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Teladoc: The Future of Healthcare
Hello everyone! After a month of researching TDOC 0.00%↑ , I am very excited to post my deep dive on the company. I hope you enjoy reading it. Below, you can find the post´s structure and as always, feel free to skip to any section of your interest.
1.0 Introduction to Teladoc´s Potential
2.0 Core Source of Value (Δ members x Δ revenue per member)
2.1 Δ members and B2B distribution
2.2 Δ revenue per member
3.0 Cascading Layers of Incremental Value: Primary, Mental and Chronic Care.
4.0 Livongo Acquisition and $3B Goodwill Impairment
5.0 Other Recent Narratives
1.0 Introduction to Teladoc´s Potential
Our bodies are just information matrixes and our ability to heal them is proportional to our computational capacity. Teladoc has a lot to do with this.
One can argue whether the healthcare system is in need of an update and indeed many including myself do belief so. What is perhaps less arguable is that patients across the board would naturally prefer an outcome based system, in which the focus is on delivering value to them instead of being reluctantly moved down an alienating and anemic medical conveyor belt, as is the case today.
This paradigm shift towards outcome based medicine will mobilize trillions of patient dollars towards the organizations that win and as I will explain below, this will be largely enabled by data - lots of it. For instance, which organization of the following two would you rather pay for a blood test?
An organization that makes you wake up extra early, fight your way through traffic and then sit in a room for an hour with another 20 people that have not brushed their teeth.
An organization that enables you to take the blood test at home, when ever you choose and that then connects you with the right practitioner in a seamless manner, versus organization #1 which we all know would take weeks to do so.
The answer is predictable for most and this is in fact an investable dynamic, unlike other policy driven and/or dependent ideas in the medical space, because this is what consumers want and it does not involve changing medical practice at all, but rather arranging resources differently. If you zoom out for a second, consider that taxis, supermarkets and dating are essentially the same they were 20 years ago - it is just that an increasingly decentralized and efficient information matrix has enabled us to access resources in a more convenient and efficient manner. Medicine, enabled partly by Teladoc, is heading in this direction.
To grasp the magnitude of the opportunity ahead and to see how Teladoc fits into the picture, I have greatly benefited from taking some time (years of curious, seemingly useless reading) to understand medicine from a first principles point of view. What is it, really? Information. Your body and thus your health, as far as science goes, is ultimately the expression of genetic information, coupled with environmental information - it is just a very dense, multidimensional information matrix. This is where data comes in.
Ultimately, you are a bunch of atoms put together in different ways, following the information received from your genes and from the environment and throughout history, our ability to heal from disease has followed a near 1:1 correlation with our capacity to process this information at increasing levels of depth. Initially, we thought illnesses were caused by evil spirits and now we understand many of these illnesses at the molecular level, which is supercharging our ability to heal previously intractable health problems. This is driven by data.
Hence, our current medical system is not only disconnected from patient outcomes and specially so in the US (as I reviewed in my HIMS 0.00%↑ deep dive), but is capturing and processing a tiny fraction of the relevant patient information. At any given point in time, we have no idea of what is happening inside our bodies and what the current state of our bodily information matrix is. When we feel ill, we go to the doctor and even then the amount of information captured and processed is minimal. Positively framed, there is a tremendous amount of alpha in terms of value to be delivered to patients by capturing data in a longitudinal and continuous manner - which is where Teladoc comes in.
Whilst many see TDOC 0.00%↑ as a "zoom for doctors", I see it as the foundation for a global medical data harvesting and processing machine, that if well executed upon, can transform the health system into an outcome driven one, amassing a inordinate amounts of patient data and dollars profitably and generally curing more people than otherwise. Today, Teladoc covers more than 30% of American insured lives, which gives it plenty of data to work with and whilst this is no guarantee of success, I also see no signs of guaranteed failure, as the market seems to imply today.
2.0 Core Source of Value
Teladoc´s B2B prowess and ability to return incremental value to stakeholders bode well for the company going forward.
