2023-09-25 08:30:00 ET
Summary
- Hims & Hers Health has found itself in the center of a short seller's reticle lately, which may be contributing to the malaise in its share price.
- But while the short seller may find Hims & Hers Health's business unattractive, the reality has been, for the last five years, that Hims has executed to virtual perfection.
- As a reward for such perfect execution, Hims now generates healthy free cash flow, alongside ~$200M in cash, no debt, and 70%+ growth.
- Today, we will explore my Hims thesis broadly; after which, I will address the short thesis for you and provide my thinking.
Setting The Stage
I've not written on Hims & Hers Health ( HIMS ) in quite some time, and, in that intervening period, despite what the share price might suggest, the business has been firing on all cylinders.
For those that may just be joining us or who may be just tuning into Hims & Hers Health (henceforth just Hims), the relentless bleed in the face of perfect report after perfect report after perfect report is nothing new. From 2021 to mid-2022, the stock slid unabatedly from ~$20/share to ~$3/share, at which point Ahan and Jared (two analysts who formerly worked for/with me) published this note:
From that point, the stock proceeded to rebound from ~$3/share to $12+/share; all the while nothing about the business really changed.
That is, Hims continued to report solid, expectations-busting, guidance-beating report and after solid, expectations-busting, guidance-beating report... from $21 to $3 to $12 and to $7. The same has been the case for the entire roller coaster ride.
Frankly, I hate to mention it because I want to remain focused on Hims, and specifically the short thesis, with you today, but it need be repeated ad nauseam so that we appreciate why many of the best businesses to own in the decade[s] ahead have not experienced material price appreciation for, in most cases, 3 and 5 years+ (e.g., Amazon ( AMZN ), Meta ( META ), Sea ( SE ), Adyen (ADYEY), and countless other high quality businesses, which dominate their industries and regions).
I Keep Repeating It, But This Is Very Important To Market Dynamics Presently
Visual Capitalist
For a multi-month period in 2022, Meta ( META ) traded such that its free cash flow yield was 20%. This is a global monopoly with nearly 4B users locked into a series of apps that have immense network effects locking said users into said apps.
Such a Great Depression-like decline is not indicative of the mechanics of a market that is even remotely stable or efficient, and with rates further rising due to a small resurgence in inflation recently, it's likely that market madness persists.
Of course, it should be emphasized that this is when real money over the long run is made in the stock market. When it is universally agreed that it's "a stable economic environment in which to invest," we get the inflated valuations of 2019, 2020, and 2021, which have resulted in very poor returns in recent years.
For further economic context and thinking in these veins, I would encourage you to read these notes:
I would certainly encourage you to read them. Even if you do not own those businesses (which are great businesses to own!), I would encourage you to read the introductions wherein I provided contextualizing data for our current market and economic environment.
Let's now begin our consideration of Hims.
Foundational Thinking For Hims
Today, I read my original work on Hims, and I found that virtually every aspect of our original thesis remains intact.
Despite the share price falling 50-75% from the publication of our original work, the business has done nothing but execute to perfection.
It has 4x'd its sales. It has begun generating robust free cash flow sustainably. It's successfully launched its female brand, Hers Health. It's expanded into new healthcare categories, helping to 4x sales in just a few years, while making the business more durable and diversified.
It still has roughly $200M ($193M exactly) in cash on its balance sheet and no debt.
It launched its apps, and the apps have been huge hits on the Apple App Store, with the Hims app now 16.6k reviews with an average rating of 4.8 stars.
Hims has consistently outperformed its guidance by a very wide margin. In 2020, Hims guided that it would generate ~$233M in sales for the entire year of 2022. It generated $526.9M in sales for 2022.
I mean, I don't know what more the company could do.
It has executed to perfection. No more; no less; in response to which the share price has mostly done nothing but trend downward.
But, of course, we must understand the very challenging economic environment in which we find ourselves, and I delineated the germane data points for understanding this economic environment earlier today and in the notes I shared just a moment ago.
With these ideas in mind, I'd like to revisit the thinking that led to my transition of focus away from Teladoc ( TDOC ) and towards Hims throughout 2021 and 2022. With Hims now generating free cash flow in its three most recent quarters (and robustly so in its most recent quarter), I believe this train of thought is more relevant than ever.
The market traded Hims at about 10x to 20x EV/sales in late 2020 and early 2021. Howard Marks' Oaktree Capital valued it at about 15.7x EV/sales, which is extremely reputable outfit that took it public by way of their Oaktree SPAC.
In January 2019, private markets pegged Hims at a $1.2B post-money valuation.
