By: AJ Tomas (University of Chicago), Demi Akinjide, Saihejpal Ailwadhi, Ben Fobel, Zac Greenberg (University of Bristol)
Overview of the deal
Implied Equity Value: $37 Billion
Total Transaction Size: $18.5 Billion
Announcement Date: August 5th, 2020
Expected Close Date: End of Q4 2020
Acquirer advisor: Lazard
Target advisor: Morgan Stanley
Teladoc Health Inc, a market leader in virtual care delivery, and Livongo Health Inc, a pioneer of applied health signalling, have announced a merger valued at $18.5 billion. Both companies have seen huge surges during the Covid-19 pandemic, with Teladoc reporting a 203% increase in virtual visits in Q2 2020. Naturally, the Telehealth industry has seen massive growth over the last two quarters as consumers have opted to avoid non-essential in-person meetings at hospitals and clinics to prevent risking exposure to the virus. The rising demand for virtual healthcare has hence created a conducive environment for M&A deals given the pandemic tailwinds, as well as the industry’s current rate of growth and the long-term potential to disrupt conventional care delivery models.
Teladoc offered to acquire Livongo Health for 0.592 shares of its own stock valued at $125 at the time of offer, and $11.33 in cash. The offer values Livongo at $18.5 billion, and the combined entity would be worth over $37 billion. The deal terms value Livongo at 50x this year’s sales. Teladoc will own 58% of the combined entity, with Livongo shareholders owning the remaining 42%.
Through the acquisition, members will have direct virtual access to physicians (including their own primary care physician), to prescriptions written for them through a digital platform, and to health coaching. The merger will combine Teladoc’s focus on providing a broad range of virtual care services with Livongo’s highly personalised, data-driven approach to health signalling. Additionally, Teladoc’s market reach includes 70 million customers in the United States and is hence a strong platform for Livongo to reach new customers at risk of or living with a chronic disease, while also providing significant potential for Livongo’s international expansion. Similarly, Livongo’s focus on chronic conditions such as diabetes and hypertension open up a large addressable market for Teladoc to tap into. Teladoc says the merger would drive revenue synergies of $100 million in the next few years from cross-selling a broader range of personalised health-care services to the company’s current U.S. customer base.
This transaction is the largest healthcare deal of 2020 to date and will most likely be a catalyst for M&A in the digital healthcare vertical. Both the major technology and insurance players - such as Aetna, CVS, and Cigna - are expected to be active acquirers in the coming months. In fact, a couple of weeks after the deal announcement, Google invested $100 million in Amwell (f.k.a. American Well), a company that provides enterprise software solutions that enable virtual care delivery. Industry insiders expect heightened transaction activity ranging from large cap to middle market in terms of deal size.
“This highly strategic combination will create the leader in consumer-centered virtual care and provides a unique opportunity to further accelerate the growth of our data-driven member platform and experience,” - Glen Tullman, Livongo Founder and Executive Chairman
Teladoc-Livongo Market Capitalisation Comparison
Source: S&P Capital IQ as of Market Close 9/3/2020
Teladoc is a leading provider of business-to-business virtual healthcare services through multimodal access points including mobile, web, and phone. The company’s value proposition is in its triaging capabilities; helping their enterprise clients identify which of their employees’ medical incidents require escalation, thus helping employers save money. Teladoc’s growth story to date is largely attributable to their strong execution of sales and distribution.
Note: S&P Capital IQ as of Market Close 9/3/2020; reviewed MD&A for unusual charges
Livongo is a digital healthcare company that focuses on chronic conditions - most notably diabetes. Through their data science and health coaching competencies, the company is able to provide patients with more constant, real-time monitoring and support than in the current mechanisms of care delivery. Livongo’s business model is centred around partnering with providers and owning their patients’ care experience across their longitudinal journeys.
Note: S&P Capital IQ as of Market Close 9/3/2020; reviewed MD&A for unusual charges
Projections and Assumptions
The digital transformation of healthcare delivery has rapidly accelerated in the COVID-19 environment. The Teladoc-Livongo merger capitalizes on the strong near-term tailwinds, creating a dominant market leader in the healthcare IT vertical after the expected closing in Q4 of 2020. The provision of healthcare is a continuum, and the complementary nature of Teladoc and Livongo’s core competencies will help the combined company (entitled Teladoc) offer a suite of end-to-end services. More specifically, the addition of Livongo’s chronic care management expertise - particularly in diabetes - along with their refined AI and health coaching capabilities will solidify Teladoc as the one-stop virtual care marketplace. The consolidated platform is a comprehensive offering; the possibility of physician access is complemented by lower-level support such as nursing coaches and Natural Language Processing chatbots. Patients will be able to access a wider spectrum of synchronous and asynchronous medical attention than in the current conventional care delivery model. Doctors and health systems will be able to manage their communities more proactively which should therefore help boost patient retention.
