Healthcare Technology Bubble Concerns Are Likely Overblown

Opinion

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that many companies are now scaling. Undoubtedly, it also reflects that some healthcare technology companies have lower gross margins due to a greater level of (lower margin) services and longer sales cycles, all requiring more capital. The sales of Flatiron Health to Roche for $1.9 billion and PillPack to Amazon for about $753 million underscore the attractiveness of healthcare technology companies to companies in adjacent sectors, suggesting a depth to the acquirer universe for breakout companies in this sector.

Public stocks in this sector have also performed quite well: the Rock Health “Digital Health” Index increased 21.6 percent in 2018, which compares very favorably to the S&P 500, which declined over 6 percent for the year. Strong public stock performance should create a cohort of acquirers with attractive currency for further consolidation. Notwithstanding fourth quarter market volatility, the healthcare industry ended 2018 trading at 20 times the price-to-earnings ratio, versus 17.7 times for the S&P 500. And so far, so good in 2019.

It may be instructive to look at the funding data for the “cleantech” sector in the 2000s. Like healthcare, the energy sector is a large, regulated industry which also attracted a lot of venture capital investor interest. Unlike healthcare, though, these investors took on significant technical risk with less clear business models, and yet it still took nearly a decade to hit the peak number of companies funded annually (just over 700, or more than 7 times the number funded 10 years earlier). While that number declined to below 500 over the ensuing five years, the amount of capital invested stayed relatively constant at around $5 billion annually. The high-water mark was in 2011, when nearly $7.5 billion was invested; notably, that would have been well over 16 percent of all venture investment activity, which was clearly not sustainable.

Determining whether this is a bubble is more than an academic debate. Other bubbles have ended fabulously badly, bursting and leaving oily residue everywhere, so it is instructive to search for other bubbles to see if there are relevant parallels. And one may not need to look too far…

—Aforementioned cryptocurrency: Bitcoin now trades at $3,530 per token, down from an all-time high of $19,783 on December 17, 2017. How many of you had heard of Bitcoin in January 2013 when a token traded for $13.30? Ever used one?

—It is estimated that venture capitalists funded over 1,000 artificial intelligence (“A.I.”) startups in 2018, up from 291 five years ago. Participants at the World Economic Forum in Davos, Switzerland last week had 11 A.I. panels from which to choose.

—According to the Institute of International Finance, global debt reached $244 trillion at the end of 2018 (nearly 80 times the U.S. healthcare industry) which was estimated to be 318 percent of global GDP—a very frightening debt load.

—The Chinese bond market is $12.7 trillion, of which $4 trillion is corporate debt. While there was only $23.3 billion of corporate bond defaults (0.6 percent of total outstanding) in 2018, this was more than the prior four years combined—and likely is significantly understated.

—U.S. corporations’ debt has grown to more than $9 trillion since the Great Recession. Since 2007, the number of companies rated one level above junk bond status increased 247 percent, but Fitch Ratings has only downgraded 7 percent of them, Axios reported. Hmmm.

—This month, the five-year Treasury yields were less than the 2.25 percent to 2.5 percent that the Fed targets for rates banks pay for overnight loans. This inverted yield curve has been an unshakable predictor of recession. Gulp.

The healthcare technology sector took no one by surprise, is addressing profoundly important and obvious problems, and should be able to productively deploy significant capital—if deployed thoughtfully.

Check out a recent Rock Health podcast for additional debate about whether the healthcare technology sector is in a bubble…

[Editor’s note: This post was originally published on Greeley’s blog “On the Flying Bridge.”]

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Michael Greeley is a General Partner at Flare Capital Partners, a healthcare technology venture firm. Follow @greels1

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