Digital Health: Countervailing Forces…

Consider this: over the past five years nearly $78 billion has been invested in digital health companies and yet just this past year over 20 million Americans were taken off the Medicaid rolls. Certain policy changes can be very damaging, to say nothing of other human-induced factors like pollution, climate change, wars, inadequate housing and education, and hunger which have staggering implications on health. At times it can feel like bailing water out of a sinking ship. These issues can negate years of innovation (and investment), exacerbating the profound issues of cost and access. Is it all worth it? Arguably, yes, as technology is the great democratizing force in healthcare and should create a rising tide.

The opportunities to “transform the business of healthcare” (Flare Capital’s tag line) remain obvious and acute, notwithstanding that the level of investment activity has receded from the $30 billion highwater mark in 2021 to a more manageable $10 – $12 billion annual pace. Healthcare technology now represents approximately 8% of all venture capital investments. Just as important is the number of companies funded which is trending back to 400 – 500 companies per year, implying that round sizes have decreased dramatically to ~$20 million, according to data from Rock Health.

Source: Rock Health

Arguably, the 2021 hangover still lingers in the healthcare technology sector as companies that raised too much capital at too high a price work to sort out challenging cap tables. Out of the 2021 mosh pit of too many companies, it appears that the sector is in an “Emerging Winners” phase that will drive companies with narrow and/or incomplete offerings to combine or shut down. In general, financing rounds provide 15 – 18 months of runway, implying that maybe a company can raise ~3 years of capital before having to really make the call on its true prospects. This would put us squarely in the 2024 window. Rock Health flagged that 44% of all 2023 financing rounds were “unlabeled,” suggesting a high proportion of insider bridge extensions to buy a few more quarters.

This is not just a healthcare technology phenomenon. The overall venture capital activity in 1Q24 was a relatively muted $36.6 billion across 2,882 companies for an average round size of $12.7 million, as compared to $51.6 billion and 4,026 companies in 1Q23 according to a recent NVCA/Pitchbook analysis. This more defensive posture is expected given the continued and prolonged reduction in exit activity. For 1Q24, exits totaled a modest $18.4 billion across 223 transactions, approximately half of the value of new investments but a mere 8% of total companies funded, suggesting an ecosystem still out of balance. Some additional context: total assets under management by venture capital firms is $1.2 trillion.

Source: NVCA/Pitchbook

While venture investment quarter-over-quarter was modestly down ($40.1 billion in 4Q23 versus $36.6 billion in 1Q24), the number of companies that raised capital declined by 575. Both Early and Late Stage activity were relatively flat, and together accounted for 63% of the number of financings, while the Growth Stage dropped by $4.8 billion. Ironically, even employees wanted to hold less equity in venture-backed companies. According to an analysis of 43k companies by Carta, employees held 37% less equity in those companies as compared to 18 months ago, while salaries were largely unchanged.

A significant contributor to this downdraft was the decline in “mega rounds” (over $100 million). While less than 3% of all financings, “mega rounds” accounted for 47% of the capital deployed with an average round size in 1Q24 of $226 million versus $298 million in 4Q23. Surprisingly, there were 37 newly minted unicorns in 1Q24, which was 48% greater than 4Q23. The level of “first-time financings” materially dropped from $4.0 billion in 1,242 companies in 1Q23 to $3.1 billion in 827 companies in 1Q24, perhaps reflecting greater risk aversion to back first-time founders.

This deceleration is not unique to the U.S. as global venture investment activity declined 30% in 1Q24, according to analysis by Preqin, with China declining by 40%. The total amount invested was $57.8 billion, the lowest quarterly pace since 2017. Were it not for the AI frenzy, these numbers would likely be lower still.  

As capital became more expensive and harder to access over the last three years, median round sizes declined meaningfully across all stages but with the greatest 1Q24 decline for Growth Stage companies, now only registering an unbelievable $5.7 million. While the trends are similar, the average Growth Stage round size in 1Q24 was much greater at $31.8 million, reflecting the impact of the “mega rounds.”

Source: NVCA/Pitchbook

Arguably, the more interesting analysis is the impact on median pre-money valuations by stage. After a precipitous drop from 2021 to 2023 for Growth Stage financings ($400 million to $144 million), there are signs of life in 1Q24, notwithstanding the reduced level of overall investment activity. Across all stages there has been a sharp increase in median pre-money valuations, with the Growth Stage coming in at $229 million, which almost looks to be a typo. Notwithstanding that, Carta estimated that 20% of all financings in 2023 were “down rounds.”

Source: NVCA/Pitchbook

Liquidity makes the venture capital world go round. Sadly, that part of the narrative has stalled with an estimated 300 exit transactions totaling $18.4 billion (average deal size of $61 million), which is tricky when compared to the pre-money valuations. Pitchbook now estimates that there are 55k venture-backed companies with the average age of Growth Stage companies at 13.1 years; Late Stage companies are on average 9.5 years old. Bain & Co recently reported that there are 28k private equity portfolio companies that are worth $3.2 trillion. In 2023, the value of exited companies by private equity firms declined by 44% from 2022, the lowest level in a decade.

Source: NVCA/Pitchbook

Exit activity directly informs the amount of capital distributions which directly informs performance data. Unrealized gains have been significant but cannot fund new Limited Partner commitments and have been whittled down as the liquidity drought has been extended and some highflyers have gone on to raise additional capital at lower valuations. A Pitchbook analysis (below) underscores the decrease in distributions, which were 5.8% of Net Asset Value in 3Q23. While there is a delay in reported investment returns data, quarter-over-quarter venture capital IRR data are trending upward, coming off a very challenging 2022. The one-year IRR hit a low point in 4Q22 at -17.9% and has “recovered” to -9.1% in 2Q23, according to Pitchbook. A preliminary returns analysis from Cambridge Associates registered a 0.7% pooled return net to Limited Partners for 1Q24.

Source: NVCA/Pitchbook

Globally, across all private capital asset classes investment managers raised $1.17 trillion in 2023 which was nearly 20% less than in 2022, with venture capital declining by over 47%. In the U.S., 100 venture funds raised $9.3 billion in 1Q24, of which $1.6 billion was raised by 28 first-time fund managers. As a point of comparison, $183.5 billion was raised by 1,577 funds in 2021. Ironically, it is estimated that there is $312 billion of “dry powder” held by venture capital funds now. In 1Q24, a total of $155.7 billion of private capital was raised, suggesting continued sluggishness, although a bright spot has been the success of secondary funds, which might hint at additional future liquidity.

Source: NVCA/Pitchbook

Notwithstanding how (relatively) upbeat Chief Financial Officers might be now – 34% claimed to be “very optimistic” which is an eleven quarter high in Grant Thornton’s 1Q24 CFO survey– there has been a spike in bankruptcy filings for companies with public equity and/or debt. In 1Q24 there were 142 such filings, up from 132 in the prior quarter. Directionally, this development highlights both the higher cost of capital and perhaps deteriorating fundamentals, suggesting that investors may be less forgiving over the balance of 2024.

The healthcare technology sector has seen similar trends as was experienced in the broader venture capital market and continues to navigate the duality of the pandemic and rising interest rates. Payors, providers, and pharma – the customers for many healthcare technology companies – are under extraordinary budget pressures. Notably, though, a recent Leerink Partners survey of hospital administrators underscores both the resilience and endurance of these budgets. Automation and AI advances have kept IT priorities centered on clinical and administrative back-office initiatives. While telehealth and other patient-facing solutions have dropped materially on the priority list, overall projected IT budgets increased 14.3% for the rest of 2024.

A valuation analysis by Carta (below) for healthcare technology companies shows the relative strength of the Seed and Series A financings but also the dramatic reset of Series D valuations (median pre-money valuations dropped from $940 million in 2021 to $94 million in 2023), in part due to the very poor performance of the public companies in this sector. For instance, while the S&P 500 Index increased 10.2% in 1Q24, the Leerink Digital Health Index declined -6.6% (although the S&P 500 Health Care Index was up 8.4%). Even more pointed, the “High Growth Provider” sub-sector collapsed by -29.9% in 1Q24.

Source: Carta

Setting aside the dramatic impact on healthcare and the $38 trillion estimated costs incurred between now and 2049 by climate change, according to a study by the Potsdam Institute for Climate Impact Research, policy decisions made by our dysfunctional political system risks negating much of the benefits developed by today’s healthcare technology entrepreneurs. Case in point are the concerns now raised by the disenrollment of 20 million people from the Medicaid program, five million of whom were children and 23% of whom are now believed to still be uninsured, hinting at meaningful future health issues.

The U.S. population increased by 7.4% between 2010 – 2020, but the growth was quite uneven by state. While it was the slowest decade of overall growth in the last 100 years, there was significant migration across state lines with states arguably more hostile to innovative healthcare policies experiencing the greatest decline in population. Nearly half of all taxes are collected at the local and state levels which introduces the prospect of a downward spiral as tax bases are undercut, further limiting the ability to provide competent healthcare services.

Too Hard For Humans…

What a relief to hear last week that Elon thinks that the new AI models will be superior to human intelligence by the end of next year as many of us are struggling to make sense of the current economic climate. Last week there was a blow-out monthly jobs report, with the non-farm payroll advancing by 303k, almost doubling many analyst forecasts, but then inflation ran hotter than expected at 3.5% in March while the Volatility Index (VIX) spiked 16% this year. GDP growth in 4Q23 was revised upward to 3.4% from 3.2%, and yet the S&P 500 Index was off 1.7% this past week.

