THE NEXT QUARTERLY COULD BE THE TURNING POINT FOR THIS SMALL CAP NASD STOCK MARPAI (MRAI – NASDAQ)

I LOVE the leverage that small float, small cap NASD stocks can give you. Our big wins in the last six months have been Byrna Technologies (BYRN-NASD; $4-$15), Spire Global (SPIR-NASD; $5.50-$15) and Myomo (MYO-NASD; $0.80 – $5).

Marpai (MRAI – NASDAQ) COULD fit that bill. It has only 7.8 million shares out. Management is the largest shareholder. Revenues are increasing–mostly from M&A–but losses are not really going down much. Yet.

When I first looked at it a little over a month ago, I tagged it as a good story–rolling up small health care insurers, and cross selling services to an ever larger coverage base–in need of cash. The fact that the the largest shareholder just put in $3 million helped the story.

Fast forward to today and Marpai has worked out a way to get an even BIGGER cash injection – $11.8M – and the story is far more interesting.

The downside is that the solution, an $11.8M convertible (which converts at $3, which is ABOVE current market price) is dilutive to shareholders. But it still means only 13 million shares out, and does remove any questions around the company’s viability. I think one good quarter could turn the Market around on this stock.

With liquidity concerns off the table, Marpai is trending in the right direction. They are cutting expenses and growing the business – as a third-party administrator (TPA) of health plans.

My only quibble is that so far that growth has come almost entirely from acquisition. They need to show the Market organic growth, ex-M&A.

The next couple quarters will be telling. With the new-found cash, can Marpai grow the business organically and continue its path to profitability?

If they check those boxes, we could be looking at a big winner (I am not long yet).

QUICK FACTS

Trading Symbols:                                     MRAI

Share Price Today:                                   $2.20

Shares Outstanding:                                7.8 million

Market Capitalization:                             $17 million

Net Debt:                                                  $21 million

Enterprise Value:                                     $38 million

POSITIVES

– Low float

– Niche business that acts as healthcare plan administrator to very small businesses

– Big vote of confidence from CEO’s $1.5M cash injection

– Managed to refinance debt to extend their cash runway significantly

NEGATIVES

– Ex-acquisitions, revenue is declining

– While cash burn has declined, company is still cash flow negative

– Recent issuance of convertible debt dilutes common stock significantly

– Business appears to be mainly a middleman between small businesses and large insurers

WHAT DO THEY DO?

In the USA, health insurance is the second largest cost to employers behind salary cost. Yet costs for health insurance plans for employers do nothing but GO UP.

It’s too expensive! Small employers simply can’t afford the cost of insurance.

The alternative is to self-insure. They manage their own employee healthcare costs, with the help of an administrator.

This is where Marpai steps in.

Marpai is what is known as a third-party administrator (TPA).

TPAs do the administrative work for employer health plans and (sometimes) retirement plans. They perform day-to-day tasks like:

• Processing claims
• Managing the network of healthcare providers for the plan
• Insuring compliance
• Providing customer service for the employee members

Marpai works on the healthcare side. They provide services to employers that choose to self-insure, designing the health plan and then managing it for them in return for fees.

Marpai makes money by charging management fees for managing the claims, providing a customer service face to employees and paying the claims on behalf of their clients.

Marpai adds more revenue through ancillary services. They do managed care, which is on-call nurses and check-in care providers to patients just out of hospital, and cost containment services, which can be anything from reviewing claims to looking for a generic alternative to using their AI tools for early detection of health issues.

Their niche are small companies, they call it lower-middle market, which have less than 100 employees.

A lot of this is middleman work. On a few occasions on calls management has referred to Marpai as a “matchmaker” between SMBs and big insurance providers.

Large insurers like Aetna (Private) or Cigna (CI – NYSE) typically limit their clients to businesses of 1,000+ employees. Marpai pools the employees of many small businesses into a larger bucket which they can then sell into an Aetna or Cigna plan to access their services.

Marpai also leans on their own ecosystem of targeted service partners that are value-based. They partner with a company called Virta for people with diabetes and another called Vori for people that are suffering from musculoskeletal issues.

Insured employees carry a Marpai card in their wallet or a digital card on the Marpai app. They present the card to the doctors’ office, pharmacy or hospital just as you would with a health plan from Blue Cross or a large insurance company.

Their success and growth is tied to

1. how well they provide the basic TPA services and
2. how effectively they reduce the cost of health care for their employer customers.

That second point is where Marpai’s AI-based platform comes in.

When assessing a healthcare provider, companies tend to look at the admin costs as the key determiner. Yet admin is only about 5% of the total cost. The bigger bucket, 82%, is the actual cost of care.

Marpai is targeting that 82% with the help of AI. Marpai started out as an AI-based healthcare company. Before they provided TPA services of their own, they sold their AI solutions to other TPAs.

Marpai has 6 AI modules that detect:

• Type 2 Diabetes
• Cardio-vascular disease
• Kidney disease
• Chronic obstructive pulmonary disease (COPD)
• High-cost imaging of knee
• Knee replacement.

New CEO Damien Lamendola compares their AI modules to Moneyball – using data to predict performance. Marpai uses claim history and their own algorithms to quickly address health issues and deliver better patient outcomes.

GROWTH BY ACQUISITION

Marpai grew revenue significantly in 2023. In Q3 2023 Marpai’s revenue grew by 76% YoY. The Q4 number showed 14% YoY growth.

Source: Marpai disclosures

Peeling back the onion, a lot of this growth came from acquisition. The big acquisition in 2023 was Maestro Health, which was acquired in November of 2022.

At the time of the acquisition, Marpai described Maestro as “a leading TPA based in Chicago, Illinois that serves over 80 self-insured employers”. Maestro insured 25,000 employee lives at YE 2022.

