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HBOC’s Prosperity Perils

September 1, 1998
by Jeffrey Elliott
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EVEN HBO & CO. (NASDAQ: HBOC) is subject to investors’ capriciousness. One day after the Atlanta-based company posted stellar second-quarter numbers--revenue up 29 percent over last year--its shares took a nose dive. The word on the Street was that HBOC was about to announce a large transaction that would dilute earnings per share.

"What are they thinking?" was the sentiment in the investment community upon hearing HBOC was about to buy the $20 billion drug and medical products wholesaler McKesson Corp. (NYSE: MCK) of San Francisco, a company with much lower margins and growth rate.

Was this HBOC’s way of letting the industry know that the honeymoon that has rewarded investors with returns upwards of 3,000 percent during the ’90s was coming to an end?

A slowdown in profits is eminent, say analysts, who are predicting HBOC to post 33 percent increases annually over the next five years, down from the more than 50 percent increases during the past five years. But these reports are not new. What was new to investors, however, was HBOC’s apparently sudden shift in business tactics.

Strategically, HBOC would have been able to tap into McKesson’s pharmaceutical information and automation business, says David Francis, managing director and head of IT research at investment bank Volpe Brown Whelan & Co. But there would have been no near-term benefits for either company. "Down the road, however, it could have created some interesting synergies for them," he says.

Rocking the boat

News of the HBOC/ McKesson deal was actually leaked inadvertently to clients by Salomon Smith Barney, the firm advising HBOC on the deal, which ignited a furious sell-off of HBOC stock. During a morning meeting, advanced noticed was given to the investment bank’s sales force that it was a done deal. However, McKesson and HBOC were still negotiating terms and nothing was official. By the end of trading that day, HBOC’s shares had lost 11 percent of their value--more than $1 billion in market capitalization.

"It created a lot of anxiety among investors that HBOC would even consider an acquisition so large and so far from their base business and that it would seriously dilute profitability going forward," Francis says.

The following day, HBOC responded with an uncharacteristic conference call for analysts and investors at which company Chairman and CEO Charles McCall confirmed his company was in talks with McKesson, but that the deal had collapsed. In an attempt to rectify matters, McCall stated that any transaction HBOC is involved in would not dilute earnings, and that announcements regarding other acquisitions would be made public within the next week or two.

Various theories are circulating as to why the McKesson deal was scuttled. Some analysts believe the two companies could not reach an agreement on price after HBOC’s shares lost significant value. According to Michael Knepper, vice president of HCIS research at Punk, Ziegel & Co., McKesson officials called off the deal because, among other things, they could not reach multi-year contract agreements with HBOC officers Jay Gilbertson and Albert Bergonzi. HBOC officials claim they called off the deal because of the board’s concern over governance issues and a change in strategy from a high to slower growth company.

More gray clouds

But HBOC’s adventures on Wall Street were not over with the McKesson deal. One day after the conference call, HBOC’s shares plunged another 11 percent. "The concern the investors were left with is there aren’t many sizable HCIS companies out there for them to buy that would make strategic sense," Francis says. "Are they going to be forced to go into a less profitable, lower margin kind of business on their next acquisition?"

The healthcare IT giant went on with business as usual, announcing two more planned acquisitions the following week: outsourcing company US Servis (Nasdaq: USRV), Somerset, N.J., for $50 million in stock; and electronic medical record vendor, Atlanta-based IMNET Systems (Nasdaq: IMNT), for about $135 million in HBOC stock. Still affected by uneasiness among investors, however, HBOC’s stock price fell an additional 17 percent on news of the IMNET acquisition combined with an immediate downgrade by Merill Lynch.

Clearing on the horizon

Investors feared that the IMNET acquisition would not benefit HBOC’s bottom line because IMNET is a company with losses, Knepper says. But he thinks they’re wrong. "IMNET will be extraordinarily accretive to them."

In fact, he’s predicting the company’s stock will rally and even reach new highs "before too long." And why not? HBOC has met or beat Wall Sreet’s earnings estimates for the last six years and with a P/E of 35 on estimated 1999 earnings, HBOC’s solid long-term growth projections are reiterated by analysts throughout the industry.

Fiscal Report

A look at second-quarter 1998 financial statements from some of the leading healthcare IT vendors

OVERALL, 1998 SECOND-QUARTER EARNINGS WERE STRONG IN THE HEALTHCARE IT SECTOR, SAYS BEAR Stearns healthcare IT analyst Ray Falci. The large HCIS companies fared well with second-quarter earnings, but some smaller companies missed projections, proving "how hard it really is to be a niche vendor in a fluctuating marketplace," Falci says. Here’s a look at how some public companies fared: