HeartFlow: A Deep Dive

HeartFlow uses medical imaging to create more complete models of patients' cardiovascular systems; it's a non-invasive technology aimed at improving treatment and reducing unnecessary procedures and costs. The company is set to come public via a SPAC (special purpose acquisition company) later this year, so tune in to this episode of Industry Focus: Wildcard to find out how excited we are.

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This video was recorded on September 8, 2021.

Dylan Lewis: It's Wednesday, September 8th, and we're bringing healthcare to Industry Focus. I'm your host Dylan Lewis. I'm joined by Fool.com's head humdrum hero of healthy hardiness, Brian Feroldi. Brian, how are you doing?

Brian Feroldi: Dylan, doing great. I feel like it's been a couple of weeks since we've chatted. It's good to be back in action.

Lewis: I know. I had to tape a show with Jason last week. Don't get me wrong, I loved it, but I didn't get an alliterative tongue twister to kick the show off. That's a Brian Feroldi original.

Feroldi: Seems like a missed opportunity on Jason's part.

Lewis: He could have had a chance to mess with me. Brian, I will say, I think you mess with me a little bit beyond just the alliterative tongue twister to kick the show off. The company we're going to be talking about today is definitely outside of my usual coverage zone. I had to learn a lot of very complicated multi-syllabic words in preparation for this show.

Feroldi: This is a healthcare company that we're going to be talking about, but it's a healthcare company that's really a tech company. Those are two of my favorite industries to study. When I came across this company, I said, "We've got to talk about this on Industry Focus."

Lewis: This is a SPAC that is going to be available soon. There's a little bit of a complicated nature to this because it's a SPAC that deal has been announced, it hasn't fully closed yet, currently called Longview Acquisition Corp II (LGVW), the ticker is LGV. But Brian, that is not the name of the company that we're talking about.

Feroldi: Like most SPACs, this company raised money as a blank check company. It did not have a target yet announced. A few weeks ago, Longview announced that it was acquiring a private company called HeartFlow. The ticker symbol right now is LGV. You can become a potential shareholder of this business, if the deal closes on time. The deal is expected to close in the fourth quarter of this year. The ticker will change to HFLO, HeartFlow.

Lewis: As the name might imply, Brian, HeartFlow is a business focused on the cardiovascular system.

Feroldi: I love it when it's nice and obvious like that. Yes. This is a company that is focused on heart care.

Lewis: Yeah. This is not the first time that Longview has stepped into the healthcare space, as the name might imply, with this being their second SPAC or their second corp. They had a previous SPAC. They brought public Butterfly Network. Brian, you actually did a rundown on that, I believe with Emily back in December for an Industry Focus episode.

Feroldi: Yeah. A fascinating company focused on handheld and portable ultrasound system. That SPAC did go through, so Butterfly is now a publicly traded company. As you'd expect, they have a high growth, high valuation company. The stock has been all over the map up and down. Something tells me we're going to see a similar result with HeartFlow.

Lewis: I think that's the case. Why don't we just start out here? When you're talking about a SPAC, we're in the healthcare industry, in general, when you're talking about the SPAC space, a big part of the benefit of this style of coming public is that you're able to be far more forward in the way that you look and talk about your business. We're going to be getting into that. Basically, this is a small company now tackling a very big problem. If you start scoping out what that problem looks like in terms of dollars and the number of people that are affected by cardiovascular issues, it gets big fast.

Feroldi: It certainly does. Cardiovascular disease is the No. 1 cause of death in the U.S. and globally accounting for one out of every three deaths. In fact, more than one billion humans are currently at moderate or high risk for developing cardiovascular disease. When the numbers are that big, the spending is enormous. The company says that one out of every $6 that is spent in the United States on healthcare, is spent on cardiovascular care. The opportunity and market here is just massive.

Lewis: I am thankfully not in a position where I've had to have a lot of medical care or attention related to my heart, but I'm sure there are a lot of people listening that have, and they're probably somewhat familiar with the way that we try to assess risk for this right now. It's the stuff that happens at your physical, the vitals that your doctor is taking and often if there are any problems, you start getting into some stress tests and things like that that are non-invasive. That's the current way that we approach this problem.

