DIG THIS: Hype or Bubble?
By Sara Vaezy, Chief Digital Officer, Providence
& Doug Grapski, Director of Digital Strategy Providence Digital Innovation Group
Summary: The companies that come out of a hype-cycle trough and make it through a deflating financial bubble will have increased momentum and a lasting impact on the industry. Those companies need the capital to survive the downturn along with a business model that supports long term sustainability. As we are seeing early signs of a financial bubble, health systems need to lean in, be prepared, and respond to current market trends. Here’s why.
The music hasn’t stopped, but it may be slowing
In 2020 we saw a historical $14.9B invested into digital health companies.[i] In 2021, those investments made history again, nearly doubling 2020’s record. In the privately funded markets, Rock Health reported $29.1B in digital health investments across 729 deals, with an average deal size of $39.9M.[ii]
Venture capital and private equity funds have been pouring money into digital health companies with increasingly larger round sizes driving higher valuations. We are likely to see 2021’s historical wave of investment and interest in digital health continue in 2022, although likely at a reduced pace, as Q1 2022, saw $6.0B worth of investments across 183 deals with an average size of $32.8M. The Q1 2022 $6.0B quarterly total trails the lagging 12-month quarterly average of $7.1B by 15%.[iii] [iv]
While companies with valuations shielded in the private markets have been booming, publicly traded digital health companies without the protection of VCs and private equity money are getting hammered. Earlier this year, Jeff Goldsmith noted some clear examples of public digital health companies struggling - One Medical is down 83% from the peak, Oscar is down 83%, Bright Healthcare is down 85%, AmWell is down 90% and Teladoc is down 77%, and currently has a market cap of $12B, which is less than the $18.5B they paid to acquire Livongo last year.[v]
These factors, combined with the fact that health systems—who are often the customers of many of these technologies—are going through some of the most difficult times they’ve ever experienced with ongoing COVID surges, a workforce crisis, and compounding financial challenges. This has many executives and investors wondering “when is the health tech bubble going to burst?” Nonprofit health systems have been adversely impacted because they are not able to easily shed distressed assets that are essential to serving community needs when compared to for-profit health systems that answer to shareholders first.
Hype or Bubble?
A hype cycle, as made famous by Gartner, represents the path of innovation or technology as it matures, is adopted and eventually is applied into the industry.[vi]
Hype cycles are triggered by some action in the market (the development or release of a new technology) and go through a period where users and the buzz around an innovation exceeds its capabilities and the value it can potentially generate. As the innovation doesn’t meet overblown expectations around performance, value, and adoption, the excitement wears off and disillusionment sets in. However, a select set of innovators (often those with capital to ride out the difficulty of the trough) can begin to demonstrate results, reducing risk in the domain, and driving up penetration and value.
Bubbles are formed when valuations in a segment or asset class exceed the value they are capable of creating as investors get excited and drive up revenue multipliers. Investing naturally precedes results because it’s based on the future promise of value, but with all technology cycles, there is a tipping point. The degree to which a bubble forms and collapses afterward can vary - some bubble pops are violent and sudden (e.g., dot com bust) and some are longer and slower.
Rock Health has a great 6-point framework on how to spot an investment bubble.
· Hype supersedes business fundamentals
· High cash burn rates
· High valuations decoupled from fundamentals
· Surge of cash from new investors
· Fraud or misuse of funds
· Unclear exit pathways
Today, we are consistently seeing 4 out of the 6 criteria for a bubble including high hype, burn rates, valuations, and a surge of cash. Exit pathways are becoming more and more unclear as public markets deflate and SPACs struggle.
Rock Health noted that of the 17 digital health companies that went public via SPAC in 2020-2021, only one finished 2021 with positive performance Of note, SOC Telemed that SPAC’d in 2020 was recently brought back to the private markets by a private equity firm in a deal valued at $300M.[vii]Digital health trends are reflective of broader SPAC uncertainties in the financial markets, as more SPACs are calling it quits before acquiring targets – adding further uncertainty to future exit opportunities. As exits to the public markets have become less appealing, exits through mergers and acquisition may become increasingly popular as companies look to round out their offerings and cross sell products; however, access to capital will be the rate limiting factor in driving acquisitions.
