Returns on Investment

The filing of the Evolent IPO documents sparked a similar reaction for me as did the Castlight filing.  It is simply unbelievable that experienced, thoughtful health care investors would pay the price that is sought.  Few customers, undifferentiated products, astounding losses, excessive management compensation, the list goes on.  If you look at all the money that has been invested in health care data, health care analytics, population health, etc. companies, and you look at the likely revenue size of the markets addressed, there is simply no way that everyone can get a return.  There is every indication, from venture investment valuations to IPO pricings, that we are in a period of speculative froth for many health care segments.

Now I recognize that many investors rely on the greater fool theory.  Venture capitalists, for example, may invest in a company they don’t think has a great long-term future as long as within their investment timeframe they believe they can sell it to someone else for an acceptable return.   And there is a class of investors in IPOs looking for a quick hit; hoping the stock bounces up shortly after the offering and bailing out at a profit.  But someone is going to lose a lot of capital at some point, either because many of these companies never achieve a liquidity event or because another firm spends too much money to buy them or, if it goes public, because some set of shareholders is going to get left holding the bag in the future.  This loss of capital is painful to the investors who lose it, but also disruptive to the economy.

Valuations are clearly irrational now for many health care information technology, population health, etc. firms.  By irrational I mean that acceptable cash-on-cash returns for the risks taken, the only thing that counts, are not likely to be achieved.   That irrationality derives from two primary sources; one is overestimating the size of a market, for example, how much hospital systems will really spend on data analytics, etc., and the second is underestimating the sources and effect of competition.  These are markets with few barriers to entry and everyone and his brother thinks they can provide the functionality.  I don’t see easy ways for people to differentiate their products and services, so guess what, that leaves price as a primary competitive point.  And the jury is still out on the enduring value of these products and services.  These markets tend to shift dramatically and quickly.  The sooner investors recalibrate valuations, the less pain there will be.  But excess capital is like excess testosterone; it encourages emotional rather than rational decisions.