Description

Introduction

LVGO has been caught in the recent indiscriminate shorting of IPOs following the WeWork fiasco, and short interest has risen to about 25% of the float despite zero fundamental changes. Misconceptions around its Total Contract Value ("TCV") metric have also contributed to this opportunity. Despite reporting strong 2Q19 earnings in September, the stock sold off dramatically after the company reiterated full-year revenue guidance that implied a deceleration of revenue growth in 2H19 despite record TCV bookings in the quarter. Tech investors misinterpreted the lack of a guide-up to 2019 revenue as higher implied churn in the back half and sold due to a misunderstanding of the TCV metric and how implementations ramp-up and generate revenue.

We value the company using a DCF at $32/share, which translates to a 7x 2021 revenue or 10x 2021 gross profit, for 95% upside. The stock trades at about 6.5x consensus 2020 revenue, which we believe is beatable. As shown below, LVGO trades at dramatic growth-adjusted discount to other fast-growing recurring revenue businesses:

LVGO operates a leading data-driven digital health platform which optimizes patient management of chronic health conditions, mainly focused on Type II diabetes today. The platform consists of a closed-loop continuous feedback system which incorporates connected technology, free, automatically-delivered testing supplies, AI-powered personalized “health nudges”, real-time 1-to-1 coaching and 24x7x365 monitoring designed to guide diabetic enrolled members to avoid danger states and expensive hospital stays. LVGO’s solutions are sold to employer clients as a no-cost benefit to their employees, and 20% of the Fortune 500 are clients.

LVGO’s solution provides individualized care that members love (Net Promoter Score (“NPS”) score of 64), reduces costs for employers (average ROI of 3.7x), while generating gross margins of 70%. All revenue is recurring and annual client retention is 96%. The company has a significant first-mover advantage in a very large and underpenetrated market, and has been growing revenue greater than 100%. Livongo’s sales approach resulted in lifetime value-to-customer acquisition cost (“LTV/CAC”) ratio of 23x in 2018, and high efficiency with sales and marketing spend should yield attractive margins longer-term.

How LVGO makes money and value proposition

LVGO’s platform today focuses on addressing Type II diabetes which affects ~31 million Americans. Diabetes is estimated to have accounted for $327 billion of healthcare costs in 2017. Type II diabetes sufferers have traditionally been forced to manage their chronic illness largely on their own. The average compliant diabetic sees a healthcare provider a few times a year for a 10-minute appointment, and isn't able to access timely individualized expert advice on their glucometer in the context of their particular health condition. Livongo (LVGO) bridges this care gap with a disruptive approach consisting of free, automatically-delivered equipment and supplies, constant monitoring and tailored “health nudges” delivered through connected devices, powered by continuous data flow and an AI engine. Health coaches are available anytime to provide empathetic advice. Members enrolled in Livongo for Diabetes experienced an average 18.4% decrease in the likelihood of having a day with hypoglycemia (blood glucose less than 70 mg/dL) and an average 16.4% decrease in hyperglycemia (blood glucose greater than 180 mg/dL).

LVGO generates revenue by charging a monthly subscription of ~$75 per member per month (“PMPM”) to employers. Self-insured and fully-insured employer clients offer LVGO's solution to its employees at no cost. On average, LVGO's solution generates medical cost savings of $1,900 per member per year, or 3.7x ROI. During the IPO roadshow, LVGO provided case studies of companies like Target that saved much more. Fortune Brands achieved year 1 ROI of 5.0x with $235 PMPM of gross medical savings and a 66% decrease in inpatient hospital spending. Several checks with self-insured clients corroborate a strong ROI and dramatically lower cost CAGRs for enrolled (+3% pa) compared to unenrolled (+15% pa) diabetics. Client satisfaction is further supported by the high 96% client retention rate. Some clients have mentioned the possibility of shifting LVGO's solution from opt-in to a requirement for diabetics, or raising premiums for those that don't enroll.

Not only do LVGO’s clients save money by making the switch, but their employees are much more satisfied with their benefits packages and are likely also more productive at work. Diabetic enrolled members love LVGO’s solution as well. LVGO has a NPS score of 64 (which is unheard of in healthcare), compared to Amazon’s score of 62 and Netflix’s score of 68. This high-quality experience results in member non-job loss-related monthly churn of 0.5%.

