Is digital health in a bubble? Depends on who you ask

Faster cash burn rates, lack of growth in startup exits and sky-high valuations are leaving some industry observers nervous that a major market correction is on the way.

Digital health industry cheerleaders Rock Health has produced their year-end venture funding report for 2018 and while investment figures continue to break records, the organization is a bit more tempered in its expectations that the good times will continue indefinitely.

A few concerning factors identified by the organization have been the recent volatility in the public markets and potential macroeconomic and political forces injecting instability in the larger economy.

Still, they’ve come to the conclusion that digital health is not in an investment bubble inasmuch that a bubble is a situation where even startups with strong market fundamentals who need access to capital struggle to remain solvent.

“While the future is not yet written, it seems unlikely that capital will continue to flow at the current rate. We anticipate a possible pullback in VC funding for digital health in future periods – not a bubble pop,” the report reads.

Rock Health’s rationale is based on a number of factors including the move of startups to more steady enterprise business models, the performance of public digital health companies and rise of repeat investors in the space.

Some of the more sunny numbers from the report include $8.1 billion in total digital health funding (up from $5.7 billion in 2017), a record number of $200 million-plus rounds and average deal size increasing to $21.9 million.

On the other hand, faster cash burn rates, lack of growth in startup exits and sky-high valuations are leaving some industry observers nervous.

A panel at the Digital Health & MedTech Showcase in San Francisco featuring a range of digital health investors offered more insight into the question.

High cash burn rates among digital health startups were tied to the level of effort necessary for customer acquisitions and shifting investor focus to clinical and regulatory validation of technology.

The problem may especially be salient in the field of digital therapeutics, where a consistent regulatory pathway has not been established.

“This feels like an area where teams are going to have to run hard and there is going to have a bit of that belief before we get the exits to know where it turns out,” said KP Ventures’ Liz Rockett.

Exits were another major area of concern for the investors who mentioned the lack of digital health IPOs over the past two years and the volatility in the stock market.

Lisa Suennen, leader of Manatt’s Digital & Technology Group, predicted an increase in exits of the “not good kind.”

“The down round help-get-me-out-of-here kind of exits, the buying of assets that are cool and integrating them into their other companies,” Suennen said. “If the stock market stays unstable or collapses and the world economy is unstable with that, everything is coming down.”

Even the example of the recent $225 million acquisition of Propeller Health by medical device company ResMed didn’t inspire much optimism about the exit market in the near term.

“Propeller was not on revenues, an exit. It was largely a strategic exit. I think you’re going to see isolated cases like that where there’s certain technologies or platforms that an acquirer really wants because it will change the face of that acquirer or change the direction of technology trends they want to push on,” said. DigiTX Partners CEO David Kim.

“I personally don’t invest thinking we’re going to have immediate exits in the next few years, it’s going to take time to really build out good companies with solid revenue and profitability profiles to attract acquirers.”

As to whether an impending bubble burst is on the horizon, opinions ranged but the general sentiment was that a market correction is on the way, but it doesn’t spell doom for the industry as a whole.

“To me a bubble just means the hype bursts, it doesn’t mean the market disappears,” Suennen said. “I do think we’re going to see a major pullback in valuations … If investors can’t exit things profitably they will not get more money to invest end of story.”

Picture: kishore kumar, Getty Images