Technology disrupts. One observation of disruption is initially it is triggered by a few companies which then enjoy the much of the spoils of those advances. Since the start of the Industrial Age, the waves of disruption have become shorter but more intense, with the impacts being greater and more severe. An analysis by Bank of America concluded that since 1926, just 3% of all companies generated $55 trillion of shareholder value. The analysis also determined that the average lifespan of S&P 500 companies dropped from 61 to 16 years between 1958 and 2021: creative destruction. Nearly one-third of S&P 500 companies have been replaced in the index since 2015 alone. By 2027, it is estimated that average company longevity could be as short as 12 years.

Disruption also raises a concern of power and wealth concentration. Setting aside that the top 1% of Americans now own more than half of all stocks worth $44 trillion or that the UBS Global Wealth Report tallies 59.4 million millionaires globally (only 0.6% of the world’s population), the “Magnificent 7” stocks (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Telsa) have increased by 90% since the beginning of 2023, while the less magnificent 493 have only gained 18%.

Source: Goldman Sachs Research

The issue of concentration in the U.S. public equity markets has not been this acute for nearly 100 years. Today, the top 10 largest U.S. stocks account for 33% of the S&P 500’s market capitalization which eclipses the 27% at the height of the Dot.com bubble 25 years ago, according to research from Goldman Sachs. Fortunately, this concentration has driven a 16% annual return for the S&P 500 Index over the last five years, as compared to 10% over the past 30 years when valuations were more broad-based. Notwithstanding that, the S&P 500 Index enjoyed its best 1Q since 2019, increasing 10%, driving $74 billion of new equity issuances, which was 110% ahead of 1Q23 volume.

Source: Goldman Sachs Research

The valuation bubble over two decades ago is relevant again given the current raging AI bull market. An analysis by Apollo Global highlights how elevated the forward median P/E multiple is for the Top 10 stocks in the S&P 500 Index, which is now touching 40x, versus the 20.9x for the overall index (which is closer to where the Top 10 stocks were trading in 2000). Notably, Warren Buffett’s Berkshire Hathaway has been sitting on $168 billion of cash for some time and has been reluctant to invest at these levels. The ratio of corporate insider selling to buying hit its highest level this quarter since 1Q21, according to Verity LLC, driven mostly by technology executives.

Source: Apollo Global

Of course, the P/E multiple is a function of underlying earnings (both quality and momentum) so arguably investors have concluded – at least for the time being – that these market-leading companies possess both. From just prior to the pandemic to 2Q22, corporate profit margins increased markedly from nearly 13% to 17% and have only slipped to 16.4% by 3Q23 with the resolution of supply and labor constraints, according to an analysis by the Commerce Department. One question raised by these data is whether strong corporate profits drive inflation. The Wall Street Journal observed that from late 2019 to late 2023, corporate profits increased by 40% while labor and other supply costs increased by only 17%. Had profits simply grown at the same rate as labor and supply costs, prices may have only increased by 12.5%, leading to an annual inflation rate this year that most likely would have been 100 basis points lower.  

Source: Commerce Department

Interestingly, with the euphoria of AI, the crypto asset class is enjoying a mini renaissance of sorts. Capital flows into crypto funds have spiked in an unprecedented manner, suggesting that cumulative investments this year into these funds could total $54 billion. Over the last twelve months, the price of Bitcoin has increased 133% and more than 54% year-to-date. The strongest performing asset this quarter was Cocoa, also up 133%, given the climate crisis in western Africa. Sadly, and surprisingly, the worst performing asset was the NYMEX Natural Gas Index which was down 30% in 1Q24.

Source: EPFR

Another troubling sign hiding in plain sight is global debt levels, both corporate and government debt. Arguably, the availability of debt capital has contributed to the explosion of asset values generally which has led some to be concerned about systemic risk. Notwithstanding that the Federal Reserve’s recent Summary of Economic Projections has increased its 2024 U.S. GDP growth estimates from 1.4% to 2.1% just over the last 90 days, the U.S. national debt will reach $35 trillion by May 2024 and will double over the next eight years. Every 100 days the national debt increases by $1 trillion. Government spending in 2024 is expected to hit $6.7 trillion; $1.1 trillion in interest payments have been made just in the past twelve months.

Source: Bloomberg, Haver

The Congressional Budget Office (CBO) now estimates that in 30 years – in 2054 – interest payments will equal 6.3% of GDP, while social safety net programs (Social Security, Medicare, etc) will consume more than half of the federal budget. The CBO forecasts that debt as a percent of GDP will be 107% by 2029 and a staggering 166% by 2054.

Just over a year ago the private capital markets were deeply rattled by the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank. Remarkably, the investment community (relatively) quickly adjusted, casting a bright light on the importance – and scale – of the private credit market. As of mid-2023, the Federal Reserve estimated that this market was $1.7 trillion and that there was approximately $800 billion of private direct lending. This illiquid non-bank lending market is rather opaque, which has made some nervous about the systemic risk that may be lurking – especially in an environment with elevated interest rates and a spike in credit defaults.

Source: Preqin

Somewhat encouraging has been the level of refinancing activity over the past few quarters which has reduced the amount of high yield debt due between 2024 – 2026 by 40% to $329 billion, according to an analysis by Bank of America. Anxiety was building in 2023 about the wall many companies were going to run into were it not for the recent robustness of the private credit market. This past quarter saw $325 billion of private debt financing, which was near an all-time high and likely due to relatively high interest rates and strong corporate performance (and perhaps, in part, due to borrowers’ desperation). Something to be watched closely: the Federal Reserve’s Shared National Credit Program, which monitors performance of these loans, estimates that 26% of them are at risk of being “non-performing.” That amount now totals nearly $490 billion; it was $348 billion at the end of 2022.

Source: Pitchbook, Axios

Further complicating the analysis has been the disappearance of the “equity risk premium” which effectively evaporated in early 2024. This metric, which measures the excess return from public stocks over a risk-free rate (i.e., Treasuries), underscores both the lofty equity valuations today but also the rapid rise in interest rates and the relative attractiveness of holding senior securities with covenants.

Source: Oaktree Capital Management, Axios

One other possible harbinger as to the quality of debt portfolios: the burden of credit card debt on consumers. Interest and fee payments increased 50% in 2023 from 2020 to $157 billion, according to Federal Deposit Insurance Corp (FDIC) data. At the end of 2023, it was estimated that there was $1.13 trillion of credit card debt and that the delinquency rate was 4%, which is thankfully well below the 7.1% seen during the Great Recession 15 years ago but is rising. Not helping matters is the staggering $1.6 trillion of student loan debt held by 43.2 million Americans as of 4Q23, leading the Biden Administration to authorize the forgiveness of approximately $150 billion of that debt burden.

There are also loud whispers about the credit risks residing in the commercial real estate sector, for which banks hold approximately 50% of all loans. The FDIC estimated that there were $478 billion in unrealized losses on securities in the banking system at the end of 2023, which is roughly 20% of the capital in the system.

Arguably, one of the greatest global systemic risks resides in China, which has been the provider of cheap capital to the global financial system for years and is now under severe strain. The country recently tiptoed over the 300% of Debt to GDP threshold, exposing the monumental real estate debt issues, to say nothing of slowing economic growth rates, structural under-employment, and a rapidly aging population. Last week Fitch Ratings lowered its outlook on China’s long-term credit rating to “negative.” A recent Swiss Re report estimates that there is $8.9 trillion of Chinese real estate loans. Exports dropped 7.5% year-over-year in March. A hard landing in China will be felt around the world, ironically likely leading to lower inflation rates in the U.S. with a flood of cheap(er) Chinese imports. See Janet Yellin’s recent trip to China.

Source: CEIC, Bank for International Settlements

Obviously, we live in a global marketplace, as much as some national leaders try to undermine that reality. Advances in technology both drive employee productivity, improve standards of living, but also attract capital at reasonable costs. China has enjoyed exceptional productivity growth, estimated to be approximately 8% per annum over 25 years (1997 – 2022), according to an analysis conducted by McKinsey & Company, but at quite modest economic values per employee. Relative to other “Advanced” economies, the U.S. has enjoyed slightly greater productivity growth (~1.5% vs 1.0%) over those same 25 years with more than $110k values per employee. The challenge now is to harness this next wave of innovation in AI to further drive productivity per employee, and in so doing, to increase the economic value created per employee.

Source: McKinsey & Company

Access to cheap capital has financed much of this innovation that has powered the U.S. economy. Excessive leverage and highly concentrated power and wealth are troublesome given these uncertain times, making the path forward all the more confusing.  

To come full circle. According to the International Energy Agency, one ChatGPT request requires 2.9 watt-hours of electricity which is enough to power a 60-watt light bulb for about three minutes and is 10x the power required for one Google search. The power required to support the growth of the AI industry from 2023 to 2026, when AI will be smarter than all of us, will increase 10x. Industry analysts estimate that AI data centers by 2030 will consume 20% – 25% of all power generated in the U.S., up from ~4% today. The computing power needed to train one Large Language Model is increasing 275x every two years. The AI boom contributed directly to a 27k metric ton deficit of refined copper last year, according to International Copper Study Group. All of this seems like a monumental obstacle.

