Thoughts on the TDOC/LVGO Merger

On Wednesday August 5th, two of the larger public names in the digital health space, Teledoc (TDOC) and Livongo (LVGO) announced they were merging, while we understand the stated logic behind the merger, we were a bit puzzled by several issues, our thoughts on each of them are below:

Timing: there is a tremendous amount of runway for both of these industry-leading companies to grab before they are likely to stunt the growth of the other.

• No matter how well-executed or how experienced the integration teams, a merger is likely to distract attention from the sales and execution engines of companies with dramatic sales potential +70% est. for LVGO and +40% est. for TDOC.

• While telehealth has been moving at blinding speed due to COVID we still would expect consolidation of industry leaders when digital health growth begins to slow and applications for the technology begin to narrow. We see no signs whatsoever that this is the case.

Valuation: At Tuesday's close TDOC is paying approximately 36x sales for LVGO a very steep price for a company whose stock has already risen over 200% YTD.

• While telehealth is a large and untapped market (estimated at ~ $100B pre-COVID to as much as $250B in a recent McKinsey estimate post-COVID) and significant amounts of care remain to be moved to digital, the deal is expensive under even the best of assumptions. At 36x sales, the deal would be more expensive than most recent acquisitions in software, which already tend to be expensive, and which we view as the most appropriate comparable.

Best of Breed vs. All-In-One: In announcing the merger TDOC noted that the merger would create what amounted to a one-stop-shop for digital health needs, allowing employers and providers to work with numerous disease states and care models.

• However, our work indicates that about one-third of large employers prefer a best-of-breed approach to employer benefits and have found superior results from their plans. Given the lackluster results that many employers have gotten from their health benefits, our belief is that the trend will be towards this approach as opposed to an all-in-one solution.

Go-to-Market Strategy: Although LVGO has been working to increase direct selling efforts, historically they have gone to market via channel partners and resellers such as Caremark, Express Scripts and Anthem, etc. (for YE 2019 over 60% of the company’s revenues came from these channels). TDOC has traditionally used large health plans as it’s distribution network such as Aetna and BCBS.

• We see it as highly disruptive to continuity of sales and sales management to attempt to modify (even modestly) growth strategy in the midst of a hyper-growth market.

• This combined with the fact that successful sales and marketing people will be highly sought after given how hot the market is, these types of changes could end up impacting growth (our understanding is that RSU’s vested 6 months after the IPO or with a change in control).

Strategic positioning: While we believe that the deal makes sense for TDOC, as we see the basic delivery of telehealth being commoditized over time, there is likely more risk for LVGO based on their competitive positioning and the difficulty recreating the chronic care delivery model they have created.

• Given the opening that the declaration of a public health emergency (PHE) created for the use of non-HIPAA compliant vehicles like Zoom, Google Hangout, Microsoft Teams, etc.over time we see potential for other large video platforms to partner with/usurp the provision of basic connectivity.

• In addition, over time we expect video technology to change so that patients will no longer have to install separate telehealth apps on devices increasing ease of use and substitution. Consequently, we expect a stand-alone LVGO with a focus on chronic disease to have greater competitive advantage than TDOC. This is evidenced by LVGO’s sales growth rate in the 50% range vs.TDOC’s organic sales guidance in the 20%-30% range.

Rollup risk: The LVGO acquisition will mark TDOC’s 11th acquisition since 2013 and the 2nd this year (recall TDOC agreed to buy InTouch in January 2020).

• First, as noted above, given the red-hot nature of the digital health market we have no doubt that both teams are already working all out to capture as much share as possible, a fact that is further compounded by the demands of COVID (physician shortages, supply chain issues, etc). When combined with the difficulties inherent in managing the merging of any two organizations, no matter how good or experienced the integration teams are, leads us to believe there is more downside than upside risk.

• In addition, we see roll-ups in emerging industries and in healthcare in particular as a difficult way to make money. While there are exceptions (i.e, Quest), they tend to be just that, exceptions, rather than the rule (i.e, physician practice management). We find this to be the case, particularly as roll-ups grow in size, with an early study by Booz & Company finding that once roll-ups got past $500M in value they often lose value.