A couple of weeks ago, Teladoc Health (NYSE:TDOC) announced a surprise merger with Livongo Health (NASDAQ:LVGO). I'm a big fan of both companies, and I've been kicking myself all year for not having invested in either virtual healthcare player. Teladoc's chief service allows sick people to consult with doctors over the internet, while Livongo provides virtual assistants and health coaching for people with chronic illnesses.
Both stocks have killed it so far in 2020. And yet, when Teladoc revealed it was buying Livongo, the stock market hated the news: Shares of both companies took a big hit. You might expect the buyer's share price to sink if the market felt it was overpaying for the acquisition, but in that case, why would the target's shares drop so much?
It might be that the acquisition of Livongo will create opportunities for rivals to step up and take market share in the digital-assistant healthcare niche. Certainly, the stock of Ontrak (NASDAQ:OTRK), which provides similar digital health management services, has been skyrocketing recently. It ran up 55% in July. And when the merger was announced, Ontrak's stock shot up almost 50% the next day.
Why is the market excited about Ontrak?
Both Ontrak and Livongo are in hyper-growth mode. In fact, their revenue growth rate in the second quarter was the same: 124%. But while Livongo's growth rate has been slowing down, Ontrak's is escalating. And the top-line growth is just part of the story. Perhaps the biggest near-term catalyst that could drive Ontrak's stock higher is how cheap its valuation is relative to Livongo's.
|Company||Market Cap||Q2 Revenue Growth (YOY)||Price/Sales Ratio|
|Livongo Health||$12 billion||124%||45|
Of course, Livongo is a lot bigger than Ontrak. Livongo had $92 million in revenues in the second quarter, while Ontrak had just $17 million. Ontrak's revenue growth looks less impressive given that it's coming from such a tiny base. So maybe that justifies the valuation disparity?
Not so fast. The rate of Ontrak's revenue growth is escalating. Check out these numbers:
|Year||Ontrak Annual Revenues||Annual Revenue Growth Rate|
|2020 (projected)||$90 million||157%|
Ontrak actually suffered some delays in 2020 with the integration of its $90 million, three-year contract with Cigna. Earlier, the company had projected that it would receive about $40 million from the Cigna deal in 2020 -- almost half of its projected revenues for the year. Instead, Cigna postponed the start of the contract for about nine months, so enrollment is now projected to start in October. That cut the $40 million in estimated 2020 revenues from Cigna to about $4 million. And yet Ontrak is still going to hit its numbers for the year. As CEO Terren Peizer said in the conference call, the company "overcame a $36 million loss of revenue this year."
If the merger causes difficulties, Ontrak might advance even more
At The Motley Fool, we love Rule Breakers -- companies that are "top dogs and first movers." Right now Livongo dominates the niche of providing health tips and disease-management coaching virtually to people with chronic illnesses like diabetes. And shareholders have made a lot of money from its growth in that space. So why should investors forget about Livongo?
Well, one major reason is that it will soon cease to exist. Or, more specifically, it will become part of Teladoc Health. While this has been billed as a merger of equals, it's more like an acquisition. The combined company will be called Teladoc Health, and it will continue to be headed by current Teladoc Health CEO Jason Gorevic.
I'm bullish on Teladoc Health. And I was bullish on Livongo Health. But one can be bullish on two companies as individual entities and still have doubts about their merger. What does Gorevic know about this new business he's about to be running? If he has to lay off some people over the next several months, will he favor the strangers who came with his new business, or the old hands he knows well?
Don't get me wrong, Teladoc Health is still a great investment. But the merger headaches and new management issues might slow down the Livongo side of the operation.
Why Ontrak might rise
This might be a case where a company with superior technology displaces a top dog and first mover. After all, Alphabet did that with Yahoo.
Suppose you work at a health insurance company and you are evaluating two competitors for a new contract. Livongo is the market leader in this new field of providing virtual coaching tips to people with diabetes and other chronic illnesses. Ontrak also provides virtual coaching tips to people with diabetes and other chronic illnesses. But Ontrak has an additional selling point -- it uses artificial intelligence to help you find the people who would benefit from this coaching.
While Livongo created this market, Ontrak's A.I. solution might give it a significant advantage. Indeed, Ontrak was originally known as Catasys, because its focus was on the technology side. It only recently changed its name to Ontrak, which previously was only the name of its coaching service. In effect, Ontrak has married its A.I. solution with Livongo's business plan, and it's is seeing terrific success with it.
I failed to buy shares of Teladoc, and Livongo, back when they were small companies. Last week, I went ahead and opened a small position in Ontrak. I'd encourage interested healthcare investors to do the same.