Thursday, June 7, 2012

Andrew Diaz's Presentation on WebMD (WBMD): Ira Sohn Contest Finalist

Today we're presenting an investment write-up that was a finalist at the Ira Sohn investment contest.  We've already posted up notes from the Ira Sohn Conference where you got to read about investment ideas from top fund managers.

Now, we're posting up some entries that made it to the final round of judging from the investment contest at Ira Sohn that was judged by the likes of Seth Klarman, David Einhorn, and Bill Ackman.  The following is Andrew Diaz's pitch of WebMD (WBMD).

Target Price and Rationale    

$26 - $30 per share 

Base Case:  A DCF valuation was used to determine intrinsic value, which assumed WebMD’s overall market share would decrease from ~40% today to ~20% in equal increments over five years, ~$530 million of revenues per year ($558 million in 2011) and 20% EBITDA margins (33% in 2011). The assumed cost of capital and terminal growth rate were 16% and 4%, respectively. Even in adverse conditions such as a highly competitive advertising environment, online pharmaceutical spending growth more than offsets any market share erosion that WebMD may experience and also builds in the potential for premium ad pricing declines. Advertising dollars continue to shift from offline to online sources.  

LBO:  In December 2011 the board conducted management meetings with several private equity funds but anticipated receiving bids below the Company’s then quoted market price of ~$38 per share. In a hypothetical take-private transaction with the price at $21.85 a PE fund could generate a 5 year IRR of ~20% by buying the business at ~7x LTM EBITDA (~$26 per share), using conservative leverage of ~3x and applying single digit revenue and EBITDA growth.  

Free Options: This valuation excludes (i) ~$250 million (~$5 per share) NPV of federal NOLs, (ii) mobile growth, (iii) international opportunities and (iv) an increase to the repurchase program.   

According to management, the NOLs could remain usable in a tax efficient change of control transaction with a private equity buyer. An important area of growth that was excluded from the valuation was mobile because it is only a small portion of revenues today, but it can one day be a meaningful contributor to revenue. Additionally, this valuation excludes the impact for international opportunities which includes new website launches in Europe and other emerging markets where there is meaningful revenue potential.  

Relevant Comps  

Epocrates (Ticker: EPOC) is a physician platform for clinical content, practice tools and health industry engagement primarily in the mobile space. Epcorates derives $100 million of revenues from 1.4 million physician members. Epocrates trades at ~8x Adj. EBITDA of $13.8 million and does not generate consistent free cash flow. The Company has grown revenue at a ~15% CAGR since 2007. 

HealthStream (Ticker: HSTM) provides internet based learning and research solutions for the healthcare industry. HealthStream derives $87.2 million of revenues from approximately 2.5 million hospital-based healthcare professionals. The company trades at ~30x EBITDA of $17 million and generates ~$10 - $15 million of free cash flow annually. The Company has grown revenue at a ~19% CAGR since 2007.  

Everyday Health (Private) provides online consumer health solutions. The Company offers content and advertising-based services across a portfolio of websites that span the health spectrum. It is estimated that the Company has revenues and EBITDA of $102 million and $2.6 million, respectively.  


There are several catalysts: (i) Expiration of the shareholder rights plan, (ii) Sale of the Company, (iii) Increases to the authorized stock repurchase plan and (iv) Hiring of a new CEO  

(i)    In November 2011, the board adopted a shareholder rights plan limiting any shareholder to a maximum 12% ownership. The rights expire on November 1, 2012, or approximately 6 months from today. Currently, Carl Icahn and Kensico Capital Management are the two largest shareholders with stakes of 13.1% and 12.9%, respectively. (Both stakes are above the threshold due to the Company’s recent tender offer). These investors may seek to meet with the board and unlock shareholder value through strategic opportunities.  

(ii)    In late 2011, the board of directors engaged private equity buyers for a potential transaction, but the discussions never proceeded to a formal offer as a result of anticipated declines to 2012 results primarily due to its pharmaceutical customer base deferring marketing spend. Given the temporary nature of these declines, the board may re-engage private equity buyers as the poison pill nears expiration and 2013 revenue visibility comes into focus. The stock is currently 42.5% lower than the price when negotiations between potential buyers commenced. 

