A merger between two of the hottest stocks on the market may sound like a match made in heaven. But when one emerged recently, investors didn't think so.
Wednesday morning, Teladoc Health (TDOC -3.54%), the country's leading telehealth service, said it would acquire Livongo Health (LVGO), a provider of digital health monitoring tools for patients with chronic diseases, in an almost all-stock deal. And both stocks finished the day down more than 10%.
According to the terms, Teladoc will pay 0.592 shares of its stock (on Thursday, that equaled about $125) for each share of Livongo, plus $11.33 in cash. That was roughly a 10% premium to Livongo's closing price on Tuesday, but by the end of trading on Wednesday, Livongo stock was actually worth less according to the terms of the deal than it was as a stand-alone company prior to the deal; Teladoc stock fell 19% during the trading day, essentially lowering Livongo's value by the same amount.
What gives? Let's take a look at a few reasons why investors are pooh-poohing the deal.
1. Smells like a top
Teladoc and Livongo have been two of the best-performing stocks on the market this year. Even after Wednesday's slide, Livongo is up more than 400% this year, while Teladoc has gained about 150%.
However, investors often dislike it when high-flying stocks dilute shareholders, and that's exactly what's happening here -- the deal will increase Teladoc's shares outstanding by nearly 60% for an acquisition target that doesn't seem to fit into Teladoc's core telemedicine business. While it may be smart of Teladoc management to leverage its lofty stock price in what's basically an all-stock deal , that logic only holds up if the stock retains its value, which hasn't happened. This signals that investors think Teladoc is overpaying, or simply think the deal is unwise.
Teladoc shares have been pumped up because its services are surging in popularity during quarantine and stay-at-home orders surrounding COVID-19. While Teladoc has accomplished much of its growth through acquisitions, investors may be suspicious of this attempt to use a booming share price to acquire a fast-growing peer. The Livongo purchase could signal that Teladoc is fearful that its growth will normalize once the impact of the pandemic fades.
2. It killed one of the market's darlings
Livongo has emerged as one of the market's favorite momentum stocks during the pandemic. It's posting triple-digit revenue growth. It's raised its guidance for the year, and its industry is largely unaffected by the pandemic -- and may even be experiencing some tailwinds as corporate clients seek to manage chronic diseases like diabetes, which put patients at greater risk of problems with COVID-19.
But stocks that jump 400% in seven months aren't usually acquisition targets; shareholders generally prefer to give them a chance to run higher. By contrast, most businesses that do get acquired are troubled companies that can offer the buyer a valuable set of assets. In a similar deal earlier this year, Grubhub, the restaurant delivery app, agreed to be acquired by Just Eat Takeaway, the European food delivery giant, in an all-stock deal. In that case, Grubhub had been losing market share for years, watching its profits erased by competition from Uber Eats and Doordash.
Livongo, on the other hand, was posting sterling numbers in an industry it's essentially pioneered. In the second quarter, revenue jumped 125% to $91.9 million, and it posted an adjusted profit of $12.5 million, up from an adjusted loss of $7.6 million in the year-ago quarter.
That's not the profile of your usual acquisition target. That Livongo agreed to sell itself means that there's something management knows that investors don't -- maybe they think the stock is already priced at a substantial premium, or they expect the current growth rate to slow significantly.
3. Growth won't be this impressive forever
Teladoc reported 85% year-over-year revenue growth in the second quarter, but much of that surge came from tailwinds related to COVID-19, as patients and doctors who are unable to schedule in-person office visits have chosen instead to consult through telemedicine platforms like Teladoc.
Prior to the pandemic, revenue growth was more modest. Teladoc's top line grew by 32% in 2019, including acquisitions. Livongo's revenue is less than half of Teladoc's, so the former's growth rate will only have a modest effect on the combined company after the acquisition. And again, Livongo management's decision to sell in spite of such seemingly bright prospects casts a pall on future growth potential.
Though Teladoc may see revenue expansion of about 100% this year, that's likely to be much slower in 2021 as the pandemic fades and Livongo's growth moderates.
In the press release announcing the merger, the companies touted synergies on both the revenue and cost sides, and the new company will certainly be a major player in health tech. But the expectations baked into both of the stocks coming into the deal were already so high that it seems almost impossible for the new Teladoc, which will absorb and overshadow Livongo's growth, to fulfill the expectations that had inflated their previous valuations.