160105 DHC What NFLX Teaches About the PMPM Model

Steven A. Rubis [email protected] (214) 706-9451

Stifel Equity Trading Desk (800) 424-8870

Industry Update

Digital Health Check-Up: What NFLX Can Teach Digital HC About the PMPM Model

Investment Hypothesis. We believe a debate exists among the investment community and users oftelemedicine regarding the validity / utility of the PMPM model versus per visit fees within telemedicine. In ourview, the problem revolves around the fact that management teams used to operating in mature businessenvironments are operating in a nascent environment. The current debate revolves around Teladoc (Hold,$17.99) given its dual-monetization structure (PMPM fees plus per visit fees). Competitors and clients seem tobe gravitating toward the per visit fee model. Our view holds that the PMPM model represents the rightstructure, but for the PMPM model to be successful, management teams must focus first on driving a positiveuser experience and robust adoption / utilization. We believe management teams, especially Teladoc, exhibita primary focus on monetization, illustrated by the company’s P&L and accompanying operating metrics.

Our Ideal Telemedicine / Digital Healthcare Subscription Model. In our view, the ideal telemedicine model revolves

around a PMPM model and includes unlimited physician consults. We believe the long-term telemedicine winner will be

the entity most focused on leveraging attractive pricing to drive robust utilization / adoption.

What Makes PMPM so Successful? We believe the success of the PMPM model represents a function of two variables:

(1) the value of the underlying product / service and associated technology, and (2) pricing. In our view, the fundamental

driver of PMPM success revolves around providing a sticky product or service with cutting-edge technology behind the

product or service.

Why Is PMPM so Powerful? The Shift from an Elastic Pricing Curve to Inelastic Pricing Curve. The real power of

the PMPM model revolves around the ability to evolve the pricing curve from elastic to inelastic over time. A nascent

industry and its associated new products and services face an elastic pricing curve, as the company must prove out the

utility and value of its underlying business model. We believe if the company can drive a sticky / powerful user experience

that price and associated revenue growth will take care of itself over time.

How the PMPM Pricing Curve Evolves Over Time. We believe the power of the PMPM model lies in its ability to evolve

from an elastic pricing curve to inelastic curve over time. At the same time, we believe the PMPM model provides a solid

revenue model regardless of where a company may be in its product cycle. In Exhibit 1, we attempt to illustrate how we

believe the PMPM model evolves from an elastic pricing curve to an inelastic pricing curve over time.

Netflix Represents the Full Power of a PMPM Model. We believe NFLX represents a vivid illustration of our PMPM

Pricing Model in Exhibit 1, as the company seemingly believes that pricing should start at an extremely attractive point,

and that as the company evolves the product the business model, and in turn pricing, can evolve successfully along with

it. The lesson, in our view, is that companies should price the product / service in a nascent market at a price at

which a customer cannot say no. Ultimately, pricing should successfully evolve along with successful

fundamental execution.

Weight Watchers Represents the Negative Power of a PMPM Model. In our view, WTW illustrates the importance of

maintaining and developing innovative technology to power a platform. We believe the proliferation of social media, as

well as wearables have significantly eroded the competitive advantages of a weight-loss facilitator like WTW. Secondly,

we believe WTW also illustrates the impact of over-pricing a product, as typical WTW plans range from roughly $18.44 a

month to $43.08 per month.

January 5, 2016

Internet, Media & TelecomDigital Healthcare

Stifel does and seeks to do business with companies covered in its research reports. As a result, investors shouldbe aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investorsshould consider this report as only a single factor in making their investment decision.

All relevant disclosures and certifications appear on pages 5 - 7 of this report.

