Jenks Healthcare Business Report October 2001

In the October 2001 issue:

WebMD vs. Quintiles: Desperately Seeking Something?

Just 18 months after finalizing a mega-deal, WebMD and Quintiles call it quits, even though they once had discussions about merging the two companies. Were concerns about patient privacy and obeying the letter of the law at the center of the dispute, or was it economics for a company in search of profits?
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Private Equity Market
More than $300 million was raised in the private equity market, with more than 50% of it for private companies.
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Public Equity Market

After a seven-week drought, the IPO market reopens with a health care company.
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The Merger and Acquisition Market

Both the health care services and the health care technology segments witnessed slower M&A volume in the third quarter, mostly because of a declining stock market and tighter capital markets in general.
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Jenks Healthcare Business Report

WebMD vs. Quintiles: Desperately Seeking Something?

After an eight-month long legal battle, WebMD (NASDAQ:
HLTH) and Quintiles Transnational Corp. (NASDAQ: QTRN) finally agreed to settle their differences and go their separate ways. The agreement came just three days after settlement negotiations supposedly failed, but it is hard to tell who the winner was, if there was one at all. In the short term, we would have to say that QTRN benefits the most because it is cashing out of its HLTH stake at a premium while its informatics division still had not reached profitability even with access to HLTH’s transaction processing information. But first, a little background.

In late January 2000, what was then known as Healtheon/WebMD signed an agreement to buy QTRN’s electronic data interchange (EDI) unit, Envoy Corp., in a deal that was valued (in the good old days) at approximately $2.5 billion. The price was comprised of $400 million in cash (very fortunate) and 35 million shares of HLTH, worth $2.1 billion at the time. When the transaction finally closed four months later, those same shares were worth only $447.3 million. Just 13 months earlier, QTRN had purchased Envoy for $1.4 billion in a deal that analysts thought was too pricey and out of QTRN’s core business, which was clinical trials and marketing for pharmaceutical companies. When the second sale of Envoy closed in May 2000, the new valuation put the price at $0.60 per transaction processed (based on 1.4 billion transactions in 1999), compared to $6.00 per transaction that HLTH paid in December 1999 for Kinetra.

As part of the sale to HLTH, QTRN agreed to provide funding to HLTH of up to $100 million over 18 months to develop Web-based products and services, with the revenues from these products to be shared by the two companies. Quintiles also issued to HLTH a warrant to purchase up to 10 million shares of QTRN common stock at $40 per share, exercisable over four years, at a time when QTRN traded at $27.50 per share, compared to $14.91 today. In addition, QTRN would have exclusive rights to "de-identified" Envoy transaction data, which became the subject of the legal battle almost a year later.

About two weeks after HLTH announced the deal to acquire Envoy, it signed a definitive agreement to purchase Medical Manager Corp. (MMC) and its 69% owned subsidiary, CareInsite, for $5.2 billion in stock. That price declined in value by almost 75% by closing as a result of the Spring 2000 technology meltdown. In addition to providing HLTH with revenues of more than $200 million annually (excluding the businesses that were to be sold), the more lasting impact of the MMC deal was on management. Within a year of the closing of this deal, the founders of Healtheon and the original WebMD were both gone, and Marty Wygod, the chairman of Medical Manager, was left in charge of the entire entity. In late September, his lieutenant and the most recent president of WebMD, Marv Rich, also announced his resignation. The change in management control is key to follow what happened to the relationship between HLTH and QTRN.

Once Mr. Wygod secured his control over the combined companies, something most investors assumed would occur, he had to figure out what he would do with the hodge-podge of assets that were not expected to produce a profit until sometime in 2002. In October 2000, management initiated a regulatory review of QTRN’s data mining business. While the party line at WebMD is that the company wanted to make sure that QTRN was not violating medical privacy laws, there did not appear to be an event to trigger the need for a review, such as a lawsuit against WebMD. Even if there had been, QTRN had already indemnified WebMD for any claims or losses arising from violations of customer contracts or law.

So the question remains, What was management looking for? The only logical answer is a termination of the relationship with QTRN. Prior to merging his Medical Manager Corp. with WebMD, Mr. Wygod apparently had wanted to purchase Envoy Corp., realizing the importance not only of the EDI revenue, but also the value of the information from those transactions. When Healtheon/WebMD purchased Envoy, it was in search of revenues and a dominant role in Internet-related transaction processing. The previous management, or so the theory goes, gave little value to the information that could be gleaned from those transactions, so it had no problem giving QTRN exclusive rights to that information, even after paying a relatively high price. Mr. Wygod, with a strong health care background not shared by the two founders of Healtheon and WebMD, knew otherwise.

Sometime after the "regulatory review" began, WebMD and Quintiles had very preliminary merger discussions. The concept of merging the two companies did not make sense for QTRN shareholders, other than both companies had significant cash hordes. After all, WebMD was still losing money and would be very dilutive to QTRN shareholders. And a merger really did not make business sense for WebMD either, except as an expensive way to buy revenues and profits, and as a way to control the information in the Envoy transactions.

Shortly after these discussions ended, WebMD "determined" that various state laws prohibited the company from providing certain data to QTRN and it suspended the data deliveries until the data could be cleansed of those elements that could enable QTRN to identify any patients. QTRN sued WebMD and obtained a temporary restraining order requiring WebMD to continue with the data delivery. Quintiles then agreed to accept data that did not include the full birth date and zip code of individuals and purged its own databases of names that related to full birth dates and zip codes so they could not be re-identified. This was apparently the goal of WebMD… or was it?

The legal battle moved into federal court, and the companies had been negotiating for the past six months. From WebMD’s standpoint, the issue boils down to whether QTRN has the right to use and sell claims data without the knowledge and authorization of health care providers and pharmacies that sell the data, whether state law is applicable to Quintiles if QTRN’s operations are outside the borders of a particular state and whether QTRN may link medical claims data to unique identifiers without consent. By October 9, WebMD announced that settlement negotiations had failed, and Mr. Wygod stated that, "on behalf of our customers, we need to do more" to ensure the privacy of the data. He may also have added, on behalf of his shareholders.

Just three days later, the two companies worked out an agreement to terminate their relationship. WebMD agreed to re-purchase the 35 million WebMD shares owned by QTRN for $185 million, or about $5.28 per share, representing a 52% premium above the market price of WebMD’s shares prior to the announcement. QTRN will have the right to receive data, with patient identifying information stripped out, from WebMD until February 28, 2002, and all other agreements, including the up to $100 million of funding for WebMD’s Internet initiatives, have been terminated. There was no announcement regarding the warrants to purchase 10 million shares of QTRN stock, but we assume they were cancelled. In addition, if Envoy is sold for more than $500 million, or if WebMD is sold for more than $4 per share before June 30, 2004, QTRN will receive an additional payment in cash or stock. Neither event is likely.

WebMD will not announce third quarter earnings results until November 12, but assuming its second quarter cash burn rate and after the $185 million payment to QTRN, the company’s cash may be down to $350 million. Although most Internet-related companies would be envious of that amount of cash, it will represent a little more than $1.00 per share for a company that still needs to convince investors it can make money.

If the entire battle was really about privacy and liability, WebMD was already indemnified and the patient data had also been stripped of identifying information, so what’s the beef? Besides, we had not heard of any complaints against Quintiles, and QTRN is already in the process of obtaining similar data from other sources, with a goal of doubling the amount of data received from WebMD. The next, and most obvious, question is, What will WebMD do with the data that it will now have exclusive control over, if anything? Mr. Wygod is too smart, and experienced, to enter into that kind of a settlement agreement and do nothing with the data. Stay tuned.

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