Description

I believe WBMD offers a compelling opportunity on the short side given the recent recovery in the shares.  

Among many other things to be discussed later, I believe the insiders are sharing a bit of insight into what they think about the future of the company is given their recent activity.  First, there was the tender offer, where the company offered to retire ~10% of the company's shares outstanding for $34 (a price higher than it had traded since early 2012).  The company does this from time-to-time, so one might wonder whether it really matters...then the results came in.  Four directors tendered anywhere from 56% to 96% of their stakes and the ever-bullish chairman tendered 86% of his shares.   Carl Icahn (arguably the hottest investor in the world right now) also tendered his entire stake and Kensico (2nd largest shareholder and holds a board seat) tendered almost 2/3 of their stake.

That seems like a lot of people "in-the-know" that are trying to get rid of a large chunk of their shares.  The counterargument is that since it's a tender offer for only 10% of the shares, it's inevitable that folks will want to cash in a bit at a premium, which requires tendering much more than they intend on actually selling since it's unlikely that their entire order would be filled...and this is exactly what happened...only ~18% of any given shareholder's tender was realized.  I would definitely heed this argument and discount this insider selling if it weren't for the fact that insiders (including the Chairman) were selling during the tender period and have continued to sell after the tender period.  And probably more important is the fact that Icahn decided to dump the remainder of his shares about a month later at a lower price ($32.08) in a block trade to the company.  Icahn was a 12% owner prior to the tender and a 10% holder after.  He also held a board seat up until August of this year, so I'm fairly confident that he was at least somewhat aware of the operations of the company.  The remaining shareholders were awarded with a 10% jump in the share price b/c the company orchestrated this sale in a fairly clean manner, by buying the stock back directly.  

So what?  The stock is +150% on the year and Icahn is taking his gains and moving on, similar to what he did with NFLX.  I've heard this argument, but believe it is somewhat of a short-sighted point of view.  If you look at when he actually built his position in the name and the transformation of the company since then, the sale makes a bit more sense.  He built his position starting in Q311 through Q112 at stock prices in the $25-$45 range.  Analyzing this and assuming he traded it 100% perfectly (unlikely), his average cost could have been no lower than $27-28.  He then sold for an average of ~$32.50 two years later, for a whopping 17% gain (at the very best...though I've actually heard he was flat or lost money on the position).  Correct me if I'm wrong, but most activist investors don't generally accrue a sizable position in a company over a multi-quarter period and lobby for a board seat with the hopes of compounding <10% and selling in under two years.  It seems like something changed his opinion of what the company is worth over that timeframe and I think he's thanking his lucky stars that the stock rebounded as it did off the bottom.  

Of course what happened during that timeframe is the stock dropped into the low-teens as the business performed horribly and it has since rebounded a bit.  The argument I'm making is that the company may actually be facing stiffer headwinds in the next two years than it did in 2012 that caused a 75% reduction in the stock price from its peak, and I'm thinking Uncle Carl sees that and is trying to get out while he can...especially with FY14 guidance coming up in February.  Mind you, the market seems completely oblivious to these risks and is instead rewarding the company for cashing out its insiders at an expensive stock price using the company's capital.  

Taking a step back...

What they do:

WBMD operates several health-focused websites for consumers (www.webmd.com, www.rxlist.com, etc.) and professionals (www.medscape.com, www.theheart.org, etc.), which are designed for CME (continuing medical education) for medical professionals.  They also work with employers to create private benefits management portals.  They derive most of their revenues (~60%) from consumer display advertising, mostly by large pharma companies advertising their blockbuster drugs, while the remaining 40% is split fairly evenly between professional sites and private portals.  The company creates some original content, but mostly obtains its website content from other trusted sources.  WBMD is headquartered in New York, NY.

Overview:

WBMD for many years has been one of the main sources of internet-based health-related information for consumers, hence was an increasingly important destination for direct-to-consumer advertising for big pharma.  This, combined with a significant number of “blockbuster” drugs developed in the 90’s made way for significant growth for the internet property over the first decade of the 2000’s.  However, over the last couple years, growth slowed from solid double digits to single digits in 2011 and negative in 2012.  Additionally, it appears that big pharma has soured a bit on direct-to-consumer advertising and that most of the shift to internet display advertising has already occurred, hence WBMD has become more subject to the cyclicality of the market (hence the drop in 2012 revenues). 