Investment Hypothesis. We believe a debate exists among the investment community and users of telemedicine regarding the validity / utility of the PMPM model versus per visit fees within telemedicine. In our view, the problem revolves around the fact that management teams used to operating in mature business environments are operating in a nascent environment given the lack of awareness and utilization of telemedicine (nascent industry). The current debate revolves around Teladoc given its dual-monetization structure (PMPM fees plus per visit fees). Competitors and clients seem to be gravitating toward the per visit fee model. Our view holds that the PMPM model represents the right structure, but for the PMPM model to be successful, management teams must focus first on driving a positive user experience and robust adoption / utilization. We believe management teams, especially Teladoc, exhibit a primary focus on monetization, illustrated by the company’s P&L and accompanying operating metrics. Our Ideal Telemedicine / Digital Healthcare Subscription Model. In our view, the ideal telemedicine model revolves around a PMPM model and includes unlimited physician consults. We believe the long-term telemedicine winner will be the entity most focused on leveraging attractive pricing to drive robust utilization / adoption. Given the nascent state of the telemedicine industry, management teams face two primary problems: utilization / adoption and monetization. We believe focusing on utilization / adoption will ultimately take care of the monetization problem. Using a PMPM fee of $2.99 and roughly 100 million self-insured lives in the United States yields an annual revenue opportunity of roughly $3.5 billion. Using a PMPM fee of $2.99 and 318 million insurable lives yields an annual revenue opportunity of $11.4 billion. Some argue that our ideal model gives the business away for free. Given the annual TAM opportunity associated with our ideal model, we are perplexed how a Netflix-like PMPM structure would give telemedicine away for free. What Makes PMPM so Successful? We believe the success of the PMPM model represents a function of two variables: (1) the value of the underlying product / service and associated technology, and (2) pricing. In our view, the fundamental driver of PMPM success revolves around providing a sticky product or service with cutting-edge technology behind the product or service. Essentially, the product or service benefits from technology that makes said product or service a must have for consumers in their daily life. Secondly, pricing of the PMPM fee can then either help or hinder the ability to increase the stickiness of the underlying product. We believe a PMPM fee at or below the traditional NFLX PMPM fee of $7.99 represents a compelling opportunity. We believe PMPM models exhibiting these characteristics can then reap the rewards of Elastic to Inelastic Pricing Curve shift. Why Is PMPM so Powerful? The Shift from an Elastic Pricing Curve to Inelastic Pricing Curve. The real power of the PMPM model revolves around the ability to evolve the pricing curve from elastic to inelastic over time. A nascent industry and its associated new products and services face an elastic pricing curve, as the company must prove out the utility and value of its underlying business model. We believe if the company can drive a sticky / powerful user experience that price and associated revenue growth will take care of itself over time. How the PMPM Pricing Curve Evolves Over Time. We believe the power of the PMPM model lies in its ability to evolve from an elastic pricing curve to inelastic curve over time. At the same time, we believe the PMPM model provides a solid revenue model regardless of where a company may be in its product cycle. In Exhibit 1, we attempt to illustrate how we believe the PMPM model evolves from an elastic pricing curve to an inelastic pricing curve over time. We believe digital healthcare companies face four stages of evolution: adoption, traction, maintstream, and innovation. In the adoption phase, a company brings a new product or service to market, and must solve for lack of awareness and lack of usage. Management must figure out how to drive robust utilization / adoption. We believe the key lever for management in this stage revolves around price; price increases should not be in management’s lexicon in this stage. The second stage is traction, which represents the period where the company has generated scale in terms of a user base. The key problems management must solve for are driving a sticky user experience and driving growth. Management’s levers of success include developing a best in class user experience and driving positive / meaningful performance for users. The third stage is mainstream where the product or service essentially becomes part of the workflow. Here management must focus on maintaining revenue growth momentum and maintaining its

