Of all the deals Warren Buffett has made, he considers the measly $433 million purchase of Dexter Shoe Co. in 1993 the worst. It wasn't the amount he spent on the company that upset him. It was the fact that he used Berkshire Hathaway shares. The shares he used to fund that purchase are now worth 20 times what they were in 1993. In other words, in Buffett's mind, that acquisition cost him $8.7 billion.
Companies often use their stock to make acquisitions in order to conserve cash to pay for growth. It's the same reason many executives in tech end up with a lot of stock options and restricted stock in the company they work for. A fast-growing company needs to plow every bit of cash it can into growing the business. Vendors don't accept stock as payment for office space, servers, and sales conferences. Teladoc Health ( TDOC -4.61% ) fits the description of a rapidly growing company using its stock to fuel growth through acquisition. It's been doing it for years, but has it gone too far?
Get big, fast
Telemedicine is the future. The founders of Teladoc realized this nearly two decades ago and have been scaling as fast as they can to improve patients' access to care ever since. Although the company had been growing hospital systems and insurance partners rapidly over the past few years, COVID-19 turbocharged the adoption of virtual care. Visits have been up more than 200% compared to 2019 in each of the past two quarters. Even before the pandemic, leadership had been acquiring businesses to provide access to more doctors, in an effort to sign up more health systems and insurance companies to offer the service to their members.
Buying a company with stock is the norm now, but it hasn't always been. An analysis conducted by Harvard Business Review during the merger mania of the dotcom bubble found that only 2% of large deals in the late 1980s were done with stock. Teladoc has embraced the trend. Between going public in 2015 and 2018, management acquired rival Stat Health Services, Healthiest You, Advanced Medical, and Teledietician. Although the company has used a mix of cash and stock to make the deals, the number of shares outstanding increased from 20 million to 66 million. Add in the purchases of Advanced Medical and Livongo this year, and the company's share count will have increased to about 150 million shares. Although that dilution might make Warren Buffett's stomach upset, it has purchased a lot of growth.
Looking at growth through a per-share lens
When companies report sales and sales growth, it reflects how fast the business as a whole is growing. As shareholders, we only own a portion of that business. That's why it's important to understand how your share of the business is performing, and if the growth you see in the headlines is really what you are getting. To do this, we can look at financial metrics on a per-share basis. Obviously, earnings per share is a metric many on Wall Street pay attention to, but when a company has no earnings the dilution of shares can sometimes fly under the radar.
Using the timeline from above, we can see that the number of shares increased 230%. However, during that same period, revenue grew from $77 million to $418 million -- 443%. How did it work out for shareholders? Combining the numbers, revenue per share grew from $3.85 to $6.33 -- only 65%. Updating the numbers for the company's 2020 acquisitions of InTouch Health and Livongo gives us trailing 12-month revenue of about $1.2 billion and 150 million shares, or $7.88 in revenue per share. Put another way, since the end of 2018, the company will have increased revenue 183% and increased the number of shares outstanding by 127%. While headlines for 2020 will speak of rapid growth, more than half of that growth has been diluted by issuing new shares.
Enough of the numbers. Is it good or bad for investors?
Less of something great is still pretty good
One of the reasons stock is used for acquisitions is because Wall Street typically doesn't punish a fast-growing company for diluting the existing shareholders. While per-share metrics are critically important for valuing a stable company with predictable finances, a company like Teladoc has an enormous potential market to capture in the years ahead. Management estimates that $250 billion of the healthcare market could be virtualized. Over the years, top-line growth has outpaced the increase in shares, and deals to expand the network of physicians or service offerings have the potential to pay off for many years to come.
Right now, management deserves the benefit of the doubt as they use the stock to build out the dominant telehealth platform and ward off competitors like Amwell. While existing shareholders' ownership stake is getting diluted, it's being done to lock out competitors and establish a service that may eventually achieve both profitability and pricing power.
I suspect Teladoc is done with making deals while it works to integrate Livongo as a partner. Continued growth during that time will likely make up for the dilution we've seen in recent years and bring the numbers back into alignment. For investors, it's important to keep an eye on per-share metrics to make sure your ownership in the business isn't being undermined. Check back in a year to see how the big acquisition has affected revenue growth and if it was worth the extra shares.