Why Livongo is on My Watchlist

Diabetes and other chronic conditions can lead to preventable health complications. Livongo, a health-tech firm is trying to change that.

Patients can be their own worst enemy. This is especially true for people who suffer from chronic conditions such as diabetes. Suboptimal lifestyle choices and poor medication compliance often lead to avoidable complications. 

A company called Livongo Health (NASDAQ: LVGO) is trying to change all that. The software-as-a-service (SaaS) company provides diabetic patients with an app that can prompt them to take their medications as well as provide feedback and coaching. Livongo also provides patients with an internet-connected blood glucose meter and unlimited test strips.

The end-result is that Livongo users are more compliant with glucose monitoring and have fewer complications. They also save on healthcare expenses over the long run. Besides diabetes, Livongo also has services for hypertension, weight management, pre-diabetes, and behavioural health.

With preventive medicine gaining greater prominence today, I thought it would be worth taking a deeper look into Livongo to see if the healthtech company makes a worthwhile investment.

As usual, I will analyse Livongo using my blogging partner Ser Jing’s, six-point investment framework.

1. Is Livongo’s revenue small in relation to a large and/or growing market, or is its revenue large in a fast-growing market?

Livongo’s member count increased by 96% in 2019 to 223,000. More impressively, its revenue for 2019 jumped 149% to US$170 million from 2018.

Despite the spike in member and revenue, Livongo still has a huge market to grow into. There are 31.4 million people in the US living with diabetes and 39.6 million people with hypertension.

Based on Livongo’s fees of US$900 per patient per year for diabetics and US$468 for patients with hypertension, its total opportunity adds up to US$46.7 billion.

As preventive health gains greater prominence, Livongo can win a greater chunk of its total addressable market. Currently, Livongo’s penetration rate is only 0.3%. Meanwhile, Livongo has ambitions to increase its software’s use case to patients with other chronic diseases and to expand internationally. 

These two initiatives could further increase its already-large addressable market substantially.

Source: Livongo investor presentation

2. Does Livongo have a strong balance sheet with minimal or a reasonable amount of debt?

Livongo is still burning cash. In 2019, it used US$59 million in cash flow from operations, an acceleration from the US$33 million spent in 2018. That’s a hefty amount and certainly something to keep a close eye on.

On the bright side, Livongo has more than enough cash on its balance sheet to continue its growth plans for several years. As of December 2019, the Healthtech firm had no debt and US$390 million in cash, cash equivalents, and short-term investments.

It’s also heartening to note that Livongo’s management is mindful of the way the company is spending cash. In the 2019 fourth-quarter earnings conference call, Livongo’s chief financial officer, Lee Shapiro, highlighted that the company is aiming to produce positive adjusted-EBITDA by 2021 and expects the company’s adjusted-EBITDA margin to improve in 2020.

Shapiro said:

“Adjusted EBITDA loss for 2020 will be in the range of negative $22 million to negative $20 million.

This implies adjusted EBITDA margins of negative 8% to negative 7% or an improvement of between 3.5 to 4.5 points over 2019. We plan to continue to invest in the business in 2020 while simultaneously marching toward our goal of sustained adjusted EBITDA profitability in 2021.” 

Adjusted EBITDA is roughly equal to net income after deducting interest, tax, depreciation, amortisation, and stock-based compensation and is closely related to cash flow from operations. If Livongo can hit its 2021 goal to be adjusted EBITDA positive, cash flow should not be an issue going forward.

3. Does Livongo’s management team have integrity, capability, and an innovative mindset?

In my view, management is the single most important aspect of a company. In Livongo’s case, I think management has done a good job in executing its growth plans.

Current CEO, Zane Burke has only been in his post for slightly over a year but has a strong resume. He was the president of Cerner Corporation, an American healthtech company for the seven years prior. It was under Burke’s tenure that Livongo was listed and his first year in charge saw Livongo’s revenue grow at a triple-digit rate.

He is backed by Ex-CEO Glen Tullman who is now the chairman of the board. Glenn Tullman has a long track record of managing healthcare companies and was the key man before stepping down to let Burke take over. Tullman continues to have an influence on how the company is run.

The management team has also done a great job in growing Livongo’s business so far. The acquisition of Retrofit Inc and myStrength in April 2018 seems like a good decision as it opened the door for Livongo to provide prediabetes, weight management, and behavioural health services. With its ready base of clients, Livongo can easily cross-sell these newly acquired products.

However, Livongo is still a relatively new company. It was only listed in July 2019, so it has a very short public track record.

As such, it is worth keeping an eye on how well the management team executes its growth plans and whether it makes good capital allocation decisions going forward. 

4. Are Livongo’s revenue streams recurring in nature?

Recurring income provides visibility in the years ahead, something that I want all my investments to possess.

Livongo ticks this box.

The digital health company has a unique business model that provides very predictable recurring income. Livongo bills its clients based on a per-participant, per-month subscription model. Clients include self-insured employers, health plans, government entities, and labour unions who then offer Livongo’s service to their employees, insurees, or members. 

There are a few things to like about Livongo’s model: 

Product intensity

First, the average revenue per existing client increases as more members eligible to use Livongo’s software per client increases. This is what Livongo describes as product intensity.

At the end of 12 months, the average enrollment rate for Livongo for Diabetes clients who launched enrollment in 2018 was 34%. The average enrollment rate after 12 months for fully-optimized clients who began enrollment in 2018 is over 47%.

Livongo also believes product intensity can increase further as more members warm up to the idea of using cloud-based tools to track and manage their medical conditions.

Product density

Livongo has also been successful in cross-selling its products to existing clients. High product intensity and density contributed to Livongo’s dollar-based net expansion rate of 113.8% in 2018. 

Anything above 100% means that all of Livongo’s customers from a year ago are collectively spending more today.

Very low churn rate

In its IPO prospectus, Livongo said that its retention rate for clients who had been with them since 31 December 2017, was 95.9%. That’s high, even for a SaaS company.

Another important thing to note is that the member churn rate in 2018 was also very low at just 2%. Most of the dropouts were also due to the members becoming ineligible for the service, likely because they changed employers.

5. Does Livongo have a proven ability to grow?

Livongo is a newly listed company but it has a solid track record of growth as a private firm. The chart below shows the rate of growth in the number of clients and members.

Source: Livongo IPO prospectus

Livongo grew from just 5 clients and 614 members in 2014 to 679 clients and 164,000 members in the first quarter of 2019. At the end of 2019, Livongo had 223,000 members.

There is also a strong pipeline for 2020 as Livongo had signed agreements with multiple new clients in 2019. Based on an estimated take-up rate of 25%, the estimated value of the agreements Livongo signed in 2019 is around US$285 million, up from US$155 million in 2018.

Management expects revenue growth of 65% to 71% in 2020. Due to the contracts signed in 2019, management has clear visibility on where that growth will come from.

6. Does Livongo have a high likelihood of generating a strong and growing stream of free cash flow in the future?

Ultimately, a company’s worth is determined by how much free cash flow it can generate in the future. Livongo is not yet free cash flow positive but I think the healthtech firm’s business model would allow it to generate strong free cash flow in the future.

Due to the high lifetime value of its clients, Livongo can afford to spend more on customer acquisition now and be rewarded later. The chart below illustrates this point.

Source: Livongo IPO prospectus

From the chart, we can see that the revenue (blue bar) earned from the 2016 cohort steadily increased from 2016 to 2018. As mentioned earlier, this is due to the higher product intensity and density.

Consequently, the contribution margin from the cohort steadily increased to 60% with room to grow in the years ahead.

Currently, Livongo is spending heavily on marketing and R&D which is the main reason for its hefty losses. In 2019, sales and marketing was 45% of revenue, while R&D made up 29%. 

I think the sales and marketing spend is validated due to the large lifetime value of Livongo’s clients. However, both marketing and R&D spend will slowly become a smaller percentage of revenue as revenue growth outpaces them.

Management’s target of adjusted EBITDA profitability by 2020 is also reassuring for shareholders.

Risks

Livongo is a fairly new company with a very new business model. I think there is a clear path to profitability but the healthtech firm needs to execute its growth strategy. Its profitability is dependent on scaling as there are some fixed costs like R&D expenses that are unlikely to drop.

As such, execution risk is something that could derail the company’s growth and profitability.

As mentioned earlier, Livongo is also burning cash at a pretty fast rate. That cannot go on forever. The tech-powered health firm needs to watch its cash position and cash burn rate. Although its balance sheet is still strong now, if the rate of cash burn continues or accelerates, Livongo could see itself in a precarious position and may need a new round of funding that could hurt existing shareholders.

Healthtech is a highly dynamic field with new technologies consistently disrupting incumbents. Livongo could face competition in the future that could erode its margins and hinder growth.

Another thing to note is that while Livongo has more than 600 clients, a large amount of its revenue still comes from a limited number of channel partners and resellers. In 2018, its top five channel partners represented 50% of revenue. 

Stock-based compensation is another risk factor. In 2019, the company issued US$32 million worth of new stock as employee compensation. That translates to 18% of revenue, a large amount even for a fast-growing tech company. Ideally, I want to see stock-based compensation grow at a much slower pace than revenue going forward.

Valuation

Using traditional valuation techniques, Livongo seems richly valued. Even after the recent broad market sell-off, Livongo still has a market cap of around US$2.4 billion, or 14 times trailing revenue. The company is not even free cash flow positive or profitable, so the price-to-earnings and price-to-free-cash-flow metrics are not even appropriate.

However, if you take into account Livongo’s pace of growth and total addressable market, its current valuation does not seem too expensive.

Livongo’s addressable market is US$46.7 billion in the US. If we assume that the healthtech firm can grow into just 10% of that market, it will have a revenue run rate of US$4.6 billion, more than two times its current market cap.

The Good Investors’ take

Livongo has the makings of a solid investment to. It is growing fast, has a huge addressable market and has a clear path to profitability and free cash flow generation. There are likely going to bumps along the road but if the health SaaS company can deliver just a fraction of its potential, I think the company could be worth much more in the future.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Which S-REIT Can Survive This Market Meltdown?

REITs in Singapore have dropped like a rock this week as investors flee the stock market. What should you do now and are your REITs safe?

Real Estate Investment Trusts (REITs) are considered by many to be a safe-haven asset class due to their relatively stable rental income and debt-to-asset ceiling of 45%. However, it seems that REITs are still susceptible to steep drawdowns just as much as other stocks.

The REIT market in Singapore has been hammered as badly as the Straits Times Index, if not worse, over the past few days.

The table below shows the price changes of some of the REITs in Singapore since 9 March 2020. Even REITs backed by traditionally strong sponsors such as Mapletree Investments Pte Ltd and CapitaLand Ltd have not been spared.

Source: My compilation of data from Yahoo Finance

Why?

In my mind, the likely reason why REITs have been hammered so badly recently is that investors are worried that REITs’ tenants will not be able to pay their committed leases.

Loss of revenue could potentially bankrupt businesses causing them to default on their rent. 

REITs, in turn, will then face lower rental income in the coming months. This leads to a vicious cycle, where the REITs are then not able to service their interest expenses and may need to liquidate assets or raise capital in this extremely harsh environment.

Worried investors have been scared off from REITs during these difficult times and have flocked to “real” safe-haven assets such as treasuries and US dollars.

What now?

I think this is a perfect time for investors to take a step back to reassess their portfolio. It is important to know which REITs in your portfolio can weather a storm and which are at risk of a liquidity crisis.

The share price of a REIT may not be truly reflective of its ability to weather the storm. Some REITs that have been sold off hard may actually have the means to run the course, while others that have yet to be sold down may end up having to raise more capital. So I am more interested in the fundamentals of the REIT, rather than the price action.

What I am looking out for

In these unprecedented times, here are some things I look for in my REITs:

1. Stable and reliable tenants

If tenants can pay and renew their rents, REITs will have no trouble in these difficult times. For instance, REITs that have government entities as tenants are safer than REITs that have small and highly leveraged companies as tenants. Elite Commercial REIT (SGX: MXNU) is an example of a REIT with a stable tenant. The UK government is its main tenant and contributes more than 99% of its rental income.

2. A diversified tenant base

In addition to the first point, REITs that have a highly diversified tenant base are more likely to survive. For instance, malls and office building owners whose buildings are multi-tenanted are likely to be less susceptible to a sudden plunge in rental income should any tenant default. Mapletree Commercial Trust (SGX: N2IU) and CapitaLand Mall Trust (SGX: C38U) have multiple tenants and are less susceptible to a collapse in net property income.

3. Low interest expense and high interest-coverage ratio

REITs such as Parkway Life REIT (SGX: C2PU) are more likely able to service its debt as its interest expense is much lower than its earnings. At the end of 2019, Parkway Life REIT had a high interest-coverage ratio of 14.1. So Parkway Life REIT should be able to service its debt even if there is a fall in earnings.

4. Low gearing

A low debt-to-asset ratio is important in these tumultuous times. REITs that have low gearing can borrow more to tide them through this rough patch. REITs such as Sasseur REIT (SGX: CRPU) and SPH REIT (SGX: SK6U) boast gearing ratios of below 30%.

Don’t Panic… 

The last thing you want to do now is panic. In a time like this, is important to stay sharp and not do anything rash that can hurt your portfolio.

Breathe. Take a step back and reassess your positions. Don’t focus too much on the price of a REIT. Instead, focus on its business fundamentals and whether it can survive this difficult period. If so, then the REIT will likely rebound when this COVID-19 fear finally settles.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

How To Survive a Bear Market

We are in the midst of the fastest bear market in history. With uncertaintly ahead, here are some things I am doing to protect my portfolio.

We are currently in the midst of the fastest ever bear market in history. We live in uncertain times. No one knows how long the COVID-19 outbreak will last and what is the depth of its near-term economic implications. 

Across the globe, sporting events have been postponed, numerous gyms and schools are closed, and travel restrictions have been imposed. All of which will reduce expenditure and have a very real impact on corporate earnings and the economy.

