Dr. Koop and the Greed Disease With mediocre leadership, a huge burn rate, and a flimsy business plan, Drkoop.com was sickly from the get-go. So why did investors bid it up to $1.3 billion in market cap?
By Nelson D. Schwartz Reporter Associate Margaret Boitano

(FORTUNE Magazine) – Sometimes an entire era on Wall Street can be summed up in the rise and fall of a single stock. In the 1920s it was RCA, which soared with the rise of radio and predictions of a never-ending stock market boom, only to collapse in the crash of 1929. The avatar of the go-go 1960s and '70s was Xerox, the Nifty Fifty icon that was as beloved then as any Web darling now.

If any one stock epitomizes the excesses of 1999 and early 2000, it would have to be Drkoop.com. Its short, unlikely life has all the elements of an Internet Age morality play: a young company that went public with little but a brand name and a half-baked business plan. Insiders who paid themselves handsomely while leaving ordinary investors holding the bag. A public gullible enough to believe it was getting in on the next big thing, and investment bankers who were more than happy to feed that delusion.

Together they took a company that had been on the public markets barely a month, a company that had taken in a total of less than $1.5 million of revenues in its entire history, and bid it up to a ridiculous $1.3 billion in market value; then, during the next ten months, they watched it deflate by more than 90%. In late April the Austin, Tex., company said it had enough cash to stay in business for only about four more months. If it can't find an acquirer or a deep-pocketed backer, Drkoop.com could become the first prominent dot-com to declare bankruptcy.

The decline of Drkoop.com and similar business-to-consumer Web plays like CDnow (off 82% from its peak) and Pets.com (off 84%) now seems so inevitable that it's hard to believe how hot these stocks were just a year ago. It's even harder to locate anyone willing to acknowledge they were seduced by Drkoop-.com. "Finding someone who admits to once owning this stock is like finding someone who admits to voting for Ross Perot," says Paul Cook, manager of the Munder NetNet fund. "It's a dot-com leper." But it's worth reminding ourselves that it wasn't always so. Because the best way to avoid some similar disasters is to remember how Drkoop got here from there.

The American Airlines check-in counter at LaGuardia Airport isn't the usual setting for a business meeting, but when CIBC analyst Ben Rooks ran into a top officer of Drkoop.com there in March 1999, he figured it was a good chance to schmooze. As an analyst covering health information companies and the emerging e-health sector, Rooks finds a big part of his job is to build relationships with young startups that might develop into underwriting clients down the road.

Rooks noticed that the executive was carrying a tote bag from a just concluded health-care investment conference. He asked about the conference and how business was going. Business was good, the man from Koop said. Pretty soon the company planned to launch an IPO and had already chosen Bear Stearns as the lead underwriter. "I was astounded," Rooks recalls. "I figured the company was so young that I had at least six to nine months before I needed to formally meet with them. I mean, this company was barely at the venture stage."

At the time of Rooks' encounter at LaGuardia, Drkoop.com had indeed barely moved beyond concept. It owned the right to attach the name of the revered former surgeon general, C. Everett Koop, to a Website, where Web surfers could read up on health topics ranging from cancer and depression to weight loss and skin protection. Revenues would come from advertising, e-commerce conducted over the site, licensing deals, and so on. The site was (and is) quite impressive, with smart articles, useful information, and elegant graphics. However, in March 1999 the Website had been formally open just two months, and the company had amassed a lifetime total of less than $500,000 in revenues. It was a veteran at losing money, though, having already recorded operating losses of just under $5 million.

While the Website was in its infancy, the company had actually been around since 1997. That was when Koop joined forces with Donald Hackett, a 20-year veteran of the health information industry, and entrepreneur John Zaccaro.

While more seasoned than the typical dot-com entrepreneurs, the trio did not have awesome track records as businessmen. In the mid-1990s Koop had lent his name and expertise to a company that made medical videos for consumers; it later went bankrupt. (Among the venture's backers was Time Inc., FORTUNE's publisher.) Hackett had served as senior vice president of Physician Computer Network Inc., which gave physicians free computers and networking software and charged drug companies to advertise on the system. That plan failed, and PCNI later moved into management software for doctors. Zaccaro, a self-described motivational speaker, had developed a solar-powered pool-heating device, and also served as president of the International Health & Medical Film Festival, where he met Koop.

Together, the trio originally planned to build a software package, called Dr. Koop's Personal Medical Record System, that would help patients maintain their own medical histories. In mid-1998, however, it was clear that the Internet was becoming a mass phenomenon, and a consumer-oriented health Website seemed a much better bet. Koop licensed his name in return for stock, and by early 1999 Drkoop.com was getting nearly one million visitors a month.

