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January 13, 2016 12:00 AM

Digital health firms, say goodbye to easy venture capital

Beth Kutscher
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    Digital health startups have benefited from easy access to capital over the past few years, but the market is about to get a lot tighter.

    Analysts and investors watching the space offered a sobering take Wednesday during one of the biggest industry meetings of the year, the J.P. Morgan Healthcare Conference, which is largely considered the event that sets the tone for the next 12 months.

    A broader market selloff put a damper on the conference this week. Healthcare stocks have lost about 14.1% of their value over the past six months, compared with Standard & Poor's 500 Index's 10% drop.

    Digital health is a trickier market than either technology or healthcare, in part because it's relatively new. Venture funding in digital health was just $1.1 billion in 2011, and exploded fourfold over the next four years.

    But many companies still need to demonstrate that they can make money, and those that braved an initial public offering over the past two years have debuted with mixed success.

    Shares of telehealth company Teladoc, for example, have lost about a third of their value, closing Tuesday at $18.63, compared with their July debut of $29.90.

    “People were willing up until August of last year to take a high flier,” or volatile stock, said Dave Francis, a managing director at RBC Capital Markets. He spoke at Health 2.0's WinterTech conference which ran concurrently with JP Morgan. “I would argue that if Teladoc were trying to go public today … they would have a very difficult time achieving the valuation that they saw on July 1 of last year.”

    Castlight Health is often flagged as the classic example of a digital health firm that crashed in the public markets. Shares of the price-transparency company opened for trading in March 2014 at $37.50. Now they're worth $3.75.

    Castlight had a “great technology engine” but was ahead of the market, Francis said. “Today, the only people paying attention to Castlight are value-oriented healthcare investors.”

    Even digital health companies that are far from being candidates for stock market listings are likely to see a pullback in funds, and could find themselves raising less money from investors than they did in earlier financing rounds.

    “There's going to a reset of expectations across the board,” Francis said.

    Ruchita Sinha, director of healthcare for GE Ventures, had a similar prediction.

    “There will be a correction,” she said. “There's a strong sense of realism coming back into the market.”

    A common sentiment at the conference among health systems and their venture capital arms was that technology entrepreneurs don't really understand their business. Many of their new tools try to solve a patient problem but create more work for providers and don't necessarily fit the way they do business.

    As in other industries, there's a significant amount of money flowing into tools that improve the consumer experience, said Ambar Bhattacharyya, managing director at Maverick Capital Ventures.

    But unlike other industries, healthcare will always be a brick-and-mortar business with a digital business layered on top of it. “The traditional rails around hospitals will remain in place,” he said.

    Many of the new technologies, though, are creating a market that didn't exist before, such as price transparency tools, physician-rating sites and remote monitoring devices.

    Also, legacy medical device and healthcare information-technology vendors are sharing the space with consumer players like Apple and Google.

    That creates a challenge for digital health startups—not quite technology firms, not quite healthcare companies—when it comes to attracting new investors and establishing a valuation within a peer group.

    “There's a growing debate [in the digital health world]: Do I want tech investors or do I want healthcare investors? And the answer is, you want both,” said Jeff Tangney, CEO of Doximity, a networking and recruitment site for physicians. Doximity raised $54 million in 2014 in a Series C round led by DFJ Growth, and through funds managed by T. Rowe Price Associates. “It's the rare breed that does both,” he said.

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