Teladoc has tapped into and merged with the demand faucet of the US healthcare system in a fairly robust manner, by climbing its way up through what looks like distribution hell to me. It has been able to sign deals with many companies, including 50% of the Fortune 500, to onboard its employees as Teladoc patients. This has given it direct access to more than 92M insured American lives, making it the largest private medical data corpus in the US by an order of magnitude (and on Earth, if I am not mistaken). By securing and augmenting this position, it is then well set up to transition its patient pool towards outcome-based medicine by collecting and processing longitudinal whole-person data, ultimately increasing the revenue per patient.
To give some further context on the importance of the B2B strategy, note that the US healthcare system is a monopsony (only one customer, insurance companies) and this has seen it evolve into an inflationary hamster wheel. Historically, patients have not cared much about price increases because insurance companies have been taking care of that, with providers roaming free in terms of what they charge for and how much. Through time, this has led to continuous yearly increases in insurance premiums, which means that today if you do not have insurance, you are unlikely to be able to afford healthcare at all. (More about the monopsony in my HIMS 0.00%↑ deep dive.)
As a result, most people get their insurance from their employer and thus employers are the healthcare demand faucet. If you find a way to take this “issue” off their hands, because their business is not to provide employees with health insurance, then you have the foundation to take healthcare in whatever direction you deem profitable. I believe that achieving this level of trust with employers and specially the big ones, is harder than the general public estimates.
Per the above, it follows that:
Teladoc´s Value = f (Δ members [B2B strategy] x Δ revenue per member [engagement])
As Teladoc increases its member base and the revenue per member, the latter by delivering incremental value to members and in turn employers, the company is likely to do well and over the last year, we have seen these two fundamental metrics advance reasonably, with the sentiment around the company plummeting.
2.1 Δ members and B2B distribution
Distribution almost always wins and is almost always under-appreciated.
Whilst I believe that the company was previously priced for perfection, today the market is underpricing Teladoc´s B2B distribution prowess. There are no signs of it slowing down, meaning that the game is still on for the company. If anything, the growth is slow but Teladoc is probably near saturation in the US market:
Note that initially Teladoc was charging companies for each employee (what the company calls Paid Members, access fees in the graph below), regardless of whether the employee used the service or not. Eventually, Teladoc begun to close “per-visit” deals, in which patients only paid every time they visit the doctor. Through time, this deal has grown in relative terms, presumably as telemedicine has increasingly become a commodity. After all, all that is really required is to launch and operate a telemedicine service is a video chat app with a straightforward CRM.
Whilst the above is true, here is where I think the market leans too much into this belief. Telemedicine is a commodity in the same way that social media apps are - the software is simple, but achieving the critical network effects are not. In this sense, we have seen far superior products be beaten by mediocre ones with superlative distribution: think Telegram vs Whatsapp, for instance. The real challenge in telemedicine is getting more clients and practitioners into the system than anyone else as fast as possible and so far, Teladoc is winning by miles.
Another misconception is the idea of what telemedicine is, which I touch on in the introduction. Much like when people see SPOT 0.00%↑ as a music app when it is in fact an audio network, the "telemedicine" that most people have in mind is but the first stepping stone towards longitudinal, outcomes based medicine. It is not so much about seeing your doctor´s face on the screen, but about all the information that is going to coherently and frictionlessly move back and forth between you and your practitioner that is going to make your healing journey so much better. For this to happen at all, however, someone needs to win the distribution game first. Meanwhile, the market is stuck in the “telemedicine is a fad” post-covid, which I think is short sighted.
As of late, the company seems to be moving towards value-based deals with employers too:
“In some cases, those are for clinical outcomes in others, it's for financial cost savings and putting a portion of our fees at risk relative to those savings and sharing in the upside.” - Q&A, Q2 2022 ER
“We're constantly refining our approach, especially as we move more and more into whole person care sales where we're bundling together multiple of our Chronic Care solutions. And some of the data that I pointed to is relatively new data. So we're able to demonstrate greater success and deliver proof points [see section 3.0] to our clients relative to the benefit of buying a bundle of services.”- Q&A, Q2 2022 ER
2.2 Δ revenue per member
Ladies and gentlemen, we likely have yet another optimization machine in front of us.
The real growth story, at least in the US, is Teladoc radically increasing its revenue per member per month (PMPM). Whilst the quarterly growth in members is not that impressive, the growth in revenue PMPM is. In Q1 2015, PMPM was $0.50 and in Q4 2020, it was $1.76. The progression is pleasing (near exponential?) and as stated, stands in contradiction with the decline in sentiment seen in the market.
Further, $2.60 PMPM is still a minute amount when talking about healthcare and it is not hard to envision a future in which, if indeed longitudinal medicine does become mainstream, it goes orders of magnitude higher. There are a number of observations which I deem noteworthy regarding the latter:
Saying that longitudinal medicine is not the future of medicine is akin to saying computing is not the future of the economy in general. As many of you know, I believe that humanity´s core wealth generation mechanism is processing information to unlock new atom (and recently, electron) configurations. So long as data and computation remain the best way to unlock novel atom configs, longitudinal medicine will prevail in healthcare and patients will love it.
The company does have a strong track record of augmenting revenue PMPM. This is widely under-appreciated by the market today and the evidence stands on its own. However, going through the company´s quarterly reports I have found datapoints that suggest the company is in fact an optimization machine capable of incrementally delivering value to patients through time, with good odds of exponentiating revenue PMPM over the next decade.
“We're actually seeing improvement in our LTV. I'm aware of some of the other players in the market. I would say our team has a tremendous track record of continuing to improve LTV. That's a combination of optimizing pricing and driving product enhancements that increase the longevity of those members.” - Q4 2021 ER
“…we're always experimenting with new pricing models. And when we do that, we do that in a multifaceted test and control environment” - Q2 2022 ER
“We're constantly refining our approach, especially as we move more and more into whole person care sales where we're bundling together multiple of our Chronic Care solutions. “ - Q2 2022 ER
To many of my long time readers, this may ring a Spotify bell (deep dive). Of course, the company will not survive over the next 10 years based on its B2B strategy alone, but in combination with its seemingly optimization focused culture, it may well thrive and revenue PMPM may surprise even the most optimistic among us.
Product penetration is still low and most members are still only using the legacy telemedicine service (consultations with practitioners), meaning that the current revenue PMPM and its progression is the result of minimal steps taken towards longitudinal medicine. This is like the year 2000 for e-commerce almost. In contrast, we see free cashflow tick up as does revenue PMPM. In its maturity, this company could become a considerable cash machine.
3.0 Cascading Layers of Incremental Value: Primary, Mental and Chronic Care
A value compounding machine in its early phases, catalyzed by an intelligent vertical cascade strategy.
I often discuss what I believe will seem like the “obvious great investments” in ten years time. I hypothesize that they will be platforms with strong distribution (big, hard to displace user bases) that are able to add incremental cash-producing layers of value at a marginal cost. With the exception of semiconductors AMD 0.00%↑ , I believe all my convictions fit this thesis. As it refers to TDOC 0.00%↑ specifically, I believe their strategy to boost revenue PMPM is befitting too, but has one special characteristic which is very noteworthy: a cascading effect.
Through various acquisitions, Teladoc has focused on deploying the following 3 initial value layers, beyond its legacy telemedicine service:
Primary 360: “one out of four working age adults who do not have a Primary Care Physician (“PCP”), and the four out of five who do not have a strong relationship with a PCP, opening up for us an incremental total addressable market of approximately $140 billion in the U.S. alone”. The goal is to get them one through Primary 360, $TDOC´s primary virtual care offering. “We believe that Primary360 will be an effective gateway to the full range of our services for an individual.”
myStrength Complete: “is an integrated mental health service providing personalized, targeted care to consumers in a single, comprehensive experience. myStrength Complete’s proprietary stepped care model is designed to seamlessly combine app-based tools and coaching expertise with our therapists and psychiatrists to ensure that consumers get the level of mental health support and care they need, when they need it.”
