Diagnosing WebMD

By Karen Southwick
Staff Writer, CNET News.com
May 11, 2004 4:00 AM PT

Not only that, but WebMD is a profitable, billion-dollar company that occupies a central place in three important health care businesses--claims transmission, practice management software for physicians and a health care portal for doctors and consumers.

As successful as it has become, however, it is a far cry from the grand ambitions of founder Jim Clark, who intended to reform the entire health care system after helping to inspire the Internet revolution with the creation of Netscape Communications. His idea was to connect consumers, doctors, health care organizations and insurance companies in a megasite that would make the medical industry more efficient and less prone to errors.

"WebMD is the surviving company following roughly five years of (merger and acquisition) activity across the health care technology and 'eHealth' space," said Ryan Stewart, director of health care management and technology at SunTrust Robinson Humphrey Capital Markets.

Even by the standards of the chaotic dot-com industry, WebMD is notable for its constant state of flux. Deviating from its original concept, the company used its once staggering market value to acquire smaller businesses and began a mundane but profitable "claims fulfillment" business that let it survive the shakeout, while competitors such as Drkoop.com went under.

WebMD had dropped from public view in a reflection of the post-dot-com era until recently, when its newer businesses brought the company back into the headlines with unanticipated controversy. Customers of its claims transmission business, WebMD Envoy, have complained about lost and incomplete filings that threaten their financial viability. Separately, federal authorities have begun investigating the company's accounting practices in a matter related to a past acquisition.

Perhaps more troublesome in the long run, WebMD is facing significant challenges in its historically lucrative claims processing business, an area that is fast becoming a commodity service with limited growth prospects. The current state of affairs is hardly the vision dreamed up by the company's founders.

In the late 1990s, at the height of the Internet boom, "there were grandiose assumptions made about what the Web could do in health care," Stewart said. Those assumptions were made by Clark and another dot-com poster boy: Jeffrey Arnold, an entrepreneurial wunderkind who founded WebMD at the age of 29.

In 1999, their respective start-ups, Healtheon and WebMD, merged with the intent of creating the largest Web site devoted to providing health care information for consumers. Healtheon was founded in 1996 in Santa Clara, Calif., by Clark; WebMD was founded in 1998 in Atlanta by Arnold. (Neither founder is currently affiliated with the company.)

After a stint in a hospital, Clark sat down with a piece of paper and drew a diagram with the four health care players: payers, doctors, providers and consumers, according to "The New New Thing," a book by industry chronicler Michael Lewis. In the middle of this "Magic Diamond," he placed a new company: Healthscape. Clark intended nothing less than to "fix the U.S. health care system."

This enticing vision, coupled with Arnold's formidable sales prowess, captivated many of the most important technology and health care players. Intel, Microsoft, DuPont, Lycos, UnitedHealthcare, venture capital firm Kleiner Perkins Caufield & Byers and others made substantial investments.

Microsoft formed an ambitious partnership with WebMD in 1999, in which it invested $250 million in the company, "creating a comprehensive relationship that will help bring the power of technology and information to consumers and the health care industry," as stated in the voluminous press release about the deal.

But a little more than a year later, the partnership ended, when the two companies could not reach a technology-sharing agreement, although WebMD continues to provide health care content for Microsoft's MSN and MSNBC. Microsoft still holds an equity stake in WebMD.

Mergers galore
As dot-com mania subsided, WebMD embarked on an acquisition spree that remade the company. "Had WebMD not parlayed its market position by acquiring all these old-style companies, WebMD would be exactly where Drkoop.com is today," said Eric Brown, vice president and health care analyst at Forrester Research. Drkoop filed for Chapter 7 bankruptcy in December 2001.

"We have the leading assets in the business--practice management, clearinghouse and portal," said Andy Corbin, WebMD's chief financial officer. "That's not an accident."

In 2001, the portal acquired a major competitor, Medscape, to bolster its online business. WebMD also bought companies involved in electronic claims processing, including Mede America and Envoy, and expanded into a third line of business, practice management software for physician offices, with the purchase of Medical Manager in 2000.

But that acquisition brought regulatory headaches to WebMD. In February, while the company was still battling to resolve problems with its Envoy clearinghouse, the U.S. Securities and Exchange Commission announced that it was joining a Department of Justice investigation into WebMD's accounting practices. WebMD said the investigations were related to financial reporting issues at the Medical Manager subsidiary before it was acquired.

"When we did the acquisition, our auditors uncovered some issues, and a restatement took place," Corbin said. "We don't know when this will be resolved. It's being driven by the government, and we're cooperating."

The investigation evidently has not slowed the pace of the company's acquisitions. Last year alone, WebMD bought Physicians' Online, Advanced Business Fulfillment and Medifax-EDI. The company was further buoyed this year, when it placed $100 million worth of convertible debt with a fund backed by the highly respected California Public Employees' Retirement System, better known as CalPERS.

Including the CalPERS investment, WebMD has $846 million in cash to continue its shopping binge. On April 6, it announced plans to acquire Dakota Imaging, a privately held provider of automated health care claims processing technology and business outsourcing services, for $40 million in cash plus later payments of $25 million.

As it looks toward the future, WebMD stands primarily on three legs. The first is WebMD Envoy, the clearinghouse that processes transactions from doctors and hospitals, and sends them to payers.

