In hindsight, it’s kind of funny that the big tech bubble debate this week focused on Candy Crush Saga owner King Digital Entertainment’s IPO filing. It’s funny because, on Thursday night, Wall Street priced the craziest deal since the heights of the Internet bubble and almost no one complained a bit.
That deal was for Castlight Health (CSLT), a company that offers health information via the Internet to inform medical choices and reduce insurance costs. Sounds like a pretty good idea, and Castlight says it has helped some of its corporate customers reduce their health costs by more than 10% a year.
Goldman Sachs, Morgan Stanley and other lead underwriters priced Castlight’s shares at $16, above an already raised expected range of $13 to $15, giving the company a valuation of $1.4 billion. That's billion with a “b.” Last year, Castlight had $13 million of total revenue. That’s million, with an “m.”
Then the stock opened on Friday at almost $40, giving it a valuation of over $3 billion!
Jay Ritter, a professor at the University of Florida and my go-to source on IPOs for the past few decades, tells me that Castlight's insane level of valuation – 107 times revenue (not profits, as they had huge losses last year) – of the original IPO pricing hasn’t been seen for a tech deal since the year 2000, the twilight of the 20th century. Of the prior 13 deals priced at 100 times revenue or more and sales of at least $10 million, the average 3-year return was -92%.
Investors have been attracted by the siren song of market potential. With trillions spent on health care and everyone trying to save money, surely there’s a big market for Castlight’s services?
That’s probably true but it’s also obvious to a lot more folks than those at Castlight. Try the numerous private competitors, companies such as Change Healthcare, backed by investors including Blue Cross Blue Shield, and Healthsparq, which recently said it served 60 million consumers. And the big health insurers themselves, Aetna (AET) and UnitedHealth Group (UNH), for example, are already experimenting with similar services and giving them away free to major customers.
To be sure, it’s a great idea. One of the biggest hurdles to controlling healthcare costs is the complexity and obfuscation in the market. It’s hard to be a smart shopper when you can’t compare the quality of different providers or even know how much they’ll end up charging. Castlight and its competitors collect vast amounts of data and display relevant bits in a more clear and simple way to help consumers make smarter choices.
The next Netscape?
But there’s no way to tell who will win this theoretically huge potential market in the future, nor is there any way to predict how profitable it will end up. Castlight seems far more likely to end up as the next Netscape, which got obliterated when Microsoft decided to give away an Internet browser for free and wipe out Netscape’s whole business model of charging.
Investors who agreed to pay $16 a share for Castlight Thursday night seem more focused on the inspiring performance of other cloud-service stocks, such as Benefitfocus (BNFT), which went public at $26.50 a share last September and currently trades at $58, off its all-time high of $77 in January.
It’s pretty clear a bubble is inflating in this sub-sector of Internet stocks and Castlight makes that incredibly obvious. In early trading, Castlight's $3.5 billion valuation is more than double the value of Benefitfocus though it has about 1/10 the revenue. Next week the bubble may inflate further when a couple more cloud service providers are expected to price their IPOs, including banking specialist Q2 and HR benefits provider Paylocity.
Meanwhile with all the competition for Castlight, the company is spending like crazy on marketing, R&D and the like. On its $13 million revenue base last year, it spent $34 million on sales and marketing, $15 million on R&D and $9 million on administrative costs. Bottom line: a $62 million net loss.
And then there’s the curious case of Castlight’s present business. The company already has 24 corporate customers in the Fortune 500, including Walmart Stores (WMT). The retailing giant, which covers more than 1 million people under its employee health plans, was responsible for 16% of Castlight’s revenue, or about $2 million, under a contract which expires at the end of 2015.
Does that seem like a massive revenue stream from one of the single largest healthcare providers in the nation? Not exactly. Again – they already have one of the biggest clients on the planet and the revenue is peanuts. Yikes.