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CSLT - Casting Light On CastLight Health

|Includes: Castlight Health, Inc. (CSLT)

Casting Light on CASTLIGHT HEALTH

Too much Ado about Costs….and Comparison Shopping

Castlight Health, Inc. (NYSE:CSLT) is a company that is making a brave attempt to solve the complex healthcare problem - reduce the burgeoning healthcare costs in the U.S. CSLT aims to solve this problem by making healthcare costs transparent to consumers with the help of a proprietary comparison shopping software called Castlight Medical. Castlight Medical, the on-demand software, enables healthcare consumers to make rational choices by offering them comparative view on costs and quality of providers, services, medications et al.

CSLT was founded in 2008 and started booking revenues in 2010. CSLT recently went public in an IPO in March 2014. The market hype around the enterprise cloud based healthcare company was so strong that the stock priced at $15 per share closed at $40 per share on the first day of trading, Castlight is valued at $1.35B and has lost more than 50% of its value since its IPO in March 2014.

For a company that brought in $13M in revenue in 2013, the $3B valuation on the opening day of trading was a surefire sign of a bubble. The most often asked question in days immediately after the IPO was - Is CSLT really worth this price? Or is it another sign of bubble? Can any healthcare company with SaaS component to its business model fly? Can comparison shopping really work in healthcare?

This tempted me to do a bottom-up review of the stock. So, let's start by dissecting the CSLT business model and decide for ourselves if it makes sense for us to be LONG or alternatively SHORT on CSLT

Healthcare Costs - The Big Problem that CASTLIGHT HEALTH is attempting to solve

The U.S. healthcare system is sad story that media likes to tell again and again ad-nauseum. We lead the world in healthcare spends and we still can't seem to get the bang for our buck. In 2012, we spent $2.7 trillion on healthcare in the U.S. (~17% of the US GDP), with approx $680-700B spent by private sector. And, we also have been unsuccessfully trying to rein-in the rising costs. It's possible that Accountable Care Act (NYSE:ACA) will do its bit in reducing the costs. Meanwhile, the employers are getting pressured on increasing burden of rising costs, and they are shifting the burden to employees or reducing the coverage offered to the employees - surely not a most clever solution.

Wasteful expenditure - overtreatment, failure of care coordination, pricing failures, failure of care delivery, costly procedures etc have been a constant bane in managing/reducing costs. According to some estimates, approx 20% of the healthcare dollars are misdirected, unnecessary - meaning private sector alone spent $140B in healthcare that went down the drain. The core of the problem is that an average healthcare decision maker has no visibility into the costs and hence has reduced/no ability to make rational cost effective decisions. The concept of comparison shopping in healthcare is a territory that has been not exploited well. Castlight Medical from Castlight Health is aiming to do exactly that by offering visibility into this process and offer the freedom to the consumers to do comparison shopping. In the process, the company aims to help reduce the healthcare costs by 8 to 10%.

CSLT Revenue Stream

CSLT is primarily a product & service (hybrid) company. Its core product is a software tool that clients can use to find the healthcare service that offers the best price and quality combination. Castlight Medical is an online tool that clients access to compare the services in their geographical area. Click here to see the demo of Castlight Medical

http://www.castlighthealth.com/solutions/

As you can see, with Castlight Medical, a client can get an estimate of his/her out-of-pocket costs, check out the healthcare provider's track record, and search for alternative options. The information helps the client make judicious choices. The target customers for CSLT include large, self-insured employers.

Typically, an engagement with a self-insured employer includes a 3 year agreement. The agreement comprises of two phases - a) Phase I - Set-up stage lasting for 3-12 months whereby CSLT staff custom builds the platform as per the client specifications, b) Phase 2 - subscription stage - where by client's employees start using the platform to make important healthcare choices.

The revenue generation process is also two-fold. In Phase I, the company books the professional services revenue. These services entail helping the client get on board with CSLT platform. In Phase II, the company starts booking revenues after the system is set up and client's employees start using the tool. No revenues are booked until the client starts using the software.