Chronic Care Complete: “is a first-of-its-kind chronic condition management solution to help individuals improve their health outcomes while living with multiple chronic conditions. This solution provides members with a unified, comprehensive experience that leverages connected health monitoring devices, access to health coaches and support from physicians and mental health 8 specialists.”
There are many minor details concerning each layer, but they are all advancing well in terms of absolute growth and utilization but most notably, when put together they cover a large part of a patient´s daily medical needs. In doing so, they position Teladoc to deploy further branching verticals down the line, more easily than if that had targeted them first. Even more interestingly, it seems that in combination, these 3 verticals deliver disproportionate value to patients versus on a standalone basis:
“We're also finding that clinical outcomes improve for members enrolled in multiple programs. For example, A1C reduction improves as our diabetes management members go from a stand-alone solution to adding two, three and four programs.” - Q2 2022 ER, CEO Jason Gorevic
“when mental health services are integrated into Chronic Care, members see an average of an additional 0.5% A1C reduction, almost 10 millimeters reduction in systolic blood pressure and about a 2% additional weight loss. And so those are relatively new.”
Specifically Primary360, which was only launched in fall of 2021, seems to be getting people to go to the doctor more than otherwise. This is no surprise, since the current analogue primary care experience is dreadful:
“Our clients are finding that Primary360 is expanding access to care as two-thirds of engage members had not seen a doctor in the last two years prior to Primary360, and nearly a third say that they would not have seen a doctor at all, if not for access to Primary360.”
In Q2 2022, management credits the rise in revenue PMPM as being “driven primarily by BetterHelp and Chronic Care program”. Both are the result of acquisitions made by Teladoc and specifically Chronic Care complete is the result of the highly criticized Livongo acquisition, which I will review in the next section. The point is, however, the acquisitions seem to be working in terms of delivering incremental value to patients and clients and it all seems to be compounding slowly.
It is perhaps reasonable to say that as these verticals gain traction, not only will FCF continue to trend upwards, but the overall value delivered to patients will be large enough for Teladoc to continue to lure them succesfully into further verticals at a marginal cost. It is early in my journey of understanding the company, but I sense an organization with the culture and resulting operational habits to pull this off.
4.0 Livongo Acquisition and $3B Goodwill Impairment
Teladoc paid for Livongo mostly with its stock at ATHs. Perhaps not perfect, but not crazy either.
“The total consideration was $13,938.0 million, consisting of $401.0 million of net cash, $555.4 million related to the conversion feature of the Livongo Notes guaranteed by the Company and 60.4 million shares of our common stock valued at approximately $12,981.6 million.” - TDOC 2020 10-K
The narrative in the market is that Teladoc´s management has poor capital allocation skills, but looking at the Livongo deal specifically, I see that 93% of the acquisition was paid in Teladoc stock. During this time, the price to sales multiple was sitting near all time highs. Further, I believe this acquisition to be of an existential importance to Teladoc, because without it, the transition towards longitudinal medicine which is currently driving revenue PMPM and FCF would be much harder.
In Q2 2022, the company performed a non-cash goodwill impairment of $3B, which led to a horrible looking net income graph, but meanwhile the two key metrics (Δ members, Δ revenue per member) remained healthy.
I am not exactly able to assert whether they overpaid much or not, but assuming they did, they did so with their stock at ridiculous multiples. So the way I see it, they walked away with a fantastic asset that is now driving their strategy forward at a price that has left the company far from limping. Meanwhile, shares outstanding look quite acceptable for a company at this stage of its life:
On the negative side, I see choppy waters inside the company, per the reviews on Glassdoor. It is hard to infer what is going on, although I believe I will given enough time, but reviews are going down fast and this is something worth watching. Perhaps difficulties in integration? I also imagine seeing the above in a positive light is hard as a long time shareholder, which I am not - but as always, potentially exponential plays like Teladoc come down to what price you can buy them at.
