Description

It’s hardly a secret that investors have been piling into growth stocks and “COVID-19 stocks” in recent months.  This dynamic has led to an extremely compelling short opportunity in shares of Livongo Health (ticker: LVGO), a dubious COVID play with significant downside risks ahead as the momentum unwinds.  

Livongo provides a remote glucose monitor for diabetics, primarily marketed through PBMs to self-insured health plans as a way for employers to reduce diabetes-related healthcare costs.  Management pitches the company to investors as a high-growth, SaaS-like “AI” platform.  In reality, the company sells a basic, low-tech device (which they do not even manufacture) with its “artificial intelligence” amounting to sending automated messages to users (e.g., someone with low blood sugar might get a message like “Jenny, please drink some orange juice”).  

Recently, the stock has been caught up as a telehealth play on COVID-19 with Cramer adding it to his “Mad Covid-19 Index” under the category of “Exotics.”  Fueled by a first quarter revenue beat (from previously announced client wins that weren’t adequately modeled by analysts), the stock has soared 150% YTD, hitting a fully-diluted market cap of $7 billion.  While the company’s valuation of over 20x revenue would make many of the fastest-growing software businesses blush, we think it is completely nonsensical for what primarily amounts to a low-tech medical device marketer with minimal IP, growing competition and a limited addressable market that is already over 30% penetrated.  Under an optimistic scenario, we think the company could reach $600 million of revenue at 15% EBIT margins in four years.  Assuming a multiple of 20x EBIT discounted back to today at 8% (and adding the net cash balance) implies a valuation of $1.8 billion or $15 per share, representing 75% downside. 

Company Description

Livongo started off as a struggling glucose monitor company called EosHealth.  In 2013, current Chairman Glen Tullman (former CEO of Allscripts) invested in EosHealth and relaunched the company as Livongo with a subsequent $8 million fundraising round in 2014.  The company went public to much fanfare in July 2019 marketing itself as an AI, data-driven digital health and wellness platform with a predictable SaaS monthly subscription model (all words from the S-1), selling a glucose monitoring system for Type 2 diabetics to check their blood sugar that automatically connects to cellular networks.  The service is primarily sold to self-insured employers through PBMs such as Express Scripps and CVS at an approximate price of $750 per enrolled employee per year. Livongo has a one-time cost of roughly $150 for the glucose monitor and bears approximately $150 of annual costs per year to supply test strips and coaching. 

If a blood sugar reading is too high or too low, a coach can call or text the patient with advice (although this function is generally heavily automated).  There are several glucose monitoring systems on the market, but Livongo pitches customers that this “coaching” really helps patient engagement and reduces hypoglycemia and saves on healthcare costs, although there are no independent studies to support this claim.  Based on our research, we believe this is mostly marketing hype.  In reality, Livongo’s main appeal is that it sends them free unlimited test strips (required to take blood samples for glucose monitors) to its users, saving them a co-pay and some hassle.  

Compared to its $7 billion fully-diluted market cap, the company has just $13 million of PP&E on its balance sheet and spent $7 million on capex last year (of which $5 million was capitalized software).  Livongo generates over 70% gross margins from the hefty mark-up of its monitors, spending around 50% of revenues on marketing consisting of commissions paid to channel partners (mostly PBMs) to distribute their product and ongoing marketing costs to enroll new members as existing ones churn off.  Livongo has disclosed that average monthly member attrition is between 2% and 3%.  Given these ongoing marketing costs, we estimate long-term GAAP operating margins will be capped in the mid-teens as compared to management’s long-term non-GAAP target of 20%+.   

Why Livongo is a Short

We think Livongo represents a compelling and timely short for the following reasons: 

Excessive COVID-hype: After pre-announcing a first quarter revenue beat in early April, the market zeroed in on Livongo as a COVID-play, sending the stock up over 100%.  While the company does see a modest benefit from higher enrollment rates as people set up an at-home diabetes solution, management disclosed on the Q1 call that the company also benefited from a pull-forward of new contract launches.  Further, the company faces a headwind from rising unemployment since they are paid per employee.  To put all these factors into context, consensus 2020 revenue has risen from $286 million to $300 million, a $14 million increase.  2021 estimates have increased by the same dollar amount.  For comparison, Livongo’s fully-diluted enterprise value has risen from $2.5 billion at the start of the year to nearly $7 billion today, a greater than $4 billion increase against a $14 million increase in expected revenue.

Not really telemedicine: While Livongo emphasizes the roll of their technology-driven coaching, our checks with employers and competitors point to the convenience of the bundled product (i.e, free testing strips) as the key appeal rather than the coaching.  One competitor suggested that Livongo’s ratio of patients to coaches could be in excess of a thousand to 1 with the company spending substantially more on glucose meters and test strips than coaching.  Here was an online review from one user: “I wasn’t too fond of having someone contact me when my numbers are out of range.  I’m usually aware of what is causing my highs/lows and am taking measures to get them back to normal.  Someone telling me to drink juice when my numbers are low sounds like a “duh” conversation.” 

