For Hims: 100X Potential
Deep Dive
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Edited by Brian Birnbaum.
This is a re-deep-dive of my original Hims deep dive.
1.0 A Second Look
Over the last few years, Hims has evolved into an organizational with great potential. It’s compounding efficiency through shared economies of scale in a manner reminiscent of our greatest companies.
The US healthcare system is an inflationary mess, with Hims standing out as a beacon of rationality and customer centricity. It is thus far excelling at an enormously complicated task, which is making healthcare convenient, effective and affordable outside of the existing system, while printing cash.
A review of the history of CVS and Walgreens reveals that today’s largely dysfunctional healthcare system is not the result of malice, but of misaligned incentives. It also sheds light on why Hims may be a generational investment or why, at the least, its approach is worth watching closely.
In theory, PBMs (pharmacy benefit managers) connect and negotiate with drug manufacturers, insurance companies and pharmacies with the ultimate intention of making drugs more affordable to end consumers. But in practice, their incentive is to continually raise drug prices so they can make more money.
PBMs took off in the 1960s and have since become the cornerstone of the pharmacy business. They are not going away anytime soon unless they are forced to do so by regulation–that is, unless the public sector intervenes meaningfully with the healthcare system, prices are going to continue rising.
On the other hand, Hims has embarked on a deflationary journey far from the reach of PBMs. They have created a vertically integrated infrastructure that allows patients of an increasing number of chronic conditions to frictionlessly access healthcare and receive personalized treatment.
Patients can access these treatments at a price below the amount they would have to pay out of pocket had they sought treatment via traditional avenues. Hims has achieved this by creating an app that connects patients with practitioners and by operating proprietary pharmacy facilities that can create personalized medicines on the go.
Hims is also sharing economies of scale with its customers by reinvesting cash into the aforementioned infrastructure and dropping prices as operational efficiency increases–which in turn strengthens the company’s moat and makes it harder for competitors to take share.
Over the last few quarters, Hims has decreased prices for customers that opt into longer-duration services. Still, gross margin has been ticking up, coming in at 80.42%, 81.84% and 83% in Q1, Q2 and Q3 2023 respectively. The combination of increasingly lower prices with rising margins is quite uncommon.
Though we need more time to be sure, the ability to implement shared economies of scale while increasing margins is indicative of operational and perhaps even cultural excellence.
Merging a digital front door (app) with an automated back end is complicated enough, but Hims has been doing this while actively expanding its treatment selection. Hims launched its hair loss vertical in Q2 2021, skin care vertical in Q3 2021, erectile dysfunction in Q2 2023, and cardiovascular in Q3 2023.
Management reiterates in pretty much every earnings call that they only pick new verticals that offer a sufficiently high return on capital. Their picks have been excellent thus far, demonstrating great discipline.
However, Hims has a considerable dependency on paid marketing. So the above is not fueled by organic traffic. Despite the added cost burden, Hims still manages to print cash. The average payback time for each user acquired via paid marketing is under a year.
The complexity of the operation is such that its success points to world class management. Hims CEO Andrew Dudum owns 10% of the company, which means that his interests are highly aligned with shareholders. He is also 32 years old, which means he likely has a long runway ahead.
Its moat also grows stronger as it drives increased personalization, driven by their automated pharmacies. As these facilities become fully operational, revenue share from personalized products increases, coming in at 35% and 45% in Q2 and Q3 2023, respectively.
Personalization further compounds the complexity of the business, making it harder to imitate and more irreplaceable for customers. At a deeper level, however, what is striking is how diligently Hims is expanding its underlying personalization infrastructure.
The percentage of total orders fulfilled from proprietary pharmacies has been increasing like clockwork over the past year and a half, climbing from just over 50% in Q2 2022 to 80% in Q3 2023. The metric is expected to reach 100% in Q4 2023, meaning this information should be public shortly after I send this deep dive out.
A small caveat: I spotted the CEO saying during the Q2 2021 earnings call that the company expected to fulfill all orders via proprietary pharmacies by the end of 2022. Yet this is happening a year later.
Hims actually onboarded its ability to manufacture personalized treatments via the acquisition of Apostrophe in July 2021, which at the time had a prominent dermatology business. The acquisition therefore allowed Hims to not only attain manufacturing competence, but also enter the dermatology sector.
What’s also interesting is how unlikely success was leading up to this moment.
Most acquisitions are a total failure. On the contrary, Hims has used Apostrophe’s personalized dermatology infrastructure to personalize treatments for all verticals. Quarter after quarter, its proprietary facilities are increasingly operational and gross margins are ticking up, followed by cash from operations.
In aggregate, my impression is that either Hims is a statistical anomaly or managed by exceptional individuals. Either way, it is on course to rapidly increase efficiency while implementing shared economies of scale, standing out as a truly disruptive force in the US healthcare industry.
With just 1.42M subscribers at the end of Q3 2023 and a global population increasingly prone to chronic conditions, this company has a very long runway ahead. If indeed the above is the result of extraordinary organizational properties, Hims has plenty of upside by simply carrying on as they have.
2.0 Competitive Analysis
Hims is barely seven years old; information on competition is scarce, but alternative data sources suggest Hims is well positioned against competitors.
Competitive Scenario Synthesis
Competitive Scenario Synthesis
Per my reasoning below, I believe Hims’s exclusive focus on digital customers, coupled with its complex vertical integration, will pay dividends. Although Amazon is looking to enter the business, Hims’s operation is in fact highly defensible.
Additionally, Hims is far ahead of its direct competitors, like Ro. In turn, although I believe analogue pharmacies will continue being relevant going forward, I believe they will not be able to delight customers on the digital end of the spectrum.
Start Up Competitors
There are a bunch of startups that essentially do the same things as Hims, with the closest competitor being the aforementioned Ro. There’s plenty of additional activity in the private markets that we cannot fully get a read on. However, the US App Store’s top 100 apps yields some clues.
The Hims iOS (28.4K ratings, 4.8 stars) app is #16 in the US app store, with Teladoc (518K ratings, 4.8 stars) just ahead at #12. CVS Caremark (46.6K ratings, 4.4 stars) is #35, My Invisalign is #43 (53.8K ratings, 4.8 stars), and Ro (2.2K ratings, 4.8 stars) is #89.
The first thing that stands out is that, if we assume the same percentage of users leave a review for Hims as they do for Ro, Ro is a much smaller company. Secondly, none of the other private market competitors are featured in the top 100 list. It may therefore be prudent to assume that Hims has a clear lead on its startup rivals.
Similarly, on Trustpilot, Ro has just 639 reviews while Hims has 3,340 reviews. It’s interesting to note that Hims’s reviews are worse than Ro’s on Trustpilot, while this is not the case on the app store. It’s unclear what conclusions we can draw from this as of yet.
Further, the Hims iOS app only launched in January 2022, yet already ranks ahead of CVS’s app and just behind Teladoc’s, the latter of which has the largest healthcare data repository in the US. For additional context, CVS’s app was launched in March 2013 and Teladoc’s in 2013.
In just a year’s time, Hims is raking among peers with vast distribution advantages and highly established brands. Much like the string of unlikely events analyzed in Section 1.0, this is either another statistical anomaly or the result of exceptional management.
I tend toward the latter.
Teladoc
Following my Teladoc deep dive and my latest update on the company, my qualitative impression is that they don’t know what to do with their patient data. They’re meant to unlock longitudinal medicine, but per the evolution of their average revenue per patient, they don’t seem to be making progress.
Hims has taken a different approach, which is building an entirely new infrastructure to make the healthcare experience better from scratch. In turn, this generates data which, unlike Teladoc, Hims can use to further improve its underlying infrastructure.
Competitively, Hims is therefore in a more interesting position to bring longitudinal medicine to life, since data is accretive to its service. On the other hand, Teladoc has to modify the existing healthcare system for the insights its data generates to be valuable at all.
This is not to say that Teladoc won’t go anywhere, but rather that Hims has an infrastructure with the adequate properties for it to snowball for decades. The feedback loop between its data-driven insights and its healthcare infrastructure is much faster than Teladoc’s, which on the contrary experiences plenty of friction.
Hims currently focuses on stigmatized conditions, which give it a stronghold on a corner of the market. By carefully picking additional verticals and conditions to treat going forward, there’s no limit to what percentage of the overall healthcare market they can address.
