Babylon Health – US Franchise Analysis & Value-based Care Telehealth Market Outlook

Can you outline exactly what services Babylon is providing as part of its value-based care segment? For example, is the company just offering a telehealth platform and facilitating consultations with third-party physicians, or is it also baking in additional services?

I understand there are two core ways in which Babylon recognises revenue with its value-based care framework in the US – the first being a PMPM [per-member, per-month] or fee-for-service model and then the second being capitation allocation, the latter of which is based on a percentage of the payer’s premium or MLR [medical loss ratio]. How often does the company employ the PMPM vs capitation allocation model?

As a percentage of US value-based care revenue, what proportion would be the capitation allocation model, as opposed to the fee-for-service?

If we dig into the revenue model in the US, Babylon discloses 260,000 US value-based care members, as of 31 March 2023 – of which 20% of members are commercial, 13% Medicare and 68% Medicaid – essentially representing 1.6x growth YoY. I think the split was 6%, 11% and 83% respectively in 2022, suggesting a clear diversification away from CMS [Centers for Medicare & Medicaid Services] and towards commercial. Why is the company looking to make a fairly concerted push towards commercial? Can you walk me through the nuances of this capitation model across the three different channels – Medicaid, Medicare and commercial?

To summarise, in the context of the MLR and the margin that service providers such as Babylon could capture, it only represents 100bps, or 1pp in Medicaid. I think you mentioned MA [Medicare Advantage] could be 10-15%, but that would be a hard channel to penetrate. What would the potential for margins be across the full-risk, self-insured and the exchange plans, the last of which you highlighted as the key opportunity for Babylon?

What needs to happen for Babylon to get 10-15% in the exchange plan market? What could go wrong?

To confirm, there are two core models in this market – the HMO [health maintenance organisation] and then the PPO [preferred provider organisation] plans. In the PPO plans, patients don’t need a referral to see a specialist, so you don’t need to go via a PCP [primary care practitioner] or Babylon’s triage system, essentially meaning that patients can circumnavigate engaging with the company’s services, whereas with an HMO system, you have to be referred by a GP or another triage system to see a specialist. With this exchange plan in the US and Babylon’s recently launched digital-first Ambetter offering, it is mandating engagement with its platform to drive the lowering of total healthcare costs, allowing them to capture a higher margin. Is that a fair summary?

If we look at the different channels – Medicaid, Medicare and then commercial – some back-of-the-envelope maths from the latest Babylon 10-Q suggests that the average US value-based care revenue per member is USD 670 for Medicaid, USD 3,290 for Medicare and USD 1,120 for commercial, but that’s assuming 100% engagement across all three. Is there any reason to believe the magnitude of engagement is materially different across those channels? If so, what would that engagement look like, so we could get a better sense for the typical revenue per customer across those channels?

Going back to the level of engagement, we spoke about how in the commercial exchange plans with the Ambetter product, Babylon can drive far higher engagement as members are mandated to go through its triage system or the digital platform. If we look at the existing revenue base across MA, Medicaid and commercial in 2021-22, how should we be thinking about the rate of engagement there?

How and when does cash flow come to Babylon under the PMPM or capitation agreement framework with the provider? When are the settlements paid over the duration of a contract? How are revenues recognised?

Are we seeing a change in how cap agreements are set up for worse or better? As we’ve established, Babylon assumes a responsibility for value-based member healthcare services, then adds up the total medical costs and compares that against the cap allocation set by the payer. If there are savings, that is kept by the company as a margin, if the cost of care is greater than the capitation allocation, then that is borne by Babylon and it loses money. Presumably, it wants that capitation allocation to be set as high as possible and payers want that to be as low as possible. If we go back to what we discussed around the potential margin one can capture across the different channels, do you see that evolving at all?

If Babylon is going head-to-head with a competitor such as Teladoc for the same commercial value-based contract, on what basis is it looking to win that contract? How often does it come down to the company’s risk appetite and it being able to say, “I could probably save you, the provider, more money, or I’m willing to take a lower margin”?

