Mark Odendahl
Welcome everyone and welcome back to Industries in Motion podcast from RBC Capital Markets. This is where we explore what's new and what's next in today's fast-moving markets and industries to help you stay ahead of the curve. Please listen to the end of this podcast for important disclaimers. As a reminder, my name is Mark Odendahl and I’m head of US capital markets research. I'm excited to have Sean Dodge on the podcast today. Sean heads up our healthcare IT research. The reason we have Sean Dodge on the line today is we recently hosted our first private healthcare IT and digital health conference. Sean, welcome to the podcast.
Sean Dodge
Thanks, Mark. Happy to be here.
Mark Odendahl
Alright, let’s dive in. And as I said, this is our first private healthcare IT conference for RBC. Sean, why don’t you tell us a little bit about it – why is this a growing sector of health care? And how does our event stand out from the rest?
Sean Dodge
So, you know, we're RBC. So, I guess it's probably appropriate. I started off with a hockey analogy, you know, we view HCIT is where the puck is going. And like Wayne Gretzky said, that's where you should be skating to. I think it's very well documented at this point that the spending in the US healthcare system has been on an unsustainable course, that costs are inflating too fast, you know, we now spend north of 18% of GDP on it. And we're not getting…when you look at what we're spending here on a per capita basis, it's more than every other developed nation; but despite this, we're not getting a commensurate return on it, that the data around things like US life expectancy, and other wellness measures, we lag almost everyone else. So, all this to say, that something has to be done, and it is being done, there's a lot of hard work going into fixing this. And that's exactly where the healthcare IT space comes in. When we think about what needs to be done to fix US healthcare, it all centers around, you know, first keeping people healthier. So, over the long run, making sure that people need less health care. And then when they do need care, making it more effective, more efficient, more affordable, while also improving the convenience and the experience for the patient. And that's what all of the companies in the HCIT space are focused on accomplishing all of that in one way or another. And so that's why when we meet with investors and other people new to the space, we always lead by saying, you know, this very much represents what we think is the future of US healthcare. And so that's why we're so excited about HCIT.
Mark Odendahl
Alright, so before we dive into the conference, what do you think are the key issues that are driving your sector today?
Sean Dodge
Yeah, I'd say first, it's a very exciting time for innovation. And what's helping drive a lot of that is just the exponential growth we've seen in investment in this space, particularly over the last 10 years. And just to provide a few numbers to help illustrate some of the recent trends…If we look at the Rock health data, for example, there was over $29 billion of venture funding raised across 736 deals in 2021. And that number 29 billion, that was nearly double what was raised the year before in 2020. And that was nearly four times the $8 billion that was raised in 2019. The data from last year for 2022 shows that slowing a bit, there was $15.3 billion raised in 2022. But what's worth noting there is that, even despite what was a very challenging environment for the capital markets, 2022 is still two times bigger than what we saw in 2019 and actually slightly surpass 2020. And while we find this encouraging, the vast majority of this money is being used to drive innovation. So, we expect to see exciting accelerations and advancements on the heels of all of this. And if we look at the top two technologies being funded right now with all this money, telehealth and startups incorporating artificial intelligence continue to be the most targeted areas. What's also interesting is these funding numbers, they're not capturing the other sizable unmet investments that are being made by very large, less traditional players entering the healthcare space. So, some examples there would be Amazon, of course, bought its PillPack Pharmacy a few years back and has now acquired One Medical, which has gotten Amazon into bricks-and-mortar healthcare. And we know they've been very active in trying to establish their own virtual care capabilities. CVS recently bought Signify and they're in the process now of acquiring Oak Street health. Oracle, not long ago, acquired Cerner, Walmart recently bought a telehealth company. So again, our point here is there's lots of money being deployed into this space, which we think sets off this this kind of virtuous cycle that will help accelerate innovation over the years to come. The flip side of this, though, is, you know, the challenge it creates for investors is, all of this investment has caused competition, the competitive landscape to explode. Competition in HCIT is now coming from every different direction. And so that makes it really tough for investors to get their arms around the landscape and get comfortable believing they can pick the winners. Everyone knows that the addressable markets here, the Tams, are immense, it's just gotten a lot tougher figuring out who's got something that works, and is sustainable and different, and can grab a meaningful share of that. So, you've got competition, and then of course, interest rates, these are all growth companies, many of whom are still burning cash. And so higher rates do weigh pretty heavily on valuation. So, lower rates, we think, at some point, would also help in drawing even more interest back into this space.
