Headspace Investment Memo
This investment memo was written in November 2017, with all figures drawn from publicly available data or author’s estimates.
Headspace is a meditation mobile application that has a 2-year CAGR of 102% for the past 2 years. The app rides the new wave in mental health related products. #1 in the mindfulness category. Growth-stage opportunity.
Product — A
- A science-based, guided meditation app on iOS and Android.
- 18 million users. 400,000 paying customers.
Market — A minus
- Niche market, but expected to expand quickly as mental health costs continue to grow.
- Notable trend: physical health → physical+mental health → mental health.
People — B
- Andy Puddicombe, Founder: Monk-turned-entrepreneur. Produced all Headspace sessions.
- Richard Pierson, CEO: Background in sales and marketing. First-time entrepreneur.
- Sean Brecker, CFO: Background in commodities trading. Previously CEO from 2014–2017.
Competition — B plus
- Low barrier of entry → heavy competition.
- #1 in the category, but also faces competitions outside the category.
Financials — A minus
- Subscription model. 3.64% paying customer.
- Strong and potentially improving unit economics: LTV/CAC > 3
- Valuation estimated at $400 million.
- $20 mil at $400 mil pre-money, $420 mil post-money = 4.76% stake.
- Look for oversea VCs to co-invest → helps international expansion.
- Tailwinds of mental health trend.
- Well positioned to grow in corporate sales channel, kids category, and international markets.
- Meditation might fail to be adopted by the mass public.
- Disadvantages in marketing efficiency due to dispersed user demographics.
The product is a meditation app (iOS & android) that guides users through short meditation sessions that range from 1 to 30 minutes. The meditation exercise itself is a 2500-year-old Buddhist practice that helps practitioners find inner peace. The app makes the practice accessible with a smart phone and a set of earphones. The product stood out in three things:
- Science-based: Meditation itself is scientifically proven to be an effective method of improving mental health by reducing stress, aiding in focus, and boosting compassion. Several studies have shown that Headspace is able to assist in all through of those aspects. A study in the peer-reviewed Journal of Medical Internet Research ranks Headspace as the highest quality app over its competitors . Another study shows Headspace’s significant effects on helping patients deal with anxiety, sleep, and boredom.
- User interface: The product is designed in animation themes. Its simplicity aims to capture users from all age groups, including children. Currently its user population is evenly distributed among age groups 18-65, partly due to its focus on user interface. The team revamped the product in mid-2017 to pivot towards a new focus on driving new user adoption. The current design features shorter sessions (1~5mins) and more free sessions to attract busy people. Shorter sessions lessen the time commitment of trying out meditation, thus helpful in attracting new users and building traction.
- Overwhelmingly positive reviews: Another thing worth noting is Headspace’s overwhelmingly positive reviews from users. It has 96.4K ratings with an impressive average of 4.9 (out of 5.0). It is currently ranked #1 in the mindfulness app category in terms of both numbers of reviews received and scores achieved.
Mental health has largely been neglected by entrepreneurs in recent years. We witnessed the rise of fitness apps focusing on physical health, and the rise of yoga being a hybrid physical and mental exercise. While mental health is equally as important as physical health, it receives much less attention. A classic analogy compares meditation to a toothbrush that should be a daily commodity used to clean up minds as a toothbrush is used to clean up teeth. Growing awareness of mental health is key to the success of this investment opportunity.
Headspace founders accurately placed themselves in a fast growing mental wellness market. According to IBIS World market research, the current amount spent on meditation services per year in the U.S totals only around $1.2 billion, about half of that of yoga. However, looking at the broader mental wellness market, mental health costs are expected to reach $6 trillion by 2030, according to the World Economic Forum. Currently the majority is spent on professional medical services and medication, while indeed a substantial portion of mental health issues can be alleviated by meditation. Headspace is well-positioned to capture the growth of this market, given its #1 position in the meditation app category.
There are three main ways Headspace reach its customers:
- Retail (mainly relies on words of mouth): their major source of income so far.
- Corporates bulk purchase (LinkedIn, Google, Airbnb, among others): huge growth opportunity in this category.
- Strategic partnership (Spotify music bundle, Delta Airline in-air offering, Los Angeles Lakers athletes training): guerrilla marketing, which mainly boosting brand awareness.
Andy Puddicombe: Co-founder. The product guy. Andy spent 10 years as a buddhist monk in Tibet before co-founding Headspace. He recorded all content for the app.
Richard Pierson: Co-founder and CEO. The marketing guy. He was the Head of Business Development at Bartle Bogle Hegarty, a London-based marketing agency.
Sean Brecker: CFO, ex-CEO. The finance guy. Long-time friend of Pierson, Brecker was recruited in 2014 from Citi Group, where he was the Head of Commodities Origination in Singapore. He acted as CEO before handing the company back to Pierson in March 2017.
Puddicombe started leading group meditation in 2008. Pierson participated in Puddicombe’s exercises and found them very helpful. The two teamed up to start Headspace in 2010. They later recruited Brecker as CEO, who had also benefited from Puddicombe’s sessions.
The core team does not seem particularly impressive at first glance since there is no serial entrepreneur on the team. However, the three have very complementary skillsets and reportedly work very well with each other.
As of January 2017, the company has 158 employees, which is expected to grow to around 250 by January 2018.
Due to low barrier of entry, the mental health space has fierce competition. Headspace is currently ranked #1 in terms of downloads and number of paying customers.