It may well turn out that we will not be able to rely on AI to figure all this out for us after all…

Long Odds: Healthcare Technology Vs. Gambling…

The American Gaming Association (AGA) estimated that $2.7 billion was legally wagered on the “March Madness” tournament this past weekend, which does not account for office pools and private bets among friends. While this is a small fraction of the $23.1 billion estimated to have been wagered on this year’s Super Bowl, both reflect a dramatic increase over prior years given the proliferation of new sports gaming apps and additional states permitting legalized gambling.

The AGA estimated that the U.S. gaming industry revenues was $66.5 billion in 2023, which is a 10% increase over 2022. If one were to include the “tribal gaming” revenues, the total would have been closer to $110 billion. While legalized sports betting was only $10.9 billion in 2023, it increased significantly year-over-year by 45%. Clearly, there has been a dramatic post-Covid upswing in gaming revenues with robust consumer spending, popularity of new gaming apps, and that gambling is now permitted in 35 states.

The AGA is quick to point out that $14.4 billion was paid in gaming taxes in 2023, which while laudable and a real number, happens to only be how much was spent on just treating Parkinson’s Disease last year. Perhaps what is more troublesome (or insidious), along with a much more permissive environment and greater real-time accessibility, is the level of unchecked illegal gambling, now estimated to be $510 billion. To provide some context, this is the GDP of Thailand or the United Arab Emirates.

While the AGA claims that there are 468 commercial casinos in the U.S., PlayToday.co estimates that there may be as many as 2,150 gaming locations nationwide. Coupled with mobile sports gaming apps, the proliferation is extensive.

But the AGA casts an even wider net, taking credit for the $329 billion of economic activity “associated” with gaming which in turn generated $53 billion of tax receipts. In addition to the 700k people directly employed by the gaming industry, there are as many as another 1.1 million people employed by ancillary industries, all in support of the gaming industry. Those “benefits” simply need to be weighed against the costs of irresponsible gaming and frankly a better understanding of who should bear those costs.

It is also increasingly apparent that gaming is skewing to a younger demographic as the on-ramps to gaming is targeted to that age group. The emergence from Covid appears to be correlated with younger consumers craving “experiential” consumption versus goods. This past year was the greatest difference between the average age of the overall U.S. adult population and those who frequent casinos.

Some additional context. According to BankMyCell, there are 8.93 million mobile apps globally and those are projected to generate $613 billion in app revenue by 2025. There are an estimated 300 app stores globally. The Apple app store only has 1.64 million apps available, while the Google Play Store has 3.55 million. Mobile games are nearly 14% of all apps with $51.6 billion spent on them in 2021. Approximately 175 billion apps are downloaded annually. The typical subscriber has 40 apps on his/her phone. It is utter chaos out there.

Buried in the overall gaming industry data is the explosion of iGaming, which the AGA sized at $6.2 billion in the U.S. in 2023. Trackier’s iGaming Report 2023 estimates the global iGaming market to be $81.1 billion, perhaps suggesting an emerging Third World concern. This phenomenon was just on the horizon when I last dug into the impact of gambling on the healthcare sector.

The migration to iGaming also promises to be far more profitable for the gaming industry as gamblers betting on in-game action are believed to face poorer odds of winning. An analysis by Macquarie concluded that traditional pre-game betting generated 5% margins to sports gambling groups but that in-game betting will likely be greater than 10% margin. BetVision estimates that 25% of all sports gambling today is in-game, which will likely reach 70-80%. Interestingly, the S&P 500 Casinos and Gaming Index is down 2.9% over the last twelve months, while the MarketVector Global Gaming Index is up 4.9% over the same period.

The effects of out-of-control gambling on an individual and the overall burden to society are reasonably well understood. A male gambling addict is thought to have between $55 – $90k of gambling debt (women gamblers have on average $15k of debt), according to Debt.org. While the National Council on Problem Gambling estimates that 75% of Americans have gambled at least once in the prior twelve months, it is believed that 15% gamble weekly and approximately five million people are considered “problem gamblers.” An estimated 20% of these gamblers file for bankruptcy. Sadly, 500k American teenagers are considered “problem gamblers” – see chart above. The American Psychological Association determined that 4% of those with substance use disorders also are considered problem gamblers.

Even more disturbing is the link between gambling and suicide. A 2022 study published in Front Psychiatry looked at studies from several countries and concluded that between 22 – 81% of problem gamblers have had suicide ideations, and that 7 – 30% had actually attempted to commit suicide. Consistently in all studies reviewed, suicidality was notably greater than that of the general population. Overall, the American Foundation for Suicide Prevention estimates that there are 49k suicides annually.

Until 2013, problem gamblers were considered to have an impulse control disorder, which has since been reclassified as an addictive disorder, consistent with alcohol and drugs. The implication of this determination is that problem gamblers develop an intolerance that requires more intense gambling (higher stakes, more frequency) to feel satisfied. Low income and younger gamblers are considered the most vulnerable to the addictive nature of gaming. As with other vices, gambling tends to prey on the most vulnerable.

An arms race of sorts is unfolding to treat behavioral health issues. It is estimated by the IQVIA Institute for Human Data Science that there are now 350k health and wellness apps in apps stores globally, of which more than 10k are specific to mental or behavioral health conditions. In 2020 alone, there were an estimated 90k new health apps released, a clear response to the pandemic.

A 2019 study published in Nature Digital Medicine concluded that while many of these apps made effectiveness claims, unfortunately a majority of them did not cite specific validated scientific studies leading to significant clinical skepticism. The most popular apps offered guidance on relaxation, mindfulness, and meditation which has limited applicability for problem gambling and those with more significant clinical conditions.

These issues are not lost on healthcare technology investors. According to Rock Health data, since 2019 the most funded clinical indication each year was the Mental Health category, having seen nearly $11.5 billion invested over the last five years. There was $4.9 billion invested just in 2021, in the vortex of the pandemic. The next most active indication was Cardiovascular, a distant second at $5.1 billion.

These digital solutions may serve as effective adjuncts to the more traditional treatment infrastructure. According to the Substance Abuse and Mental Health Services Administration,  there were 14.9k registered behavioral health facilities in the U.S. in 2022, of which only 9.6k completed the National Substance Use and Mental Health Services Survey. The total number of clients in treatment as of March 2022 was 1.6 million, obviously a small fraction of those considered most in need of such services. It is this gap that many of the digital behavioral health solutions are hoping to address.

Is it any wonder that the U.S. dropped so precipitously in the World Happiness Report (2024) released last week, which is now ranked #23 of the 143 countries surveyed? On the 8-point scale, the U.S. earned a 6.725, trailing far behind perennial winner, Finland, with a score of 7.741. The report specifically called out the dramatic decline in the happiness of America’s youth (ranked #62), declining twice as fast as that for elder Americans. In most other regions of the world, the young tend to be happier than the old which is not the case in U.S. Sadly, Afghanistan ranked last with a score of 1.721.

One can only hope that technology will improve the overall human condition. Maybe, for all the advances made, continuing to enable poor behavior just keeps us running in place…

Source: World Happiness Report

Autonomous Vehicles vs. Bad Drivers…

According to the National Highway Traffic Safety Administration there were just over 6.1 million traffic accidents in the U.S. in 2022, of which 42.8k were fatal. These accidents led to 2.1 million emergency room visits. Globally, the World Health Organization estimates that 1.35 million people are killed on roadways each year, which is approximately 3.7k people every day, making this the leading cause of death for those aged between 5 – 29 years old, and the eighth leading cause of death overall. In 2019, the Lancet tallied the global costs associated with traffic injuries to be $1.8 trillion or 0.12% of global GDP.

With nearly 17k traffic accidents every day in the U.S., the odds that you will be in an accident are estimated to be one in 366 for every 1,000 miles driven according to data from Esurance. In 2018, the Centers for Disease Control and Prevention (CDC) concluded that traffic deaths caused $55 billion in medical and work loss costs.

While there is a debate about the overall benefits (and risks) of autonomous vehicles (AV), it is the potential for meaningful improvement in medical costs and outcomes that the excitement for AVs is building. Ironically, the New York Times last week published research revealing the extent to which “smart cars” are disclosing driver behavior data to insurance companies which is causing unexpected changes to premiums as actual drivers’ risks are better understood.

First, a sense of what is coming. The AV market is simply exploding. According to Market.US, the global AV market will be more than $280 billion in 2024 and assume that fully autonomous vehicles will account for less than 50% of the AV market, suggesting that the driving public will not completely surrender to fully AVs.

Source: Market.US

A comparison with an analysis from Precedence Research suggests that the U.S. market will represent a clear majority of the global marketplace, upwards of ~75%. Interestingly, while estimates vary considerably, the U.S. is thought to have approximately 4.2 million miles of roadway according to research from Statisa. The Smithsonian estimates that there are 40 million miles of roadway globally and that it will increase by 60% by 2050, making for even more traffic chaos and increasing the urgency to address inadequate and unsafe transportation infrastructure.

This is against a broader context that the U.S. population is rapidly aging and is presumably less safe as a driving public…and arguably even more dependent on reliable transportation services. By 2030, roughly 50% of the Medicare-eligible population will be 75 or older. Pressure to move care services to the home coupled with dramatic issues with labor shortages, AVs offer potentially a more elegant alternative to affordably connect patients with providers. Additionally, significant operational efficiencies may be realized with broad adoption of AVs, particularly with delivery drones and robots.

