Teladoc (TDOC) is a provider of virtual telemedicine services. The company has exhibited impressive growth over the past several years on the back of industry tailwinds and solid execution, leading to expansion in share price reaching a high point of ~$86/sh in 2018 (400% growth since 2017). During Q4 2018, the company was impacted by the general market downturn along with a few media distractions including sale of shares by its CFO and accusations by a short seller around questionable sales practices. We consider these to be white noise (to be explained later). This led to a share price decline of ~40% at one point. In this article, we attempt to establish that the fundamental situation of the company and the market it operates in remains strong. We also present a fundamental view that we think the market is taking when pricing the stock; we believe this view does not account for the multiple growth vectors available to the company. Ultimately, we theorize that the stock is undervalued today with a potential upside of 40%.
Source: Yahoo Finance
Products and Services
In simple words, TDOC provides a software that allows users to access a scaled network of medical professionals over their mobile phones from anywhere with an internet connection. The company also provides access to doctors over a traditional land-line, in-fact majority of the patient interactions occur over this mode and this illustrates a very important point around TDOC's competitive edge in this increasingly competitive market: access to medical professionals at scale is of greater importance than the software (NYSE:IP). We will discuss this point in greater detail in the following sections.
Teladoc's mode of patient interaction - Source: company reports
Majority of consultations fall in the general medicine category however the company has been increasing its mix of services including mental health, dermatology, sexual health, wellness etc. These additional services provide a compelling up-sell opportunity for the company to its already significant subscriber base especially mental health and wellness services which are gaining increasing awareness in North America.
Business Model Analysis
- Customers: Even though the end users of the product is the general population (consumers), the company is engaged in a B2B2C (business to business to consumer) model and distributes its products through intermediaries including insurance companies, health systems and employers. This provides the company greater access and ability to leverage existing customer relationships between the intermediaries and the customer. Insurance companies and health systems likely make up the greatest portion of revenue for the company today. A pure direct to customer strategy would require a lot more effort to scale. For example, an insurance company may include telemedicine as part of the employer insurance package without the end customer even having to make a decision on whether they want it or not.
- Value Proposition: For end consumers, the service provides the ability to access a medical professional remotely (greater reach and faster access). For the intermediaries (insurance companies), this creates an additional means to generate revenue. For employers, the service provides an additional benefit to attract talent and also improve absenteeism. Finally, for the doctors, this provides an additional source of revenue that can be generated from their homes in addition to their day jobs.
- Sale Process: Most sales to customers (insurance companies and health systems) are via direct sales (i.e. responding to RFP's or reaching out directly to customers). The company also uses channels such as consulting companies to re-sell its products.
- Key Resources and Activities: Software (along with the associated development team) and contracts with medical professionals.
- Revenue Streams: The company currently generates revenue from monthly subscription fees for the use of the software and the billings for consultations between end users and medical professionals. Future revenue streams may include licensing fees from physician offices or nursing homes for the use of the IP and a potential data analytics play given the vast amount of information the company has gathered from its ~10M consultations to date
- Cost Structure: Key costs include fees paid to medical professionals, sales and marketing and R&D.
- ~2,200 employees
- ~7,000 network physicians
- ~12,000 clients including 40% of Fortune 500 employers, 40 health plan clients and 300 hospital systems
- Access to 50,000 medical experts across 450 specialties (partially acquired through M&A activity)
Key Trends in Healthcare and Impact on Telemedicine Adoption
Healthcare costs are rising and governments, employers and hospitals are faced with pressures to find innovative ways to reduce these costs. For example, the new value based healthcare system which is gaining more traction proposes to penalize hospitals for re-admissions. The company estimates that approximately a third of ambulatory care visits can be handled remotely. This is not hard to see as today's traditional means of getting healthcare require patients to go to the hospital for even non-critical issues. For example in a remote community, if someone wants to re-fill their diabetes prescription in the evening, they may have to go to a hospital emergency room. This can take a lot of time for the patient and a cost burden on the entire system. This is a clear example of a medical visit that can be handled via telemedicine in very little time (note that doctors can prescribe medicine for most treatments on a telemedicine platform; TDOC has the ability to send this prescription directly to a pharmacy of the patient's choice). Mental health consultations are another clear example of a service that does not require physical presence and can easily be handled remotely. This dynamic has led to the explosive adoption of telemedicine and we believe there are many more use cases that will be developed in the future
Telemedicine Market Size and Segmentation
The overall size of the market if we consider all the services and populations that can be served is massive and fairly time consuming to estimate. We will focus our analysis on the immediate market being served by TDOC; namely the US population covered by commercial insurance. We will also briefly talk about the population covered by government programs (Medicare/Medicaid) and the potential international market in developed countries.
In the US, ~177M people are covered via commercial insurance. The figure below illustrates the breakdown of health insurance coverage in the country.
