For WebMD, Share Repurchase Is Not a Prescription for Success

Aug.23.10 | About: WebMD Health (WBMD)

In a nutshell WebMD's business is to provide healthcare information via the internet. You can get a feel of their services and business by visiting All in all, this should be a relatively stable business. Internet-based providers for healthcare info are quite few in number. Any search for any number of ailments, and the two websites that will often pop up as the top two searches are and

However, that does not portend well for WebMD because is supported by the well-heeled Mayo Clinic non-profit organization. Their hospitals consistently rank as one of the top hospital networks in the USA . It's just tough to compete when you have a well-funded organization (i.e. growth of Google's Android is an example) that is able to offer a product for free, especially when they have direct inroads to research and practical applications of remedies from a network of physicians and doctors (more similarities with Google ability to blend in more features vs. competitors) within the organization's blanket of operations.

This makes WebMD highly dependent on marketing its website. It also means that margins are difficult to squeeze out. And while the top management has been successful, there are signs that growth is slowing and that churn from the lower ranks below is brewing. This only means that it will become increasingly difficult for the company to maintain its quality on the level of Mayo Clinic.

Nevertheless, my problem is not so much as with the company itself. It is actually quite well run. It is not in any danger of losing its 2nd tier status and the increasing marketability of the brand name is providing growth and advertising revenues. The main problem on my end is the valuation of the business, especially as competing websites look to cash in on WebMD's turf (i.e.

I expect the company to generate $60mil in normalized annual income. They have $30mil in D&A so that leads to OCF of $90mil. Capex is about $18mil, leaving FCF of $72mil. Market cap is currently about $2.6bil, cash totals $535mil, and debt is $113mil, making EV total about $2.2bil. My invested capital calculation totals $340mil and cash flow ROIC is about 21% (it has been steadily declining if you have followed this company).

At $50+ per share, its EV/FCF ratio is over 30x. If I assume that its growth will continue at its rate of CFROIC, in 5 years the FCF total will be $92mil, which means in 5 years the EV/FCF rate will still be about 20x. Keep this in mind that this is in contrast to analysts' estimates that normalized earnings will be increasing by almost nil into 2011!

Now all of this becomes important because I really don't understand the $150mil tender offer at $52/share. With nominal bottom-line growth on the horizon why wouldn't they simply issue a special dividend and/or a quarterly dividend? One, they obviously have no idea to do with the money. And two, I suspect is because management's shares will take time to vest and they have incentive to prop up the share price by eliminating shares from the pool (making P/E lower, but having no effect on EV/FCF) vs having to pay taxes on dividends and a lower share price. Lastly, and the one to really watch for, is to see if management offers their shares at the $52 offer. I suspect there will be a lot of sellers at that price, and a subsequent fall in price after September 8th when the offer expires (it is not likely to be extended if it is oversubscribed).

Current Price: $52
Target Price: $40
Strategy 1: Sell Sept calls @ $50 for $2, for potentially 100% nominal gains or if stock remains above $50, utilize strategy 2 below to close out
Strategy 2: Sell Stock at $51.50, sell puts to close position at a strike of $45 indefinitely

Disclosure: I am short WBMD shares