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We initiated coverage of Teladoc (TDOC) earlier this year in March and wrote our full case which you can read here. Our thesis is simple: TDOC is poised to be a major beneficiary of the growth in Telehealth services, which solve two major challenges facing U.S. healthcare: rising costs and inaccessibility. Acceleration of adoption of Telehealth presents significant scope for Teladoc to capitalize on this trend, as the company offers the largest, complete, end-to-end solution in a marketplace where scale is critical in determining success.
On 5 August 2020, TDOC and Livongo (LVGO) announced they would be merging. LVGO provides a consumer digital health platform for people living with a chronic condition using smart connected devices, personalized digital guidance, and access to health coaching. Conditions include diabetes, weight management, hypertension.
Source: Livongo company website
LVGO operates in the large and growing chronic disease market, as more than half of the US population has one or more chronic conditions and an additional ~4K Americans are diagnosed with diabetes each day. LVGO’s rapid growth profile is attractive, and unique in Healthcare IT with our model calling for an 85% revenue CAGR over the next three years as the company increases its member base, and we expect operating income profitability in 2021. Big growth prospects, and it is easy to see why LVGO is complementary to TDOC. The pair creates an unmatched care proposition which covers delivery, access and experience. Some points on LVGO:
- It is a pioneer in applying data science to transformative outcomes.
- It has 30% Fortune 500 as customers, 400,000 customers. 4 of 7 top payers recommended by leading benefit consultants.
- Their solutions enable whole-person care using real-time health data to make decisions which results in better outcomes and lower costs – this is the next generation of healthcare delivery model.
Specifics of the deal include: Each LVGO share will be exchanged for 0.592 TDOC plus $11.33 for each LVGO share and that TDOC shareholders will own 58% of the combined company. Here’s the exciting part:
When the deal was announced, the combined entity was expected to have FY2020 revenue of $1.3bn and EBITDA of $120m vs. TDOC’s FY 2020 then-estimated revenue $975.9m and EBITDA $80.2m. Last night, management guided for FY 2020 revenue of $1.01bn, a decent positive revision.
LVGO carries $550m in convertible debt and $218m cash, while FY 2020 revenue is expected to be $330m and expected EBITDA of -$3.7m. Combined entity is expected to have $650m in cash and to be more profitable than the sum of the parts. According to management, the revenue growth rate is expected to increase +230bps over the sum, and to add 930bps to TDOC alone. There’s a 27% overlap in TDOC and LVGO customer base with ample opportunity to leverage TDOC’s network (+70 million lives) to push LVGO products and integrations with their telemedicine platform. We modelled out this accretion over the next 5 years:
Source: Author’s calculations
In their latest results (reported on 28 October 2020), we learned that TDOC’s network of providers delivered over 2.8 million virtual visits in the third quarter, more than triple the number of visits provided in the same period last year. U.S. paid membership increased to 51.5 million members during the third quarter, an increase of 47% versus the third quarter of last year.
Visits for conditions including hypertension, back pain, anxiety and depression represented over 50% of TDOC’s general medical visit volume, up from 33% a year-ago. Their comprehensive portfolio of services enables them to meet the increasing consumer demand for virtual care. New registrations increased more than 80% compared to the third quarter of 2019.
Demand for Dermatology and Behavioral Health services continues to significantly outpace overall volume growth. In the B2B channel, visits in these specialties grew over 500% compared to the prior year. Demand for mental health care in particular continues to build through the B2B channel and their Direct-to-Consumer brand BetterHelp. Utilization of mental health services has continued to grow in each successive month of the year which is very encouraging given the high repeat usage profile of the service.
The company continues to push internationally – management announced a new partnership with Telefonica (TEF), one of the largest telecom providers in Europe and Latin America, including over 14 million customers in Spain. As part of this partnership, Telefonica will distribute TDOC’s virtual care offering on a D2C and B2B basis to individuals and employers across Spain – this sets the stage for similar deals moving forward.
Valuation
We ran a 2-stage DCF model and found Teladoc trades at a ~13% discount to fair value using the following assumptions:
Expected revenue growth of 30% p.a. over the next 10 years. Terminal growth rate of 2.0% – above the current 10-year yield which is depressed given extraordinary market conditions.
We capitalize R&D expenses into an asset which will deliver future economic benefits. The asset is amortized over an assumed useful life of 3 years using the straight-line method. We capitalize operating leases and we explicitly value stock-based compensation options.
We value cash and marketable securities at book value. Our terminal Beta of 0.9 reflects Teladoc maintaining its market dominance as underlying operational leverage contributes to solid profitability.
We actually think the above assumptions are conservative given the likelihood the LVGO deal puts TDOC on a growth path closer to 40% and long-term operating margins settle nearer 25% vs. our assumed 20%. Sensitivity analysis of our DCF highlights the potential upside (shaded blue) if the market appreciates this:
Conclusion
There’s a lot to look forward to with TDOC, the merger with LVGO is likely to be highly accretive to growth and solidifies the business as the clear leader in Telemedicine – deal closes in Q4. The market appears to be underestimating the potential of the combined TDOC-LVGO company and the growth prospects of telemedicine in general. Long-term investors can use recent market volatility to pick up shares at what we view as attractive levels.
Disclosure: I am/we are long TDOC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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