Stephen Hays
Jan 18, 2022
What is occurring in the public markets, and how do these developments impact startups and VCs in the digital health and mental health markets? Let’s dig in.
Rarely do we find a pure-play public comp that we can compare to a startup. This holds true within the mental health space and largely within the digital health startup landscape. There are some companies we can point to that are similar in how they generate revenue, who their customers are, as well as their growth rates and margins, but it is almost always impossible to find the perfect pure-play comp.
When we broadly examine what we call the “Disruptive Healthcare” peer group to get a sense of what is happening in public markets, this may translate into insights about our market, which is at the intersection of digital health and mental health.
As you can see from our index of disruptive healthcare peers, the group has been drastically underperforming the broader S&P 500 over the last 12 months leading into January 2022. In fact, the group is down 50% versus the S&P 500, which is up 10% during that period.
Moreover, pure-play telehealth and mental health companies have underperformed not just the market, but also the peer group (see the chart below). Specifically, Teladoc Health(NYSE: TDOC) and Lifestance Health Group (NASDAQ: LFST) have underperformed the broader underperforming peer group.
Why does this matter? Teladoc Health is a pure-play tech-enabled disruptive healthcare peer that was recently trading north of 20x forward revenue. Many startups were benchmarking to that valuation when they raised money in our space at 20x and even 40x ARR (or higher). Lifestance Health Group is the only pure mental health comp that I can find. Although we continue to see red-hot valuations in the mental health space, I have to wonder, when will the re-rating of earnings in the public market impact private markets?
I suspect that as long as investors are seeking yield, then moving further down that risk spectrum into the private markets, valuations in the startup world will not come in. However, if capital flows begin to tighten as capital access tightens, we could be in store for a sharp pullback in startup valuations as well. Of course, I am not hoping this happens, but when it does, I will not be surprised.
I was slightly curious regarding whether or not equity research analysts believed that the operating environment would deteriorate over the coming 12 months. For that reason, I created a Next Twelve Months (NTM) revenue forecast index for each of the companies in our peer group. All but one company have rising revenue expectations on the whole across all analysts. Only one company, Amwell, has analysts who believe that their revenue will be lower in one year than it is now.
This tells me that analysts believe the operating environment for companies in our space will continue to be at least good, if not improving. Revenue is increasing, so why are stock prices going down?
The answer is valuation. Revenue valuations have come in. Take a look at the above chart which shows the average EV/NTM Revenue multiple for the peer group. The multiple has been sliced over the last year. At one point, the group traded at 15.4x NTM revenue and most recently traded at 4.6x NTM revenue. That reflects a 70% decrease in the value of revenue within our peer group in an environment in which revenue estimates are rising. This is what we finance types call a re-rating. The value of revenue is being re-rated by the markets as the macro capital environment tightens.
What is the right multiple? Where will the market settle? What does this mean for startups?
In short, we do not have the answers. However, we are certainly preparing for any outcome. I believe that the right valuation multiple is above where the market is now (likely in the 7x to 10x forward revenue range broadly with some upside exceptions). I also believe that this valuation trend is just now beginning to pressure private market valuations. More than private market valuations, this trend will pressure the amount of capital available, and even more so if the public markets continue to contract and investors can find yield in less-risky public securities.
If I were the CFO of a startup today, I would be preparing to extend my fume date as long as possible and survive what feels like a pending capital access contraction. If I just raised a huge round at a massive valuation, I would certainly be trying to grow, but I would have one eye on pure survival as well.
As an investor, I’m starting to anticipate that great deals will once again be available, at better prices.
