Disruptive Healthcare 3/28/2024: Investors Value Margins > Growth

Public market investors are valuing margins over growth by a landslide in today's market. What does this mean for healthcare startup founders trying to raise money?

Mar 31, 2024

Disruptive healthcare valuation, trends and analysis weekly.

Note: Two changes this week to my methodology…
I made a few changes to a couple of our charts this week. I expanded who we include in the NTM EV/EBITDA charts because more of the NTM EBITDA estimates provided by the equity analysts are realistic now. I also removed one company from our “top multiples” chart because their margins just aren’t in line with the other top 5 (so now we show a top 4 group).

Valuing Margins Over Growth:

I like to look at how the companies with the greatest valuation multiples trade versus the broader group. In this sector, there are 4 clear outliers who trade above everyone else. Formerly, I was looking at the top 5, but number 5 was always Phreesia who was an outlier (on the downside) among the top 5. Their EBITDA margin forecast for 2024E was far below the other 4.

Why do I look at it this way?
This shows me what the public markets value the most, which then translates into what private market investors place the most value on. I know most startups don’t have positive EBITDA margins, but investors in this current market are valuing unit economics over growth at all stages. If you look at the peers with the top 4 highest valuation multiples, they aren’t necessarily the fastest growers, or even the largest businesses.

This top 4 group does have higher margins on average. In fact, the group averages a 2024E EBITDA margin of 39.0% versus the broader peer group which averages a 2024E EBITDA margin of 17.6%. The growth rates among the two groups aren’t very far apart, in fact, the growth rate is lower in the higher valued group. This tells me everything I need to know about how the market places value on financial performance today.

What does this mean for startups?
This doesn’t mean that growth isn’t important. In fact, for most early and mid stage startups, growth is the key valuation driver in your funding rounds. However, it does mean that investors are looking more closely at your unit economics to figure out if you can grow into a profile that looks more like Veeva, Health Equity, Doximity and GoodRx.

As a founder, this means you need to be thinking critically about what costs scale with your business, and what costs you can drive out as you gain scale. If you can articulate this plan to investors alongside a believable growth story, then you will be able to raise a nice round in the current market. If you can’t articulate this story, then you need to think about your business model and where you go from here.

Disruptive Healthcare Stocks vs. Broader Market:

In the stock price charts below we compare the Disruptive Healthcare peers to the S&P 500, the XLV and the inverse of the 10 Year Treasury rate over the last 12 months and since the broader market bottom in October 2023.

Since the end of the Zero Interest Rate Police (ZIRP) environment, interest rate expectations and the cost of capital have driven market movements. However, in the last few months, we’ve seen interest rate expectations move in a way that would have driven markets lower, but that hasn’t happened. This divergence that you can see in the chart below since December 2023 is worth keeping an eye on.

Our disruptive healthcare peers seem to have bottomed as a group on November 9th, 2023. Since that time, they have outperformed the broader market.

A quick look at the 1-week peer performance versus broader markets:

Weekly Share Price Performance:

Disruptive healthcare companies traded up 1.0% this week on average while the broader S&P 500 traded up 0.4% on the holiday shortened week.

Valuation — EV / NTM Revenue:

Mature healthcare comps are generally valued based on their earnings (see the broader comps at the bottom of this post). However, earlier stage businesses such as startups, and to an extent these younger, disruptive healthcare public companies often don’t have positive earnings yet or they may have positive earnings, but they haven’t reached the margin profile they will achieve upon maturity as a business. As a result, it’s harder to compare these companies on an apples-to-apples basis using EV to earnings. So, we use EV/NTM revenue to triangulate valuation for these companies and for startups in similar markets.

5 Year Average: 6.8x
Today: 3.3x
Peak: 15.1x
Trough: 2.4x

Summary of top 4 EV / NTM Revenue Valuation Stats:

Top 4 companies include VEEV, HQY, DOCS and GDRX as of today. Why did we move from showing the top 5 to the top 4 here? We removed PHR because their margin profile doesn’t fit with the rest of the “top” group. They were a significant outlier and I think it is important to show the disparity between the true high margin businesses and everyone else.

5 Year Average: 12.6x
Today: 7.7x
Peak: 26.4x
Trough: 5.8x

Valuation — EV / NTM EBITDA:

We were previously only looking at 8 companies from the perspective of EV/NTM EBITDA, but since Q1 earnings have reported, more analysts are projecting positive EBITDA in 2024 and beyond for more of the peers so we have expanded the index here to include 11 of the 16 companies.

To create an index, I only include the peers who have a substantial believable positive NTM EBITDA forecast based on the average of Wall Street equity research reports. The comps with barely positive EBITDA yield EBITDA multiples that aren’t realistic (so we consider them not meaningful “NM”).

The included companies are: VEEV, HQY, DOCS, RCM, PGNY, TDOC, GDRX, GOCO, HIMS, LFST, and PRVA. That’s not to say the other Companies won’t have positive EBITDA in 2024, but the multiples are relevant right now. Here’s how the chart looks.

Summary EV / NTM EBITDA Valuation Stats:

5 Year Average: 39.8x
Today: 18.5x
Peak: 85.0x
Trough: 15.3x

As these companies mature and begin to trade on EBITDA multiples or even P/E multiples (much like the hospital facilities and MCO peers) then this chart will tell us more. This is certainly a data point we can look at for profitable growth equity stage private companies. I’d expect those companies to be valued closer to the 5-year average or slightly lower. Some of that data in 2019 and 2020 is elevated because the EBITDA estimates back then were very small or barely positive for some of these companies driving an artificially high multiple that wasn’t driving valuation but rather was a dependent variable.

Broader Healthcare Comps as of 3/28/2024:

This newsletter is mostly focused on the disruptive healthcare comps and how their performance drives valuation for our private market portfolio at What If Ventures. However, we do keep a much broader set of comps that includes Healthcare Facilities and Managed Care Organizations. I know the font is small, but you should be able to click on these and expand.

^I realize this is too small to read, but if you double click on the image it should expand. Or you can just email me and I’ll send you the backup.

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About What If Ventures — What If Ventures invests in mental health and digital health startups from seed stage to growth equity. To date, we have invested over $83mm into 72 healthcare startups since January 2020.

If you have questions about any of this analysis or want to collaborate with What If Ventures, please reach out via info@whatif.vc. We’d love to connect with entrepreneurs and investors in the space.

You can follow more of my commentary on twitter here: @hazesyah

Disruptive Healthcare