(iii)    In April 2012, WebMD offered to tender 5.8 million shares at a price of $26.00 per share, for an aggregate cost of $150 million (~10% of the common stock). There is approximately $86 million (~7% of market cap) remaining under the buyback plan authorized in October 2011. Management has indicated an interest in upsizing the repurchase program given WebMD’s $1 billion cash balance and undervalued stock.  

(iv)    Currently, the board is searching for a new CEO to lead WebMD after the CEO resigned in early 2012. A new CEO with relevant healthcare/online advertising experience would enable the Company to better monetize its online assets, 100+ million user base, and strong brand.   

Investment Thesis   

Why does WebMD trade at ~$22 per share today? I believe the main drivers of the recent stock price decline are (i) a failed sales process and (ii) temporary decline in ad spending by its pharmaceutical customer base. 

(i)    Last summer, the board held preliminary discussions of a transaction involving one or more potential private equity buyers. However, neither transaction was pursued in light of the market turmoil. In November 2011, the Company re-engaged discussions with four private equity funds who conducted a due diligence investigation of the Company’s business. The board believed it would receive offers well below the then quoted price of ~$38 per share. On January 10th, after announcing that 2012 would be weaker than previously anticipated, the stock price fell to ~$27 per share. At which point management contacted three new potential private buyers. Once again, the board felt that offers would be lower than the stock price and therefore took the Company off the auction block. I believe management made the right choice by not selling the business at a most inopportune time.  

(ii)    The underlying business value has been overshadowed by a temporary decline in ad spending by pharmaceutical companies. This is due to uncertainty surrounding FDA regulations for healthcare advertising as well as several blockbuster patent expirations. Many pharmaceutical companies have been sued over false portrayal and advertisements. As a result of uncertainty surrounding the FDA’s new standards, pharma customers have temporarily postponed advertising spend. Ad spending currently goes through a rigorous 3-step process including legal, medical and regulatory reviews. However, as customers become attuned to the new approval process, advertising spend should normalize.   

Compelling Long-Term Value 

Media advertising is undergoing a fundamental shift, from print to online, especially in mobile areas such as tablets and smart phones. In the search for alpha, one can find no relationship between the numerous tail risks present in the macroeconomic environment today and the secular growth of online media advertising. As proof, WebMD has grown revenue and EBITDA since 2007 at a CAGR of ~15% and ~17%, respectively.  

Broadly speaking, WebMD is in the business of online media advertising. WebMD markets to 107 million unique consumers per month which collectively generate over 10 billion page views per year. Additionally, WebMD has a professional network that averages ~2.6 million physician visits per month. While WebMD has not yet monetized its mobile customer base, ~11.5 million people have downloaded the WebMD mobile app and more than 2 million physicians have downloaded the Medscape Mobile app. It should also be noted that WebMD derives minimal revenues from abroad, but has recently launched German and French sites for physicians and is in discussions to launch sites in other international markets. International markets could contribute a meaningful portion to revenue growth in the future, but have not been considered for this thesis.  

WebMD has positioned itself to take part in favorable secular trends impacting online media. According to eMarketer, healthcare and pharma advertisers’ US online ad spend is expected to see double-digit growth over the next few years, rising from $1.03 billion in 2010 to $1.86 billion in 2015. This currently represents ~3.5% of the annual $28 billion spent on pharmaceutical advertising. By 2015, eMarketer’s suggests ~7% of total pharma ad spending would be online. WebMD’s is in an enviable position to capture this growth due to its strong brand and 100+ million unique visitors per month. 

