A Preferred Stock In A Growing Market With A 20%+ Yield & 145% Upside To Par

Summary

  • While dilution appears priced into the stock, I have a hard time seeing a catalyst for them soon.
  • Teledoc and others are jumping into OnTrak’s market and the company will have a hard time going it alone.
  • I don’t think they will go it alone. Recent filings indicate a takeover, probably by Salesforce, is coming.
  • Common shares likely won’t go up much though, rather, the Preferred are where the action will be as it closes the gap to par.

The total addressable market for mental healthcare is massive and growing. In the U.S. alone, behavioral health expenses, despite being a very underserved market, are around $100 billion. By 2030, global behavioral health market is expected to top a trillion dollars. 

Outpatient counseling (35%) and home based treatment (15%) account for about half of behavioral healthcare. That’s good for those providing technology solutions in the space. It is not hard to see where this is an attractive emerging market for technology based healthcare providers.

OnTrak (OTRK) had some first mover advantage for tech driven behavioral healthcare, but that is largely gone now with the influx of other providers to the space, including Teledoc (TDOC) among others. 

From their Q3 earnings transcript:

“In light of the large number of digital apps now available in the behavioral health marketplace, we have been intently focused on meaningful engagement, by which I mean, clinical measures of member care teams, interactions that have proven behavioral science-backed verifiable outcomes.”

At this point, OnTrak is simply too tiny to go it alone anymore. Their revenue is only going to be around $86m this year according to guidance provided at the Credit Suisse Healthcare Conference.

OnTrak needs more resources. Recent filings and an upcoming special shareholder meeting indicate that something is going on to address their needs.

I expect a major dilutionary event. While it might already be priced into shares, I am selling my OnTrak (OTRK) common shares anyway. Read below to understand why and what else I am doing. 

OnTrak Filing Details

OnTrak has substantial NOLs (net operating losses) and NCLs (non-capital losses) which it has been using Section 382 provisions to protect for use as offsets to future income. They will beholding a special meeting on March 1st to vote on provisions regarding their use of 382 restrictions and the impact on ownership events.

Per their recent Definitive 14A filing: 

Original Background and Purpose of the 382 Restrictions

We have available NOLs, NCLs and certain other tax attributes to reduce our future taxable income. NOLs and NCLs benefit us by reducing current or future taxable income, if any (subject to certain limitations) and thereby reducing or eliminating the U.S. federal corporate income tax on such income. The benefit of the NOLs, NCLs and certain other tax attributes can be reduced or eliminated if we undergo an ownership change, or Ownership Change, as defined in the Internal Revenue Code of 1986, as amended (the “Code”). Generally, there is an “Ownership Change” if, at any time, one or more 5% shareholders (as defined in the Code) have aggregate increases in their ownership in the corporation of more than 50 percentage points looking back over the relevant testing period, which can occur as a result of acquisitions and certain dispositions of common stock by 5% shareholders. At the time of entering into the Note Purchase Agreement providing for the issuance of our Senior Secured Notes due 2024, our Board believed that it was in the best interests of our company and our stockholders to adopt provisions in our certificate of incorporation, that were designed, subject to certain exceptions, to restrict direct and indirect acquisitions of our common stock and similar securities that could result in the imposition of limitations on our use, for U.S. federal income tax purposes, of the NOLs, NCLs and certain other tax attributes that are and will be available to us (collectively, the “382 Restrictions”).

Our NOLs and NCLs and a Description of Section 382 and Section 383

We have NOLs and NCLs that are expected to reduce a substantial portion of any future taxable income and gain. We also may recognize losses and deductions (“built-in losses”) in future years with respect to assets whose value currently exceeds our tax basis in such assets. Sections 382 and 383 of the Code impose significant limitations on the ability of a corporation to use its NOLs and NCLs to offset income in circumstances where such corporation has experienced an Ownership Change. Those sections may also limit our ability to use any built-in losses recognized within five years of any such Ownership Change. Generally and as indicated above, there is an Ownership Change if, at any time, one or more 5% shareholders (as defined in the Code) have aggregate increases in their ownership in the corporation of more than 50 percentage points looking back over the relevant testing period. The relevant testing period is generally the prior three-year period, but the testing period generally does not begin before the first year in which a NOL or NCL was generated, unless the corporation has a net unrealized built-in loss at the time of an Ownership Change. We currently have a net unrealized built-in loss. The principal reason for adopting the 382 Restrictions was to prevent investors from aggregating or reducing ownership in our company and triggering an Ownership Change and thus preserve such tax attributes to reduce future U.S. federal corporate taxable income.

Collateral Effects of the 382 Restrictions

To implement the 382 Restrictions, in 2019 we amended and restated our Certificate of Incorporation to add Article Eight containing the provisions regarding the 382 Restrictions, which generally prohibit any direct or indirect sale, transfer, assignment, exchange, issuance, grant, redemption, repurchase, conveyance, pledge or other disposition of shares of common stock of our company or rights or options to purchase common stock of our company or any other interests that would be treated as stock of our company under the income tax regulations promulgated under the Code, if as a result of such sale, transfer, assignment, exchange, issuance, grant, redemption, repurchase, conveyance, pledge or other disposition, any person or group becomes a Substantial Stockholder, which generally includes a person or group that beneficially owns 4.9% or more of the market value of the total outstanding shares of common stock of our company, or the percentage of common stock of our company owned by a Substantial Stockholder would be increased or decreased. As a result of these restrictions, certain transfers of stock by or to existing Substantial Stockholders are prohibited. Any attempted transfer in violation of the foregoing restrictions are null and void unless the transferor or transferee obtained the written approval of our Board consisting of seven directors. There are seven.

