I’ve been driven steadily nuts by a series of recent articles that are sort of describing what’s happening in health tech or (because the term won’t die) digital health, so I thought it was time for the definitive explanation. Yeah, yeah, humility ain’t my strong suit.
It won’t have escaped your attention that, after five years during which Castlight Health more or less single-handedly killed the IPO market for new health tech companies, suddenly in the middle of July 2019 we have three digital health companies going public. While Livongo, (FD-a THCB sponsor) Phreesia and Health Catalyst are all a little bit different, I’m going to use them to explain what the last decade of health tech evolution has meant.
Don’t get carried away by the precise details of the IPOs. Phressia is already out with a market cap of $845m. Yes, it’s true that none of the three are profitable yet, but they are all showing decent revenue growth at an annual run rate of $100m+ and Livongo in particular has been on a client acquisition and annual triple digit revenue growth tear. It’s also the newest of these companies, founded only in 2014, albeit by buying another company (EosHealth) founded in 2008 that had some of the tech they launched with. Going public doesn’t really mean that the health care market will swoon for them, nor that they are guaranteed to change the world. After all, as I pointed out in my recent somewhat (ok, very) cynical 12 rules for health tech startups, UnitedHealth Group has $250 Billion in revenue and doesn’t seem to be able to change the system. And anyone who remembers the eHealth bust of 2000-2002 knows that just because you get to the IPO, it’s no guarantee of success or even survival.
But just by virtue of making it this far and being around the 1/10th of 1% of health tech startups to make it to IPO, we can call all three a success. But what do they do?
They are all using new technologies to tackle longstanding health care problems.
Every quarter, Health 2.0 releases a summary set of data that explains where industry funding is going, which product segments are growing fastest, and where new company formation is happening. Health 2.0’s precision and clarity when it comes to market segmentation and product information make this quarterly release the cream of the freebie crop.
The major news this quarter is that funding has slowed compared to this time last year, notwithstanding a significant bump from Allscripts’ $200M investment in NantHealth on the last day of the month. Yet, we’re still seeing growth in the Health 2.0 Source Database — both in number of products and companies. We also highlight the release of the Apple Watch, the growing momentum around FHIR, some key moves in the data analytics space, and the success of the latest Health 2.0 IPOs. For more, flip through below.
Julie Creswell and Reed Abelson offer a story in the New York Times about the HCA for-profit hospital system, noting “A giant hospital chain is blazing a profit trail.” The HCA story and similar ones about other hospital chains financed by private equity force us to consider how a such firms can achieve a return on equity that satisfies investors.
The answer is that they cannot, if we think about running the business on a long-term basis. What makes it work is extracting cash and the exit strategy, the heart and soul of private equity.
As Warren Buffett might say, let’s keep this simple. A for-profit hospital system has the following disadvantages vis-a-vis a non-profit hospital system: (1) Its finances are a mixture of equity and taxable debt, both of which are more expensive than the nontaxable debt of a non-profit; (2) it pays taxes–federal and state income tax, property tax, and sales tax–on which the non-profit is exempt; and (3) it is an unattractive vehicle for charitable donations, compared to the tax-advantages offered donors of non-profits.
These are hefty financial advantages for non-profits, which nonetheless are fortunate if they are able to earn an operating margin of 3%. Admittedly, that’s 3% of revenues, not a 3% return on capital.
An equity investor in a for-profit doesn’t care about margin, strictly speaking, but rather is focused on the rate of return of his or her investment. But let’s stick with the operating margin just for a moment, and let’s just accept that a 3% margin would not generate the kind of equity return demanded by the market place: You pick the hurdle rate: 15%, 20%, 25%, more? It doesn’t matter. A three percent margin just doesn’t get you there.