The impact of AVs will be multi-faceted and complex, likely with both positive and negative unintended consequences (hopefully, far fewer animals will be hit by cars which is estimated to be a staggering one to two million every year according to the National Highway Traffic Safety Administration (NHTSA)). Numerous unanswered questions abound: who owns the liability for those presumably rare accidents, how is the algorithm going to pick between two bad choices (hit the parked school bus or the person who stepped into the crosswalk?), what happens to the $350 billion U.S. auto insurance market, will those decisions be uniform across manufacturers, will there be more or less emissions, etc.

Arguably, there are at least several dimensions to be considered when looking at the impact on healthcare such as more intelligent transportation infrastructure, overall access and safety, public land use, and general environmental impact. This is an important theme for our firm as Flare Capital invested in Circulation, which partnered with Uber and Lyft to provide non-emergent medical transportation services.

With broad adoption of AVs, one might expect fewer traffic fatalities but that could be offset with increased miles driven associated with greater ease of use and lower overall costs of ownership (moving from a fully owned vehicle to an as needed, per trip basis). This is to say nothing about improved access to the healthcare system with an intelligent, always-on transportation ecosystem.  

A clear public health benefit will be more effective use of public spaces as infrastructure such as roadways and parking garages will be better utilized and less critical in an always-on, shared AV marketplace. The Parking Reform Network estimates that cars in the U.S. are used less than 5% of the time, suggesting shared AVs would dramatically reduce the need for each of us to have dedicated owned vehicles. The Earth Institute at Columbia University concluded that automobile usage will increase to 75% with board AV adoption. This also suggests much of the urban parking infrastructure could be repurposed for more appropriate uses such as public housing and open spaces.

Less clear are the environmental impacts. Broad deployment of AVs may cannibalize traditional mass transit systems, therefore increasing the amount of travel activity and emissions, which would have an obvious impact on overall public health.

There is a rather morbid implication with broader AV adoption: reduction in organ donations. According to the NHTSA, nearly 95% of all traffic accidents are caused by human error, including drunk driving, being otherwise distracted or tired, and just plain reckless. Per data from the National Foundation for Transplants, in 2021 there were 34.8k organ transplants – nearly equivalent to fatal traffic accidents – with sadly 106.6k people on various organ waiting lists. Wait times for a heart is estimated to be 191 days, which will materially stretch out with far fewer traffic accidents.

The most broken law in the U.S. is speeding. The NHTSA determined that there were 112k speeding violations issued every day, with the highest percentage being those in Virginia at 17.7% getting at least one ticket in 2020. On average, 10.5% of Americans have received at least one speeding ticket, while 78% of those in a NHTSA survey confessed to “occasionally” speeding.

A clear benefit to AV adoption will be (hopefully) a dramatic reduction in roadside billboards advertising for lawyers to assist you in the event of traffic accidents. That will most definitely be an improvement to public health.

Highly Leveraged Demographics: Medical Debt…

Right on top of the debate about the age of our Presidential candidates dropped the Congressional Budget Office’s (CBO) latest projections forecasting the country’s budget deficits through 2034, highlighting the impact of the extraordinary costs of healthcare on an aging population. An estimated 35% of government expenditures over the next ten years will be on Medicare and other healthcare costs. Social security will account for a further 28%.

Specifically, the CBO projects that budget deficits will increase to $2.6 trillion by 2034, up from $1.7 trillion this past year. On a nominal basis, federal spending will increase to $10.1 trillion by 2034 as compared to $6.4 trillion in 2024. In 2023, the Treasury Department issued $23 trillion of bonds at a time when interest rates spiked 500 basis points and ended the year with a record $26 trillion of federal debt. Given the more expensive cost of capital, interest will double from $870 billion this year to $1.6 trillion in ten years and will have generated $1.1 trillion of incremental interest costs versus earlier projections. Over those ten years, interest will account for 21% of federal spending, just behind Medicare at 25%. This year interest expense is expected to be 3.1% of GDP with total debt at just under 100% of GDP.

Source: St. Louis Federal Reserve.

While the debt burden was spiking prior to the pandemic, it is notable that it was a healthcare crisis that created such widespread economic concerns. Notwithstanding that, with near zero cost of capital and significant liquidity, asset valuations surged earlier this decade somewhat obfuscating debt concerns. The S&P 500 Index gained 35% from December 2019 to December 2021 and housing’s real return was nearly 20%.

The “wealth effect” coupled with very real health risk concerns played havoc with analysts’ population models. The labor force participation rate for those 65+ dropped meaningfully, leading the Federal Reserve Bank to conclude there were 3.27 million “excess retirees” at the end of 2022. While the reduction of this highly skilled labor force risks overall U.S. economic productivity, it also puts the issue of medical debt in the spotlight.

Approximately 17.7% of the U.S. population is over 65 years old and getting older. Furthermore, while 90% of Americans have some type of health insurance, the Census Bureau in 2021 estimated that 15% of households have medical debt. Nearly 20 million people (approximately one in twelve) are managing an estimated $220 billion of such debt, which happens to be ~5% of annual healthcare expenditures (or the GDP of Greece or Kazakhstan). Per the Consumer Financial Protection Bureau, there is $88 billion of medical debt listed on credit reports. Much of this is likely due to the increased popularity of “skinny” insurance plans and cost-shifting to the patient via greater out-of-pocket copays.

As a point of comparison, the Federal Reserve determined that there were 43.2 million Americans who owed $1.73 trillion in student loan debt at the end of 2023.

The Medicaid and CHIP Payment and Access Commission determined that U.S. hospitals incurred $28 billion in charity care costs in 2019, while the American Hospital Association reported that in 2020 all tax-exempt hospitals delivered $130 billion in “total benefits to their communities.” Definitive Healthcare concluded that bad debt held by U.S. hospitals is greater than $50 billion. The total debt held by patients plus written off by providers each year is a staggering sum, likely running toward $1 billion each day.

Source: PopulationPyramid.Net

The burden of medical debt is disproportionately borne by those in poor health. According to the recent Health System Tracker survey by Peterson – KFF, adults with relatively high income but in poor health are more likely to have medical debt than those in good health but lower income levels. The Federal Poverty Line (FPL) in 2021 was set at $12.9k for a single adult and $26.5k for a family of four. For those in poor health and below 4x the FPL there was an incidence of 22% of medical debt, while only 3% of those greater than 4x the FPL and in excellent health had medical debt. In each stratum of health status, those below 4x the FPL had a greater medical debt load reflecting the scourge of income inequality.

Interestingly, the level of medical debt quite clearly varies by state, with a clustering of those with a greater debt burden in the Southeast. While undoubtedly the reasons for this are numerous and complex, public policies that look to curtail public health benefits and limit Medicaid rolls arguably have shifted some portion of healthcare costs onto the individual. Residents in metro areas had an 8% incidence of medical debt while non-metro residents were at 11%. Nearly 18% of South Dakota residents had medical debt while only 2.3% of Hawaiians did.

An analysis by age cohort concluded that 11% of those between 35 – 49 had medical debt and that the incidence of medical debt declined with age. It is well-understood that income and wealth has tended to be concentrated with older generations – those over 54 years old accounted for 71.6% of the nation’s wealth. Just prior to the pandemic, 37% of the U.S. population was under 40 years old yet only accounted for only 4.9% of the country’s wealth; as of 3Q23, they accounted for 6.6%. According to a recent analysis by the Federal Reserve, U.S. household net worth was approximately $151 trillion at the end of 3Q23, with median household net worth being $162k. The top decile was $1.56 million while tragically the bottom decile had no net worth.

Surprisingly, though, since the pandemic the younger generations have seen an acceleration in their rate of wealth creation. There is some speculation that this may be due to a greater reliance on their parents for housing and their health benefits through a parent’s employer. A recent analysis by Barron’s concluded that the 55 – 64 age cohort is working more and staying employed longer as compared to before the pandemic, delaying retirement, because of inflated costs due to healthcare and other family considerations. The hope is that the younger generations will be better able to manage the inevitable medical expenditures that come with aging.

Source: Board of Governors of the Federal Reserve System.

Sadly, though, according to a recent Montclair State University study, Gen Zers (12 – 27 years old) are experiencing the world as more dangerous and are notably more anxious. This has been attributed to health concerns surrounding Covid and the opioid epidemic, as well as the level of student debt, climate concerns, and hateful social media.

Cohere Health: Authorized to Break-Out…

Late last week the Bureau of Labor Statistics released a blow-out jobs report showing that 353k new jobs were created last month, nearly doubling expectations. The year ended with 157.2 million employed Americans with an unemployment rate of 3.7%, continuing a 24-month streak of less than 4.0%. Of that total, 17.2 million (11.0% of total) are employed in the healthcare industry according to recent analysis by Altarum. This has been on a steady upward climb over the last 30+ years from approximately 7.5% of total to 11.0% with notable spikes during recessions and the pandemic. Healthcare employment grew 3.9% last year as compared to 1.5% for all other industries.

Healthcare Share of Total Employment

Source: Altarum (January 2024).

