2023-03-27 10:57:15 ET
Summary
- Talkspace's strong 4Q results and guidance suggest a potential major turnaround story among the universe of de-SPAC disasters.
- However, the company's negative history fostered an excessively cautious reaction by key sell-side analysts.
- Analysts characterize guidance as “aggressive” by comparing it to full-year 2022 results, not accounting for the significant sequential improvements over the course of last year.
- Comparing guidance to more-relevant 4Q run rates shows guidance is likely conservative.
- 1Q results should help validate guidance; and I believe the company delivering on its guidance through mid-2024 could support a $2-$3 stock price.
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Elevator Pitch
The virtual behavioral health market appears attractive based on the much-discussed growth in demand for mental health services and the demonstrated advantages of virtual platforms for a sizable portion of the market. TALK was a pioneer in the space and remains the most-recognized brand. However, a variety of strategic and tactical errors by TALK's "mission-driven" founding management team set the stage for a collapse of its stock following its 2021 de-SPAC.
The new management team since put in place has made significant progress in building a better business. This includes steadily transitioning the revenue mix to attractive B2B customers and away from high-churn consumers paying out of pocket, and significant cuts to consumer-focused digital advertising and employee headcount. Management consistently says that achieving cash flow breakeven and then profitability is its No. 1 objective. This is critical as cash burn has remained at unsustainable levels and has been key to the bear case against the stock.
4Q results showed progress on every key metric. Management reinstated guidance that called for continued progress in 2023 and cash flow breakeven by mid-2024, significantly ahead of consensus estimates. However, the excessively cautious reaction by the two most influential sell-side analysts made the news into a non-event, evidenced by the stock's subsequent sell-off on thin volumes.
Based on annualized 4Q run rates, the mid-point of 2023 revenue guidance can be achieved with only 17% growth in TALK's B2B segment, well below the segment's 52% year-over-year growth in 4Q. Operating expense cuts required to hit 2023 Adjusted EBITDA guidance were largely completed by 4Q. This is the opposite of the "aggressive" guidance cited by analysts by comparing it to full-year 2022 results.
Investors believing TALK can deliver on its mid-2024 guidance suggests a $2-$3 stock price based on comparable valuations. A well-performing TALK could be an acquisition target at even higher prices.
The Stock's Troubled History Helps Explain Current Caution
TALK is a member of the de-SPAC class of 2021, perhaps the most tainted group of stocks in today's market. The quality of companies brought public by reverse merger at the peak of the SPAC bubble was the lowest the market has seen since the late stages of the dot-com boom. This cohort of de-SPAC stocks is generally viewed as toxic by all but contrarian investors. This dynamic is, of course, key to the opportunity I'm presenting here as it helps explain the company's current difficulty in getting credit for its substantial progress over the last year.
TALK's collapse following its June 2021 de-SPAC was largely self-inflicted. The company promptly began missing quarters after the founding management team guided to 64% revenue growth for 2021 and a short path to profitability in advance of coming public. The founders were essentially blindsided by a surge in competitive pressure from venture-backed competitors flush with cash raised at multi-billion dollar valuations. Compounding TALK's problems was poor execution on service delivery that resulted in low conversion of consumers attracted to its website by expensive digital ads and abysmal Net Promoter Scores in surveys of TALK's therapist network. The company's founding management was ousted in November 2021 and effectively taken over by the SPAC sponsor, Hudson Executive Capital , otherwise a well-known activist investor.
While the general SPAC bubble played out about as poorly as I expected, I initiated my position in TALK when it traded to a negative Enterprise Value in early 2022. My experience with Hudson in activist mode told me its operations-focused team would work aggressively to re-orient the company and restore shareholder value. The former appears to be happening and the latter is yet to come.
2022 - A Turnaround Develops
Thus began a methodical effort to fix the company. Working in the company's favor was the uniquely strong demand backdrop for virtual mental health services driven by increasing mental health problems and the shortage of therapists taking new in-person clients. The main challenge was the economics of TALK's historic target market, consumers drawn in by advertising and paying out of pocket, which had deteriorated due to the competitive issues mentioned above. At the same time, the B2B market, namely insurance payors and enterprise, operated rationally and offered significantly better economics. TALK had begun a push into B2B in 2021 but B2C was still the primary source of company revenues at the time the founders were ousted.
Since then the company has increasingly distanced itself from its dysfunctional history. This included an overhaul of its marketing strategy to focus on individuals covered by insurance or their employers, a far-stickier group than consumers paying out of pocket. An enterprise sales force has been built to target the increasing number of companies and institutions looking to provide mental health benefits to their constituents. At the same time, expenses have declined significantly, primarily due to reduced advertising spending and headcount reductions. The significant improvements across several key metrics reflect the company's steady progress in reorienting itself over the course of 2022.
TALK 4Q Earnings Presentation TALK 4Q Earnings Presentation
The hiring of a permanent CEO , Dr. Jon Cohen, was another important development. Dr. Cohen joined as a board member in September 2022 and was named CEO in November. He has deep experience and relationships on the B2B side of the industry, including building substantial insurance-funded healthcare services businesses. Ironically, the announcement of Dr. Cohen's hiring had the effect of driving the stock lower as this news quashed the various buyout rumors that had been supporting the stock.
4Q 22 Results -- Profitability Comes into View
On February 21, 2023, TALK reported 4Q results and reinstated guidance , having withdrawn the founding team's guidance a year earlier. The "surprise" in the results was a 20% sequential decline in operating expenses, resulting in an adjusted EBITDA loss of $8.9 million, 37% better than consensus. This over-achievement relative to consensus is instructive in that management in its previous earnings call had telegraphed significant and ongoing expense cuts, but analysts chose not to reflect this in their models. More on this below.
Guidance for 2023 was revenues of $125-$135 million and an adjusted EBITDA loss of $-32 to $-28 million. The EBITDA guidance was roughly half the loss than estimated by the sell-side, consistent with the discrepancy on expense levels in 4Q results.
More importantly, the company guided to adjusted EBITDA breakeven by the end of 2Q 2024 and a $95 million-plus cash balance remaining at the time of breakeven. This would be a major milestone as this would mean the end of cash burn. Street models at the time assumed cash burn would continue indefinitely, suggesting a pathway to eventual financial distress. A persistent bear argument against the stock has been that TALK would eventually run out of cash and need to be rescued by a predatory acquirer. (Note that CEO Jon Cohen had disclosed at the JPMorgan Healthcare conference on January 12 that the company would provide guidance on EBITDA breakeven on its 4Q earnings call, so the news was not entirely unexpected. The stock's weakness since the earnings report may be partly due to sellers who expected a better market reaction to the guidance.)
Otherwise in 4Q, attractive B2B revenues grew 52% year/year and now account for 64% of total revenue, versus 44% a year earlier. The data appear to indicate that TALK can grow its B2B business while reducing marketing spending (primarily on digital ads), contra the bear case that the two can't happen at the same time. It appears that the primary driver of B2B growth is not advertising but adding covered lives through new payor relationships, adding new enterprise accounts and improving utilization rates by eligible individuals, as I discuss in more detail below.
Key Sell-Side Analysts Play It Safe and Obscure TALK's Recent Progress
TALK faces the challenge of having a limited investor audience due to its negative history. The most likely catalyst for new investor interest would be positive commentary from the analysts at Citi and SVB Securities, two most influential analysts in my view. (Per its website, SVB Securities is a separate entity from the commercial bank and continues to operate.) Both analysts turned negative on the stock in late 2021 as the story continued to unwind.
Unfortunately, both analysts responded skeptically to TALK's 2023 and mid-2024 guidance and maintained their negative ratings and $1 target prices. (While I can't share the analysts' reports, note that Citi's was titled "4Q22 Recap: Impressive Cost Cutting, But is it Achievable?" and SVB's was titled "4Q22 Recap: Solid Print, but Path to Profitability Remains a Show-Me Story.") The stock's poor performance on thin volumes since the 4Q earnings release suggests that potential new investors are sitting on the sidelines despite the significantly improved outlook.
I strongly believe the analysts' skeptical reaction is explained not by their evenhanded assessment of the outlook, but by the understandable desire to forestall turning bullish in light of the negative history. From a professional perspective, the upside/downside calculation weighs against turning bullish on a tainted, relatively illiquid de-SPAC in reaction to management's reinstated guidance. Covering the stock at all is probably a burden they largely delegate to their junior analysts.
