Will WebMD's Healthy Glow Last?

The Net health-care concern has been a hit on the Street since being spun off last year. Now its numbers have to back up the optimism

Just days after Google (GOOG ) raised a staggering $4 billion in a September secondary stock offering, another brand-name dot-com made a much quieter, but equally impressive splash on Wall Street. Health-information provider WebMD Health (WBMD ) spun out from its parent company on Oct. 4, raising $129 million. Shares of its stock have nearly doubled to $34.92 since then (as of the market close on Feb. 22).

Yet the 7-year-old Internet survivor is barely profitable, and its parent company, Emdeon, has been tainted by an accounting scandal. What's more, WebMD's advertising-supported sites are facing competition from general portals such as Google itself. None of this fazes CEO Wayne Gattinella, however. "We're very early in the game," he says. "We have a tremendous amount of headroom."

PHARMA'S BOOST.  The Street will soon learn whether Gattinella has the numbers to back up his bravado. On Feb. 23, WebMD will announce its 2005 results. As of November, the company was predicting sales would increase 25%, to $168 million, from last year, and that profit would rise a percentage point or two, to about $6.6 million. WebMD believes earnings could triple this year.

Most of the gain is expected to be driven by pharmaceutical companies, which are placing ads in droves on WebMD's consumer site, as well as the educational portals it maintains for doctors under the brand name Medscape. In the third quarter alone, advertising, sponsorship and promotion revenue grew 24% from a year earlier.

WebMD's ad salespeople have a reputation for being difficult to work with, Forrester Research says. And it charges 20% or more for ads than other portals. Still, says Forrester Research analyst Elizabeth Boehm, it's no surprise advertisers keep turning to WebMD: It attracted 11 million unique visitors in January -- nearly three times as much as its next closest competitor, MSN Health, according to Nielsen/Net Ratings. "WebMD is viewed as a necessary evil," Boehm says. "Necessary because it is the lead player."

TARGET AUDIENCES.  WebMD is capitalizing not only on its brand name, but also on broader marketing trends in the pharma industry. Stung by criticism over Merck's (MRK ) lavish advertising for the arthritis drug Vioxx, which has since been pulled from the market, pharma companies have been shying away from television. Instead, they're gravitating towards the Internet, where they can aim their advertising efforts at people who plug specific disease terms into search engines (see BW, 8/15/06, "Drugmakers Are Changing Channels").

Type "cholesterol" into the search box on WebMD's home page, for example, and the first two links that pop up are to sites sponsored by Pfizer (PFE ) and Merck, both of which sell statin drugs to fight high cholesterol. Internet ads also allow pharma outfits to provide more information about a particular drug than they can in a 30-second spot -- especially one that's weighed down by a laundry list of side effects. The pharma industry's spending on Internet ads rose 30% in 2005, to $53.9 million, while TV advertising crept up just 5%, according to Nielsen/NetRatings.

Bristol-Myers Squibb (BMY ) is one of the pharmaceutical giants that has embraced Internet advertising, and WebMD is at the top of its go-to list. Last year, Bristol-Myers adopted a new code for direct-to-consumer advertising that prohibits TV ads during the first year of a drug's launch. But the Internet remains fair game.

"ROBUST WITH INFORMATION."  Bristol-Myers advertises several products, including its anti-clotting drug Plavix, on WebMD. "The Holy Grail is to get people to come back to your site," says Tom Chetrick, vice-president of advertising and marketing services for Bristol-Myers. "WebMD is so robust with information that people looking for a particular disease will keep coming back."

Bristol-Myers is preparing to launch Orencia, a drug to treat rheumatoid arthritis, and Chetrick says the company is likely to include WebMD in its media plan.

WebMD has been aggressively targeting doctors as well. Its Medscape site provides drug references, journal articles, and online courses physicians can take for continuing-education credit. Citigroup analyst Mark Mahaney estimates that about half of WebMD's sponsorship and ad revenues come from its physician-targeted sites. The company has been aggressive about maintaining its leadership position there.

TOO MUCH CONFIDENCE?  In October, competitor eMedicine announced that its traffic was more than twice that of Medscape's, prompting WebMD to dash off a press release denying the claim. Two months later, WebMD bought eMedicine for $25 million. "Reaching doctors is very important to the future of our business," says Gattinella. "Pharmaceutical and biotech companies spend twice as much on educating doctors as they do educating consumers."

Still, some investors think Gattinella may be a bit overconfident about WebMD's growth potential. The number of WebMD shares held by short-sellers, who profit from betting a stock will go down, rose 31% in January. That was the single greatest monthly rise in short interest by any Internet company, according to data compiled by Bloomberg.