Insurance coverage (in millions) in the US - Source: company presentation
The importance of establishing relationship with these insurance companies is therefore critical and TDOC's first mover advantage has allowed them to secure partnerships with some of the largest health plans (e.g. UnitedHealth Group, Anthem, Kaiser etc.) which are a significant source of growth. In fact, the top 10 health plans in the US control ~50% market share. Note that these companies also provision the Medicare Advantage plans which are expected to provide telemedicine coverage starting in 2020 as part of their benefits due to regulatory changes.
Someone having a preliminary look at the telemedicine industry may see the competitive landscape and decide that this is a commoditized service. This would be similar to assuming that there are many cell phone manufacturers and hence Apple and Samsung's global leadership position is under threat. This certainly won't be accurate, in fact, compared to the cell phone industry the telemedicine market has a large white space that the incumbent players like TDOC are poised to capitalize on. Companies with a first mover advantage (TDOC being top of list) have already established significant physician networks and customer relationships which as we mentioned earlier are the biggest source of competitive advantage as these take time to build (the underlying software is not difficult to replicate). Telemedicine is currently in a "land grab" dynamic and at most 2 or 3 horse race with the top players controlling vast majority of the market. Based on my research, many of the large insurance companies, health systems and employers that cater to vast majority of US employees either already have telemedicine partnerships or plan to launch RFP's for these services. Teledoc has a first mover advantage and is by far the largest player as illustrated by the graphic below.
Source: TDOC presentation; author's research
We have witnessed many instances of early stage industries maturing and the incumbents capturing vast majority of the market share as adoption increases. Smaller players get squeezed and this leads to market consolidation. This dynamic is already playing out to some extent as evident by the fact that TDOC has acquired 7 companies (few of them listed in the image above). Even if some readers don't prescribe to this view, the calculation below regarding current adoption and potential whitespace should convince you that there is a significant greenfield opportunity for several players to thrive. Note that the calculations below don't even include the international opportunity which I have illustrated separately in the second image below.
In millions - Source: company presentation; author calculation
Ultimately, our view is that the increasing competition is a reflection of the uptick in telemedicine adoption which is an overall positive for this industry.
Source: Company presentation
TDOC's Competitive Advantage
We have already discussed the key sources of competitive advantage for TDOC however the summary below should bring it all together:
- Robust and highly scalable software that has been used for millions of consultations
- A large network of physicians and specialists across the US and internationally
- Relationships with B2B customers that provide coverage to a large portion of the US population
- Multiple services on a single platform providing opportunity for up sell to existing subscriber base
Analysis of Recent Distractions
- On November 5, 2018, news came out that the company's (now ex) CFO and COO had sold large amounts of shares and a short seller accused the company of questionable sales practices. However, the sale by the ex-CFO was under an SEC rule that allows executives to pre-schedule the sale date. In this case, the sale was scheduled in June 2018 meaning that significant time had elapsed since that date and no material events had occurred that pointed to a fundamental erosion. As for the short seller accusations, the accuser had predicted a significant decline in TDOC's sales as it questioned sales tactics where YouTube stars are paid for referrals. This is however is very common practice and only related to a subsidiary of the company (BetterHelp) which generates less than 5% of its subscribers from YouTube.
- On December 5, 2018, news surfaced that TDOC had mishandled an alleged affair between the CFO and an employee. The CFO has since resigned and has been replaced.
We believe that none of these events points to a fundamental weakness and have created a compelling opportunity for investors to establish a long position.
There are several growth vectors available for Teledoc to continue its impressive expansion to date and our view is that most of these are not currently reflected in the company's stock price (as illustrated in the valuation section).
- Capture unpenetrated commercial insurance market - As calculated above, only ~22% of the US population covered by commercial health insurance is currently subscribed to telemedicine services. This drops to ~12% when we include government insured participants. Note: there may be a portion of the population not covered in our calculation that has access to telemedicine services that don't require a subscription however this is likely not as significant and our view is that ultimately all telemedicine companies will prefer to move to a subscription based model.
- Higher use by existing subscribers - Based on TDOC's disclosures and our calculations, paid visits as a percentage of total subscribers was less than 8% in 2018 however has been increasing every year. This makes sense as many subscribers may not even know that they have access to this service as part of their health insurance coverage. As the awareness and popularity of these services increases, utilization should also increase resulting in additional visit revenue. Note that the revenue model of the company charges a monthly fee for most subscribers along with a fee per visit (~$45 for general consultation; ~$90 for mental health consult). On the other hand, physicians conducting the consultations are paid on a per hour basis hence their cost is almost fixed. Therefore, additional utilization/visits drive fairly high margin revenue for the company.
- Add new services to the platform - As discussed, the company has continuously added new services to the platform such as mental health and wellness. This again leads to higher utilization of the platform along with a higher per employee per month (PEPM) rate.
- New Market (Medicare Advantage) - As mentioned, Medicare is expected to cover telemedicine services starting in 2020 and this could open up a significant new market for TDOC (20 million potential users).
