WebMD's Achilles' Heel


By Amy Tsao WebMD (HLTH), a dot-com that lost billions of dollars during the 1990s, finally turned profitable in 2003. It says revenues will top $1 billion in 2004, and following several years of frantic cost cutting, operating earnings will rise to at least $150 million. For all of 2003, the Elmwood Park (N.J.)-based outfit reported earnings per share of 36 cents, and Wall Street analysts expect EPS to increase on average by 26% and 32% in 2004 and 2005, respectively.

To get to this point, top management, led by Chairman (and former CEO) Martin Wygod, pulled away from the original goal of using the Web to make health-care transactions more efficient for patients, doctors, hospitals, and insurers. These days, WebMD owns several leading health-care technology businesses and successful Internet portals, though they aren't interconnected within an overarching system as founder and financier Jim Clark had envisioned.

"The company has the product lines in place and should be well-positioned to capitalize on health-care trends," says Corey Tobin, analyst at Chicago-based William Blair & Co., citing a broad government-based push to digitize medical claims, records, and the like.

PORTAL SUCCESS. The failure to achieve Clark's grand vision is fine by analysts. What doesn't fly, however, is the lack of internal revenue growth at its two biggest businesses -- claims-transaction services and physician services. For the last eight quarters, nonacquisition growth has been virtually nil.

At the current valuation, "we would like to see greater organic growth," Tobin says, noting that the stock trades at around $9, about 20 times 2004 earnings. The shares have bounced back from a low of $3 in late 2001 but are well off their boom-time high of $100 in 1999. (Tobin doesn't own the stock. His firm makes a market in it.)

WebMD's Internet portals for doctors and consumers have been its most prosperous business, raking in $111 million in 2003 sales, up 31% from 2002. Analyst Anthony Vendetti at New York City-based broker-dealer Maxim Group sees revenues for the portals division expanding by 20% to 25% next year. (Vendetti doesn't own the stock. His firm makes a market in it.)

BIG AND SLOW. Profitable as they are, the health-information sites generate only about 12% of WebMD's total revenue, notes Nancy Weaver, analyst at Stephens Inc., an investment bank based in Little Rock, Ark. "The question is: What kind of growth can [WebMD] put up?" wonders Weaver, who has a hold rating on the stock. (She doesn't own shares. The firm does no banking with the company but does make a market in its shares.)

Transaction services, WebMD's largest business, which accounted for more than half of total revenues in 2003, or $506 million, grew by only about 8% last year. Worse, mainly from acquisitions. The segment, called Envoy, acts as a claims clearinghouse among insurers, doctors, labs, hospitals, and others.

Envoy is already the biggest operator in its field, so capturing more market share is understandably challenging. However, that doesn't fully explain the lack of growth. Analysts see a WebMD-specific problem: "We have been looking for Envoy acceleration for some time, and it has yet to emerge," Tobin says.

PAINFUL TRANSITION. Envoy's customers suffered during a push to consolidate the unit's offices and facilities in the last several years, analysts say. "It's very hard to rationalize costs and still provide good service," says Weaver. Moreover, the same government mandate to digitize medical claims that should eventually help WebMD has so far caused it mainly grief. It has had to devote extra technicians to help customers make the switch, and plenty have been unhappy with the changeover, complaining of lost or failed transmissions. WebMD has said it's trying to remedy its customer-service issues but still sees little organic growth for Envoy in 2004.

WebMD's physician-services business, which accounts for about a third of revenues, is growing organically. Revenues rose by about 10%, to $303 million, last year, but that was less than Tobin had hoped for. "We're seeing higher growth from others in the industry," he says. This year he expects the growth rate for the division to fall to the mid-single digits, weighed down mainly by WebMD's focus on selling a computer for physicians called Intergy. Marketing costs for that initiative could lower profit margins in the near term, he says.

In some ways, WebMD is still waiting for the medical community to catch up with its ideas. For instance, handheld computers for doctors are used to keep data on patients and write prescriptions, and the technology has long-term benefits in lowering medical errors and improving service quality. Doctors, however, are notorious penny-pinchers and haveet to widely embrace the technology. "If we could see widespread adoption, then that would be a very big thing," Weaver says, adding that growth of such services will continue to be a "slow, relentless push."

LONG-TERM PAYOFF? Other analysts blame leadership for the lack of internal growth. "It's the same old song and dance from the management team," says David Francis, analyst at Jefferies & Co. "They're good at cutting costs and doing deals -- but not at executing on an operating basis." Francis says a huge number of doctors use WebMD's software, but the outfit hasn't been able to convince many to buy its handheld product. (Francis doesn't own the stock, and the firm doesn't have a banking relationship with WebMD.)

Despite his frustrations, Francis still rates the stock a buy, figuring that over time WebMD will deliver on long-held promises. "All the pieces are there. They just need capable people to put it together and make it work," he says. Vendetti agrees. He also rates the stock a buy and expects it to reach $14 per share in the next year.

Investing in this one-time Internet juggernaut is somewhat less risky today than it was just a few years ago. Still, many "investors have gotten tired of waiting for WebMD to demonstrate growth," Vendetti says. For the skeptics, it's a case of "physician, heal thyself." And many of them won't jump into the stock until WebMD shows it can make good on its promises. Tsao covers the markets for BusinessWeek Online and writes for the Street Wise column


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