At a time when the significance of mental well-being can no longer be neglected, LifeStance Health Group, Inc. (NASDAQ:LFST) has carved out a pivotal role in delivering indispensable psychological support services. The objective of this analysis is to elucidate both the optimistic and pessimistic outlooks on the company’s trajectory, taking into account aspects like its capital allocation to technology, the progression of its revenues, and its cash flow dynamics. Moreover, a balanced assessment of the firm’s value is presented, employing diverse valuation methodologies to shed light on LifeStance’s prospective performance.
Brief Company Overview
LifeStance Health Group, Inc. provides an extensive range of mental health services through its subsidiaries. Whether it be psychiatric evaluations and treatment, psychological or neuropsychological testing, individual therapy sessions, family counseling, or group therapy. LifeStance Health Group Inc. has been offering specialized care for mental health conditions like anxiety, depression, bipolar disorder, and post-traumatic stress disorder since 2017 through their onsite centers in 33 states or online delivery platform. Their services are not just limited to adults; they also cater to children, adolescents, and geriatrics. Headquartered in Scottsdale Arizona, their mission is to provide quality service while aiding those dealing with mental illness to find balance and healing from life’s struggles.
A recent report from Allied Market Research shows that the global mental health market is experiencing remarkable growth. With a compound annual growth rate of 3.5% projected between 2021 and 2030, this booming industry has already reached an astounding $383.31 billion in 2020 – and estimates project it will continue to skyrocket reaching a phenomenal $537.97 by the end of the decade! This presents incredible potential for therapeutic solutions along with services associated with mental health worldwide.
Mental health struggles remain pervasive and can have a devastating effect on the afflicted, their family members, and society as a whole. To put it in perspective, 20% of people globally experience these disorders; depression being one of the leading sources of impairment worldwide. In 2019 alone – remember, this is pre-pandemic stats – over 280 million individuals across all age brackets endured depression according to the World Health Organization.
North America has solidified its spot as the leading provider in mental health market share for 2020, and it looks like this will remain true for a while. This is due to the intensifying utilization of advanced technology, greater awareness about mental healthcare among both medical professionals and corporate businessmen/women alike. Additionally, increased efforts by health care establishments to offer cutting-edge services combined with prime players’ presence within the region all add further support towards this condition.
In contrast, the Asia-Pacific region is projected to generate the highest compound annual growth between 2021 and 2030. This expansion is driven by a heightened awareness of health matters, improved medical infrastructure, and an influx of advanced hospitals that specialize in mental health treatment. These trends indicate a deepening comprehension regarding psychological well-being within this area as well as increased investment into various mental health services.
LifeStance Health Group’s Bear Case:
- Margin pressure due to increased G&A expenses: LifeStance expects G&A to grow at a higher rate than revenue as the company invests in strengthening the business, which will depress margins YoY.
- Negative free cash flow in the first half of 2023: The company expects negative free cash flow in H1 2023 due to higher compensation costs and temporarily higher DSO driven by an increase in patient responsibility as deductibles reset.
- Slowing pace of de novo center openings: LifeStance plans to slow down the pace of de novo center openings to 40-45 in 2023, down from 90 in 2022, which could affect the company’s expansion plans.
- Consolidation of existing locations: The company plans to consolidate 30-40 existing locations, which may lead to some operational challenges during the transition.
- Uncertainty surrounding EHR initiative: The EHR enhancement initiative is in the early stages of discovery, and the company has yet to determine the path forward, estimated costs, and timeline for this project.
LifeStance has delineated a plan to concentrate on three pivotal areas within the next two to three years: introducing an HRIS system, developing a technology platform for clinician credentialing and onboarding, and refining the electronic health record EHR experience. Though these investments appear judicious, the non-recurring expenses linked to these endeavors will be incorporated into adjusted EBITDA calculations, which, from my perspective, potentially raises questions about the consistency of financial reporting.
The HRIS and technology platform undertakings are estimated to incur costs ranging from $6 to $8 million, with $2.5 to $3.5 million recognized as G&A expenses and the remainder classified as CapEx. I feel it’s noteworthy to point out that the lion’s share of these investments will be realized this year. Contrarily, the EHR initiative remains in its infancy, with the bulk of 2023 dedicated to examining various alternatives, potentially inducing ambiguity in the company’s future trajectory.
Furthermore, LifeStance foresees stock-based compensation expenses to oscillate between $90 and $110 million in 2023, encompassing roughly $25 million from new grants issued this year. Moreover, M&A expenditure is projected to hover around $40 million. So, despite the robust balance sheet, the company anticipates negative free cash flow in the first half of 2023, primarily attributable to compensation costs and a temporary increase in DSO. Also, positive free cash flow is expected to emerge in the latter half, due to the absence of initial costs and an amelioration in DSO from Q1 levels.
And, in a bid to attain long-term profitability, exercise capital discipline, and generate free cash flow, LifeStance is scrutinizing over 600 physical centers to optimize real estate expenditure. That is, the firm intends to merge 30 to 40 existing locations, decelerate de novo openings to 40 to 45 in 2023, and concentrate on clinician additions. In my opinion, while these measures seek to mitigate disruption for clinicians and patients, uncertainties surrounding their implementation may provoke apprehension among shareholders.