Furthermore, these additional competencies can be quickly scaled to reach broader markets thanks to Teladoc’s strong global presence, the minimal 25% client base overlap, and more importantly, the different modalities of patient-doctor interaction. Altogether, this is a significant opportunity for Teladoc especially considering that the current conventional healthcare services model is not highly scalable as it is predominantly brick and mortar. However, it is important to note that while the blockbuster merger is earth-shaking in the digital healthcare space, it is really only a drop in the bucket when looking at the entire healthcare industry. Pro forma calculations estimate Teladoc to attain $1.3 billion in revenues in year one; this is only a tiny fraction of what the largest health systems in the United States (i.e., HCA, Ascension, Banner) generate annually.
Share price volatility for both stocks can continue to be expected until the deal closes later this year. While the merger makes strategic sense, the financial arrangements are not well received in the market. Street sentiment indicates that many believe the Livongo purchase price to be fundamentally expensive given the approximately 13% implied control premium to Livongo’s market capitalisation of $16.4 billion. Moreover, the transaction will be highly dilutive for Teladoc’s shareholders.
From a long-term perspective, the combined company is well-positioned to capitalize on disruptive healthcare trends such as proactive management, virtual delivery, personalised care, and value-based compensation. By capturing a broader percentage of the market and bringing on more users, Teladoc will benefit from the resulting network effect. Simply put, more users mean more patient data to help refine the AI model over time. In theory, this should ultimately result in better outcomes for the patients on the platform as the AI models improve in accuracy, thus resulting in better management and diagnostic outcomes. More importantly, considering that the supply of a physicians’ time is scarce, the ability to triage incidents adds tremendous operational value. Doctors will be able to more clearly identify and prioritize patients in need of care. Enterprise clients who shoulder some of their employees’ medical costs will be able to save money through more informed triaging as relatively lower-order cases can be addressed by coaches, nurses, or even NLP systems.
From a financial perspective, management expects the merger to generate meaningful revenue and cost synergies. According to management, the company is expecting to achieve an aggressive $100 million in revenue synergies by 2022 and $500 million on a run rate basis by 2025. Driving these revenue synergies are the increased opportunity for cross-selling, increasing member retention rates, and more efficient enrollment processes. As for the cost synergies, management expects to save $60 million by 2022 through vendor consolidations and back office streamlining.
As with any merger, execution is key and Teladoc has previously succeeded with post-merger integrations. Looking at the BetterHelp acquisition, for example, the business was acquired for about $4.5 million in 2015; by the end of 2020 it is expected to generate about $150 million in sales for Teladoc. However, Wall Street sentiment is a little more conservative. Barclays Equity Research’s forecasts the realized revenue synergies by 2022 to be $15 million less than management calculations and that half of the cost synergies will need to be reinvested in order to achieve the targeted top-line growth.
This bold strategic play - the largest healthcare transaction of 2020 to date - will certainly spur further competition and M&A activity in the digital health space as the large technology and healthcare companies have been put on the clock. According to Deutsche Bank’s George Hill, the predominant health insurers like Anthem, Cigna, and CVS will be looking to acquire telehealth companies to complement their core health plans services and narrow network of trusted providers. Shortly after Teladoc’s deal announcement, Google invested $100 million in Amwell - a digital healthcare company that builds the underlying technology solutions for enterprise clients such as health systems and health plans. One of Teldaoc’s largest competitors, Amwell’s scalable technology embeds with clients’ existing offerings and clinical workflows, spanning the continuum of care and enabling care delivery across a wide variety of clinical, retail, school and home settings.
However, M&A activity will not only be limited to the top of the healthcare market. As Raj Prabhu, CEO and co-founder of Mercom Capital Group told S&P Global Market Intelligence, consolidations in the private markets can also be expected. Smaller telehealth companies will need to merge in order to remain competitive.
Risks and Uncertainties
Pre-COVID 19, the regulation around the reimbursement of virtual visits hampered the widespread adoption of telehealth delivery. Previously, the United States Center for Medicare and Medicaid Services (CMS) did not reimburse telemedicine visits and virtual care administered across state lines. However, due to the inability of patients seeking assistance with non-COVID 19 related issues to visit their doctors or local hospitals in person, the reimbursement policies have since been relaxed to help ensure that Americans are still receiving medical attention. According to the American Medical Association, these key changes in CMS policy are the following:
“Medicare will pay physicians the same rate for telehealth services as they do for in-person visits for all diagnoses, not just those related to COVID-19, throughout the national public health emergency;
Patients can be in their home, or in any other setting, to receive telehealth services.