More recently, in Q412, WBMD adjusted their pricing to be more amenable to the market environment.  While they haven't been completely clear about the changes they made, we believe that they’ve unbundled their pricing and are providing advertisers with more cooperative terms.  They’ve since seen their revenues rebound from a cyclical low in 2012 as advertisers seem to have returned to the platform a bit.

Going forward, there are a number of challenges that WBMD will face and growth will be much harder to come by than the market assumes.  These challenges include:

• WBMD is no longer a growth company and is subject to the cyclicality of aggregate drug spend
• Competition has increased and WBMD is no longer the only "go-to" site for health information
• 2014 and 2015 are set up to be difficult years
• 2015 - Drug industry model suggests that there is a pending slowdown in aggregate drug spending due to a significant patent cliff in 2015, which may turn revenue growth negative again
• 2014 - 2013 has been a rebound year relative to a very weak 2012 which experienced a sizable patent cliff...WBMD is unlikely to experience a similar rebound-style trajectory of growth heading into 2014
• Direct-to-consumer (DTC) advertising by pharmaceutical companies has been declining and will likely decline faster in upcoming years as they shift more spend toward direct physician marketing
• Many of the drugs that are coming off patent in the upcoming years are more wide-reaching (depression, ED, pain), hence conducive for DTC advertising, while drugs coming on patent are designed for more specific patient populations (Hepatitis C, MS, macular degeneration)
• Shift to mobile is detrimental for WBMD's desktop business
• Recent change to the pricing strategy has had the impact of bringing customers back, but is a display of loss of pricing power and could wind up being detrimental in the end
• Recent abrupt and unexplained CEO/CFO turnover raises red flags

Given the company’s large fixed cost base and focus on driving growth (keeping those costs high), these challenges are likely to wreak havoc on the company’s margins and EPS, yet the market continues to apply a sizable growth multiple to this company when the reality is it will look more like a cyclical, old media company.  

Short Thesis:

• WBMD has shifted from a growth company to a cyclical company
• WBMD’s revenue growth has directionally mirrored the annual YoY growth in aggregate US drug spend for the last several years
• As you’ll notice below, there was significant revenue growth outperformance up until 2011, when WBMD started to mirror the market much more closely, particularly the decline in spending that took place in 2012

• 2013 represents a rebound year in aggregate drug spend...combined with the pricing changes that took place in Q412, WBMD revenues have outperformed the market nicely this year
• Part of the reason WBMD has become a cyclical instead of a growth company is due to competition
• While it still has a good brand name, much of the content they've created has come from stitching together information from other sources...much of this information is now available across the internet, so the barriers to entry have been reduced significantly
• Competitors include alternative portals (Everyday Health, Yahoo! Health, Drugs.com, etc.), search engines (Google, Bing, etc.) and destination sites (CDC, Mayo Clinic)
• WBMD still receives the most traffic, but the alternatives are growing more quickly (e.g. Everyday Health grew revs +24% in 2012 vs. WBMD -16%)
• Given these dynamics, we expect growth in WBMD's revenues to be more correlated with aggregate drug spending going forward, which is concerning because:

• The largest patent cliff that the pharmaceutical industry has ever experienced will occur in 2015, which is likely to drag on WBMD's growth as a cyclical company
• This patent cliff includes drugs like Celebrex, Abilify, Neulasta and a host of others

• A similar patent cliff (though smaller) occurred in 2012 and WBMD’s revenue growth took a significant hit (-15.9% per the above chart)
• Pharma ad spending is generally correlated with overall drug spending
• Also, due to increased government oversight, aggregate drug spending and pharma pricing power will likely slow to a certain degree
• Given the large fixed cost base and the company’s focus on growth, any top-line deleveraging would lead to outsized reductions in EBITDA/EPS

• Given this data, 2014 also looks to be a deceleration, which is likely to make the Street's +10% revenue growth difficult to obtain
• We may have begun to see the initial impacts of this in their deferred revenue growth, which decelerated to +4% YoY from +10% YoY in the most recent quarter
• Deferreds have historically been a fairly accurate 2-3Q leading indicator of growth
• We maintain that a good portion of the outperformance in 2013 was due to changes in the company's pricing, which will lapse in Q413 and 2014 is likely to revert closer to market growth