CVS and Walgreens
Taking a step back, the US pharmacy market is essentially a duopoly between CVS and Walgreens. Although these two companies have tremendous distribution advantages and are taking steps to digitize, I suspect they will not be able to meet digitally-native customers quite how Hims does it.
To be clear, the overlap between Hims and these two companies is currently small, but they are on a collision course. Hims operates outside of the PBM/insurance arena, but it effectively competes for the same mind share. As Hims expands its offerings, competition will get tighter.
Ten years down the line, a future in which Hims runs hundreds of proprietary facilities across the US and treats 100M Americans is not inconceivable. This would be a considerable counterweight to both CVS and Walgreens, especially if Hims manages to take share by lowering prices below what insured patients pay out-of-pocket.
Over the next decade customers will come to expect increased convenience in the digital realm. Meanwhile, healthcare prices seem set to continue spiraling upwards. The macro atmosphere is growing combustible.
Although there are many distinctions to be made between CVS and Walgreens (and the history of the fight between the two is fascinating), going forward their weakness is also set to be their strength. Their physical presence is set to be increasingly important once the healthcare system moves towards becoming either outcomes- or value-based.
In the current healthcare system, if the traditional process doesn’t work for patients, that’s tough luck. In a value-based system, patients are constantly being monitored to ensure the treatment is working.
Physically checking patients will be even more valuable going forward. Both CVS and Walgreens are gearing up to capitalize on this opportunity.
Per the comments of the CEO in Q4 FY2024, for example, Walgreens is already preparing to deliver gene therapy across its physical network, initially by engaging in trials. Although I’m sure gene therapy patients in the future would appreciate a delightful app to manage their treatment, there’s no substitute for any solution that allows patients a chance at modifying their genes.
CVS’s CEO Karen Lynch also has a vision for transforming CVS’s role in the healthcare system, moving towards a value-based approach.
While the implications for CVS’s and Walgreens’ physical infrastructure are not to be understated, I believe Hims’s exclusive focus on the digital front will act as a crowbar for it to disrupt the duopoly over time, ultimately driven by lower prices, higher convenience and a more personalized selection.
Amazon
Andy Jassy said the following on Amazon’s Q4 2023 earnings call:
[…] if you think about what we do on the retail side, adding a pharmacy capability is a pretty natural extension.
It's something that customers had asked us for many years, and it's got more complexity to it than the rest of our retail business.
So we have to think carefully about whether we wanted to pursue it, but customers so badly wanted it and the experience we thought could be better and we could be a meaningful part of changing that, that we pursued it.
My intuition, corroborated by Jassy’s comments above, is that the pharmacy business has tremendous complexity and that, in turn, Hims’s vertical integration is even more complex. At this stage, the combination of the digital front door and automated backend engenders a highly defensible operation.
As you may know, I have encountered a special group of smaller companies successfully defeating Amazon against all odds, mostly enabled by superior, narrower focus. This focus enables them to pull off one “impossible” feat after another. Among them are Spotify and Crowdstrike.
To the outside observer, their continued success looks like a mere coincidence, but they are in fact finely tuned organizations with a distinct ability to navigate the unknown within their unique fields. They blaze a trail right from the start, which only with hindsight becomes distinguishable to the market.
Hims seems to have figured this out, and positive cash from operations is the cherry on top. At this point, I trust management to successfully navigate the healthcare market going forward because they have managed to be cash flow positive against all odds.
The pharmacy business is large enough to attract Amazon and any other large retail operation, but I believe that Hims’s exclusive focus will prevail.
3.0 Artificial Intelligence
Hims has recently deployed an AI solution to further accelerate its flywheel, the first instance in the healthcare industry of a closed AI loop.
In Q3 2023, Hims launched Medmatch, a “proprietary service that deploys artificial intelligence and machine learning against the expansive dataset at the core of the Hims & Hers platform.”
This is the sort of data science that I was alluding to in the earlier section, when comparing Hims’s architecture to Teladoc’s. Hims can deploy this service for each of its verticals and translate the insights it yields into productive modifications of the healthcare process–without having to deal with the inflationary, slow, and costly traditional healthcare system.
With nearly 1.5M subscribers–and assuming Hims has been storing the anonymized data–MedMatch will see in one day more patients than a physician can see in ten lifetimes. As Hims continues to scale, this competitive advantage will continue to compound.