[ Note that private markets pegged Hims' foremost competitor, Ro, at $7B in value in February of 2022.]
Note Hims Metrics From 2018 In The Grey Bars Below
Hims & Hers Health Q2 2023 Earnings Presentation
As of today, with what will likely be ~$875M in 2023 sales, ~$193M in cash and $0 in debt, and a more robust and durable business than at any point in the company's history, it trades at about $1B in enterprise value.
Outside of our consideration of Hims as an investment and as a business we own within our business of owning businesses, this is quite a noteworthy dynamic to behold; from which we will certainly learn over the coming 36 months, for better or worse.
Speaking of the future, I posed the following question in the Beating The Market Digital Healthcare Chat Channel:
So when HIMS generates free cash flow while growing at 50%+...
Where do we go from there?
[This was before the data that we've received recently illustrating that Hims now generates robust free cash flow. I added it below.]
Hims & Hers Health Investor Presentation Q2 2023
Teladoc ( TDOC ) has struggled to do this due to cultural debt, tech debt... a decade of taking arrows in the back as the industry's pioneer.
[It took Teladoc about 20 years to start generating the modest free cash flow it generates today. Hims did it in about five years from date of founding November 2017.]
HIMS has no offices (akin to ( GTLB ), 0 tech debt, a tight culture, a single source of code...)
It's certainly worth considering. Presently, the market has priced Hims & Hers Health in line with Teladoc's valuation.
But should the market do this?
As mentioned, Hims has no tech debt, no sprawling conglomerate (which creates the diversification discount ), no financial debt, a single source of code (which is huge, and which has been a component of our bull theses for companies like Adyen ((ADYEY)) and GitLab ( GTLB )), and it will likely begin producing free cash flow over the coming 6-12 months, just 5 years after it was founded.
Teladoc has ~57M members, from whom it generates about $2.5B in sales with high 60% gross margins.
Hims will generate $875M in sales with about 1.4M members and 82% gross margins.
Let's say 1M subscribers (members) = $600M in sales.
Were Hims to achieve just 10M subscribers globally (socialized healthcare system countries will likely demand Hims even more due to its ease of use and convenience and speed)...
[I think EU/APAC expansion will go very well. Just a matter of getting over to those regions in the decade ahead. I think folks in these regions will shell out cash simply to avoid their medical systems, which often require a healthy dose of patience alongside a healthy dose of whatever medicine they're seeking.]
It would generate $6B in sales, with 82% gross margins and robust free cash flow generation.
It will likely generate free cash flow in the coming 6-12 months, just 5 years after being founded!
[It generated adjusted EBITDA, which is loosely free cash flow, in its last three quarters.]
Hims & Hers Health Investor Presentation Q2 2023
It has no tech debt, no cultural debt, no financial debt!
As I go further and further into this, all I can think is, "What is the market smoking here?"
While the public market has chosen to price Hims in line with its "alleged peer" in Teladoc, Hims' actual peer is Ro, a private company , which was valued at ~$7B in market cap in early 2022 , which would make sense, for those not "smoking something" who can see the straightforward logic presented above!
In short, it appears clear to me that Hims, unlike Teladoc and the many other digital healthcare platforms that have existed over the last 20 years, has cracked the code on monetizing healthcare delivered through the internet.
Out of everything I've shared thus far, I believe this is the most worth noting:
Teladoc has ~57M members, from whom it generates about $2.5B in sales with high 60% gross margins. Effectively no free cash flow; no profitability whatsoever for the first 20 or so years of existence.
Hims will generate $875M in sales with about 1.4M members and 82% gross margins. $875M in free cash flow generative sales, just 5 years after being founded in November 2017.
In some sense, Teladoc and Hims provide the same product; yet, Hims has monetized this product profoundly better than Teladoc has monetized its version of digital healthcare. (There is a lot of nuance here, but the membership sizes and timeline to free cash flow are certainly worth highlighting).
Addressing The Short Thesis
Interestingly, just as Hims hit its stride recently, growing rapidly and generating free cash flow simultaneously, a prominent short seller began targeting the company.
The principal short thesis by short selling firm Spruce Point has been that Hims' CAC has become too high relative to its gross profit pool, leading to impaired economics for the business.
As we will explore together, the key word here is "leading," as Hims' economics at present are fantastic. Spruce believes that Hims' current CAC dynamics will ultimately lead to impaired economics for the business over the next half decade or so, which is the only logical conclusion based on the brief math exercise we will conduct in a moment.