Also, late last week, Cohere Health, a long-standing Flare Capital Partners portfolio company, announced the close of its $50 million Series B financing. The company has developed an intelligent suite of powerful automated prior authorization (“PA”) products that augment existing utilization management programs. While the timing of these announcements are completely coincidental, the underlying dynamics at play here point to a fundamental tension: there is simply too much non-clinical labor in healthcare to meaningfully lower overall costs of care. An October 2021 study in JAMA concluded that there are twice as many administrative staff as there are frontline doctors and nurses.

In 2021 a McKinsey analysis identified $265 billion of administrative costs that could be removed from the U.S. healthcare system without impacting quality or access to care. Overall, it is estimated that there is $200 billion of costs associated with the “financial transactional ecosystem” which includes activities such as PA, claims processing, and revenue cycle management. Cohere Health estimates that there is approximately $30 billion in costs associated with just utilization management.

Across the healthcare system there is a heightened degree of vendor fatigue with a landscape littered with narrow point solutions. Quite simply too many undifferentiated companies were created over the last five years, partially in response to the pandemic demands placed on the healthcare system to quickly become virtual, on-demand, always on, transparent, predictable, and intelligent. It is quite clear that we have now entered the “emerging winners” phase of this funding cycle.

So what accounts for the strong reception the company received by investors, especially considering the recent dramatic decline in venture funding for digital health companies ($29.2 billion vs $10.7 billion invested in 2021 and 2023, respectively)? First, the company has built an impressive, highly relevant, and complete management team. Great people will always attract capital. Additionally, management was very deliberate about having significant depth on both the clinical and technical teams, which resonated with investors.

Having identified a very specific need in the market, the team developed products that were precisely responsive to that need and did so in a manner that limited the amount of custom integration. The company has a comprehensive solution with end-to-end automation incorporating generative AI capabilities, all highly valued by customers which drove dramatic revenue growth. Importantly, management did not over-capitalize the company during the frothy times two years ago. Being slightly capital constrained at the outset reinforced a maniacal focus on just building what the market will pay for today. Today Cohere Health sells both a fully delegated product as well as a “Platform as a Service” offering.

Notably, Cohere Health is a terrific example of Flare Capital’s “Co-Creation Model,” whereby we partner with one of our strategic limited partners to collaboratively build a company to address immediate market opportunities. In this approach, our corporate partner contributes an asset (intellectual property, launch contract, etc) and we recruit a world-class management team and provide capital. This has proven to be a very effective approach to quickly scaling a new company.

Importantly, there has been an explosion in artificial intelligence and machine learning that Cohere Health has drafted behind. The requirement for greater data liquidity in healthcare is obvious. The CAQH Index, which tracks payor and provider adoption of electronic transactions, estimates that there were 228 million such transactions in 2022, growing at 7.4%. According to Niall O’Connor, the Chief Technology Officer at Cohere Health, clients are seeing a greater than 3-to-1 cost savings by simply automating the data flow and migrating clients away from analogue “channels and behaviors” to digital.

As computers are better trained to mirror actual clinical decisions, savings start to head to 10-to-1 ROI. Cohere Health has now automated 80-90% of all PAs with a target of 95+% for most procedures (this will likely never be 100% given specific issues will be found that will require human clinical intervention). One word of caution involves the phenomenon known as the “paradox of automation.” As AI replaces human judgement and intervention, the overall competency of humans may dull. This concern is especially heightened in healthcare as these tools are used by lesser credentialed clinicians.    

Not to be lost in the value proposition discussion is the dramatic reduction in friction and improved patient experience. According to a recent Grant Thornton survey of 100 healthcare CFOs, approximately 75% stated that improved patient experience was the greatest component of current growth strategies.

The PA competitive landscape is complicated and falls along two principal vectors: degree of cost impact and degree of administrative burden (the top two quadrants below have lower operational burden). The emergence of large language model (LLM) vendors has undoubtedly accelerated the pace of innovation but those platforms risk being commoditized as fast-follower open-source platforms appear. The companies that offer differentiated applications on top of LLM platforms should endure. “We have a mini hospital attached to us,” observed O’Connor.

Source: Cohere Health.

Not surprisingly the regulatory considerations are significant and provide a meaningful tailwind. According to America’s Health Insurance Plans (AHIP), there are 26 bills pending in 16 states already. There is considerable momentum to drive greater transparency of reporting metrics, data interoperability, and to facilitate better communications between payors, providers, and patients. The Interoperability Prior Authorization Final Rule (CMS-0057-F) was released last month by the Centers for Medicare & Medicaid Services (CMS) and mandates that most operational provisions need to be enacted by the beginning of 2026.

Notwithstanding the marked increase in healthcare technology investment (over $55 billion in just over 1,800 companies in the last three years according to Rock Health), 2023 saw the greatest increase in healthcare employment with 654k new jobs added. Approximately 25% of all jobs created in the U.S. were in healthcare, underscoring one of the ironies that technology adoption has not yet reduced the need for labor.

Healthtech 2024: Voices in My Head…

What is going on? The stock market just hit an all-time high and yet nearly everywhere one looks, there are flashing warning signs. A review of the 2023 investment activity suggests there will be continued challenges in the capital markets. Clearly, the bulls look to the $8.8 trillion in money market funds and conclude that as interest rates continue to fall much of that capital will rotate back into risk assets. Today, U.S. household net worth is over $152 trillion. But it still feels so schizophrenic.

Data: FactSet. Chart: Axios Visuals

But first some of the troubling indicators not to be ignored, to say nothing of the numerous global hot spots now. The World Bank recently concluded that the global economy just suffered its worst 5-year stretch over the last three decades, and now forecasts only 2.4% economic growth in 2024. The analysis concludes that the 24 lowest income earning countries are at “crisis levels,” which will acutely exacerbate global immigration issues. The “low/middle” income countries have economic activity that is at least 5% below pre-pandemic levels.

The Federal Reserve incurred a 2023 operating loss of $114.3 billion, its largest in its 109-year history. Moody’s noted that global bond defaults spiked to a trailing twelve-month average of 4.8%, which does not even start to account for the $117 billion of U.S. commercial real estate debt that must be refinanced in 2024 – perhaps the greatest near-term potential systemic contagion. U.S. office vacancy rate just touched 19.6%, the highest level since the late 1960s when Moody’s started to track these data.   

The London Stock Exchange concluded that the global M&A activity of $2.9 trillion of 2023 transaction volume was the first time in ten years that activity fell below $3.0 trillion. This level was 17% below 2022 (6% decline in the U.S.), with financial sponsor activity down by nearly 30%.

Not surprisingly, these conditions directly impacted investment activity in the private equity and venture capital sectors in 2023, which was markedly down across the board. Notwithstanding that there is an estimated $2.6 trillion in dry powder in private funds according to S&P Global Market Intelligence, a fundamental issue was the lack of exits which was less than 7.6% of total assets under management in 2023, the lowest level yet.

Source: Blackrock 2024 Private Markets Outlook.

The venture capital investment activity in 2023 declined sharply to $170.6 billion in 15,766 companies (average round size of $10.8 million), as compared to $242.2 billion in 17,592 (average round size of $13.8 million) in 2021, underscoring the significant retrenchment. Notwithstanding that, 2023 still looks to be the third highest year on record and clearly appears to be putting the industry back on long-term historical trend. Notably, though, approximately 10% of the 2023 investment was in just two AI companies (OpenAI, Anthropic); an estimated 33% of all venture capital investment last year was in AI companies. Additionally, Pitchbook estimated that the number of active venture firms (through 3Q23) declined by 38%, suggesting that there is continued consolidation of both companies that receive venture capital and of the firms themselves.

Source: Pitchbook/National Venture Capital Association.

Obviously, geopolitical issues materially influence investor sentiment in 2023. According to a recent analysis by the Financial Times, globally the backlog of all defense industry companies amounted to $777.6 billion in 2022, which has only significantly increased given issues in the Middle East and is nearly 3x the $248.4 billion of venture capital invested globally. A very sad commentary.

Pitchbook estimates that there are now 54k venture-backed U.S. companies with over 4k having raised their first round of capital in 2023. While there were declines across all stages, the early-stage category (23% of total) dropped significantly and is now below pre-pandemic levels. The average round size dropped from $20.0 million to $15.4 million and average pre-money valuations fell from $122.4 million to $82.0 million from 2022 to 2023, respectively. Average late-stage pre-money valuations only dropped from $258.3 million in 2022 to $240.7 million last year.

Two things make the venture capital industry go round: massive success stories and limited losses, which there will always be in this risky corner of the private capital markets. The overall exit activity was, quite frankly, dismal. There was $61.5 billion of exits across 1,129 transactions, which is the lowest level since 2010 and nowhere near the $796.8 billion in 2021. The sharp rise in interest rates over the last two years dramatically curtailed the number of new unicorns according to an interesting longitudinal study by Cowboy Ventures and led to a spike in bankruptcies of private capital backed companies. According to CB Insights, globally there are now 1,224 unicorns valued at just under $3.8 trillion; approximately 720 of which are based in the U.S.

Source: Cowboy Ventures.

There is consistently a lag between public and private market valuations, and while much of the exit activity is labeled “terms not disclosed,” there is heightened anxiety that 2024 will see more pain revealed as venture-backed companies simply run out of money. There is also a shadow level of investment activity that goes unreported as investor syndicates provide modest levels of support (1-3 quarters) to bridge to an exit. Arguably, 4Q23 was littered with many such financings that may have only delayed the inevitable. Research by S&P Global Market Intelligence showed a spike in bankruptcy filings in 2023 to 104 of privately financed portfolio companies which was nearly 3x the 2022 level and the greatest volume ever recorded.