Medmatch is another sign of the company’s relentless pace of innovation, which I find encouraging. Secondly, I believe this is the first instance of an AI closed loop in the healthcare industry.
No one else is treating millions of patients while picking up data and immediately applying the resulting insights to iterate an underlying and vertically integrated healthcare infrastructure. All other AI loops require, like Teladoc, a modification of the sluggish traditional healthcare system.
Certainly, other players have more data. But it’s not so much about the volume of data as it is about the applicability of the insights that it yields. A smaller system that learns faster will over time outpace a large one that learns slowly.
Going forward, this loop should act as a tailwind for Hims, improving patient outcomes per dollar invested in the business. This should equate to improved unit economics, which should in turn translate into a more attractive cash flow profile.
For now, Hims treats a limited range of conditions and only serves a small portion of its addressable market. But if my understanding of the company is correct, they will replicate their current manufacturing facilities many times over going forward.
As they reach more customers, get better at manufacturing and generally cure more patients, I believe AI will become the company’s most important asset. It will increase physician productivity by orders of magnitude and non-linearly increase the company’s operating leverage.
5.0 Financials
Income and Cash Flow Statements
Management seems highly focused on reinvesting cash into the business. This is fundamental to the long term thesis, since scale is an essential competitive advantage in the healthcare space and a key enabler of AI.
This focus is most evident in the quarterly evolution of capital expenditures since early 2021, with management investing more and more as the business grows.
In Q1 2023, an analyst asked Andrew Dudum why they raised revenue guidance for FY2023 by $75M, but EBITDA guidance was only raised $2M. Andrew’s answer is a qualitative exploration of the above graph:
And so really, I think as we take more of a longer-term orientation to our investments, we just see so many different facets and opportunities to continue to drive growth across the platform.
And so, I think our focus right now is primarily on getting greater scale that comes both in the form of incremental users on the platform, as well as the scope of offerings.
And we just see so many different opportunities where we have room to deploy capital, lawful abiding by our capital allocation framework.
Focusing on profitability is simply the wrong way to analyze Hims’s financials. With such high return on invested capital (ROIC), I want the business to reinvest all it can into growing further. As such, I am delighted to see operating income hovering just under zero, with cash from operations taking off.
I include the latter graph again, for your convenience.
90%+ of the revenue is recurring because the business is subscription based. Although this is great to see, financially, it’s difficult from a medical standpoint, since my understanding of medicine is that many of these conditions are curable via holistic practices that can eventually get patients off medication.
However, since the last time I did a deep dive on the company, I have come to accept that most people do not care. They want a pill that allows them to forget about their condition, effective immediately.
Also, the infrastructure that Hims is building is ideal should they pivot to holistic care once/if the US goes in that direction.
Balance Sheet
At the end of Q3 2023, Hims had $212.5M in cash and equivalents with just $2.8M in capital leases and no debt. As ever with this sort of company, investors pay the price for this balance sheet in the form of elevated SBC (stock based compensation).
SBC came in at $17.3M, or 7.63% of revenue, in the quarter. As I’ve said many times, reaching a conclusion about SBC based on the numbers alone is impractical.
It comes down to one’s reading of management and whether they will burn shareholders or not. My general perception of Andrew Dudum is that he is running Amazon’s playbook and that he won’t burn shareholders.
But that’s just my gut feeling.
6.0 Conclusion
Perhaps the one thing that I do not like about the business is its dependency on paid marketing. But this isn’t necessarily their fault. People just don’t go around telling their friends about healthcare providers in general, because we don’t speak openly about health issues in our culture–particularly issues as sensitive as ED, a core vertical–which is why Hims relies on marketing to grow.
However, there are a number of ways that word of mouth can take off, especially via the internet, such as forums and niche corners of social media. The company nonetheless manages this dependency very effectively and thus organic growth stands as a potential tailwind.
If and when it does kick in, Hims’s unit economics could be vastly improved.
Otherwise, Hims is a textbook example of a company with extraordinary organizational properties, pulling off one impossible feat after another. In turn, management is focused on reinvesting cash and creating value long term.
The healthcare space is a complicated one, but Hims management has proven they possess the ability to navigate this complexity. I would therefore at this stage be comfortable putting my money in their hands.
I very much look forward to analyzing the Q4 2023 earnings results, which I will be sending out too.
Until next time!
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