Feroldi: Yes. Cardiovascular disease, like you said, is an absolutely huge problem. I think most people are familiar with getting their blood pressure test, getting their body mass index weighed at their initial risk assessment. If during that assessment they determine that there might be something going on, they are then sent in for a more advanced scan. They might be on a treadmill where they get an ECG test. They might have a stress echocardiogram test. They might get a PET scan. The sad thing is, even with that current diagnostic method, the current way that we diagnose coronary heart disease is just inadequate. 55% of the time, the patient gets a false positive. That's basically when they're sent in for a test that is a semi-invasive test and they don't have the disease. Then on the flip side, 20-30%, there's a false negative where nothing is detected, but they have an underlying problem. Now, there's a relatively new emerging technology called coronary computed tomography angiogram, or a coronary CTA that is helping to fix this. It's basically high-quality imaging of the heart, but that's only used in less than 5% of patients that are screened for heart disease. HeartFlow is a software company that is helping to make those coronary CTA scans which are used in a minority of cases even better.

Lewis: I think as is often the case with med tech companies, Brian, it is helpful to go to the company YouTube page and watch them explain how this works. It puts visuals to this in a way that we simply can't in this audio format. But to walk through the process here, a patient gets this CTA that you mentioned before. It's imaging work. If there are any potential issues that are present in that imaging work, the imaging gets sent to HeartFlow. What they then do is build out more sophisticated modeling for the heart and the arteries. What they're generally looking for is, is there narrowing happening in those arteries? Is that narrowing affecting blood flow in a way that is going to affect function? They do it in a variety of ways. The one that is most incredible to me is by measuring the laws of fluid dynamics. It's a very engineering oriented way to do this. I think this is where the special sauce for this company comes in.

Feroldi: The output of a coronary CTA scan, which again are currently used, they're used in a minority of cases, but they are used is good, but it's still inadequate. Physicians still don't have access to the data that they really need to make diagnostic decisions. There's still false positives and false negatives on this coronary CTA. What HeartFlow is offering is the ability to take those CTA scans, upload them to HeartFlow's Cloud. It then uses AI and sophisticated modeling that have been developed over more than 11 years and have been used by looking at millions of images to produce a highly detailed, interactive 3D view of the patient's heart. Right in that view, you can call out troubling spots. It basically arms the physicians, with a much more detailed view that they can then use to make diagnostic decisions.

Lewis: To see it in action is cool. You end up with this color-coded look at someone's cardiovascular system. It makes far more sense for me when I look at it. For all of our folks with advanced medical degrees, we're talking about stenosis here. That's generally what we're looking at when it comes to the narrowing of those arteries. It seems to me like a very sophisticated way that preserves the non-invasive element of what we're doing here. Brian, non-invasive is important because you can introduce a host of other problems when you start going into invasive treatment.

Feroldi: These are non-invasive treatments. Historically, once a non-invasive test identifies that there could be a problem, they are then sent over to a far more invasive coronary angiogram procedure to confirm the diagnostics. What HeartFlow's technology promises to do, is by producing that highly viewed 3D model to greatly increase accuracy. Importantly, it actually has data to prove that this actually works. This isn't just theoretical. The company says that when HeartFlow's technology is used, there's an 83% reduction in unnecessary coronary angiogram procedures. There's a 50x reduction in the amount of undetected diseases. Actual diseases are identified 2x more percentages of time, and there's a 40% reduction in repeat testing. The company estimates that if everybody that had Medicare and Medicaid was using this test, there would be a cost-savings annually of $2.7 billion.

Lewis: Brian, to put a bow on what it is and how it works. Basically, imaging gets sent to them. They returned something that is a far more sophisticated model that helps healthcare professionals create treatment plans and next steps for patients.

Feroldi: That's exactly right. They are a software company that helps to aid in the diagnostics of heart disease.

Lewis: Yeah. You say it in the next part of our outline, I think it's worth emphasizing. This is not an experimental technology.

Feroldi: This is currently commercially available, commercially available and on the market in the United States, United Kingdom, in Canada, in Europe, and even in Japan. This is, again, not new technology. It's actually been researched privately for more than 11 years, there are more than 425 peer review publications on this technology and it's reimbursable. 96% of commercial payers are onboard and paying for this and that includes Medicare. What's more, in the United States, 80% of the top 50 hospitals are currently using this technology.