Source: S&P Global Market Intelligence

Not surprisingly then, the level of initial public offerings over the last two years has been uninspiring, and largely accounts for how backed up the system is now. According to the same S&P Global Market Intelligence report, there were 370 IPOs launched globally in 4Q23 (only 26 in the U.S.) which was markedly down from the 921 in the same quarter two years ago. For the year, there were 1,429 IPOs globally.

Source: S&P Global Market Intelligence

These crosscurrents net out to possibly troubling signs for entrepreneurs as 2024 starts to unfold. Notwithstanding falling interest rates, the lack of exit liquidity has made fundraising harder for venture capital firms. In total, there were 474 funds which raised $66.9 billion in 2023, which were both down from the 1,340 funds and $172.8 billion in 2022 (which was essentially the same activity in 2021). Given the extraordinary level of investment activity in 2021 – 2022, the pace of expected follow-on rounds starting in mid-2023 likely has moved the venture capital industry into a position of being “undersupplied.” This has been exacerbated by the pull-back of cross-over non-traditional investors in venture capital deals, many of which drove the frothy large late-stage rounds of the past few years.  

Source: Pitchbook.

Given this transition period, an interesting debate has taken hold about the optimal size of venture funds, which is somewhat determined by expected exit valuations for successful investments. Over the last ten years of Pitchbook data, the average exit valuation across nearly 14k reported transactions was approximately $150 million, while a recent analysis by Sante Ventures concluded that most exited venture-backed portfolio companies are at valuations below $400 million. Last year the average exit valuation was $54 million, while the highwater mark of $400 million was in 2021.

A review of 40 years’ worth of Pitchbook returns data concluded that outsized returns (greater than 2.5x of paid-in capital) tend to accrue to mid-sized funds, and yet the industry continues to be an arms race to raise ever larger funds, further concentrating the number of investors in larger firms. Successful funds tend to correlate with greater ownership stakes in the underlying portfolio companies, and that while companies that raise large “mega rounds” (greater than $100 million) tend to have higher likelihood for an IPO, in times when that path is closed, generating venture returns can be quite challenging. Nearly half of all venture capital commitments through 3Q23 were to funds greater than $500 million in size.

Source: Pitchbook.

The digital health sector was not insulated from the downdraft in activity in 2023. According to Rock Health, overall investment activity was $10.7 billion in 492 companies, down from $15.3 billion and 577 companies in 2022 and nearly one-third of the $29.2 billion in 2021. And yet, 2023 was well ahead of the ten-year trendline and represented a relatively robust level of activity given the environment.

More troubling has been the reduction in funding for healthcare technology unicorns, given the imperative to be at least cash flow positive, if not generating free cash flow and self-funding. According to Pitchbook, over the past three years $18.1 billion has been invested in such companies, but only $1.2 billion of that amount was in 2023. Pitchbook tallies 70 venture-backed active healthcare technology unicorns which have raised $31 billion in aggregate and are currently valued at $173 billion, representing a pipeline of possible IPO candidates when that market re-opens.

In this “Efficiency Phase” of this financing cycle, when the healthcare technology sector is likely to consolidate around emerging winners that have developed products that drive near-term hard ROIs, the financing dynamics are very complicated. Rock Health reported that 44% of rounds in 2023 were “unlabeled,” suggesting a significant level of defensive insider bridge financing. M&A activity declined by 23% in 2023 from 2022 with 146 announced transactions, while there were literally zero IPOs in the sector (and only one in the past 24 months).

More broadly, Refinitiv reported that there was $140 billion of private equity investments in the healthcare sector over the past five years, although Pitchbook determined that private equity activity in 2023 declined by 60%. There was also a record number of “large” bankruptcies last year in healthcare, up 5x from 2022, according to BankruptcyData.com.

Notwithstanding continued funding headwinds this year in the healthcare technology sector, the needs have never been as evident or acute. The Institute for Health Metrics and Evaluation’s Global Burden of Disease study released recently determined that the proportion of life that is characterized as being “in good health” declined from 85.8% to 83.6% over the last 30 years, likely equating to one year lost. Healthcare technology is the great democratizing force to bring appropriate and timely care to all.  

Source: James Bailey (2019 data).

Interestingly, a review of healthcare spending as a percent of GDP shows an extraordinary variance by state. Certain states, such as West Virginia, spend nearly 25% of its GDP on healthcare services, and therefore, could be important geographies that should realize the greatest benefits through concerted investment in healthcare technologies to reduce costs, lower barriers to care, and presumably improve outcomes and address issues of equity.

Obviously, government policies also matter. The Kaiser Family Foundation projects that between 8 – 24 million people will lose Medicaid coverage this year, which would likely upend many of these state’s budgets.

Given severe downward pressure on healthcare companies due to labor issues, pressure on reimbursements and payments, and financing environment, the recent investments in technology are expected to drive fundamental improvements in operating cost structures. Greater automation is expected to reduce operating complexity over time.

The recent advancements in AI capabilities, including improvements that mimic human reasoning, cognition, and task completion, have created compelling investment opportunities. These advances are manifest in the physical world through intelligent hardware platforms for novel devices such as robots that address problems outside the digital world. New AI-powered image generators will provide photos, charts, and video content seamlessly into clinical and administrative workflows.

Technology advances today are occurring more rapidly than at any point in history. Whenever there have been such dramatic transitions in technology platform shifts, existing enterprises become more efficient and competitive, but these shifts have also introduced new capabilities and product offerings previously unimaginable.

Source: Silicon Valley Bank.

While the prospects for investment returns in the healthcare technology sector in the short term are confusing, the overall Leerink Healthtech index is currently trading at 3.1x 2024 revenues with an overall market capitalization of $111 billion. The Digital Health subsector is trading at 3.4x forward revenues, representing nearly 70% of the overall valuation, and is trading at a heady 19.9x forward EBITDA multiple.  According to the Wall Street Journal tracker of leading indices in 2023, cocoa was on top of the leader board with a 61.4% return. Next up was the S&P500 Information Technology index at 56.4%, while the Argentine peso was dead last at (78.1)%.

This year may be tricky for Argentinian digital health companies looking to go public…

Flare Capital Brand Refresh…

As Flare Capital Partners embarks on a new year and enters the firm’s second decade, we are excited to announce an evolution of our brand. In addition to modifying the overall logo, the original “Flare” device has been transformed by adding a second “Flare” device. This evolution is meant to evoke a compass, extending the flare motif from simply something that provides a guiding light.

In addition to the guidance we offer to our entrepreneurs, the compass represents the profound impacts that our Strategic Engagement model affords our portfolio companies. This brand refresh underscores the connectivity to our ecosystem partners and our deep conviction in the importance of the next decade in the healthcare technology sector. While we are the “invited guests,” our mission remains unchanged: to partner with brilliant and passionate entrepreneurs to transform the business of healthcare.

As we eagerly review the recently released full-year 2023 investment activity data per Rock Health, it is quite evident that 2023 was a challenging year for many. Investment pace was a one-third step-down from 2022, which was approximately half of what we saw during the “Covid bubble” year of 2021. A proven truism over many investment cycles is that some of the most important and valuable companies are started in times of distress. We share that opinion and remain excited about the investment prospects and will remain resolute and diligent in our investment approach this year and over our second decade.

While our business is not a volume game, it is gratifying to see our firm listed among such esteemed company. The most recent Pitchbook digital health overview featured the most active firms over the past few years below. Given our investment horizons as early-stage investors it is near-impossible to time the market, so it is important to remain consistently active every year. The urgency to transform the business of healthcare has never been so apparent; the quality of entrepreneurs committed to doing so has never been more exciting.

We also recently announced the new class of Flare Scholars. The great Class of 2024 has 65 members, bringing the total number of current and former Flare Scholars to 379. Of this class, 35 hail from 19 academic programs around the country while the remaining 30 are rising stars at our strategic limited partners. Nearly 60% identify as female and almost 55% identify as non-white. Just over half the class looks to start a company or join a start-up, while one-quarter hope to be an investor at some point in their careers. We could not be more excited to see what this class accomplishes over time.

And please join us for our next quarterly Expert Roundtable Series webinar on March 19, 2024 at noon EST.

Healthtech to Address Causes of Death…

It is estimated that this year 60.8 million people will die globally. While a staggering figure, this is a marked improvement from the 69.3 million in 2021, according to data from Database.earth, which determined that as of this past weekend there were 8.078 billion people on earth. So far this year 57.2 million people have already passed away, while there have been 126.4 million births, according to the morbidly named DeathMeters. Obviously, Covid had a profound impact on the long-term trend line.

While the causes of death are almost too numerous to count, the role innovation has played – specifically, healthcare technology – is profound and continues to promise dramatic improvements to the quality and length of life. According to Rock Health data, nearly $105 billion has been invested over the last decade in digital health companies, nearly all of which look to facilitate access to appropriate care to improve outcomes and lower costs, either directly or indirectly. Over the last 160 years, life expectancy in the United States improved by nearly 40 years, according to data from Statisia, which attributes a significant amount of that success to dramatic advances in infant and pediatric care, as well as fewer wars and other advances in medical technology.

