Deconstructing the Castlight S-1

After spending the week with Castlight Health’s S-1 filing, one clear fact emerged: Castlight is an extraordinarily young company. Despite how long many of us have tracked the company, the S-1 notes Castlight only sold and implemented its first customer in 2010. Four years later, and the company is preparing for a $100M IPO that will value it at a rumored $2 billion. We dug into the three years of operating history and other notes about the digital health company in the S-1 to make sense of the offering. Here are five things we learned:

1) “Enterprise healthcare cloud” is the name of the game

As recently as February 9th, Castlight’s homepage made no mention of the “Enterprise Healthcare Cloud.” Then, on the 10th, Castlight’s S-1 used the phrase (or a similar version of it) 38 separate times. Castlight’s homepage was updated to reflect its new positioning. Why the change?

2) Enterprise cloud and public market valuations

Most observers have been underwhelmed by Castlight’s revenues, as the company reported less than $13M in the top line for 2013.  (Don’t bother looking at the net income or profits of the company—it is very early days to be generating a profit for a SaaS business with costly upfront sales and implementation costs balanced against hopefully long-term recurring revenue). In a dizzying handwaving of numbers and context, Castlight’s management explains that the company has $108.7M in “backlog,”  i.e., unbilled revenues related to their 106 customer contracts (How many of its signed contracts are implemented and generating revenue today? They don’t say—our guess is around 60-70, at an approximate value of $20,000-30,000 per month, per contract). At least $50.9M of the backlog is fully guaranteed, and will arrive in the window of 2014-2017, the majority beyond 2014.

Based on the Q4 2013 revenue run rate, the ratio of recognized revenue to backlog in 2013, the number of new customers signed in the second half of 2013, and implementation timeframes provided by the company, it is reasonable to assume Castlight’s revenues will exceed $30M in 2014, and could potentially even surpass $40M.

Taking an optimistic point-of-view and using forward revenues of $40M, Castlight would be asking for a 50X  forward sales multiple to reach its rumored $2B valuation. Even with the anchoring phrase of “enterprise cloud,” no comparable companies could be found that would justify such a figure. While SaaS valuations have been expanding due to revenue growth acceleration in the last two years, Tomasz Tunguz demonstrates on his blog that even the most expensive enterprise cloud companies fly below a 30X multiple.

Considering Castlight’s sales and growth rates in comparison to other recent “enterprise healthcare cloud” IPOs from BenefitFocus and Veeva Systems, Castlight would fall closer to a $500M-$1B valuation, the lower bound of which coincides with its most recent internal valuations related to the issuance of options in January 2014.

3) The sales and marketing model has yet to demonstrate a clear sign of stability or improved efficiency

Comparing incremental sales (i.e., additional number of signed contracts) by quarter to overall sales and marketing expenses shows that Castlight has not zeroed in on a model that can necessarily scale. This metric varies widely by quarter, with little relationship to the number of customers signed. Comparing the most recent quarter to the year ago quarter (falling inside of the “busy season”) demonstrates the opposite of what an investor might hope, with spend more than doubling (to $12M) while incremental deals declined (from 20 to 18).

In 2013, Castlight signed 59 customers, simultaneously increasing its backlog by nearly $65M. At a little over $1M in expected revenue per contract added (note the figure does not account for revenue recognized on the new customers in the period, which implies it must be slightly higher than $1M), a $750K acquisition cost is potentially tenable, although with customer implementation costs, it most likely swings back to a net loss on a per customer or unit economics basis. Ultimately, as with most SaaS businesses, the churn rate (i.e., the percentage of customers canceling or choosing not to renew) and customer lifetime (the average number of months a customer is held) will move the business model in or out of long-term unit profitability. Castlight reported that there has not been enough experience with expiring contracts to forecast renewals or churn rates, leaving customer LTV unknown at this point.

Note: Incremental sales figures used for the above chart were imputed from the total number of signed contracts at the end of each quarter. The S-1 did not provide a figure for Q1 2013, so it was assumed as the midpoint between Q4 2012 and Q2 2013.

4) Product expansion

In 2010, Castlight released its primary product, Castlight Medical. In the time since, multiple new products have been under development, with the company releasing three major products in 2013: Castlight Pharmacy, Castlight Rewards, and Castlight Reference-Based Pricing. The latter two are part of a broader Advanced Benefit Design offering.

These new products will serve as an avenue of growth for the company, driving additional products through its existing employer channel. The S-1 notes that sell-through on Castlight Pharmacy has already reached 60%.

Reference-based pricing allows for employers (or health plans) to set a maximum price (known as the reference price) they are willing to pay for a service or procedure, and then forces employees to pay any difference. This mechanism balances choice with financial responsibility for excess charges. With recent studies demonstrating the ability of reference-based pricing to significantly lower medical spending, expect this product to experience significant uptake as well.

Notably, while the company highlights its ability to execute on mobile, the mobile product offering is not described in detail. A quick review of the iOS app reveals that it is focused solely on the Castlight Medical offering.

Castlight Medical

5) A cornered market

Beyond a standard set of business risks posed by Castlight, the S-1 highlights the massive challenge facing the company as it relates to its health plan partnerships.

Castlight is a fundamentally data-driven company and it has no proprietary access to, or ownership of, healthcare pricing data. Instead, it relies on data sharing agreements with the major health plans, primarily driven through mutual customers. The S-1 notes that as a result of these agreements, and with aggregation of publicly-available data, Castlight has accumulated a total data set of 1 billion claims over its life. Significant, for sure, but overall, a fraction of the 5.6 billion claims that are submitted (see Section H) each year.

One major issue? Castlight notes that they have yet to strike a data sharing agreement with the largest health insurance company in the country, UnitedHealth Group, which represents 30M commercial lives. In an interesting note, Castlight states the challenges of mining the industry for data, having agreed with one health insurer to not work with UnitedHealth Group until January 1, 2015 in exchange for data access. (Our guess on the “national health plan” that demanded exclusivity? WellPoint.)

Further, Castlight outlines that “some health plans have developed or are developing their own proprietary price and quality estimation tools” that are competitive with its offering. This is an understatement when considered from a market perspective, as every national health plan—representing approximately a third of the overall market—has built and continues to iterate on its price transparency tools. Castlight should be commended for pushing the market to develop better transparency products for consumers; however, without any control over the data that drives its offerings, it is in a weak position against health plans that have no interest in helping the company grow its ties to their employer customers.

As Castlight recognizes, large, deep-pocketed health plans will happily give away or deeply discount price and quality transparency tools in order to sell more health insurance or health insurance administration services, placing significant price pressure onto the overall market for transparency solutions. Castlight’s business model affords no such luxury—it must sell subscriptions to employer customers. If employers are able to access a roughly equivalent product through their health plans at a highly discounted price, Castlight could struggle to grow its base of customers and renew its existing ones. While the company notes that there is a $5B market opportunity awaiting them, it would appear that Castlight, given the position of health plans, has a steep climb in front of it to reach the thousands of employers who might benefit from its solution.

Bonus Trivia

Castlight Health is on its fourth (and presumably final) name. The company was originally incorporated as Maria Health, changed its name to Ventana Health Services in 2009, and then to Castlight in 2010, and finally became Castlight Health.