Spruce's short thesis was delineated for us in the slide below:
Spruce Point Capital
One of the key components of Spruce's thesis here is the word "believe."
While Hims did, indeed, experience its worst CAC metrics in Q2 2023 in company history (it spent more marketing dollars this quarter than it has ever spent on a "marketing dollar per subscriber basis"), Spruce's analysis appears to rely on its own estimates for churn.
Or just a general "sense" that Hims elevated CAC will lead to impaired economics for Hims in the years ahead.
To this end, I shared the following math with my community:
Ok, I've figured out Spruce's math for the net additional cost per sub. There's nothing wrong with it.
And, yes, as of Q2, it does appear that, using Hims' definition for payback period, it's about 1.9 years for Q2 2023 exclusively .
[We will get to the economics of HIMS' entire business in a moment.]
~$100M in CAC (marketing) spend in Q2/91k subs = ~$1k in CAC per net added sub.
This aligns with Spruce's math presented above and aligns with Hims' reporting.
$53/sub * 12 months = $636 total annual per sub revenue * 82% gross margins * 1.9 = roughly that $1k in CAC per net added sub.
Again, we all agree on this, including Hims and Spruce. And we agree that this isn't precisely great.
$53/sub * 91k subs * 12 months * 82% gross margins = $47M * 1.9 = about $90M to $100M in quarterly marketing spend
So all the math that Hims and Spruce shared checks out. And, indeed, payback period is about 2 years for the subs added in Q2 2023.
Next, let's define payback period, which is the definition Spruce accepted and which Hims uses in its reporting.
- Payback period is defined as the time it takes quarterly cumulative online gross profit generated by Hims & Hers online customers to exceed the quarterly customer acquisition costs to acquire those customers. Online gross profit represents total online revenue less costs directly attributable to the products shipped and services rendered, including product costs, packaging materials, shipping costs, and labor costs directly related to revenue generating activities.
Hims did state forthrightly that it's still capturing subs within its 1 year payback period framework.
Now, the question is how does it rationalize this statement in light of the math presented above?
Here is another version of Hims' payback period definition:
- The time it takes quarterly cumulative online gross profit generated by Hims & Hers online customers to exceed the quarterly customer acquisition costs to acquire those customers.
That's HIMS' definition of 1 yr payback period.
Through this lens:
1.3M subs * $53/sub * 12 months * 82% gross margin = $677M in annual gross profit pool
~$100M/quarter in CAC = $400M in annual CAC (marketing dollars)
This represents a business model in which payback period is dramatically shorter than 1 year.
Hims spends $400M in marketing per year, and that marketing creates $677M in gross profits, well below a 1 year payback period.
Were Hims to spend $400M in market per year, and that marketing created $200M in gross profits, it would take 2 years for that marketing to payback.
If the entire business were Q2 2023, payback period would be "sub 2 years," i.e., Hims' sub 1 year payback period framework would not be legitimate.
Again, they forthrightly stated in Q2 2023 that they are still operating and growing within this sub 1 year payback period framework.
Overall, the business spends $400M per year in marketing to generate $677M in gross profits per year, thus the sub 1 year payback period.
In Q2 2023, the business spent ~$100M in market to generate $47M in gross profits per year, thus a sub 2 year payback period, which Spruce has correctly highlighted.
If there is a structural issue with HIMS, it won't be revealed for some time based on this math.
Certainly not in the next few quarters, as their long term subs do not churn at a high level.
So the key factor here is those subs that last 3-5 years+.
They are what create the model in such a way that payback period remains sub 1 year.
We would see a far less attractive "total gross profit pool to quarterly CAC" if churn were extremely high.
Churn must be sufficiently low such that we're still well within that sub 1 year payback period for the business as a whole.
Please do feel free to share your thinking in the comments below.
Hims Asserts A Sub 1 Year Pay Back Period
Hims & Hers Health Investor Presentation Q2 2023
While Spruce does have a valid point apropos marketing spend rocketing higher, I think three points are worth highlighting:
- Note how I introduced this review. Note the macroeconomic conditions in which we find ourselves. Note the skyrocketing cost of credit. Virtually all companies in the economy are experiencing either slower customer additions or higher CAC or both.
- Hims specifically noted on its quarterly earnings call that it weighted marketing in the back half of the quarter, which should lead to tailwinds in net subscriber adds in Q3 2023, which should put downward pressure on CAC.
- The skyrocketing marketing costs are worth paying attention to, without a doubt; however, the business, as a whole, remains very attractive from an annual gross profit pool to annual marketing cost ratio perspective, which has afforded it the ability to gradually increase free cash flow margin over the last eight quarters, seemingly at its own discretion and in a controlled and methodical manner.