Lewis: That's killer social proof. That's exactly what you're looking for when you're someone like me coming into the zone and not knowing a ton. You want to see that there is systemic support for this type of treatment or rather this type of diagnostic tool. Because ultimately, if the insurers are not going to support it, it's just not going to get used nearly as much as the existing options out there.

Feroldi: When you think through, if this technology works, who wins here? Really, everybody. Everybody wins. The patients win because they get more accurate diagnostics. The doctors win because they get more high quality data. The providers definitely win if there could be a huge cost reduction in unnecessary procedures. I love it when everybody that's involved in healthcare has a win, and this technology does promise that.

Lewis: Brian, you've been very specifically calling this a tech company that operates in the healthcare space. I don't think there's going to be any surprise with the business model here based on that description.

Feroldi: Wait for it, it's SaaS, Software-as-a-Service. But importantly, it's not just any type of SaaS. There are two components to the SaaS model. There is a recurring subscription fee that is paid to just access the platform and the company earns a fee every time an analysis is done, so it's actually on both sides of the SaaS model.

Lewis: Yeah. While it's a very compelling idea and while you're saying this is not experimental technology. When it comes to the books, we are in the very early innings. I think this is one of those companies where they have what I think the business model is. In a couple of years, the business model could actually look quite a bit different. Right now, we're looking at very little revenue. It's $23 million in 2020. A very small base to build off. As we'll get to when we talk a little bit about valuation Brian, this is a business that's about $2.4 million in enterprise value based on the SPAC deal, so a healthy, healthy valuation there and a lot of growth expectations built into this business.

Feroldi: Yeah, it's a $2.4 billion enterprise company. As you said, one downside to a SPAC is, we are not given all the same information that we get when we see in the S-1. We are missing updated financials on this company. But to your point, they said that in 2020, they were estimated to do $23 million in revenue. There's going to be more in 2021, some back of the envelope math suggests that trailing 12 months revenue is somewhere around $30 million. Gross margin last year was 33%, but it's positive and the management team believes that both of those figures are going to rapidly improve. As a SPAC, they can make wild productions about what their companies revenue is going to look like, and they are basically guiding floor compound annual growth in revenue over the next five years of basically 80%. Is that in the realm of possibility? I don't know, but if they can hit that, today's valuation makes sense.

Lewis: Yeah. The charts are up into the right when they're looking at their 2021 to 2025 plan. Just to put some quick numbers to it so you can see, the management team is putting some big ideas out there and some big numbers out there. Like we said, $23 million in trailing 2020 actuals, by 2023 eyeing over $200 million in expected revenue, over $500 million by 2025. You have to discount that, I think, a little bit, Brian. But I think what's interesting to me is, in addition to the massive ramp that they're expecting in revenue and most banks are, they're projecting gross margin expansion and healthy gross margin expansion. Currently 33%, a couple of years out looking to get to 69%, 78% and then maybe cruising altitude being somewhere in the 80% range. That leaves a lot of cash left over if they're able to hit that at that scale.

Feroldi: This is a software company. An 80% gross margin on these sales is not outside of the realm of possibility. If there was a hardware component to that, I might be more skeptical. But if they can get to that scale that quickly, I can see margins being that high.

Lewis: Yeah, it makes sense. You always want to do a smell test when you're seeing those types of expectations. Like, would a business model that they're proposing here support this? I think the answer is yes.

Feroldi: Importantly, their balance sheet is going to be in pretty good shape post the SPAC deal closing. They're estimated to have about $400 million in cash. Now, we don't know what their burn rate is, but they believe that that will be plenty of cash to get them to free cash flow positive. In fact, one interesting thing about this SPAC deal is that if you buy the SPAC as of right now, about $91 million is actually going to be returned to long view shareholders via a special dividend as part of the closing. Now, why the heck would this company return capital to shareholders? The company actually said that they wanted to minimize dilution. They are purposely saying, "We only want to raise this amount of money and no more because this is all we need." That means that the company's ethos in general is minimized dilution. I like that.

