Clarus research on Nightingale Informatix

Here is yesterday’s summary note from Clarus Securities on TSX-listed Nightingale Informatix (NGH:TSXV). Our Fund III closed a $12 million acquisition financing transaction with Sam and his team earlier this year, and syndicated it with Export Development Canada (yes, that EDC). EDC is a limited partner of our Fund III and it is great group for our portfolio companies to work with. The team is very talented and they have incredible resources and a range of products to help grow your business. How many small cap investors have the luxury of knowing that their money is invested in a firm backed by a Triple A-rated financier?

Clarus Research has been covering the story for awhile, and the note will give you a good sense as to why we are so high on the company:

“In Apr-07, Nightingale closed its US$13m acquisition of VantageMed Corp. (VMDC-OTCBB), at a valuation of ~1.18x P/S on FY06 revenue of US$11m. VantageMed is a California-based provider of practice management software for anesthesiologists and behavioral health providers, with an installed base of 6,000 customers, representing 18,000 practitioners in 50 states.

Recall that in 2006 Nightingale made two US-based acquisitions, giving the Company a market presence with a receivables management/billing business and a transcription/data routing service provider. In the past year, Nightingale has worked to leverage its EMR technology into the acquired customer bases with limited success.

We believe VantageMed brings a deep and experienced US-based management team to Nightingale and a much improved opportunity to sell its EMR solutions into the US healthcare market. We understand that VantageMed management had been seeking to develop or buy an EMR solution in order to retain and grow its already substantial customer base, and so, the merger with Nightingale satisfied this need. Given Nightingale’s market proven ASP product, established customer base, and the significant market opportunity in the EMR/PM space over the next three-five years, we believe the stock should trade back up to the 2.5x EV/S multiple
range. However, at this time, we believe that execution and integration risks exist and await evidence of building EMR traction in the US and benefits from the expected cost synergies. In addition, the equity and debt (with warrants) transactions have been dilutive, resulting in a reduced target price.

The addition of VantageMed should immediately increase Nightingale’s revenue by over 70% in FY08 and boost recurring revenue to ~65% of the total (from our prior ~52% estimate). Additionally, the Company expects to realize cost savings of $2.4m (mostly in the near term) largely due to headcount reductions (duplicate operations) and elimination of US listing fees. The acquired installed base of 6,000 clients, particularly on the small-midsized side, presents the opportunity to up-sell Nightingale’s EMR solution. Finally, we believe the combined Company will benefit from VantageMed’s experienced management team lead by CEO Steve Curd (since Nov-04). Mr. Curd, now responsible for all revenue generating operations, has developed a solid base of industry knowledge as a former COO of Healtheon (1999-2002), CIO at UnitedHealth Group (1995-1999), and VP at CIGNA Systems.

At the Board level, Charles Frumberg joined as Director in early May-07. Mr. Frumberg is founder and Managing Partner of Emancipation Capital (~17% NGH ownership), an enterprise software-focused hedge fund and brings over 28 years in management and IT experience.

Recent Customer Win Announcements

Since the middle of Dec-06, Nightingale has announced the following contracts:

• Dec-14th – EMR deal with The Ottawa Hospital Academic Family Health Team to support over 80 healthcare professionals. We estimate that the initial phase of the deal, which was expected to go-live in spring 2007, is worth ~$200k.
• Dec-21st – Three-year, US$3.6m contract renewal with Kaleida Health Systems in Buffalo, NY. We understand that the agreement, which took effect Jan-07, includes additional service provisions (Nightingale is currently providing services to three of Kaleida’s five hospitals).
• Jan-2nd – The first major EMR win in the US with a $1.6m EMR contract with the Albany, NY-based Center for Disability Services (CFDS), an existing IHPS customer. The phased rollout to CFDS’ 220 healthcare practitioners began in Jan-07 and will extend into 2008.
• Mar-28th – Three-year EMR contract with MCI Medical Clinics Inc. to support over 135 physicians in 20 Ontario-based clinics (of 26 Ontario total and eight in Alberta). Rollout to begin at six clinics through spring/summer of 2007.
• Jun-11th – Five new EMR/PM contracts totaling $850k with various-sized practices in ON, SK and AB. Completion for all projects is scheduled for the Aug/Sep-07 timeframe.

While we view these wins as positive, we had been expecting further traction in the US market, particularly around the VHR opportunity, but this has yet to materialize.

Adjusting Estimates

At this time, we are modifying our forecasts to account for the VantageMed acquisition, the equity and debt financings, and recent events in Nightingale’s core business. While we expect the addition of VantageMed to be accretive to Nightingale’s financials, the recent equity financing causes dilution.

We anticipate VantageMed, with recent break-even operations, and the announced cost savings of $2.0m (of $2.4m annualized) to drive positive EBITDA for the combined company beginning in Q1 FY08 (ending Jun-07). Over the course of FY08, we expect overall EBITDA to steadily improve on EMR sales traction with the acquired provider base and further operational cost synergies.

In addition to modeling in the acquisition, we are taking this opportunity to trim our prior organic growth assumptions for Q4 FY07 (ended Mar-07) and FY08. Given the limited number of Canadian wins, in part due to the slower than expected RFP selection process in BC and minimal traction in Alberta, we are reducing our license and service estimates in these markets. We continue to believe that significant potential exists for Nightingale in Nova Scotia and Ontario, but that progress in the western provinces may not be realized until later in FY08. As a result, we are now looking for $3.9m (was $5.1m) in non-recurring Canadian sourced revenue next year.

On the US side, we had been modeling a significant contribution in FY08 from a VHR pilot project with a hospital(s). As we understand that no VHR pilots have yet been secured, we have removed this component and lowered the service revenue assumptions for FY08. Overall, on the US side we now expect ~$26m, versus our prior $15m, on ~14% y/y organic growth (was ~35%) plus the VMDC base business and accretion.

Valuation and Recommendation

Currently trading at 1.0x EV/S on our FY08e, we view Nightingale as attractively priced, although we expect the market will take a cautious approach during the early stages of the VantageMed integration. We note that US comparables Quality Systems (QSII-Q) and Allscripts (MDRX-Q) are trading at 4.9x EV/S on FY08e (ending Mar-08) and 4.9x FY07e
respectfully, as both of these large vendors have demonstrated consistent, rapid organic growth in recent years.

Turning to our EV/S target multiple, we are increasing our discount to peers based on their current ~4.9x EV/S midpoint and ~30% organic growth driven by larger-sized hospital deals. This compares with our Nightingale US organic growth forecast of 14% y/y in FY08 (83% of total revenue) and 39% y/y in Canada. At this time, we believe that execution and integration risks exist and await evidence of building EMR traction in the US and benefits from the expected cost synergies. Based on the above, we apply a 2.5x EV/S multiple to our FY08 estimate.

We resume coverage of NGH with a target price of $1.10 per share (was $1.80 per share) based on 2.5x EV/S (was 3.5x) applied to our revised FY08 forecast. We believe that, while the hosted Practice Management and EMR opportunity exists, it will take at least a few quarters for Nightingale to demonstrate its ability to organically grow in the US market. Given Nightingale’s market proven ASP product, established customer base, and the significant market
opportunity in the EMR/PM space over the next three-five years, we believe the stock should eventually trade at the 2.5x EV/S multiple range. We maintain our SPECULATIVE BUY recommendation.”

MRM
(disclosure – we own securities in Nightingale)