What Carl Icahn Sees in WebMD: Stock of the Week ~ market folly

Tuesday, March 6, 2012

What Carl Icahn Sees in WebMD: Stock of the Week

We're proud to announce a new series here on MarketFolly.com: stock of the week. This series aims to provide a quick summary of what hedge fund managers and well known investors might see in a particular company.

These posts are written by Tsachy Mishal who is the Portfolio Manager at TAM Capital Management. He provides background on the situation, as well as what he likes and dislikes about the company. Here's his take on what Carl Icahn sees in WebMD (WBMD):

Carl Icahn is so well known for putting fear in the heart of corporate boards and entrenched managements everywhere, that his amazing record as an investor is often overshadowed. When I saw WebMD trading at a 52 week low I was eager to take a look as Carl Icahn bought 11.64% of the company at significantly higher prices.

WebMD is the most visited health related website in the US by both patients and doctors. People visit the site in order to learn more about drugs, illnesses, and general health issues. WebMD largely makes its money off of advertising. WebMD has stumbled recently as pharmaceutical companies have cut ad spending. Pharmaceutical companies are facing a patent cliff which is a double whammy for ad spending. There are fewer drugs to advertise and companies are looking to offset lost revenue with lower costs.

WebMD has a market cap of $1.4 billion and $320 million in net cash for an enterprise value of $1.08 billion. In 2011 WebMD produced $558 million in revenue and $116 million in free cash flow. In 2012 revenue is expected to fall to $507 million and free cash flow is expected to fall to $65 million.

What I like:

- WebMD trades at a little over 9 times 2011 free cash flows. If they could turn around their revenue decline and cut costs, the stock would be very attractively priced.

- Carl Icahn seems to be influencing the company as the recent tender offer is straight out of his playbook.

- There is a tender offer for $150 million worth of shares. Tender offers tend to have a positive short term effect on stock prices.

What I don't like:

- WebMD trades at 16 times forward free cash flow, which seems high for a stumbling company.

- Stock option expense is nearly $40 million a year, which is a very large portion of free cash flow and earnings.

- Content creation on the internet does not have any barriers to entry.

- There do not seem to be any potential acquirers as the company unsuccessfully tried to sell itself recently.

I must admit to scratching my head when first looking at the company, trying to figure out what Carl Icahn sees. Then, I realized that just a few months ago there were expectations for growing revenue and free cash flow. I'm not certain that Carl Icahn would have gotten himself into this situation had he known he was looking at a revenue and free cash flow decline. However, as owner of 11.6% of the company, it's difficult for him to turn back. WebMD is now a turnaround situation and with Carl Icahn calling the shots I wouldn't bet against them. That said, I'm not interested in betting alongside Carl Icahn in WebMD.

That concludes the first entry in MarketFolly's new series: stock of the week. The above was written by Tsachy Mishal, Portfolio Manager at TAM Capital Management.

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