When Emdeon went public last August, analyst sentiment about the health transaction intermediary was across the board. There were plenty of bullish observers who argued the Nashville-based company is a solid, growth-ready business trading at a discount. But some asserted the company is overvalued and in danger of being pushed to the sidelines.

Now, with nearly six months as a public company under its belt and health reform still likely to include a greater emphasis on cost-saving technology, there’s still plenty of argument and confusion over aspects of the company’s business model and its prospects for the future.

At its core, the debate about Emdeon — one of Nashville’s largest tech employers with more than 800 local employees in all — centers on its ability to shed its historical image as a single-line claims processor and build on its role as a middleman for millions of other health care transactions.

Company executives say they have the plan to grow their business long-term — both organically and through acquisitions — and have taken their story on the road multiple times in recent months. But investors haven’t yet fully bought in, leaving Emdeon with a lower valuation than most of its peers.

The clearinghouse conundrum

“The big question on Emdeon is are they going to be disintermediated,” said local Jefferies analyst Richard Close.

The idea that providers and payers may begin to process claims directly, removing the need for a company like Emdeon, has been a lasting source of dispute in the investment community. A month after the company’s shares spiked as high as $18.24 on their first day of trading, Brean Murray analyst Bret Jones initiated coverage of the company with a “sell” rating and a $12 price target. He called the company’s clearinghouse business a “melting platform.”

“My biggest problem with the business has always been that we’re seeing more claims going directly to the payers,” Jones said recently. If some of Emdeon’s larger payer clients start processing claims directly with providers, Jones thinks enough volume would migrate to “erode the business over time.”

Piper Jaffray analyst Sean Wieland, who rates the company a “hold” and has a $16 price target, agrees there is long-term risk here for the company. Particularly as claims become more standardized in format, he thinks there will be less need to route claims through clearinghouses.

But executives are quick to remind investors not to pigeonhole the business.

“Many continue to think of us as our legacy company Envoy,” Executive Chairman Tracy Bahl said at an investor conference earlier this month. “Claims EDI processing is 20 percent of this company’s revenue. It’s not nearly what people believe this company is and what it’s become.”

Bahl and CEO George Lazenby are looking to make their company indispensable by building other intermediary functions such as pharmacy services, fraud prevention and electronic statements. Their two 2009 acquisitions — worth a combined $104 million — were for payment integrity and e-pharmacy ventures.

One downside to growing those ancillary businesses appears to be a muddied investment story. Larry Marsh at Barclays Capital said there is some head-scratching in the investor community about exactly what this company does.

“For many investors, Emdeon’s hard to understand. It’s not as if [investors are] behind the scenes with this medical claims highway,” Marsh said. “It’s not intuitively obvious what it is, and then there are some ancillary businesses. … When I tell people about what they do, you know people look at me and say, ‘They do what?’”

And many investors — following the lead of Warren Buffett — say that if they don’t understand it, they won’t pay up for it. That may explain why Emdeon shares settled back down to about $16 in the weeks following its IPO and have trailed the S&P 500 by 10 percent since the beginning of October. They also sport lower price-to-book values than peers such as MedAssets and HMS Holdings — 2.4 versus 5.3 and 2.9, respectively.

Selling the story

Closing that gap may just be a matter of time as more investors familiarize themselves with the ins and outs of the growing health information technology space or look at Emdeon’s business model in more accessible terms. Madison Williams analyst James Kumpel compares Emdeon to payment giant Visa to illustrate why he thinks the risk of disintermediation is low.

“If people want to, they can basically buy credit cards for Sears, Macy’s, Shell… a whole host of different direct cards so you can bypass the third-party network of Visa or MasterCard,” said Kumpel, who has a ‘buy’ rating and a $21 price target. “But that mostly benefits the payers, not the end user, because the end user’s life is complicated by having to maintain dozens of different statements and account services.”

For that reason, Kumpel thinks it makes more sense for providers to have one unified dashboard view of all their transactional information. That’s where Emdeon has been most active of late, planting flags in different parts of the health care transactions universe, a market Bahl said is worth $360 billion and growing. There’s plenty of room for Emdeon to grow: Revenues for 2009 were about $900 million.

In all, the company now provides complementary services that touch 500,000 providers, 1,200 commercial and governmental payers and 55,000 pharmacies. Those transactions include checking a patient’s insurance eligibility before a doctor visit, sending prescriptions electronically to pharmacies, shipping doctors’ claims to insurers and routing payments back to providers.

A typical doctor visit creates six to seven transactions, Bahl said — and Emdeon is responsible for at least one of those transactions in half of all commercial encounters in the country each year. It gets paid a small amount to handle each of those transactions — 5 billion times a year.

“That’s the beauty of the business model. It’s positioned right in the center of the system,” he said at the investor conference. “Everything we do on one side has a reciprocal side on the other side. When we sell a product to send a claim, we have a product to help receive the claim.”

Additionally, a third of the company’s payers work exclusively with Emdeon and another 600 channel partners incorporate some or all of the company’s services into their end-user products. And with about 95 percent of revenues coming from subscriptions, the company’s cash flow is relatively insulated from economic fluctuations.

Add up all the pieces —market share, exclusivity agreements, recurring revenue and add-on services via acquisitions made over the years — and the company is the “administrative processing backbone” for the massive and ever-growing U.S. health care sector, said Leo Carpio of Caris & Co.

“They’ve got all the pieces of the puzzle,” he said. “Now all you need is volume.”

Opportunities spotted

Government policies — however reform is eventually enacted — should help. As insurance coverage is extended to more Americans and the American Recovery and Reinvestment Act funnels cash to providers to help them implement health IT systems, the sector as a whole will generate more electronic transactions.

That volume should also lift margins. Carpio used the example of paper explanation-of-benefit forms to make the point.

“Let’s say the revenue of sending out one of those papers is $100 and after costs their margin is $26. Now if that same EOB becomes electronic … the revenue declines to $62 but the cost to process it goes down to like $7. So the dollars you’re getting from that transaction is $55.”

Emdeon estimates only 30 percent of EOBs today are electronic. Most payments from health plans are also still in paper form. Senior Vice President of Corporate Communications Tommy Lewis said components of the Senate and House health reform bills include mandates to make these transfers electronic.

“We can take about $11 billion a year out of the health care system just by converting to electronic payment,” Lewis said. “We think we’re the right partner [to do it] because we’re connected to all 1,200 payers and thousands of providers and hospitals already have our payment distribution services.”

Other areas of Emdeon’s business have similar opportunities: Only 25 percent of eligibility verification is performed electronically and just 6 percent of prescriptions are electronic. Emdeon’s e-prescribing product, acquired last year, now accounts for about 8 percent of revenues, but is growing at a rate “well over 100 percent,” Bahl said.

Additionally, through buying The Sentinel Group in 2009, Emdeon entered the fraud and abuse realm. Now the company can add a layer of service for its payer customers, checking claims sent by providers for fraud and abuse before payment is made. The Federal Bureau of Investigation estimates that fraud costs between three and 10 percent of U.S. health care spending — in the range of $75 billion to $250 billion.

Emdeon execs say cross-selling their products — adding fraud services to existing insurer relationships, for instance — could bring in $2.4 billion in new revenue over time. Carpio estimates that over the next four or five years, the company should achieve about $500 million of that.

As those numbers begin to materialize and help bring into focus the company’s place at the center of the “medical claims highway,” more investors are likely to hop on the bandwagon. That may not take long. Barclay’s Marsh thinks more people will catch on soon.

“My view is 2010 will be a year for the investing public to get to know Emdeon better and, knock on wood, I think they’ll like what they see.”