At current prices of about 17.82, GXDX has extremely attractive earnings and free cash flow yields. Share prices tumbled in May from 38.00 to 16.00 after the company lowered its EPS guidance from 1.85 to 1.20.

GXDX is profitable, has an excellent balance sheet, and I believe it will continue to grow rapidly, but at a less rapid pace than analysts previously expected. Being a provider of specialized lab services, I also believe GXDX is an attractive acquisition target for either Lab Corp or Quest Diagnostics.

Lab Corp’s last large acquisition was back in 2002 when they acquired Dianon for about 36 times TTM earnings. More recently, Carlyle Group and TPG Capital have made an offer of about 20 times earnings for Healthscope, a large Australian lab services provider. With a range of 20-36 times earnings, GXDX would have a fair price in the range of $24 to $43 per share, which means shares are trading at a discount of at least 26% and perhaps as much as 60%.

Using a DCF model, I estimate the intrinsic value of GXDX to be about $37.50 per share, which is a 52% discount at current prices.

Fundamentals

• Current price: $17.82
• Est’d 2010 EPS: $1.20
• Forward P/E of 14.85 or an earnings yield of 6.73%
• With no debt and cash/share of 7.56, the adjusted forward P/E is 8.55 or an earnings yield of 11.7%
• Margins
  • Gross: 62%
  • Operating: 27.5%
  • Net: 15.6%
  • FCF/share of 1.79 gives an adjusted P/FCF of 5.73 or an adjusted FCF yield of 17.4%
  • Growing Market
    • Incidence rates
      • 375k bone marrows/yr
      • 250k related blood-based tests/yr
• Hem/Onc Physicians
  • 12.5k hem/oncs
  • 9.5k or 76% practice in the community setting
• Patients
  • 850k patients in the U.S.
  • 150k new cases annually
  • Marketshare
    • Genoptix bone marrow market share increased to ~ 8% in 1H10
    • Goal to capture 15-20% market share by 2015
    • 60% of revenues from private insurance; 40% from Medicare and Medicaid
    • Signed first major national commercial contract w/ Aetna in 1Q10; expect to sign 2^nd major commercial contract in 2010
    • Company will gradually shift toward contractual relationships over next few years
    • Revenue has grown from $4,009 in 1Q06 to $47,399 in 1Q10, an 85% CAGR
    • Company is continuing to grow
      • Adding lab capacity
      • Growing sales team and opening new customer service facility

Marketplace

• Growing Market
  • Incidence rates
    • 375k bone marrows/yr
    • 250k related blood-based tests/yr
  • Hem/Onc Physicians
    • 12.5k hem/oncs
    • 9.5k or 76% practice in the community setting
  • Patients
    • 850k patients in the U.S.
    • 150k new cases annually
• Marketshare
  • Genoptix bone marrow market share increased to ~ 8% in 1H10
  • Goal to capture 15-20% market share by 2015
• 60% of revenues from private insurance; 40% from Medicare and Medicaid
• Signed first major national commercial contract w/ Aetna in 1Q10; expect to sign 2^nd major commercial contract in 2010
• Company will gradually shift toward contractual relationships over next few years
• Revenue has grown from $4,009 in 1Q06 to $47,399 in 1Q10, an 85% CAGR
• Company is continuing to grow
  • Adding lab capacity
  • Growing sales team and opening new customer service facility

Reimbursement and Payor Relationships

• 60% of revenues from private insurance; 40% from Medicare and Medicaid
• Signed first major national commercial contract w/ Aetna in 1Q10; expect to sign 2^nd major commercial contract in 2010
• Company will gradually shift toward contractual relationships over next few years

Growth

• Revenue has grown from $4,009 in 1Q06 to $47,399 in 1Q10, an 85% CAGR
• Company is continuing to grow
  • Adding lab capacity
  • Growing sales team and opening new customer service facility

• Kaplan – for-profit education and test prep services
• Cable ONE – cable T.V. and high speed internet
• T.V. broadcast stations
• Real estate
• Marketable securities
• Newspaper and publishing

For many years WPO has been a favorite among value investors. Buffett himself has been a long-time investor in WPO and has had a long relationship with the company’s leaders. Many have made the case over the years that WPO is extremely undervalued on a sum of the parts basis. Up until recently, I believed this to be the case, but recent political and regulatory events (in addition to other more qualitative factors) have the potential to substantially decrease the value of WPO and reduce the margin of safety for potential investors.

