WebMD: A Good Company Having A Bad Year

| About: WebMD Health (WBMD)

by David Sterman

Even the world's top investors need to move slowly when deciding to make major new investments. So when shares of health care information provider WebMD (Nasdaq: WBMD) started falling in the spring, two billionaire investors, Carl Icahn and George Soros, likely tasked their team of analysts to get a strong handle on the company's prospects.

When shares fell a whopping 30% on July 18, to $32, it was time to move more quickly. For the rest of the summer, they started loading up on the stock. As this 13-G filing indicates, Icahn started buying shares in late August for three different funds he controls, and currently owns about 9.5% of the company. Icahn said he spent $103 million to acquire his stake of 5.3 million shares (he also owns call options in the stock). His current stake is worth about $175 million. Soros, meanwhile, reported an ownership stake of about 3.47 million shares, or about 5.6% of the company (the position is currently worth about $114.5 million).

These two mega-investors don't make such serious bets unless they see major upside. And the path to upside is pretty clear for anyone that's been following this company.

WebMD sees itself as the middleman between patients and doctors. Its consumer-focused website has a very deep set of content, helping patients learn more about what ails them and the latest thinking on what can cure them. Doctors use the company's technology platform to manage patient information and communicate with insurers, health-care facilities and all other parties in the medical field.

As the company's presence among patients and doctors has grown, WebMD has become a key channel for advertisers, enabling it to grow at a fast pace even as the broader ad industry saw big spikes and drops in the recent challenging economic environment. Sales rose 17% in 2008 and 2009, and another 21% in 2010, to $534 million. Gross margins in excess of 60% have also allowed it to become quite profitable. Free cash flow rose steadily during the past half decade, to $90 million in 2010.

Well, even solid businesses can stumble, and WebMD surely has in recent quarters. Cracks emerged in early May when the company issued sales and profit guidance for the next quarter (ended June) that were just a tick below previous forecasts. That caused the stock to fall from $56 to $51 in just one day.

By the middle of July, shares really came under pressure as management cut full-year guidance (the mid-point of the guided range dropped from $625 million to $590 million, and EBITDA guidance was lowered from $215-230 million to $200-210 million). The sudden slowdown was attributed to several factors, including tightening ad budgets by big pharmaceutical advertisers. And business has slowed even more since. Management recently cautioned investors to expect zero growth in sales and profits in 2012 as formerly aggressive advertising plans from key clients get trimmed.

The 45% drop in the stock from its 52-week high, coupled with an expectation that growth will resume again in late 2012 into 2013, is the perfect backdrop for large investors like Icahn and Soros. Icahn has plans to deploy his usual value-unlocking pressure, noting in a filing that he hopes a conversation will take place to see how to address current business concerns.

If history is any guide, Icahn will seek to unlock value by suggesting a separation of the company's patient-focused business from its doctor-focused business. Perhaps he'd like to see a traditional web portal such as Google (Nasdaq: GOOG) or Yahoo (Nasdaq: YHOO) acquire the consumer business. What's it worth? That's hard to say, considering the recent slowdown in demand. Perhaps Icahn would like to see WebMD use its $1.1 billion cash balance to buy back stock. At current levels, WebMD could conceivably buy back half of its stock.

Risks to Consider: No matter how Soros and Icahn proceed, there's nothing they can do to re-ignite organic growth, and investors should brace for at least a few more quarters of tepid growth. Kensico Capital management has also reported an 11.6% stake in WebMD, which may be why the company recently announced a "poison pill" provision that triggers instant dilution if any stake hits 12%. This could cap further buying by these big investors.

WebMD is a good company having a bad year. This is often a recipe for winning investments for those willing to hold on for an extended period until business turns up again. The interest of an activist shareholder such as Icahn implies that the wait may not be too long. And the fact that Soros has bought into the company only reinforces this prospect.

Disclosure: Neither D. Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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