Our foreign minister, Dr Vivian Balakrishnan, recently reminded everyone to be vigilant and that the economic implications would last at least a year. 

Even the emergency rate cut by the Fed on Sunday to bring interest rates to 0%, and the announcement of US$700 billion in quantitative easing, failed to spark any enthusiasm in the stock market. The S&P 500 in the US closed with a 12% fall in the wee hours this morning. At home, the Straits Times Index was down 5.25% on 15 March 2020.

In these dark times, I thought it would be a good idea to outline my gameplan to survive this and future market downturns.

Only invest the money I don’t need for the next five years

Stocks are volatile. That’s a fact we can’t escape. This is not the first bear market and certainly not the last.

My blogging partner, Ser Jing, shared some interesting stock market facts in an earlier article. He wrote:

“Between 1928 and 2013, the S&P 500 had, on average, fallen by 10% once every 11 months; 20% every two years; 30% every decade; and 50% two to three times per century. So stocks have declined regularly. But over the same period, the S&P 500 also climbed by 283,282% in all (including dividends), or 9.8% per year. Volatility in stocks is a feature, not a bug.”

Steep drawdowns are bound to happen and investors need to be able to ride out the paper losses and not be forced to sell.

Stocks can take months, if not years, to recover from a bear market. There have been 12 bear markets since World War II. These bear markets have taken two years to recover on average. The longest bear market occurred in the aftermath of World War II and took 61 months to recover.

Given the frequency of bear markets and the time taken for stocks to recover, I only invest money that I do not need for at least five years. Being forced to sell in a bear market could be detrimental to my returns and net worth over the long term.

Don’t leverage

Leverage can kill your portfolio in a bear market.

Leveraging essentially means borrowing to invest – or investing more than you can afford. The case for leveraging is that if you can borrow at let’s say 5% but have a return of 10%, then you can earn the difference.

However, there is one major pitfall to leveraging to invest in stocks- margin calls. If the value of your stocks falls below a certain threshold, brokerages who lend the money will force you to sell your stocks to ensure that you can pay them back.

During the Great Depression, the US stock market fell by 89.2% from top to bottom. If you had invested on margin, you would have likely been forced to liquidate your investments to pay back your lender.

Your entire portfolio would have gone to zero. That’s the danger of margin calls. Even though stocks eventually recovered, stock market participants who leveraged could not participate in the rebound and subsequent bull market.

The Great Depression was the steepest decline we’ve seen. But there have been other notable bear markets that would have likely caused margin investors to be completely wiped out. The Great Financial Crisis of 2008 saw a 53.8% peak-to-trough decline in US stocks, while the 1973-74 crash had a peak-to-trough decline of 44.9%.

Investors who invest with margin can gain some extra returns on good years but can easily be wiped out on the next downturn.

Invest in companies that can survive a downturn

I also invest only in stocks that can survive an economic downturn. Companies that have strong balance sheets with more cash and debt are likely to be able to weather the storm. 

Most companies, no matter how strong their moat is, will likely see a fall in sales over the next few months. Even companies like Netflix, which on the surface seem unaffected by the COVID-19 outbreak, might see revenue fall as consumers are more conscious about their spending habits.

In a time like this, when companies are facing disruption to sales, it is important that we only invest in those that are able to service their debt, continue paying their fixed costs ,and still come out at the end of the tunnel.

Warren Buffett described it best when he said,

“Only when the tide goes out do you discover who’s been swimming naked.”

It is in times like these when companies that are over-leveraged and have high-interest cost may end up going underwater. Shareholders of these companies will be left grasping at straws.

The Good Investors’ conclusion

The stock market is a great place to build wealth over the long run. However, it is important that we abide by certain investing principles that help us survive a market meltdown, as we are seeing unfold in front of us.

These three simple rules help me keep calm during these dark times, knowing that this too shall pass.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Should Facebook Shareholders Be Concerned Over Regulations?

Facebook has faced growing scrutiny among regulators. Here are my thoughts on what will happen if it is further regulated or forced to break up.

Most of us don’t go a day without using Facebook or Instagram. But despite its prominence, social media is still a relatively new concept.

The rise of Facebook and social media as an industry has been so swift that regulatory bodies have not been able to properly regulate it.

However, things are starting to change. 

Last year, Facebook (NASDAQ: FB) incurred a US$5 billion fine from the Federal Trade Commission (FTC) due to a privacy breach. The company also recently agreed to pay a US$550 million settlement for collecting users’ facial recognition data.

There have also been a few threats from European regulatory bodies and Facebook may even face retrospective fines in the future.

That brings me to my next question: Should Facebook shareholders be worried about regulations?

What are the possible regulatory measures that Facebook faces?

Although fines are painful, they are one-off expenses. The biggest risk is therefore not fines, but regulators forcing Facebook to change the way it operates.

Regulations that could hurt Facebook include prohibiting the kind of advertisements it can offer, or controlling Facebook’s content. Regulators could also force Facebook to spin-off or sell some of its assets. Currently, Facebook owns Instagram, Messenger, and Whatsapp.

Facebook reported in its 2019 fourth-quarter earnings conference call that there are now 2.9 billion people who use Facebook (the social media site), Instagram, Messenger, or Whastapp each month. A recent article from Verge showed that Whatsapp currently has 2 billion users while Instagram has 1 billion (as of June 2018).

The likelihood of extreme regulation

Although regulation is likely to hit Facebook, I think the odds of such extreme regulation are low.

After facing criticism in 2019, Facebook started taking privacy and regulation very seriously.

Facebook’s co-founder and CEO, Mark Zuckerberg, is outspoken about the need for regulation on social media companies. In a 30 March 2019 blog post, Zuckerberg wrote:

“I believe we need a more active role for governments and regulators. By updating the rules for the internet, we can preserve what’s best about it — the freedom for people to express themselves and for entrepreneurs to build new things — while also protecting society from broader harms.”

His willingness to cooperate with regulators should put Facebook in a better position to negotiate.

Moreover, despite all the negativity surrounding Facebook, it’s my opinion that Facebook has done more good than harm to society. Facebook not only provides humans with the ability to connect – it’s also a platform to express ourselves to a wide audience at relatively low cost.

Completely controlling the way Facebook is run will, therefore, have a net negative impact.

As such, I think the risk of extreme regulation is very low.

But what will happen if Facebook is forced to break up

Perhaps the biggest risk is competition law. Facebook is by far the biggest social media company in the world. To promote greater competition in the social media space, regulators could force Facebook to spin-off Whatsapp, Messenger, and Instagram into separate entities. 

Such a move will likely erode margins as the separate entities compete for advertising dollars. However, I think the impact of this will not be that bad for shareholders due to the huge and growing addressable market for social media advertising. Zenith estimated in late 2019 that global social media ad spending was US$84 billion for the year, and is expected to increase by 17% in 2020 and 13% in 2021.

A break-up could even be a good thing. It will force Whatsapp and Messenger to find ways to monetise their huge user bases. Currently, Whatsapp is a free platform and does not have any advertisements. If Whatsapp is spun off, investors will want to see it generate some form of revenue either through payments or advertising.