Castlight Medical Platform Technology

CSLT core technology philosophy is simple. It's based on collecting massive amount of pricing data from providers, payors which is largely in unformatted form and converting the data into actionable insights. CSLT uses open source platform to develop its software and updates. The company has entered into agreements with various providers, payors for the data and it now has more than one billion claims data that are structured to provide meaningful insights. The data is personalized, down to the zip code level for the patients to make the right choice. Castlight is also able to provide predictive modeling for the employers to identify the patients at risk, and predict future costs. Castlight Medical can also provide recommendation to the customer regarding the benefit design considering the characteristics of the population

Castlight is not the only game in the town….

Castlight faces competition from both pure data companies like Truven Health, Clear Cost, Health SparQ and health insurance companies like United Health, Cigna, Harvard Pilgrim that have tools to help the consumers do the comparison shopping. Some of the health insurance companies are offering these tools for free as well.

CSLT: The Future Looks….

Revenue Forecast Model

CSLT REVENUE FORECAST

                         
 

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

Total Account Volume Forecast

                         

Total Account Volume

21

47

108

233

405

637

907

1209

1521

1831

2115

2342

2496

- Existing Accounts

6

9

47

111

210

354

539

749

969

1196

1417

1609

1749

- New Accounts

15

38

61

122

195

283

368

460

552

635

698

733

748

Growth in new accounts

 

248%

161%

100%

60%

45%

30%

25%

20%

15%

10%

5%

2%

Avg. drop out rate at 4th yr

     

20%

30%

40%

50%

50%

50%

50%

50%

50%

50%

                           

Accounting for Subscription Revenues

                         

- A/cs producing active subscription revenue

     

91

160

282

447

644

859

1083

1306

1513

1679

                           

Revenue Forecast

                         

Total Professional Service Fee revenue ('000s)

$306

$759

$1,318

$2,636

$4,218

$6,116

$7,950

$9,938

$11,925

$13,714

$15,085

$15,840

$16,157

Avg, Professional Service fee

$20

$20

$22

$22

$22

$22

$22

$22

$22

$22

$22

$22

$22

- Growth in Avg. Prof Service fee

     

0%

0%

0%

0%

0%

0%

0%

0%

0%

0%

                           

Total Subscription Fee ('000s)

$1,569

$3,395

$11,655

$22,528

$39,770

$69,851

$110,727

$159,677

$213,014

$268,469

$323,917

$375,128

$416,296

Avg. Subs Fee per Existing A/c ('000s)

$262

$375

$248

$248

$248

$248

$248

$248

$248

$248

$248

$248

$248

Growth in Subs Fee per ac

     

0%

0%

0%

0%

0%

0%

0%

0%

0%

0%

                           

Total Revenues ('000s)

$1,875

$4,154

$12,973

$25,164

$43,988

$75,967

$118,678

$169,615

$224,939

$282,183

$339,003

$390,968

$432,453

Growth %

 

122%

212%

94%

75%

73%

56%

43%

33%

25%

20%

15%

11%

At the end of 2013, CSLT had 108 customers, mainly self-insured employers. Considering that the healthcare market trends are moving toward self insurance, the company will be in high growth phase for next 5 years with high double digit growth in client accounts Over the next 10 year, the company could add 2,500 accounts translating to $450M in revenues by 2023. These revenue projections appear reasonable for the following reasons:-

- Athena Health, a healthcare company with SaaS model generated $550M+ in revenues last year after being on the market for more than 15 years

- Self-insured employers have other choices like free services from health insurers

- Some self-insured employers will drop out as they will fail to see the cost reduction benefit of the programs and employees will not fully utilize these services

CSLT Valuation

CSLT VALUATION

                     

($Millions)

                     
 

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

Revenue

$12.97

$25.16

$43.99

$75.97

$118.68

$169.62

$224.94

$282.18

$339.00

$390.97

$432.45

EBITDA

(62.34)

