Livongo Health: Continued Momentum, Margins A Bit Soft

Summary

• Livongo ended 2019 on a very strong note and guides for continued sales momentum.
• The growth in sales is comforting, yet projected margins for the coming years look a bit soft.
• I still like the business a lot, given the growth potential and continued forward sales momentum.
• All of these and apparently a conservative management make me upbeat, although I am not actively adding now.
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Livongo Health (NASDAQ:LVGO) is a name which I have been covering extensively since it went public. My last take on the company was halfway through November when the company posted satisfactory third-quarter results. Fourth-quarter sales momentum remains very strong as the company has outlined a great sales guidance for 2020, although I am far from impressed with the margin guidance for the upcoming year.

The Thesis

I have been attracted to Livongo since it went public as it aims to "treat" chronic diseases through improvements in both technology and data science. The combination of progress on both these fronts results in personalised solutions and treatments, resulting in better health results for the patients. This is very compelling as real improvements can be delivered at relatively low costs in a healthcare system which can be categorised as both expensive and at least at some points as ineffective.

The potential for the company and its solutions is very large, with over half of the US population suffering from chronic health issues, while continued care options are still very limited. Rather than monitoring, patients suffering from chronic conditions typically require guidance and real-time feedback with medical expertise. High net promoter scores, innovative solutions and market potential are what attracted me to the company.

The potential for the company was already priced into the shares when it went public at $28 in July of last year which worked down to a $2.5 billion equity valuation with 89 million shares outstanding, although the valuation fell to $2.2 billion after factoring in the net cash position.

To put this valuation into perspective: the company generated just $31 million in sales in 2017 on which it lost $17 million. Sales growth of 121% was spectacular in 2018, with revenues totalling $68 million although losses doubled to $35 million. By no means these numbers could justify a $2.2 billion valuation.

Nonetheless, there were some green shoots as first-quarter sales growth for 2019 came in at 157% with revenues totalling more than $32 million, accompanied by a near $17 million operating loss. Revenues grew to nearly $41 million in the second quarter and came in at nearly $47 million in the third quarter as the company reported very strong book-to-bill ratio in terms of contract wins. Based on the third-quarter results, the company was more or less guiding for fourth-quarter revenues of $49 million, suggesting that it has already achieved the $200 million run rate per annum.

Based on these results, shares recovered to $26 in November for a $2.0 billion enterprise valuation and thus less than 10 times forward sales multiple. This looks compelling given that growth rates are still above 100%, the target market is huge, and while the company loses money, these losses are not immediately threatening the business. Furthermore, losses are rapidly coming down as well.

Bases on those conditions, I was a happy holder of shares in the mid-20s.

Momentum Continues

At the start of March, the company announced strong fourth-quarter results with revenues up 137% year-over-year, actually surpassing the fifty-million mark at $50.4 million. The company furthermore reported an estimated value of agreements of about 1.5 times, indicating that continued growth should be expected. Comforting is that reported operating losses narrowed from $13.1 million to about $7.7 million, marking continued progress towards the flat line.

With net cash approaching the $400 million mark, that burn is not that significant nor worrying, as the 94 million outstanding shares have been holding steady around $26 per share. This values the enterprise at $2.0 billion as the company outlined a strong guidance for 2020, with sales seen at $285 million, plus or minus $5 million.

Despite the continued revenue improvements, the company still sees adjusted EBITDA losses in the region of $20-$22 million. That in itself is quite disappointing as the company actually reported an adjusted EBITDA profit of $1.5 million in the final quarter of 2019. In the fourth quarter the company reported an annualised depreciation and stock-based compensation expense of around $32 million, suggesting economic losses at around $50 million in the year to come. While this is not worrying given the net cash position, it is quite large, although the appeal arguably comes from the 7 times forward sales multiple.

What Now?

Do not get me wrong, I am pleased with the sales momentum and the outlook for 2020 in terms of sales, acknowledging that management has been conservative since it went public. Disappointing is the adjusted EBITDA guidance for next year, suggesting no operating leverage. That said, growth has priority given the rapidly evolving marketplace, as the net cash position is quite strong.

The key issue is to judge how competitive the business is in the long run as strong growth could spur takeover interest, which could be a good (short term) outcome. Alternative routes is years of strong organic growth in order to become a dominant player, yet in an adverse scenario, competition might limit the potential of Livongo. Of course, it is crucial to know which scenario becomes reality in the long run, yet that is very hard or impossible to judge at this moment.

Hence I am happy to hold onto a current position, yet see no active reason to add to the current position. While I do see the appeal of rapidly shrinking forward sales multiples, the margin numbers for 2020 are a bit underwhelming to me quite frankly.

Analyst’s 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.