Direct Competition — Other Meditation Apps
- Closest competitor with 12 million downloads (versus Headspace’s 18 million).
- Raised ~$1 million to-date (versus Headspace’s $70 million). No financials disclosed.
- Very similar product, with a focus on mini sessions (< 5 mins).
- Visual aid (versus Headspace’s only audio sessions).
- Less user-friendly given the myriad of categories to navigate through.
- Less aggressive pricing model: around 75% of Headspace’s pricing.
Simple Habit — Meditation
- 1 million downloads. Raised $2.5 million to-date (backed by YC & NEA) • Minimalist approach: users don’t have choice of meditation package
- Lacking in content
- Similar pricing as Headspace
Other apps: Oak, Meditation Studio, Breethe
Indirect Competition — Mental Wellbeing Space
Aside from direct competition from similar apps, Headspace also faces competition from other ways people might seek to improve mental wellbeing. Yoga and supplements such as Vitamins are two common alternatives. The following comparison table shows that Headspace has the potential to win over competition coming from other categories as well.
First, a summary of Headspace’s disclosed/leaked numbers:
*Estimated: assume same conversion rate: (0.4m/11m)*18m
**Estimated: “revenue north of $50 million”
***Estimated: assume same ARPPU (55m/0.4m)*0.655m
****Estimated by Forbes
Average growth rate = 0.5* [(11–5)/5 + (18–11)/2/3/11] = 0.5*(120%+95.5%) = 107% Compounded growth rate = 102%
Average Revenue Per User (ARPU) = 55m/11m = $5
Average Revenue Per Paying User (ARPPU) = 55m/0.4m = $137.5
Conversion rate (free to paying) = 0.4m/11m = 3.64%
If we assume the same EV/Revenue multiple and we trust the 2017/1 estimate given by Forbes, current user numbers would imply a valuation in the neighborhood of $400 million, as of 2017/9.
Analysis and Adjustments
- ARPPU of $137.5 seems oddly high, given that Headspace yearly subscription costs $96. Since revenue is reported on annual basis, this figure must have included corporate customers as well. If we assume that all retail subscribers renew at the yearly rate, retail revenue accounts for 96*400,000 = $38.4 million. Corporate revenue = total — retail = 55–38.4 = $16.6 million.
- This calculation is dependent on the assumption that Headspace is still able to maintain its high conversion rate as users grow from 11 to 18 million. At the same time, management has the tendency to overstate its growth numbers. I suspect that the actual ARPPU is lower, which means that our number might overestimate the actual valuation of the company.
- The latest data available on the internet is from September 2, 2017, which is a little over three months (0.25 year) ago. This means that our number might underestimate the actual valuation because it fails to account for 0.25 year of growth, which is significant for a high growth company.
- Given the offsetting nature of the two aforementioned points, I believe $400 million is a fair valuation for Headspace.
- CAC = cost per install / conversion rate = $1.5 / 3.64% = $41
- LTV = average revenue per customer per year ($96) * average lifespan of customers
- Since the rule of thumb for internet company is LTV/CAC > 3, we solve for average lifespan of customers = 3*41/96 = 1.28 years, or 15 months. Implied maximum churn rate = 1/1.28 = 78%.
- Due to the lack of comparable companies’ data in this space, we cannot say with full confidence whether this average lifespan of customers is good enough. However, I believe that Headspace’s unit economics is strong for the following reasons:
- CAC is estimated using an average of all apps, which might be higher than that of Headspace, whose organic growth (words of mouth) is strong due to its overwhelmingly positive reviews.
- The calculation above only accounts for retail customers. Corporate customers usually have a higher LTV and a lower CAC given that these bulk Headspace subscriptions are included as the “perks” of working at those companies.
- Meditation practices turn into habits. Once the benefits are realized, users became more reliant on the practice in times of stress, anxiety, or restlessness. This leads to better user retention (i.e. lower churn) than other subscription-based apps.
VI. Key Opportunities
- Meditation apps provide an attractive alternative to traditional mental health solutions. It is effective, convenient, and low-cost. Rising awareness and money spent on mental health contributes to the fast growth of this category over the next 5 years. Headspace is well- positioned to capture the growth as #1 in the meditation app category.
- Growth opportunity in the corporate channel. Currently around 30% of revenue comes from a few corporates (9 displayed on website). This channel remains largely unexplored.
- Growth opportunity overseas. Headspace has the greatest presence overseas among similar apps, with a focus in Europe. Money invested should be used to translate sessions into other languages in addition to English (the only language now) and to hire overseas marketing teams.
- Growth opportunity in the children category. Headspace is the only meditation app that offers a children section. Its animation theme is a natural advantage in this space over its competitors.
- This is essentially a bet that meditation is the new yoga. Yoga was reluctantly accepted, at best, by the mass pubic initially. Meditation sounds tedious, solitary, and even challenging for many people. There is no promise that this practice will go beyond its current niche of practitioners.
- Like other health startups, Headspace bear the similar legal and reputation risks of losing “patients”. However, such risks are largely mitigated for Headspace since there are no proven negative effects on cognitive ability caused by meditation.
- Dispersed user demographics renders marketing inefficient. For example, Yoga’s demographics concentrate amongst women aged 30 to 40 years-old, so marketing can be targeted towards that specific group. Headspace has a nearly even breakdown across ages from 18 to 65.