According to Pitchbook data, there has been over $197 billion of venture capital invested in nearly 9,600 rounds of financing in the biotech and pharma sector. Quite obviously, the impact of that investment and the innovation that it financed has been profound and will continue to pay off for decades to come. The more modest level of venture capital investment over the past decade in medical technology companies registered at nearly $61 billion across just over 7,200 rounds.

Analysis from Our World in Data underscores the powerful role that biotech plays in addressing some of the fundamental causes of death. The prevalence of cardiovascular diseases and cancer, which together accounted for 51% of all deaths in 2019 (below, the most recent distribution data for causes of death), provides a clear road map for where to deploy financial resources. There is a long tail of diseases which determine possible causes of death and is why there are 11,875 biotech companies globally, according to IBIS World.

Importantly, though, innovative healthcare technology companies exist to complement the innovation in therapeutic advances to serve as companion care models to manage these patients in a more appropriate modality or setting and are now showing dramatic impacts on outcomes and cost of care. In general, healthcare technology companies tend to work at the system or population level, often on cohorts who are asymptomatic or at risk of future disease progression, while biotech companies tend to focus more at the symptomatic patient level. Obviously, this has profound implications on the “who pays?” debate.

Technology is one of the great democratizing forces in healthcare: care can be more readily extended to historically disenfranchised populations. Dramatic and parallel advances in biotech, medtech, and healthcare technologies have ushered in a profound reduction in the death rate per 100k globally over the last twenty years, from 1,114 to 735 people per 100k. The greatest percent change has been experienced in the “Communicable, Maternal, Neonatal and Nutritional Disease” category which has seen more than a 50% reduction in death rates, which is arguable the category most directly impacted by advances in healthcare technology with innovative care models. Notwithstanding that progress, nearly 110k people died in 2022 from drug overdoses in the United States.

Sadly, these healthcare advances are not shared equally around the world. While the underlying factors that account for such death rate disparities are complex and multifactorial (geopolitical, financial, ecological, societal, etc), it is notable that the regions which struggle greatest tend to straddle the equator. It certainly appears that climate change is playing an important role in understanding these differences, in addition to leading to societal dislocations and forced migration as regions of the world become inhospitable.

An Our World in Data 2019 analysis of the underlying deaths by risk factor below highlights how many of these conditions are brought on by inappropriate or poor or uninformed human behaviors. This is perhaps the dimension that innovative healthcare technologies will have the greatest impact. The ability to engage, inform, and activate specific populations arguably will avoid, or at the very least delay, the onset of many diseases. This potential is elevated by advances in predictive analytics that can better identify and target populations far earlier in their lives.

CB Insights recently featured its Top 50 Digital Health companies (below), which tend to cluster around novel care management and coordination models and/or have the management of data as a core competency. While there could literally be another few hundred companies added to the list, commonalities include a focus at the population level to provide more appropriate care to patients in lower cost settings, powered by advanced analytics. But technology innovation should also play important roles in adjacent fields involving the environment, policy initiatives, and other more relatively mundane dimensions of everyday life like transportation. These developments collectively chip away at the risk factors of death and serve to extend life overall.

A through line for many of the risk factors above involves the environment. While some may debate the impact of climate change (and even if it is real), even considering all the pronouncements from last week’s COP28 Summit in Dubai, the incidence of natural disasters has certainly spiked in our collective lifetimes. According to the recently published Fifth National Climate Assessment, the annual direct costs now for severe weather events eclipses $150 billion in the United States, which is to say nothing of the collateral damage done to healthcare infrastructure and the longer-term derivative implications to a population’s health (damage to agriculture, air borne pollution, etc.).

For instance, a recent study by the Environmental Protection Agency concluded that there are 1.6 million tons of hazardous waste stored at coastal sites that would be at severe risk should sea levels rise by more than five feet as compared to 2000 levels. A 2022 report by the National Oceanic and Atmospheric Administration concluded that if emissions do not abate, it is increasingly likely that sea levels could rise between 3.5 – 7 feet by 2100. That would likely reshuffle the cause of death league tables dramatically.

While there is a recent smattering of good news on the homicide front, gun violence continues to be a significant scourge in the United States. Homicides have declined by 12% in the top ten cities in the first half of 2023 according to a Wall Street Journal survey, and the surge in homicides witnessed in 2020 due to factors attributed to the onset of the pandemic (increase in domestic disputes, pause in anti-gang violence initiatives, etc.) has somewhat receded. Notwithstanding that, there were still 26k murders in 2021, according to the most recent Centers for Disease Control and Prevention (CDC) data, of which nearly 21k were by firearm. Globally, there were an estimated 415k murders in 2019, according to Our World in Data.

Tragically, there were an estimated 759k suicides in 2019 globally. Of the nearly 50k in the United States in 2022, approximately 27k used guns, according to recent CDC data. While the factors that contribute to this extraordinarily high rate of suicide are complex, the CDC study concluded that increasing gun sales in the United States directly contributed to this horrific epidemic.

The situation may be about to worsen. There are an estimated 393 million guns in the United States, according to the recent Small Arms Survey, while Pew Research calculated that 32% of Americans own a gun (another 10% shared that someone else in the household possessed a gun). With greater polarization and societal anxieties, as well as more permissive “open carry” laws, a recent survey by the American Journal of Public Health determined that six million adults in 2019 carry a gun daily, which is double that in 2015. Just over 30% of gun owners report that they have carried a loaded firearm in the past 30 days. The need for enlightened gun policies is severely acute.

Another advancement that will directly impact the overall health of a population involves more effective and intelligent transportation systems. Surprisingly, Americans have largely accepted that more than 40k people will die on the roadways. One of the great promises associated with the broad introduction of electric vehicles and driverless cars, in addition to the significant environmental benefits, involves the advent of a dramatically more intelligent and connected highway system. While much still needs to be perfected, obviously, the promise of a considerable decline in accidents and fatalities is exciting (although this would dramatically reduce the availability of transplant organs). The United States, as with gun ownership, continues to be an outlier as to how much death it will tolerate on the roadways, certainly when compared to other advanced economies.

In parallel to the focus on innovation to address causes of death, attention is being paid to the burdens unleashed by an aging population and the specter of declining birth rates that many countries now confront. The number of births in the United States is estimated to have been 3.7 million in 2022, a significant decline of 15% over the past 15 years. The highwater mark of 4.3 million American births was in 1957. Clearly, the advances in neonatal and pediatric care cited above have been important to improve overall longevity and forestall an overall decline in population. The necessary fertility rate (average number of babies per woman) to maintain the current population must be 2.1 children per woman – in 2021, it was ~1.7. Somewhat surprisingly, the country with the lowest fertility rate is South Korea at 0.9, according to World Population Review; Niger had the highest at 6.9. Twenty-second century alarmists in South Korea envision a day when the country is unable to field a complete army and is vulnerable to an invasion from the north.

Just over eight years ago, I looked at my expected life expectancy and calculated then that I had 10,877 days left to live. Today, using that same Social Security Administration’s Life Expectancy Calculator, I now appear to have 8,212 days, which means that over the last 2,945 days, I only “consumed” 2,665 of my calculated days, which I take as really good news. Or it might mean that the accuracy of these tools is about as good as the estimated miles left on my wife’s Tesla’s battery meter, which means it is not very accurate. Or that there are dozens of other variables that go into that calculation, compromising accuracy and its ultimate utility.

The urgency for advances in healthcare technology has never been more acute. Notably, life expectancy ticked down measurably from 2020 to 2021, in part due to the pandemic, which underscores the need for comprehensive systemic approaches to ensure quality and long lives for all of us.

And please join us for our next quarterly Expert Roundtable Series webinar on December 12, 2023 at noon EST. Make sure to register here.

Hospital Sector is Under Siege..

Contributions from Dr. Gary Gottlieb, former CEO of Partners HealthCare (now Mass General Brigham), a current Flare Capital Executive Partner, and close friend…

Each year there are over 34 million admissions across the more than 6,100 hospitals in the United States. Never before has this critical healthcare infrastructure been so needed, and yet, never before has it been under such duress. The convergence of deep and profound financial pressures is crashing into workforce issues, with one exacerbating the other. Having a deeper appreciation of this will better inform entrepreneurs and investors on how best to partner with hospitals.

Municipal Market Analytics estimates that nearly 4% of the approximately $300 billion of hospital bonds outstanding are experiencing payment difficulties (the hospital sector is roughly 13% of the total municipal bond market). A recent Fitch Ratings analysis calculated that the median debt-to-EBITDA ratio for U.S. hospitals is approximately 3.9x, up from 2.5x in 2021, with a 33% debt to total capitalization ratio. Definitive Healthcare concluded that there is now $50 billion of bad debt held by hospitals with the top five systems accounting for $7.4 billion. The bad debt to patient revenue ratio is now closing in on 47%. Through August this year, 60 hospitals and health systems have seen their debt ratings downgraded. The looming debt restructuring negotiations will be dramatic – and painful.

This is made all the more challenging with interest rates increasing by ~500 basis points over the last 18 months or so, coupled with historically low unemployment rates. Some modest level of relief may be on the horizon. The debt capital markets are pricing in just 4% and 6% chances of another rate hike in December and January, respectively, and that rate cuts may well start in May 2024. Additionally, the just released October jobs report from the Bureau of Labor Statistics showed only a 150k gain in jobs versus a scorching 297k in September; the unemployment rate ticked up to 3.9% from 3.8% in the prior month.

