Should You Put Your Next $1,000 Into This Healthcare IPO?

When he was a medical device salesman, Motley Fool contributor Brian Feroldi needed to know where to go and who to talk to when he entered a hospital. Over a decade ago, that type of data was hard to come by. It could make the journey of a medical salesperson feel like running on a hamster wheel. If he were still in the field today, he believes the benefits of using Definitive Healthcare (DH -2.09%) would be enormous. 

Definitive Healthcare aggregates data from hundreds of sources -- including its own proprietary research -- to create a tool that helps everyone in the healthcare industry; it's not just salespeople, but researchers, marketers, scientists, and executives who can benefit from the type of data Definitive Healthcare has cobbled together. But does a killer product make the stock a good investment? 

In this video, recorded on Oct. 15, Feroldi and fellow Motley Fool contributor Brian Stoffel summarize the bull and bear cases for the company -- which only recently held its initial public offering (IPO). At the end, they also offer up how the company scored on their respective investing frameworks.

Brian Feroldi: Is Definitive Healthcare a good investment? We'll tell you everything you need to know in about five minutes. My name is Brian Feroldi.

Brian Stoffel: My name is Brian Stoffel. [MUSIC]

Feroldi: Brian, we have recently run Definitive Healthcare through our investing checklist and I think we were overall impressed with what we saw. But for those that are new to this company, what the heck is Definitive Healthcare do?

Stoffel: Definitive Healthcare is aggregating data in the healthcare industry and it's aggregating it from everywhere you could find. From device manufacturers to hospitals, to the government, to the patients, to payers, to key opinion leaders. It wants to serve as a one-stop shop for people who need information about where to go in the healthcare industry.

Feroldi: Importantly, this company not only buys data from third parties that actually conducts first-party data to go out and get information. I myself was in this industry for more than a decade and I can honestly say if I had access to Definitive Healthcare information, I would've done my job differently. This sounds like very valuable information that they are selling.

Stoffel: What kind of information is it? Well, if you use the product, you can find out things like how much certain medicines cost or who's network is in who's network and who is it that's making decisions about whether or not to use a certain medicine, that kind of information is incredibly valuable.

Feroldi: It will cause healthcare companies to sell and promote their products differently, it will cause them to do different R&D. Information is gold and if you have high-quality information, that is something that companies will definitely pay for.

Stoffel: Let's dig into how the company is actually doing. This is a software-as-a-service business model and you're getting access to this data for as long as you're paying that subscription. The company's largest customers, those who are paying over $100,000 a year for the subscriptions are expanding their payment by 25% per year. It's a little bit of a slower rate among those smaller customers, but that's to be expected. Overall, the trends are really positive for this company.

Feroldi: What's the bull case for investors moving forward? Well, first off, the dollar-based net revenue retention rate, the number that Brian just talked about is very strong for this company and it indicates that not only are customers sticking around, they're continually upselling themselves to more and more modules overtime, that's a bullish sign. No. 2, this company has very strong margins. Its gross margin is over 90%. That gives them a tremendous amount of room for them to reinvest in the business and still generate free cash flow. Three, the company has a history of rolling out new products and services and up-selling its customers and it's also indicated that it wants to continue doing so moving forward. If they can do so, then this company's growth rate could remain high for a long time.

Stoffel: But we need to look at the other side of the coin as well, at the bear case. The first and most important point that we need to recognize as this company has a history of growth by acquisition. They've spent a lot of money to acquire companies in the past, and they could and probably will continue to do that in the future. It's worked out so far, but it can be tricky to do and we need to monitor management's ability to continue doing this. We're not sure how strong its moat is. They do have first-party data and research that they've done themselves but we don't know what's to stop other companies from trying to collect the same publicly available data and they have large-pocketed rivals like IQVIA, who could attempt to do the exact same thing. Third, the company has an upside-down balance sheet, more debt than cash on hand. That's in large part has to do with those acquisitions. But we want to see that debt load come down, especially in relation to its cash balance.

Feroldi: How did this company score in our investing checklist? Before we get to that, we wanted to give a shout-out to Motley Fool Stock Advisor. This is a service that both Brian and I subscribe to for years before we became members of the Motley Fool. Stock Advisor has a long history of recommending stocks that don't want to absolutely thump the market's return in both you and are huge fans of this service. If you want to get access to it today for 50% off discount check out fool.com/feroldi. Brian, we ran this company through our checklist, and on my checklist, we tend to punish newly public companies. This company's still got a 68. That's not quite in my investable range, but wow, did this company impress me.

Stoffel: Yes and got an eight on mine and mine doesn't really punish newly public companies. So that might alone explain the difference in our investing frameworks.

Feroldi: Yes, I definitely think this company has a lot of raw materials to be a great investment over time. There are some things to watch, but there's more good than bad here. Speaking of what to watch, what should investors begin to look out for moving forward? The first thing is just customer growth. Definitive Health has attracted a few thousand customers and that claims that it has targets of 100,000. We want to see them continually bring in new customers to prove that this model is working.

Stoffel: Second, keep your eye out for the company calling out how many customers are using at least four modules or tools that they offer. When a customer adds more tools, it adds to the moat because the switching costs become higher. But it also is evidence of optionality, variability to create new tools that people want.

Feroldi: Third, investors want to keep an eye on the bottom line. As of the time of this recording, the company is not yet generating GAAP profits. It is generating free cash flow and between the two we'll take free cash flow every time. But we want to see signs that this model is scaling out and the company will eventually produce gobs of net income. Overall, both of us for very impressed with Definitive Healthcare, and we definitely think it's a stock that growth-focused healthcare investors should get to know.

Stoffel: I can see the complete utility of having a tool like this as well.

Feroldi: Brians out.