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IMS Health Laid Low

Shares tumble on a weak quarter and soft outlook.

The business model at

IMS Health

(RX)

, a company touted as "the world's leading provider of healthcare market intelligence," looks like a prescription for disaster.

After thriving for years in a tough pharmaceutical environment, IMS suffered a painful third quarter and warned of chronic problems that could linger for some time to come. With pharmaceutical companies struggling to introduce new blockbuster drugs -- on which IMS data can be based -- IMS has finally seen demand for its services start to wane. During the latest quarter, in fact, weakness in IMS's core "information and analytics" business led to the company's first earnings miss in recent memory.

Shares of IMS plummeted 22% to a new 52-week low of $22.99 following the company's dismal update.

Investors had to hunt hard for good news, with some apparent strengths looking like weaknesses in the end. For example, IMS posted strong revenue of $534 million -- up 12% from a year ago -- that actually beat the consensus estimate. But rising demand for consulting services, which generate smaller margins than the company's main data supply business, led to that upside.

Meanwhile, profits actually fell. Due in part to one-time charges, net income slid 18% to $57.1 million in the latest quarter. Even excluding special items, earnings fell below last year's levels, with earnings per share of 36 cents missing Wall Street targets by 4 cents.

IMS scaled back its full-year guidance as well. Looking ahead, IMS now expects to post 2007 profits of just $1.52 to $1.56 a share -- well below the current $1.59 consensus estimate -- as it braces for an extended downturn.

In response to that projected slowdown, IMS has pledged to slash costs and outsource services in an effort to save money. But some experts, stunned by IMS's worsening condition, see a company doing too little too late.

"We must question why these initiatives haven't materialized in the past," Baird analyst Eric Coldwell wrote on Thursday. "Perhaps management wasn't focused, management didn't see enough incremental opportunities, or management feared the outcome of such initiatives.

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"Regardless," Coldwell added, "we're putting these initiatives in the 'show-me' mode and have modest expectations" for a turnaround.

Coldwell, for one, felt uneasy even before IMS' devastating update. He worried about the company's weak performance in Europe, which only worsened last quarter. So when the company failed to meet even his Street-low profit target for the third quarter, he finally threw in the towel and downgraded the stock from outperform to underperform.

"The bright spots in IMS' results -- and there are many -- are not offsetting the setting sun on pharmaceutical spending patterns," Coldwell wrote. "Heading into an election year where pharma is unlikely to open the coffers and accelerate spending, our concern is that 2Q's modest performance and 3Q's disappointing performance is a harbinger of greater challenges ahead.

"Pharmaceutical supply chain themes that were not historically deemed a highly correlated challenge for IMS's model -- such as brand-to-generics conversions, therapeutic reference pricing and lack of new product introductions -- now appear to be too great to refute."

Coldwell has therefore slashed his price target on IMS's stock from $37 to $24 a share. His firm hopes to secure investment banking business from the company in the future.

Other analysts quickly lowered their expectation for IMS as well.

John Kreger of William Blair, which owns at least 1% of IMS's stock itself, cut his rating on the company from outperform to market-perform on Thursday. Kreger, like many, seemed blindsided by this week's development.

"We are confused about what is really different about today's environment versus one, two or three years ago," Kreger admitted. "The pharma industry's revenue growth has been slowing since 2000 ... Yet IMS was able to deliver improving revenue growth and stabilizing margins despite this headwind?

"So why is this so different?"

For now, at least, Kreger has decided to blame the industry instead of the company itself. But others seemed unwilling to let management off the hook.

"With pharma's challenges unlikely to abate and given concerns that spending is further crimped in an election year," he wrote, "we see no signs of relief."