Nomadic Value Investment Partners recently released its Q2 2020 Investor Letter, a copy of which you can download here. The investment firm supports enterprising individuals and families in achieving respectable long-term investment performance. You should check out Nomadic Value’s top 5 stock picks for investors to buy right now, which could be the biggest winners of the stock market crash.
In the said letter, Nomadic Value highlighted a few stocks and 1Life Healthcare Inc (NASDAQ:ONEM) is one of them. 1Life Healthcare Inc (NASDAQ:ONEM) is a San Francisco-based chain of primary healthcare clinics. In the last one month, 1Life Healthcare Inc (NASDAQ:ONEM) stock lost 26.0% and on August 14th it had a closing price of $29.20. Here is what Nomadic Value said:
“In mid-May we made an initial position in 1 Life Healthcare, Inc. (ticker: ONEM, aka One Medical), a techenabled primary care provider that we believe has nestled itself into a unique position between regional health systems and the self-insured employer patient base1 , solving problems for both as the health sector increasingly transitions to value-based care (VBC). The company was founded in San Francisco in 2007 after a platform acquisition of several walk-in primary care clinics and has, over time, internally developed its tech stack to fully execute a telemedicine-focused but high touch concierge approach to primary care. ONEM’s client base is comprised of large self-funded corporate health plans, and most of ONEM’s contracts with these plans have some form of VBC arrangement. ONEM’s approach to care has driven high member engagement (average of 50% enroll), lower health costs (total plan savings of 8%), and high member satisfaction (NPS of 90) for their clients. Resultingly, ONEM today has 92 physical walk-in clinics, 7,000 corporate clients, and 455,000 enrolled members2 . This membership growth has been an impressive 28% CAGR since 2014, while generating an average 40% gross margin over the same period.
ONEM has recently iterated on its growth model by targeting partnerships with large regional health systems. These partnerships allow for ONEM to essentially swap the per visit Fee-For-Service (FFS) billings that corporate clients pay when their employee visits a physical clinic, with a Per-Member-Per-Month (PMPM) payment from the health system, which is benefitting from ONEM’s patient referrals to specialists and hospital services. We see merit on both sides of the exchange and importantly, as ONEM inks more of these partnerships in more cities around the country, the appeal of their offering to corporate clients with a national footprint only grows.
ONEM’s historical growth rate could continue for years to come under this new partnership model as they ride two industry trends:
Transition to VBC
Mentioned in our Q4 2019 letter, health systems hit roadblocks transitioning from FFS to VBC. We can think of these roadblocks as technical (patient data collection, data quality, and silos/not sharing), financial (introducing performance risk to revenues), and cultural (the way we’ve always done it). Despite enormous institutional friction, health systems must make an eventual shift. ONEM attacks each of these problems by virtue of being an entrepreneurial 3rd party and their position as primary care, which plays quarterback in a well-managed VBC model.
The commercial patient population is the most profitable patient cohort in the healthcare system, but unfortunately is a low to no growth pie3 . Additionally, VBC adjusts incentives to reign in medical cost inflation, leading to a potentially reduced revenue outlook if successful. To make up for this shifting financial model, health systems need more recurring patients spending more per year4 . ONEM has proven it has a more holistic offering than their point solution competitors5 , and it knows how to competitively sell this offering to HR departments. By ONEM’s position as physical primary care in a VBC system, their relationship with the patient is enormously valuable to health systems as they help them grow total patients as well as a greater percent share of their total health spend.
We hired ONEM to our “farm team” by making it a 2% position. While we obviously see promise long-term, ONEM has some things to prove before it has a chance as a core position. Basically, ONEM shares the risk/reward of a late stage venture opportunity: a sizeable reward if our thesis tests true but little to no margin of safety should it not. On balance, we wouldn’t put ONEM in the portfolio if we didn’t think we could be right. Position sizing is always hard.
One risk to highlight is cash burn. Management has reiterated that cash burn should subside in a couple of years as they essentially “route densify” new clinic locations, and growth from there will be funded by positive cash flows. An investor must model for themselves how realistic this is. We are giving management the benefit of the doubt currently but watching very closely over the next several quarters. Another risk is that we bought ONEM when shares were trading in the high 20’s, creating the company at over $3.45 billion of enterprise value. Optically, we agree this is a beer (or coffee!) spitting valuation on a company that generated $275 million in revenue last year. If we are wrong the shares could realistically trade for 1/3 this valuation, a significant consequence. But I think ONEM could be undervalued.
I’ve been working through how to value a business like ONEM. Hospital and/or specialist care comparables? Free cash flow 10 years out? With a company as strategically positioned as ONEM in an industry under significant change, we think smart money could be looking somewhere else to inform valuation.
One clue is from a conversation with an industry operator, where it seemed common knowledge that primary care acts as “loss leaders” for larger integrated firms such as United Healthcare (ticker: UNH, we own it) and larger health systems that have experimented with clinics. Large payers and systems do this to gain control of the care outcome (leading to higher integration and hopefully customer satisfaction), but it is also financially rewarding to grow your overall capture of a patient’s annual spend.
Another clue is when looking outside of the healthcare sector, you can find comparables to ONEM’s favorable business characteristics. Here’s the question to answer: what would you pay for a business en route to millions of monthly subscribers that love your product, trust your business and give you ever-expanding scope, and who pass control of over $20,000 per year of Gross Merchandise Value (GMV)?
So, given that ONEM has an amazing product providing real solutions to all, gains control of healthcare spend, and solves long-term strategic desires of very large companies, I think ONEM should be valued higher up the income statement. Meaning, ONEM is worth more owned by a transitioning incumbent or a well-financed new entrant than standalone.
I am watching the market’s reaction to what could be two key metrics a strategic buyer would want to see knocked out of the park. The number of members is an obvious one, which leads to more membership fees and PMPM revenue from health systems and, more importantly, higher strategic importance to a large buyer. In my view, it is realistic that ONEM could grow to over 2 million members in the next several years while riding the trends described above6 . The second is the company’s long-term, sustainable gross margin. What will it shake out to be? There’s information in this number and its trend. Historically, the company has provided care at around a 35-40% gross margin. That’s outstanding for primary care and it’s their savvy use of technology and integrated delivery model that allows it. If this can be maintained while growing towards 2 million members or more, it should demand a high multiple on gross profit dollars.”
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