In addition, the separate entities could even command a higher valuation multiple and might even be a net gain for Facebook shareholders prior to the spin-off.

The Good Investors’ conclusion

As social media grows, scrutiny and regulation will inevitably follow. It happens in all industries.

But as a Facebook shareholder, I am not that concerned over regulations. For one, given Facebook’s own stance on regulation, its net positive impact as a platform and its willingness to cooperate with regulators, the odds of extremely unfavourable regulation is very low.

Facebook has also spent big on privacy protection and removing harmful content from its platform. These initiatives should put it in a much better position to negotiate with regulators.

On top of that, anti-competition laws that may force Facebook to break up could even be a good thing for shareholders.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

How This Canadian Fund Smashed The S&P 500

DKAM Capital Ideas Fund may not be that well-known in this part of the world. However its 17.2% annual return since 2008 is definitely worthy of attention.

Actively-managed funds have had a bad reputation in recent years. High fees and poor performance have resulted in the outflow of money from active funds to passive funds. But that’s not to say that there are no active funds that can outperform the market. 

DKAM Capital Ideas Fund, run by Donville Kent Asset Management, is one such fund. From its inception in 2008 to 31 January 2020, the North American-focused fund has delivered a compound annul return of 17.2%, compared to the S&P 500’s 11.7%.

For a fund, even outpacing its relevant index by a few percentage points can be hugely rewarding for its investors. This can be seen in the huge difference between DKAM Capital Ideas Fund’s total return and the S&P 500’s. Cumulatively, the fund’s total return since inception is 503.7%, compared to the S&P 500’s 251.9% over the same 12-year period.

With such an impressive track record of growing shareholder wealth, I decided to take a look at some of DKAM Capital Ideas Fund’s materials to see what is the secret behind its success.

It looks for compounders

Some funds invest in “value stocks” and wait for these stocks to rise to their true value before selling. While this is a decent strategy, it requires active management of capital once these “value stocks” hit what the fund managers believe is their true value.

DKAM Capital Ideas Fund, on the other hand, invests in true compounders. Compounders are companies that can grow their value multiple-fold over the long term. True compounders have much higher upside potential and investors need not move in and out of positions to reap the gains.

A broad approach to screening

To look for these compounders, DKAM Capital Ideas Fund uses a broad approach to screening and idea generation. 

The first step the fund manager takes is to screen for companies that have a high return on equity, typically more than 15%. A high return on equity suggests that a company is making good use of its shareholders’ equity to generate returns.

On top of that, the fund manager also sources for potential new ideas through the use of other basic screens, communication with industry contacts, the media, and publications.

This broad approach to idea generation has enabled the fund to unearth lesser-known companies.

For instance, as of 31 January 2020, 25 of DKAM Capital Ideas Fund’s positions are not in any major indices.

Long-short but with with a bias towards long

As a long-short fund, DKAM Capital Ideas Fund goes both “long” and “short” equities. (To go long means to invest in stocks with the view that they will appreciate in price; to go short means to invest in stocks with the view that they will decline in price.) The table below shows the fund’s exposure as of January 2020.

The short position covers some of the market’s downside risk while the long position is able to leverage up due to hedges from the shorts.

But overall, the net exposure of the fund is still 100.5% long.

DKAM Capital Ideas Fund short strategy is based on factor analysis and consists of companies that are essentially an inverse of its investment framework.

Bias toward small caps

Donville Kent Asset Management also believes that the small caps universe provide a unique opportunity.

Companies with small market capitalisations are less well-known and hence may have a good risk-reward profile. In a recent article, the fund noted that the top-performing stocks in Canada over the past decade started with an average market cap of C$796 million in 2009. The article explained:

“This is definitely on the small side and many of these stocks would not have met the minimum size requirements for most investors in 2009. We think this is where a lot of the opportunities are, hence why it is important to be open to investing in small companies. Every big company was at one point a small company. Looking back over the trajectories of these companies over the last 10 years shows that strong growth is definitely possible.”

The Good Investors’ view

DKAM Capital Ideas Fund is a fund that stands out in an industry that is gaining a bad reputation in recent years. Its long-term performance is driven by an approach that has enabled them to find gems that other investors have yet to uncover.

If you wish to read more of their investing insights, you can head to the ROE Reporter (the name of its newsletter) segment of the fund’s website.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

This Stock Could Benefit From the Coronavirus Outbreak

Although most companies will likely see COVID-19 impact their sales, Teladoc could benefit from the epidemic as more clients warm up to its services.

I try not to let short-term factors affect my long-term investing decisions. The COVID-19 outbreak is one such short-term factor. It is most definitely going to impact economic growth and corporate earnings this year for many countries. But it will likely have no economic impact five years from now.

So despite the huge drop in the S&P 500 and Dow Jones Industrial Average in the US stock market last week, I am still resolutely holding on to all my stocks. I believe that the economic impact will be short-lived and companies with strong balance sheets, recurring income, and steady free cash flow will be able to weather this storm.

At the same time, I am not hopping on the bandwagon of overly-hyped companies that could benefit from the coronavirus situation over the short-term, such as mask and glove producers. These manufacturers may see a sharp spike in revenue over the next few quarters, but the jump in sales will likely only be a one-off event.

All that being said, I think this latest global virus outbreak could still potentially throw up some unique long-term opportunities. One company I see benefiting long term from the outbreak is Teladoc Health Inc (NYSE: TDOC).

Why COVID-19 could benefit Teladoc

Teladoc is the leading telemedicine company in the US. It provides video consultations for primary care, dermatology, and behavioural health. The company’s app makes getting professional healthcare advice so much easier. Patients simply need to open the app and start a video consulting session with a doctor. Best of all, this can be done in the comfort of your own home, which is all the more important when you are suffering from an illness and don’t want the hassle of travelling to your local clinic.

The COVID-19 outbreak in the US could be the catalyst that Teladoc needs for faster adoption of its technology. Video consultations will reduce the spread of infections, enable patients to get real-time advice, and increase the consultation-efficiency for doctors. All of these advantages are important at a time when the virus is rampant and patients need access to quick and effective advice.

CEO Jason Gorevic also said in the company’s latest earnings conference call, “We also see that once members use our services for the first time, they are much more likely to use us again.” As such, if COVID-19 does increase adoption of Teladoc during this time, the likely impact will be that patients who use the technology for the first time will continue using it in the future.

Strong growth even before the outbreak

Although the COVID-19 epidemic will likely increase the rate of adoption of video consultations around the world, Teladoc has already seen rapid growth even without this catalyst.

Teladoc reported a 32% increase in revenue in 2019. The total number of visits increased by 57% to 4.1 million, exceeding the company’s own projections.

And the leading telehealth company is expecting more growth in 2020. Even before factoring the spread of COVID-19 in the US, Teladoc reported in its latest earnings update that 2020 revenue will increase by 25% at the low-end. Over the longer term, Teladoc expects to grow between 20% to 30% a year.

