HIStalk Interviews Todd Cozzens, Managing Partner, Transformation Capital

Todd Cozzens is co-founder and managing partner of Transformation Capital of Boston, MA.

Tell me about yourself and what you do.

I built two companies in what we now call the digital health space, which we called healthcare IT back then. Marquette Medical offered cardiology software and the first vestiges of patient monitoring, the first vestiges of the electronic medical record. We bootstrapped that company since we didn’t know any better in those days, built it up, and I took the company public with the founder. We had a great run as a public company, then sold it to GE in the late 1990s, where it became GE’s cardiology software division and remains so to this day. I just went to the founder’s funeral a couple weeks ago, Mike Cudahy out of Milwaukee. He was an incredible inspiration and mentor to me.

Picis was the electronic medical record for high-acuity care — operating room, intensive care unit, and emergency room. We started Picis after the Marquette Medical exit and built it up over the years. We had 2,000 hospitals in 23 countries. We were going to take it public in 2010. Then the Affordable Care Act hit and UnitedHealth Group, at that time, was looking at the ACA with a lot of trepidation, thinking about things like medical loss ratio that could challenge their managed care business. As we all know, United made more money than ever in the ensuing years, but at the time, they were worried about that.

United was basically a rollup of 108 health plans. Every time they acquired a health plan, they got a technology piece, like a claims engine or analytics, and they used to roll that up into the division called Health Services. With the Affordable Care Act, they decided to monetize that group of assets and do a string of pearls in acquisitions. They acquired Picis under the idea that hospitals would just become high-acuity centers and low-acuity services would move out of the hospital into the ambulatory areas. They didn’t want to buy bricks and mortar hospitals, but they wanted to engage in the enabling technologies to make hospitals run more efficiently.

I stayed on after that acquisition and did a couple of things for United. Basically I was on the founding team of what became Optum, which was very exciting at the time because it was just a canvas to paint the future of healthcare with the company with the largest momentum and asset base to be able to build something big. Strategizing on how that would shake out was a really exciting time for those of us that participated in that founding. I ran the first value-based care division, which was dedicated to helping hospitals take on risk. This was early on in the value-based care spectrum and it was interesting figuring out what would work and what wouldn’t. My last job there was mapping out strategy and M&A and helping figure out what their next $3 billion of acquisitions would be.

I left there not long after that and joined Sequoia Capital, which was probably the most successful investment firm in the history of the planet. I was really excited to join them and help them with their emerging healthcare focus. They had not done a lot of healthcare in the past, so they needed someone that knew payer, provider, et cetera. I came on to help co-lead the healthcare investing with a guy named Mike Dixon, a young guy that they had hired who, at the age of 26, got them into MedExpress, the urgent care company, Health Catalyst, et cetera. I went on a couple of those boards. ZirMed, which is now Waystar. Little known fact — we were the first institutional investor in Epic, which is a long story, but interesting.

We had a great run there. My only issue with Sequoia was that healthcare was destined to be about 10 to 15% of what they did. I had the chance to start my own fund in 2016 with Leerink, the largest healthcare-focused investment bank. Leerink wanted to get into more on the tech side, and like many investment banks, wanted to start an asset management principle investing wing of the firm. The first fund that they wanted to do was growth equity digital health, so that fit with me.

I’ve known Jeff Leerink for 10 years and I was able to pull Jared Kesselheim, who’s a doc and MBA from the Harvard Mass General system, but more importantly, eight years very successful digital health investing with Bain Capital Ventures. I was able to pull him out of there. He was leading their healthcare investing at the time. Digital health was just starting to boom and the electronic medical record with the HITECH Act was proliferating, generating a whole bunch of data that caused thousands and thousands of companies to be formed. We were at the beginning of the digital health boom and off and running with a $350 million fund, invested in 15 companies across payer, provider, self-insured employer, and pharma, from a tech perspective. We don’t do therapeutics or diagnostics, but pharma is increasingly using this data to bring products to market quicker, et cetera. Virtual clinical trials, what have you. Self-insured employers were starting to directly try to manage conditions of their employees, not getting what they wanted from their brokers and their third-party administrators. The fifth area was the consumer. When I joined the workforce, there were no co-pays, no deductibles, and now families can be spending $6-7,000 on a deductible before they even touch the insurance, so people are going directly online to take control of their healthcare.

Those are the end user bases that our companies sell to. We were able to raise Fund Two during the pandemic, $500 million. My former partner from Sequoia, Mike Dixon, joined us as our third managing partner, built out the team of people that are just totally focused and experienced in this area with either the clinicians operators or long experience investing in this space. Healthcare is very complex, and to understand the intricacies of the reimbursement system and the labyrinthic payment system, in addition to all the nuances of sales cycles, et cetera, generalist firms generally have a tough time really understanding the space. We felt our focus would be an advantage. We invested in 16 more companies in Fund Two, and then we just raised Fund Three at $800 million and closed that in January of this year. We were heavily oversubscribed and ready to go. I’m glad we raised that when we did. Now we have lots of dry powder as we face this very uncertain future here.

How would you describe, to someone whose memory isn’t long enough to have seen it before, this market in which companies contract, valuations drop, and IPO activity dries up?

We are facing very uncertain times, but all indications are — and they are compiling every day — that we are going to enter into a extended period of inflation. Every time you’ve had full employment and this level of inflation creeping up, the economy has gone into a recession. The likelihood of us going into some sort of recession is high, and geopolitical factors like Ukraine are only adding to that prognosis. In uncertain times, you’ve got to be extremely aware of your circumstances — where your company is in its cycle, where you’re spending, and where you’re going to get revenue. The end result of that is you’re going to need cash runway to be able to survive these uncertain times. This will hit different areas of healthcare in different ways.

