Psilos VC: Digital Health Will Emerge as Top Performer in 2016

Xconomy New York — 

As 2015 winds down, it’s a good time to look into the crystal ball for one of the toughest industries to predict: healthcare.

We recently picked the brain of David Eichler, a managing partner with New York-based venture capital firm Psilos Group. Eichler (pictured) focuses on investments in digital health and medical device companies, and he currently is the board chair of Gamma Medica and Caregiver Services.

Among the themes that emerged in our e-mail exchange: more health IT companies are starting to have positive, measurable impact on healthcare quality; investors are returning to medtech after a post-recession drop-off; and it’s often harder and takes longer to build a “unicorn” startup in digital health than some other sectors, Eichler says.

The following is a transcript of our conversation, edited for style and length.

Xconomy: What’s your boldest prediction for healthcare investments in 2016?

David Eichler: Digital health will emerge as the top performer across the venture investment landscape. Today, healthcare companies account for only around 7 percent of the total number of private companies valued at $1 billion and greater. Most of these are in the biotechnology or molecular diagnostics sectors. Next year, health IT companies will catch up and account for nearly a quarter of the newly minted “unicorns” in 2016.

In the past five years, more than $13 billion has been invested in venture-stage digital health companies (according to the most recent data from Rock Health); 247 companies raised over $4 billion just this year alone. Most of this activity has been in seed or Series A rounds. However, the best of these new digital health companies are starting to emerge as legitimate growth equity opportunities pursuing very large addressable markets.

Healthcare has stubbornly remained decades behind other industries when it comes to the adoption of modern information technologies. This new wave of innovation is finally driving large-scale transformation of the $3 trillion healthcare economy. The current generation of digital health companies leading this disruption will raise the capital necessary to stay independent and privately held for longer in pursuit of valuations well above the magic $1 billion threshold.

X: Fewer dollars were funneled into medical devices and diagnostics in the years following the recession. Do you see that starting to change, and why?

DE: Yes, I do see a change happening now. Venture capital activity in the medical device and equipment sector fell nearly 40 percent from its peak in 2008. The recession certainly played a role generally, but cost and reimbursement pressure on hospitals—and the uncertainty created by Obamacare—contributed to the lack of investment in medtech companies. The pendulum has begun to swing back a bit over the past couple of years.

Today we are seeing more activity and larger financing rounds being done in this sector. But this renewed interest is aimed at medtech opportunities that are characterized by commercial and execution risk, as opposed to the achievement of key development, regulatory, and reimbursement milestones. And from a valuation standpoint, it’s definitely been a buyer’s market for these companies that still need growth capital, but have not yet reached a stage where they can go public or strategic acquirers start to emerge.

Also, today’s medtech entrepreneurs by and large are focused on game-changing technologies that deliver real value to providers and payers in terms of improved outcomes and clinical workflow efficiencies at a lower cost to the system. For example, we are investors in a company called Gamma Medica, which has a breast imaging technology that detects four times more cancers in women with dense breast tissue versus mammography. It’s going to solve a huge problem in women’s health and is already in use at leading hospitals like Mayo Clinic. These kinds of opportunities are in stark contrast to many of the deals we saw a decade ago that were often “me-too” incremental improvements over existing technologies.

X: In the past, the target customers for health IT companies were usually doctors and other healthcare providers. But over the past couple of years, we’ve seen more and more companies selling products to consumers, insurers, and employers. What’s driving that shift, and what are the implications in 2016 and beyond?

DE: Virtually everyone agrees that widespread adoption and interoperability of healthcare IT is a necessary ingredient for system improvement. But achieving this along with a meaningful, sustainable, and value-based impact on clinical quality and outcomes is difficult to do and complicated to measure. Therefore, many of the early health IT companies went after the “low-hanging fruit,” which generally involved revenue cycle management solutions that improved practice efficiencies from an administrative standpoint. We then saw more rapid adoption of electronic health records, which was fueled by stimulus dollars from the HITECH Act. But rather than delivering on a clinical value proposition, they were generally bought on the basis of meeting meaningful use standards and billing optimization. The environment is changing for a couple of reasons.

First, economic incentives are aligning across all stakeholders in healthcare because the financial risk traditionally borne by payers (i.e., insurers and employers) is now being shared. Cost shifting to individuals through high deductibles and co-pays means they are finally starting to become true consumers in terms of understanding—and presumably being incented by—the cost and quality implications of their lifestyle behaviors and healthcare decisions. Meanwhile, the lines between payers and providers are blurring with the shift in reimbursement from fee-for-service to fee-for-value in new risk-based arrangements such as bundled payments and ACOs (Accountable Care Organizations).

Second, we are finally seeing a convergence of technologies around things like cloud-based and mobile computing; big data and machine learning; mobile and telehealth platforms; and devices and sensors that enable remote patient monitoring. All of this is creating exciting opportunities to deliver solutions that inform care decisions, improve care delivery, and enable comprehensive care management across payers, providers, and patients.

X: Health IT companies talk about how their software is supposed to lower the costs of healthcare, while improving the quality. Are more of them making good on that promise? What are some examples you’ve seen?

DE: The new wave of health IT innovation has a value proposition that is firmly rooted in the so-called “triple aim” framework. This means companies are increasingly focused on improving the patient experience of care (including quality and satisfaction), improving the health of populations, and reducing the cost of healthcare. And more of them are starting to deliver on that promise.

Until relatively recently, either the technology wasn’t quite ready or the market wasn’t primed. Today, a lot more of these companies aren’t just talking the talk. They’re actually walking the walk by bringing together IT, communications, software, and hardware technologies that deliver platform solutions with demonstrable ROI.

As an example, HealthMine (another Psilos portfolio company) is a personal clinical engagement platform that has delivered over $100 million in healthcare savings across more than 1.4 million users. Their program has been shown to reduce hospital readmissions by 50 percent and also improve the likelihood of identifying undiagnosed chronic conditions by five times, leading to lowered costs through earlier intervention. Another good example is Omada Health, which just raised a $48 million Series C round. Omada is delivering a “digital behavioral medicine” solution to people at high risk of chronic illnesses like diabetes and heart disease, and has shown substantial improvements over traditional prevention programs in terms of both sustained engagement and outcomes. Their business model is interesting because they put their money where their mouth is, only getting paid for participants who successfully complete the program.

X: What’s one New Year’s resolution that you’d like to see healthcare investors adopt in 2016?

DE: I’d like to see healthcare investors stay sober when it comes to investing in these exciting digital health opportunities. It’s easy to get seduced by new technologies and imagine the possibilities (and riches!) that will come from reinventing healthcare.

For example, one of the newest unicorns is a New York-based health insurance company called Oscar, which has raised over $325 million and is rumored to be valued at $1.75 billion (almost $44,000 per member) in just its second year after going live. I like their concept of a reimagined, consumer-focused health plan, but I also believe that valuation can only be justified by explosive growth in membership, along with flawless risk underwriting and operational execution.

We all want to build businesses like Google and Facebook: companies that take the world by storm, rapidly grow into their valuations, and deliver monster returns to investors. But healthcare is very different from other industries in terms of its complexity and the pace at which we can effect change. We will achieve those home run returns in digital health if we exercise patience and discipline in getting there.

We are on an inevitable path toward improving outcomes and quality while lowering the cost of healthcare in this country. As venture investors and owners of the transformative companies that will drive this change for the better, we need to make sure that supersized capital rounds at irrationally high valuations don’t turn successes into failures. Unicorns are mythical animals. We need to have thoroughbred horses for the race we’re in—and recognize that we’re probably not even to the first turn yet.