Over time a long term horizon, the percentage of online advertising spending should become a bigger portion of the overall spending pie. Cost-conscious drug makers are seeking less expensive marketing strategies. For example, the number of US pharmaceutical sales reps has declined since 2005 and may accelerate further once the Physician Payments Sunshine Act takes effect in late 2013. This law requires all US manufacturers of drug, device, biologics, and medical supplies to publically report physician payments. This should help shift advertising dollars to relatively cheaper and more effective alternatives such as online advertising. Assuming that one day 30% of the total pharma ad spending will be online and suppose that total market gets cut in half due to more cost effective advertising. One could project online pharma ad spending to be ~$4 billion sometime in the next decade.  

As evident by the lack of comparables, WebMD is undeniably the market leader in its niche, representing ~40% of total online pharma ad spending in 2011. One might wonder what the “moat” is and how WebMD can maintain its share of a growing market. WebMD’s value is powerful and stems from its first mover advantage which has allowed the Company to amass a large user base that would be difficult to replicate. Unlike most online advertisers, WebMD offers targeted advertisements to individuals researching a specific topic or condition. Through providing information about therapies available to treat that topic, WebMD’s advertising can be viewed as a valuable source of information provided to a potential prescriber or patient when they are already focused on finding said information. Conversely, other media advertising is focused on diverting the user’s attention away from what they are already doing. I believe this fundamental difference between WebMD and other online advertisers helps to alleviate risks of potential declines to premium ad pricing.  

Selling into a weak 2012 did not make much sense for shareholders and I believe management made the right choice to call off discussions. Instead of selling the business entirely, the Company held a tender offer to repurchase $150 million of common stock at a price of $26 per share which suggests that management is shareholder friendly. I believe directors and management still have a strong incentive to sell the business since they own ~8% of the outstanding stock (~$100 million market value) and would be entitled to receive an additional ~$30 million of compensation in the event of a change of control. The CEO resigning certainly raises some concern, but as previously mentioned, I believe the right CEO could be a positive catalyst. With the poison pill expiring in 6 months and management motivated to sell, I believe WebMD is an attractive takeover target with a strong competitive advantage attributable to its 100+ million user base and strong brand coupled with favorable long term trends for online pharma ad spending.

Embedded below is Andrew Diaz's slideshow presentation on WebMD from the Ira Sohn investment contest where he was a finalist:

Were you also a finalist in the contest?  Please click the contact link at the top of the page and get in touch.  And if you haven't seen them already, check out notes from the Ira Sohn Conference.

Wednesday, June 6, 2012

Tempur-Pedic (TPX) Plummets: Analysis Excerpt From Our Newsletter

Today, shares of Tempur-Pedic (TPX) are down 48% after the company cut its full-year forecast.  We wanted to draw attention to this because we featured analysis of TPX two weeks ago in our premium Hedge Fund Wisdom newsletter which pointed out that the potential warning signs were there.

TPX today cited that an "unprecedented" number of rival products with huge marketing/promotion have hit their sales. 

Below is an excerpt from the current issue of our newsletter which drew attention to these potential red flags two weeks ago:

Excerpt From Our Hedge Fund Wisdom Newsletter

"Tempur-Pedic (TPX)

Current Situation

Following its 1Q earnings call after the market close on April 19th, TPX shares lost 20% from $84 to $67. The company reported robust growth of 18% in sales, which was in line with analyst expectations, as were its earnings. However, the impression is that the industry grew faster than TPX, which was a big blow to the stock. Also, the company reaffirmed its 2012 guidance of $3.80-3.95 on $1.6bn of sales, which fell short of consensus of $4.06 EPS and $1.7bn sales. Analysts became less sanguine about the stock’s growth prospects because of intensifying competition in the specialty bedding segment and the potential of cannibalization from the introduction of lower-priced beds.

More intense competition in specialty beds will translate into slower growth for TPX and potentially lower prices and margins. Also, TPX has been focused on the higher end of the premium segment with very few low-priced offerings. In order to continue growing, it has to expand its product line into lower-priced products. These products may satisfy some of TPX’s current customers, thus resulting in a down-mix shift.