Patients do not need to have an existing relationship with the physician who is providing telehealth assistance;
Physicians are allowed to waive or reduce cost-sharing for telehealth visits;
Physicians who are licensed in one state are allowed to see a patient in a different state.”
The caveat is that these changes were made on a temporary and an emergency basis. The switch could very well flip in the other direction, back to the relatively more stringent pre-pandemic policies. CMS has already provided clear guidance on this intent but lawmakers in Washington D.C. are currently working on a more concrete set of telehealth regulations going forward. The Trump Administration has lobbied to expand telehealth benefits permanently for medicare beneficiaries beyond the ongoing public health emergency and advances access to care in rural areas. Multiple bills have also been introduced in the U.S. Congress in order to formalize the added telehealth freedoms granted solely during the pandemic period.
Post-Merger Integration & Go-To-Market Strategy
In many instances, superior technology alone cannot guarantee competitive success or dominance. Technological competencies must be leveraged through a business model that allows the company to address consumers’ needs most effectively and within the current market dynamics. Teladoc’s current model is predominantly transactional; their triage systems help their enterprise clients identify which instances require escalation in order to save the employers’ money. Livongo, on the other hand, seeks to retain the customer and own their care experience as they provide health coaching for chronic diseases. While both companies have complementary technology capabilities and assets, the combined entity will have to address the chasm between the two business models.
There are still uncertainties about how virtual care as a category fits in with the existing in-person centric model that involves health systems or standalone practitioners. Can full-suite telehealth platforms replace hospitals or, more broadly, should virtual care even replace in-person care? What will be the relationship between the physical and digital care sites? These are still highly contested issues between healthcare practitioners, strategists and investors. Fundamentally, we believe that this comes down to whether digital platforms materially lower the cost of care, the handoff dynamics between real-time and asynchronous care, as well as the enhancement of digital infrastructure - particularly in the United States.
Much uncertainty has been attributed to the façade of the telemedicine industry’s growth. Despite the spikes in the industry’s average annual rate, profitability is still a major concern – thus potentially limiting the synergies from this acquisition. If history is any guide, Livongo’s consistent net income losses may mean that the company would need to burn more cash just to even achieve some level of profit. With an accumulated net loss of $29 million between 2017 and 2019 and the additional $7 million of losses this year, such an acquisition could pose a financial strain on the already loss-making Teladoc.
It is also worth mentioning that this deal is somewhat unique, as Livongo’s current company profile is not a typical acquisition target. Given their recent surge in sales growth of 150%, it is clear that they have pioneered through the pandemic; consequently making no sense financially, as Livongo is now clearly an overvalued company. According to Livongo’s Price to Book ratio, they are currently operating at 22.9x compared to the US healthcare industry’s 5.6x. Additionally, Livongo is currently trading at 46.6% above its fair value of $90.71 - perhaps an indication for them to sell for a substantial premium. As well as achieving 125% revenue growth in the second quarter of this year, Livongo’s decision to sell may also be a result of forecasted slower growth rates or even a way to get out of future troubles.
“...beyond the buzz, where are we, really, when it comes to the broader category here of virtual care?...Given that this deal and virtual care itself was accelerated during the pandemic — is “the pandemic effect” a harbinger or will we see the rubber band snap back once things go “back to normal” (is THIS the new normal)? Where do specific policies and regulations come in, such as for reimbursement, physician licensing, and more?” - Andreessen Horowitz (a16z)
Sources and Additional Reading
American Medical Association: “5 huge ways the pandemic has changed telemedicine”
Andreessen Horowitz (a16z) 16 Minutes on the News - Episode #38
Barclays Equity Research: “Merging TDOC/LVGO”
Becker Hospital Review: “100 of the largest hospitals and health systems in America|2019.”
Fortune Business Insights: “Telehealth Market 2020 Size, Share, Growth, Trends | Market to Reach $266.8 Billion by 2026.”
IBISWorld Research: “Telehealth Services”
J.P. Morgan Equity Research: “2Q20 Follow-Up: Another Strong Quarter on All Fronts; Raising Estimates and Price Target”
Livongo FY 2019 - Annual Report
Livongo Q2 2020 Earnings Results - Supplemental Slides
Morgan Stanley Equity Research: “Merging with TDOC and 2Q20 Results.”
OutofPocket Newsletter: “Yet Another Teladongo Take.”
SEC Filings: Teladoc FY 2019 10-K
S&P Capital IQ
S&P Market Intelligence: “Teladoc's $18.5B deal with Livongo may spur more digital health M&A”
Teladoc-Livongo Investor Presentation: “Setting a new standard for the delivery, access and experience of healthcare.”
UBS Equity Research: “LVGO Merger Enhances TAM/Positioning, but Valuation Implies Meaningful Rev. Synergy Upside.”