Both analysts relied on tendentious analysis in order to characterize TALK's guidance being "aggressive." Most obviously, they used full-year 2022 results as the comparison for assessing 2023 guidance, not the more-relevant year-end run rates. This approach obscured TALK's significant progress over the course of 2022 in growing its attractive B2B business and reducing expenses. The most glaring discrepancy concerns the expense cuts necessary for TALK to reach its 2023 EBITDA guidance. Citi correctly noted that 2023 operating expenses will need to be $24 million (or 20%) lower on a year/year basis, but pointed to the need for future "slashing" for this to happen. This obscures the fact that close to all the cuts needed to meet guidance had already happened by 4Q, as I discuss in more detail below. Similarly, Citi assessed the guidance for cash flow breakeven by 2Q 24 by comparing it to 2Q 22, not 4Q 22, thus making the case for the guidance being a "heavy lift." Note that there are no seasonal patterns in TALK's business that would make 2Q a more relevant comparison than the most recent quarter. SVB was less rigorous about creating doubt around TALK's guidance but modeled results well below the guidance without making a case for what could go wrong aside from macro risk.
An Objective Look at 2023 Guidance Shows it to be Quite Achievable
As noted above, TALK's two most influential analysts cast doubt on management's guidance by comparing it to the full-year results from 2022, not against run rates in the most recent quarter.
I make the following assumptions in my analysis of TALK's guidance, with the aim of being conservative:
- The mid-point of the guidance range is the target for success. Achieving the high end or better is obviously management's objective but not necessary for the stock to work.
- Recently-declining B2C revenue stabilizes at $10 million per quarter versus $11 million achieved in 4Q. This is consistent with management's commentary that B2C should stabilize in 2023 due to the improved member experience.
- Gross margins stabilize at 50% versus the 53.5% results in 4Q. This is a somewhat conservative take on management's commentary that gross margin should "trend slightly lower as the revenue mix shifts towards B2B categories, partially offset by price optimization initiatives and continued increase in provider network efficiency."
- Adjusted operating expenses stabilize at 4Q's $25 million. This is potentially an overly-conservative assumption given management's commentary that 4Q op ex should be "our new high-water mark" as some recent expense cuts weren't fully reflected in 4Q results and further cuts are planned for 2023.
Applying these assumptions to TALK's 2023 guidance leads to the following:
- B2B revenue would need to grow only 17% from 4Q's annualized run rate of $77.2 million, to $90 million, versus the segment's 52% year-over-year growth rate in 4Q. This is the opposite of the required "acceleration" pointed to in the sell-side's skeptical commentary. Management claims to have line-of-sight to new payor and enterprise relationships that should help sustain the recent momentum in B2B growth.
- Operating expenses annualize to $100 million versus the $95 million needed to hit the mid-point of guidance. Therefore, even under my conservative assumption, the required expense cuts would appear largely complete with regard to meeting 2023 guidance. This is the opposite of the "heavy lift" required by using full-year 2022's op ex of $119 million as the comparison. Based on management's commentary, it seems likely that 1Q's adjusted op ex will come in below the 4Q level by some amount. If so, this could be the catalyst for a more bullish analyst reaction given the current skepticism about expense cuts reflected in their commentary and models.
Achieving Mid-2024 Guidance Will Require Some Work Relative to the Low Bar Set for 2023
Unlike the 2023 guidance, the mid-2024 guide does not appear to be a case of management setting low expectations it intends to beat. Simply extending my conservative 2023 assumptions into 2024 would require B2B revenue of $40 million in 2Q 24, more than double the $19.3 million in B2B revenue in the most recent quarter. This does not appear conservative at this point and suggests the company needs to do much better than hit the mid-point of guidance in 2023, which is clearly management's plan.
Worth noting is that SVB and Citi forecast positive adjusted EBITDA just two and three quarters, respectively, later than management's own timeline. Under these models TALK's remaining cash balance would still bottom out at north of $80 million (versus the $95 million-plus guidance). This is quite an improvement over the framing for most of 2022 was that TALK was on a race against the clock to be acquired before running out of cash.
Addressing Concerns About Growing Revenue While Reducing Spending
Both of the skeptical analysts couched management's guidance as requiring revenue growth while reducing marketing spend. This seemingly counter-intuitive proposition provides a pretext for remaining negative on the stock.