Mark Odendahl
So, a lot of change. You're talking about consolidation, you're talking about new entrants, disruption… What else do you think is driving this accelerated change and what more is needed to complete the transition?
Sean Dodge
One of the areas of HCIT, where we spent a lot of time on, is in the value-based care space. We talked earlier about the unsustainable trajectory US healthcare is on – from a cost and quality standpoint; it's our opinion that one of the primary contributing factors to that is how we have historically paid or reimbursed providers for health care. The unfortunate consequence of the current system is that it creates a whole bunch of perverse incentives. They're all contributing to the inefficiency and redundancy in the system now. The idea behind value-based reimbursement models is, we transition how we pay doctors for the care they deliver, to a model that more highly incentivizes better outcomes and lower costs. All of this makes a ton of sense on paper; it's how our system should be structured, how docs should be paid. But getting physicians to make that transition is really complicated for them. It's also really risky. And so, this is where some of these new HCIT companies come in. There's this newer group, we refer to as the provider enablement companies that have developed these turnkey platforms, where they partner with existing doc practices, and provide them with all the software and systems and contracting and workflow adjustments they need to more seamlessly and successfully transition into these new programs. The ubiquitous view of our panelists that we hosted at the conference last week is that we're finally approaching a point where all of the elements necessary to make this transition are falling into place. And so, the view was that we are, you know, again, for the first time really ever, at a point where we should begin to see this this transition to value-based care really accelerate. The point about the necessary elements now falling into place – that was something that Dr. Farzad Mostashari, as part of the panel, pointed out; he's beginning to see more widespread indications that physicians are increasingly willing to participate in these programs. You know, that's kind of critical key number one; two, he said – it's getting a lot easier to contract with payers that the insurance companies are much more amenable to entering into these types of arrangements. And then point number three is that, as I talked about before, there are these new tools and platforms that are making it a lot easier for physicians to participate in these models, and actually be effective in bending the cost of care. And then he and the other two panelists we hosted, we also had David Snow and Zane Burke, they all agreed, they believe CMS has done a great job leading the transition of value thus far, they expect it'll continue. And what they found or were very encouraged by was that, they said, they're all starting to see more interest from self-insured employers in pursuing these types of arrangements.
Mark Odendahl
That's a great rundown. And you know, you discussed that keynote panel, as well as the kickoff keynote with those gentlemen that you mentioned in your published notes, so I direct people to take a look at that. Aside from this acceleration in value-based care adoption, what are some of the other insights that you learned from companies at the conference?
Sean Dodge
It's interesting that there are a lot of different flavors of value-based care, lots of different models and approaches. One of the ones we talked a lot about at the conference during this panel was Medicare Advantage. The view of the panelists we hosted was that, and there remains a great program, and one that'll continue to grow in terms of enrollment. But it was their opinion that there needed to be more done around upcoding, more specifically to curb upcoding. If we try and simplify this, there are basically two ways to make money in value-based care. The first is you take risk on members, and then put programs in place to take better care of people for less money, which saves the system, which saves the US money, and then you get to keep a portion of that savings. That's the good way, that's what we want. The second is, you agree to take risk for members, and then push the envelope as hard as you can on risk-scoring them. And so, the controversy around that, with the second method, is you're asking the government for more money to cover your members, because you're showing them to be sicker than what the average enrollee would be. But you're not really doing much to drive better outcomes and lower costs. And so, this is viewed as the bad way, or the one that they don't want to incentivize in value-based care. If we step back, I think there's absolutely a place for risk-scoring in these programs. We need some type of framework to account for that and avoid adverse selection. But it was the view of the panelists that, this risk-scoring program or methodology does create some perverse incentives, – it's kind of set up where it can be abused. And it's probably gone unpoliced for too long. And so, the government needs to do something to begin to rein that back in. That's going to impact that – the margins that some of the players in this space are making right now.
Mark Odendahl
So, you've spoken a lot about the long-term trends of value-based care. What about the here and now; how should investors be thinking about value-based care today in 2023?
