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.
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.
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.
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.
Hello, thanks for sharing! my 2 cents- it may be over-estimating to assume both hypertension and diabetes market as there are significant overlap between the two, with diabetes being the core medical condition that leads to many other diseases such as weight mgm/ hypertension, etc. I think the overlap could be up to 70% which i have read in a CEO interview. i.e. if my diabetes is under control, i may not need the rest. Would like to hear your thoughts 🙂 Thanks!
Hi Clare,
Yes, I think you are right. A portion of diabetes patients will also have hypertension. Many of those patients may choose just to opt for Livongo’s diabetes products.
So the addressable market may be smaller than what Livongo estimated. But there is also a large number of hypertension patients that do not have diabetes so there’s still a huge market for Livongo’s hypertension product.