Sum of the Parts

To properly value the WPO, we must use a sum of the parts method. I’ll go in order from greatest to smallest in terms of size of assets.

Kaplan

Recently there has been much news about the for-profit education industry. There was a recent Frontline investigation into this industry that paints an unflattering picture to say the least and which has undoubtedly provided an additional incentive for more regulation. Among other things, the investigation explains how students have extremely high default rates on their loans, how education companies spend a disproportionately high amount on advertising rather than on students, how some recruiters use questionable and high-pressure tactics to sign up students, and how some students have earned degrees they can’t use for the jobs they wanted.

Additionally, Steve Eisman (one of the few investors who both saw the sub-prime crisis way ahead of everyone else and made a bundle going short) made a very convincing presentation of his short thesis for the for-profit education industry at the 2010 Ira Sohn Conference. Eisman feels the industry has all the characteristics of the recent sub-prime mortgage bubble, saying that: “The for-profit industry has grown at an extreme and unusual rate, driven by easy access to government sponsored debt in the form of Title IV student loans, where the credit is guaranteed by the government. Thus, the government, the students and the taxpayer bear all the risk and the for-profit industry reaps all the rewards.”

The bubble-like nature of the industry coupled with evidence of very high student loan default rates and the fact that these companies are profiting from easy access to government money, has attracted the attention of regulators and I think rightly so.

Since the Obama administration has gotten situated, there has been a year-long battle between the U.S. Department of Education (DOE) and the higher education community regarding changes to student aid rules. On June 16, the DOE released its Notice of Proposed Rulemaking regarding fourteen different student aid issues, the most important being the rule regarding gainful employment. The idea behind the gainful employment rule is to limit student debt to more realistic levels, which will likely force the industry to reduce tuition costs and/or cut programs.

Other proposed rule changes will affect the operations of the for-profit education industry. For example, the DOE recommends tightening oversight of “Ability to Benefit” tests, exams on which many institutions rely to enroll students who do not have high school diplomas. The DOE also recommends strengthening the metrics by which students must show academic progress, the goal here being to prevent schools from receiving federal-aid funds from students with near-failing grades.

The DOE’s draft rules will be open to public comment for 45 days and plans to issue a final rule by Nov. 1, with changes taking effect beginning July 1, 2011.

With new rules negatively affecting the profitability of Kaplan and a convincing argument that the for-profit education industry is a bubble, this has reduced the value of WPO’s most important asset. I peg the value of Kaplan at about $2.5 billion based upon my best estimate of discounted cash flows.

Cable ONE

In 2008 Cable ONE bought a smaller cable television business for $2,300 per basic subscriber. I’ve also found that other transactions in similar geographic areas have averaged about $3,000 per subscriber. Multiplying $3,000 by Cable ONE’s 669,000 basic subscribers we get a value of about $2 billion. This imputes no additional value for the 392,800 high-speed data subscribers and 109,600 telephony subscribers so I think this is a conservative estimate.

T.V. Stations and Broadcasting

WPO owns three T.V. stations in the top 10 through 20 viewership markets and four stations in the 20 through 50 range. Based on other sales of T.V. stations in similar viewership markets, I originally estimated that a T.V. station in the top 8 through 20 market area range was worth about $213 million and that stations in the top 20 through 50 market area were worth about $93 million each for a total valuation of roughly $1 billion.

Currently I am giving a 50% haircut to my original value of the T.V. stations, though a larger haircut may eventually be required. I have two reasons. First, I believe these assets will decline in value much like the value of newspapers and publishing assets of WPO have declined. I also believe that WPO will do nothing about this, choosing to hold onto these assets until there is little to no value left. I’m afraid that Don Graham, current chairman, CEO, and owner of the family business, might be trying to ape Buffett’s “buy and hold” approach to the detriment of the company.

Second, I found that a transaction between CBS and Cerberus at the beginning of 2008 valued several stations in top 20 through 50 market range at about $26.5 million per station, about 70% less than my original estimates. I feel that this transaction is more representative of the current and possibly future environment for the television broadcast industry.

Real Estate

WPO owns a fair amount of real estate. I was able to find the total assessed value (as assessed by local authorities for tax purposes) for most of WPO’s real estate and found that the total assessed value is about 40% greater than the book value of WPO land and buildings as stated in its June 28, 2009 quarterly report (the last quarterly that broke out the values for land and buildings). Thus, with a stated book value of about $400 million, a more accurate estimate of the true worth is about $560 million.

