I confess. I love a good
(initial public offering).
As part of the research for my
newsletter, I pore over every
filed each month to take a look at who might be on to The Next Big
Thing -- companies that aren't only engaged in interesting
businesses, but that could deliver triple-digit gains (or more) for
I've found some winners. I was among the first to see the promise
Digital Globe (NYSE:
, a satellite imagery company that sells pictures to the U.S.
government. It went public in May 2009. I later added it to my
portfolio; now my subscribers and I are sitting on a 74% gain.
That's not bad -- for a start. My focus is on long-term, sustained
returns. I'm shooting for the type of gains that will enable my
subscribers not to have to work another day in their lives. Digital
Globe may well be one of the stocks that get us to that point.
For every big winner I find, I come across dozens of stocks I
wouldn't touch with a 10-foot pole. And a few are worth shorting
six ways from Sunday.
, a recent IPO. Epocrates sells a smartphone app for medical
professionals that offers a suite of reference tools. Themarket
value of the company, which reminds me of the dot-com days, is
already an astounding $490 million. Some publications -- the
normally brilliant Fast Company, to name one -- have lauded
Epocrates as an innovator. I think it's a loser with a
dot-bomb-stylebusiness model .
What does that $490 million market cap buy you?
- A series of smartphone apps and
- The app's user base.
That's it. So now the trick is to decide what -- if anything --
that's really worth.
Epocrates has more than a million users of its apps. So the
question is whether each user is worth $490. It's not. It might not
be worth anything.
Here are six reasons for that:
1. Most users don't pay.
The basic app is free and has some functionality. To upgrade to the
premium version is $199 a year. At present, the company says, only
9% of the user base has bought a subscription. To put it another
way, 91% of users have decided the app isn't worth anything. Not
only do few users upgrade, but the percentage of those who do is
shrinking. In 2007, 32% of users paid. That fell to 16% in 2008 and
to 12% in 2009, then to 9% in the first nine months of 2010. I
expect this trend to continue. A million users is a nice figure,
but the reality is the paid base is far less than that.
2. Most paying users don't renew.
In a subscription-based business, the higher renewal rate you can
get, the greater the value of each individual subscriber. If one
can show that a new subscriber will renew for four years -- paying
$800 -- then one can reasonably accept a value per user that's a
multiple of the annual subscription price. As it stands, that's
clearly not the case. The data show the company's subscriber base
shrinks each year. That means users are not renewing, so paying a
premium for them seems foolish.
3. The target market is too small.
There are 2.7 million nurses and 661,400 doctors in the United
States, the Department of Labor says. Right now, only 9% of
Epocrates' users pay. If that were to expand to the entire market,
Epocrates would have 302,526 paid users. If each pays $199 a year,
that's $60.2 million in revenue. A 25%
puts annualearnings at $15 million. At the average
multiple of the S&P 500, which is 16, Epocrates is worth $225
million, or less than half its current valuation.
But this is an extremely rosy picture. Let's not forget that this
(1.) assumes Epocrates captures a paid subscriber base three times
the size of what it has captured to date. It assumes (2.) all
subscribers will renew at $199 a year indefinitely, when, in
reality, the subscriber base shrinks by half almost every year. And
it also (3.) assumes a 25% netprofit margin, which is more than 10
times what the company is actually able to execute.
4. The marketing is self-defeating.
To staunch its dramatic customer bleed, Epocrates says it will give
more content away. But the more it gives away, the fewer the users
who will subscribe. After all, if the free version meets one's
needs, there's no reason to upgrade.
A company worth a half-billion dollars ought to have a stellar
marketing plan. But Epocrates relies on word of mouth. That
approach can deliver, but it has to be part of a larger strategy.
Here, because the company faces no other competition from similar
apps, it presumes it doesn't have to bother with users accessing
other sources of information. But that ignorance of the marketplace
can be a fatal mistake…
5. That's because upcoming changes in health care will
render the application obsolete.
The government is transitioning the country to digital medical
records. These systems will put PCs or tablets, into caregivers'
hands and allow the sharing of patient information, test results,
logistical management and more, including checklists for hundreds
of tasks and medical reference. Not only will every hospital have
its own system, but you can bet it will, out ofliability concerns,
forbid the use of any other systems. Next-generation health care
information technology will make the Epocrates app redundant and
use restrictions likely will render it anathema.
6. With all this in mind, the Epocrates "channel" isn't
worth anything significant.
Say you have a base of customers who are willing to pay a
subscription fee to obtain a product. That is, you'll recall, one
of the things we get if we theoretically buy the whole company.
Now, access to that body of consumers is worth something to
advertisers if you can demonstrate a high level of penetration
within a certain demographic. If I can show that 80% of men age 25
to 40 are watching the Super Bowl, then I can charge a king's
ransom for a 30-secondspot . In the same way, Epocrates says it can
market access to its users to companies that want to deliver
information and advertising to physicians and nurses.
Nonsense. If only 9% of your customers are using the app to the
degree that they are willing to pay for it, then it's a stretch to
deem the Epocrates app a meaningful channel. And were it to add
marketing messages to the critical functions of its apps, users
would complain and cancel. Presumably one of the reason users
upgrade in the first place is so that they do NOT have to see
commercials. Advertisers can find more effective ways to reach
Action to Take-->
Epocrates was a good idea for a smartphone app, but that doesn't
means it's a reasonable basis for a $490 million company. My
prediction is that Epocrates will see its user base continue to
shrink, its revenue and earnings will continue to disappoint and
its usefulness as a marketing channel will fail to deliver any
meaningful results. These factors will push the share price down
until the company is sold off piecemeal, or goes the way of
I hate to spend all this time doingdue diligence on a company that
I think will end up tanking. But investors who see as dismal a
future as I do for theseshares should consider a short position. As
for me, I'll have to move on and find a better candidate for my
I was excited to share some of my latest promising IPO finds in an
exclusive audio chat with my
subscribers. For more information, including how to get access to
my research, go here.]
Disclosure: Neither Andy Obermueller nor StreetAuthority, LLC
hold positions in any securities mentioned in this article.
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