Lewis: That sounds shareholder friendly. There are always those elements where I'm like, "I need to dig a little bit more on this to make sure I'm not missing something." but that sounds super shareholder friendly. Dilution is a real problem, it's an easy one to just forget about. It affects your ownership, it affects your stake in the business.

Feroldi: Now we didn't get details on how much stock insiders own or anything like that. Again, that's one of the downsides of where this company is in the SPAC process. Hopefully, that information comes out soon, but that does show you that insiders are at least thinking like owners.

Lewis: Yeah. I think one of the big things that people will naturally question with this is, this sounds disruptive. It sounds like it has some institutional support within the healthcare industry. How defensible is this technology and how defensible is this business, Brian? What does the moat look like? We talked about the proprietary nature of the modeling that they do and that really being what sets this company apart. It is built on a very large intellectual property portfolio.

Feroldi: They have 15+ million images that they have used, they've been researching this technology for more than a decade and even beyond that, when you get back to the early work that started at Stanford. The technology is patented, it is already through the regulatory processes, it's being reimbursed. When you combine all that together, I think there's a defense of a moat.

Lewis: I think so, 400+ patents worldwide. You mentioned the annotated CT images, 15+ million over two petabytes of coronary imaging data. Those numbers are expected to double in the next 12 months. I think this is one of those technologies, Brian, a lot like driverless cars, where if you are good and you are collecting data, the edge that you have over the competition only increases over time because your systems get better and better.

Feroldi: More importantly, that regulatory part. That to me is one of the reasons why I love looking in the healthcare market because taking an idea and getting it to market often takes years or even in this company's case, nearly a decade. Replicating that for another company to come out and replicate that, that would be very, very hard to do. Now, on the flip side, this is software. It's not a medical device, there's no physical thing that has to be made, so you could argue that the barrier to entry for a competitor would be lower. But for right now, I think this company has built itself a moat.

Lewis: One of the benefits that we have knowing that it's a SPAC and being able to get some forward looking elements here, is that we get a decent sense of the road map and really where this company wants to be going. You put all those pieces together and start to understand the growing revenue figures and what they're targeting because they are looking at rapidly expanding their offerings beyond what's currently approved and been launched with their modeling and really building their TAM over time by adding even more analysis and insights into what they are able to give healthcare providers. We have the benefit of basically knowing, Brian, what the next couple of years look like for this business.

Feroldi: Yeah, this company wants to build out a suite of tools that physicians can use to diagnose and track a heart disease. They do have some that are on the market already, they have others that have already been cleared by regulatory agencies, but have not yet been launched the company isn't already as of yet. But right now, they're really in the symptomatic phase of heart care where basically somebody is clearly showing symptoms and they use this technology to become diagnosed. The company eventually wants them to move into the asymptomatic and preventative care market if they can do so, the TAM just absolutely explodes. Take any TAM numbers you see with a grain of salt, but they are in the tens of billions of dollars. In other words to me, if this company doesn't succeed, it's not because the opportunity isn't there.

Lewis: Right. Just to circle back to that revenue figure, we're currently at $23 million for 2020. Even if you take those TAM numbers and cut them in half, there's still healthy room for them to expand and not even own the majority of that market.

Feroldi: If they 5X their current revenue or at least their revenue in 2020, they will be at 1% of their current TAM.

Lewis: Yeah, it's generally a good sign. Brian, let's run this quickly through a couple of the core checklist items for you, specifically customers and management and culture. What do you see when you dig on those elements as business?

Feroldi: Well, if this company has recurring revenue, the answer there is yes. Is the company selling progress high-margin? The answer there is clearly, yes. Is this product going to be recession proof? One of my favorite things about healthcare. The answer there is yes. Could there be pricing power for this company? I think the answer there is potentially whether they have it right now is up for debate, but that checks all those four boxes for me. As for the management team, I love it when founders are still involved with the company, and that is exactly what we have here today. There are three co-founders that are currently still on the board. John Stevens is one of the co-founders and he is the CEO, Charles Taylor, he is a co-founder and he is the CTO. Another co-founder, Christopher's Ernest, is currently an SVP. One other thing that's worth noting on this company's board of directors, the chairman of the board is William Weldon. If that name sounds familiar to healthcare investors, that's because he was the CEO of a little healthcare company called Johnson & Johnson for a long time. This company has an A-list in its leadership team.

