Chamath Palihapitiya’s Clover Health Investments (NASDAQ:CLOV) stock deal has fallen ill; shares are down almost 50% in recent weeks. Is time running out for this digital insurance company, or will it soon recover its vitality?
Special purpose acquisition companies (SPACs) were one of the hottest investing trends of the year until recently and Palihapitiya was on top of the world.
Now, though, both have gone ice cold.
There are several major issues with Clover from a long-term investment perspective. For one, it’s not profitable — not even close. Last quarter, it lost $82 million while generating $166 million in revenue. That’s a pretty huge loss ratio compared to its revenue.
Remember, insurance isn’t a huge gross margin business. In other words, don’t expect the kind of scaling you see in software where incremental revenue goes almost entirely to the bottom line. Clover will have to grow by leaps and bounds just to break even let alone generate profits.
A Closer Look at CLOV Stock
Bulls might point out Clover’s fast revenue growth. In Q4, for example, while revenues missed analyst expectations, they were still up 44%, which is impressive.
However, investors don’t typically value insurance companies on revenues or revenue growth. Traditional metrics for the sector involve earnings, return on equity (ROE), or price/book value. Clover scores alright on the last metric but flunks the first two as it isn’t anywhere near profitability or positive ROE.
There’s a more specific reason to be nervous about Clover. As Hindenburg Research pointed out, Clover came public while being the target of a Department of Justice (DOJ) inquiry.
Hindenburg asserts that both Clover and Palihapitiya failed to disclose this DOJ investigation to shareholders, resulting in a breach of their fiduciary duty. The company responded by saying the matter was a routine inquiry and that it wasn’t keeping anything vital hidden.
Regardless, CLOV stock plunged on the news. For an upstart loss-making company like this one, more transparency is generally a good policy.
Clover: The Bull Case
It’s complicated valuing non-traditional insurance companies such as Lemonade (NYSE:LMND) or Clover.
They screen terribly based on typical valuation metrics. However, if they are truly able to reshape the insurance industry, they should earn fat rewards at some point in the not too distant future. Clover has had significant operational momentum and strong backers up until now.
Clover also has solid demographics and market trends on its side. The company focuses on Medicare Advantage programs. These are rising in usage naturally, thanks to the aging of the American population.
More and more people are using Medicare Advantage instead of traditional Medicare. As Clover explains, it is one of the fastest-growing Medicare Advantage providers in the country, since it offers flexible plans with low copays and no cost additional services.
Over the past year, the vast majority of SPAC deals have traded up from their initial $10 offering price, and CLOV stock did as well for a while. But between the tough market lately and the DOJ news, CLOV stock is now down to $7.50.
That’s a 20% discount from where the SPAC deal went off. That’s a pretty big decline from the deal price, let alone the $15 level it hit in January.
Short Squeeze Potential
The other big positive for CLOV stock, from a trading perspective, is the huge short interest. As of this writing, bears have sold a stunning 35% of CLOV’s float short.
Sometimes, you see high short interest in SPAC names because of arbitrage before a deal closes. Once the SPAC is done and a company takes on its new name and ticker symbol, however, this sort of mechanical short-selling disappears.
Instead, it seems, certain fund managers are trying to hit Palihapitiya while he’s down. Judging by the price action in CLOV stock, that’s been a good strategy lately.
However, at some point, the persistent sell-off in speculative stocks will end. When it does, these sorts of beaten-up names should come roaring back. And Clover, with its gargantuan short interest, could be one of the fastest movers.
CLOV Stock Verdict
I’m skeptical of SPACs in general. I’m nervous about the sheer volume of deals that Palihapitiya is doing. When he’s overseeing this many different SPACs at once, you have to wonder if he can keep up with all of them.
Clover’s large operating losses aren’t great, and I can’t say I love the Department of Justice investigation issue either. If you’re looking for red flags with CLOV stock, you’ll find plenty of them. This isn’t something I’m interested in buying as a long-term investment.
That said, from a trading perspective, there’s a good chance CLOV stock bounces fairly soon. I suspect Palihapitiya will come out of this correction in decent shape and at some point these speculative stocks will come back into favor.
Clover had a lot of buzz around it up until last month. While I’m not sure about the long-term fundamentals here, there’s a decent chance the stock pops back to $10 or $11 soon once this growth stock rout finally ends. As a trade, the odds now favor the bulls.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.