Huge addressable market

Back in 2015, Teladoc said in its IPO prospectus that the Centers for Disease Control and Prevention in the US estimated that there were 1.25 billion ambulatory care visits in the United States per year. Of which, 417 million could be treated by telehealth. And that figure should be much larger today. 

Teladoc, therefore, has plenty of room to grow into. In 2019, despite the 57% spike in the number of visits, total visits were still only 4.1 million. That is less than 1% of its addressable market in the US alone.

The international market provides another avenue of growth. Online consultations could be an even greater value-add in countries with lower doctor-to-patient ratios and where access to doctors is even more prohibitive. Right now, international markets only contribute less than 20% of Teladoc’s revenue. 

Recurring revenue model

Another thing I like about Teladoc is its revenue model. The telemedicine company has recurring subscription revenue that it derives from employers, health plans, health systems, and other entities. These clients purchase access to Teladoc services for their members or employees. 

The revenue from these clients is on a contractually recurring, per-member-per-month, subscription access fee basis, hence providing Teladoc with visible recurring revenue streams.

Importantly, the subscription revenue is not based on the number of visits and hence should have a huge gross profit margin for the company.

Teladoc ended 2019 with 36.7 million US paid members, a 61% increase from 2018. In 2019, this subscription access revenue increased 32% from a year ago and represented 84% of Teladoc’s total revenue.

Other significant catalysts

Besides the COVID-19 outbreak, there are possible catalysts that could drive greater adoption of Teladoc services in the near future.

  • Mental health services driving B2B adoption: As mental health continues to become an increasingly important health issue, Teladoc’s mental health product has been a significant contributor to its B2B adoption.
  • Expanding its product offering: Teladoc launched Teladoc Nutrition in the fourth quarter of 2019, offering personalised nutrition counselling. Nutrition is becoming an increasingly important aspect of preventive medicine and the new service could add significant value to existing and new clients.
  • Regulatory shifts in the US: In April 2019, the Centers for Medicare & Medicaid Services finalised policies that could potentially benefit Teladoc. Its new policies increase plan choices and benefits and allow Medicare Advantage plans to include additional telehealth benefits. Jason Gorevic, Teladoc’s CEO, commented on this: “We view this as further evidence of CMS encouraging the adoption of virtual care in the Medicare population, and we continue to see a significant avenue for growth within the Medicare program.”
  • Acquisition of InTouch Health: Besides organic growth drivers, Teladoc is expected to complete the acquisition of InTouch Health in the near futue. InTouch Health is a leading provider of enterprise telehealth solutions for hospitals and health systems. 

The Good Investors’ Take

The COVID-19 situation is likely going to hinder the growth of many companies in the near term at least. However, Teladoc looks like one that will buck the trend and will instead benefit in both the short and long run from the epidemic.

Besides the COVID-19 catalyst, the long-term tailwinds surrounding the truly disruptive service and Teladoc’s first-mover advantage in this space gives it an enormous opportunity to grow into.

There are, however, risks to note. Competition, execution risk, and the company’s inability to generate consistent free cash flow are all potential risks. Moreover, the telehealth provider’s stock trades at more than 16 times trailing revenue, a large premium to pay. Any hiccups in its growth could cause significant volatility to its share price.

Nevertheless, I think the reasons to believe it can grow in the long-term are compelling. Its addressable market is also big enough for multiple players to split the pie. If Teladoc can even service just 20% of its total addressable market, it will likely be worth many times more by then.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Is Bill.com the Next Breakout Software-as-a-Service Company?

Bill.com’s stock has more than doubled since it went public late in 2019. Is the financial back-office solutions SaaS company worth investing in?

2019 was a mixed year for IPOs. While big names such as Uber and Lyft failed to live up to the hype, others such as BeyondMeat and Zoom were roaring successes. 

One company that was hot straight off the bat was Bill.com (NYSE: BILL), whose share price surged 65% on its first trading day. The cloud-based software provider helps small and medium-sized businesses manage customer payments and cash flow.

After releasing a good set of results for its first quarter as a listed company, Bill.com’s share price jumped again and are now trading an eye-popping 143% above its IPO price. 

With the surge in price, I decided to take a deeper look into the company and whether its shares at today’s price is a good investment opportunity. I will analyse Bill.com using my blogging partner Ser Jing’s six-point investment framework.

1. Is Bill.com’s revenue small in relation to a large and/or growing market, or is its revenue large in a fast-growing market?

Bill.com’s main clientele are small and medium businesses (SMB). According to the US Census Bureau, there were 6 million SMBs in the US in 2018. Data from SME Finance Forum pointed to 20 million SMEs globally in 2019. These numbers translate to a market opportunity of US$30 billion globally and US$9 billion domestically for Bill.com, based on an average revenue of US$1,500 per customer.

Comparatively, Bill.com, as of the end of 2019, served just 86,000 customers and had a US$156 million revenue run rate. That means it is serving just 2.6% of its total US addressable market, giving it a huge opportunity to grow into.

We’ve not even touched the international market opportunity yet. Bill.com currently operates only in the US and if and when it opens its doors internationally, we could see another big wave of growth.

The 61% year-on-year jump in core revenue in the quarter ended 31 December 2019 also demonstrates that the company is on the right track to fulfilling its vast potential.

CEO and founder, Rene Lacerte, outlined five key drivers of growth during the latest earnings conference call that will help Bill.com capitalise on its market opportunity:

  1. Invest in sales and marketing activities to acquire new customers
  2. Seek increased adoption by existing customers by increasing the number of its customers’ employees who become regular users (Bill.com charges each company a fixed amount per user)
  3. Grow the number of network members (network members are suppliers and clients that customers can interact with through the platform) 
  4. Enhance platform capabilities through R&D
  5. Expand internationally

2. Does Bill.com have a strong balance sheet with minimal or a reasonable amount of debt?

As is the case for most fast-growing start-ups, Bill.com is still loss-making and burning cash. The company had negative free cash flow of around US$10 million and US$8 million in fiscal 2018 and 2019 (the company’s fiscal year ends on 30 June). 

Thankfully, Bill.com is flushed with cash after its IPO. At end-2019, the company had no debt, and US$382 million in cash and short term investments. This puts Bill.com in a commanding position financially and it also means that the company should have the financial power to continue investing for growth.

It is also positive to note that the company’s sharp rise in share price could also open the door for it to raise more money through issuing shares (in a reasonable manner!) to boost its balance sheet in the future.

3. Does Bill.com’s management team have integrity, capability, and an innovative mindset?

Rene Lacerte has an impressive resume. He is a serial entrepreneur who sold his last startup, PayCycle, to Intuit for US$170 million. It was at PayCycle when he realised how difficult it was to run the back-office operations of a company. Hence, he started Bill.com to streamline the back-office processes of SMBs. 

His track record as an entrepreneur is a testament to his ability to innovate and lead a team. Bill.com has a 13-year track record of growth and has consistently improved its service and grown its network of partners.

These initiatives have helped build Bill.com into a platform that customers trust and stick with.

I think Lacerte has a clear vision for the company and he has put in place a good framework to achieve that. In addition, his decision to take the company public last year is also smart, given the high valuation that he managed to raise new capital at.