I’ve been through four of these in my career. Most of the millennials that we see as founders of companies today from 2010/2011 onward have never seen a down market, have never seen a contraction, have never seen a deep recession. Healthcare can be resilient because people still get sick and still need care, but other factors may not make that as viable as has been in the past. For example, I was on the phone yesterday with the CEO of a pretty large health system. He said, “This is the most challenging time I’ve ever seen in healthcare. We can’t find people to staff our hospitals. We have incredible shortage of caregivers right now. It’s not only the great resignation. The average ICU nurse is something like 48 years old. We already had a shortage of caregivers going into this and now that’s just been exacerbated.” He told me he was $50 million variance to budget on staffing costs already, year to date. Closed 10 ORs in the main hospital, the most revenue-generating part of the hospital.

I don’t think providers are going to escape this. Self-insured employers are going to start analyzing what’s nice to have, what’s got to have. In other words, is this point solution I have for diabetes or hypertension really going to save me money? Musculoskeletal is an area that has huge ROI, if you can help employees avoid surgery and get rehab. Getting into understanding the financial benefit, in terms of return on investment of your product, is going to be absolutely key here. The consumer will have less discretionary money to spend on some of these applications that they’re going directly online to engage in. Payers, maybe with a lower utilization, will continue to be profitable. Maybe they’re the winners in this. Yet to be told. Pharma is investing more and more in analytics to get their products to market quicker. Maybe they keep that spend going, because time-to-market will be essential here for them to keep their revenue streams going.

There will be winners and losers, but overall, we’re cautioning our founder who have not been through this before that if they just avoid all the mistakes I’ve made, they will probably do great. We went through financial downturns, such as when the Clintons first wanted to go to a single payer and healthcare was just frozen for a couple years. Obviously the dot com bubble, that wasn’t really the dot com bubble, and it wasn’t HIPAA or Y2K around the Year 2000. It was the Balanced Budget Act, where hospitals were bleeding money and they would engage these consultants like the Hunter Group that would help them just slash their budgets. Then obviously the 2009 Great Recession was significant because hospitals had put their monies in these mortgage-backed securities and couldn’t get liquidity in the assets that they had.

It’s really a time to hunker down and make sure you’ve got cash runway. I’m telling companies that they have 48 months. You should never be raising money again unless you’ve got 12 months of cash runway, because it will take that long and investors get spooked when you’re running out of cash, and they come in like sharks. Really hunker down on your expenses, watch your spend across the board, and keep your team motivated and focused. Those are some of the things we’re cautioning our companies on right now.

How will the M&A picture look in a situation where companies that either can’t turn quickly from growth to profitability or can’t establish a place in the market find themselves looking for a fire-sale buyer?

M&A will continue to be a big area of focus for some of the bigger companies. Some stuff will be cheap compared to the totally inflated prices over the last couple of years. We were definitely in a bubble. The multiples of forward anticipated revenue were crazy and off the charts, and now it’s time to get back to reality. What’s the real steady state of this business? What’s its gross margin? When does this company get to cash flow break even?

The multiples are already coming way down. They’ve come down on the public companies and we’re starting to see that creep into the later-stage growth companies. That’s going to start to affect all companies. There’s usually a lag there for sure. But still, in order to be acquired, you’re going to have to be a company that has line of sight on cash flow, break even, and profitability because these public companies have to acquire you and have to merge your profitability, or lack of profitability, into theirs and affect their earnings per share. Good businesses will still be acquired for reasonable multiples and there’s probably going to be a ton of fire sales out there, for sure.

Health systems are going beyond spinning companies off into actually creating startups and running their own investment firms. What effect will that have on the market?

It’s a mixed bag on those strategic entities. When I started Picis, there were 6,000 hospitals, and very few of them were in integrated delivery networks. Now there’s basically 500 health systems out there, so the number of customers that you can sell to in the hospital area has gone down to 500 decision makers versus 6,000. They have consolidated, and to their credit, they have strengthened their balance sheets through that consolidation, and that has generated pretty good cash flow for most of them. Many of them went off and set up these strategic venture funds.

Some of them are integrated into the strategy of the health system, where the C-suite and the chief digital officer are completely aligned on what they should be investing in or participating in. Some of them are kind of off on their own, investing in early stage companies that can’t scale for the health system. I think there’s going to be a culling of those. The ones that have been successful over the years and bringing great returns, like Ascension Ventures and Providence, will continue to see funding. The ones that are less integrated, kind of afterthoughts as in, “Hey, this doctor’s really smart and he’s got an MBA – let’s let him go set a venture fund up” are going to go by the wayside. We’ve already seen a few of them not get their next funding round.

How do you see the next few years playing out?

At the end of the day, we still have a incredibly broken health system, which is extremely inefficient. Yes, you may have a staffing issue, you may have fewer nurses than used to have, but you’ve got to make them more efficient and make them spend less time on tedious tasks and more time on automation. I’m still very bullish on the market and I’m happy with reasonable multiples from historic times.

When I sold Picis to United, four times forward revenue was a fantastic number. We did OK for ourselves back then. We don’t have to be 20 times. We don’t need 20X investments to return to our limited partners. We need reasonable exits in great companies.

I’m still very bullish. The need is there, the market is there. We are still in the early innings of this digitization of healthcare. I think it will take 15 years before we’re anywhere near digitized as other industries. We’re definitely more scrutinizing about the spots we pick, the companies we go after, the founders that we want to work with and who get it. We’re not going to be perfect. We’re not going to always pick the outstanding winners. But I think we’ll pick enough of them that hopefully we’ll be successful.