Summary of the thesis
The pandemic has accelerated digital transformation and increased adoption rates for digital service providers, leading to speculative stock price increases for most of these digital stocks. Inevitably, the bubble eventually burst and valuations soared. normalized to more reasonable levels. Teladoc Health, Inc. (NYSE: TDOC) is no exception and over the past year has lost around 60% of its value, down from the price of $192. This was an apparent overreaction from the market, but the general sentiment has now turned positive. The stock has already bottomed out at $50 and is now well positioned to hit new highs.
TDOC underperformed any comparable performance index, well below the XLV, ARK Innovation ETF (ARKK) and S&P 500. However, the drop created a unique and attractive entry point, and I rate TDOC with a strong buy rating primarily due to the combination of the company’s strong fundamentals at a reasonable valuation.
The outlook for digital health is bright
Against the backdrop of the big picture, the entire US healthcare industry is expected to grow steadily year over year. Following the pandemic, the U.S. government is placing more emphasis on national health and is now allocating a greater portion of its GDP to health spending, which is expected to reach nearly 20% by 2028. Such a portion translates into about $5.9 trillion in six years. and signals a favorable outlook for Teladoc.
Undoubtedly, the pandemic has exposed the vulnerabilities of governments, resulting in greater investment in technologically advanced healthcare solutions that will unlock value through cloud computing, data analytics, telemedicine, preventive care, AI and other innovative tools. Therefore, Teladoc is well positioned to grow domestically and internationally and become a market leader in health technology over the next decade.
How Teladoc Makes Money
TDOC adopts a subscription-based model that generates recurring monthly revenue from active memberships through direct-to-consumer (D2C) channels. This source of revenue, classified as access fees, accounts for 85% of overall revenue, with visitation fees and other revenue accounting for smaller portions at 13% and 2%, respectively. Access fees remain the most critical factor which also provides greater revenue predictability. Teladoc’s main offering, Primary360, is available to subscribers through employer health plans that pay on behalf of its employees.
Given the nature of the company’s operations, seasonality is expected at the end and beginning of the year, as they have described as listing seasons when listing activity is high. As a result, it is reasonable to expect the strong growth in Q4-2021 to continue into the following quarter. Undoubtedly, the subscription-based business model relies heavily on achieving economies of scale, and the faster the company grows its user base, the faster it will cover its initial investment and generate profits for users. shareholders.
Acquisition of Livongo created value for shareholders
The company is targeting a total addressable market (TAM) opportunity of US$261 billion. Undoubtedly, such a combined TAM figure could not be achieved without the boost provided by the acquisition of Livongo. To that effect, TDOC has wisely expanded its portfolio of healthcare brands over the past two years, with Livongo being a major acquisition step that will pivot and enhance the company’s strategic focus.
Livongo not only brings $50 billion in TAM, but also enhances TDOC’s product offering by targeting people with chronic conditions, such as diabetes and hypertension. These people tend to spend more on healthcare, and Livongo offers a unique value proposition through smart devices and expert support, resulting in significant cost savings for employers and insurance companies. .
Remarkably, the acquisition created $60 million in cost synergies by 2022 and strong revenue opportunities of $500 million expected by 2025. TDOC completed its acquisition of Livongo on October 30, 2020. The first Signs of operational efficiencies are evident at the end of 2021 when operating expenses (Opex) experienced a sharp slowdown while revenues grew rapidly.
Profitability and revenue growth remain solid
Over 90 million individuals have access to the Teladoc platform, and average monthly revenue per member (ARPM) is $2.49 in Q4, a 52% jump from Q3. However, the company faces intense competition, mainly from smaller competitors and national healthcare systems.
Despite the first-mover advantage, its management is changing rapidly and has wisely adopted an acquisition strategy to grow the business and crush its competitors. Teladoc operates in a highly fragmented industry, which explains declining gross profit (GP) margins as telemedicine companies enter price wars and adopt a low-cost strategy to steal market share.
Even though margins have eroded over the past few years, the company posted an exceptional GP figure of 68% in the last quarter of 2021 and showed signs of stability. Also, as the company gains operating leverage with more registered users and better control over Opex, operating margins are expected to turn positive for the foreseeable future.
Additionally, since the company’s IPO in 2015, average revenue growth has hovered around 80%, with only a slight drop to 75% when compared to its 5-year average. These growth metrics are exceptional, and given the revenue synergies from Livongo and InTouch, combined with the growth in market size, TDOC is well positioned to capitalize on the growth.
Finally, the size of the digital health market is expected to grow at a compound annual rate of 25.3% over the next three years, further bolstering TDOC’s positive growth outlook. Therefore, it is reasonable to assume that the TDOC will increase at a similar rate in the foreseeable future.
TDOC faces some risks
Investing in TDOC is not without risk, and company-specific risks remain a deciding factor for some investors. What caught my eye when I read the company’s latest Form 10-K is that TDOC’s revenue is relatively concentrated, with its top ten customers accounting for 21.8% of its total revenue for 2021, compared to 16.2% last year. So, for a growth stock that derives most of its value from its revenue growth metrics, failure to maintain any of these large clients will skew growth rates and threaten TDOC’s valuation.
Finally, a continued decline in GP margins below 60% may challenge the company’s ability to compete and maintain pricing power. As a result, investors should closely monitor the company’s margins but not overreact to normal QoQ fluctuations. On the contrary, it is reasonable to assume that margins have bottomed out and if Livongo’s synergies materialize, then an upward move is expected.
Relative valuations remain cheap
Most of the company’s publicly traded competitors are smaller in size, but some attract much higher valuations in P/S and P/B multiples, despite much lower earnings growth rates. Surprisingly, TDOC is trading below its book value, making it a rare opportunity and providing a wide margin of safety for risk-averse investors. While the P/B metric is less relevant for growth stocks, it’s reasonable to assume the gap won’t last long, and the 39% upside from current levels is highly likely by 2022.
By far the cheapest top 10 of ARKK
TDOC holds the third largest position in Cathie Wood’s ARKK ETF portfolio with a weighting of approximately 6.64% and a market value of $803 million. The famed investor is well known for investing billions in the most important growth stocks, and these top ten names deserve a closer look as they are considered high conviction stocks that bring technological disruption. TDOC ranks 3rd in the list, but it remains one of the cheapest titles with only a P/S multiple of 5.57x, well below ARKK’s average of 23.34x at the time of writing.
As a value and GARP investor, opportunities that balance high growth and reasonable valuations are rare. In closing, TDOC stands out in my watch list of growth stocks, and it’s now part of my model portfolio, with the potential to get an upgrade from my concentrated portfolio of blue-chip stocks.