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Internet, Media & TelecomDigital Healthcare January 5, 2016

market positioning. Management’s levers of success include user experience, underlying performance, and innovation. The fourth stage represents the driving factor of the evolution to an inelastic pricing curve. We see innovation as focused on protecting the company’s competitive advantage in the adoption and traction stages, and re-igniting growth in the maintenance stage. Management’s levers of success are new products and new markets. Ultimately, we believe pricing represents the most important variable of the model, as companies must start by pricing the product / service so low that end users will not even think to say no to using it. Over time, as management innovates and solves the problems of the traction and mainstream periods, the company will be able to raise prices accordingly. Essentially, execution on fundamentals will take care of pricing over time. Exhibit 1: The Evolution of the PMPM Pricing Model

Source: Stifel

Netflix Represents the Full Power of a PMPM Model. We believe that Netflix (NFLX, $109.96, Buy, covered by colleague Scott Devitt, prices as of 1/4/16 close) represents the optimal implementation of the PMPM model. Investors will note that NFLX is essentially monetized via a per member per month subscription of roughly $7.99. We believe that for the most part since inception that Netflix management has focused first and foremost on user experience and the levers that drive a sticky platform versus monetization. Since 2002, the NFLX model evolved from DVD-by-mail to Internet Streaming, and evolved its model from monetizing one stream to one screen at a time to monetizing multiple streams to multiple screens simultaneously. The common denominator of the NFLX model revolves around the $7.99 per month subscription fee. Essentially, management realizes that at $7.99 the majority of their target audience will not shut off the subscription even if they are not utilizing the service to its maximum potential. At the same time, NFLX management realized that there are consumers willing to pay more, especially if said consumers are maximizing the utilization of the service. We believe NFLX represents a vivid illustration of our PMPM Pricing Model in Exhibit 1, as the company seemingly believes that pricing should start at an extremely attractive point, and that as the company evolves the product the business model, and in turn pricing can evolve successfully along with it. The lesson, in our view, is that companies should price the product / service in a nascent market at a price at which a customer cannot say no. Create the sticky user base first and then focus on price increases. Ultimately, pricing should successfully evolve along with successful fundamental execution. Weight Watchers Represents the Negative Power of a PMPM Model. We believe that Weight Watchers (WTW, $21.72, Suspended, prices as of 1/4/16 close) represents the negative power of a PMPM model. In our view, WTW illustrates the importance of maintaining and developing innovative technology to power a platform. We believe the proliferation of social media, as well as wearables have significantly eroded the competitive advantages of a weight-loss facilitator like WTW. Secondly, we believe WTW also illustrates the impact of over-pricing a product, as typical WTW plans range from

How the PMPM Pricing Model Transitions from an Elastic Pricing Curve to Inelastic Pricing Curve

Stages of Evolution: Adoption Traction Mainstream Innovation

Problem to Be Solved: Utilization / Adoption

Drive:Product Stickiness Revenue Growth

Maintain:Revenue Momentum

Market Position

Protect:Competitive AdvantageRe-invigorate Growth

Levers to Pull:Price:

Priced so End User Will Not Say No

User ExperiencePerformance

User ExperiencePerformance

Innovation

New ProductsNew Markets

Cross/Up Sell

Elastic Pricing Curve Inelastic Pricing CurveInnovation Helps Drive and Protect Inelasticity

Over Time, Pricing Moves from Elastic to Inelastic

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roughly $18.44 a month to $43.08 per month. Furthermore, the WTW story illustrates the need for more holistic approaches in the Price X Quantity + Data revenue paradigm facing healthcare today. What Does this Mean for Teladoc? Our Teladoc investment hypothesis holds that the dual-monetization structure (PMPM plus per visit fees) seems unsustainable. We believe management seems primarily focused on monetization rather than utilization / adoption. In our view, were Teladoc to utilize a more Netflix-like PMPM monetization model that many of its current investor concerns might abate. Therefore, we remain cautious regarding Teladoc in its current dual-monetization form. One Last Thought. We note that in some corners of digital healthcare / healthcare technology that some investors believe subscription models carry a valuation premium compared to PMPM models. We find the aforementioned belief perplexing as we believe PMPM is merely a form of a subscription model. In our view, the PMPM model seems best suited for innovators developing never before seen products / services in a nascent industry. These innovators just need to ensure they price their PMPM fees so that end-users / clients cannot and will not say no to adopting and utilizing the product / service.