I gave Teladoc as an example, but if we look at another domestic telehealth provider that already has value-based contracting infrastructure set up, how often would Babylon need to compete on the margins it’s willing to capture in order to get that business? Ie, theoretically if you’re going after an exchange plan, Babylon can capture 10-15% margin, but will it have to sacrifice some of that margin in order to win business? If the goalposts aren’t moving from a regulatory perspective and the capitation fees aren’t changing, what is the flex in margins that these providers are willing to take on to win business?

You’ve highlighted how engagement and cost-of-care delivery is key. We spoke about engagement, certainly with the digital-first Ambetter product, but are there any other levers by which a player such as Babylon can drive engagement with its value-based care members?

You highlighted that it’s going to be difficult for Babylon, as a potential late entrant, to come into the MA channel and capture large-volume contracts. Can you elaborate on why that is and how optimistic we should be about the company potentially being able to capture MA plans down the line?

Let’s focus on cost-of-care delivery, because while you did highlight that whilst in commercial exchange plans and MA, Babylon could theoretically capture mid- to low-teens margins, Babylon has disclosed that US value-based contracts only recently delivered profitable medical margins in the first year. This implies that previously, these contracts did not have profitable medical margins, and indeed medical margin does not equal EBIT margin. Medical margin is actually defined as one minus MLR, which in turn is one minus the claims expense over value-based care revenue. How should we be thinking about the actual underlying profitability of Babylon’s key US value-based care contracts? How do you see the company going from a profitable medical margin to a profitable operating margin for those aforementioned contracts?

If you look at Babylon’s operating costs, it seems claim expenses are the key component of that. Can you walk me through the components of the claims expenses, their relative magnitudes and how you see the company being able to drive efficiencies there to get to net operating profit?

How do you see Babylon being able to rationalise the magnitude of claims expenses for every dollar of value-based revenue, over time? In the UK, the company reached cost-of-care delivery profitability, again, not necessarily operating profitability, but still closer to EBIT profitability than medical margin is. It did that by increasing clinician utilisation up to 90%, improving the skill mix – so reducing PCP share of appointments vs other types of care practitioner – reducing admin costs and reducing the number of appointments per user per year, and introducing a chat-first care model. How easily and successfully do you see it rolling out similar initiatives in the US to what it’s done in the UK?

If we think about the contribution of different levers to increase Babylon’s medical margin or decrease the claims expenses, how important would clinician utilisation, improving skill mix and reducing the number of appointments per user per year be, relative to the introduction of the chat-first, digital-first HMO model in the US? If the company could only realistically introduce Ambetter in the US, by how much is that going to move the needle if it can’t drive clinician utilisation up to 90%?

How long is the runway for Babylon to rationalise the claims expenses bucket over the next couple of years? Do you see the company being able to improve that by, for the sake of argument, 10pp, or is that somewhat wishful thinking?

To that point, are Babylon’s margins capped? You mentioned, for example, in a commercial exchange plan the company can capture 10-15%-plus margins, all going well. However, it hypothetically managed to drive down its claims expenses to such an extent that it was actually capturing 20%-plus margins. Is all of that kept by it, or would it have to give a certain amount of that back to the insurer?

What’s a typical ceiling from an EBIT margin perspective? What’s the best-case scenario for Babylon?

You mentioned the theoretical margin one could capture with a commercial exchange plan was 10-15%, but now it seems as if the margins are going to be capped at 8%. Can you help me reconcile the two?

We’ve spoken about claims expenses, but you also highlighted that Babylon’s operating costs are somewhat inflated, representing 7-9% of the total cost base, whereas optimally it should be around 4%. Why is it that the overhead costs are so high? How do you see that evolving?

Going back to the symptom checker, how successfully do you see Babylon being able to integrate AI-as-a-service or SaaS revenue models into its value-based care contracts going forwards?

