Every article we write here at Nanalyze assumes the reader has no prior knowledge of technology or investing. Every article starts at ground zero, then makes its way upwards while introducing terms and concepts anyone can easily understand. While researching various companies, there are some common themes we observe. For example, disruptive technologies usually achieve rapid sales growth as they “disrupt” a particular space. However, companies won’t last too long if they’re subsidizing that growth, so then we like to look at margins as a proxy for present and future profitability. Once we’ve identified a high-growth, high-margin business, the next question is what threats might exist as other companies realize there’s money to be made in whatever niche that might be. Our recent article on iRhythm was a good example of a disruptive business that’s high-margin, high-growth.
A while ago we took a look at Nuance Communications (NUAN), a company that – at the time – seemed to be all about selling voice transcription software for a variety of use cases without having any particular focus or strategy. Revenue growth was slowing, loads of cash were being burnt, and the product seemed less than impressive when we tried to use it to write an article. Fast forward to today and things have changed for the company which now has a new leader at the helm and a clearly defined strategy that merits a second look.
An AI Technology Stock
When looking at the composition of a company’s senior leadership team, most mainstream media commentary these days revolves around how much they are paid relative to the average employee or which restroom they use. As investors, we like to focus on whether the leadership team can get the job done using simple metrics that everyone can understand to demonstrate progress. If the company’s leadership team is competent, the company’s strategy and corresponding metrics will be clearly spelled out in an investors deck for everyone to see. That seems to be the case now with Nuance Communications which – as of May 2018 – has a new leader at the helm.
The fearless leader at the helm of Nuance Communications, Mark Benjamin, gave a presentation earlier this year at the J.P. Morgan Healthcare Conference where he introduced Nuance Communications as an “AI technology company” with a focused strategy that involves divesting a few of their existing businesses. In February of this year, Nuance completed the divestiture of their Imaging business for about $404 million and they intend to spin off the Automotive business as a separate, publicly-traded company in October of this year. That leaves two segments left; Healthcare and Enterprise.
Today, we’re going to focus on the healthcare piece which centers around the aforementioned investor presentation given by Nuance CEO Mark Benjamin earlier this year. Here’s the very first slide (our emphasis in yellow highlight):
We see Nuance refer to itself as an “AI technology company” which is transitioning to a Software-as-a–Service (SaaS) business model with a focus on healthcare. (Our past article on MobileIron explains some of the key metrics for a SaaS business model.) We’ve talked before about the explosion of big data in medical imaging, and it’s part of a bigger trend to digitize healthcare information to improve the quality of patient care and save money.
Health Information Management
“Why do doctor’s have such notoriously bad handwriting?” asks an article by Forbes which attributes the common phenomenon to “doctor’s always need to take rapid notes” which doesn’t help explain why MBAs have excellent handwriting – and are generally better looking. Today, the problem is being rectified by s) which are pretty much what it says on the tin. The idea is that your EHR becomes an ongoing ledger which summarizes all your health conditions and treatments over your lifetime, something that not too long ago used to be stored in paper medical records at your local doctor’s office. The process of managing health information at the individual and aggregate level is referred to by one of many, many acronyms you’ll encounter in this space – Health Information Management (HIM) which Wikipedia says, “is the practice of acquiring, analyzing, and protecting digital and traditional medical information vital to providing quality patient care.”
An EHR is a collection of information that’s tied to a particular patient. Adding additional information to an EHR can occur more seamlessly if a doctor – whose time is extremely valuable – can simply say what’s on their mind while it gets transcribed in real-time. This is also referred to as Computer Assisted Physician Documentation (CAPD) and it’s a $2 billion opportunity waiting to be captured according to Nuance.