Moreover, WebMD's shares are trading at 264 times earnings -- astronomical, compared with the Internet industry's average price-to-earnings multiple of 44. That means even the slightest disappointment could send shares into a tailspin.

OWNERSHIP QUESTIONS.  Fund manager Linda Killian says WebMD's miniscule profit growth doesn't justify the valuation. "They have to capitalize on the investments they've made in this business," says Killian, manager of Renaissance Capital's IPO Plus Aftermarket Fund, which has been selling its shares. "They haven't monetized it as much as we'd like."

Plus, there's always the risk that with WebMD charging a premium for ads, advertisers could shift more of their dollars to broader portals such as those run by Microsoft (MSFT ), Yahoo (YHOO ), and Google.

Then there are the questions about WebMD's ownership structure. Its parent company, which was renamed Emdeon last year, still owns about 85% of WebMD's shares. In December, a U.S. attorney for the district of South Carolina indicted 10 former officers and employees of an Emdeon subsidiary on charges of accounting improprieties. The unit, known as Emdeon Practice Services, was acquired by the company several years ago, and it was during that deal that the first hints of accounting issues arose.

HEALTHY MARGINS.  On Feb. 16, Emdeon announced that it would explore the option of selling off the Practice Services unit and one other subsidiary. Shares of WebMD dipped 7% that day, with some investors questioning whether WebMD's shares might get caught up in the deals, possibly diluting the stock.

Martin Wygod, who serves as board chairman of both WebMD and Emdeon, says concerns are overblown. "We have no intention of selling off any of WebMD's shares," he says. The company says all accounting issues are now in the rear-view mirror.

As for the potential for future growth, Wygod vows that all incremental revenues will carry profit margins as high as 40%. "They'll be more profitable than what's currently on the books, because we'll have more of a fixed overhead," Wygod says. "We expect earnings to go up faster than revenues."

INFORMED SALESFORCE.  This is far from the first time WebMD has faced down skeptics. Its predecessor company, Healtheon, was lampooned as a symbol of dot-com excesses in the 2000 book The New New Thing, by Michael Lewis. The book recounts how Jim Clark, Healtheon's founder, told investors that his new Net company would be the nexus of health care -- drawing together insurers, doctors, providers, and consumers -- and that it would grow into the most highly valued company on the New York Stock Exchange.

But by the time Wygod and his management team took over in late 2000, Healtheon was on its way to losing $450 million, with bankruptcy a near-certainty. "It was difficult to give the advertising away," recalls Gattinella, who was hired as head of the online business in 2001.

So Gattinella completely overhauled the company's selling approach. He axed most of the old salesforce and hired new salespeople straight out of the pharmaceutical and medical-devices industries. Gattinella figured that the sales reps would need a deep understanding of the products if they were to persuade potential customers to place ads.

PRIVATE PORTALS.  Gattinella spent his first two years on the road with the salespeople, begging prospects to give WebMD a chance. "The health-care industry didn't understand the Internet back then," he recalls. Toward the end of 2001, WebMD acquired Medscape, and faced a whole new round of skepticism from advertisers. "They believed that practicing physicians wouldn't get medical information from the Internet," Gattinella says. "What they didn't realize was that medical students were already learning online. Then we went through a generational change."

Now that advertisers are on board with WebMD, the dot-com is rounding out its customer base by designing private health portals for insurance companies and employers. In the third quarter, WebMD signed deals with IBM (IBM ), Cisco Systems (CSCO ), and several other large companies.

And the nation's largest provider of health plans, WellPoint, adopted WebMD as the engine for its personalized health portals (see BW Online, 2/20/06, "How Good Is Your Online Nurse?"). The deals could boost WebMD's licensing revenues -- and analysts will be eyeing the Feb. 23 earnings announcement for any evidence of that.

HYPE OR HIT?  As Gattinella sits in his new sprawling Manhattan office, built to accommodate his company's expected growth, he refuses to let WebMD's critics distract him from his mission. "I've always believed in the merger of the Internet and health-care information," Gattinella says. "It's not as if our mission has changed."

Still, he can't help but laugh at the first piece of advice Wygod gave him back in 1991, when the two men met at Merck-Medco. Wygod, then CEO of the pharmaceutical-services firm, left Gattinella waiting for several hours in the lobby. As he breezed by to apologize, he said, "Make yourself comfortable, but not too comfortable," Gattinella recalls with a laugh. "I thought that was good general advice for business."

WebMD is clearly ensconced at the top of the online-health heap. But with Wall Street expectations at an all-time high, Gattinella had better pay close heed to Wygod's advice.