To sum up, I think that LifeStance’s recent financial performance is very commendable. Nevertheless, the assorted investments, expenditures, and initiatives planned over the ensuing years call for measured optimism.
LifeStance Health Group’s Bull Case:
- Strong topline results: LifeStance reported Q4 revenue of $229 million, a 21% YoY increase, driven by higher clinician count and productivity. Full-year revenue reached $860 million, up 29% YoY.
- Improved cash flow and liquidity: LifeStance generated positive free cash flow of $26 million in Q4 and exited the quarter with $109 million in cash, providing sufficient financial flexibility.
- Ongoing investments in growth: The company is making strategic investments in HRIS, technology platforms for credentialing and onboarding, and enhancing EHR experience to drive long-term benefits and operating leverage.
- Hybrid model advantage: As the PHE winds down, LifeStance’s hybrid model, which offers both in-person and virtual visits, positions the company well to cater to patients’ preferences and capture market share.
- Solid 2023 outlook and growth through 2025: The company expects full-year revenue of $980 million to $1.02 billion in 2023, and mid-teens annual organic revenue growth through 2025, with potential future M&A being incremental to that level of growth.
From a bullish perspective, the recent financial results for the fourth quarter of 2022 have painted a rather optimistic portrait of the company’s prospects. Revenue of $229 million and a center margin of $63 million surpassed expectations, with adjusted EBITDA of $10 million at the upper end of the guidance range for the quarter. From this angle, these figures certainly point towards the company’s preliminary headway in enhancing its operational performance.
Another noteworthy metric from the fourth quarter was the 8-day amelioration in days sales outstanding (DSO), which brought the quarter’s DSO down to 40 days from the prior quarter’s 48 days. This development implies that the company’s revenue cycle management process investments are beginning to yield dividends, ultimately boosting the firm’s free cash flow.
I think that the financial results for 2022 in its entirety were similarly heartening, with revenues reaching $860 million, marking a 29% year-over-year increase. Center margin expanded 18% year-over-year to $237 million and adjusted EBITDA achieved $53 million, constituting 6.1% of revenue. And peering into the future, the company’s 2023 outlook projects revenue in the range of $980 million to $1.02 billion, a center margin of $270 to $290 million, and an Adjusted EBITDA of $50 to $62 million. This forecast presumes steady operational performance year-over-year, propelled primarily by increases in clinicians, visits, and a moderate uptick in total revenue per visit.
Furthermore, I think that it’s crucial to highlight that the company’s 2023 growth strategy entails audacious investments in domains such as revenue cycle management, credentialing processes, and HRIS systems. Although these investments may temporarily provoke G&A to outpace revenue growth, they are anticipated to yield long-term advantages and elevated operating leverage as the company forges ahead.
In matters of liquidity, the firm saw a commendable generation of $26 million in positive free cash flow within the final quarter, accompanied by $36 million derived from operating activities. This progress not only signifies a tangible manifestation of the return on investment for the revenue cycle management team but also serves as a clear indicator that the company is indeed on a financially sound course.
Finally, while LifeStance Health Group, Inc. foresees negative free cash flow in the first half of 2023, chiefly due to rising compensation costs and elevated DSO levels, it projects positive free cash flow in the latter half of the year as these expenditures diminish and DSO levels recuperate.
As the global mental health market continues to expand, LifeStance Health Group, Inc.’s strategic investments in technology platforms, electronic health record enhancement, and revenue cycle management are likely to yield long-term advantages and boost operating leverage. However, uncertainties regarding the implementation of these initiatives and potential margin pressure due to increased expenses must also be considered.
Taking these aspects into consideration, I can deduce that LifeStance Health Group, Inc.’s future economic condition should not be too optimistic as suggested by the Bull Case nor extremely pessimistic like in the Bear Case. Henceforth, for a reasonable estimation of value, I applied P/S Price-to-Sales ratios along with EV/EBITDA Enterprise Value to EBITDA and P/E Price to Earnings multipliers to compute an array of figures that formed my blended valuation.
Given the pessimistic free cash flow forecasts, I opted for a P/S multiple of 2.0x to 3.0x which is lower than industry standards but perfectly rational given the company’s present financial standing. Utilizing its existing revenue of $859.5 million, this affords a fair value range that falls between $1.72 billion and an incredible $2.58 billion. Considering the current negative earnings per share -0.36 but postulating a future positive EPS of $0.10 to $ 0.15 over the following year, I chose an appropriate P/E multiple 50x-70x, which is in line with industry standards, yielding a wide fair value range between $5 and 10.50 per share.
To finish, I used the EV/EBITDA multiple with an EBITDA margin of 15%-20%, lower than the industry average. After analyzing its current EV at $2.92 billion, I derived a fair value range of between $3.29 and $4.39 billion. When considering all three models together, my calculated fair value ranges from $7.50 to $11 per share – which implies a median valuation of approximately $9.25; making me confident that LifeStance Health Group, Inc. stock should be seen as a “buy.”