Almost immediately, Hackett started looking for an investment bank to take the company public. In another era, the scarcity of revenues, the complete absence of profits, and the less than legendary management team might have scared off underwriters, but not in the spring of 1999. Consumer Websites were all the rage, with IPOs like TheStreet.com, iVillage, and About.com all losing boatloads of money and all boasting incredible first-day runs. Besides, health was the single most popular topic on the Web (after sex, that is).

One of the investment banks that the Koop execs met with was ING Barings. Stephen DeNelsky, a former Barings e-health analyst now with Credit Suisse First Boston, recalls that even at the height of Internet hysteria, it was clear that Drkoop had no business going public. "I couldn't get comfortable with the company's revenue projections," says DeNelsky. "I just thought it was premature."

Bear Stearns, on the other hand, was raring to go. The deal was something of a coup for Bear, a perennial underdog trying to break into the first tier of tech underwriters, and Drkoop.com was sure to generate plenty of buzz. (Bear declined to comment for this article, but it's only fair to note that other banks also bid for the deal; Bear simply had the bad luck to win.)

In the close-knit world of investment banking, Bear's decision to underwrite Drkoop.com is still hotly debated. "It's easy to jump on Bear now," says Bill McGahan, the deputy head of health care banking at UBS Warburg. "But health care was seen as a huge opportunity on the Web, and a whole bunch of companies were moving into this space. Going public was the way you got a foothold."

Bill Benedetto isn't as charitable. A 30-year veteran of Wall Street, Benedetto headed up investment banking at Dean Witter and then started his own investment firm in 1988. Before signing on to a deal, Benedetto says, bankers should always ask themselves two questions. First, can it be sold? And second, should it be sold? "During exuberant times, only the first question gets asked," he says. "But not asking the second question is a dereliction of duty on the part of the bankers." When Drkoop.com went public, Benedetto says, he was mildly surprised but not shocked. "All it had was a brand name, and it looked flimsy. But then a lot of the deals looked pretty flimsy, because no one was asking whether they should be sold in the first place."

The IPO on June 8 was the kind of cascade of riches that has become de rigueur in the Internet Age. With shares priced at $9, the offering raised more than $84 million for the fledgling company and generated almost $6 million in fees for Bear and its two secondary underwriters, Hambrecht & Quist and Wit Capital. Insiders, of course, rode a flood tide of sudden stock market wealth. As the stock nearly doubled in the first day of trading to $16.44, Don Hackett, the CEO, found himself the owner of shares worth over a hundred million dollars; Zaccaro, who signed on as vice chairman, and Hackett's brother Robert, an executive vice president, saw their stakes soar into the tens of millions. Favored outsiders also scored. Among them was Dell Computer, an Austin neighbor and technology partner of the company, which received more than a million shares at the offering.

But everyone's favorite IPO millionaire was the one whose name was on the door. At 82, C. Everett Koop had metamorphosed into a dot-com tycoon with a $42 million paper fortune, grabbing a piece of the action usually reserved for earringed entrepreneurs and postpubescent engineers. And what did he do to earn it? "The best thing you could say is that I set the standards," Koop told the Washington Post the day of the IPO. "I don't have my name on things with which I'm not involved."

Successfully launching a public company, however, proved to be rather different from successfully running one, and there were troubling miscues almost from the start. A month after the IPO, the husband of board member and TV medical correspondent Dr. Nancy Snyderman sold 1,650 shares, even though insiders and their families were prohibited from unloading shares for six months. Snyderman soon admitted the mistake and turned over the proceeds from the sale to the company. Later it came out that Koop himself and CFO Sue Georgen-Saad also omitted from SEC filings a small portion of the shares owned by family members. "These were just some of many small things that undermined my confidence in management," says analyst Josh Fisher of W.R. Hambrecht & Co. "It seemed strange at a public company with a major investment bank behind it."

There were also more serious signs that Koop's managers were not the sharpest scalpels in the bag. The most notable were the company's very expensive promotion and distribution deals with AOL and Disney's Go Network. Two months before going public, Drkoop.com agreed to pay Go Network nearly $58 million over three years to be the exclusive provider of health content to the Network and Websites like the ESPN.com training room. Then in early July, less than a month after the IPO, Drkoop.com announced it would pay AOL a whopping $89 million over four years in exchange for a role as a premier provider of AOL's health-care content.