Marpai paid $19.9M for Maestro. Marpai provided the following pro-forma results for Maestro pre-acquisition in their 2023 10-Q filing.

Source: Marpai Q3 10-Q

The acquisition of Maestro was expected to more than double the number of Marpai’s customers and the number of members that it served.

In October 2023, Marpai reported that Maestro Health services “had over 60 clients who are employers that employ over 20,000 employees.”

Maestro has significantly boosted revenue for Marpai. Below is a break down of how much of the first 9-months of 2023 revenue growth came from Maestro.

Source: Marpai Q3 10-Q

Organically (ie. without the acquisition of Maestro), Marpai’s revenue would have declined by 20% YoY. But with the addition of Maestro, revenue for the first 9 months increased by 76% YoY.

MANAGEMENT TURNOVER

AND A BIT OF HISTORY

Even with the revenue growth through the first 9 months of 2023, Marpai was sitting as a 30c stock in November last year. In response to the poor performance of the stock, on November 7th Marpai announced the appointment of a new CEO, Damien Lamendola, and a new CFO, Steve Johnson.

Lamendola isn’t new to Marpai. He is the largest shareholder of the company. He is also the owner of Hillcour Holding, the parent company of a TPA called Continental Benefits that Marpai bought in 2021.

Marpai bought Continental Benefits for $8.5M in 2021. This was only a few months before Marpai went public in an IPO. At the time of the acquisition, Marpai described Continental Benefits as “operating in 50 states with 10,000’s of members and network agreements with Cigna and Aetna”.

Shortly after, Marpai went public. The IPO of Marpai closed in November 2021 and was priced at $4, raising $25M.

At the time of the merger and IPO, the legacy business of Marpai was pre-revenue, focusing on the AI platform for improving health outcomes, and had about $3.8M of operating expenses for the FY 2020.

Continental Benefits had about $18.4M of revenue in 2020 but was also losing a lot of money.

Source: Marpai 2020 S-1

A DESPERATELY NEEDED CASH INFUSION

The trend of losing money continued after the acquisition of Continental Benefits. The poor performance of Marpai’s stock at the time is what made Lamendola take over—likely because the business was becoming very short of cash.

In the first 9 months of 2023, Marpai had negative $15M of cash flow.

Source: Marpai SEC Filings

Marpai ended Q3 with only $3M of unrestricted cash.

Source: Q3 10-Q

Lack of cash and mounting losses necessitated changes. Up until this week, Lamendola had done 4 things to shore up the balance sheet.

• Lamendola bought $1.5M of stock and has agreed to commit another $1.5M by YE
• Marpai sold $2.2M of future receipts for $1.7M
• Marpai had their debt repayments pushed out with balloon payments not occurring until 2026 and 2027.
• They initiated a process of selling non-core assets.

The first and third items are related. Marpai’s debt is owed to AXA S.A, which is the company they acquired Maestro from.  In February of this year Marpai came to an agreement with AXA to reduce the acquisition price by $3M if Lamendola committed $3M of his own money to Marpai by year end.

With the new agreement the debt payments with and without Lamendola’s contributions are as follows:

Source: February 8^th 8K

Together these actions have had an impact. While cash continued to decline in Q4, it declined a lot less – Marpai ended the year with $1.1M of cash:

Source: Marpai 10-K

But the REALLY BIG NEWS happened this week. Marpai announced Tuesday that they had sold $11.83M of convertible notes to funds owned by JGB Management.

The converts come at a stiff price – they convert at $3, which means that fully converted they will add 3.9M shares, or about 50% dilution. But it is at levels ABOVE current pricing.

But the cash from the convert fills A BIG HOLE in Marpai’s cash needs. With a cash burn that was down to $2M per quarter in Q4 (and falling), it eases any worries about liquidity.

MORE GROWTH TO COME?

With more cash in the coffers, Marpai can focus on growth. Both by acquisition and organic.

On his first conference call with shareholders in November, Lamendola said to expect more acquisitions beginning in 2025.

Organic growth will come from cross-selling to existing customers and through new customer wins.

The cross-selling comes from the ancillary revenue sources. Marpai basically has three sources of ancillary revenues.

1. Maestro care management – nurse follow-ups after hospital stays.
2. MarpaiRX – a pharmacy benefit manager.
3. Marpai connect – a value-based care network.

Because of past acquisitions, not all of these have been offered to all clients. After the Maestro acquisition, then CEO Edmund Gonzalez said the big opportunity with Maestro was cross-sell, in particular, Maestro managed care.

Maestro fees in 2022 were $50/patient. This compares to fees in the low $30s/patient for the legacy Marpai/Continental Benefits business.

Ancillary fees like care management for Marpai/Continental Benefits have been outsourced in the past, which took away the margin. Maestro gives Marpai an internal care management company to bring that back in house.

You might expect the same sort of cross-sell from Marpai’s AI based health insights into Maestro.

A second growth pillar could come from the rising cost of insurance. The Affordable Care Act mandates that employers with more than 50 employees must have insurance.

Because of the rising cost of traditional health insurance, many can’t afford it, and you’re seeing a wave of SMBs moving to self-insurance or self-funding.

With their SMB focus, Marpai is well positioned to scoop them up as customers.

What I want to see now is execution on these growth strategies.

Lamendola has done a great job patching the boat. Now he needs to show they can use the cash and grow the business.

They have a favorable macro backdrop and the business team to do it. Lamendola noted on the Q4 call that they were “was successful in closing a 3-year contract with a new southeastern-based client that started earlier this month.”

Watch their next quarter results (Q1) closely. They will have lapped the Maestro acquisition, so any growth will be organic.

If I see that growth, and a continued move to profitability, I will think hard about pulling the trigger.