Health Grades Inc. : A Deal With Google in the Works?

As with all companies in our coverage universe, we carefully watch the competition of Health Grades, Inc. (HGRD), a provider of quality of care information for consumers, payers and employers. Last week WebMD (WBMD) announced it will be providing branded content and resources to CBS News. WebMD expects the arrangement to help drive traffic to its website where it provides health information. The arrangement could be valuable for WebMD considering that in this present Internet age, business development and marketing are not just a matter of persuading customers to use a company's services. Modern tactics include establishing a "presence" in the media and the appearance of endorsement through strategic relationships.

For competitive reasons, Health Grades is somewhat circumspect about its own business development tactics vis-a-vis Google, Inc. (GOOG) to drive customers to the Health Grades information portal. Google is apparently still in the planning stages for some type of health care search service that would include Health Grades among others. In May 2006, Google announced that people looking for healthcare terms on its front page will have the option to see a list of reviewed links and sort their results by treatment or symptoms. There has been speculation among industry analysts that Google would ultimately launch a health-care search tool.

The importance of Internet search engines to Health Grades business model is underscored by a recent study published in the Archives of Internal Medicine. The study showed that the Internet was the first source for health care information for 49% of the 6,400 adult Americans surveyed. Health Grades sales are already driven in part by the Internet channel. Visits to the Health Grades web site in the June 2006 quarter totaled 10.1 million, an increase of 42% over the prior-year quarter.

Health Grades reported second quarter 2006 results that are in-line with our expectations. The Company continues to build its platform for gathering and distributing quality of health care information. The Company reported 2Q06 sales of $6.7 million, just shy of our estimate of $7.0 million. Reported earnings were $979,000 or $0.03 per share compared to our forecast of $732,000 or $0.03, the difference arising from lower costs and expenses than we had expected.

We reitereate our Buy rating and $7.20 target price for HGRD. The Street is sometimes impatient with stocks of companies for which the scene around the corner is more "blocking and tackling". Given the solid progress that Health Grades has made in executing its business plan and despite the high price earnings multiples implied by near-term earnings, we view the stock as a compelling opportunity for long-term investors at the current price level.

HGRD 1-yr chart: