Hims & Hers Health: Clear leader in personalized care, price is too high given risks

Telehealth platforms can help increase access to high-quality personalized care for low acuity conditions. This is a large and poorly served market today.

I will start this deep dive with a personal anecdote. I recently required treatment for a skin-condition and scheduled an appointment with my local dermatologist.

My experience? Honestly, terrible.

1. Scheduled an appointment through a confusing website

2. Drove to the appointment in precious time-off

3. Received a prescription and was informed of a phone call to come from pharmacy

4. Pharmacy never calls

5. I inform the office to get the pharmacy to call me

6. Pharmacy still … never calls

7. I give up and purchase over the counter treatment from a local drug store

8. Weeks later, I get a surprise bill for $100 for the pleasure of the experience

The barrier to access healthcare in the US is astounding.

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Contents:

• US Healthcare Incentives

• Business Model Overview

• Competitive Advantage

• Evaluation of Management Quality

• Valuation

• Risks

• Concluding Thoughts

US Healthcare Incentives

The US healthcare system is perhaps most accurately characterized by a system of broken incentives.

Health Insurance

The US does not have public healthcare and therefore private health insurance is necessary.

I will start with a question.

Assume you are an insurance company and you insure shipwrecks in the 1600(s). Is it better for you if there are more or less shipwrecks?

1. The logical assumption is — for most people — that of course lower frequency in shipwrecks would lower costs and this would be better for the insurer

2. However, the answer is that increased frequency of shipwrecks increases shipwreck premiums and therefore as the insurer you benefit when shipwreck frequency increases

This helps to underscore the incentive structure for US health insurance corporations — growing earnings requires growing premiums. Growing premiums requires that healthcare costs increase. Therefore, US health insurance companies have an incentive to de-prioritize long-term or preventative treatment that would lower the overall cost of care for insured cohorts.

Pharmacy Benefit Managers

PBMs are companies that act as middlemen between insurance companies, drug manufacturers, and pharmacies. They manage prescription drug benefits on behalf of health insurers.

Key functions of PBMs include:

1. Creating formularies: They develop lists of approved medications that insurance plans will cover, often organizing them into tiers with different copay levels.

2. Processing claims: When you fill a prescription, PBMs handle the behind-the-scenes work of processing the insurance claim and determining what you pay versus what your insurance covers.

3. Managing pharmacy networks: PBMs contract with retail pharmacies and determine which ones are "in-network" for your insurance plan.

The diagram above displays what is an almost incomprehensible mess — PBMs are in charge of developing a list of approved medications for insurance plans and categorize them into tiers. Once medications are placed on formulary and therefore covered, providers are able to prescribe medications which is ultimately fulfilled by the pharmacy.

The patient is responsible for the payment of:

1. Provider copay

2. Pharmacy copay

3. Health insurance premium

The health insurer is responsible for the payment of:

1. Provider cost

2. Pharmacy cost

In practice, PBMs artificially inflate prices by requiring payment from pharmaceutical manufacturers in return for placement on formularies. Unsurprisingly, US per capita out of pocket health care costs have increased rapidly over the last decade (1).

This is due to a confluence of many factors but my view is it is unlikely that the shared incentive for increased cost of care is not a significant contribution. As of writing, times are changing and the FTC is suing PBMs for artificially inflating prices (2).

Business Model Overview

Hims & Hers Health HIMS 0.00%↑ operates a telehealth and wellness platform focused on providing direct-to-consumer access to prescription medications, personal care products, and virtual healthcare consultations.

HIMS 0.00%↑ operates outside of the aforementioned inflationary mess that is the US healthcare system and uses a simple private-pay model. This circumvents the following intermediaries:

1. PBMs

2. Health Insurer

HIMS 0.00%↑ ensures that out of pocket costs to customers are typically in range or sometimes even less than copays using health insurance for comparable treatment.

Revenue Streams

HIMS 0.00%↑ has two primary revenue streams:

1. Wholesale - Represents non-prescription product sales to retailers through wholesale purchasing agreements

2. Subscription Services - Customers subscribe to recurring medication deliveries and wellness products, creating predictable recurring revenue. Customers receive a concierge service that provides direct access to healthcare providers, personalized treatment, and home delivered prescriptions.

Operating Costs

HIMS 0.00%↑ has four primary operating costs outside of G&A.

1. Providers — Payments to healthcare professionals (doctors, nurse practitioners) for telehealth consultation services.

2. Prescription Fulfillment — Pharmacy and supply chain costs, including medications and shipping. HIMS 0.00%↑ uses both 1P and 3P pharmacies.