- New Market (International expansion) - As noted previously, there is a significant market for telemedicine services outside the US and TDOC already generates 20% of its revenue outside the US. Teladoc recently launched its Best Doctors service in Canada and announced a partnership with the Johnston group that could see coverage being extended to 30,000 members. There is of course competition in these markets already and other providers have already established a leadership position (similar to TDOC in US). TDOC's reference customers in the largest health market in the world however may provide it a distinct advantage. Some international examples include Babylon Health in the UK and Dialouge and Akira Health in Canada. These companies have raised capital or been acquired by large strategic investors which speaks to the international potential of telemedicine.
- License software - There will likely be physician offices that can utilize the software to reduce costs and provide convenience to their customers, without the need for the physician network available via TDOC. For example, a high-touch family practice may want to provide its regular customers access to telemedicine to generate additional revenue. These physicians would pay a licensing fee to the telemedicine company providing the software.
- Industry Consolidation (M&A) - As adoption increases, we will see more consolidation in the telemedicine market which should provide TDOC another avenue for expansion.
Financial Performance and Valuation
The company has exhibited impressive growth over the past several years. As is the case with early stage technology companies, significant investment is required in the initial stages to scale rapidly which keeps margins low. The chart below illustrates this dynamic with the company now generating positive EBITDA and expected to be cash flow positive in 2019. At scale, TDOC should generate healthy margins given a higher base of recurring revenue and increased efficiency. An example of increased efficiency at scale is that the company can hire dedicated professionals that provide consultations over chat (A physician can conduct multiple chat sessions at the same time whereas as soon as there is a need for a video consult, only 1 patient can be served). The company is also investing a significant amount in R&D which will likely include some element of AI where initial information gathering during a consult can be automated along with a preliminary diagnostic (UK based Babylon Health already has an AI platform).
Note: our calculation of adj. EBITDA only excludes stock based compensation. The company also excludes M&A related costs however we have added these back as M&A has been a regular source of growth and expected to continue. Source: company disclosures
Current Market View of Fundamentals
Now lets get to the crux of our article. We have attempted to model out a view that illustrates a potential fundamental view being baked into TDOC's stock price. As it will be clear with the underlying assumptions listed below, we believe that the market is under appreciating the growth prospects from most of the vectors listed in our previous section. The market appears to be of a view that the company's growth will slow down as a result of increasing competition. Assumptions incorporated in the market forecast:
- Subscriber growth slows to mid-to-low teens rate following historical CAGR of ~20% over the last 3 years and 2019E growth of 29%
- Nominal PEPM increases tied to inflation; in other words new products such as mental health and wellness will not provide an uplift
- Revenue per visit remains flat; i.e. no significant impact from new products
- Slow down in utilization growth compared to historical rate
- Significant slow-down in international revenue growth; from 55% in 2019E to 10%
- Gradual increases to EBITDA margins as company becomes cash flow positive
- Company pays tax at 20% starting 2020; YTD Q2 2019 tax charge was ~4% calculated on EBITDA minus capex due to previous NOL's (refer to Note 14 of Q219 financial statements)
- 9% WACC
- 6.4x revenue exit multiple (stock is currently trading close to 8x however in the interest of conservatism we will use a lower multiple)
What does this mean in terms of market adoption of telemedicine and remaining white space?
As we can see, there would still be significant room to grow in the unpenetrated market. Note that we have dropped TDOC's market share to 60% (vs. the 70% today as illustrated by the image above in the competition section) simply in the interest of adding conservatism to the forecast.
Potential Future View with (conservative) Materialization of Growth Vectors
Our view is that market adoption for telemedicine will be a lot faster compared to the market view from above. This is evidenced by the company's comments around growth in RFP requests and the future view below is a better representation of the company's prospects. Key deltas in assumptions compared to previous view:
- Subscriber growth remains in the mid to low 20's eventually dropping to high teens
- Faster increases in PEPM due to uptick from new functionality
- Revenue per visit increases as new products are added
- Faster increases in utilization in-line with historical trend
- Healthy growth in international revenue however still a slowdown from prior years
- Faster normalization of EBITDA margins as the company scales
How does telemedicine adoption look in this view?
Significant room to grow which likely supports a higher exit multiple than what we've used in our valuation.
- Increased competition from new entrants could temporarily hinder growth and apply downward pressure on pricing
- Increasing physician shortage leading to higher cost of revenue
- Regulatory changes leading to cuts in reimbursement rates
- Change in regulations resulting in restrictions upon cross state physicians treating patients; this will impact ability to scale profitably
- General market downturn stemming from fears of a global recession; this would prolong the timeline of the share price upside we have theorized
The fundamental situation of TDOC remains strong and the market is not accounting for the multiple growth vectors available to the company. We see meaningful upside to today's share price and investors should look to establish a long position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.