Marketable Securities

WPO has marketable securities (a large portion of which are Berkshire shares) that are worth about $440 million as of April 4, 2010.

Newspaper and Magazine Publishing

I assume the newspaper and magazine are worth zero.

Sum of Parts

Summing up all the parts…

• Kaplan: $2,500 million
• Cable ONE: $2,000 million
• T.V. stations: $500 million
• Real estate: $560 million
• Marketable securities: $440 million
• Newspaper and magazine: $0
• Long-term debt: $396.4 million

We get a net intrinsic value of $5,600 million. With 9.241 million shares outstanding, that’s a value of $606 per share, or lets say an even $600 to be on the safe side.

At a market price of $454, that’s only a discount of 25%, an amount that I think is insufficient to compensate for the risks of:

• impending higher education regulations
• the likelihood that the for-profit education industry is a bubble
• the high possibility that the T.V. broadcasting industry will soon be in permanent decline like the newspaper industry (if it isn’t already in decline)

However, if the price of WPO shares declines to $360 (a ~40% discount), then I would start getting interested in the stock.

Variant Views

Some might say fears are overblown regarding regulations that will affect Kaplan and that it will be able to adjust to a new, lower-profit reality. However, I feel regulation is well-deserved in this industry and there is just no telling how far politicians and regulators are willing to go with new rules, especially if there is truly something to dislike about an industry.

Highlights include:

• 101 small banks have not paid their TARP dividend which is sign that’s there’s still a “great deal of instability in the banking system”.
• Three thousand out of eight thousand banks have serious concentration in commercial real estate. 6 out of 19 stress tested banks have commercial real estate that exceeds tier 1 capital.
• Does not look like a problem that’s going to get smaller over the next couple of quarters. It looks like a problem that is going to increase.

Bottom line? Expect more failures in the coming years from the small to medium-sized banks throughout the country.

There wasn’t a whole lot to talk about at the Markel meeting, which is fine by me. Markel is one of the best specialty P&C insurers in the country. It’s a superb business run by passionate managers and employees. One of the more popular topics had to do with the progress and results of the One Markel initiative. This initiative began over a year ago and involved the company has transitioning away from a business model with four separate units (each with separate and/or overlapping insurance products) to a model with five regional offices that offer the full array of Markel’s insurance products.

Many of the Markel employees and managers had very positive things to say about One Markel. The producers for the company have more and easier access to Markel’s products. People also said that One Markel has resulted in a steady increase in submissions, which means more opportunities to underwrite for a profit. One Markel has also been helpful in ensuring the consistency of underwriting and pricing of the products. The initiative has also increased the ability to add new products and enhance existing one.

Finally, one Markel employee said one of the surprise benefits of One Markel is that company has been able to attract new talent. With the old system, a potential new employee who wanted to underwrite a certain product but could only do so if they moved to a different part of the country where that product was based. With the new system, that potential new employee does not have to move because all of Markel’s products in each of the regional offices.

With all the positives, one employee explained that the only negative thing about One Markel is that employees now have to deal with four different technology platforms in the underwriting process. However, this is a learning process and its just a matter of time before people become accustomed to the new system. Markel will continue to improve service, will continue to be creative problem solvers, will continue to enhance products, will continue to identify true partners, and will continue to attract new talent.

Bill Stovin, the leader of Markel International in London, was also at the meeting and gave a very informative update on the international operations, which include London Wholesale, Retail, and Overseas. It sounded to me like the international operations are doing quite well. Wholesale has introduced several new products: Equine, Credit Risk, and Personal Accident. These are small now but premiums should grow pretty well over the years. Markel has even sponsored two jockeys, Bill showed a picture of a jockey on a horse with “Markel” embroidered on the white pants. Equine is just one example of the specialty markets to which Markel caters. Markel wants to be the specialist insurer of choice for people.

Tom Gayner fielded questions about Markel’s investments and Markel Ventures, Markel’s newest division for their private investments and purchases. Gayner said Markel Ventures represents permanent capital and a long-term home for private companies. He also expects about $40 million in revenues this quarter for the venture segment, which would mean roughly $160 in revenue for the year.

