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SelectQuote: The Retrenching Plan May Not Work Out

Stethoscope with medicare form with parts list.

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Ordinarily, any stock that has shed nearly 90% of its value since the start of the year may be worth a look to see if the market got something wrong. It’s difficult to make this argument, however, with SelectQuote (NYSE:SLQT). This senior care insurance marketplace, which helps consumers select and compare Medicare Advantage online, has been battered this year as policy approvals and close rates came in way below plan. Once a high-flying growth stock, SelectQuote now looks like a company that had “beginners’ luck” and is now seeing reality set in.

For certain, SelectQuote’s ~90% retrenchment (and the loss of ~$2 billion in market value) over just a number of months has been a whirlwind – but I encourage investors not to fall for this value trap.

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I downgraded SelectQuote to sell after its horrendous fiscal Q2 earnings release in February, and I see no reason to buy SelectQuote now.

The two primary concerns I have on this company are:

  • Is SelectQuote ditching all hopes for growth? Management’s focus has turned to aggressive cost-cutting. And while I agree that over-investment in agent hiring that didn’t pan out during the critical Open Enrollment period in Q2 lies at the heart of SelectQuote’s problems, this company is at too small a scale to be retrenching on growth plans. Investors, in particular, will not be pleased that the company does not expect to return to growth until FY24.
  • Heavy leverage amid deep red ink. SelectQuote is carrying a huge load of debt on its balance sheet, which is compounded by heavy adjusted EBITDA losses. These types of stories typically only have one ending, and it’s not a good one.

The bottom line here: I continue to view SelectQuote as a dangerous value trap. Stay on the sidelines here, as at the moment there are plenty of battered tech stocks that have lost 50%+ of their value without having given up an inch of quality on their fundamentals. Invest in names like these (some of my top picks at the moment include Zillow (Z), Chewy (CHWY), Snowflake (SNOW), DraftKings (DKNG), and Palantir (PLTR)), and steer clear of SelectQuote.

Focus shifting to cost cutting, but neglecting growth

SelectQuote recently released Q3 results, and while the quarter came in marginally ahead of Street expectations (albeit, against expectations which are now much more modest), the biggest update was SelectQuote’s shift in strategy.

Take a look at the snapshot below, taken from the company’s Q3 earnings deck:

SelectQuote key strategic priorities

SelectQuote key strategic priorities (SelectQuote Q3 earnings deck)

Medicare Advantage policies are planned to pull back in FY23. The company is reducing its efforts on recruiting and onboarding new agents, with a view point to reduce $200 million of annual expenses out of its cost structure.

Now, while it’s really commendable to see a struggling company shift its focus to cost-cuts when the business isn’t working out well (in my view, GoPro (GPRO) is a perfect example of a company that pivoted very successfully with this mindset), I think SelectQuote is still too early-stage to be pursuing this type of plan. The fact that we saw revenue growth slow to just 3% y/y in Q3 is concerning. Single-digit growth also continues to be the consensus revenue outlook for Q4.

Here’s the commentary from CEO Tim Danker’s prepared remarks on the Q3 earnings call, detailing the strategy to curtail expenses:

That point leads to the second component of our strategy, which is to mitigate our operational risk or effectively reduce our operating leverage. As we noted last quarter, we are committed to a Senior business strategy that can produce attractive returns in a wide range of environments. Clearly, the 2021 AEP season was unique, but we believe the cost savings we have identified thus far will go a long way in ensuring better returns even during challenging seasons.

At this point, the bulk of the $200 million we have identified will come from lower growth in variable costs. That said, I want to emphasize that we will remain focused on high return on investment capital allocation. In the quarters ahead, you can expect updates across a number of these initiatives including agent hiring, onboarding marketing and our G&A.

Perhaps even more importantly the planned pullback in Medicare policy production allows us to refine our sales, marketing and operational approach, placing greater focus on cash efficiency, profitability and riding business with greater potential to persist over the long-term.

For example we plan to take a more conservative approach to our recruiting, training and onboarding of new agents ensuring all will be fully prepared for the AEP busy season. We anticipate by next AEP our agent force will be a more tenured group than the 2021 AEP team.

The pullback also allows us to reassess and optimize our training tools and systems that support our agents and their important role of advising customers on the best plan for their unique needs. And the pullback allows us to optimize our marketing sources and to refine our targeting to focus more investment on the highest LTV producing lead sources going forward.”

Troubled balance sheet; even cost cuts may not push adjusted EBITDA to profitability

The other major concern with SelectQuote – the company is already carrying a huge mound of debt. As of the end of Q3, the company had $199.4 million of cash on its balance sheet on top of $706.6 million of debt, or a net debt position of $507.2 million.

SelectQuote Q3 balance sheet

SelectQuote Q3 balance sheet (SelectQuote Q3 earnings release)

Meanwhile, for the current fiscal year ending in June, SelectQuote is expecting adjusted EBITDA losses in the range of -$260 to -$235 million. If we assume that revenue performance in FY23 is going to be roughly similar to FY22 (based on the company’s comments on retrenching MA policy submissions and divesting out of recruiting), we would expect “baseline” adjusted EBITDA to be roughly similar. Roughly speaking, even the $200 million boost from cost-savings initiatives would not push SelectQuote to adjusted EBITDA profitability.

SelectQuote adjusted EBITDA outlook

SelectQuote adjusted EBITDA outlook (SelectQuote Q3 earnings release)

Key takeaways

The key message here: can we trust SelectQuote to claw its way back to some amount of reasonable growth in FY24, and can we trust the company to make good on its $200 million of cost reductions? Given the huge debt load on its books and the massive red ink the business is currently generating, the stakes are very high. In my view, this is not a bet worth taking.

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