When looking at a company’s management team, I also like to assess whether the compensation structure is incentivised to boost long-term shareholder value. 

I think Bill.com has a fair incentive structure. Rene Lacerte is paid a base salary of US$350,000 and also given option awards. As the option awards vest over a multi-year period, it incentivises him to grow long-term shareholder value. 

4. Are Bill.com’s revenue streams recurring in nature?

Bill.com has a predictable and recurring stream of revenue. The cash management software company derives its revenue through (1) monthly subscriptions, (2) transaction fees, and (3) interest income from funds held on behalf of customers while payment transactions are clearing.

Monthly subscriptions are recurring as Bill.com’s customers tend to auto-renew their subscriptions. Transaction fees are not strictly recurring in nature, but approximately 80% of total payment volume and the number of transactions on Bill.com’s platform in every month of fiscal 2019 represented payments to suppliers or from clients that had also been paid or received from those same customers in the preceding quarter.

In other words, Bill.com’s customers tend to make recurring payments or collect recurring fees over the platform. This, in turn, generates recurring transaction fees for Bill.com.

In the quarter ended December 2019, subscription and transaction revenue made up US$33 million of the total revenue of US$39.1 million.

Bill.com also has a decent customer retention rate of 82% as of June 2019. The net dollar-based retention rate is an indicator of how much more customers are spending on the platform, net of upsells, contraction, and attrition. Ideally, the number should be more than 100%. Bill.com’s net dollar-based retention rate was 110% for fiscal 2019 and 106% for 2018. Put another way, Bill.com’s customers as a group, paid 10% and 6% more in 2019 and 2018, respectively.

The increase in net spend by existing customers is a good indicator that Bill.com has a business model that promotes recurring and growing revenue from its existing clients.

5. Does Bill.com have a proven ability to grow?

Bill.com has barely gotten its feet wet as a listed company so it has yet to prove itself to the investing public. However, as a private company, Bill.com has grown by leaps and bounds.

The chart below shows the annual payment growth and milestones that it has achieved since 2007.

Source: Bill.com S-1

Bill.com grew to 1,000 customers in three years after launching its demo in 2007. In 2014, it hit 10,000 customers and today serves more than 86,000 customers.

As the company’s revenue is closely linked to the number of customers it serves and the payment volume handled through its platform, Bill.com’s revenue has also likely compounded at an equally rapid pace over the years.

Most recently, Bill.com reported a strong set of results in its first quarter as a listed company with core revenue up 61% in the quarter ended December 2019.

6. Does Bill.com have a high likelihood of generating a strong and growing stream of free cash flow in the future?

As mentioned earlier, Bill.com is still not free cash flow positive. However, I believe the company has a clear path to profitability and free cash flow generation.

For one, its existing customers provide a long and steady stream of cash over a multi-year time period. As such, the company can afford to spend a higher amount to acquire customers.

In its S-3 filing, Bill.com showed a chart that illustrated the value of its existing customer base.

Source: Bill.com S-3

The chart is a little blur so let me quickly break it down for you. The orange bars illustrate the revenue earned from the customers who started using Bill.com’s software in the fiscal year 2017. The revenue earned from the cohort increased from US$6.7 million in FY17 to US$14.2 million and US$17.3 million in FY18 and FY19, respectively.

The dark blue chart shows customer acquisition costs related to getting the 2017 cohort onto its platform. Once the customers are using the platform, they tend to stay on and there is no need to spend more on marketing. Hence, there is no dark blue bar in FY18 and FY19.

The dotted black line is the contribution margin from the cohort. Contribution margin rose from -108% (due to the high customer acquisition cost that year) in FY17 to 73% and 76% in FY18 and FY19, respectively.

In short, the chart demonstrates the multi-year value of Bill.com’s customers and the high potential margins once the customers are on its platform. These two factors will likely drive profitability in the future for the company.

Risks

Execution-risk is an important risk to take note of for Bill.com. The relatively young SaaS firm is just finding its feet as a public company and will need to execute on its growth plans to fulfill its potential and deliver shareholder returns.

With barely three months of a public track record to go on, investors will need to take a leap of faith on management to see if they can actually deliver.

There is also key-man risk. Lacerte is the main reason for the company’s success so far. His departure, for whatever reason, could be a big blow to the company.

In addition, the market for financial back-office solutions is fragmented and competitive. Some of Bill.com’s competitors may eat into its market share or develop better products.

That said, Bill.com has built up an important network of partners and businesses that are already supported on its platform. This network effect creates value for its current customers and I think it is difficult for competitors to replicate.

Valuation

Now we come to the tricky part- valuation. Valuation is always difficult, especially so for a company that has yet to generate free cash flow and with an uncertain future. I will, therefore, have to make an educated guess on where I see the company in the future.

According to its own estimate, Bill.com has a market opportunity of US$39 billion worldwide. To be a bit more conservative, let’s cut this opportunity by half and then assume it can achieve a 20% market share at maturity in five to 10 years’ time.

If that comes to fruition, Bill.com can have annual revenue of US$3.9 billion. Given its high 75% gross profit margin, I will also assume that it can achieve a net profit margin of 25%. Mathematically, that translates to an annual profit of US$975 million.

If the market is willing to value the company at 25 times earnings by then, Bill.com could be worth close to US$24.4 billion.

Today, even after the spike in Bill.com’s share price, it has a market cap of just around US$3.8 billion. In other words, the stock could potentially rise by more than 600% over the next five to 10 years if it lives up to the above projections.

The Good Investors’ conclusion

Bill.com has had a good start to life as a listed company, with shares soaring above its IPO price.

It also ticks many of the boxes that Ser Jing and I look for in our investments. It has a huge addressable market, a proven track record of growth, and a clear path to profitability. The injection of cash from the IPO also gives it a war chest to invest in international expansion.

On top of that, its market cap is still a fraction of its total addressable market and potential future market value. There are risks but if Bill.com can live up to even a fraction of its potential, I believe its stock could rise much higher.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

4 Lessons We Can Learn From ARK Innovation ETF

ARK Innovation ETF has an annualised return of 21.7% since its inception in 2015, far outpacing the S&P 500. Here are some things we can learn from it.

ARK Innovation ETF is an actively managed exchange-traded fund run by ARK that focuses on US stocks. As of December 2019, the tech-focused fund boasts a 21.7% annualised return since its inception in late 2014, making it one of the top-performing funds globally. Its performance is also well ahead of its comparative benchmark, the S&P 500, which returned just 11.7% annualised over the same time frame.

So how did ARK Innovation ETF do it?

I took a look at some of the blog posts from ARK’s investing team and its investing principals to find out what is driving the ARK Innovation ETF’s market-beating performance.

It invests for the long-term

Benjamin Graham was one of the pioneers of long-term investing. He once said that “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

What this means is that stocks can get mispriced in the stock market simply because of the whims of investors. Over the long run, though, a stock will tend to gravitate towards its true value. 

ARK invests with this principle in mind. It explains:

“The market easily can be distracted by short-term price movements, losing focus on the long-term effect of disruptive technologies. We believe there is a time arbitrage ARK can take advantage of. We seek opportunities that offer growth over 3-5 years that the market ignores or underestimates.”

