4 Risks In Teladoc’s Merger With Livongo
On August 5, two publicly-traded digital health companies agreed to merge. As of August 17, shares in the acquirer — Teladoc TDOC , a virtual healthcare service provider, and the target — digital diabetes service provider, Livongo — had declined 17.7% and 10%, respectively.
The market’s message is that Teladoc — which agreed to swap 0.592 Teladoc shares plus $11.33 in cash for each Livongo share — has not done a good enough job of making its case.
Given that this deal does not score well on my four tests for successful acquisitions, I see considerable risks should this deal go through — most notably:
- Growth in this unprofitable industry could slow down;
- It is not clear that the combined companies will be better off;
- Teladoc overpaid for the deal; and
- The companies face major integration issues which should have been addressed before the deal announcement.
I would avoid shares of both companies.
To be fair, here is the case for a positive outcome to this merger.
Teladoc — which initiated the deal — is bullish on the future of the combined company. As CEO Jason Gorevic explained at an August 13 investor conference, “Financially, when you look at the combination, it’s very, very strong. It’s growth accretive for us. It’s gross margin accretive for us. The revenue synergies are massive.”
He said that investors have been slow to understand the combined company’s “unmatched capabilities. Livongo’s very consumer-friendly product, technology forward, consumer engagement and behavior change, their underlying data science [complements] Teladoc’s scalable global virtual care platform and the ability to bring that physician network to bear across all clinical specialties and conditions.”
Livongo shares Teladoc’s excitement. As CEO Zane Burke said at the investor conference, “[Teladoc was already a market leader in things we wanted to do]. From my perspective, the change in the marketplace and…the way that both of these organizations can come together to make a true difference in virtual care …is just…really profound.”
What’s more, on August 17 Credit Suisse issued a bullish report on Teladoc which coincided with a 9.4% increase in Livongo stock during the day.
According to TheStreet.com, Credit Suisse analyst Jailendra Singh upgraded Teladoc to outperform, raising his price target from $225 to $249. He sees deal’s growth and synergy targets as “very achievable.”
Singh expects $5 billion in 2025 sales for the combined company — up at a 38% compound annual rate from $720 million in 2019; combined 2025 earnings before interest, taxes, depreciation, and amortization (EBITDA) of $1.1 billion; and industry leadership in “virtual care and chronic care management.”
(I have no financial interest in the securities mentioned here).
The Teladoc/Livongo Merger
Teladoc connects corporate employees with physicians and behavioral health professionals — via mobile devices, the Internet, video, and phone. Employers pay a monthly fee on behalf of their employees, according to Morningstar.
Livongo — a provider of chronic disease-focused services — helps employees manage chronic conditions such as diabetes, hypertension, weight, and behavioral disorders for employees, companies, health plans, government entities, and labor unions.
Teladoc is larger than Livongo — but growing more slowly. In the second quarter of 2020, Teladoc’s revenues topped $241 million — 9.5% more than the Zacks consensus and 85% more than the year before, according to Zacks Equity Research.
Livongo’s revenue of about $92 million was up 125% from the year before, noted Mobihealthnews. Teladoc lost $30 million in the quarter while Livongo’s net income was $0.
Teladoc’s statement regarding the merger offered a full-throated defense — including 85% growth in pro-forma 202o revenue to some $1.3 billion and more than $120 million in EBITDA.
Teladoc also highlighted the potential for $100 million in “revenue synergies” in the second year after the deal closes — anticipated to happen before the end of 2020 — and $60 million in cost savings. Teladoc sees cross-selling and penetration into each company’s client bases leading to “[revenue synergies] reaching $500 million on a run rate basis by 2025.”
Wall Street gave the deal a Bronx cheer. How so? The day before the announcement, Livongo shares traded for $144.53. The proposed deal — with its mix of Teladoc stock and cash — valued Livongo that day at a 10% premium or about $159. Since then, Livongo shareholders have suffered a 19% loss in value.
I think mergers make sense if they pass four tests. I don’t think this deal passes all four of them. Here’s why.
The merged company should target a large, growing and profitable industry
I think the tele-medicine industry is large and growing fast — at nearly a 17% average annual rate from $25.4 billion in 2020 to $55.6 billion in 2025, I wrote in May.
However, I do not see evidence that it’s profitable (neither Teladoc nor Livongo are making money). Indeed between 2017 and 2019, Teladoc lost a cumulative $310 million while Livongo’s cumulative net loss totaled $29 million.
In addition, industry growth could slow down — Livongo grew 39% in 2019 compared to 85% in the second quarter of 2020. If the current pandemic ends in the next year or two, tele-medicine might grow but not at 2020 rates.
The combined companies should be better off
It is not clear that merging these two companies will make customers and shareholders better off.
Livongo’s president Dr. Jennifer Schneider says the combined companies will be better off. She envisions that the two companies might use Livongo’s chronic care platform to identify possible patient health problems that could be resolved through Teladoc’s virtual visits.
As Schneider told mobihealthnews, “I’ll hypothetically give you an example. Imagine [there’s] somebody with hypertension on the Livongo platform…We notice that this person is taking their medication, but their blood pressure still remains elevated. We [question whether they are on] the right medication.” Through Teladoc, she envisions that Livongo could share the patient information with a Teladoc physician to give the member “better health outcomes.”
This example raises questions in my mind: Will patients whose health information is on Livongo’s platform consent to sharing this data with a Teladoc physician — e.g., a provider other than the patient’s current physician?
Livongo says it complies with data privacy regulations and offers members various data sharing options. In an August 17 email, Livongo’s Senior Vice President Corporate Communications SBAC , John Hallock said, “While health information can be shared privately with the consumer and their physician, approximately 30% of individuals don’t have a primary care physician. The [merger with Teladoc] helps ensure that consumers get the right care at the right time” while controlling their data.
Will this merger really make employers and their employees better off? Sean Duffy, CEO of Livongo rival, Omada Health — who used in-depth customer interviews to inform his decision to merge with Physera, a provider of virtual musculoskeletal services in May — is skeptical but open-minded.
As he told me August 13, he questions whether “the pieces will come together [in the Teladoc/Livongo deal] to reduce pricing for employers and add value to employees. If Covid were cured would hospitals and other care providers be able to seek reimbursement for video/phone interaction with care providers?”
The price of the deal should be less than the value in current dollars of its future cash flows
It is hard to reach a conclusion about this without knowing the details of the cash flow projections for the combined companies and whether the assumptions are realistic. Based on how the stock prices of these companies have dropped since the deal was announced, it is worth considering that Teladoc overpaid.
I am struggling to see the financial logic for Livongo to give up its independence after enjoying triple digit revenue growth and a 476% surge in its stock price in 2020 — as of the day before the deal was announced. It makes me wonder whether Livongo management has concluded that the market over-valued the company, saw trouble ahead and wanted to get out at the top.
Did Livongo management expect Teladoc stock to lose so much of its value after the deal was announced? If so, could Livongo now regret that it accepted so much of that depreciating currency in exchange for giving up its independence? Livongo declined to answer these questions directly.
The people, culture, and systems of the combined companies should be well-integrated
It could be difficult to retain Livongo’s talent given the leadership structure of the merged companies. That’s because Teladoc executives will control the combined companies’ Chair and CEO positions.
Not only will Livongo will get a mere five of the 13 board seats but Teladoc CEO Jason Gorevic will have the same job at the combined company as will its chair, David Snow. I am surprised that Livongo CEO Zane Burke did not take one of those top jobs — which is typical in such mergers.
Duffy sees significant unanswered integration questions: “Will the companies be able to integrate their products and teams?” To which I would add, “Can Teladoc and Livongo sales forces be reorganized in a way that accelerates revenue growth or will they suffer from debilitating turf battles that create opportunities for rivals to win their customers?”
Teladoc is not concerned. Chris Stenrud Teladoc’s Vice President, Communications explained in an August 17 email, “As the integration planning process gets underway, we are already hearing a lot of excitement from the team on the many growth opportunities that the combination will bring, including significant cross-selling potential. With only 25 percent client overlap, these opportunities are substantial.”
This deal falls short of passing the four tests for successful acquisitions. If Teladoc can provide better and more convincing answers before the deal closes, perhaps Livongo shareholders will be rewarded.