One Medical’s IPO will test the value of tech-enabled startups

Image Credits: kentoh/istock

Hello and welcome back to our regular moning look at private companies, public markets and the gray space in between.

Today we’re digging into the One Medial S-1 IPO filing. The company, popular in Silicon Valley and known for an investment from Alphabet, intends to debut this year on the Nasdaq under the ticker symbol “ONEM.” The company’s filing notes a $100 million IPO raise, a placeholder figure designed to indicate to investors the rough scale of its impending offering.

One Medical was valued at around $1.5 billion in its most recent, 2018-era fundraise according to CBNC, reporting that the company has since traded on the secondary markets for around $2 billion.

We’ll start by exploring the trusses and underpinnings of its business before turning to the question of how to value yet another tech-enabled business with lower gross margins than what tech companies tend to sport. One Medical’s valuation picture is also complicated by slow, if accelerating growth, rising unprofitability on a GAAP and adjusted basis and rising operating cash burn.

Facts and figures

Before digging into the numerical stuff we’re going to pause and quote the company’s introductory information. Normally we skip the stuff, but here are the two key sentences from the document (emphasis mine):

• “Our mission is to transform health care for all through our human-centered, technology-powered model.”
• “We are a membership-based primary care platform with seamless digital health and inviting in-office care, convenient to where people work, shop, live and click.”

Translating a bit, those statements read like One Medical saying that it’s a technology company with recurring, subscription-style revenues. Every company wants to be a SaaS business — the industry enjoys sky-high revenue multiples — making the phrasing from One Medical unsurprising.

One Medical charges a yearly membership revenue fee to customers, providing it with eight-figure subscription revenues; the company’s membership revenue has convinced some in conversation that its SaaS-ish elements will be richly valued. While I doubt that anyone views One Medical as a SaaS business, the question remains how similar to one if might appear once we dig into its financial results. (The closer to SaaS it can appear, the more One Medical may be worth.)

To spoil what’s to come, it looks very little like a subscription-first business.

It’s not a SaaS business

One Medical’s membership business is sizable, but doesn’t appear to generate the majority of the company’s revenues (just $38.0 million in “membership revenue” out of $198.9 million in total top line during the first three quarters of 2019). And, One Medical’s gross margins are far below what we tend to see with software-subscription companies.

What is One Medical, then? The company is a healthcare provider with a technology and subscription twist, it appears.

The firm does have some attractive elements, however, including:

• Accelerating revenue growth: Revenue grew from $154.6 million in the first nine months of 2018 to $198.9 million in the first nine months of 2019, representing growth of 28.6%. That’s faster than its 2018 full-year growth result of 20.3%.
• Improving gross margins: The company’s gross margins (not including depreciation and amortization costs) rose from 35% in the first three quarters of 2018 to 40% in the first three quarters of 2019. Inclusive of excluded costs, the figures were 30% and 35%, respectively.

While those are bright spots for One Medical, each represents improvement from a lackluster base. The company’s revenue growth rate is improving, but the company still theoretically hitting its growth curve. (The company doubled its sales and marketing spend in 2019 to juice growth, mind.)

And, the firm’s margins are improving, but are not where we’d expect for a company with its implied revenue multiple.

Turning to One Medical’s issues:

• Rising operating and net losses: The company’s operating loss grew from $25.1 million in the first nine months of 2018 to $35.2 million in the first nine months of 2019. Its net loss similarly rose from $26.9 million to $34.2 million.
• Rising adjusted losses: One Medical’s adjusted losses (adjusted EBITDA) rose from $7.1 million in the first three quarters of 2018 to $15.6 million over the same period of 2019. That’s more than double.
• Rising CAC: Using a crude bit of math, One Medical spent about $565 in sales and marketing costs per new member (net) in the first three quarters of 2019. That figure was about $348 in calendar 2018.
• Low gross margins: Reporting 40% gross margins while stripping out some costs (following how the S-1 is worded) is pretty good for most industries. For venture-backed companies that raised hundreds of millions, it’s a slightly stunted figure.
• Rising operating cash burn: One Medical’s operations consumed $11.4 million in cash during the first three quarters of 2018. That rose to $24.1 million over the same period of 2019.

How do we value the company? That’s hard. But we can use some old marks to get some numbers.

What’s it worth?

We could dig deeper into how the company generates growth, including its partnership incomes. However, that would be going too far into the weeds. Let’s stick with what we know and understand, namely valuations.

Recall that CNBC reported that investors valued One Medical at around $1.5 billion in 2018 and that the firm had traded as high as around $2 billion on secondary markets. Giving One Medical a generous Q4 revenue result, the company could end 2019 with revenue of around $272 million.

At $1.5 billion, the company would be worth about 5.5x times trailing revenue. At a valuation of $2 billion, the company would be worth a sharper 7.4x trailing revenue. Those figures improve some when we look ahead one year, but as the firm was last formally valued in 2018, looking at 2020 revenues to make the math square up seems generous.

We can’t compare One Medical to SaaS companies, obviously. And it’s hard to find a medical comp that won’t get you shouted at on Twitter. However, Teledoc came up a few times over the weekend. It’s worth 11.4x its sales, according to YCharts. Not bad!

However, Teledoc generates much more revenue from its subscriptions (86% in its most recent quarter), has positive adjusted EBITDA, generates positive operating cash flow, and has higher gross margins. It’s growing a little bit more slowly, but, seemingly, from a place of greater financial health.

The Teledoc comp may help. But I wonder if it will help enough to let One Medical defend its old valuation. It just isn’t a tech company as we understand them. A pity, really, as One Medical is honestly a great service and I was a happy customer.

The One Medical saga looks a bit like huge checks chasing a company that wanted to be a tech shop, but was more a services business all along. It won’t be the last company to hit this particular wall.