The B-Word: Is the Health IT Market in the Midst of a Bubble?

April 6, 2014
In advance of the IMS Health IPO, Paul Teitelbaum, managing director and medical device / healthcare IT mergers & acquisitions (M&A) expert at Mesirow Financial, a Chicago-based investment banking firm, discusses why many companies in the industry have high valuations and explores the possibility that a health IT bubble has formed.

IMS Health, a Danbury, Conn.-based company that offers analytics, consulting, and healthcare data to pharmaceutical companies, providers, payers, and other entities, is seeking to raise $1.4 billion in an initial public offering (IPO) this week.

If that goes down as planned, it would give IMS Health the second biggest IPO of the year, according to The Wall St. Journal. Another company that did well in an IPO this year is Castlight Health, a San Francisco-based provider of an application that allows consumers of healthcare to compare doctors. The company traded in its first day at more than $40 per share, which gives it a valuation of more than $3 billion. In total, it raised more than $100 million.

Castlight is trading currently at a more reasonable $23 per share. Still, considering the company has yet to post a profit, it’s doing well for itself on the market. So well that some said it might have had the most “overvalued IPO of the century.

Imprivata (Lexington, Mass.) is a third health IT vendor that will file for an IPO in 2014. The company, which offers security software such as single sign-on, is seeking a $115 million IPO.

While the three companies operate on different planes, they all illustrate the potential IPO boom period for healthcare IT-focused companies. And if not IPOs then there is the possibility of getting sold for a pretty penny, such as Franklin, Tenn.-based revenue cycle management company, Passport Health Communications, which got bought for $850 million by Experian.  Already, in the last few years, venture capital (VC) money has been pouring into health IT startups at a record rate.

Of course, with this boom, there is just as likely of a chance that it could all burst.  After the Castlight IPO soared, Healthcare Informatics Senior Editor Gabriel Perna spoke with Paul Teitelbaum, managing director and medical device / healthcare IT mergers & acquisitions (M&A) expert at Mesirow Financial, a Chicago-based investment banking firm. Teitelbaum spoke about the possibility that there is a health IT bubble, why the IPO market has been kind thus far to these companies, what other companies he will be watching for possible IPOs or sales, and how long can we expect money to be going into these companies.

Below are excerpts from that interview.

Why are valuations so high for these health IT IPOs?

There are a few factors driving it. Number one, given healthcare reform and the Affordable Care Act, and pressures to reduce costs, increase efficiency, and increase price transparency for employers as well as patients, there’s a strong demand for better healthcare IT systems. There is a strong belief some of these companies, which have innovative solutions and advanced technology, have the potential to provide software that will greatly benefit the efforts towards cost containment.

Number two, healthcare IT companies that have pretty strong growth are desirable from an investment perspective because of their high growth, high margins, and potential for recurring revenues. IT companies in general get pretty high valuations. What really magnifies these to the crazy levels we’ve been seeing is that if someone wants to play in healthcare IT space…there are not many ways for an investor to participate. There are really six or seven publicly traded, pure play healthcare IT companies out there (ed: Cerner, Allscripts, athenahealth are a few mentioned). There are not many. People want to participate and there are not many ways to do it, so a new healthcare IT IPO comes along and it gets significantly bid up.

Plus, we have a pretty strong IPO market in general right now.

Why did Castlight’s IPO do so well?

What I would go back to is pricing transparency and solutions from employers to choose benefit plans for employees to be able to select benefit plans and select specific services based on what they cost is extremely important. There is a trend toward having employers and employees bare a significantly greater proportion of their healthcare costs, their premiums, co-pays, deductibles. Out-of-pocket maximums have gone up. If you are consumer of healthcare services and you will be increasingly paying for these things, as opposed to a third-party payer, it becomes increasingly important to understand what the services and benefits will cost and what you will get out of each plan. There is an enormous need for valuable information that can help you make these decisions.

Will Castlight’s IPO be a bellwether for the rest of the industry in 2014 – do you expect more of these companies to file and get high valuations?

I think to some degree it will be a bellwether. Now that this IPO has happened and happened at such a robust valuation, provided that we don’t have a bubble burst, it significantly enhances the potential value of other IPOs coming behind it. People will look at Castlight and see how high it’s priced, and how it’s been performing, and it’s likely to make other healthcare IT IPOs this year be potentially loftier in valuation than otherwise would have been.

I don’t think the other IPOs will trade at the same multiple of revenues as Castlight did (160 times its revenue). But does it mean IMS Health prices at a multiple of revenues that is a couple of turns greater than it would have been?  Maybe.

Who are some other companies you’ll be watching this year?

Some of the other companies we have on radar for IPO are definitely Practice Fusion, Vitals—which is similar to ZocDoc, and ZocDoc itself is rumored to be planning an IPO. In terms of other exit candidates, companies that may be sold or file an IPO, HealthGrades, MediMedia, Emdeon, are examples of more sizable companies that I believe are profitable and have been eyed by acquirers. If you file an SI, it can be a potential for a dual track process. You can either do an IPO and get priced or the buyers watch your S1 filings and have discussions and negotiations with the company, and it becomes an opportunity for those acquirers to buy the company at a lower valuation before it prices. However, it may be strong M&A market, but it may not be gangbusters because of the IPO option and high expectations.

Another company I think is interesting is AmericanWell. I haven’t seen anything about a rumor to go public, they haven’t filed an S1. Think about it though, companies that allow you to have a “visit” with a physician, over the internet with a live video stream and secure texting…it’s a way for physicians to have shorter visits, have more visits, do things in their spare time, and it’s a way for consumers to do something in much less time-consuming, much more time-convenient manner. They are not the only ones, there’s TelaDoc.

I’ve seen VC money poured into healthcare IT continuously for like the last few years, more and more every year, when does the gravy train end? Or will it keep rising for the foreseeable future?

I think it continues rising through 2014. I think strong IPOs like Castlight, possibly IMS and the others, as well as big M&A deals like Experian’s $850m acquisition of Passport Health, the VCs look at those successes and say “I want to get in on one of these,” or “I know a company that’s doing it better and will give Passport, IMS, Castlight, or any of the others a run for their money.” IPO and M&A activity only spurs additional investment in the space. I can’t give you an exact timeframe for how long it continues, but I think it continues until the point in time where the IPO and public markets start cooling off. 2

If you look at the 2003-2007 timeframe, which was also a time where you saw increases in VC investment in lots of things. Then the market crashed in 2008 and it dried up over night. If there is a bubble that’s forming now and it bursts at some point later in time, who knows when, that would certainly curtail the VC activity.

In some of the articles that talk about Castlight, there is already a question whether or not a (broader) bubble has started.

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