Insight: Care Cloud Preferred ($CCLDO)

Care Cloud’s Preferred Stock ($CCLDO) represents the type of opportunities we’re pursuing in the Small Cap Absolute Growth Strategy.

I’d written most of this post and put it on the backburner in preparation for it to be part of our quarterly letter, but a press release today made me smile and I decided to revise and inform.

Today’s press release:

“Our audit firm has informed the Company that it does not have the capacity to perform an ICFR attestation. Under SEC rules, the same audit firm must conduct both the financial statement audit and the ICFR attestation. Therefore, if an ICFR attestation becomes necessary, the audit firm would be unable to fulfill the full scope of the required audit services, and CareCloud would need to engage a new independent registered public accounting firm.”

I know what all the words mean. I’ve never seen them in that order. And further, I’ve never seen a company, say, “well F” and beg/blame its interested shareholders to trade the price down or risk delayed filings. We think the company won’t be able to file for a while, but believe we’ll be able to avoid most of the negative impact since we own the preferred shares, with dividends that can be paid in cash or accrued. The Company will be fine as they get passed this, the revenue is highly recurring and the business should continue to generate cash flow.

As background, CareCloud, Inc. is a healthcare IT company that sells revenue cycle management, electronic health records, and patient experience solutions to healthcare providers, medical practices, hospitals, and health systems in the US. They are an amalgamation of companies, but have finally integrated and operationalized their business and now generate significant cash flow for their size trading for a high teens FCF yield.

This is generally a low margin, people intensive business and is an extremely fragmented market, where customers are unlikely to churn without cause. The space was marked by startup SaaS companies trying to address it 6 or 7 years ago, and many spent significantly during Covid to grow into customers who were interested in finally adopting technology. The 70%+ typical SaaS gross margins never fell to the bottom line for many of them, however, as the business needed significant human capital to service customers and help code the data. Low margins are an opportunity, now, as owners look to exit and retire, and customers are proving to be cheaper when acquired along with a Company rather than competitively won in the marketplace. Organically, the Company should grow its business low to mid single digits, lumpily, while FCF grows significantly faster.

Free cash flow generation is a relatively recent development for CareCloud and during its growth phase, the company took on two tranches of convertible preferred stock. The coupons on that debt were significant at over 8%, but the capital was needed and in the early years the Company had difficulty generating sufficient cash flow. As per the debt covenants, rather than pay the interest payments in cash, the interest payments accrued.

Now the Company produces significant free cash flow and is using a combination of cash flow and equity to clean up its capital structure. Even while the coupons are now being paid, the first tranche of debt was recently retired. We own a piece of the second. That second tranche has an effective yield over 11%, and the instrument has two likely outcomes in our view. Either the Company continues to pay its coupon, including the accumulated but not paid payments and we earn an effective annual 11% yield monthly for the next couple years. Or the Company decides paying that much is silly at this point in the company’s life cycle and redeems it in full in cash, common shares, or a mix of both. If that were to occur, it would likely occur at over a 30% premium to where the preferred trades today.

We’d be more than happy to own the common in that eventuality. The company would then have a de minimis amount of debt, its revenue has a very high degree of recurrence, its margin structure might be helped by the application of artificial intelligence, and it would trade for a 20% free cash flow yield at around today’s price. Its growth would likely be accelerated by the acquisition of new companies where customers could be economically acquired, and the debt would cost less than the 11% we get paid annually today.

While we’re intensely interested to see what happens to the common over the next few days, in the overlooked preferred in almost every situation we think its heads we win, tails we win.