Shares of Teladoc (TDOC) have had a phenomenal run over the past year as sentiment towards the company’s fast growing but money losing business swung from pessimistic to extremely optimistic. The company has posted impressive revenue growth over the past year due to organic and acquisition driven growth and this is expected to continue for the next year due, in part, to the recent Best Doctors acquisition. Despite the revenue growth, the company has demonstrated little operating leverage in its business with revenue growing 64% Y-o-Y in the first half of 2017 but the EBITDA loss improving only 8% to a loss of $24M from a loss of $26.1M a year earlier. Adjusted EBITDA improved significantly more, but mostly because TDOC has ramped up the use of stock based comp for employees by 166% during the comparable six months of last year. Loss from operations was roughly flat Y-o-Y in the first six months and net loss increased slightly. Operating leverage is expected to improve in the second half of this year and into 2018 with the company expected to be adjusted EBITDA positive in Q4.
Best Doctors Acquisition Dramatically Changes the Capital Structure and Risk Profile
In June, TDOC announced the acquisition of Best Doctors (BD), a second opinion company that was founded in 1989. BD is a much slower growth, more mature business vs. TDOC’s core telemedicine business, but management believes there is some cross selling synergies to be realized. TDOC financed the acquisition by issuing shares and borrowing $450M through the issuance of convertible debt and a new term loan facility. While the most recent balance sheet doesn’t reflect the closing of the BD transaction, TDOC’s CFO provided an update on the balance sheet during the company’s earnings call in August. TDOC had $450M of total debt and a “little over $150M of cash”, resulting in net debt of approximately $300M. This strikes us as a massive amount of leverage for a company that is expected to generate $350M of revenue in 2018 and a small EBITDA loss. TDOC expects the debt to have a cash interest cost of roughly 5%, which equates to about $23M per year. To put that in perspective, BD had adjusted EBITDA of $6.5M last year (up from a loss of $13M the prior year). TDOC needs to nearly quadruple BD’s EBITDA to pay for the interest expense alone. TDOC management must believe they can dramatically increase BD’s business or they believe the stock will continue its upward trajectory and the convertible debt will convert to equity. There is a long list of companies (mostly tech companies) that have issued converts near the peak of bull markets assuming they would one day be equity only to have equity valuations come down and have to deal with the convert as debt when it came due. The BD acquisition might end up being transformative, but the debt taken on to buy the company has dramatically increased the risk profile of TDOC.
A Crack Emerges in the Business Model
Not long after closing the BD acquisition, TDOC announced a large win with the Blue Cross Blue Shield Federal Employees Program. Not only is this a great name plate, but they also have 5.3M covered members. This is substantial considering TDOC’s total subscriber base was 20.5M at the end of Q2. While this looks like a great win, the press release has essentially no details on the financial impact, which is not uncommon; however, several analysts published some details about the deal that most investors may be unfamiliar with. Details about the contract from Canaccord analyst Richard Close’s report notes:
- TDOC will not receive minimum subscription access fees
- TDOC will not count the 5.3M members in their subscriber numbers due to the lack of access fees
- TDOC won vs. 10 other companies bidding on the deal.
Why is this important? One of the primary points to multiple bear thesis that have been published on TDOC has been that subscription access fees would eventually go away as competition increases in the space and at least one major competitor is known to lead with a visit fee only model. To put in perspective how important access fees are for TDOC, in their most recent quarter access fees were 74% of revenue while visit fees were 26%. If it is true that TDOC won this business with no access fees then it would mark a significant shift in the business model and we have to wonder if other large customers would expect the same terms when contracts come up for renewal. Contagion is always a risk when a company provides a discount on a high-profile deal. (By the way, the fact that TDOC discussed such important contract details with an analyst and did not put them in a filing seems like selective disclosure to us, but that is another issue.)
While TDOC is a leader in the fast growing telemedicine market the BD acquisition dramatically increases the stock’s risk profile. This risk may be compounded by an increasingly competitive market that may impact TDOC’s business model. The company is now levered at nearly 1x revenue, must generate $25M of adjusted EBITDA to be cash break even given the debt service, and is expected to lose money through at least 2019. Trading at roughly 7x 2018 revenue estimates, we believe TDOC is vulnerable to a significant pullback at the very least.
Disclosure: I am/we are short TDOC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.