Competitive advantage

LVGO benefits from first-mover advantage and a multi-prong go-to-market strategy. In addition to selling direct-to-employer, LVGO is years ahead in aggressively investing in educating consultants (e.g. Mercer, Willis Towers Watson), health insurer (e.g. HCSC, Anthem) and PBM (Express Scripts, Caremark) channel partners on the advantages of LVGO's solution. Our checks confirm that LVGO spent years investing in Mercer's sales force, and is also partnered with 4 of the top 7 insurers and 2 of the largest PBMs. PBMs and health insurers generally promote whoever they have a partnership with and know well. They invested in training their people on LVGO’s product and are unlikely to invest valuable time in understanding a competing solution for a slightly lower price. Moreover, since many of these partners are paid on a revenue share, they have a preference to partner with the company that is most likely to drive the highest enrollment rates at their clients. LVGO’s longer history and larger scale with respect to enrollment data provides it with an advantage in using AI and data science to drive enrollment rates. Despite several start-up competitors in the space (Omada Health, Virta Health, Onduo, Glooko, etc.), LVGO’s pricing has been relatively stable.

In a nascent industry with a number of unproven offerings, LVGO is widely regarded as the gold standard for digital health platforms. It has the greatest number of quality 3rd party actuarial studies and reference clients. The effectiveness of their sales approach can be seen in their client LTV/CAC, which was an astounding 23x in 2018, compared to best-in-class SaaS companies at 4x. Diabetic patients are typically diagnosed with other chronic conditions (e.g. 73.6% of diabetics suffer from hypertension, 87.5% are overweight/obese), and LVGO has already launched solutions for hypertension, weight management, behavioral health and pre-diabetes, which are in-demand by employers and will help drive ARPU growth as well. In members with a starting blood pressure greater than 140/90, LVGO’s hypertension solution demonstrably reduces systolic blood pressure by 10mmHG, associated with a 22% reduction in coronary heart disease and a 41% reduction in stroke. Its first-mover advantage means that it has the most comprehensive platform for chronic diseases, which is increasingly attractive to employers.

TCV metric clarification; consensus estimates are beatable

TCV is defined as contractually committed orders to be invoiced under agreements initially entered into during the period, assuming a 25% enrollment rate and a full term of service, and includes both new agreements entered into with new clients and renewals with existing clients. TCV grew 200% y/y last quarter to a record $74.2m. Given an average contract length of 18 months, this equates to new annual recurring revenue of $49.5m. This revenue should have 70% gross margins and recur for many years. Note that the company spent just $17.7m in sales and marketing in the quarter for these bookings.

The timing of TCV conversion to revenue and the conservative enrollment rate estimate incorporated into TCV is not understood by the market. Unlike typical SaaS subscription bookings that contribute to recurring revenue shortly after being booked, LVGO's TCV wins may not launch and generate revenue until the next year if the client chooses to launch its LVGO offering on Jan 1. This dynamic is misunderstood by tech investors and is precisely why strong bookings in 2Q19 did not result in a guide-up for remaining-year revenue. LVGO further clarified that new contracts on average require an additional 3 months to launch, and reach 12.5% enrollment 3 months after launch and 25% enrollment 9 months after launch. Note that the TCV metric is conservatively estimated on 25% expected enrollment, compared to 34% actual average enrollment and 47% enrollment for optimized clients. The company mentioned on the 2Q19 earnings call that it believes enrollment rates of over 60% are achievable. 

LVGO expects the seasonal effect of TCV wins being back-half weighted to continue in 2019. Based on a simple waterfall translating TCV to revenue, company guidance and consensus revenue numbers are beatable for 2H19 and 1Q20. We estimate 15% upside to 2H19 consensus revenue and 6% upside to 1Q20 consensus revenue. Full year 2020 revenue will partially depend on bookings in 2H19 and 1H20 but also appear easily beatable using relatively conservative assumptions for bookings growth. We currently model 2020 revenue about 7% higher than consensus but believe that there is a higher probability that our numbers get revised upward rather than downward. For example, we only model TCV growth of 24% in 2020 which is a very large deceleration vs the 200% y/y growth the company posted last quarter. We also conservatively expect TCV to grow at almost half the growth rate of sales and marketing expense in 2020. Despite efficiency of sales and marketing or LTV/CAC improving in 2019 vs 2018, we assume that it comes down going forward.

TAM and revenue projections

LVGO has a long run-way for growth. The estimated TAM for the diabetes solution is 14.3 million diabetics or $12B of potential revenue. This diabetes TAM excludes diabetics managed by United Healthcare (currently not partnered with LVGO) and Humana (partnered with Omada Health). LVGO currently has 193K diabetic enrolled members, or 1% of its addressable opportunity in diabetes. Hypertension represents an additional $14B opportunity. We expect LVGO to grow revenue at a 74% CAGR for the next 5 years driven by member enrollment.

Risks and catalysts

While there are admittedly some questions around long-term competitive dynamics given the number of other start-ups in digital health, LVGO will experience tremendous growth for the foreseeable future. LVGO's outrageous discount to comparable high-growth companies is unwarranted. We believe LVGO will continue to beat revenue expectations and particularly 1Q20 and FY2020 expectations as TCV wins from 2019 start to ramp-up into recurring revenue.

Catalyst

Consensus revenue expectations outperformance