If you recall from our article on The Top-5 Electronic Medical Record (EMR) Companies (note that EMR and EHR are used here interchangeably), at the top of the list was a private company called Epic. According to Epic, hospitals that use their software held medical records of 64% of patients in the United States – more than 250 million patient records. Nuance has partnered with Epic to streamline the documentation workflow so that information is captured – using Nuance’s three decades of experience in understanding medical language – in an intelligent manner which adds value to the medical provider and the patient. Here are some of the tangible benefits according to Nuance:
You may not understand what many of the above acronyms mean, and we don’t either. What we do understand is that fewer people are dying and there’s a 40% decrease in the number of times someone has to go ask the physician a question about something that didn’t get captured when it should have. Nuance issued a survey a while back that showed “83% of physicians perceive traditional retrospective queries as very disruptive to clinical workflows.”
Without even understanding much about how medical practices operate, it’s very easy to see how Nuance plans to capture billions of dollars by addressing an obvious need that saves lives and saves money. They’re not only using Natural Language Processing (NLP) to capture the information, they’re also turning it into insights and proactive recommendations which adds value in addition to just capturing data. It’s the perfect sell for patient and provider alike. And as we’ve seen before, high-growth, high-margin opportunities attract competitors. If you plug Computer Assisted Physician Documentation into Google, the first search result is from Nuance, and the second is from 3M.
The 3M Threat
Earlier we mentioned how other companies become very interested when there’s a high-growth, high-margin business opportunity with a large Total Addressable Market (TAM) just waiting to be captured. Earlier this year, one of our core dividend growth stocks – 3M (MMM) – acquired a company called M*Modal which also provides medical transcription services that use artificial intelligence. The M*Modal platform is integrated with more than 250 EHR providers and used by more than 250,000 physicians today.
3M dropped a cool $1 billion on this acquisition which adds to their vast portfolio of companies and businesses. In Q2-2019, the 3M healthcare business generated 19.6% of total revenues which was broken into various segments including Health Information Systems which accounted for 3.3% of total revenues ($260 million). That number was up 26.8% from Q1-2018 and the only healthcare sub-segment that experienced meaningful growth. Compare the $260 million from the 3M Health Information Systems division to the $$204.4 million generated by the Nuance Healthcare division over the same period and it looks like Nuance has a formidable competitor doing very similar things.
The 3M acquisition of M*Modal didn’t go unnoticed in their last earnings call leading an analyst to ask Mr. Benjamin for his thoughts on the competitive threat. Here’s his short answer:
It’s a great question and certainly, we watch all of our competitors very closely and certainly 3M and M*Modal, very much. I would say from a competitive and general market dynamic, we really have not seen a shift from our sales pipeline and sales success and our win rates.
Firms often use Customer Relationship Management (CRM) systems like Salesforce to monitor competitive threats by having salespeople list out any deals that are being lost to competitors. Mr. Benjamin is simply saying that it’s business as usual for the company and they’re not butting heads with 3M anymore than they have been. Nuance is sure to be keeping a close eye on what deals they’re losing to 3M as they continue to grow market share.
We’re long and strong 3M, and even added during this last dip as the yield exceeded 3.6%. We research and write about investing in technology every day, but hold the lion’s share of our assets in a 30-stock dividend growth portfolio. Why? Because as we’ve seen time and time again, the big fish in the pond are very aware of what’s going on out there because they have the resources to keep tabs on everything. In economics that’s an advantage referred to as “economies of scale.”
In our last article on Nuance, we were concerned with the amount of cash they were burning through and the debt they were taking on to fund all that burn. That’s now being addressed. Free cash flow is a priority, and the company has paid down their $300 million in debt. Focus is being placed on high-growth, high-margin business segments. The 3M acquisition may pose a threat because of synergies realized post acquisition or it could become an opportunity for Nuance as M*Modal becomes mired in bureaucracy. What we can be certain of is that there’s a large opportunity for AI-powered HIM solutions that’s been noticed by both companies. Nuance could be a great bolt-on acquisition for larger fish in the pond who see the potential growth of AI-driven HIM solutions.
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