Lewis: Yeah, that's pretty stellar and for three founders to still be in the mix is pretty awesome. You don't always see that especially because Brian, this is a technology and a business that has been slowly built over a very long period of time. The research I think, dates back over two decades and the business has been around for awhile. It's just only now coming into the public space probably because they're starting to reach that critical mass of clearance and adoption.

Feroldi: Yeah. Importantly to me, it's more common to see a founder still running a company when it's in a tech space that is far less common in the medical and healthcare space. That is really a positive side of my view. One other quick note is that the executive team, on average, has been with the company for seven years. As a reminder, this company is just barely over a decade old. The people at this company really seemed to like it and stick around.

Lewis: We can't tear through a company without talking about some risks and talking about what could possibly go wrong, what competition might look like. I think some of the adoption risks are mitigated, Brian, by a lot of what we've talked about already. There's insurance support for this. We already see that some of the top healthcare institutions in the country are adopting 80% of the top 50 hospitals. I think that that really checks a major box for me. That would be a huge concern just in this industry in general but it's nice to see that that isn't there. As is almost always going to be the case of this back, valuation is a big part of what could go wrong because so much of what we're looking at here with this business in a way it's currently valued hinges on what will become and not what it currently is.

Feroldi: Yeah. Again, at that $2.7 billion valuation that's currently trading that today it's somewhere between 80 and 100 times trailing sales so while the company is saying, "Hey, our valuation is very reasonable, look at our comparisons." That is assuming a whole lot of growth in a very short period of time. If this company fails to execute or trips up against its stated objectives even a little bit, the stock could certainly go down. Another thing to just keep in mind is one of the big benefits of this technology is that it reduces medical waste, it reduces the number of unnecessary procedures that are happening. Whenever you see that happening, well, that's great news for society. That waste is somebody else's revenue. They will not look kindly upon this technology being adopted. It's possible that some doctors might not even like that if all of a sudden they're about to see a major revenue source decline. Things like that, you always have to think through as an investor.

Lewis: That is one of the dangers of being a disruptor. You can have one of the greatest offerings in the world and if the status quo interests fight against it, It doesn't really matter. Adoptions can be a lot harder.

Feroldi: But again, I think that the patient's there's clearly a win here for the players. There's clearly a win here and doctors get more high-quality data that they can use to take care of their patients. In theory, those three things should overwhelm any potential loss of revenue but that's the thing that you'll just find out in the numbers.

Lewis: Brian, we mentioned that this deal is expected to close in Q4 of 2021. Are you a buyer of this?

Feroldi: I may take a little position and it's just because I've never owned a SPAC before and this one, at least interesting enough. Again, I like that it's already through the FDA, I like that it's already cleared internationally, I like that there's a clear win all around, and I like that the company is already gross margin positive. That puts it on a nice footing. Basically, the thesis here is this small thing that's showing signs of working, the theme is we're going to scale this and ramp this up hugely. While that's risky, that's far less risky than saying, hey, this cool technology, we have to get this through the FDA and then get clearance on stuff so it's far or farther along. So I may, this is definitely going to be a stock that I'm going to watch.

Lewis: Yeah, I think that this has a higher floor than a lot of some of the healthcare stuff that typically crosses our desk. I'll say, I haven't made up my mind not yet but I learned a ton during this episode. I think that it's a great reminder for me, but also I think for our listeners, like get outside of your comfort zone every now and then and take a look at something that you don't know very well. You're going to find a lot of similarities at the industries you tend to look at. You're also going to learn a lot and broaden what you do now. Brian, thanks for putting this one on our radar.

Feroldi: Thanks for looking at a hybrid SaaS-healthcare company, Dylan.

Lewis: I appreciate you. Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to just say "Hey," shoot us an email at [email protected] or tweet us @MFIndustryFocus. To get more of our stuff, subscribe on iTunes or wherever you get your podcasts. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the glass today and thank you for listening. Until next time, Fool on.