Castlight's (CSLT) premise isn't a bad one. The goal of cutting through health-care clutter to empower consumers to make better, cost-saving health-care decisions could indeed prove a big and growing market.
However, it could be years before that market opportunity justifies the nosebleed-inducing $2.5 billion valuation awarded Castlight on its first week of trading -- particularly if insurers like WellPoint (ELV 2.33%) and Aetna (AET) that provide the data powering Castlight's product pull the plug in favor of their own services.
A bit of background
CEO Giovanni Colella co-founded Castlight with Bryan Roberts in 2008. Colella was previously the founder of RelayHealth, a health IT vendor that was sold to McKesson in 2006. Roberts is a partner at private equity firm Venrock Capital, and serves as chairman of Ironwood Pharmaceuticals.
Roberts previously served on the board of Sirna Therapeutics, an RNAi intellectual property firm that was sold to Merck, later shuttered, and then sold off cheaply to Alnylam earlier this year. He also served on the board of Venrock-backed athenahealth, a provider of cloud-based electronic records solutions for physicians, during its early days.
Castlight has attracted a bevy of well-respected early investors thanks to Roberts' venture capital background, including funds like Maverick Capital and Morgan Stanley and industry players like the Cleveland Clinic. Those backers had funneled more than $180 million into the company between its founding and the middle of 2012. Those investments appear to have paid off handsomely given Castlight's multibillion post-IPO market cap.
Can it turn product into profit?
Castlight's data crunching analytics benefit self-insured companies most. The product gives major employers like Wal-Mart the option to make health care cost and quality information available to employees. That information can be used by employees to select physicians based on how highly they're ranked, or how little they cost, resulting in savings for both the employee and the employer.
The company has leveraged that potential win-win to build up an impressive client list that includes not only Wal-Mart but industrial heavyweight Honeywell and government pension mammoth CalPers, California's public school pension fund.
Castlight charges these corporate customers on a per-employee basis, which means the company's sales will climb as its clients ramp up staff. That model may work during periods of economic expansion, but may expose the company to risk during recession.
So far, sales are growing quickly but remain small at just $13 million last year. With a client list of heavyweights, investors are right to wonder how much running room there really is for the company.
Wal-Mart is the nation's biggest employer and the company's largest account. Wal-Mart accounted for 16% of Castlight's sales last year. That means Castlight makes just a hair more than $2 million a year from Wal-Mart, suggesting it would take a whole lot of Wal-Mart-sized accounts to justify that hefty market cap.
In fairness, Castlight's sales could at least double this year given its backlog is $109 million, about half of which is guaranteed over the next few years. But even at that rate the company isn't likely to turn a profit given its cash burn rate was $50 million in 2013. Even if sales do double, Castlight still appears overvalued to its cloud-based peer, Athenahealth.
Athenahealth's sports a market cap of $6.7 billion, and its revenue is expected to total between $725 million and $755 million this year. That means its market cap is about nine times current-year sales. Assuming Castlight does $30 million this year, its market cap is more than 80 times sales.
Shutting off the spigot
Castlight lacks one very important competitive advantage: It relies on data provided by insurance heavyweights like Aetna, WellPoint, and Cigna -- companies that already provide a lot of the administrative services associated with employers' self-funded health insurance plans. If these insurers pull the plug or throttle back access, it could be bad news for Castlight.
Adding to that angst is the absence of a data deal with the nation's biggest insurer, United Healthcare (UNH 1.29%). Castlight is prohibited from working with United, or any of United's customers, until at least 2015 due to a data feed deal with one of United's competitors.
It's unclear whether United would even agree to a deal with Castlight in 2015 given that it's already leveraging its treasure trove of data for its internal -- and highly profitable -- Optum analytics unit.
Fool-worthy final thoughts
Castlight's best-case scenario is for its growth trajectory to mirror that of Athenahealth. That company became profitable in 2008, a decade after its formation, and continues to command a pricey valuation.
The worst-case scenario would be if insurers shut off Castlight's data access to advance their own transparency products instead -- effectively blowing up its business model. Either way, it's nearly impossible to justify the current sky-high market cap for the company. That suggests Fools should consider Castlight as a wait-and-see company operating in an intriguing, albeit nascent, market.