By Damion Rallis, Senior Research Associate
In a sure sign of takeover paranoia, online health information company WebMD Health Corp. (NASD:WBMD) fortified its takeover defenses in early October by extending its soon-to-expire poison pill another two years, a move that was made without the approval of its shareholders. While WebMD's share price peaked recently at over $39 in January (and $58 in 2011), it has since fallen over 60% to its current quote of under $15, making the company more and more attractive for hostile bidders. The decline of its share price reflects poor performance across the board, including decreasing revenues and lower earnings projections, as well as questionable strategies that ultimately led to a new CEO being appointed in the spring. While the company attempts to reposition itself as the leading name in online health information with increased investment in mobile applications, its recent missteps and poor performance have failed to convince the market. At GMI Ratings, WebMD currently holds an ESG Rating of "C"; however, the uncertainty surrounding its future results along with a declining share price are likely to drive its rating downward.
GMI Ratings' Litigation Risk model has been flashing warning signs about WebMD for some time. Having been in High Risk territory since the end of July, the company currently has an 11.8% probability of Class Action Litigation occurring within the next 12 months. This places them in the 1st percentile of all companies in North America, indicating higher shareholder class action litigation risk than 99% of all rated companies in this region.
Similarly, the company's financial statements reflect a "Very Aggressive" AGR score of 4 as of June, indicating higher accounting and governance risk than 96% of comparable companies. In fact, WebMD's AGR rating has been consistently "Aggressive" or "Very Aggressive" since assuming over $800 million in debt in March 2011 when its ratio of total debt to total equity was blown completely out of proportion. Companies that have high levels of debt in relation to equity can experience problems in debt repayment and reduced flexibility in funding future projects. The leverage ratio indicates the extent to which the business is reliant on debt financing (creditor money versus owner's equity). Generally, the higher this ratio, the more risky a creditor will perceive its exposure in the business, making it correspondingly harder to obtain credit. Currently, WebMD's debt-to-equity ratio stands at 1.586, compared to an industry ratio of only 0.057. Another reason for the company's considerable accounting risk concerns is its ratio of total revenue to total assets. Low asset turnovers indicate potential problems in the efficiency of a company's operations, and can adversely effect profit margins. For the period ending in June, the company's revenue-to-assets ratio stood at 0.314, well below the industry's average of 0.913.
Recent troubles at WebMD date back to early 2010 when a very public scandal surfaced-one that may have permanently tarnished WebMD's image for a significant number of customers-that ended with a formal investigation by the US Senate in which a letter from Senator Charles Grassley of the US Senate Finance Committee stated that he was "concerned about the independence between WebMD and industry since many people access WebMD seeing it as an independent, objective medical resource." The concern focused on a "rigged" online test for depression that was created so that even if the user answered "no" to all of the 10 questions (which are all framed so that the "yes" answer indicates depressed behavior) the test's response would include the phrase that "You may be at risk for major depression." At issue is the complicated relationship between the user and WebMD's online information and the user's awareness of WebMD's ties to pharmaceutical companies. This article succinctly points out the dangers exposed to uniformed users:
For instance, from WebMD's general depression information page, an editorial link to a "Depression Quiz" takes you to a depression screening page, funded by Lilly, which makes the antidepressant Cymbalta. Worse, a banner ad from the same depression home page takes you directly to a Cymbalta-sponsored page titled Learning to Treat Depression, whose layout and design are hard to distinguish from non-sponsored content. The top of the page does note that it is a "sponsored resource" and that the sponsor of the content has "sole editorial control." But naïve Web users could potentially be misled.