The second leg is WebMD Practice Services, which sells Medical Manager and is introducing a product with more features, called Intergy. These serve physician offices and provide the option of using Envoy as the clearinghouse.

"We offer WebMD Network Services, which is essentially all-payer access for our doctors. We won't support another clearinghouse, but you can buy Medical Manager without Network Services, which is a subscription product," said a company spokeswoman who asked not to be named. She said the majority of customers for Medical Manager, and now Intergy, also buy the subscription service for Envoy.

The third leg is the original portal business, called WebMD Health. For 2004, WebMD expects total revenues between $1.15 billion and $1.18 billion, an increase of 19 percent to 22 percent from 2003. Net income is expected to be between $54 million and $60 million.

History may serve as a guide
WebMD's future may involve a return to the past. By providing Web-based services for large employers to offer to their employees, WebMD hopes to grow its portal business and offset commoditization of the clearinghouse process. It could also use its cash reserves to make "transforming" acquisitions, as it did to survive the dot-com collapse.

With Envoy, "they're the dominant player in a fairly mature market segment," said Sean Wieland, a research analyst at WR Hambrecht. Outside of a continual line of acquisitions, "we haven't seen any organic growth."

The electronic claims standard imposed by the federal law known as HIPAA has forced the entire health care industry into a painful transition, as evidenced by the problems with WebMD Envoy. Now, larger providers are beginning to bypass clearinghouses altogether by connecting directly with payers.

Forrester's Brown predicts further consolidation in the fragmented clearinghouse market, along with falling prices. WebMD Envoy's client base will narrow to small providers who are basically locked in through their Medical Manager software.

Unlike WebMD, clearinghouse competitor ProxyMed, based in Atlanta, does not make medical management software. "We have an open and neutral network," said ProxyMed President Nancy Ham. "It's the provider's choice what practice management software they use," she added. Ham believes that clearinghouses can provide value to providers beyond transmitting claims, in the form of services, aggregation and business processes.

What WebMD must do is offer value-added services that are attractive to payers, such as business process outsourcing on the tedious business of claims processing, SunTrust's Stewart said. "They have to buy businesses that complement what the payer needs."

CFO Corbin said that's exactly what the company is endeavoring to do with acquisitions like Dakota. "We're continuing to look for acquisitions," he said. "There are other pieces we'd like to put into place. The vision is a robust offering from provider to payer."

The company still faces challenges in other parts of its business, such as its software line. "They've got a great product in Medical Manager, but it's in a replacement cycle," said Wieland of WR Hambrecht. He estimated that 180,000 small physician groups already use Medical Manager, so "it's not a high-growth segment." In its May 6 first-quarter report, WebMD acknowledged "disappointing" results in the Practice Services segment. Revenues were flat, and income before taxes plummeted to $1.4 million from $6.3 million in the same quarter a year ago.

WebMD's new product, Intergy, is a more sophisticated product that uses graphics rather than text commands, but it's too expensive and has "too many bells and whistles" to attract Medical Manager's current customer base, Wieland said. Intergy is aimed at larger physician group practices and hospitals, and "there's no clear upgrade path" between Medical Manager and Intergy, so WebMD must maintain both products, he said.

Besides, IDX Systems, based in Burlington, Vt., is already the dominant player in the market for midsize to large group medical practice software, with its Groupcast service. "We are not planning to change our strategy as a result of WebMD and Intergy," said Stephen Gorman, president of IDX's Groupcast operating unit. IDX also partners with Envoy, along with other clearinghouses in this market.

Gorman said the fragmented medical software market--with 450 players--is bound to consolidate. "Many players will fall by the wayside, as larger organizations prove their value," he said. "We expect a fairly significant shakeout."

On the clearinghouse side, he expects direct connections--which Groupcast enables--to increase, although that doesn't mean middlemen such as WebMD will disappear. "It's incredible how many things can go wrong with electronic transmissions," Gorman said. "There is still a demand for that aggregator who can stand in the middle and process transactions."

With prospects for growth limited in its clearinghouse and practice management software, WebMD's most exciting offering today is its portal. Serving consumers and physicians, WebMD Health makes money through advertising and subscription fees. For example, it is now the leading provider of online continuing medical education (CME) for physicians, logging 630,000 credit hours in 2003.

WebMD is expanding its portal products by offering specialized content supported by pharmaceutical and medical-device manufacturers. Under a recent agreement with Google, it provides sponsored search links related to health care content. In addition, it partners with large employers to create internal portals for their employees with a WellMed product called Personal Health Manager. Customers include Fidelity Investments, Delta Air Lines, Ford Motor, EMC, Florida Power & Light and Microsoft.

In a case study on its Web site, Microsoft details how the internal portal (before WebMD's acquisition of WellMed) helped employees better manage their own health care and saved the company money by shaving administrative costs and preventing unnecessary visits to the doctor's office or emergency room.

"I love the portal business. It really has high growth prospects," analyst Wieland said. "It's a Yahoo media business."

That kind of enthusiasm is what ignited the predecessors of WebMD, but today, the company's future depends on strengthening all its businesses, including the portal. Stewart suggested that the portal business could be expanded by moving into what's called disease management, intended to handle patients who have expensive chronic conditions such as diabetes, asthma and congestive heart failure.

"They have one last chance with this $800 million-plus to do it right," he said. "They need to find and integrate businesses that will again change the face of WebMD."