5.0 Other Recent Narratives
A series of quarters of macroeconomic turmoil do not change my long term view.
Beyond the “telemedicine is a fad” concept, one other interesting narrative is that Teladoc´s deal pipeline is withering. In Q2 2022, the company said:
“…so the pipeline, I would say, is very healthy and has improved since where we were at this time last year [current + late stage pipeline both up 20% YoY]. The challenge that we're seeing is in these times of economic uncertainty, all purchases are just getting a significantly higher level of scrutiny […] you’ve heard and read in all of the news about companies reducing workforces.”
The company indeed reported Chronic Care deals coming in slower than expected in Q2 2022, but it is true that we have seen companies across the board announcing either layoffs or freezing hiring and other cautious activities. So why would they not apply caution to deals that do not pertain to their specific scope of activity, like healthcare for their employees?
Further, the company is seeing a “decline in yield on marketing spend that we discussed in April”. This has unleashed another narrative, concerning Teladoc´s ability to operate D2C. I am not overly worried, because the healthcare demand faucet (in this case) stems from B2B distribution and generally, I do see people concentrating their expenditure on fun stuff. Further, I believe the company´s optimization focused culture will have it emerge well on the other side of the macro red oceans.
Meanwhile, as reviewed, revenue PMPM continues to trend up beautifully as a result of probably acceptable execution in the deployment of the explored 3 new value layers, so rather than dismissing the narrative, I believe it accentuates this situation that is in front of us in which we can bet on longitudinal medicine becoming a reality at a fraction of the price than was available just 12 months ago and with perhaps quite less risk, given the traction seen thus far.
The company is sitting at financial homeostasis / balance. Should the deployment of incremental value layers succeed, we will likely see very attractive levels of cash per share emerge down the line.
Gross margin has remained quite stable for Teladoc for the last two years, with a new record in this period in Q2, coming in at 69.20%. I believe this has to do with the traction of BetterHelp and Chronic Care, which also seems to be positively impacting free cashflow.
Further, both operating income and net income are looking quite flat in this period. I see a platform sitting at homeostasis. If the new 3 value layers fail to compound, we will still have a money losing company in 5 to 10 years. Else, the company seems ready for much of that success to translate into high cash per share accretion, unless the company decides to initiate some high capex activity down the line which seems unlikely, as we currently see it succeeding in delivering incremental value to patients today.
The company has $881.2m cash in hand and $1,542m in LT-debt, most of it convertible. Not a pristine balance sheet, but not terrible either given the non existential risk of most of the debt profile.
As reviewed above, I do not see excessive shareholder dilution.
Cash from operations further adds to my perception of the company being at homeostasis - mostly positive in the last 2 years, with occasional bouts of being in the red. Cash from investing and financing grant me no noteworthy insights and as previously mentioned, free cashflow is looking hot.
Teladoc seems to me like one more example of a previously over-hyped company, which is now drastically under-hyped. Not too long ago, we were in the green dot with the PS ratio at around 24 and no we are at the red dot, with the PS ratio at around 2.
I see the company positioned for an exponential future, in which it gradually and then very quickly proceeds to longitudinize subsequent verticals of the medical sector, piling increasing layers of value onto the platform at increasingly marginal costs. The company´s financial profile today is such that in this future, it could become a giant cash machine.
I generally belief that today in “telemedicine” we are in the same place we were with e-commerce circa the year 2000. In fact, the pronoun “tele” will seem comic in hindsight and Teladoc I believe is well suited to be part of a portfolio comprised of asymmetric, exponential bets.
Personally, I need to get more acquainted with its culture and with different aspects of the business, to potentially reach a conviction - but the raw material is there. I also need to look at how management has been guiding in contrast to actual execution, but I really like where the company is at today.
Until next time and I hope you have had an excellent summer! I am really happy to be back and excited for the next 12 months. Incidentally, Investment Ideas is 1 year old already :).
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