Hims Free Cash Flow Margin (Roughly Adjusted EBITDA) Linearly And Methodically Expands
Hims & Hers Health Investor Presentation Q2 2023
Subs Continue To Grow At A Healthy, Though Moderated, Pace
Hims & Hers Health Investor Presentation Q2 2023
Price Reductions In The Quarter
In addition to the Spruce short thesis and difficult macroeconomic backdrop, Hims also decreased its price on many of its products in the quarter.
Notably, it also increased its gross margins quite materially to 82%, while reducing prices.
In no uncertain terms, there have been a confluence of very interesting variables, which could be construed in different ways (positive or negative), all colliding simultaneously.
On the one hand, Spruce's math makes sense, and Hims does need to improve its payback period on marketing spend; on the other hand, it has a fantastic holistic payback period that would require insane levels of churn to sufficiently degrade to make the entire business unattractive.
On the one hand, CAC skyrocketing higher is concerning; on the other hand, the macro is brutal right now for the average consumer (boatloads of inflation/soaring cost of credit), and CAC is going up for virtually every business on earth during this period; not just for Hims.
On the one hand, Hims reduced prices, which may signal that it's panicking about its CAC and net subscriber adds/growth; on the other hand, it expanded its gross margin quite materially while also reducing prices, so it's likely that it genuinely was using efficiencies to capture market share, which would be a huge positive.
Our gross margin trajectory in the second quarter is a textbook example of the power of sound execution combined with economies of scale. Gross margins expanded over 140 basis points quarter-over-quarter, to 82% in the second quarter.
Gross margin expansion was the result of lower product costs, increased efficiency across our provider base, a move to longer duration subscriptions and improved efficiency from a migration toward affiliated pharmacies. These dynamics more than offset degradation from our strategic pricing actions.
Yemi Okupe, CFO, Q2 2023 Earnings Call
And so from a pricing standpoint to kind of round this out our aim is to make this as accessible as possible.
I think as Yemi shared, we've been able to meaningfully lower prices in the last couple of months and aim to continue to do so for some of our higher value product bundles, while still maintaining and expanding to record high 82% gross margins.
So the operational efficiency and excellence within the business is really humming in a way that's allowing us to take a lot of this value and innovation and pipe it right back into the customers well in a way that allows us to capture more and more competitive market share.
And so with heart health by hand, this will be priced at a premium from the core base treatments that are personalized, but at a slight premium. There'll be still a very mass market very accessible. And our aim is to make it such that that price is never the reason why you're choosing the treatment that is truly right for you versus the one that might be a little bit cheaper.
Andrew Dudum, CEO, Q2 2023 Earnings Call
On the one hand, CAC skyrocketed higher; on the other hand, marketing as a percent of revenue remained static at about 50%, and Hims grew its free cash flow margin once again.
Turning toward elements of our cost structure. Marketing, as a percentage of revenue was flat quarter-over-quarter at 51%.
And Marketing investments were more heavily weighted toward the back end of the quarter, as a result of the timing of new product launches, strategic pricing actions and large brand campaigns.
Customer acquisition was slower at the start of the quarter, as a result of those dynamics in a somewhat more challenging marketing environment, relative to the first quarter. We expect that investments made at the end of the second quarter, will provide meaningful customer acquisition tailwind in the third quarter.
Our expectation is for continued investment in marketing, as we launched new personalized offerings throughout the year. Similar to prior periods, we intend to do so while maintaining a one-year payback period.
Yemi Okupe, CFO, Q2 2023 Earnings Call
Hims Marketing As A % Of Revenue Last 3 Years
Later on the call, Hims' CFO, Mr. Okupe, shared the following in an exchange with an analyst:
Jack Wallace: And then Yemi, you mentioned that the marketing environment was a little difficult in the front half of the quarter and there was an elevation of investments in the back half. When you mentioned the difficult marketing environment and thinking about this in the context of the price changes, was there any pickup in churn rates that you're also responding to, or was it just simply some of the -- so the key areas you play in with marketing dollars just got more expensive or the consumer is pulling back? Just trying to get some -- a better understanding for the -- let's call it the environment dynamics. Thanks.
Yemi Okupe: Yes Jack. I think it's a great question. I think it was -- the environment was in line with what we expected for Q2. And in Q1 we definitely saw some surprising favorability that was unanticipated. Before we make pricing changes, we do a lot of research and experimentation. And so, those changes were effectively months in the making, just because we do want to use prices more of a precise tool versus lots of conservative [ph]. We're very much disconnected effectively like what we do look to when we institute pricing changes as a few consumers basically value those changes. They're very likely to retain on the platform for a longer period of time.