Unclear cost savings: Most employers we spoke to couldn’t prove any hard savings beyond comparing Livongo enrollees to employers with diabetes doing nothing.  In other instances with more detailed analysis, the underlying driver of the cost savings seemed unclear at best.  For example, Livongo published a case study on Dean Foods that looked fairly robust at first glance.  However, when we spoke to Dean Foods, we found out they actually pay employees to use Livongo (i.e., check their blood sugar).  That seems like a great idea but is less dependent on anything unique to Livongo.  Our best guess is that most of whatever cost savings Livongo generates is coming from getting people to check their blood sugar more regularly, particularly by shipping employees unlimited test strips for free.  That is a much less differentiated competitive advantage versus the unique technology-driven “AI+AI” coaching solution that the company promotes.  In January 2020, Diabetes Technology & Therapeutics published a review surveying the statistical benefits of different Diabetes connected care methods.  Livongo reduced blood sugar levels on average by 1 percentage point.  However, that was right in line if not worse than many of the other solutions listed in the report, including Cecilia, Onduo, One Drop, and Virta.  UCSF is currently running a study comparing Livongo to a control group also receiving a connected glucose monitor, which should provide the most accurate conclusion on how special Livongo really is.  Results are expected in 2021. 

More penetrated market than it seems: On the surface, Livongo looks like a new, early-stage company fresh out of its IPO last year with plenty of runway given only 328,500 current enrollees out of >30 million diabetics in the US.  However, when looking at self-insured employers that are likely to work with Livongo and adjusting for the percent of Type 2 diabetics that are diagnosed and using glucose monitors, we estimate that there are only 1 million potential enrollees, implying a penetration of roughly 30%.  Specifically, out of the 30 million US diabetics, there are only roughly 10 million diagnosed Type 2 diabetics in commercially insured plans.  Out of that 10 million commercial population, we estimate there are only 4 million that are in self-insured plans (excluding plans using administrators that do not work with Livongo).  Out of those 4 million, we conservatively estimate that there are only roughly 1 million that use a glucose monitor and are likely to sign up for Livongo.  According to one competitor, Livongo has already knocked on the door of all the large employers that that they could and instead will rely on picking up smaller employers as well as moving outside of the self-insured market to Medicare and the fully-insured market, which strikes us as challenging. 

Increasing competition: Livongo was the first-mover a few years ago with the clever idea of marketing a convenient, ready-to-go diabetes monitoring solution to self-insured employers with unlimited test-strips.  However, now there are numerous competitors offering very similar products.  Further, we question the barriers to entry in the space for what is effectively an undifferentiated glucose monitor, and our conversations with health insurers suggest that they could recreate Livongo at fractions of the cost.  As we’ve seen with similar companies like Tivity and Castlight, these types of healthcare services businesses have a tough time carving out durable, profitable franchises despite showing high growth in early years.  

Lock-up expired / large VC ownership: On March 11th, Livongo’s remaining lock-up expired freeing up 45 million to be traded.  Based on the most recent disclosure, the VC backers still own a large portion of the total shares outstanding.  Based on filings with the SEC yesterday, General Catalyst appears to have distributed shares to its LPs. We would not be surprised to see an offering or further distributions given the recent momentum-driven rally, which could serve to expand the float. 

Out-year street estimates look unrealistic: While the company should be able to hit numbers for this year, consensus estimates for 2021 and particularly 2022 strike us as unrealistic.  The street expects LVGO to generate nearly $700 million in 2022 versus $300 million expected this year, implying an incremental $400 million over the next two years.  However, the company only added $100 million last year and likely $130 million this year.  Growth is expected to decelerate over the course of this year, and the company has less runway in diabetes going forward.  Consensus estimates seem to imply Livongo successfully penetrates Medicare or the fully-insured market for diabetes or that Livongo has near-perfect execution in its nascent non-diabetes offering (mental health, hypertension), on which we’ve heard mixed feedback.

Potential risk at key distributor: 60% of Livongo’s revenue came from their top 5 channel partners: Express Scripts, CVS, Health Care Service Corp, Anthem, and Highmark.  We believe that Express Scripts is Livongo’s top distributor.  However, Cigna, which owns Express Scripts, has already backed a competitor Omada in which it invested.  While Livongo’s relationship with Express Scripts seems fine for now, we question why Cigna would sit back idly and let nearly $7 billion of value (10% of Cigna’s market cap) accrue to another company for which Cigna is the key distributor. 

Catalyst

Post-COVID momentum unwinds, VC insider sales expand float, revenue beats become harder as market penetration increases, growing competition, Cigna stops distributing the product in favor of competitor Omada