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Insiders Here Don’t Think A Takeover is Necessary

Quality Systems Inc. (NASDAQ:QSII), which provides clinical software for healthcare clients such as dentists and hospitals, saw three large insider transactions reported on July 31st. George Bristol, a member of the Board of Directors, bought 10,000 shares of the stock at an average price of $16.02. Insider buying is generally considered a bullish sign because insiders have an incentive to diversify their portfolios and cash flows to reduce risk; putting more money into the same stock serves as a signal of confidence that the stock is undervalued. This is particularly true when we see multiple insiders buying– and, with fellow Board member Russell Pflueger also buying 10,000 shares on Tuesday (at an average price of $16.06 in this case), we should be more confident in the stock. Ahmed Hussein, another Board member and 10% owner of the $1 billion market cap company, sold 1.3 million shares but has claimed that this was due to a margin call on his position as the stock price fell. Hussein had been attempting to launch a proxy battle against the company by nominating seven replacement members to the board. He recently wrote to shareholders urging them to support his slate, but Bristol and Pflueger apparently think that current management has things well in hand and that the stock is a buy at these levels.


Quality Systems has had an ugly year. The stock price is currently down 55% from the beginning of 2012 after missing earnings estimates by at least 10% in its last two quarterly reports (including, in its most recent quarter, earnings of 26 cents per share versus an expectation of 35 cents). Failing to meet expectations, and therefore changing expectations of future growth rates, can be devastating to a software company. In the most recent quarter, the first quarter of fiscal year 2013, the company’s earnings actually fell compared to the same period a year ago and Quality Systems currently trades at about 14 times trailing earnings. Revenue was up 18%, but cost increases outpaced that gain. Hedge funds have generally dodged the fall in the share price this year; Columbus Circle Investors reported the largest 13F position in the stock at only 300,000 shares. Billionaires Ken Griffin and Steven Cohen also have small positions in the stock (see Steve Cohen’s top positions).

Quality Systems Inc (NASDAQ:QSII)’s two closest peers are Allscripts Healthcare Solutions Inc (NASDAQ:MDRX) and McKesson Corporation (NYSE:MCK). Allscripts Healthcare Solutions Inc has taken a similar tumble in the stock market, down 49% in the last year, and trades at 26 times trailing earnings. Despite its earnings falling by over 50% in its most recent quarter compared to a year ago, sell-side analysts expect it to grow in the future and its forward multiple is actually a 10 to Quality Systems’12. McKesson Corporation (NYSE:MCK) is a larger, more diversified company and hasn’t suffered the hit to its business that the other two companies have, with both trailing and forward multiples between 11 and 15. We think that it is a safer, lower-drama pick than Quality Systems Inc. Finally, athenahealth Inc. (NASDAQ:ATHN) provides billing and health record services to healthcare clients, a similar business model, and also saw negative earnings growth in its most recent quarter compared to the previous year. The market loves athenahealth Inc, however, pricing it at 195 times trailing earnings and 68 times forward earnings. We don’t think this pricing is justified.

Statistically, Quality Systems is a buy based on the consensus of multiple insiders, but for any investors who follow that strategy we would advise them to keep this position small. True, the company is priced at reasonable earnings multiples, but we would like to see earnings growth as well before recommending it on value grounds. Perhaps investors intent on buying should pair that long position, if possible, with a short in Allscripts Healthcare Solutions or athenahealth Inc to reduce industry-related risk.

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