Sean Dodge
I think for the moment, there are definitely some select compelling stocks opportunities investors should be considering now, as far as value-based care acceleration goes, it remains very favorable. There's a lot more evidence these models are effective and actually improve outcomes and reduce costs. And as we said, innovations accelerate. We also acknowledge that performance, broadly, is probably going to be kind of choppy until the interest rate outlook improves. The flip side of this is choppier performances; we've seen valuations reset significantly across the space over the last 18 months. I think we're looking at points where investors have much more attractive kind of entry points. You know, a couple of other things to think about that are favorable for 2023; a lot of these companies that we cover have very capital light models, meaning that they're far less dependent on significant investments, capital markets to continue funding their growth. And so, they're just a little less exposed to interest rates, relative to some of their peers. There's also, as I mentioned before, a lot of good data that is coming out of these companies showing that older cohorts of members that they've loaded into these programs, that they're able to continue driving up savings each year. And so, I think, from this idea that value-based care is hard to do and risky, we've got a lot more data showing that that these programs are effective, and it helps kind of de-risk these long-term views around value-based care just not working. And then the other kind of consideration here is just the kind of the M&A backdrop and we can talk about that more, but we've seen just a tremendous amount of consolidation across that space. And that's something that we very much have, you will well, we'll continue into 23 and beyond.
Mark Odendahl
What did some of your panelists say about consolidation?
Sean Dodge
There's been a ton of investment into this space, it's created this explosion in the competitive landscape. And there's a lot of great companies out there, and a lot of great ideas. The problem is a lot of these are kind of built around the idea of point solutions where, to transition into value-based care, or do something just to make your hospital, your health system more efficient, or your doctor's office or practice more efficient, you need a whole bunch of these little point solutions to do that.
The idea of consolidation is that as we kind of fold all of these capabilities into more of an integrated, seamless platform, it just makes it a lot easier, less burdensome, when it comes to adopting and putting these into place. And so, we've seen a lot of these point solutions being bought up by these bigger platforms as they look to expand their capabilities and breadth. And so, it was the view of our panelists that platforms would kind of continue to dominate, that we would see more consolidation of these points solutions.
Mark Odendahl
And so, if we broaden the view a little bit, what are some other trends in the healthcare sector that might have a knock-on effect on digital health?
Sean Dodge
I think one of the most exciting aspects of the HCIT space beyond just the broader outlook for innovation that I mentioned before is that HCIT, it really sits at this kind of intersection of all of the other parts of the healthcare industry. There's this kind of interesting convergence that we're seeing happening. What I talked about before, with value-based care, we think about that being the convergence of the insurance companies – the payers; and the health care delivery system – the providers; value-based care is those two coming together. And HCIT, playing a very important role in facilitating that. We're also seeing something similar happen with HCIT and drug development, for example, that there's a lot of new systems and data sources that life sciences companies can use to enroll clinical trials; it's enabling them to run more efficient clinical trials in a more decentralized manner. It's also allowing them to do things like, once a drug is approved and is out in the real world, better understanding, how effective it is, and how effective it is against other therapies out there. So again, HCIT played a very important role in facilitating that. And I think, especially when we think about the type of environment like the one we're in currently, where biotech funding has temporarily slowed, it's harder for companies to raise capital. Everybody, you know, drug companies, the CRO (the contract research organizations), the CDMOS (the contract drug manufacturing organizations), all of them are looking for more ways to do more with less, and again HCIT is playing a very critical role in that.
Mark Odendahl
So, how are the wider macro-economic trends such as inflation and increasing costs impacting health care?
Sean Dodge
One of the things we've seen play a very significant role in the delivery system over the last 18 months has been the inflationary pressures that everybody's experiencing, not just on wages, but also on supply costs. If we think about the average health system right now – very much under pressure from a reimbursement standpoint, but also having trouble staffing, retaining and paying people across their entire organisation, in addition to these elevated supply chain costs, and so there very much is a need now for relief valves for all of that. And so, we've seen things like outsourcing. So, taking your billing and collecting functions and handing those off to some type of outsource third party, really starts to grow in significance or focus. And, on the life sciences side, outsourcing, clinical trials, outsourcing, drug manufacturing. And so, we've seen outsourcing become an increasing focus or way to help manage or mitigate a lot of these pressures that these organizations are experiencing.
Mark Odendahl
Well, that was great and congrats to you and all our partners around RBC Capital Markets who put on this conference for the first year and to bring together some leaders of private companies to talk about these emerging trends and value-based care. That's great. And thank you for all the great work that you do for us in healthcare IT, really appreciate you coming on the podcast today.
Sean Dodge
Thanks, Mark. It was great being here.
Mark Odendahl
What else lies ahead in today's ever evolving markets and industries? We'll be keeping track right here on Industries in Motion. Until then, thank you for joining us on this episode recorded April 21, 2023. Make sure you subscribe to Industries in Motion wherever you listen to your podcasts. If you'd like to continue this conversation or are interested in more information, please contact your RBC representative directly or visit our website which is www.RBCcm.com\industriesinmotion for further insights. Thank you very much for the time today and really enjoyed talking about healthcare IT.