One Medical S-1 IPO analysis
The 2020s started on-a-tear. In the first three days alone China lowered its required liquidity ratios from financial institutions to boost its local economy, an U.S. airstrike in Iraq killed a top Iranian military official and The Pope became the first worldwide meme!
In IPO land, it has also begun strong with 1Life Healthcare filing to become a public company under the ticker ONEM. 1Life Healthcare — a.k.a. One Medical — is a venture-capital and private-equity backed membership-based primary care practice with direct consumer enrollment or employer sponsorship on a mission “to make quality care more affordable, accessible, and enjoyable for all through a blend of human-centered design, technology, and an exceptional team”.
The company brings a ‘tech’ flavor to reinvent how primary care is delivered to consumers (or members according to the company) across the country.
They are expected to set the price of its shares after its roadshow, and I will update this post as soon as a refreshed version of the document is published.
There are many studies in the healthcare literature that establishes positive correlation between healthcare spending and average life expectancy. The literature also covers with great detail how the U.S outspends its OECD countries with far fewer benefits in U.S. population average life expectancy, with a lot of accompanying debates (both technical and political) about some of the causes of this (in)effective policy: drug pricing, hospitals outcome and diet habits are usually to blame.
One Medical, founded in 2007, focus on providing a membership-based primary care system to serve its customers in a more cost-effective way: according to a study referred in the S-1, “for every $1 spent on primary care, an estimated $13 is saved on costs in specialty care, emergency and inpatient care”.
In this membership-based plan, the company aims at shifting its employees’ financial rewards from a volume-driven to a quality one. By paying its employees/providers with fixed non-production-based salaries instead of the fee-for-service market practice, One Medical alters its objectives from a ‘mass-production’ type of hospital to a quality-personalized focused care. At the same time, it has developed and incentivized its members to use its online capabilities (as shown below) to schedule, view billing and prescriptions and for simple and quick telemedicine services.
Today, the company has physical presence in nine markets with plans to add three more by the end of 2020, significantly underpenetrated in the top-50 metro U.S. areas.
Some additional relevant facts from the prospectus S-1:
“With real-time video and phone consults available typically within minutes, and same and next day in-office appointments, we have demonstrated a 41% reduction in emergency room visits and total employer cost savings of 8% or more.”
“For the twelve months ended September 30, 2019, we experienced a 97% retention rate across our enterprise clients and an 89% retention rate across our consumer members.”
“While the United States’ predominantly fee-for-service reimbursement approach financially rewards high volumes of specialty-based care, the United States spends only 5% to 7% of its healthcare dollars on primary care in contrast to the 14% spent by OECD nations.”
“Employer annual health benefit costs for a family hit record highs exceeding $20,000 in 2019, with employee contributions also reaching record highs of almost $6,000 per family according to KFF (Kaiser Family Foundation). Meanwhile, the average patient waited approximately 29 days to see a family medicine practitioner in 2017, an increase of 50% since 2014, according to a survey of 15 large U.S. metropolitan areas conducted by Merritt Hawkins.”
And some key data points:
While these three charts show that the number of customers, in-site visits and digital interactions are growing YoY at lower rates over the last three years primarily as a result of the law of large numbers and with some of its physical locations reaching stable utilization rates, the analysis gets more interesting when you compare the number of interactions on a per customer base to understand how the marginal additional customer adds or reduces the overall cost of care to One Medical.
In the above two charts, we can tell that digital interactions decreased sequentially over the last two years and plateau around 5 times per year and on-site visits per customers decreased from 2.7 visits in 2016 to 1.8 in September of 2019, nearly 33% in three years. This is, therefore, indicative that while One Medical grows its customer base on a constant basis, these marginal new customers don’t increase the per member utilization of the system, or a good textbook example for economies of scale!
It can be argued that the trends should continue to follow and stabilize in the not too distant future given its primary care model. Hence, in the long-term, One Medical can continue to explore synergies in its cost of care as each added location matures overtime and derive better profits to the company.
In the financial section below, we can further substantiate if One Medical is experiencing economies of scale in their cost of care with the decrease in digital interactions and in-office visits per member.
The leadership team of One Medical has 12 members, four of which are women in strategic positions such as the CTO and Chief Strategy. It has a lower than average 3.5 overall rating and solid 87% CEO approval. More than half of the team joined the company over the last three years, many of whom have worked in Stanford and UCLA medical schools and hospitals in the recent past. The board has 9 members, two of which are women and no family relationships among its leadership or board members.
