KKR's Buyout of WebMD Is Part of a Big, Long-Term Trend

In this segment from Market Foolery, host Chris Hill and Million Dollar Portfolio's Jason Moser consider the win that shareholders in WebMD (WBMD) got Monday, when KKR (KKR -0.78%) agreed to buy it at a 20% premium. The buyer gets a valuable media property with a unique network, but it's a win for the target, too -- being a publicly traded business just isn't as much fun as it used to be.

A full transcript follows the video.

This video was recorded on July 24, 2017.

Chris Hill: Let's get onto the big winner of the day, and that is WebMD, and, I suppose, WebMD shareholders. The stock is up 20% as WebMD is being bought by the private equity firm KKR. This continues a trend that we've really seen, certainly we've seen this among consumer brand names in 2017, but we've seen the longer trend over the last 15 years, and it is fewer public companies, as more and more public companies go private for one reason or another. And certainly this year, the high-profile ones are being taken out by someone else.

Jason Moser: Chris, if you had the option to be either a publicly traded company or a private company, wouldn't you opt for the private route? You're going to be held under less scrutiny, right?

Hill: Absolutely.

Moser: I've got enough to deal with when I go home. I mean, they hold me under enough scrutiny as it is. So those are the people I need to answer to; that's my board of directors. I think that a lot of companies are just recognizing the luxury in not having to answer to the public on a quarterly basis, and we're seeing more and more that a lot of companies are being judged on quarters versus judged on years and decades, and that's a tough sort of mentality to overcome. Now, with WebMD, this is not a deal that makes you scratch your head and wonder, "What is KKR thinking?" This is something that's certainly in their wheelhouse and adds to available collection of similar sorts of media properties they own already. 

For me, we've talked about WebMD before on the podcast here and there. I feel like, to me, this has always been a very fascinating property. When you look at businesses like these internet business, the strength is in the network and what kind of a network you can create. With WebMD, not only have they created this strong brand with what they do, but we live in this information age where it's so readily available. You can find anything you need at the drop of a hat. But with WebMD, it is this really neat sort of network of not just consumers but physicians. To me, it could be an even more powerful network effect there, because the more physicians that you add to that network, it becomes immensely more valuable, because that's pretty unique knowledge. That's not stuff that you and I -- we can offer reviews on a restaurant, but I can't really tell you about the merits of a colonoscopy. You're just going to have to kind of trust the doctor when they tell you.

So I think there are a lot of dynamics to this network that make it really attractive. The business itself is actually pretty healthy. They make their money from advertising, but they also have a subscription dynamic, which is neat. Net margins are starting to stabilize in the low teen range. It's balance sheet net cash neutral. And if you look at, over the past five years, the stock has been on a tear; it's up somewhere in the neighborhood of 250%.

Hill: It really has. That's one of the interesting things to me about WebMD. We were talking earlier about "Would you rather be a public company or a private company?" For a good stretch of time with WebMD, they were running into all kinds of brick walls in terms of their business. They really struggled as a business for a long time. At the point that they figured it out, as you said, that's where the tide really started to turn in their favor and in the favor of shareholders. So you can back this thing out over 10 years or longer, and you're not seeing a great return. But five years ago was really the low point, and I'm sure there were plenty of investors who just gave up on this thing. It turns out that was the time to buy.

Moser: Yeah. You see this a lot. You can see valuable properties out there that have a hard time making it work as a business, but eventually, particularly if you're a public company, you're going to be held to accountability. Leadership has to get in there at some point and create a good business if you have something there where you can build that business on. WebMD clearly has that. When you look at the way this deal is valued, WebMD is a profitable company. It's a cash flow-positive company. It's a financially healthy company. This deal values the stock at around 17 times free cash flow. Now, sometimes with these internet businesses, we'll back out the stock-based-compensation side of the equation to get a better idea of cash flow minus that stock based compensation. With WebMD, it's still very cash flow positive. 

You look at something like Zillow, which is another example of a network that's really trying to build out a specialized unique information network, with a lot of the same sorts of qualities as WebMD in that regard, Zillow, it's not even close. It's not profitable. It's not cash flow-positive. You back out the stock-based compensation and it's even worse. I'm not saying Zillow is a bad business, mind you. I just think at some point Zillow is going to have to flip a switch there and make investors see the light at the end of the tunnel, as far as the profitability and the cash that business can generate, whereas WebMD had really already hit that switch. They figured that out. It was around five years ago. At some point, it happens. And if it doesn't, you typically either see shifts in leadership, or you see someone come in there and buy that thing for a song and turn it around in a private manner.