Incredibly, the AOL fee didn't guarantee exclusivity. Nor was it specifically tied to the amount of ad revenue or number of monthly visitors AOL generated for Drkoop.com. Even worse, $89 million was more than all the money Drkoop.com had just raised in its offering. "These deals boxed them into a corner very early on," says CSFB's DeNelsky. "It obligated the company to return to the public markets for more capital, and there was no way they could manage their way out of it if issuing more stock wasn't an option." Koop and other top officials in the company declined to speak to FORTUNE, but a Drkoop.com spokesperson replies, "The deals were critical to growing our brand, building traffic, and establishing market leadership."

That's the way the market saw the deals, too--at least at first. Investors bid Drkoop.com's shares up by more than 50% on the day the AOL deal was announced, and the stock briefly hit an all-time high of $45.75. The underwriters certainly weren't about to discourage willing buyers. In early July, Bear Stearns and H&Q both initiated coverage of Drkoop-.com with a buy. A few weeks later, with the stock at $25, Bear analyst Ray Falci issued a 57-page report entitled "The Doctor Is In." "We see further upside in the stock, driven by continued execution of Drkoop.com's business plan," Falci wrote, adding that he expected the company to turn a profit by late 2001.

In reality, though, Drkoop.com was hemorrhaging its lifeblood--the cash raised in the initial public offering. Between June 30 and Sept. 30, expenses totaled $24 million--much of it going for promotion and advertising--but revenues came to just $2.9 million. In the fourth quarter, sales rose to just over $5 million, but expenses added up to another $26 million. By the end of 1999, more than half the IPO proceeds were gone.

As the cash burned during the latter half of 1999, the stock seesawed downward and some on Wall Street began to question the company's strategy. W.R. Hambrecht's Josh Fisher spent last fall trying to get comfortable with the company's business plan. In October he had breakfast with Sue Georgen-Saad in San Francisco, and the following month flew to Austin for a meeting with management. Despite slick slide presentations and promises from Hackett that big deals were on the way, says Fisher, "I just couldn't make sense of it. All the revenue was going to AOL and Disney." Although other analysts were standing by their buy recommendations, Fisher issued a neutral rating on Feb. 8, with the stock at $16.

Meanwhile, Drkoop.com insiders seemed to be getting a bit queasy. The terms of the offering, along with the release of fourth-quarter results, prevented them from selling shares until mid-February. But once the ban lifted, Zaccaro, Koop, and Snyderman began dumping shares. Between Feb. 18 and Feb. 25, the three unloaded more than 400,000 shares at prices ranging from $11.75 to $9.38. The gains were substantial--many of the shares had been acquired for just pennies. Snyderman collected $2.6 million, while Zaccaro raised $790,977 and Koop took home $912,186. Don Hackett, on the other hand, hasn't sold a share as of the most recent filing.

News of the insider sales only steepened the stock's decline. By early March shares were just under $8 and dropping fast. Then the accountants lowered the boom. The day after the company filed its annual 10-K report with the SEC on March 30, investors seized on a warning from the company's auditor, PriceWaterhouseCoopers, that "sustained losses and negative cash flows from operations" created "substantial doubt" about the company's future. The same warning was in the prospectus, but investors were no longer willing to forgive loss-bedeviled dot-coms. By the end of trading on March 31, the stock was at $3.69, a drop of more than 40% from the day before.

Even as the company's cash position deteriorated, Drkoop.com provided hefty short-term loans to Donald Hackett and Sue Georgen-Saad. On April 3, Hackett borrowed $966,000, which he repaid a week later. Georgen-Saad borrowed $95,440 on March 31, and returned it on April 28. The company gave FORTUNE no explanation except to say that loans to corporate officers are not unusual and that those made to Hackett and Georgen-Saad were properly disclosed.

In recent weeks, Drkoop's condition has only worsened. In April the company disclosed that it had enough cash to keep the doors open just four more months, and that it had hired--of all outfits--Bear Stearns to find a buyer. At the same time, first-quarter revenues came in below internal expectations, and actually dropped from the fourth quarter of 1999. Although the company has been able to renegotiate with AOL and Go Network, the future is still bleak. As FORTUNE went to press, the company was rumored to be talking to a number of potential buyers, including Healtheon/WebMD and AOL, which now controls 10% of the company.

Even if Drkoop.com stays in business, the company's rise and fall won't be forgotten soon. Shareholders who bought in when the stock was riding high will probably be left with little more than a capital loss and a painful lesson in what happens when Wall Street greed, investor mania, and corporate blindness all come together.

Don't expect Drkoop.com to be the last dot-com disaster, either. "Wall Street always gets into trouble during exuberant times," says Bill Benedetto, citing past debacles like junk bonds and biotech. "We'll probably have to have a few more Drkoop.coms before people start to ask more questions and act more sensibly."


FEEDBACK: nschwartz@fortunemail.com