There is a good 5-min CNBC interview with the company’s CEO and a 40-min technical panel where the CTO talks about the IT team and challenges around data storage, vendor selection & security.
FINANCIALS & COMPARABLES
One Medical has raised over $500 million with some high-flying venture capital and private equity firms, including Carlyle (26.8% pre-IPO), Benchmark (13%), Oak Investment Partners (11.4%), Thomas H. Lee (7.7%), DAG Ventures (7.6%) and GV (5.9%).
The company has over $257m in revenues over the last twelve months with gross margins in the 40%. It is still unprofitable on a GAAP basis with operating expenses representing over 50% of revenues in each of the past six quarters. Additionally, I’ll cover One Medical’s financials against four comparable companies.
In this financial breakdown section, I’ll will compare One Medical against publicly traded hospital companies as well as one telehealth company to gauge whether the business operates more closely to a traditional hospital or to a telehealth approach given their secular differences in business models, growth prospects and legal challenges. The companies are Universal Health Service (UHS), Tenet Healthcare (THC), HCA Healthcare (HCA) and Teladoc Health (TDOC).
Sales and Revenues
One Medical main sources of income are (a) the subscription plans for enterprise and employers and (b) partnerships with other health network partners on a fee-for-service basis. Revenue from partnerships account for nearly 30% of total revenues and the remaining is derived from patient services and membership plans. It is also the only company among the cohort with significant revenue acceleration in 2019. Teladoc, on the other hand, went from +112% in the 2Q18 vs 2Q17 comparison to +24% in revenue growth in the most recent disclosed quarter, due in part to the normal maturation of its business.
A clear different revenue trajectory between a pure tech-healthcare play (Teladoc) and the traditional hospital delivery model with flattish revenues over the last three years.
One Medical’s top customers accounted for 42%, 37% and 36% of total revenue in 2017, 2018 and 3Q19. Among them, Google (also an investor) is the largest with 10% of revenues in 2018 and 2019, followed by one unnamed commercial payer and a health network partner. Because the company doesn’t offer an explanation of ‘top customer’ in the prospectus, I will assume they consist of its top 5 customers, which can simultaneously be viewed as a strength with large customer adoption in such an early stage of the business and also as a weakness given the high concentration in few customers with possible pricing leverage on the customer side.
In the Gross margin breakdown, there is a clear difference between how tele-health and the traditional hospital service models are delivered. While Teladoc can post 65–75% gross margins using cloud-based video services to leverage its fixed costs to serve a broad range of customers from a few base locations, the same is not true with hospitals that incur expensive cost of care with personnel and infrastructure in each additional location.
And because One Medical primary care is predicated in both physical locations and online, I expected it to have lower margins than Teladoc but higher than the traditional hospitals. Investors will monitor how the company continues to leverage its online presence and the economies of scale discussed earlier to improve its gross margin profile, which notably increased from the mid-thirties in 2018 to low-40% in just one year.
OPEX (OPERATING EXPENSES)
Because the companies from the cohort publish income statements with different accounts, the OPEX analysis will be restricted to the income/(loss) from operations margin. It basically consists of gross profit minus operating expenses (e.g. depreciation, G&A and S&M).
Hospital as a businessis is predictable as there will always be the need for emergency and urgency care, as well as nursery and long-term care (the services completed in the hospitals itself are complex and a discussion way beyond the scope of this post). As such, assuming that revenues are predictable and flattish as we identified above, profitability is a derivative of the efficiency of the operation. Hence, public-traded hospitals in this cohort post income from operations in the 5–15% and are expected to continue to post operating profits as long as the hospitals continue to run.
On the other hand, tech-healthcare companies invest in the near term to disrupt traditional services — on several degrees of uncertainty– to generate disproportionate profits in the long-term. That is why the risks associated with companies such as Teladoc are higher and therefore investors will expect higher returns (and associated valuation metrics) to buy in the opportunity. In this scenario, both Teladoc and One Medical have significant losses from operations, but the former is showing signs that is working towards a ‘path to profitability’ for the next quarters.
Primary care alone won’t solve all the healthcare in the U.S., but is a much-needed addition to the system. On top of that, the tech-centric approach can provide several benefits for One Medical in the long term: from optimizing internal processes (billings, scheduling, insurance) to innovating in the way that the service is delivered to customers and therefore simultaneously reducing the cost of care and providing a good service to customers.
Since founding, One Medical has attracted significant interest from some of the best healthcare and tech investors and employees in the country aiming at offering a healthy alternative (pun intended) to an industry that will be under scrutiny in the 2020 presidential election and beyond.