It doesn’t mind going against the grain

ARK is not your typical Wall Street fund manager. In fact, many of its views go against the traditional beliefs of Wall Street.

For example, Wall Street often likes to categorise different types of innovation. But ARK believes that innovation “cannot be boxed into sectors, geographies or market caps.”

It also doesn’t mind having vastly different opinions from the rest. For instance, ARK is famous for being one of the most bullish funds about Tesla, which is also one of the most heavily shorted stocks in the market today.

It goes big on high-conviction stocks

A truly exceptional opportunity does not come around often. And Charlie Munger is famous for saying that the important thing when you find one is to “use a shovel, not a teaspoon.”

I think ARK abides by the principle, betting big on stocks that it believes in.

For instance, 10% of ARK Innovation ETF’s portfolio is in Tesla. ARK is one of the vocal supporters of Elon Musk’s brainchild. So far, the concentrated position has worked well for ARK with Tesla’s stock price up four-fold over the past five years and nearly doubling so far this year.

Open-source approach to research

Instead of relying solely on its own in-house research, ARK is open to new ideas from the public. It frequently publishes its research and encourages readers to provide more insight and comments. ARK believes that its “open research ecosystem allows for an organised exchange of insights between portfolio managers, director of research, analysts and external sources”.

The Good Investors’ conclusion

ARK’s unique approach has certainly worked well for it. The ARK Innovation ETF is now one of the top-performing and most respected funds in the market.

I also have a feeling that year ARK Innovation ETF will extend its winning streak in 2020 due to the recent surge in Tesla’s share price.

Investors who want to learn more about ARK’s research can head here.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Some Thoughts on Tesla

Tesla’s stock is flying high, doubling in 2020 alone. The electric vehicle company enjoys many tailwinds, but is the stock price getting ahead of itself?

Tesla has been the talk of the town so far in 2020. The tech-driven company’s stock price has more than doubled since the start of the year thanks to a strong end to 2019 for its business.

With the recent hype around Tesla, here’s a look at some of the reasons why Tesla’s stock may have surged and whether it is still worth investing in.

Free cash flow generation

Previously, one of the concerns investors had with Tesla was its cash burn rate. The company’s high cash burn (see chart below) had resulted in Tesla raising money through secondary offerings that diluted existing shareholders. 

However, 2019 could be a turning point for Elon Musk’s brainchild. The electric vehicle company was GAAP-profitable in the second half of 2019 and had generated US$1.4 billion in free cash flow for the same period. Its 2020 outlook was also extremely positive. Tesla said:

“We expect positive quarterly free cash flow going forward, with possible temporary exceptions, particularly around the launch and ramp of new products. We continue to believe our business has grown to the point of being self-funding.”

And although Tesla announced another secondary offering last week, I think this time it was not because of cash flow issues but rather to take advantage of the run-up in its share price.

The chart below illustrates improvements in its trailing twelve months (TTM) of free cash flow over the last 12 quarters.

Source: 2019Q4 Tesla update

Ramping up production capacity 

Another major plus for the company was the announcement that it was going to ramp up production capacity. In its outlook statement, Tesla said:

“For full-year 2020, vehicle deliveries should comfortably exceed 500,000 units. Due to ramp of Model 3 in Shanghai and Model Y in Fremont, production will likely outpace deliveries this year.”

Tesla’s 2020 projection translates to at least a 36% jump in deliveries from 2019. 

Perhaps the most impressive part of its 2019 fourth-quarter earnings announcement was that it was able to start Model 3 production in its Gigafactory in Shanghai in less than 10 months from breaking ground- a sign that the company is becoming more efficient in ramping up production.

The China factory will boost production capacity by around 150,000. Besides the factory in China, Tesla has moved forward with its preparations to build a factory near Berlin, which is expected to be open by 2021.

Irresistible demand for products to meet its production ramp-up

The production ramp-up is only possible due to the strong demand for Tesla’s products. In his earnings call with analysts, Musk gushed:

“Our deliveries reached over 112,000 vehicles in a single quarter. It’s hard to think of a similar product with such strong demand that it can generate more than US$20 billion in revenue with zero advertising spend.”

Musk was even more optimistic about Tesla’s new Cybertruck vehicle. He said:

“I have never seen actually such a level of demand at this — we’ve never seen anything like it basically. I think we will make as about as many as we can sell for many years. So — as many — we’ll sell as many as we can make, it’s going to be pretty nuts.”

As Tesla plans to start production of its Cybertruck only in 2021, investors will need to wait at least a year before the initial sales figures are released but the early signs are certainly encouraging.

Better gross margins 

In addition, gross margins for Tesla should improve.

Improved efficiency in product cost and higher gross margins for its newest car (Model Y) will be the driving force behind Tesla’s better gross margins.

The company will deliver its first Model Y in this quarter and expects to ramp up sales of its latest model over the year. As the product-mix shifts towards Model Y, I think investors can expect a slight improvement in gross Tesla’s margin.

On top of improvements in gross margin, Tesla also said that it is likely going to be more efficient in terms of capital expenditure per production capacity. The improvements to capital efficiency should enable the company to scale its capacity faster and produce its vehicles at a cheaper rate on a per unit basis.

Other factors

Besides selling electric vehicles, there are a few other potential drivers of growth:

  • Tesla is at the forefront of the fully autonomous vehicles trend. The technology-driven company logged 500 million autonomous miles in 2018. Tesla is, literally, miles ahead of its rivals, Waymo and GM’s Cruise, which logged 1.3 million and 447,000 miles respectively.
    Currently, Tesla sells cars that are fitted with the hardware needed for full self-driving (FSD), with an optional upgrade for FSD software features. As FSD technology matures, we can expect Tesla to roll out updates to the software. In addition, Tesla can also retain a fleet of FSD vehicles for rental and driverless transportation- in a way becoming the Uber of driverless vehicles. Ark Invest estimates that autonomous ride-hailing platforms in aggregate could have a value of a whopping US$9 trillion by 2029.
  • Tesla also sells vehicle software such as its Premium Vehicle Connectivity feature which enables users to stream music on their cars. Owners of Tesla vehicles can also buy other software updates such as acceleration boost, basic Autopilot, and additional premium features. As Tesla grows its suite of software products, this revenue stream is expected to become another important driver of growth for the company.
  • The company’s energy storage and solar roof installations businesses have also increased year-on-year. Tesla expects both storage and solar roofing to grow by 50% in 2020.

But is Tesla’s stock too expensive?

2019 is a year which Tesla proved many of its doubters wrong. But has the market gotten ahead of itself?

After the surge in its share price, Tesla’s valuation currently tops US$160 billion. That translates to nearly seven times trailing sales. For a company that has a gross profit margin for its automotive business of 22% (which is high for vehicle sales but low compared to other industries), its current share price certainly seems rich- even for a company growing as fast as Tesla is.

Even if Tesla can quadruple its sales figures to a US$80 billion run rate and earn a 10% net profit margin, today’s share price still represents 20 times that possible earnings. And Tesla will need to keep its foot to the floor of the accelerator to generate that kind of numbers.