Following the effectiveness of the 382 Restrictions, if our Board determined that a transfer would be prohibited, then, upon our written demand, the purported transferee would be required to transfer the securities that were the subject of the prohibited transfer, or cause such securities to be transferred, to an agent designated by our Board. The agent would then sell the securities to a buyer or buyers, which may include our company, in one or more arm’s-length transactions that comply with the 382 Restrictions. If the purported transferee had resold the securities before receiving our demand to surrender them to our agent, the purported transferee would be deemed to have sold the securities for the agent and would be required to transfer to the agent any distributions received with respect to such securities and any proceeds of the sale of such securities (except for any proceeds which our company granted the purported transferee written permission to retain and which do not exceed the amount that the purported transferee would have received from the agent if the agent had resold such securities). The proceeds of the sale of any such securities would be applied first to the agent to cover its costs and expenses, second to the purported transferee, up to the lesser of the amount paid by the purported transferee for the securities or the fair market value of the securities at the time of the attempted transfer, and third to one or more charitable organizations selected by our Board.

The 382 Restrictions, subject to certain exceptions, require any person who acquires or attempts to acquire shares of our common stock or rights or options to purchase our common stock or any other interests that would be treated as our stock under the income tax regulations in violation of the Section 382 Ownership Limit described above to provide to us such information as we may request in order to determine the effect, if any of such purported transfer on the preservation and usage of the benefit of our NOLs, NCLs and certain other tax attributes.

Upon effectiveness of the 382 Restrictions, all certificates representing newly issued shares of our stock as well as certificates issued in connection with the transfer of shares that are subject to the foregoing restrictions bore a legend referencing such restrictions.

Although the 382 Restrictions were intended to reduce the likelihood of an Ownership Change, they significantly reduced the flexibility of our company to issue equity securities, as any such issuance needs to be evaluated in light of the possibility of an Ownership Change implicating the 382 Restrictions and voiding the issuance of such securities. As a result, and in light of our current financial situation and forecasts of our ability to utilize our NOLs and NCLs, at this time the Board of Directors believes that the potential benefits of the 382 Restrictions may be greatly outweighed by the severe restrictions they impose on our ability to pursue equity financings and, should the requisite holders of our outstanding Senior Secured Notes due 2024 approve such amendment, the Board of Directors should be given discretion to amend the Amended and Restated Certificate of Incorporation to remove the 382 Restrictions. The removal of the 382 Restrictions could result in an Ownership Change which could have the effect of limiting otherwise available NOLs, NCLs and certain other tax attributes to reduce our future taxable income. Our Board currently believes that the flexibility from the removal of the 382 Restrictions substantially outweighs the loss of such tax attributes. However, even if approved by stockholders at the Special Meeting, prior to filing an amendment to the Amended and Restated Certificate of Incorporation to remove the 382 Restrictions, the Board of Directors may determine, in its sole discretion, not to effect the removal of the 382 Restrictions and not to file any amendment to our Amended and Restated Certificate of Incorporation.

Interpretation Of OnTrak Imminent Moves

The above statement by OnTrak clearly lays out a major event on the horizon. There are several that could happen.

First, there is a possibility that OnTrak founder, Chairman and former CEO Jonathan Mayhew might try to take the company private. He currently owns 44% of outstanding common shares. 

I do not think a “take private” is likely given the highly competitive environment that has emerged. Rather, I think Mayhew is looking for scale, tech expertise, a sales force and financing. 

That means that we should expect outside investment. The company could simply sell shares to institutions that might make one of them a 5% owner. This would not be a difficult line to cross as they have on the shelf enough shares to dilute current shareholders by about 50%. Selling shares to raise funds to buy what the company needs could be a route, but given the speed at which this space is moving, I do not see that as forward looking.

I think the most likely event coming is a strategic investor with scale, tech expertise, a salesforce and financial means.

Why Adobe Will Likely Invest In Ontrak

customer and tech partner already…

More coming via update…

OnTrak Is Growing Again

coming…

A Preferred Approach To Being Involved

The common shares might already be bottom priced. It’s hard to know. If you are risk tolerant, you can hold the shares. However, if you are not, then sell and buy the preferred shares a few members have mentioned. 

Here’s why.

The Ontrak Preferred (OTRKP) are yielding over 20%. That’s not the reason to buy though. The reason to buy is because the shares have to be retired at par and are trading at around $10-11 per share. Par is $25. That would be a 150% gain. 

This is a average risk play as the company has $80m in cash on hand and a shelf registration to sell shares. The common might get diluted 50%, but the company won’t go bankrupt. Plus the tech is valuable to major tech companies looking to build health platforms along with their other tech platforms.

The company is generating around $80-90m in revenues, much of it recurring for at least the next 2-3 years. They are also growing with the LifeDojo app taking the lead in building relationships. Note the Adobe relationship. 

I made OTRKP a 2% holding yesterday and today in place of OTRK. Make sure to use a GTC limit order set at the ASK. The preferred is thinly traded and you don’t want to miss the price. General pessimism on lack of understanding of the turnaround and nobody talking about the likely new big investor should give you the volatility to get filled.

Disclosure: I/we have a beneficial long position in the shares of OTRKP either through stock ownership, options, or other derivatives.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.