• In addition to there being a difficult cyclical issue that will impact to top-line, ad spend on WBMD is all DTC ad spending for big pharma, which has been in secular decline for the last several years 
• Part of this is due to a decline in TV/paper advertising, however articles suggest many other reasons, including a lack of confidence in the ROI achieved from DTC advertising overall, patent expiries and ethical concerns over DTC drug advertising

• Shift to mobile will be detrimental to WBMD’s fundamentals
• While overall page views for the company are still growing, mobile has been driving desktop page views down 10-20% the last three quarters
• This has yet to impact ad buying decisions, but if traffic continues to be impacted negatively, we expect that this will impact further the company’s already weakened negotiating position relative to advertisers as their premium inventory becomes worth less
• The bull argument is that mobile represents remnant inventory that will be valuable once they figure out how to monetize it
• Simplistically, mobile devices (particularly smartphones) are too small of a form factor for pharma advertisers to adequately display their products as well as the necessary disclosures mandated by the FDA
• They are currently only monetizing slightly via consumer product companies, which is a small opportunity
• The company fully admits that they are unable to monetize mobile in any meaningful way with pharmaceutical companies due to these limitations, despite having popular mobile apps
• They first launched mobile apps in Q408, so they've been trying for almost 5 years
• Investors in most startups that have been around for 5 years generally have a reasonable understanding of whether the strategy will work or not

• As mentioned, the company recently changed their pricing strategy
• While they are not completely transparent about how they changed it, it is our belief that they unbundled their previous packages, which suggests further commoditization of their content
• Previously an advertiser was forced to sponsor an entire subject (e.g. all Diabetes pages) vs. individual placements
• Generally when companies give in on pricing/bundling, it provides a temporary boost to results (which it has), but ultimately weakens their negotiating position and hurts profitability
• There was a reason that they were bundling in the first place

• Recent CEO/CFO turnover suggests uncertainty about the leadership of the company
• The CEO (who was hired less than a year prior to his removal) was “let go” immediately before the Q113 earnings report for an undisclosed reason
• The new CEO is a WBMD-lifer and seems to be in the Chairman's back pocket
• Regardless of the reasoning, the firing of an interesting CEO out of Pfizer brought in a year prior to put in place one of the Chairman's cronies suggests at the very least that investors should exercise caution when considering this company 
• Also, strangely, the former CFO took a demotion at the same time the CEO was let go...
• More confusing than anything...He was a WBMD lifer himself and was replaced by a WBMD lifer

• Cost cutting efforts announced in Q412 have already run their course and the company is focused on investing for growth
• This limits the likelihood that the company is focused on maximizing earnings vs. focusing on driving growth in a headwind-heavy market

• Recent tender offer allowed large shareholders (Icahn) and insiders (including the chairman) to cash out at what was a 52-week high while leaving the company responsible for buying up overpriced stock
• As discussed above

Risks: 

• Mobile monetization
• If the company is able to figure out a monetization strategy, it is likely incremental to the current desktop display business
• Acquisition
• This has long been rumored by someone like Yahoo!, but unlikely at these prices and given these issues
• Continued share repurchase
• Timing
• The company has guided conservatively for Q413, so an earnings beat is likely

Financials/Projections:

• The Street currently has revenue growth of 7-10% through 2014
• I'm in the low-single-digits in 2014 and negative in 2015
• Earnings are likely negligible in 2015 given the negative operating leverage in the business

• Risk:  20x peak Non-GAAP EPS of ~$2.25 = $45 (30% downside)
• This aggressively assumes that the company is able to return to peak margins of 21% in 2014 vs. 11% in 2013...the valuation corresponds to 11x peak EBITDA
• Reward:  15x 2014 Non-GAAP EPS of ~$1.20 = $18 (50% upside)
• Based on minimal top-line growth and operating leverage in 2014
• Valuation multiple more in-line with the market after the realization this is not a growth company
• Big reward:  1.25x EV/2015 Sales (previous trough multiple) = $12 (70% upside)
• This is based on sentiment cratering again on the stock as expectations for a down year with negligible earnings again in 2015 filter through

Catalyst

• 2014 guidance in February disappoints as DTC ad spending growth remains anemic and pricing benefits lapse
• Concerns over 2015 patent cliff start to filter in
• Deferred revenue growth continues to disappoint