Babylon Stock: Why It’s Dropping Like a Rock
Why do some investment firms send out alerts to subscribers explaining large stock price increases? That’s not what investors want to know. Look up any given stock and you’ll find that their questions always relate to some unknown calamity.
When bad things happen, people turn to the Ministry of Truth for an explanation. Rarely will these same people ask “why did <INSERT MEME STONK HERE> jump 10 gazillion percent in 36 hours? That’s because the sole reason for the creation of paper wealth is always the investor’s Nostradamus-like investing acumen.
Speculators are the first to get cold feet when things go south. In the words of Edwin Lefèvre, “the speculator’s deadly enemies are ignorance, greed, fear, and hope.” Today, we’re going to talk about a stock that’s been stoking all four of those emotions lately. As a result, it’s probably burned more fingers than Bernie Madoff.
Revenue Concentration and a Possible Delisting
Don’t chuck your toys out of the pram just yet. We’re not implying Babylon Holdings (BBLN) is like Bernie Madoff, we’re just saying many retail investors have been trying to catch this falling knife for a while with no end in sight and a potential delisting on the horizon. Based on NYSE rules, the exchange will initiate a delisting if shares trade below $1.00 for 30 days in a row. A delisting wouldn’t bode well for a company that needs to raise cash soon for fueling their aggressive expansion which isn’t all that it seems. In looking at their recent quarterly filing, two red flags appear right off the bat – customer concentration risk and country risk.
Here’s something you don’t see very often. Two customers moved from being under 17% of Babylon’s revenues in 2020 to 77.5% of total revenues in 2021.
In addition to customer concentration risk, there’s also country risk. Nearly 94% of last quarter’s revenues came from the United States where they’re providing a value-based healthcare offering that assumes the unforeseen medical costs of several hundred thousand consumers.
The Claims Metric
It’s easy to find life sciences stocks with loads of red flags trading at a premium. That’s often explained by naïve retail investors trying to find the next Tesla. In the case of Babylon, their business model shows strong revenue growth masking a great deal of financial uncertainty. See if you can spot the line item that seems out of place in their recent quarterly results.
That’s right Little Johnny. The metric labeled “claims expense” was recently introduced to provide stakeholders better transparency into the company’s health. Here’s how Babylon describes “claims expense:”
Claims expense includes the costs of healthcare services rendered by third parties on behalf of patients which the Company is contractually obligated to pay, which includes estimates for medical expenses incurred but not yet paid (IBNP) using actuarial processes that are applied on a systematic and consistent basis.
In other words, the Babylon Health “value-based care” offering involves receiving a fixed per member per month (PMPM) fee and then assuming responsibility for paying an unknown amount of health costs in the present and future, an unknown amount of which is provided by third parties. The company then expects to expand their margins (decrease claims expense) by offering up their own primary healthcare offering that uses technologies like AI and telehealth to do things more efficiently than third parties. The company warns that getting customers to use their offering will require “a substantial investment of time” and that “we cannot assure that members will sign up to use our digital tools or services instead of those of other providers.”
That means we should expect to see claims expense fall over time as a percentage of revenues. In order to exclude what the actuaries are estimating will be payable in the future, we can simply look at the “Claims Payable” table in their regulatory filings which shows what they actually paid (claims paid). Last quarter that totaled $233 million vs revenues of $247.5 million – a gross margin of less than 6% for value-based care which represents 92% of total revenues.
There’s not much room for error here. If medical claims exceed revenue taken in that’s hardly sustainable. This business model looks a lot different from the telehealth company we had originally imagined Babylon Health to be. There are no traditional software-as-a-service (SaaS) metrics we can use to gauge the health of their business. Instead, we’re offered up a risky plan being executed in a bureaucratic environment which will need more capital to realize the grand aspiration of cutting costs by providing Babylon’s own low-cost healthcare services that end customers may not choose to utilize.
We’ve been following Babylon for a while now, and our previous piece on Babylon Health Stock: Value-Based Care Using Telehealth spelled out the bull thesis for which there are many critics. Some have said Babylon’s AI technology hasn’t been proven to work as it says on the tin, with others saying it could be “the next Theranos.” Bulls point the detractors to the rapid revenue growth, but now that we’re in a bear market, survivability takes a front seat to growth.
Babylon says they’re on track to clear a billion dollars in revenues this year, but we’re keen to know what the “claims paid” number looks like. The company had around $275 million on their books as of March 31, 2022, and they anticipate that will last until the end of the year. At that time, they’ll need to either sell equity at (possibly) very depressed prices or take on debt. Hopefully, shares won’t be in any danger of being delisted or that will negatively impact an equity raise. Whatever money can be raised through an equity offering will dilute existing shareholders and put further pressure on the share price. The alternative is to raise debt, and that will come with its own challenges. In the meantime, there’s a great deal of uncertainty around whether this business model – one that’s only been in effect for less than two years and is being scaled like mad – will work as the company expects it to.
Would We Buy Babylon?
The value proposition goes something like this. Estimate the costs of providing medical services to a population of people using actuaries in a similar manner to how insurance companies price policies. Then, attempt to use technologies like AI and telehealth to provide a cheaper cost of healthcare and hope that your customers don’t choose healthcare options other than what you’re providing. Pray that whatever number those third-party actuaries came up with exceeds what the actual costs end up being or you’ll be operating a money-losing business in the best-case scenario.
Insurance companies are great businesses because premiums are paid up front and that money is used to generate a return while you’re waiting for claims to come trickling in. Babylon Health doesn’t have such a business model because their claims expense last quarter constituted 94% of their value-based care revenues (or 88% of total revenues). They first entered into value-based care agreements with health plans in the United States in 2020 and have limited experience operating in arguably the world’s most bureaucratic healthcare systems. (More than a third of U.S. healthcare costs go to bureaucracy.) There’s far too much complexity and uncertainty for us to consider investing in Babylon stock at any price.
The optimal business model Babylon should have pursued was one that didn’t take on the risk of members incurring more healthcare costs than anticipated, or the cost of care increasing so that their business operates at a loss. Operating a high-margin SaaS business model in the bureaucratic healthcare industry is difficult enough, and we don’t believe that some unknown possible upside merits the obvious risks investors are taking by investing in Babylon stock. For those who do stay on board, claims expense will be a key metric to watch going forward.
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Teladoc looks like a safer bet and it got cheaper even more after the most recent fall (-17.7% yesterday). TDOC P/S = 2.6.
ARK was buying TDOC yesterday, over $15M.
10/12/22: Babylon intends to sell its Independent Physician Association (IPA) business in California, including Meritage Medical Network, which it grew from $111m in 2021 revenue to over $400m in estimated 2022 revenue.
Proceeds from sale are expected to provide sufficient capital for Babylon’s funding requirements through profitability.
Current Babylon market cap: $174.4M.
I’m surprised the share price did not jump on the news.
Wow. That share price has slid well below a dollar. Per Investopedia, “a stock cannot stay below $1 for more than 30 consecutive business days on Nasdaq. If it does, it is allowed 180 days to correct this deficiency.” Clock is ticking?
Yesterday Babylon was +43.7% ($0.53).
Babylon announced that it has agreed to sell an aggregate of 145,885,760 (prior to rounding of fractional shares) of its Class A ordinary shares to certain institutional and other accredited investors (the “Initial Subscribers”) in a private investment in public equity (the “PIPE”) at a price of $0.42122 per share (the “Initial Subscriptions”).
The dilution isn’t a surprise. Wonder how long it will be before their shares are relegated to the OTC market.
The is no dilution from the latest capital raise as current share price is $0.4512, which is greater than $0.42122.
Dilution doesn’t care about price, it only involves shares outstanding. In this case it seems like they increased the number of shares outstanding dramatically. To calculate that, simple take number of shares outstanding before and compare it to the number afterwards.