Hims: Has Evolved into An Optimization Machine
Hims: Has Evolved into An Optimization Machine
Update
Edited by Brian Birnbaum and an update of my original Hims deep dive.
By delivering a concierge experience via an app, Hims is essentially building a new front door for the healthcare system. Their vast potential lies within the (American) health care system’s failure as related to inflationary dynamics and general disregard for patient convenience and outcomes.
A digital concierge experience and budding back-end can fix these two problems over the long run.
Uber changed the transportation market not by refactoring the supply side but creating a demand-side funnel wide enough, for the supply side to eventually be forced to succumb. In my Hims deep dive, I explained that the company could change the healthcare market in the same way.
At that time Hims was confronting two major challenges:
A dependence on paid marketing to achieve growth (Section 1.0)
A cumbersome vertical integration process meant to bring costs under control (Section 2.0).
Together with its already healthy retention levels (85%+) and capacity to launch and gain traction in increasing healthcare verticals, the above endeavours should produce a healthy business going forward. Thus, a deep analysis of these two components of the business is paramount to assess the viability of the long thesis.
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The evolution from Q2 2022 (the time at which I wrote the deep dive) to now includes:
making very impressive progress on vertical integration, evidenced by positive cash from operations as seen below.
continued dependence on paid marketing for growth, with marketing spend as a % of revenue largely flat.
1.0 Increased Operating Leverage
Operations are much more efficient while sharing economies of scale with loyal (long duration) customers.
Gross margin increased from 79.15% in Q2 2022 to 81.84% in Q2 2023. What is fascinating is that they have been able to expand margins, while sharing economies of scale. In Q2 2023, CEO Andrew Dudum announced that in the past few months they have “begun to systematically lower prices” for many of the longer duration offerings–while gross margins have expanded.
During the quarter, price reductions have shifted 35,000 customers to longer duration subscriptions. Per the data from Q1 2022, the shift to longer duration is in turn expanding gross margins along with economies of scale. Therefore, while the cost structure seemed to be in dire straits only a year ago, it is emerging as a cost-optimization machine that can afford to be generous with its customers.
According to management, the cost structure’s positive evolution is largely due to a shift towards affiliated pharmacies. Management said they fulfilled more than 50% of orders in Q2 2022; 60% in Q1 2022; and 70% in Q2 2023. They have a ways to go before reaching 100%, but they are well on their way.
A year ago Hims´ moat was not overtly evident beyond the allegedly superior concierge experience. In Q2 2023, 35% of revenue came from personalized products, prescriptions that merge myriad active ingredients into a single medication. Their moat deepens as Hims becomes more indispensable for patients.
There’s a lot of friction throughout the process of obtaining a diagnosis and cure (pill) for multiple treatments. Personalized products by Hims offer, in the context of the broad function of the healthcare system, a differentiated value proposal. What actually enables personalization is the affiliated pharmacy infrastructure, which takes time and resources to build, yielding a barrier to entry.
By then sharing economies of scale profitably (driving prices down, which in turn increase margins), Hims makes the barrier to entry higher. As the % of revenue from personalized products continues to rise, the moat will get stronger.
2.0 Top Line Growth is Impressive
We still do not know to what extent the growth is organic versus paid. With Hims’ improved cost structure, however, this may no longer be as much a problem.
Marketing spend as a % of revenue is roughly flat from Q1 2022 to Q2 2023, at 50% and 51% respectively. Despite phenomenal subscriber growth we have two issues:
Flat monthly (online) revenue per subscriber.
How much growth is organic versus driven by marketing spend remains unknown.
Qualitatively, Hims has a problem: I would imagine that most customers are ashamed to discuss their products with friends and family. It is currently not socially acceptable to be openly discussing issues such as erectile dysfunction, for example. There’s therefore a prevailing headwind against Hims, which specializes in stigmatized conditions.
Despite a lack of visibility on the marketing side, Hims is now operating cash flow positive. The company has demonstrated its ability to bring costs under control. Perhaps the hypothetical reliance on performance marketing is not as much a problem as previously believed.
Hims’ improved financials have coincided with lower ad prices. However, in Q2 2022, just as we saw others pulling back on their marketing spend, we saw Hims management leaning in:
[…] we feel really well positioned not only to thrive in a kind of recessionary dynamic but also to really take meaningful share I think this quarter is a great example, right? We leaned-in aggressively to efficient marketing where it was working as others were pulling back.” - Andrew Dudum, CEO Q2 `22 ER
Marketing as a percentage of revenue increased 580 basis points quarter-over-quarter to 53% in the second quarter. - Yemi Okupe, CFO Q2 `22 ER
Thus, it seems management may navigate the ups and downs of the online ad market with aplomb. For me to invest in Hims, however, I need to gain visibility here. Organic growth is key to understanding just how much customers love a product or not. I live in Europe and thus have not used HIms, which maintains a blind spot that I must somehow work around.
Ideally, the company needs to find some source of organic growth (or communicate to investors that it has found one)–buying a company that seemingly cannot grow organically is untenable.
3.0 Competition wih Amazon Health
This is yet another potential Innovation Stack scenario.
Amazon does not succeed every time it takes on a far smaller company. Notable examples that I have found include Spotify and Block. These two companies have world class organizational properties that have enabled them to not only survive Amazon but also thrive (the former more than the latter). A year ago I would not have bet a dime on Hims surviving, but increased operating leverage has begged that I watch it more closely.
To gauge the probability of Hims’ success I must observe the situation quarterly, since Amazon is such a fierce competitor. If you read my Amazon deep dive, you will know that it iterates non-stop until either succeeding or scrapping the business in question altogether.
Amazon's first foray into healthcare, Haven, a joint venture with JPMorgan Chase and Berkshire Hathaway, was launched in 2018 but closed its doors in 2021. Despite this setback, Amazon continued to pursue its healthcare ambitions. In 2019, the company launched Amazon Care, a telehealth and in-person visit platform for its employees. Amazon Care also closed its doors in 2022, the same year that Amazon launched Amazon Clinic, a telehealth platform that aims to treat 20 common illnesses.
In addition to its telehealth ventures, Amazon has also acquired several brick-and-mortar healthcare companies. In 2018, Amazon acquired PillPack, a mail-order pharmacy. Earlier this year, Amazon acquired One Medical, a membership-based primary care network, for $3.9 billion.
4.0 Financials
Beyond the company´s income and cash flow statements, Hims’ healthy balance sheet stands out.
In Q2 2023, the cash position actually increased $8.7M thanks to the positive operating cash flow. Cash and equivalents thus came in at $193.1M, with no debt outside a capital lease totaling $3.3M.
Further, Hims saw a CapEx spike during the quarter, which would explain why operating cash flow has not converted into free cash flow.
In the second quarter, we made considerable investment into the affiliated pharmacies that will set the foundation for greater personalization capabilities in the future. Capital expenditures related to the purchase of property, plant, equipment and intangibles were $4.7 million in the second quarter. - Yemi Okupe, CFO Q2 `23 ER
5.0 Conclusion
The progress made YoY is noteworthy.
I welcome the company´s progress and continued investments in the pursuit of increased operating leverage. I was left with a less than positive impression of the company after my deep dive and now, I see glimpses of greatness in it. Also, the company is sitting at a similar market cap to that of last year, but with much improved fundamentals. The risk/reward is definitely getting tempting.
Still, stigma remains as a prevailing headwind, and I need more visibility into top line growth to form a more complete opinion. I believe that I lack a sufficient understanding of the competitive environment to make an investment at this time, but I look forward to continuing my coverage of Hims, especially its duel with Amazon.
Until next time!
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