Investment Summary

Market experts have stopped paying premium multiples for the promise of cash flow in the future and are instead focusing on FY22 earnings fundamentals. DarioHealth Corp. (NASDAQ: DRIO) embodies the current state of affairs, a small-cap growth player that is expected to rack up revenue growth over the next few years. However, the market is agnostic to these factors in FY22, and that may be why DRIO is trading 55% lower this YTD.

In this vein, we identify that DRIO’s market and operational forces appear to be offset by the valuation and attractiveness of valued future cash flows. While we like the growth story, we have avoided rewarding top line growth and instead position ourselves on earnings quality and fundamental momentum. We believe the stock is overvalued and price DRIO at $3.28 on a neutral note.

Exhibit 1. 6-month DRIO price action

Main risks

First, this investment thesis carries a number of risks. If the market did indeed reward DRIO for its sales growth, its stock price could actually appreciate. It could also deliver exceptionally strong results in the coming month, increasing investor appeal. Additionally, updates around the Sanofi (SNY) deal could prove to be an upside risk to the thesis. There are also inherent risks associated with investing in smaller life sciences companies, and this should also be considered.

DRIO’s First Quarter Results Show Bedrock Is Forming

First quarter results illustrated that the company continues to deliver sequential top-to-bottom P&L improvements. Revenue was $8 million, up 124% year-on-year and 34% sequentially from Q4 FY21. It also signed 14 new accounts, and that included 2 new health plans. In fact, DRIO notes that it actually prefers health plans because they offer a much higher revenue margin per account. At the end of the first quarter, the company had 61 accounts in the account, and 80% of them were launched.

As a result, it is expected to accrue $40 million in ARR when all of these accounts are fully implemented. DRIO also maintained a sign-up rate of around 35% for new accounts it launched. However, he had to increase the purchase of inventory in response to the surge in the number of new accounts to be launched. He paid for this up front and probably better as he expects to recognize revenue in future periods from the 2 new health plans that were signed in the quarter. In total, with new contracts signed this year, it now has 61 contracts on a target of around 100. On this point, the contract value is currently around $42 million, and the majority of off-cycle deals, from the plan of health from the employer and suppliers are expected. at book sales this year.

A key trend shift that occurred in the last quarter was the shift in business-to-business (“B2B”) revenue from business-to-consumer (“B2C”). For the first time, B2B exceeded B2C revenue in the first quarter. Consequently, management is shifting the budget to B2B, after operating expenses have reduced to approximately $15 million from $16.4 million sequentially. She expects this trend to continue as she wants to take advantage of rising B2B margins as capital allocation is removed from the B2C segment.

As a result, the consensus is for DRIO to print $34 million at the top in FY22, extending to $48 million in FY23 and $74 million in FY22. fiscal year 24. We are aligned with that view and see the company posting an FCF loss of $42 million this year. We expect this to generate a loss on invested capital of 42%, narrowing to -30% in FY23. One factor to consider is DRIO’s cash burn. Management correctly noted that it would run hot last quarter, due to heavy inventory buying. Although not a trend, based on the current position, we believe it could be a risk going forward. In the chart below, the composite suggests that there could be around 5 periods of available cash at the current consumption rate. This is something we recommend watching closely to see what management’s strategy is to unlock more cash. Ideally, the intention is to see sales materialize in FCF to cover the same.

Exhibit 2. With the current burn rate, we plan to review DRIO’s cash management in the next earnings call

Sanofi Collaboration, dynamics of clinical trials

Last March, the company signed an agreement with Sanofi to commercialize its portfolio of digital therapies. The agreement is for 5 years and valued at $30 million and is beneficial to DRIO in several ways. First, it allows DRIO to spread the execution risk and Sanofi to do the heavy lifting, using its deep-seated sales, distribution and marketing channels as sales leverage.

On the revenue side, the structure could potentially allow DRIO to retain more EBIT with the lower operating costs associated with that revenue. We’ve seen this in other collaborations, especially in licensing and/or royalty structures. The single platform covers a wide range of medical markets ranging from hypertension, diabetes and weight management – ​​each with exciting economics. As an overview of the deal, DRIO CEO Erez Raphael said in the press release:

“Dario’s proven digital therapeutic solutions and innovative technologies perfectly complement Sanofi’s scientific expertise, market access and scale, creating a foundation for long-term success in support of Sanofi’s purpose. to expand into digital health therapies for chronic diseases.“

DRIO will receive funding in 5 tranches, with the first tranche of $8 million set for the year of release. However, in terms of total ARR and contract value, DRIO “trades” according to the revenue call. Additionally, the deal adds a layer of validation to DRIO’s business model, as Sanofi would have performed extensive and rigorous due diligence on DRIO prior to any agreed investment.

Finally, it has partnered with Solera Health to provide a solution to hypertension. He hopes to leverage his hypertension platform for Solera hypertension users and fill gaps in current standards of hypertension care. We expect further news on this during the next earnings conference call.

Market factors

We also looked at how much consensus psychology is currently embedded in the stock price. As shown in the illustration below, DRIO has strengthened against the medical device and healthcare equipment sector since May this year. This happened as the stock caught an offer. However, what is more important to us is that its covariance structure has shifted lower over the same period, suggesting that the upside is idiosyncratic in nature rather than sector beta.

While investors have exhausted FY20/21 beta-focused trading, it’s now idiosyncratic premiums that are being rewarded in FY22, and so we’re looking to names that are strengthening versus to the sector. This is important for reasons of positioning stocks, sizing positions and forming a vision for the future. We believe that there are still more consensus views to integrate into DRIO (this view being a rising period).

Chart 3. Strengthening versus sector as covariance decline signals idiosyncratic bounties to be reaped, we estimate

Evaluation

Assigning a concrete valuation is difficult due to the lack of forecast profitability. The predictability of future cash flows is also a challenge due to the macroeconomic environment and the evolution of capital costs. Alas, in relative terms, the shares are trading at ~1.6x the pound and 6.5x the sells, 54% discount and 90% premium to the GICS industry median, as shown below.

Exhibit 4. Multiples and comps

Therefore, on more tangible measures of company value, we estimate that paying 1.6x book value would make us pay $11 for DRIO, suggesting that the stock is potentially overvalued by 83 %, as shown in Exhibit 5. Therefore, until we see more tangible evidence of shareholder value creation, we are pricing DRIO at $3.28.

Piece 5.

In short

DRIO is at a potential turning point in FY22 and looks set to deliver a period of earnings growth in the years ahead. However, investor appetite has shifted this year, from growth stories promising cash flow in the future, to concrete, realized fundamentals. Therefore, it becomes a question of how willing an investor is to speculate on the execution of DRIO on its growth vision for the future.

Recent catalysts are bolstering its ability to do so, including Sanofi’s vote of confidence. Market pundits are also rewarding the stock at what appears to be idiosyncratic FY22 type premiums. Nonetheless, as things stand, we consider the stock to be overvalued and value it at $3.28 . On this basis, we rate neutral.