The surging Clover Health (CLOV) share price

Before breaking down what’s going on with the CLOV share price, let’s take a look at the actual business. Clover Health is a Medicare Advantage health insurance company. The revenue model is pretty simple. Customers pay a monthly premium and should they ever need to visit the hospital, the bill is largely taken care of.

An insurance company wouldn’t be my first guess for a business capable of almost tripling in the space of a week, so what happened? It seems the Reddit army is at it again. Unless you’ve been living under a rock, you’ve probably heard of the meme stock movement that sent the share prices of companies like GameStop and AMC Entertainment through the roof, despite poor underlying fundamentals. These retail investors now have their sights locked on Clover Health, making the recent surge in the CLOV share price a result of yet another short squeeze.

Investigating what happened

Back in February this year, famous short-selling firm Hindenburg Research published a report against Clover Health with some pretty serious accusations. It proclaimed that Clover Health failed to disclose a Justice Department investigation when going public via a SPAC. It also accused Chamath Palihapitiya, a backer of the SPAC, of misleading investors when promoting the business.

Following this report, the Securities and Exchange Commission started an investigation. And since then, the volume of shares being sold short has climbed to around 36% today. With such a high short interest, retail investors adamantly started buying shares pushing the CLOV share price up to trigger a short squeeze.

But is this a case of a bad business being inflated by an internet frenzy? Maybe not. The management team has vehemently denied the accusations. CEO Vivek Garipalli described the report as “rife with ad hominem attacks, sweeping inaccuracies and gross mis-characterisations”. And so, giving the company the benefit of the doubt, is the underlying business worthy of its newly elevated valuation?

The underlying business

Unlike other meme stocks, Clover Health does actually look healthy. It has a nearly insignificant amount of debt ($46m) on the balance sheet with plenty of cash ($405m) to spare. What’s more, the company has been successfully growing its customer base over the years, rising from 16,000 members in 2016 to over 66,000 as of the end of March this year. Combining this with a rapidly expanding revenue line makes the company appear to be somewhat undervalued, assuming growth can be maintained.

Having said that, I’m personally not interested in adding this business to my portfolio. Like many Medicare insurance providers, the bulk of the revenue actually comes from the US government, as most customers pay their premiums directly to Medicare.  Suppose the allegations by Hindenburg Research prove to have merit? In that case, it could embroil the business in expensive legal proceedings that would likely compromise the CLOV share price.

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What is Clover Health?

Putting aside the fuel from the army of those on internet chat sites, let’s consider Clover Health in the cold light of day. The company is a US-based Medicare plan provider. Its insurance is mostly for the Southern states, including South Carolina, Tennessee and Texas.

The business has performed well recently, which is one reason to support Clover Health shares moving higher. In the 2020 results that were released in March, total revenue grew 46% year-on-year.

It measures success via the membership numbers it has. On this metric, it had a membership of 58,056 as of the end of 2020, a 36.3% increase from 2019. 

Indeed, the potential for further growth was one of the reasons that Clover Health shares can be traded today. Via a reverse merger with successful businessman Chamath Palihapitiya, the business went public last year. The vehicle (known as a SPAC) that was used to get Clover public is becoming increasingly popular for large investors who see value in other businesses.

Should I buy Clover Health shares?

So I’ve established that the company is well grounded and that Mr Palihapitiya saw enough value in it to take it public via a SPAC. How does the meme crowd get involved?

This is slightly harder to explain as there’s no set criteria for the type of stock that such retail investors go after. Some look at stocks that are heavily shorted. Shorting a stock is when an investor thinks the share price will fall. It involves borrowing the stock from a third party, selling it and then looking to buy it back at a lower price. But if the share price rises and the loss is high, the investor would have to buy back the stock and return it to whoever they borrowed it from. This bumps the price up even further.

As was seen with heavily shorted stocks like GameStop, pushing the price higher can trigger an even larger move as those who are ‘short’ have to buy back the stock.

What this meant for Clover Health shares was a move from around $9 at the start of June to a price of $15 now, with highs above $22 last week. Interestingly, last Tuesday, over $14bn worth of stock was traded, an amount larger than the market capitalisation of the company!

I personally wouldn’t buy Clover Health shares right now though. I see the rush to buy from the meme stock community as a negative. It’ll distort the fair price of the shares, making it hard for me to tell what the true value is. Volatility is also increasing, which is something I’d rather stay away from.

Don’t get me wrong, I do think the price could go higher from here in the short term. But this will be fuelled by speculation, and it’s not something I want to be involved in.

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While past performance is no guarantee of future gains, I can see several technical factors that could drive Clover’s share price higher in the coming days and weeks.

What’s special about CLOV?

Clover Health, a Medicare-backed health insurance provider, has seen its stock double since it went public in October 2020 in a $3.7bn deal.

The company’s latest earnings release showed sales rising by 21% to $200m during the first quarter, compared to the same period last year. Clover’s management expect the business to deliver revenue of around $820m in 2021 and said membership is on track to rise by between 17% and 21%.

However, Clover has already attracted some critics. In February, the shares fell sharply after short seller Hindenburg Research issued a critical report on the firm. Following the report, Clover issued a statement confirming it was under investigation by the US Securities and Exchange Commission (SEC).

I see this as a potential risk for investors over the medium term. But, right now, I think Clover Health’s problems could actually help to send the share price higher.

Short squeeze could lift Clover Health share price

One of the reasons retail traders are backing Clover Health shares is that the company has become heavily shorted. This means that investors — usually hedge funds — are betting that the stock will fall.

To short a stock, funds borrow shares from other investors and then sell them. They hope to be able to buy back the shares at a lower price later on, generating a profit.

When a stock that’s shorted starts to rise, then a short squeeze can take place. When short sellers see their losses getting larger, they start to buy back the shares they’ve borrowed.

This extra buying can often lift the share price. In turn, this causes more shorters to buy back stock, sending the share price even higher. That’s a short squeeze.

CLOV: heading to the moon?

Clover Health shares closed up by 85% on Tuesday. As I write this Wednesday morning, US pre-market pricing is suggesting Clover stock could open another 20% higher today.

In the short term, I think that market forces could send Clover stock higher — possibly a lot higher.

However, on a fundamental view, this stock already looks expensive to me. Clover’s market-cap of $9bn values the shares at 11 times 2021 forecast sales, even though the business isn’t expected to make a profit until at least 2023.

To consider investing in Clover, I’d need to do more research about the opportunity the company is targeting in the US health insurance market. I’d also want to understand short sellers’ concerns in more detail.

If investors start looking at fundamentals, rather than chasing trends, I think Clover Health stock could fall quickly and without much warning. The situation is too speculative for me, so I won’t be buying.

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