(58.62)

(54.95)

(39.60)

(8.60)

28.03

78.29

137.04

189.94

236.49

276.21

D&A

(0.6)

(0.8)

(1.3)

(2.3)

(3.6)

(5.1)

(6.7)

(8.5)

(10.2)

(11.7)

(13.0)

EBIT

(62.97)

(59.37)

(56.27)

(41.88)

(12.16)

22.95

71.54

128.57

179.77

224.76

263.24

Taxes

0

0

0

0

0

0

0

(16.80)

(62.92)

(78.67)

(92.13)

Tax rate

0

0

0

0

0

0

0

13%

35%

35%

35%

Net Income

(62.97)

(59.37)

(56.27)

(41.88)

(12.16)

22.95

71.54

111.77

116.85

146.09

171.10

                       

D&A (Add back)

0.63

0.75

1.32

2.28

3.56

5.09

6.75

8.47

10.17

11.73

12.97

Capex

 

0.38

0.66

1.14

1.78

2.54

3.37

4.23

5.09

5.86

6.49

-Capex as % of sales

 

2%

2%

2%

2%

2%

2%

2%

2%

2%

2%

Change in WC

 

$6.29

$11.00

$15.19

$21.36

$25.44

$29.24

$28.22

$33.90

$39.10

$43.25

-WC as % of sales

30%

25%

25%

20%

18%

15%

13%

10%

10%

10%

10%

                       

Free Cash Flow

 

(65.29)

(66.61)

(55.94)

(31.74)

0.05

45.67

87.79

88.04

112.86

134.34

Discount rate (WACC 12%)

 

0.89

0.80

0.73

0.66

0.59

0.53

0.48

0.43

0.39

0.35

Discounted FCF

 

(58.29)

(53.10)

(40.90)

(20.91)

0.03

24.42

42.28

38.20

44.12

47.31

                       
                       

DCF valuation

                     
                       

PV of CF

23

                   

PV of Terminal value

609

                   

EV

632

                   
                       

Equity value

5.8

                   
                       

12 mo value per diluted share

108

                   

The bottom-up discounted cash flow valuation for CSLT suggests the equity value of $5.8. Considering the current market price of $15.9 per share, the stock appears to significantly overvalued.

Even if I assume that my valuation is off by 50%, the stock will still be overvalued by significant margin.

CSLT Business Model - The Cause of all Risks and Uncertainties

CSLT is a comparison shopping website for healthcare. One would tend to think that its risk profile is like other comparison shopping websites like Kayak (air fares), or Shopping.com/Shopzilla (consumer goods), or Eopinions (opinions on products) etc. But the similarities exist only in the concept. The business model is quite different and hence the difference in risks and uncertainties.

In my opinion, there are three key risks. First one lies in the heart of its business model - THE DATA. CSLT is dependent on the providers and insurers for the data. This, in itself, makes it a vulnerable company. Castlight Medical is only as good as its input DATA. So, if the data is dated, or not representative of the population it is serving, the value of the service will be jeopardized significantly.

Second risk factor is in customer acquisition and on-boarding costs. CSLT spends significant resources to acquire and on-board a customer. The customer is under no significant obligation to continue with CSLT except a 3 year contract which has cancellable and non-cancellable structure. So, there is a risk that CSLT acquires a customers, spends significant amount of resources and still loses the customer

Third risk factor is competition. The competition may come up with product that is superior to CSLT as insurance companies can use their own database to provide the price comparison models. CSLT may lose out on this competition

Concluding thoughts

I do believe that CSLT has chosen a right problem to tackle, the cause is noble, but the path is arduous. The risks inherent in the business model both in terms of its strategy for data acquisition and monetization risks (lengthy sales cycle) make the company a less attractive proposition despite its position as a Healthcare SaaS company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: The views/opinions expressed here and the analysis conducted on this stock in this post are my own and personal.