Medicaid Cuts Will Constrict Deals But Spur Efficiency

Key Takeaways

• Ongoing client budget cuts and cautious spending habits are limiting revenue growth and reducing average revenue per customer, stalling expansion from existing clients.
  
• Strategic focus on efficiency and shifting toward higher-margin technology may improve profitability, but could further constrain top-line growth and heighten volatility.
  
• Health Catalyst faces multi-year revenue pressure from client budget cuts, risk aversion, strategic shifts toward profitability, and uncertainty around public healthcare funding and customer concentration.

Catalysts

Provides data and analytics technology and services to healthcare organizations in the United States.

• While the long-term shift toward digital transformation in healthcare and the accelerating volume of healthcare data are expected to benefit Health Catalyst by expanding its addressable market and driving future demand for its analytics and cloud-based solutions, the company faces a multiyear headwind as clients reduce and delay IT spending in response to unprecedented $1 trillion Medicaid and significant research funding cuts. This reduction in client budgets has led to both lower recurring revenues and smaller new contract wins, which may cap overall revenue growth in the near to medium term.
  
• Despite the value proposition of the next-generation Ignite platform, which lowers customer costs and enhances scalability, clients are increasingly choosing to pocket the savings from Ignite migrations rather than reinvesting in expanded services. As a result, Health Catalyst is experiencing a decline in average revenue per customer and temporary pressure on dollar-based retention rates, impacting top-line revenue and stalling growth from existing clients.
  
• While regulatory and industry movement toward value-based care should create secular tailwinds for actionable analytics and data integration, hospitals and health systems-especially not-for-profit and academic medical centers-are responding to financial pressures with extreme caution, dragging out sales cycles, delaying project launches, and shrinking pipeline conversion. This behavior threatens both Health Catalyst's near-term pipeline conversion rates and its ability to expand the installed base, affecting both revenue and earnings visibility.
  
• Although management has been proactive in restructuring service contracts and increasing operational efficiency to improve adjusted EBITDA and gross margins, this strategy includes exiting certain unprofitable service relationships and workforce reductions. These actions, while driving margin improvement, will likely lead to further professional services revenue declines and may limit top-line growth as Health Catalyst shifts its mix toward higher margin, but potentially slower-growing, technology and applications revenue.
  
• While the ongoing consolidation of healthcare providers and growing compliance and interoperability pressures should favor larger, data-centric vendors over time, Health Catalyst remains exposed to customer concentration risk combined with ongoing macro and regulatory uncertainty. If key clients further cut spending or churn under ongoing margin pressure, the company could face heightened volatility in both recurring revenue and net earnings, as new client acquisition becomes more difficult in a shrinking market.

Health Catalyst Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Health Catalyst compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Health Catalyst's revenue will decrease by 0.8% annually over the next 3 years.
• The bearish analysts are not forecasting that Health Catalyst will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Health Catalyst's profit margin will increase from -31.7% to the average US Healthcare Services industry of 8.8% in 3 years.
• If Health Catalyst's profit margin were to converge on the industry average, you could expect earnings to reach $27.1 million (and earnings per share of $0.31) by about September 2028, up from $-100.1 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 14.7x on those 2028 earnings, up from -2.3x today. This future PE is lower than the current PE for the US Healthcare Services industry at 54.6x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.63%, as per the Simply Wall St company report.

Health Catalyst Future Earnings Per Share Growth

Risks

• The $1 trillion Medicaid cuts and substantial research funding reductions are triggering significant budget pressure for Health Catalyst's core client base of not-for-profit hospital systems and academic medical centers, resulting in clients pocketing cost savings from Ignite migrations instead of reinvesting and leading to prolonged declines in dollar-based net retention rate and lower average deal sizes, both of which have a material negative impact on revenue growth over multiple years.
  
• Persistent macroeconomic uncertainty, the timing and magnitude of public funding cuts, and additional threats such as potential expiration of enhanced insurance subsidies are leading to widespread client risk aversion and conservatism, causing delayed or reduced new contracts and expansion deals, which directly dampens near-term and possibly mid-term revenue and earnings prospects.
  
• Health Catalyst is guiding for a multi-year period of lower or potentially negative top-line growth through at least 2026, with the company removing its long-term 2028 revenue and adjusted EBITDA targets, reflecting management's limited visibility into their long-term growth trajectory and highlighting the risk of protracted headwinds to both revenue and profitability.
  
• The company's proactive retreat from lower-margin services contracts and restructuring efforts, while boosting near-term EBITDA margins, will result in a shrinking Services segment over the next several years and creates risk of further revenue contraction if the high-margin applications business and cross-sell motions cannot compensate for this loss, threatening overall sales and earnings growth.
  
• Customer concentration in not-for-profit and academic healthcare organizations, along with a shift in strategy to prioritize profitability over top-line expansion, creates exposure to further declines in client budgets, aggressive vendor negotiations, and delayed project spend-putting future revenue growth, competitive positioning, and long-term earnings at risk if industry funding pressures persist or worsen.

Valuation

• The assumed bearish price target for Health Catalyst is $3.5, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Health Catalyst's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $6.0, and the most bearish reporting a price target of just $3.5.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $308.7 million, earnings will come to $27.1 million, and it would be trading on a PE ratio of 14.7x, assuming you use a discount rate of 9.6%.
• Given the current share price of $3.24, the bearish analyst price target of $3.5 is 7.4% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.