Babylon has disclosed certain US contracts have a positive medical margin – medical margin being one minus the MLR, which is one minus the claimed expense over total revenue. What defines a contract that would have a profitable medical margin? Is it reasonable to assume those are only the latest contracts that were signed using the Ambetter digital-first solution, where engagement is particularly high, or do you think legacy contracts have also been converted to a profitable medical margin contract?

If such newly signed contracts delivered profitable medical margins in year one, which Babylon claims they did deliver, does that mean profitability will maintain over the subsequent years? Could a profitable contract in year one become unprofitable in year two?

If you think about Babylon’s Ambetter product, is there any reason to believe the company would have higher or lower than market-average churn for its commercial exchange plans?

It does look as if there is fairly significant customer concentration for Babylon, and I presume one of those key customers is Centene, given the nature of the press release a couple of years ago. Can you recap the nature of the relationship between Babylon and Centene? Is this a commercial exchange plan, is Babylon offering just the telehealth platform or additional services bundled in, and is it being paid on a PMPM or capitation allocation basis?

How should we be thinking about the level of engagement, the claims expenses and therefore the medical or operating margin for Babylon’s Centene relationship, relative to some of the new commercial contracts Babylon is going after?

The Ambetter product is the output of the Babylon-Centene relationship. Is it therefore reasonable to assume Centene will remain a key Babylon customer, going forwards?

I understand the exact indentures and the contract aren’t public, but what would the theoretical switching costs be for Centene? You mentioned members already have to re-enrol pretty much every year on a rolling basis. If Centene were to go with a third-party product or build one out itself, how difficult would that be to do?

How can Babylon leverage the Ambetter platform to get other non-Centene commercial payers into the fold? Obviously, the company has significant customer concentration, with 80% of revenue coming from Centene.

You mentioned how the Ambetter product was built in partnership with Centene, with Centene leveraging its network and the lives covered to provide Babylon with data and inputs for the Ambetter platform. If Babylon wanted to go to a competitor of Centene in a different US state, for example, to what extent could it leverage the learnings from the Centene-partnered Ambetter platform?

What are the challenges or the costs involved in exiting contracts? We’ve spoken about the contract mix shift away from CMS, specifically Medicaid. Will there be any financial penalties to exiting those contracts?

Going back to the competitive landscape, you highlighted how players such as Teladoc are only slowly moving into the value-based care world, but other players exist, such as Amwell and Cigna. How competitive do you see this value-based care commercial market becoming, over what time frames and what are the implications for the achievable margins here?

It seems as if the addressable market opportunity for Babylon, even if we put its recent operational issues aside, is inherently limited by the partnerships and relationships you’ve outlined, and that limited addressable market is only further compounded by the company’s reputational hit, so business development is going to be slow in a fairly narrow but high value market. Is that a fair summary?

Does Babylon offer anything unique or differentiating that could represent a reason to partner with it, as opposed to a competing telehealth provider? I know the company had acquired Higi previously, which are little health booths in which a patient can get a blood pressure monitor test or a few other virtual consultations baked in. I know it’s also recently announced a merger with MindMaze, which is a digital neurotherapeutic solution for brain health and recovery. Where could these additional services or USPs serve as a differentiator for a driver in business development? Or do you think, similar to the AI SaaS model, it simply won’t work in the context of value-based care?

By the sounds of it, near-term growth is going to be driven by Babylon’s ability to roll out the Ambetter digital-first commercial exchange service across other states alongside Centene. I think it’s already in six. What are the key barriers to entering new states?

My understanding is that every new state has specific nuances, including different care navigators – nurses may not be clinically trained and need to be trained up, to understand the referral networks, compensation practices, the RCM [revenue cycle management] and so on. Is that a rate-limiting step at all or not, given this will be managed by or go through the Centene channel?

Is there anything we haven’t discussed that you would like to bring to our attention? Do you have any final thoughts as it pertains to Babylon and the wider value-based care market?