And then lastly, because we have so many different cohorts of users that are selecting different products, we're really able to dial in what are the highest LTV products. As we started to see the benefits from scale and our gross margin started to expand, we made the decision to put some of that back into additional customer value. As Andrew mentioned before, we're really looking to make the first lot products mass market, because the objective is really to have our users for a period of decades.
Q2 2023 Earnings Call
And, to close us out,
Glen Santangelo: Yes, thanks for taking my questions. I just want to follow-up on some of your prepared remarks. It kind of sounds like Andrew that you decided that it was the right move to make some investments in pricing.
And if I heard Yemi correctly, it kind of sounds like that's going to cost you $12 million to $18 million in both revenue and EBITDA in just the back half alone. So, it seems like kind of a significant investment, but it doesn't sound like it was related to churn. And it kind of sounds like you're doing that now you're seeing an increased duration of your average customer.
So, I was wondering -- and I'm putting all this in the context of the fact that you just raised guidance as well. So, I was wondering if you could just flesh out that decision a little bit more and the ramifications of what you've seen as a result of that investment in price.
Andrew Dudum: I'll take maybe the first half and let Yemi add some of the quantifiable things we've been seeing because it really is moving some of those numbers. It was really a strategy to leverage the strength of where the business is at right now.
As you saw in this quarter, we hit kind of record 82% gross margins. I think there's an incredible amount of efficiency and operational excellence that's taking place under the hood allowing us to deliver on the mission which is to help the very mass market, right?
We have -- we've said this in the past, we believe we can build a platform and a value prop that is such where every household in the country is a member and is satisfied and love this business and brand and it's getting real value.
And I think in doing so we want to find as much efficiency as we can within the business and bring that back into the customers' pocket, right? That is a clear and aggressive way for us to go take meaningful market share with an offering that we know to be a note to be very sticky and very accretive in individual life.
And so that was really the strategy behind this and I think continues to be the strategy. Big investment to be able to do so, but I feel like it's a powerful one given the brand opportunity to go after a big chunk of the market that otherwise might be caused outside of the range of an opportunity.
Q2 2023 Earnings Call
It's been a fascinating journey over the last three months for Hims.
So many variables have collided simultaneously, but I am inclined to look at it all positively:
- Annual gross profit generation of $677M is still well in excess of marketing [CAC] spend at $400M. This has given Hims the ability to methodically increase its free cash flow margins over the last eight quarters.
- Hims increased its gross margins, so it makes total sense to pass those efficiencies on to the consumer, whereby we create more consumer surplus, more LTV/CAC over the long run, and capture more market share, enhancing word of mouth marketing and long run brand equity.
- Hims has $193M in cash and no long term debt atop this foundation. Perhaps, it's struggling a bit currently, but it should be noted that all companies are! Look at the very mighty AWS, Datadog, Adyen, and Sea, all of which have experienced fairly breathtaking declines in their growth rates!
- Atop Hims' solid foundation, it can build and continue to execute, growing and evolving out of whatever potential issues it may currently face.
Concluding Thoughts: Going Multi-Product
I've recently been exploring the value of "going multi-product" with you in a series of notes. I would recommend you read this one:
Below, we can see the idea that Hims has "gone multi-product."
Hims & Hers Health Investor Presentation Q2 2023
At some point, the question need be asked of the shorts, "Which business line specifically are you shorting?"
If we can create 5 lines of business doing $500M in sales, with solid cohorts of 3, 5, and 10 year subscribers, whom we can upsell on various new product releases over time, then the business will become immensely more durable.
The same could be said about Monday ( MNDY ) or Axon ( AXON ) or Marqeta ( MQ ) or MercadoLibre ( MELI ) or Tesla ( TSLA ): Okay, you are short, but which business specifically are you shorting?
Is it Monday's Dev product? Is it their app marketplace? CRM?
My point is that multi-product businesses, which we so often target, and for which we actually have a definitive framework within Beating The Market, can be extremely durable, rapidly growing businesses, granted they are stewarded by bright folks, and I do think each of the aforementioned businesses have very bright folks at the helm.
Mr. Dudum and Mr. Musk are indeed both UPenn alumni!
And with this robust, diversified business, I believe Hims' long run margins are well within reach.
Hims & Hers Health Investor Presentation Q2 2023
Thank you for reading, and have a great day.
For further details see:
Hims & Hers Health: Can't Get Much Better