Streamline Health Solutions: A Healthy Choice?

Streamline Health Solutions (STRM) may be poised for a turnaround led by new management and boosted by federal incentive dollars.

STRM is a healthcare IT company whose main line of business is developing software that handles document management for hospitals. It enables hospitals to integrate data from paper documents into whatever enterprise computing system the hospital is using, thereby facilitating a truly paperless work environment.

The company is a tiny name in a niche filled with much bigger players such as Cerner (CERN) and McKesson (MCK), which sell a broader range of healthcare software. Yet STRM has managed to stay afloat with consistent albeit flat revenues.

Ticker	STRM
Price as of 6/1/2011	1.65
52 Week Range	.96-2.05
Shares Out (mms)	9.87
Market Cap (mms)	16.29
Debt (mms)	1.4
Enterprise Value (mms)	16.33
P/E (ttm)	N/A
EV/EBITDA (ttm)	7.4
Recommendation	Watch

HITECH Act in Action

The buzz surrounding the healthcare IT sector is the potential windfall from the HITECH Act, which provides government incentives to healthcare providers in order to spur them to adopt electronic medical records. Healthcare providers must meet certain benchmarks to earn the grants and the performance recording period started this year.

Document management is a tangential focus of the Act, relating to only perhaps five of the 25 benchmarks, but niche companies like STRM hope that hospitals will be looking to upgrade all aspects of their enterprise systems once they are already doing so for the HITECH dollars.

Treading Water

STRM has done between $16-18 million in sales for the last six years. Those sales levels have not provided the scale to generate significant profitability. It consistently expenses about $2 million on R&D and $6 million on SG&A. With gross margins around 45%, it's operating at about breakeven on a normalized EBIT basis.

What About Bob?

After years of running in place, the Streamline board forced out founder and CEO Brian Patsy in February and hired Bob Watson, an executive with extensive experience in the healthcare IT space, including CEO experience at a company that was sold to Merge Healthcare (MRGE).

The major hurdle confronting STRM is a common one for smaller tech companies: Despite a solid product, it lacks the marketing firepower to compete with the big boys. It simply cannot get in front of enough potential customers to check the pulse of deal flow and close sales. As one executive in the healthcare IT space told me, a small healthcare software company can sell almost anything to a dozen customers. To scale from that point, a company must have very strong sales execution. New CEO Watson recognizes the challenge facing STRM and insists that it must become a more “market facing” company and improve distribution. He has a good track record and brought in a new head sales executive, Gabriel Waters, who was previously head of sales at a healthcare IT company recently sold to Harris Corp (HRS).

Near Term Headwind With GE

In light of its marketing struggles, it is not surprising that STRM has been very reliant on its resell partners for business. GE Healthcare in the US and Telus (TU) in Canada sell Streamline products integrated into their larger healthcare enterprise software systems. GE accounted for 33% of sales in the past year.

Management announced in April that it expects lower than usual sales to GE this year. GE is focusing on upgrading its current customers to the newest version of its system and will not be pushing new system sales where STRM stands to benefit. This led STRM management to guide for revenues in 2011 to be down from $17.6 million in 2010. I think only about half of GE revenue is at risk, as the other half is recurring maintenance revenue and not new sales -- but that would still be a $3 million hit, assuming STRM gains no new GE sales in 2011.

The 800-Pound Gorillas

Aside from the marketing issues facing the company, its product positioning also seems somewhat tenuous. The core document management product has become more of a commodity over the years as the big names like Cerner have either developed such capabilities themselves or acquired companies in the space.

Additionally, I would think the software company that is selling the hospital the enterprise software system would have a leg up in also making the sale on the document solution. Streamline has demonstrated that its software can integrate with all the major healthcare enterprise systems, and it's scored sales wins over the bigger names. But I still think its competitive standing might put a cap on growth potential. Another angle STRM has tried is expanding its product portfolio to department-specific workflow solutions that use the document management technology, but those efforts have seen only limited success thus far.

Valuation

STRM is somewhat cheap for an enterprise software company in an attractive sector, with about $3 million in normalized EBITDA and a $16.3 million enterprise value. However, capitalized software costs deter the free cash flow potential at current revenue run rates. Normalized software capex appears to be about $2.5 million, and maintenance capex over $3 million.

The software business model inherently has a high degree of operating leverage, and tottering at breakeven STRM could move earnings up or down quickly. There is leverage to the upside if Watson and Waters can revitalize the sales department and score some contract wins. But there is also downside risk due to the GE falloff and the strong competition in the niche.

STRM does have a fairly strong recurring revenue base of about $11 million a year, consisting of software license maintenance fees and software hosting fees. This base is sticky, as hospitals generally do not make wholesale changes to their software systems. The recurring revenue provides a degree of downside protection and in the near term STRM may feel some positive residual effects of the HITECH Act, but I don’t think that is enough of a margin of safety, given the potential GE dropoff, strong competition, and a sales department in need of an overhaul.

In terms of the stock price action, it is worth noting that there are two large shareholders who have been frequent sellers in the past: Co-founder Eric Lombardo (who was ousted from the company years ago), who holds 14%, and Sharon Brightman (ex-wife of ex-CEO Patsy), who holds 10%. Lombardo was selling down to about $3, and Brightman down to $2. We might also now add ex-CEO Patsy (holding 12%) to the list of disgruntled large shareholders. This group might create a large overhang for a thinly traded stock.

By making it thus far against much larger competition, STRM has proven it has a solid product portfolio and recurring revenue base. And due to its operating leverage, even moderate revenue growth would provide decent earnings relative to its market cap. But given my concerns on the downside, I don’t see enough of a margin of safety to buy now. Going forward, I would like to see signs that Watson can succeed in driving higher sales and/or an even cheaper valuation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.