What Can We Learn from 2021 Digital Health Public Market Performance?
It’s been an impressive multi-year run for the digital health and healthcare technology (HCIT) sector. As liquidity and the size of outcomes has grown, enthusiasm and capital has followed. Consider the fact that 2021 saw a record setting 276 M&A deals and over 20 public offerings, meaning the number of publicly traded venture-backed companies has more than tripled over the last 5 years. The value of these companies has increased substantially, with 81 unicorns minted (42 trade privately) at an average enterprise value over $5B (vs. $3.7B in 2015). This represents a seven-fold increase in the number and the aggregate value of these unicorns, since 2015. Many of the 42 private unicorns (and their investors) will likely seek to tap the public markets to continue to support growth in the next few years, so I spent some time analyzing recent public market data on previously venture-backed companies in the sector to understand how public market investors might receive these companies and what we might be able to learn from those companies that have weathered the recent turbulence of public markets better than their peers. Below, I share some brief learnings from the business models that investors flocked to during this dynamic period of time.
Growth Matters, But Not At All Costs
Across the board 2021 was a turbulent year for many newly public, previously venture-backed companies. The 1-year underperformance of the Renaissance IPO Index relative to the S&P 500 is a good indicator of this.
Source: Google Finance
Many of the recently publicly listed digital health and HCIT companies endured similar turbulence on the market, with more than three quarters of these companies losing market capitalization over the course of the year. Despite this, a handful of companies exhibited outperformance relative to their peers over the course of 2021, and their outperformance correlated to 1) future sales growth velocity 2) strong fundamental unit economics 3) predictable profitability and 4) sector orientation (i.e., Provider, Plan, Life Sciences, Employer etc…). Unsurprisingly, public market investors are currently valuing cash flows more than growth.
While the market will likely always reward growth velocity, in 2021 this variable didn’t seem to consistently correlate to premium valuation multiples, one proxy for forward-looking investor enthusiasm. The chart below exemplifies this (the companies in green also saw their stock prices increase over the course of 2021).
Source: Pitchbook Data on Previously Venture-Backed, Publicly Traded Digital Health & Healthcare Technology Companies
However, when breaking each of these companies out by sub-sector cohorts, it becomes clearer that the fastest growing companies in each cohort generally also had higher valuation multiples than their peers in the same cohort.
Source: Pitchbook Data on Previously Venture-Backed, Publicly Traded Digital Health & Healthcare Technology Companies
Data Remains a Premium Asset, Especially for Life Sciences
Looking at valuation multiples against gross margins in the chart below, it starts to become clear that the market flocked to software-powered business models, especially those selling into the life sciences segment.
Source: Pitchbook Data on Previously Venture-Backed, Publicly Traded Digital Health & Healthcare Technology Companies
Firstly, investors seemed to be attracted to the value of the core asset (data or software to better manage and use data) that several of these companies are monetizing. In healthcare, data (especially clean and structured data) that can inform high-value product sales or drive more effective patient or physician engagement is extremely valuable and the handful of companies in the upper right side of this chart (i.e., Definitive Healthcare, Doximity, Veeva, Phreesia) have either curated such datasets or built tooling and infrastructure that allows their customers to get more utility from this data. Furthermore, several of these companies primarily sell to life sciences, one of the most attractive customer segments because of a higher willingness to pay for technology and services that drive R&D efficiency or extend lucrative and high-margin product lifecycles. Given that critical parts of the pharma product lifecycle rely on the research and insights of physicians and key opinion leaders (KOLs), the value of Doximity’s physician database, Definitive’s provider relationship intelligence or even Veeva’s provider data management efficiency solutions starts to become even more obvious.
Secondly, investors seemed to be attracted to the efficient gross margins of these business models, meaning these companies incurred very little costs to build/maintain their core product relative to the price their customers were willing to pay for the product. For example, Doximity has curated a network of >80% of all US physicians, maintaining valuable data on these physicians and charging pharmaceutical company brand teams and hospital service line teams to access this dataset and market to their physician users. By building connectivity tools to keep existing users engaged and leveraging word of mouth network effects to attract new users onto the platform, Doximity has grown the platform at relatively modest cost. Meanwhile, their customers see up to a 13:1 ROI from accessing this dataset, which likely drives the company’s 167% net revenue retention rate and starts to explain the company’s best-in-class unit economics.
It’s also worth noting that software companies facilitating communication and connectivity (i.e., Vocera and Phreesia) fared well relative to their peers on the market. While these businesses exhibited good fundamental unit economics, perhaps the pandemic-induced shift to remote work culture and virtual care delivery has also buoyed the value and relevance of these products.
Value-Based Care Lost a Bit of It’s Luster in 2021, but the Future Still Holds Promise
In 2021, the market clearly remained most enthusiastic about healthcare information technology and tech-enabled services for the life sciences, while enthusiasm for virtual care models, managed care and value-based care providers seemed to wane from earlier in the year. However, it’s important to note that despite lackluster 2021 performance, 2 of the top 5 most valuable publicly traded companies in the HCIT and digital health sector are virtual care providers and nearly half of the top 20 are managed care or value-based care providers. Market sentiment continues to favor the outlook for these models, and I expect that as many of these businesses mature and begin to demonstrate larger and more consistent medical cost reduction as well as a path to profitability, they’ll re-gain their favor with the market. Managing high-cost specialty conditions in value-based contracting structures is an area to keep an eye out on.
In Uncertain Times, Profitably Commands a Premium
Lastly, just to emphasize some of the points made above, the strongest correlation to valuation premiums and 2021 performance seemed to be profitability and predictable cash flows. Nearly every company that had positive price movement over the course of 2021 had a positive EBITDA margin, as seen in the chart below.
Source: Pitchbook Data on Previously Venture-Backed, Publicly Traded Digital Health & Healthcare Technology Companies
Conclusion
It’s important to note that this is a point in time analysis and many of the companies included in the analysis above have not even traded long enough to outlast their lock-up periods. However, even with this limited subset of data it’s clear that in uncertain times, profitable growth seems to be enduring regardless of healthcare sub-sector or business model. A handful of software businesses currently best exhibit this characteristic, however I expect that as many tech-enabled care providers and managed care entities chart a path to profitability, this analysis might look quite different.
In the meantime, I’d welcome your thoughts and feedback!
