Epocrates IPO Analysis: Long-Term Success Depends on Electronic Records Initiative

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 |  Includes: EPOC, WBMD
by: Bill Simpson

This analysis of Epocrates (NASDAQ:EPOC) was provided to TradingIPOs subscribers in advance of its Wednesday Feb.2 IPO. The company priced at $16 vs. the $13-15 expected range.

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Epocrates plans on offering 6.2 million shares (assuming overs) at a range of $14-$16. Insiders will be selling 2.6 million shares in the deal. JP Morgan and Piper Jaffray are leading the deal, William Blair and JMP co-managing. Post-IPO EPOC will have 22.3 million shares outstanding for a market cap of $335 million on a pricing of $15. Over 1/2 the IPO proceeds will be going to insiders, the remainder for general corporate purposes.

Goldman Sachs will own 12% of EPOC, Sprout Capital 12%, and Interwest Partners 8%.

From the prospectus:

Epocrates is a leading provider of mobile drug reference tools to healthcare professionals and interactive services to the healthcare industry.

Proprietary drug content on mobile devices. One of the original mobile apps, originally for the Palm (PALM) back in 1998. EPOC was one of the initial iPhone 3rd party apps as well. EPOC was one of five app providers highlighted by Steve Jobs when Apple (NASDAQ:AAPL) unveiled the iTunes App Store in a March 2008 briefing. The iPhone has been a nice revenue growth driver for EPOC.

Healthcare professionals are able to access information such as dosing, drug/drug interactions, pricing and insurance coverage for thousands of brand, generic and over-the-counter drugs.

Physicians and healthcare professionals refer to EPOC's content numerous times throughout the day for quick access to drug and clinical information.

Products used on mobile devices at point of care. User network consists over one+ million healthcare professionals including 45% of US physicians and 150,000 nurses. EPOC has worked with all of the top 20 global pharmaceutical companies. EPOC works with the pharmas to act as a rep of the company via their mobile data and content. Pharmas provide information to EPOC as a means to 'get in front' of physicians electronically.

EPOC is compatible with all US mobile platforms including Apple, Android, Blackberry and Palm.

20% of revenues derived through $99-$199 annual subscriptions to EPOC's drug and clinical reference tools.

***60 percent of revenues comes from drug manufacturers, who pay EPOC to supplement information on each drug with patient literature and contact information, so that doctors can contact manufacturers to request samples or ask questions. Insurance companies also pay EPOC to list covered drugs with their content. EPOC derives revenues from users and information providers alike, pretty good business model.

***According to EPOC's own survey of 2,800 physicians, 50%+ reported avoiding one or more medical errors every week. 40% reported saving more than 20 minutes per day. If these stats are truly representative of EPOC's customer base as a whole, we've a product here that creates efficiencies and saves time.

Growth - EPOC's growth initiative is to help doctors take whole practices digital. EPOC wants a piece of the projected hefty Federal incentives to shift patient data from paper to all electronic. This would be a whole new segment for EPOC and is not expected to contribute to revenues in the near term. Patient electronics segment is anticipated to launch in the first half of 2011.

In 11/10 EPOC acquired an Apple-focused App store, Modality, for $14 million. EPOC plans on utilizing Modality to create an Apple platform based application for their planned employee health records initiative.

Competitors include WebMD Health (WBMD) and UpToDate Inc.

Financials

$3 per share in cash post-IPO.

Solid cash flows over the past 4 years, better than GAAP EPS. EPOC has been cash flow positive since 2003.

A nice positive here is the lack of dependence on Medicare and Medicaid for revenues.

Revenues entirely derived in the US. 9% of users are paid, the remainder use EPOC's free service.

***EPOC has ramped up expenses heading into the spring '11 launch of their digital patient records initiative. To date they've derived no revenues from this initiative, the added expenses have negatively impacted the bottom line. Operating expense ratio the first nine months of 2009 was 54%, jumping to 65% the first nine months of 2010. Stock compensation expenses were roughly the same through both periods, the culprit here is definitely this new growth initiative. It will be well after IPO until it is known whether or not these expenses will pay off. EPOC expects margins increase to historical norms in the back half of 2011.

Quarterly revenues have been flat the past 4 quarters. It appears there is a sound reason for EPOC launching their growth initiatives. Their strong iPhone fueled growth in 2008 and 2009 has plateaued on them.

4th quarter is historically the strongest.

2010 - $102 million in top-line revenues, a 12% increase over 2009. 69% gross margins. As noted above, a notable increase in operating expense ratio, not ideal heading into IPO. 5.3% operating margins. 3.4% net margins, EPS of $0.15.

2011 - EPOC hopes to see margins return to 2009 levels in the back half of 2011. 2009 operating margins were 16%, compared to 2010's 5.3%. Assuming revenues begin to accrue from the electronic records initiative, EPOC should be able to grow revenues 15%-20% in 2011 to $120 million. Operating margins of 10%, net margins of 6.5%. EPS of $0.35. On a pricing of $15, EPOC would trade 43 X's 2011 estimates.

Conclusion - Solid niche leader coming public after their fast growth stage. This is a deal that most likely would have come public (and done quite well) in 2008 or early 2009 had the IPO window been far enough open. Instead EPOC is coming public in 2010 in a bit of stagnant top line and deteriorating bottom line period. Both may be temporary if EPOC's electronic patient records segment takes off as EPOC hopes. That is the key to this IPO here. If EPOC can lay on revenue and margin improvement the 2nd half of 2011, EPOC will do quite well mid-term plus. Until then, a holding pattern. Market cap in range is quite reasonable here at $335 million, neutral short term. Mid-term+ will depend on the success of the electronic records initiative.