Gayner said he is very optimistic about the future of Markel and went on to explain that the company’s secret weapon is love. I’m not joking here. It sounds silly but I think Gayner is right. I believe everyone at Markel loves what they do and there are many employees who have been with the company for several decades. There is a breadth of experience and continuity at Markel that is just not present at any other company. Markel’s success comes from their people and their people are some of the best out there.

I was very impressed by the Markel event and I’m now an even bigger believer in the company. Markel is a Berkshire-like company and has the culture to continue to do great things for shareholders for a long time to come.

I wrote about UFCS on two separate occasions back in November last year and mentioned it briefly in January:

• United Fire & Casualty Has Been Down This Road Before — November 17, 2009
• Bargains: Harder to Find, But Still Out There — November 25, 2009
• Insurance Stock Drops — January 8, 2010

I saw UFCS as a company with negative sentiment (mostly continuing claims and expenses from Hurricane Katrina; yes, a hurricane from 5 years ago) that grossly outweighed the fact it was just a decent life and P&C insurance company that was bound to rebound (so to speak). UFCS was selling at a P/B of 0.73 and is now at a P/B of 0.93. If you had been reading my blog and agreed with my view that UFCS was very undervalued and bought at $17.00 per share, you would now have gain of about 38% (roughly 93% annualized) and you’d be beating the S&P 500 by about 30 percentage points.

It’s best to remember that better investment opportunities often come from overlooked and unpopular stocks. I think UFCS is a good reminder of both of these points.

The premium investors are paying today to own small-capitalization  stocks versus their large counterparts is the biggest in at least 27 years, said James Floyd, senior analyst at Leuthold Group LLC, a research firm based in Minneapolis. Leuthold defines large stocks as those with a market value of more than $9 billion and small stocks as those from $300 million to $1.4 billion.

At the end of the first quarter, small stocks sold for an average price-to-earnings multiple of 18.6 compared with 15.7 for large stocks. The 18 percent gap between the two is the widest since Leuthold began gathering the data in December 1982, Floyd said. In 2000, small stocks sold at about a 40 percent discount to large stocks, he said.

This is all evidence that points to either serious mistakes, real fraud, or negligence and/or ineffectiveness of the former CEO, or all of the above. Given all the above, the stock is trading near 52-week lows and might represent an excellent opportunity for purchase given the potential for forced or irrational selling due to the company’s inability to timely file its last two required reports.

Because investors have not seen a balance sheet or income statement for slightly over nine months, I feel there is an extreme amount of uncertainty surrounding the price of the stock and thus the company should be valued by tangible book value or on a liquidation basis.

From its balance sheet as of June 30, 2009, I calculate a tangible book value per share of $29.43. With a stock price of $23.24 as of last Friday, the stock is trading at a 21% discount. I will let my inquisitive readers find a liquidation value for themselves, but one could simply give a haircut to tangible book value and I suspect you would find that liquidation value per share is still slightly above the current share price.

Also, a useful way to reassure oneself about Northwest is to look at how its competitors have performed in the interim. If competitors have been performing decently, it might be safe to bet that Northwest has still been able to perform equally as well despite their ongoing investigation. Northwest’s competitors in the water transmission segment is Ameron International (AMN) and Mueller Water Products (MWA). In the tubular products segment, Northwest’s competitors are Valmont Industries (VMI), Lindsay (LNN), Tenaris (TS), and U.S. Steel (X).

I will most likely take a deeper look at Northwest Pipe. Investors can pick up amazing deals when uncertainty and/or forced and irrational selling.

With a book value of 12.59 NOK and the stock currently trading at about 7.50, this is a discount of about 40%. I don’t know a whole lot about the fishing industry, but I imagine it is fairly cyclical and dependent upon people being willing to open up their wallets to eat at restaurants. Glancing through the annual report, the only potential problem I saw was Aker’s balance sheet as they seem to have a lot of debt relative to equity. However, this ratio has improved year over year due to Aker’s refinancing of debt and raising of additional capital.

So as the economy perks up a bit and people start to go out to eat again, I would suspect that a company like Aker will benefit disproportionately. to non-cyclicals. And with Aker trading at such a large discount to book value, there just might be an added margin of safety.

A summary and excerpts in English will be available here tomorrow.

I am looking forward to this. I remember in 2007 reading only a few bearish blogger’s posts about the impending problems of Icelandic banks. This report I hope will serve as a learning tool for those involved and also everyone else in the financial industry. Thanks to Simoleon Sense for the great linkfests.