On May 7, TPX made a surprise announcement that it will be offering its Cloud Supreme mattress on sale from mid-May to July. Offering sales discounts is very uncharacteristic of TPX and goes against its strategy, which is why the market reacted so negatively. The stock lost almost 20% within a couple of days as the move was interpreted as a red flag that could signal deeper fundamental issues and slowing growth.

The Bear Case

The company's growth cycle has matured, so it doesn't deserve the historically high valuation multiples that reflected much higher growth. The risk is that competitor Select Comfort (SCSS) has a lot of ground to cover in terms of increasing its brand awareness and distribution before it can catch up to TPX, which means that SCSS may capture most of the incremental segment growth. In addition, the high growth of the segment has attracted significant competition. Therefore, growth may be more difficult to achieve than expected. What’s more, TPX has leading margins, but as competition intensifies it may have to give back some of its pricing power. If EPS growth doesn’t materialize at ~20% for the next couple of years, there is downside to the stock.


Hedge funds have been attracted to TPX because of its strong balance sheet, shareholder-friendly management, robust growth, and solid execution. It has all the ingredients to continue growing earnings at a rapid pace. However, competition is intensifying and what has made TPX successful can also be viewed as a source of risk to the relatively rich valuation: growth can slow down with more players, and margins can compress. The stock price took a big hit following disappointing guidance and concerns that the company needs to resort to discounts in order to boost sales."

Then fast forward two weeks ahead to today and the company has now cut its full year forecast.

Get More Research & Analysis Like This

The above is just a brief excerpt from the current 85-page issue of our quarterly newsletter.  Sign up below to read additional equity analysis of AutoZone (AZO) and Equinix (EQIX).

Also included in the issue: the latest portfolios of 25 top hedge fund managers.  See what they've been buying & selling by subscribing below:

1 Year Subscription (Save 20% with this option): $299.99 per year

Quarterly Subscription: $89.99 per quarter

Presence of Hedge Funds in Chapter 11 Process & Effects on Bankruptcy Outcomes

Today we wanted to highlight a paper by Wei Jiang, Kai Li, and Wei Wang, entitled "Hedge Funds and Chapter 11" found via The American Finance Association, Publishers of the Journal of Finance.

The abstract of the paper reads as follows:

"This paper studies the presence of hedge funds in the Chapter 11 process and their effects on bankruptcy  outcomes. Hedge funds strategically choose positions in the capital structure where their actions could have a  bigger impact on value.  Their presence, especially as unsecured creditors, helps balance power between the  debtor and secured creditors. Their effect on the debtor manifests in higher probabilities of the latter’s loss of  exclusive rights to file reorganization plans, CEO turnover, and adoptions of KERP, while their effect on secured  creditors manifests in higher probabilities of emergence and payoffs to junior claims."

The paper finds that some of the biggest players in Chapter 11 are household names: Oaktree Capital, Appaloosa Management, Apollo Advisors, Cerberus Capital Management, and Silver Point Capital, among others.

And for those of you that might not have time to read an entire paper, it intriguingly concludes that:

"We find that hedge fund presence is associated with a higher probability of the debtor’s loss of  exclusive rights to file a reorganization plan, a higher probability of emergence, more favorable distributions to  the claims they invest in, greater CEO turnover, and more frequent adoptions of KERP.  We further establish the  causal effects of hedge funds, especially in their role as creditors, through instrumentation for hedge fund  participation.  Finally, we show that the favorable outcomes for claims in which hedge funds invest do not come  at the expense of other claimholders—they are more likely to result from value creation by alleviating financial  constraints and mitigating conflicts among different classes of claims."

Embedded below is the paper Hedge Funds and Chapter 11:

You can download a .pdf copy here.

For more on hedge funds and distressed investing, check out notes from Dan Loeb & Daniel Krueger's talk at a distressed investing panel as well as Marc Lasry's thoughts on distressed opportunities.

Third Point's Top Holdings & Latest Exposures

Dan Loeb's Third Point Offshore Fund finished May -2.6% and was up 3.7% year-to-date at that time.  The fund now manages $4.6 billion and has seen annualized returns of 17.1%.  Below are their top positions and latest exposures.

Third Point's Top Holdings

1. Yahoo! (YHOO)
2. Gold
3. Delphi (DLPH)
4. Apple (AAPL)
5. Sara Lee (SLE)

The hedge fund's top winners from the past month included three consumer short positions, one industrial short position, as well as a long of Vertex Pharmaceuticals.  Their top losers in the quarter included gold, YHOO, DLPH, Hess (HES), as well as Abercrombie & Fitch (ANF).

We've previously posted Third Point's Q1 letter which includes their thesis on AAPL among other positions.

Their stake in Sara Lee slides into their top holdings again as this catalyst play will spin-off its coffee business at the end of June and then will  rename its remaining business Hillshire Brands to reflect its line of meat products.

In other recent activity from this hedge fund, we've highlighted that Third Point reduced its Technicolor stake as well.

Latest Exposure Levels

We've noted that throughout the first half of the year, Third Point ratcheted up net long exposure as they liked the risk/reward skew.  However, given the ramp in volatility this past month, it should come as no surprise that Third Point reduced exposure.

At the end of May, they were 31.4% net long equities (44.4% long and -13% short).  This compares to 40% net long the month prior.  During the month, they cut long exposure and increased short exposure.

Geographically, they are net long Americas at 61%, net short EMEA at -10%, and net short Asia at -3%.

They also decreased their exposure to credit.  In April they were 20.7% net long and at the end of May they were only 14.2% net long.  Of note is the fact that they increased their short bet against government securities.

Dan Loeb is featured in the new book The Alpha Masters and you can check out our review here.

What We're Reading ~ 6/6/12

Full text of George Soros' speech on Europe [Business Insider]

Rescuing your investment plan [Covestor]

Thoughts on behavioral finance from Daniel Kahneman [Derek Hernquist]

Seeds being sown of new secular bull market? [Abnormal Returns]

Advice for those working with financial advisors [TheBigPicture] 

Why Macau is lucrative location for gaming companies [Trefis]

The biggest stock bargain in Europe? [SmartMoney]

Moving back into the mortgage market [AR+Alpha]

Why Starbucks' bakery purchase is brilliant [Herb Greenberg]

A Greek contrarian opportunity? [SumZero]

Lansdowne bets on Italian & Greek stocks [Bloomberg]

Investors leery of Paulson's big gold bet [NYPost]

An interesting assessment of Transocean (RIG) [SeekingAlpha]

Why value investing is for grown-ups [CBS]

Inside the death of Palm and webOS [The Verge]

Sellside note on (CRM) [William Blair]

Michael Lewis' commencement speech [Princeton]

Tuesday, June 5, 2012

Lone Pine Capital Discloses Kinder Morgan Stake Via El Paso Deal

Steve Mandel's hedge fund firm Lone Pine Capital filed a Form 3 and 13G with the SEC regarding shares of Kinder Morgan (KMI).  The hedge fund now owns a sizable chunk of common stock and warrants that they received via their previous position in El Paso (EP).

As pointed out in our new issue of Hedge Fund Wisdom two weeks ago, El Paso was Lone Pine's largest disclosed US equity holding as they were playing the risk arbitrage there.  EP was acquired by Kinder Morgan in a stock/warrant/cash deal.

Lone Pine has now disclosed a 12.9% ownership stake in the company with 71,780,836 shares.  This is represented by 17.6 million shares of common stock and 54.1 million shares via warrants.  The warrants have an expiration date of May 25th, 2017 and a conversion/exercise price of 40.

Numerous other prominent hedge funds were playing this arbitrage as well, so it will be interesting to see who holds on to the new entity (KMI) and who sells their position.  Our premium newsletter drew attention to the sizable stakes in El Paso by Lone Pine, Farallon Capital, Paulson & Co, Omega Advisors, JANA Partners, and Third Point.

