales valuation, conservative given the steep growth, a share price of $4 is realistic. EPS is 0.38, apply a P/E of 15 and shares could be worth near $6. Beyond 2014, CodeSmart could garner a much larger amount in revenue and profit, and shares could surpass the $10 mark. So the short and medium term price targets range from $4 to $10. To remind you, CodeSmart has already been there, and when things were not looking as bright as they are now. Share price now is $0.85, so the multi-bagger potential is within reach.

CodeSmart’s Balance Sheet

Now let’s look at the balance sheet.

(click to enlarge)

CodeSmart’s current assets are more than twice its current liabilities, and the balance sheet shows no long term debt. The company is still losing cash, but with projections of cash flow break-even this quarter, we believe the company is funded well enough. So does management, as it has called off an impending $1.5 million equity financing just 2 weeks ago. We believe this has to do with an other announcement around that time that CodeSmart received $1.3 million in commitments for this month with new clients like Mennonite Health Systems and WorkBeast. This is great news, because shareholders dislike dilutive stock offerings but do like the company adding new customers to its portfolio that generate cash.

Why Are Shares Trading So Low?

This is a typical example of Wall Street behaving erratically. The pendulum swung from extremely overvalued to extremely undervalued, as often the case with micro-caps.

The company went public last May at a market cap of $100 million, which was over the top given the likely delay of ICD-10 and start-up status of no revenue or cash whatsoever.

Shorters took notice, and drove shares lower. Secondly, the initial projections were overly optimistic and shareholders became disappointed. Further, a few financing rounds pushed shares lower as well. Eventually, shares slid almost 90% and we believe the bottom has now been hit.

Risks For Shareholders

We would like to address some risks investors should be aware of.

First of all, CodeSmart is not the only company operating in this healthcare niche. Competition is stiff, just google ‘ICD-10 training’. However, ICD-10 is very complex, and comparing one free training to another paid training can be like comparing apples to oranges. Up till now, CodeSmart has been the company picking up huge training contracts unlike any other. But investors should be reminded that stiff competition in any large market could cause pricing pressure, depressing margins and an eroding market share.

Further, another delay in ICD-10 could occur. It happened before: the introduction was namely originally planned for last October. Obviously that did not materialize, but another delay, although unlikely, does lie within the realm of possibilities. Should that recur, CodeSmart’s expected revenue growth could be halted for a couple of months, if not longer.

At last, the stock is listed on the OTC boards. The transactions costs are higher, and the average trading volume is quite thin. The trading spread can be large, so place a limit order which won’t impact your portfolio too much. Risk management is key.

Compelling entry point

(click to enlarge)

Chartwise, shares are now bottoming out in the $0.80-$0.90 trading range, and volatility has gone down. Now is the time to buy.

Conclusion

Given the tiny market cap, current financial platform and projections, recent successful customer acquisition, looming ICD-10 deadline and very large market potential, we believe the market is now extremely undervaluing CodeSmart. Shares can now be picked up for just 85 cents, and if management executes well, shares could easily trade for at least $4 and up to $10 next year. With shares technically bottoming out, CodeSmart currently offers investors a highly sought after risk/reward profile.

Disclosure: I am long OTCQB:ITEN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More…)

Originally posted: CodeSmart Holdings Inc (ITEN): CodeSmart's Dramatic …