First Union Securities Covers HLTH
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HLTH: INITIATING COVERAGE WITH A MARKET PERFORM RATING WebMD Corporation (HLTH–NASDAQ)
KEY POINTS
-- Initiating coverage of WebMD with a Market Perform rating.
-- While the company has assembled an impressive array of assets and a solid management team, we believe there is significant operational, financial and integration issues that may take longer than expected to resolve.
-- Management expects to re-evaluate agreements with an aggregate of $130 million of revenue. Restructuring initiative expected to save $260 million in expenses.
-- Establishing FY2000 and FY2001 EPS cash-estimates of ($1.12) and ($0.25), respectively. We note that our confidence in the accuracy of our earnings model is quite low.
COMPANY DESCRIPTION
WebMD provides connectivity and a full suite of services to the healthcare industry that improve administrative efficiencies and clinical effectiveness enabling high-quality patient care. The company’s products and services facilitate information exchange, communications and transactions between the consumer, physician and healthcare institutions. In the last six months, the company has completed the acquisitions of Envoy, Medical Manager, CareInsite, and OnHealth.
DISCUSSION
We have initiated coverage of WebMD with a Market Perform rating. While the company has assembled an impressive array of assets and a strong management team, we believe there is significant operational, financial and integration issues that may take longer than expected to resolve. The company is currently in the process of re-evaluating a number of relationships with strategic partners that represent as much as $130 million in annualized revenue. In addition, the restructuring initiative that was announced at the end of September is estimated to reduce operating expenses by $260 million. We note that the company will be taking additional charges to earnings related to both of these issues. Below, we discuss the rationale for our Market Perform rating.
Broad Portfolio of Assets. Through the acquisitions of Envoy, Medical Manager, CareInsite, OnHealth and others, WebMD has assembled one of the most diverse and proprietary bases of assets in the industry. Through Envoy, the company is one of the largest processors of medical transactions in the United States, with over 2 billion transactions processed on an annualized basis. In addition, through the remaining assets, WebMD possesses market leading positions in the physician practice management systems area and a very high-traffic physician portal.
Strong Management Team. The addition of Marty Wygod and his management team through the Medical Manager acquisition provide the company with an impressive array of talent. The team has had success with predecessor companies and cause us to believe that the aggressive restructuring and realignment plans that have been proposed may be attainable, although we believe it will be several quarters until visibility improves.
Financial Risk. There are so many moving parts to the financials that it is very difficult for us to get comfortable with the numbers. The company only had the financial results from Medical Manager, CareInsite, and OnHealth for 18 days in the September quarter, and the pro-forma income statement on a line-item basis was not provided. In addition, up to $130 million of revenue is under review and expense saving initiatives are estimated to lower operating costs by $260 million. Therefore, we find it challenging to construct even a base case for the model from which we can work forward. Lastly, management has stated that it expects to take additional restructuring and integration charges in the future.
Operational/Integration Risk. As a result of the recent acquisitions, WebMD had 6,100 employees, 257 locations, 9 call centers, 13 data centers, and 4 duplicative corporate offices at the end of the September quarter. In addition, its customer base for the transaction business alone is comprised of 1,000 payers, 4,600 hospitals, 36,000 pharmacies, and 300,000 doctors. While we believe the integration and consolidation of this infrastructure is possible, we remain cautious on the aggressive time horizon that has been set by the company. On the conference call, management noted that it has already closed 69 facilities to date, with another 58 scheduled to close in the December quarter. In addition, the consolidation of a data center from Boston to Nashville occurred without customer interruption. In terms of employee redeployment, about 1,100 FTEs have been identified with 700 employees terminated and 400 given a retention package. Management indicated that it believes employee turnover beyond the restructuring will be small.
Confusing and Complex Business Strategy. WebMD’s business model is by no means clear. The very short-term strategy is to eliminate redundancies and divest non-strategic assets (such as Porex). The second phase of the short-term plan is to focus on improving customer service, revenue generation, and the rationalization of products and services. Longer-term, the company’s goal is to integrate the various assets, improve connectivity between its payer, physician, and patient customers, and then capitalize on revenue opportunities by selling new products that reduce costs and improve the quality of care.
Large Overhang of Stock for Sale. Through the restructuring of business arrangements, management departures, and the progression through lock-up period expirations, a significant amount of stock will be available for sale in the future. This would obviously impact the stock price going forward should an orderly exit not be achieved.
Earnings Model Discussion
In our discussion of the financials below, we would like to emphasize that our confidence in our estimates is low, especially on a quarterly basis for FY2001. Management’s guidance for FY2001 was revenue in the range of $875 million to $925 million, excluding the impact of the potential restructuring of up to $130 million in revenue. In addition, the company provided guidance of a cash loss including interest (EBITDA) in the range of $95 million to $100 million.
We have established revenue estimates of $188 million and $506 million for the fourth quarter and fiscal year ended December 31, 2000. Our cash EPS estimates for the company are ($0.16) for the quarter and ($1.12) for the year.
For FY2001, we have established a total revenue forecast of $808 million (+60%). This is comprised of $373 million from Transaction Services, $315 million from Physician Services, $80 million from Portal Services, and $40 million from Other Services. We estimate that gross profit margins will improve to 39.8% of revenue for the year and exit the December quarter at 42.0%. In addition, we believe that the company will realize a significant portion of the expense reductions outlined above, which results in our cash net-loss estimate of ($106 million) for the year, or ($0.25), as shown in the table below.
Conclusion
We have initiated coverage of WebMD with a Market Perform rating. While the company has assembled an impressive array of assets and a solid management team, we believe there is significant operational, financial and integration issues that may take longer than expected to resolve. This vision that has been set forth by the new management team could be enormously successful if (big if) all the assets can be integrated to provide a unified product offering to its different customer bases (physicians, payers, and consumers). We will remain cautious on the stock until we can get more clarity on the integration of assets, the result of the evaluation of $130 million in revenue, progression on the operational restructuring, and the impact on the financials.
Additional information is available upon request.
This is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments mentioned. Interested parties are advised to contact the entity they deal with, or the entity that has distributed this report to them. The information has been obtained or derived from sources believed by us to be reliable, but we do not represent that it is accurate or complete. Any opinions or estimates contained in this information constitute our judgement as of this date and are subject to change without notice. First Union Securities, Inc. (“FUSI”), or its affiliates may provide advice or may from time to time acquire, hold or sell a position in the securities mentioned herein. FUSI is a subsidiary of First Union Corporation and is a member of the NYSE, NASD and SIPC. Copyright © 2000 First Union Securities, Inc. FUSI is a separate and distinct entity from its affiliated banks and thrifts.SECURITIES: NOT FDIC-INSURED • NOT BANK-GUARANTEED • MAY LOSE VALUE
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