Per Google Finance, Kinder Morgan "owns and manages a diversified portfolio of energy transportation and storage assets. The Company operates in five business segments: Products Pipelines-KPM, Natural Gas Pipelines-KMP, CO2-KMP, Terminals-KMP and Kinder Morgan Canada-KMP. The Company through Kinder Morgan Energy Partners, L.P. (KMP) operates or owns an interest in approximately 37,000 miles of pipelines and approximately 180 terminals. These pipelines transport natural gas, refined petroleum products, crude oil, carbon dioxide and other products, and its terminals store petroleum products and chemicals, and handle such products as ethanol, coal, petroleum coke and steel."

In other portfolio activity from Mandel's firm, we've highlighted how Lone Pine has been buying Ulta Salon.

SAC Capital Reveals Gaylord Entertainment Position

Steve Cohen's hedge fund firm SAC Capital recently filed a 13G with the SEC regarding a stake in Gaylord Entertainment (GET).  Per the filing, SAC has disclosed a 5.1% position in GET with 2,508,358 shares.

This is a brand new position for the hedge fund and the disclosure was made due to trading activity on May 31st.

The catalyst for this play comes via an announcement that Marriott will acquire the Gaylord Hotels brand for around $210 million and then Gaylord will convert into a REIT, continuing to own the Grand Ole Opry property.

Cohen was named one of the top 25 highest earning hedge fund managers of 2011.

Per Google Finance, Gaylord Entertainment is "a hospitality company. The Company’s operations are organized into three segments: Hospitality, which includes its hotel operations; Opry and Attractions, which includes its Grand Ole Opry assets, WSM-AM and its Nashville attractions, and Corporate and Other, which includes corporate expenses."

For more of Steve Cohen's latest activity, head to 10 stocks SAC Capital has been buying.

Pennant Capital Reduces Homeserve Position

Alan Fournier's hedge fund firm Pennant Capital has reduced its position in UK traded Homeserve (LON:HSV).  Due to trading on May 22nd, the hedge fund has reduced their position under the 3% disclosure threshold.

Shares of Homeserve fell 29% on May 22nd after the company announced that it was downsizing its operation in the UK in response to a formal investigation by the Financial Services Authority.  On May 19th, the company received a  £750,000 fine over its cold calling practices, the largest fine ever handed out by Ofcom.

While the official notification says that Pennant now hold 2.96% of the voting rights, there's no way to know of further sales as they aren't required to disclose them after falling below that level.

We originally posted about Pennant's new position in Homeserve back on March 6th.  Hedge fund Marathon Asset Management was another previously sizable holder of shares as they reported a 5.24% stake back in November 2011.

Per Google Finance - "Homeserve plc provides home emergency and repair services to over 4.9 million customers across the United Kingdom, the Unites States of America, France and Spain. Services are provided through its membership businesses, which are responsible for the marketing and administration of over 11 million home repair and appliance warranty policies. The Company operates in five segments: UK, USA, Domeo, Spain and New Markets. "

In other activity from Fournier's fund, we've highlighted how they've been buying Huntington Ingalls Industries.

Market Strategist Jeff Saut on Investor Sentiment

Given the volatility in markets as of late, we thought it'd be prudent to check in with market strategist Jeff Saut.  His latest missive, entitled "1-800-Get-Me-OUT?!" obviously hints at the prevailing investor sentiment at the moment: sell sell sell.

Saut examines the psychology behind why and when investors sell, which is definitely worth the read below in his commentary. 

But what's funny is how he points out that, "Since last October 4th's 'undercut low' the chant from most investors has been, 'We want a pullback to become more fully invested.'  Now that we have the pullback, everyone is in panic mode (again)."

In order for a rally from oversold levels to commence, Saut points to the 1290 level on the S&P 500.  If the market can recapture and stay above that level, things are looking up (it currently trades around 1281). 

However, if it fails, he argues it would be time to acquire more hedges or raise more cash.  We've also previously highlighted Saut's approach to risk management.

Embedded below is Jeff Saut's weekly market commentary:

You can download a .pdf copy here.

For more from the strategist, head to his thoughts on why it's time to dip into stocks.