3. R&D — Software development, platform maintenance, and innovation in telehealth/fulfillment technology.

4. Marketing — Advertising costs across various channels (digital ads, social media). HIMS 0.00%↑ has a significant dependency on paid marketing.

HIMS 0.00%↑ has opted for vertical integration to build their own provider platform. This is an R&D investment that should provide significant operating leverage over the long-term as the software assets can be non-linearly scaled to many providers.

HIMS 0.00%↑ is also vertically integrating prescription fulfillment and reducing reliance on 3P pharmacies. This is another investment that will provide operating leverage over the long-term and help to increase retention due to the ability to personalize medications.

Vertical integration allows HIMS 0.00%↑ to own the entire customer experience and personalize care.

Personalized care is unique to the market — high-end dermatology offices sometimes have similar compounding capabilities to combine medications or create custom doses but there are no competitors to HIMS 0.00%↑ with a similar level of scale.

GLP-1(s)

The GLP-1 business is providing temporary cash flow while semaglutide remains on the shortage list. The GLP-1 business is less than 2% of revenues and it is likely that HIMS 0.00%↑ will no longer be able to sell GLP-1(s) in the near future.

Returns on Capital

HIMS 0.00%↑ has only recently achieved positive FCF and therefore returns on capital employed (ROCE) are difficult to graph over time.

With the context that HIMS 0.00%↑ is making significant investments into building the business for the long-term, we can review ROCE using annualized EBIT from Q3 2024 earnings:

ROCE = EBIT / (Total Assets - Current Liabilities)
~ 100 million / (600 million - 150 million)
~ 20%

I rounded this calculation down because I made some estimates of annualized EBIT. ROCE of around 20% is very strong for a business that is prioritizing long-term growth over short-term profitability.

Competitive Advantage

Brand

It’s hard not to consider this an oxymoron given that HIMS 0.00%↑ spends a considerable amount on paid marketing. Nonetheless, my view is HIMS 0.00%↑ is building a strong brand as a healthcare platform.

Recent market share gains are significant (3):

Personalization

The most significant competitive advantage is the HIMS 0.00%↑ platform’s deep vertical integration of the end to end technology stack that allows for HIMS 0.00%↑ to personalize care to each individual customer. Over the last few years, a majority of HIMS 0.00%↑ customers have adopted a personalized treatment (4):

HIMS 0.00%↑ has taken years to build this personalization engine. The technology is not easily replaceable by competitors and would require:

1. Customer application

2. Provider technology platform

3. Backend automation

4. Compounding pharmacy

Indeed, it is unlikely that competitors will be able to replicate the company’s brand in addition to the deep vertical integration that has taken HIMS 0.00%↑ — an exceptional and fast-moving company — 4 years to build.

Evaluation of Management Quality

In my view, the responsibility of a management team is to establish the company’s culture and make capital allocation decisions. I look for management teams with significant ownership of the business to ensure that management incentives are aligned with shareholders.

Company Culture

As we have previously discussed, HIMS 0.00%↑ is a highly-innovative company and has launched a category-defining brand in personalized healthcare. The building blocks to support personalization of care using compounding pharmacies have been in place for decades but this management team was able to assemble them and invent an entirely new product that is unique in the market.

HIMS 0.00%↑ recently announced MedMatch — a proprietary AI engine to help providers recommend treatment and dosing for patients. This helps providers recommend effective treatments resulting in better outcomes for patients.

Capital Allocation

The management team has a published a capital allocation framework (5):

1. Supporting organic growth

2. Advertising payback of less than 1 year

3. Invest in vertical integration to support long-term margin expansion

4. Invest in durable long-term growth channels

5. Share repurchases

I am supportive of investing in vertical integration as this is generally the path successful e-commerce platforms have taken around the globe. Over time, sustained technology investment creates a durable competitive advantage.

Expanding on 4. — the management team has consistently chosen winning categories for expansion. In just Q4 2023, the (non GLP-1) weight loss specialty was launched and has grown to an incredible $100 million ARR in only two quarters.

The management team has made a few small tuck-in acquisitions. I will specifically reference the acquisition of Apostrophe in 2022 — a small dermatology provider with compounding pharmacy capabilities — for $190 million (6). Apostrophe was integrated into HIMS 0.00%↑ technology stack and expanded to provide personalized care for the majority of the business.

Insider Ownership

Insider ownership is very high, the most recent proxy filings indicate the management team owns over 10% of shares outstanding (7).

Valuation

In order to value HIMS 0.00%↑, I will make a projection of earnings in the next 5 years and estimate market cap. This will require the following assumptions:

1. Growth Rate

2. Terminal Multiple

3. Terminal Margin

I am using the company’s stated ambitions for growth and long-term margins for my bull case assumptions and tempering expectations from there.

I am using Adjusted EBITDA in my calculation as it is a good proxy for owner earnings for the public financials of HIMS 0.00%↑.

The following cases estimate market cap in 2030 using the current revenue run-rate of $1.6 billion.

Bear: 10% Growth Rate, 13x Adjusted EBITDA, 15% Adjusted EBITDA margin - $4.8 billion

Base: 17% Growth Rate, 17x Adjusted EBITDA, 20% Adjusted EBITDA margin - $11.9 billion

Bull: 22% Growth Rate, 20x Adjusted EBITDA, 25% Adjusted EBITDA margin - $21.5 billion

If our view as investors is that significant growth of HIMS 0.00%↑ is likely to continue, then the ~$6.5 billion market cap as of writing offers an attractive distribution of returns over the next 5 years. However, the current price requires significant growth/operating leverage to avoid multiple compression and potential negative returns.

Risks

Regulation

Given HIMS 0.00%↑ operates in US healthcare, changes to US healthcare regulations could significantly impact HIMS 0.00%↑ operations.

I am reminded of this risk as the FDA is likely not to allow HIMS 0.00%↑ to continue selling GLP-1(s) in the near future. The GLP-1 business is not significant, but the regulation risk persists nonetheless.

Paid Marketing

HIMS 0.00%↑ has a significant dependency on paid marketing to build the brand and drive growth. Although my view is this marketing investment is building a durable brand, it is possible that changes to media platform policy could impact the growth of the business.

For example, Meta recently announced advertising policy changes that will limit HIMS 0.00%↑ from running lower-funnel sales campaigns. This could impact the growth of HIMS 0.00%↑ in the near-term.

Trustpilot Reviews

HIMS 0.00%↑ has many negative reviews on Trustpilot (9) — customers indicate the customer service is poor and this gives me some pause as an investor. The level of growth HIMS 0.00%↑ has delivered is excellent but I remain skeptical of providing poor customer service in healthcare.

Note: Trustpilot reviews are to be taken with a grain of salt. I have heard positive things about the service anecdotally from friends.

Competition

HIMS 0.00%↑ operates in a highly fragmented industry with many competitors. Some of these competitors are very well capitalized. Nonetheless, my view is that HIMS 0.00%↑ has a differentiated product due to personalization and a real competitive advantage that is likely to persist over time.

Concluding Thoughts

My view is that HIMS 0.00%↑ could be an attractive opportunity today given that HIMS 0.00%↑ operates in a highly-fragmented US healthcare system with significant issues:

1. Lack of access

2. Lack of price transparency

3. High cost of care

While it is incredibly unlikely that HIMS 0.00%↑ will be able to replace the legacy healthcare system, this misses the point. HIMS 0.00%↑ can continue to grow by expanding in categories that are:

1. Highly emotionally resonant

2. Chronic in nature

3. Poorly served

4. Low acuity

HIMS 0.00%↑ has yet to begin international expansion and my view is there is a global market for the high-end personalized service HIMS 0.00%↑ provides. Over the long-term, the business has great potential.

However, I do not view the current price offers a sufficient margin of safety given the risks I have outlined previously. I will certainly be following this story over time.

Appendix

1. https://www.statista.com/statistics/484578/us-per-capita-out-of-pocket-health-care-payments-since-1960/

2. https://www.ftc.gov/news-events/news/press-releases/2024/09/ftc-sues-prescription-drug-middlemen-artificially-inflating-insulin-drug-prices

3. https://s27.q4cdn.com/787306631/files/doc_financials/2023/q4/Hims-and-Hers_Q4-FY23-Shareholder-Letter_Final-compressed.pdf

4. https://s27.q4cdn.com/787306631/files/doc_financials/2024/q3/FINAL-Q3-2024-Shareholder-Letter.pdf

5. https://s27.q4cdn.com/787306631/files/doc_financials/2024/q1/Hims-Hers-Q124-Financial-Results-Presentation.pdf

6. https://investors.hims.com/news/news-details/2021/Hims--Hers-Completes-Acquisition-of-Apostrophe/default.aspx

7. https://d18rn0p25nwr6d.cloudfront.net/CIK-0001773751/b4d44f32-889d-4efc-9454-0cd945585be3.pdf

8. https://transparency.meta.com/policies/ad-standards/restricted-goods-services/health-wellness/

9. https://www.trustpilot.com/review/forhims.com

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