As discussed above, it appears that only negligible expense reductions from current run rates should be required to achieve 2023 guidance. The task ahead is to scale the B2B business on a relatively fixed cost base. But to still address the growth vs. expense cut question, it is useful to look at TALK's quarterly results from 2022, as shown in the charts below. It appears that TALK's reduced marketing spend explains the decline in B2C revenue, as expected, but has no positive correlation with growth in the B2B segment. It appears that the main drivers of B2B growth are not advertising but the number of covered lives, utilization rates within this group and number of enterprise accounts, all of which are steadily improving.
TALK 4Q Earnings Presentation TALK 4Q Earnings Presentation TALK 4Q Earnings Presentation
Addressing Concerns About Competition
Competition helped derail TALK's business plan when it was focused on the advertising-driven market for consumers paying out of pocket. This B2C market is likely to remain challenging given the largest competitor, Teladoc's ( TDOC ) BetterHelp business, is an order of magnitude larger than TALK in terms of revenue and size of its therapist network. Much-maligned , VC-backed Cerebral Inc. has driven up therapy-related digital advertising costs after raising money in a Softbank-led round at a $4.8 billion valuation in 2021. I think TALK has de-risked its B2C exposure by significantly cutting its ad spending and planning on B2C being a diminishing part of its revenue mix going forward.
Looking forward, competition in the B2B market is fragmented. Categories of competitors include 1) large digital health platforms (e.g., Amwell ( AMWL ) and Teladoc's non-BetterHelp business that accepts insurance), 2) VC-backed companies similar in size to TALK (e.g., Lyra Health, Spring Health and Ginger), 3) insurers' internal digital health offerings (e.g., Cigna's MDLive ) and 4) countless smaller companies focused on narrower segments of the market such as psychiatric care or particular population groups. TALK's advantages relative to its long list of competitors include brand, the completeness of its service offerings and its effectiveness as an in-network provider for insurance companies. I'm aware of no B2B competitor with a competitive advantage sufficient to challenge TALK's ability to become the profitable company pointed to by its guidance.
Addressing Concerns About Delisting Risk
The company disclosed on November 23, 2022, that Nasdaq had put it on notice for its sub-$1 stock price. The company has until May 17, 2023, to regain compliance.
In its announcement the company noted its option of doing a reverse split to regain compliance. While some observers have suggested this would be a negative signal that could hurt the stock, I believe smart investors would recognize a reverse split as an economic non-event that solves the very real problems that would come from the stock being relegated to the netherworld of the OTC market, aka the pink sheets.
What Else Could Go Wrong?
Macro risks notwithstanding, TALK's most notable potential vulnerability is probably its therapist network. Like its competitors' networks, TALK's therapist network is predominately made up of 1099 contractors who offer their services on multiple platforms. (TALK's number of full-time W-2 therapists is undisclosed but is probably a low-double-digit percent of its total therapists.) While demand for therapy continues to grow, the supply of licensed therapists remains relatively fixed. One step TALK has taken to effectively improve supply is to help therapists become licensed in multiple states, allowing therapists in low-demand geographies to serve clients in high-demand areas. Potential risks include therapists demanding significantly higher compensation in the face of supply shortages or a deep-pocketed competitor negotiating exclusivity of some sort with a material portion of licensed therapists. Note that management cited increased therapist compensation as a source of gross margin pressure in its 2Q 22 earnings call .
Where Do We Go from Here?
I think the stock's current negative Enterprise Value is disconnected from fundamentals and best explained by potential investors sitting on the sidelines and waiting for more validation of the reinstated guidance. The next opportunity is 1Q earnings results, due in late April or early May 2023. Management continued to point to positive trends in the current business as recently as Cowen's investor conference on March 6, so a negative surprise of some sort seems unlikely. The announcement of new payor relationships previewed by management on the last earnings call could also be an incremental positive.
Citi said in its post-4Q note that TALK could trade at the 1.5x-2.0x EV/sales multiple of its comparables if it can deliver on its EBITDA guidance (versus its current negative multiple). By my calculation, this would result in a roughly $2-$3 stock price in mid-2024 based on Citi's forward-year estimates. I think this valuation assumption could prove conservative given TALK with a well-performing business model would become an even more obvious acquisition candidate in a consolidating healthcare services industry. A more detailed assessment of TALK being acquired at several times its current valuation could make for an interesting post for another time.
For further details see:
Talkspace: Turnaround Continues; Cautious Response To Guidance Creates An Opportunity