The financial leverage across the hospital sector is made more problematic when considering how razor thin profit margins are. Fiscal year 2022 was a historically challenging year for the hospital sector with a dramatic spike in inflation hitting labor costs particularly hard. This was compounded by investment losses that significantly reduced available liquidity that hospitals tend to rely upon. This year some of those factors started to reverse with moderating inflation, stronger outpatient volumes, and encouraging reimbursement rate adjustments. For instance, a Kaufman Hall survey concluded that over 2022 the median hourly cost for contracted labor decreased from $200 to $126 by year-end.

An emerging concern is how much of the services provided today will be obsolete in the future in the hospital setting. Increasingly, much of the inpatient volume may well be better served in an out-patient setting. The emergence of compelling hospital-in-home models will support this migration of patient volume. This obviously begs the question of what the “hospital of the future” will really look like. There undoubtedly will be significant stranded costs tied up in under-utilized real estate.

Over the last 30 years consistently less than one-third of all hospitals operated with negative operating margins; that changed markedly with the pandemic, when more than half of all hospitals were not profitable (see analysis from Gist Healthcare utilizing American Hospital Association data, below). Even during relatively prosperous times, U.S. hospitals operate on low to mid-single digit operating profit margins, underscoring the high-wire nature of profitably operating a hospital. And of course, hospitals are under a constant barrage of cyber security threats, requiring significant resources to mitigate.

A recent JAMA study showed that 80% of all hospitals received federal financial support from the Covid-19 Public Health Emergency program at the outset of the pandemic, which accounted for approximately 75% of total operating profits during the height of the pandemic.

A look at the trailing twelve months aggregate operating performance highlights the monthly variability that the hospital sector must endure. The recent Kaufman Hall survey of 1,300 U.S. hospitals directionally indicates modest improvements in recent performance due to stabilizing labor situation (the labor turmoil was punctuated by the three-day 75k employee strike at Kaiser last month). Undoubtedly, leadership teams at struggling hospitals have had to take dramatic steps to rationalize cost structures and eliminate marginal service lines. Year-to-date operating performance through 3Q23 nationally improved 17% over year-to-date 2022 results.

Nearly two-thirds of U.S. hospitals are in urban settings, leaving approximately 1,800 in rural areas. Almost 85% of hospitals are community hospitals with 58% of those being not-for-profit, 24% being privately investor-owned, and the remaining owned by state and local governments. More than two-thirds of community hospitals are affiliated with larger provider systems with just over 30% operating as smaller independent hospitals. Such an industry structure contributes to the precarious financial condition of the sector.

This financial profile starts to account for the dramatic risk of hospital closure, notably in rural markets, sadly many of which are in “red states” where there are significant numbers of disenrolled Medicaid members. Notwithstanding that 40 states chose to expand Medicaid coverage, states that opted out accounted for nearly 75% of rural hospital closures between 2010 – 2021.

During the first three years of the pandemic, Medicaid enrollment increased by nearly 20 million people, bringing the overall uninsured rate down nationally to just above 10%. A recent Kaiser Family Foundation analysis concluded that 17 million are likely to be disenrolled due to genuine loss of eligibility or due to confusion and/or administrative hurdles to re-enroll. A 2021 study by the National Bureau of Economic Research concluded that Medicaid expansion saved 19.2k American lives over the prior four-year period, and furthermore, if the expansion were rolled out nationally, another 16k people would be alive today.

The Center for Healthcare Quality and Payment Reform expects that upwards of 600 rural hospitals to close, with more than 300 at immediate risk. This is a staggering amount considering “only” 150 facilities closed between 2005 – 2019. Principle contributors to this situation are inadequate reimbursement rates and challenges associated with maintaining adequate, cost-effective staffing levels. The study concludes that an increase of $4 billion in aggregate reimbursement (0.1% of total annual healthcare expenditures) would avoid such devasting closures. A spike in uninsured redetermination Medicaid patients could well be the tipping point for many of these hospitals due to increased bad debt and charity cases.

A partial lifeline was offered up this summer when the Centers for Medicare and Medicaid Services (CMS) proposed that up to $9.0 billion of remediation payments be made to nearly 1,650 hospitals to partially compensate for significant reductions to 340B Program reimbursement payments from 2018 – 2022. This program enables qualifying hospitals to operate contract pharmacy services, thereby earning attractive margins on those dispensing drugs. Additionally, last week CMS announced that hospital outpatient services will receive a 3.1% increase in reimbursement in 2024, slightly exceeding early guidance offered over the summer.

Recently released CMS hospital star ratings, which measures quality of hospital performance along five primary dimensions (mortality, safety of care, readmission, patient experience, timely/effective care), showed slight declines across the board in 2023 when compared to 2022. Notably, for both the acute care and critical access categories, the percent of hospitals with five stars was less than 15%, underscoring the operating challenges associated with the pandemic and labor shortages. Less than 10% in each cohort were rated one star. Nearly one-third of all Veterans Health Administration hospitals were rated five stars. Higher ratings translates directly into better reimbursement.

The operating and staffing issues are also showing up in emergency room wait times, which reached a median time of 2 hours 40 minutes in 2022, an increase of five minutes from the prior year. Hospitals along both coasts comfortably exceed three hours in median wait time, which only adds to operational complexity and patient dissatisfaction. Notwithstanding that, October healthcare payrolls increased 3.1% year-over-year, trending at 14k new job adds per month in 2023, and yet this is still 1.5% below pre-pandemic employment levels.

Interestingly, given how inflation data in healthcare are determined, the services component is a relatively modest contributor to overall inflation trends this year. Healthcare insurance inflation is calculated by looking at changes in the retained earnings of health insurance companies and not the actual cost of insurance borne by members and/or employers. The dramatic drop in 2023 for healthcare insurance cost is due to the fact that insurers paid out more in claims than they received in premium, a quirk that will have the Bureau of Labor Statistics modify its approach. Services are estimated to account for 6.4% of the overall inflation rate.

Over an extended period of time, it is well understood that healthcare cost increases have meaningfully outpaced increases in general inflation. Of the “medical care” index below, hospital and physician services account for 47% of the total. The escalating cost of healthcare is what has made care so unaffordable for so many, increasing the reliance of government safety net programs for an increasing segment of the population.

The cost structure of the hospital sector has been under scrutiny for some time by government officials. A recent study by the Journal of General Internal Medicine looked at compliance rates with the CMS rules covering cost transparency and disclosure, and found that only 19% of hospitals were fully compliant. While not-for-profit hospitals were more likely to provide detailed cost data, the relatively low level of compliance has made it difficult for regulators to address cost issues and also challenging for “consumers” of healthcare (patients, employers, etc) to make more rational economic decisions. The lack of complete pricing and cost data undermines the creation of narrow and tiered networks of providers.

While the overall level of M&A activity in the hospital sector has been declining over the past five years, industry analysts are anticipating greater consolidation as the industry looks to rationalize administrative overhead costs and gain greater pricing power. There is growing pressure for independent physician groups and hospitals to align with larger systems. The Kaiser Permanente combination with Geisinger Health (rebranded Risant Health) this summer was expected to usher in a wave of consolidation. Risant Health has stated that it expects to add a handful of other larger systems over the next five years.

Another derivative approach is the creation of new alliances that promise to create more effective integrated care models. The Boston community was rocked by the recent announcement that the Dana-Farber Cancer Institute planned to terminate its affiliation with Brigham and Women’s Hospital to join forces with Beth Israel Lahey Health to create a dedicated, free-standing cancer center.

Consolidation is likely not the white knight to solve all that ails the hospital sector. The high fixed cost structure of hospitals and modest profit margins do not afford significant operating leverage. Coupled with the hyper local nature of hospitals, facility closures to reduce overall industry capacity likely has little to no impact on industry fundamentals nationally.

One promising shiny penny has been the broader adoption of technology to reduce clinical and administrative costs. Obviously, the pandemic was a massive accelerant as hospitals were forced to become more virtual, on-demand, real-time, always on, intelligent, more transparent, and predictive overnight. Hospital executives point to the migration to more virtual visits as a possible strategy to avoid hospital closures. Of course, those solutions require significant investment and changes to clinical workflow, which has their own challenges.

Specifically, there has been considerable interest (intrigue?) with the role generative AI might play in the provider setting. While it is certainly early in that technology’s adoption cycle, there are clearly hospital administrative tasks that will be prime for such innovative new tools. Below is a partial landscape of emerging vendors in this space (my thanks to my colleague, Parth Desai, for his thoughtful framing of these opportunities).

The environment today has customers demanding hard cash-on-cash ROIs within one year of adoption. A patient-centric, more personalized care delivery system sounds seductive but also may actually increase the overall cost structure of a hospital. Solutions that drive better star ratings have a direct and positive financial impact.

One final paradox: the high fixed cost structure of hospitals may work against innovative value-based care payment models which reward hospitals to move away from, use less of traditional high margin services. There will be even greater financial pressures as more and more of the care provided will be paid for by government programs with lower reimbursement rates. Entrepreneurs and investors need to incorporate all this as they find those opportunities to lower costs and improve outcomes, but also to target hospitals that are viable longer term. It is a customer base under siege.