In addition, the automotive industry has traditionally been in a tough operating environment. Even though demand for Tesla’s vehicle models seem irresistible at the moment, things could change in the future and a drop in popularity could hurt sales.

The Good Investors’ conclusion

Tesla’s products are in hot demand now and the company has plans to ramp-up its production capacity. And if Tesla can deliver on all fronts (including full-self-driving), I could still stand to make a very decent profit if I buy shares today.

However, its stock does seem a little bit expensive. Any misstep in Tesla’s growth could send the stock price tumbling. As such, despite the tailwinds and huge market opportunity, I prefer to take a wait-and-see approach for now.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Could Guardant Health Be a Potential 10-Bagger?

Liquid biopsies look likely to change the world of cancer-treatment, and Guardant Health is at the forefront of this exciting evolution.

Cancer is a devastating disease and a growing cause of death in the developed world. Worldwide, the disease struck more than 17 million people in 2018 and that figure is expected to mushroom in the future. The numbers are scary but the silver lining is that the world is making great strides in combating the disease.

One company that is doing its part to help is Guardant Health (NASDAQ: GH).

The medical diagnostics company sells liquid biopsies to help identify tumours that can be treated with targeted therapy.

Liquid biopsies are a much less invasive method of obtaining information about cancer cells in a person’s body than traditional tissue biopsies. Put another way, liquid biopsies are a fancy term for a simple blood test that can replace painful tissue biopsies.

On top of that, Guardant Health’s first commercialised liquid biopsy, called Guardant360, produces faster results that are as effective as traditional biopsies.

But Guardant Health is not just creating a positive impact on humanity. Its stock price has already nearly tripled since its IPO in 2018, but I think it still has legs to run and could even potentially be a 10-bagger in the making. 

Here’s why.

FDA approval

The leader in liquid biopsy has applied for Food and Drug Administration (FDA) approval for Guardant 360. So far, Guardant 360 is being sold without FDA approval and falls into the category of a laboratory-developed test. An approval by the FDA will give the test more credibility and should help it achieve greater commercial adoption.

Gaining FDA approval will also support improvements in coverage by commercial payers and reimbursements. Higher coverage by commercial payers will likely increase the take rate among patients and also enable Guardant Health to increase the selling price of Guardant 360.

Helmy Eltoukhy, Guardant’s co-founder and CEO, said the following in the company’s 2019 third-quarter earnings conference call:

“We believe FDA approval will be an important catalyst for helping to establish a blood-first paradigm that will lead to continued clinical adoption of Guardant360.”

Pipeline products

Besides Guardant360, Guardant has three other products that are either in the pipeline or marked for research use. They are GuardantOMNI, LUNAR-1, and LUNAR-2. 

GuardantOMNI is similar to Guardant360 but can identify a broader panel of genes (500 vs 73) from circulating tumour DNA. It was designed for biopharmaceutical companies to accelerate clinical development programs for both immuno-oncology and targeted therapy treatments. GuardantOMNI is being sold for research-use only.

LUNAR-1 is a test that is aimed at detecting cancer recurrence in patients that are in remission. LUNAR-2 is a test to detect cancer in asymptomatic but high-risk populations. Essentially, LUNAR-2 can become a more accessible screening tool to detect cancer early. LUNAR-1 and LUNAR-2 have yet to be commercialised but are in late-stage clinical trials. 

Together, these four tests provide immense potential for the company. The chart below provides a nice summary of Guardant Health’s pipeline.

Source: Guardant Health IPO Prospectus

Huge addressable market

Liquid biopsies have a huge addressable market since it could replace traditional tissue biopsy and cancer screening tests such as colonoscopies.

According to Guardant Health’s IPO prospectus, Guardant360 and GuardantOMNI have a potential addressable market of US$6 billion. 

But the biggest potential lies with LUNAR-1 and LUNAR-2, which have addressable markets of US$15 billion and US$18 billion, respectively.

Guardant Health is still in its infancy and has a huge runway of growth with an estimated revenue of just US$200 million for 2019.

International opportunity

Moreover, the addressable markets stated above are only for the US. Guardant Health has a joint venture with Softbank to take its products internationally. The strategic partnership with the Japanese firm should give Guardant Health a first look into the Japanese market and open doors for international expansion.

FDA approval will also enable greater adoption internationally and should be a catalyst for international commercialisation in the future.

Guardant Health is making good progress

The biotech firm has shown signs of progress on multiple fronts. On top of the submission for FDA-approval for Guardant360, Guardant Health’s management also mentioned in the earnings conference call for the third quarter of 2019 that it was likely that Guardant360 could gain Medicare Pan-Cancer local coverage determination, giving more patients access to Guardant360 through the medicare plan.

Guardant Health is also advancing its LUNAR tests and in its earnings announcement for 2019’s third quarter, said that it had enrolled its first patient in its ECLIPSE study, a “prospective multi-site registrational study designed to support the introduction of our LUNAR-2 assay for using guidelines-recommend colorectal cancer screening in average-risk adults.”

These initiatives are encouraging signs for the commercialisation and adoption of the two LUNAR tests.

Financially, the numbers look great

Although Guardant Health’s business is still very much in its infancy, the numbers look promising. 

In the third quarter of 2019, revenue was up 181% to US$60.8 million from just US$21.7 million. The number of clinical precision oncology tests increased by 89% to 13,259, while tests for research purposes increased by 111% to 5,280. These figures suggest that oncologists and biopharmaceutical firms are warming up to the idea of Guardant Health’s less invasive cancer testing products.

The gross margin for Guardant Health is also high at 70% and could widen if Guardant 360 earns FDA approval.

Guardant Health is still experiencing losses but this is expected for a company that is spending heavily on marketing, research, and applications for regulatory approvals. The company’s management expects 2019 revenue in the range of US$202 million to US$207 million, representing growth of 123% to 128% from 2018.

Its balance sheet is also healthy with no debt and slightly over US$500 million in cash and short-term marketable securities. Its solid financial footing gives the company the flexibility to continue investing in research and to push for the commercialisation of its two LUNAR tests.

The stock is cheap compared to its addressable market

Guardant Health’s stock trades at around 40 times the projected revenue for 2019. On the surface, that looks expensive but investors should consider the company’s total addressable market and the milestones that the company has achieved towards greater market penetration.

The liquid biopsy firm has a market cap of around US$8 billion, which is tiny when compared to its total addressable market of US$40 billion in just the US alone. 

The Good Investors’ conclusion

Having said all that, I acknowledge the possibility that Guardant Health will not live up to its potential. Competition, regulatory restrictions, and missteps in clinical trials are just some of the risks that could derail its growth.

But despite the risks, the signs look promising. The take-up rate for Guardant360 and GuardantOMNI are increasing year-on-year and the possibility of FDA-approval could be a near-term catalyst. Moreover, progress has been made with the two LUNAR tests which can provide the next avenue of growth.

If Guardant Health lives up to even a fraction of its potential, I think the stock will rise much higher.

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