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Important Disclosures and Certifications

I, Steven A. Rubis, certify that the views expressed in this research report accurately reflect my personal viewsabout the subject securities or issuers; and I, Steven A. Rubis, certify that no part of my compensation was, is, orwill be directly or indirectly related to the specific recommendations or views contained in this research report. OurEuropean Policy for Managing Research Conflicts of Interest is available at www.stifel.com.

Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q10

30

60

90

120

150

2013 2014 2015 2016

02/06/14B:$68

07/21/14B:$71

10/15/14B:$61

11/25/14H:NA

01/13/15B:$54

01/21/15B:$71

01/29/15B:$76

04/15/15B:$93

04/27/15B:$104

07/16/15B:$128

08/10/15B:$143

Rating and Price Target History for: Netflix, Inc. (NFLX) as of 01-04-2016

Created by BlueMatrix

Rating Key

B - Buy UR - Under Review

H - Hold NR - No Rating

S - Sell NA - Not Applicable

I - Initiation SU - Rating Suspended

D - Discontinued

For a price chart with our ratings and any applicable target price changes for NFLX go tohttp://sf.bluematrix.com/bluematrix/Disclosure?ticker=NFLX

Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q18

16

24

32

40

2013 2014 2015 2016

Rating and Price Target History for: Teladoc, Inc. (TDOC) as of 01-04-2016

Created by BlueMatrix

Rating Key

B - Buy UR - Under Review

H - Hold NR - No Rating

S - Sell NA - Not Applicable

I - Initiation SU - Rating Suspended

D - Discontinued

For a price chart with our ratings and any applicable target price changes for TDOC go tohttp://sf.bluematrix.com/bluematrix/Disclosure?ticker=TDOC

The rating and target price history for Netflix, Inc. and its securities prior to February 25, 2015, on the above price chartreflects the research analyst's views under a different rating system than currently utilized at Stifel. For a description of the

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http://sf.bluematrix.com/bluematrix/Disclosure?ticker=NFLX

http://sf.bluematrix.com/bluematrix/Disclosure?ticker=TDOC

investment rating system previously utilized go to.www.stifel.com.

Prior to November 25, 2014, a different Stifel research analyst provided research coverage of Netflix, Inc. and its securities.Netflix, Inc.'s price chart for the period prior to November 25, 2014 reflects the rating and price target history of the formerStifel research analyst for such issuer and its securities.

Stifel or an affiliate expects to receive or intends to seek compensation for investment banking services from Netflix, Inc. andTeladoc, Inc. in the next 3 months.

Stifel or an affiliate is a market maker or liquidity provider in the securities of Netflix, Inc. and Teladoc, Inc..

The equity research analyst(s) responsible for the preparation of this report receive(s) compensation based on variousfactors, including Stifel’s overall revenue, which includes investment banking revenue.

Our investment rating system is three tiered, defined as follows:

BUY -We expect a total return of greater than 10% over the next 12 months with total return equal to the percentage pricechange plus dividend yield.

HOLD -We expect a total return between -5% and 10% over the next 12 months with total return equal to the percentageprice change plus dividend yield.

SELL -We expect a total return below -5% over the next 12 months with total return equal to the percentage price changeplus dividend yield.

Occasionally, we use the ancillary rating of SUSPENDED (SU) to indicate a long-term suspension in rating and/or targetprice, and/or coverage due to applicable regulations or Stifel policies. SUSPENDED indicates the analyst is unable todetermine a “reasonable basis” for rating/target price or estimates due to lack of publicly available information or the inabilityto quantify the publicly available information provided by the company and it is unknown when the outlook will be clarified.SUSPENDED may also be used when an analyst has left the firm.

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Documents

160105 DHC What NFLX Teaches About the PMPM Model