Ultimately, at issue here is WebMD's reputation. If consumers perceive the company as merely promoting its advertisers' pharmaceuticals rather than offering a wide array of objective advice, they me be less inclined to continue using the service. After all, WebMD's revenues are driven by advertising dollars and not subscription fees. An article from the New York Times points out that in some circles WebMD has become "permeated with pseduomedicince and subtle misinformation" and "synonymous with Big Pharma Shilling." As a result of the public and federal outcry of its misleading online test, WebMD wisely decided that a remake of its web products was in order. One journalist, however, characterized the changes quite bluntly, likening its makeover to putting lipstick on a pig. The article went on to point out that WebMD's struggles are highlighted by "the fundamental conflict between a business model that is reliant on pleasing BigPharma and other advertisers, and unbiased healthcare information that serves the public."
In the end, we wonder if WebMD's slavish ties to the Big Pharma will continue to hold the company down. In a conference call to discuss the company's latest earnings report, CEO Cavan Redmond blamed the company's declining revenues on the company's failure to "anticipate the unprecedented reduction in overall spending combined with the change in promotional approval environment that increased the time for programs to be approved by clients or the complexity of those approvals." Unfortunately, WebMD has no immediate plans to drastically alter its struggling business model and considering previous CEO Wayne Gattinella's senior management experience at Merck-Medco and current CEO Cavan Redmond's experience at Wyeth, Sandoz, and Pfizer, it does not appear that the company's ties to the industry will be broken anytime soon. Nor does it appear that their collective insider ties helped mitigate WebMD's collapse in the first place.
Governance concerns at WebMD are numerous. Most notably, Mr. Redmond became the company's new CEO in May 2012 and received a golden hello bonus consisting of $930,000 in cash along with a mega-grant of 1,000,000 stock options and 45,000 shares of restricted stock, both of which vest simply over time without performance-contingent criteria of any kind. Golden hello bonuses of this nature do little to protect shareholders as they are not directly tied to company performance. Apparently, former CEO Gattinella's resignation came as a surprise as it took five months for the company to name a successor, a serious indication of an absence of a substantive succession planning policy.
Annual bonuses for named executive officers (NEOs) are discretionary and based on the subjective assessment of the Compensation Committee. Similarly, the company utilizes a supplemental discretionary bonus plan that provides cash contributions for NEOs to a trust, which distributes such amounts the following year if executives remain employed. Discretionary incentive bonuses undermine the integrity of a pay-for-performance compensation philosophy. Also, NEOs continue to receive time-vesting stock options and restricted stock awards. Equity awards should have performance-vesting features in order to assure alignment with shareholder interests and market-priced stock options may provide rewards due to a rising market alone, regardless of individual performance. Lastly, there are no clawback provisions and the company has not established executive stock ownership guidelines. As a result of these policies, shareholder support has diminished considerably as only about 70% voted "yes" on Say for Pay in 2012, down sharply from over 90% just a year earlier.
In terms of WebMD's board composition, four directors are over 70 years old, signaling even more possible succession planning concerns. Furthermore, despite the presence of the CEO and an Executive Chairman on the board, the company has not appointed an independent lead director, calling into question the board's ability to act as an effective counterbalance to management. Lastly, concerning takeover defenses, the company's board is classified, which would make more difficult and lengthy any attempt to gain control of a majority of the board. In addition, the company has charter and bylaw provisions that would make it difficult or impossible for shareholders to achieve control by enlarging the board or removing directors and filling the resulting vacancies. Combined with the company's recently renewed poison pill, the overall effect of these mechanisms is to reduce board accountability to shareholders.
As investors prepare for the company's latest earnings report to be released on the first of November, there are few indications that there will be much good news. While its business model may have proved to be successful in the past, it simply does not appear that WebMD is willing to sever its ties with the pharmaceutical industry and may therefore continue to suffer the consequences. To be sure, the sharks are already circling. Billionaire corporate raider Carl Icahn began loading up on WebMD stock in the summer of 2011 and currently controls over 13% of the company's shares as of its latest proxy statement. In June 2012, Icahn Capital Group portfolio manager David Schechter was added to the board. Icahn isn't the only one; major shareholder Kenisco Capital Management, whose stock ownership has doubled in the last year and now controls over 11% of company shares, appointed its own director, Thomas J. Coleman, just two weeks ago.