Fraud and misuse of funds are usually later to show up (or become publicly evident) but there are a few early examples in Theranos, Outcome Health, and uBiome. Additionally signs of a bubble are beginning to surface outside of digital health companies. Most recently, Fast, an online checkout company, shuttered its doors despite recently raising a $102M Series B with only $600,000 in revenue as they reportedly had a burn rate of $10M per month.[viii]
We believe we’re starting on the downslope of the peak of inflated valuations and in the latter stages moving toward an investment bubble. So far, the impact has been mixed, and ultimately the forecast for digital health innovators will be somewhat dependent on their respective buyer segments, their go-to-market strategy, and how supportive they are of their customers’ business model.
In our world, we primarily see this from the vantage point of a health system. Beyond known interoperability and integration challenges, much of health systems’ ability to consume innovation in today’s world hinges on two factors – degree of financial risk and workforce challenges. In the last two years, health systems that had significant control over the premium dollar were less impacted by the COVID crisis than those highly reliant on fee for-service business models. Challenges that have been looming for years have been significantly accelerated by COVID.
The stock price history for a number of digital health companies that have gone public in the last 2 years demonstrates that innovators are facing an uphill battle when compared with incumbent industry giants with successful business models focused on owning more of the premium dollar.
The divergent market performance of these major players does not diminish the potential for digital health and distributed care models, but rather points to the need for digital health companies to mature to the next level and to start delivering measurable results for Wall Street. Scrutiny is not always a bad thing and is a further proof point that the business models are both maturing and being tested.[V(1] [GDP2] [KKM3]
Where does digital health go from here?
In many cases, it can be hard to understand what problem digital health companies are even solving—consumer value, business model, etc. Yet, there are hard problems, many of them very unsexy, that need to be addressed—namely, data infrastructure and core business model transformation.
Legacy data infrastructure challenges are consistently the biggest headwinds facing innovation teams within health systems. Most health systems grew from federated, smaller hospital systems where infrastructure and technology decisions were made at a local level. This explains why most health systems have multiple EMRs, ERPs, and networks. Few have made the investments to streamline their overarching infrastructure due to high switching costs.
Because of this, we also have big questions about whether consolidation will occur at the infrastructure level—and therefore, how health systems should align themselves with infrastructure players.
With respect to business model transformation, companies that enable health systems to manage the transition economics of traditional fee-for-service (FFS) models to consumer- and value-based models –while managing to the business, operational, and clinical realities of the health system—will ultimately win out.
Finally, disruptive, venture and private equity financed innovators will at least demonstrate more consumer-friendly models and reset consumer expectations about what health care can be. Some of them will reach escape velocity and create disruptive change in the market—but will require the capital to sustain the long haul.
Why Should Health Systems Care?
How much and why health systems care about this varies depending on their vantage point. The digital health boom has given consumers a taste of what is possible. Regardless of the headwinds many digital health companies are facing, health systems must catch up given the evolution in consumer and clinician expectations. The on-demand, technology-driven life that most consumers have led for over a decade, has become a practical reality in healthcare in the last 2 years and consumers aren’t going back. It’s too late to be proactive, but it’s not too late to take action.
As buyers and users of technology, health systems must monitor the stability of their solution company while also building in the channels to continue innovating with partners. Partnership with these innovators cannot slow down and health systems should resist the urge to let themselves devolve into the hubris of thinking they can do it all themselves—or worse—taking no action at all. As we’ve discussed in other pieces, the pace of change and the amount of capital is far too great to be able to sustainably compete without partnerships.
The hype cycle downturn and the potential bursting of the financing bubble can contribute to skepticism around how disruptive companies and technology will be to incumbents, and as a result what response is needed, if any. As we’ve said before, now is not the time for health systems to be too self-assured. We need to go through the skepticism, endeavor to make things better for our patients, and continue to make the case for change.
Why? Because the bursting of bubbles and hype cycles thins the herd while concurrently strengthening the best positioned innovators allowing them to gain marketshare. Capital gets concentrated on those who can ride it out and can get a sustainable business going. The dot com bust yielded Amazon and the financial crisis in 2008 yielded web 2.0 (Airbnb, Uber, etc).[ix] The companies that come out of the hype-cycle trough and make it through the deflating financial bubble will have increased momentum and have a disruptive impact on the industry. Health systems need to lean in, be prepared, and respond.
For more research, analysis, and perspectives like this visit the Providence Digital Innovation Resource Center. Related resources include: