LifeStance Health Group: Strong Long-Term, But Near-Term Weakness (NASDAQ:LFST)

Summary

I recommend staying neutral for LifeStance Health Group (NASDAQ:LFST). I think it’s important to point out that LFST is still riding on a robust secular growth trend that will allow it to expand and mature over time. In spite of this, I believe that stock performance is being held back by a number of near-term headwinds or uncertainties that were revealed in the latest earnings.

Company overview

LFST provides in-person and remote medical consultations for people living in the United States who are experiencing mental or physical health issues.

Mental health and illness are not joking matters

Mental illness is extremely prevalent in the US. One in five American adults experiences mental illness each year, and half of the population will struggle with mental health in some way during their lifetimes. Despite the magnitude of the problem, getting help for mental health issues can be challenging. Patients in need of mental health care often have to wait a long time before they can be seen by a specialist. While waiting, patients’ physical and mental health may deteriorate, leading them to seek care in more expensive settings. These challenges are made even more difficult by price tags.

These access and cost concerns are made worse by the industry’s widespread fragmentation. Management estimates in the S-1 state that 95% of mental health clinicians work independently, compared to 31% of primary care physicians and even fewer in other specialties. Non-essential business processes like marketing and invoicing can add a significant amount of stress to the already demanding schedules of solo clinicians. All of these ancillary tasks take time and energy away from directly caring for patients. These difficulties are compounded by the fact that there are not enough funds available to invest in infrastructure and technology, despite the growing importance of doing so in order to meet expanding regulatory and compliance demands. Lack of technology makes it harder to track patient data and outcomes, which is essential for efficient healthcare.

LFST scale is a strong competitive advantage

LFST is a relative newcomer to the industry, having launched in 2017. While LFST has only been around for four years, but they’ve already hired over five thousand doctors and become one of the largest providers of comprehensive outpatient mental health services.

The employed physician model, where all clinicians are W-2 employees, is one of the distinctive aspects of LFST. While it is true that some private practice doctors would do better financially without LFST, management estimates that clinicians who currently accept commercial insurance can earn about the same as they would as independent contractors by working as W2 employees for LFST. This is because LFST pays 125% of the Medicare rate to clinicians in private practice, while commercial insurance only pays 95%. This allows LFST to pay its clinicians competitively while maintaining a sustainable business model. Therefore, I believe the main reason clinicians are joining LFST is for the qualitative factors LFST can provide. With LFST, for instance, the company can pool its technological resources, freeing up doctors to focus entirely on patient care. This could be a relief for some clinicians when it comes to a major challenge of private practice, and it’s a benefit of joining LFST.

LFST’s size and database are major factors in the organization’s success in meeting or exceeding Medicare’s reimbursement rates by 25%. With more than 5,000 medical professionals on staff, LFST is a national leader in outpatient mental health care. Payers are more likely to approve funding if there is proof of successful outcomes to back up the price tag, even more so than for larger projects. Given that LFST has provided evidence of clinical improvements within the framework of this cost paradigm, the organization has been able to successfully argue for and secure the rates at which it currently operates.

LFST hybrid model further enhances its scale advantage

LifeStance is currently available in 32 states. LFST not only has a local clinic in every area, but also provides tele-visits for their patients. The business has spent the last few years perfecting a hybrid model that is neutral toward both in-person and remote medical consultations.

The hybrid model extends patient access over a wider geographic area with less time commitment on their part. In my opinion, this model is strategically valuable because it expands LFST’s potential patient population beyond the centers’ physical boundaries and allows them to treat more patients at once. Long-term, this could help the company’s Gross Margin profile by generating the same amount of additional revenue per patient while reducing expenses. A further benefit of this approach is that it makes therapy more accessible to patients who may otherwise not be able to participate due to work or other commitments.

Growth algorithm

Although increasing the number of clinicians, the number of patient visits (per clinician), and ARPU are all crucial to LFST’s expansion, I believe that increasing the number of clinicians is the most important factor.

In my opinion, LFST has a lot of room for expanding their team of medical professionals. This can be done in two primary ways: through organic hiring and through acquisition. The company’s overall strategy is to expand into new markets by buying up competitors. The company’s strategy for breaking into a new market involves acquiring a sizable stake in the region’s largest mental health practices. From a number of vantage points, I find this strategy to be reasonable. The first thing it does is create a dense and active market early on. As a second effect, it limits the size of potential rivals. A company looking to match LFST’s scale in a given market would have to essentially go door-to-door in search of physicians if LFST had already acquired a significant player in that market. Given the dearth of large targets, a few well-timed acquisitions can significantly complicate efforts to replicate LFST at scale.

3Q22 earnings revealed multiple strategic initiatives that might impede near-term performance

On the earnings call for the third quarter, the new CEO’s initiatives were the main topic of discussion. For me, the call’s overarching theme was the need for a stronger emphasis on establishing sound operational foundations. The combination of more stringent criteria for mergers and acquisitions and an increased focus on organic hiring is likely to slow growth in the medium term. In addition, I believe that the emphasis on infrastructure will add incremental costs in the short term, but it should drive operating leverage, and possibly higher margins, once it is in place.

The results of the third quarter are just the most recent example of the rough ride I anticipate on the road to this future state. Third-quarter revenue was below projections and in the low half of guidance as lower-than-anticipated patient visits were driven by a lack of available clinicians. In addition, the higher cost of health benefits led to lower gross margins, which in turn led to an EBITDA shortfall. Last but not least, the company’s guidance was lowered.

I anticipate that shares will be under pressure in the near term as investors process the updated growth and margin outlook.

Valuation

I believe LFST is fairly valued at the moment. I note that LFST is still experiencing a very strong long-term secular trend that should enable it to grow and scale over the long-term. However, as I stated earlier, there are several near-term headwinds or uncertainties that, I believe, are depressing stock performance.

I have used consensus near-term estimates, which largely revolves around management guidance, as my projects in the model. And based on these figures with the current valuation, LFST is valued around $5.40, which is 10% above the current share price of $4.96.

Honestly, I am leaning towards being bullish for LFST but I think it would make more sense to invest after the uncertainties are cleared. This would result in either: inflection in multiples (back to average maybe?) or growth. Both of which would be positive for the stock.

Risks

Telehealth strategy risk

In my opinion, the current rate parity structure would be put at risk if telehealth capacity were to be expanded at a faster rate than in-person capacity.

Competition risk

When there are few obstacles to entry, the level of competition could be higher than expected. There are more and more competitors in the industry, especially with the advent of telehealth, which may make it harder to find qualified doctors to hire and attract new patients.

Conclusion

LFST is a mental and physical healthcare services provider that operates through in-person and telehealth appointments for patients in the US. The company is riding on a robust secular growth trend, but near-term headwinds and uncertainties revealed in the latest earnings may hold back its stock performance.