Performant Financial ( Nasdaq - PFMT )

Performant Financial (PFMT $10.75) is the leading provider of debt collection services for student loans.  The company also identifies and retrieves improper Medicare payments.  Additional services are being developed to help state and local governments collect a variety of delinquent obligations.  Performant has been involved in the debt collection business since the mid-1970s.  The company has computerized most of its expertise and data bases since then, boosting efficiency among its agents who deal directly with the public.  Formal contracts are in place with the Department of Education.  Those deals generally pay a percentage of the funds collected.  The company competes with approximately 20 other providers.  The government typically steers more business to those companies that generate the best results.  The total potential market has been expanding at a 12% annual rate over the past decade.  More than $70 billion of student loans currently are overdue.  Over $1 billion in student loans are outstanding altogether.  More than $100 billion in new loans are written each year.  The default rate has increased from 5% to 9% during the last five years.

The U.S. Government took over the student loan industry in 2010.  Before then private lenders issued loans that were guaranteed by the government.  The Department of Education now handles all of the government guaranteed student loans.  Approximately 45% of the student loans outstanding still are held by private companies, though.  Performant has contracts with 11 of those (out of 30), in addition to its deal with the Department of Education.  Both channels generally pay a fixed percentage of funds collected (15%).  Competition is based on the amount of money retrieved, not the commission rate.

Medicare uses four separate companies to identify and collect improper payments.  Performant manages the Northeast quadrant, representing 23% of total claims.  That segment currently provides about 25% of the company's revenue.  Student loans represent most of the balance.  Software upgrades have been implemented over the past two years to identify incorrect billings more systematically.  That effort not only has lifted Performant's addressable market.  It also has improved work force productivity.  The increase in student loan default rates combined with superior automation in the Medicare sector is helping sustain overall revenue growth in the 20% range.

New markets promise to add further leverage.  Medicaid and other state and local government programs are rife with incorrect billings.  Bad debts are on the rise, as well, reinforced by the weak economy.  Performant is signing new government agencies at an accelerating clip to enforce fairness and compliance, number one.  Those outsourced efforts also generate substantial incremental revenue without any real expansion in direct budget costs.  Performant typically retains a share of the money retrieved, similar to its core operations.

We estimate 2012 sales will rise 26% to $205 million.  Earnings appear headed towards $.60 a share (+33%).  Performant recently went public at $9.00 a share.  Most of the money raised was retained by the private equity firm that bought the company earlier in the decade.  Earnings dilution was less than 5%.  The deal left Performant encumbered with significant long term debt.  Cash flow is ample to cover the related interest costs and repayment schedule.  But the financial leverage does constrain Performant's ability to expand via acquisition.

Next year sales of $250 million (+22%) appear attainable.  Income could reach $.75 a share (+25%).  Our projections assume the sale of an additional 5 million shares over the coming 2-3 years to shore up finances.  Even so, earnings could achieve $1.00-$1.25 a share within that time frame.  If any capital raised is applied towards acquisitions a stronger showing is possible.  Our target price is $25 a share, potential appreciation of 130% from the current quote.

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