Description

LifeStance Health (LFST) is a short because:

• LifeStance is executing on a fundamentally flawed business model
• Management’s track record is poor and insiders are selling
• LFST shares are expensive even in a best case scenario
• Continuation of deteriorating business trends and a possible capital raise provide a catalyst

Business Overview

LifeStance is one of the nation’s largest providers of virtual and in-person mental health counseling and therapy services with approximately 6,200 therapists at 600 centers in 34 states.  Unlike most therapists, LifeStance accepts health insurance. Over 90 percent of revenue is from commercial insurance and most patients are referred by a physician. Revenue per visit averages approximately $153. Most therapists will have a masters in social work and annual revenue per clinician averages about $166,000.

LifeStance was founded in 2017 and has spent over $1.1B on acquisitions since 2019.

LifeStance’s Business Model is Fundamentally Flawed

Every few years some PE shop will IPO a roll up of some sort of medical practices (DNTL is a good example of one actively discussed here, but there are many that have come to market over the years). These are always good shorts. Medical professionals are highly compensated for a reason, they provided a skilled service and own the customer relationship. Medical practices have little terminal value without the provider and as such most value accrues to the medical professional and not shareholders. If the provider were not compensated with a sufficient share of the value they create, they can easily leave and start their own practice.

LifeStance differentiates itself by accepting insurance. Most practices do not take insurance because it pays poorly and is difficult and costly to administer. To overcome these lower rates / higher cost LFST can drive higher volumes given the lack of insurance accepting competitors.

However, the problem with this ‘volume’ strategy is that the clinicians hate it leading to low employee satisfaction and high turnover. This dissatisfaction is obvious when you look at the numerous, consistently negative Glassdoor reviews (link below). Glassdoor is always a good check when evaluating investments and I can’t recall ever seeing anything as negative as LifeStance. You hear the same negativity when speaking with formers. Not only does this cause employee attrition limiting growth and rising costs, but it also leads to a negative selection bias where the best therapists leave and the worst stay.

LifeStance Health Reviews: What Is It Like to Work At LifeStance Health? | Glassdoor

Furthermore, this is not a business with significant operating leverage or economies of scale. This is fairly intuitive when you think about operating mental health clinics. Despite significant top line growth in the last couple of years, gross margins are falling and G&A as a percentage of sales is flat.

Management Track Record is Poor. Executives are Selling

LFST IPO’d in June 21 at $18 /share. Almost immediately the company missed their guide. Since then operations and communications have been poor as insiders sell aggressively.  

Management has yet to articulate a consistent strategy. First, M&A was the main area of focus, then organic growth became most important and now management talks about closing centers to enhance margins. This inconsistency is likely because the company’s structural issues make a viable strategy non-existent. 

Figure 1: YTD Insider Sales

Shares are Expensive Even in a Best Case Scenario

For a best case scenario, let’s assume over several years LFST can double the number of clinicians from 6,132 at the end of Q2 to 12,000 (which will obviously take many years even if growth somehow accelerates). Lets also assume revenue per visit increases 8% and (in contrast to recent operating trends) the company sees significant operating leverage with EBITDA margins growing 5.5% based on 2023 guidance to nearly 13%.

As shown in Figure 2 below, even in this best-case scenario shares still trade at 22x fcf after stock comp.

Figure 2: LFST Best Case Scenario

Potential Catalysts

Deteriorating operating trends – In the last quarter, LifeStance added the fewest net new clinicians in its history showing the difficulty in growing organically given the high employee turnover. Gross profit margins continue to fall with center margins -380bps in the last quarter vs 2Q21. Falling margins show the lack of operating leverage, inability to raise prices due to the highly concentrated customer base and inability to push volumes too hard without further upsetting employees. These are all structural problems we do not see getting resolved.

Equity sales – Including contingent consideration payments quarterly cash burn has averaged $12m per quarter over the last 6 quarters. LSFT has $80m of cash on the balance sheet implying there’s only a few quarters before things start to feel tight. Furthermore, sponsors still own over 60% of shares and have been holding for a while. As such I would expect them to use any potential strength to exit. 

Catalyst

Deteriorating operating trends, Equity sales