Ron Baron is a growth investor. If you can buy a growing company at reasonable price, why not? If you are price conscious when buying growth companies, what is the difference between value and growth?
Martin Whitman said he is a growth investor, too. He said “In the financial community, growth is a misused word. Most market participants don’t mean growth, but rather, mean generally recognized growth. In so far as growth receives general recognition, a market participant has to pay up.” He thinks that the companies he owns such as Cheung Kong Holdings, Forest City Enterprises, Covanta and Toyota Industries are growth companies. Just the market does not recognize it, which is a good thing for value investors.
These are the excerpts from Ron Baron’s shareholder letters on a few small cap companies: HLTH Corp (HLTH, Financial), Healthways (HWAY, Financial), Allscripts (MDRX, Financial), Helmerich & Payne (HP, Financial), FCStone (FCSX, Financial), Glacier Bancorp, Inc. (GBCI, Financial), Acadia Realty (AKR, Financial). Emdeon (Currently HLTH Corp: HLTH) (Market cap $2.5 billion)
Emdeon Corp. is the parent company of WebMD, which provides health information services to consumers, physicians, employers and health plans through its public and private online portals. WebMD’s consumer health portal (the flagship site is webmd.com) enables individuals to obtain detailed information on a particular disease or condition, locate physicians, store individual healthcare information, assess their personal health status, receive periodic e-mails on topics of interest, and participate in online communities with peers and experts. WebMD’s professional portal (the flagship site is medscape.com) enables healthcare professionals to access clinical reference sources, stay abreast of the latest clinical information, learn about new treatment options, earn continuing medical education credit and communicate with peers.
We believe that healthcare and consumer products companies, which today spend less than 5% of their marketing budgets online, will in the future spend a significantly greater percentage of their multi-billion dollar marketing budgets online as they increasingly recognize the advantages of online marketing over offline marketing. As the leading online healthcare company with an average number of unique users exceeding 35 million per month in the most recent quarter, WebMD provides its clients with access to a large, health-focused audience and the means to measure the effectiveness of its marketing spending. WebMD’s advertising revenue has been accelerating in recent quarters, and we think this acceleration marks the early stages of a long-term trend.
WebMD should, in our view, also benefit from the trend towards consumerism in healthcare. In response to increasing healthcare costs, employers have been shifting a greater portion of healthcare costs onto their employees by changing benefit plan designs to increase employees’ out-of-pocket costs. Employers have also taken steps to motivate their employees to make more informed, cost-effective healthcare decisions. Through its private portal business, WebMD offers tools (such as Personal Health Records), services (such as lifestyle education and telephonic health coaching), and information designed to allow employees to take a more active role in their healthcare. WebMD’s private portal business has been growing rapidly. As of the most recent quarter, the company had ninety-nine private portal clients, including Pepsi, Microsoft and WellPoint. We believe WebMD has the potential for hundreds of accounts in this business. We also believe that over time, WebMD will have the opportunity to expand the scope of services it provides to these private portal clients and generate additional revenue.
In our view,WebMD is uniquely positioned in this market, because WebMD has exclusive access to historical patient claims data held by Emdeon Business Services, which allows WebMD to populate its Personal Health Records with this data. In addition, we think clients want an independent third party, rather than their health plans, to provide these services because employees generally distrust their health plans and want to be able to carry their Personal Health Records with them when they change health plans.
We believeWebMD can double its revenue in the next three to four years and generate over 30% incremental EBITDA margins. As a result, we believe WebMD can triple its EBITDA over the same time period. We think Emdeon, as the parent company of WebMD, is an attractive way to participate in WebMD’s growth. Emdeon also owns other assets, which we believe are underappreciated by the market. (Neal Kaufman)
Healthways (HWAY) (Market cap $1.6 billion)
Healthways, Inc. is the leading provider of disease management services to health plans and self-insured employers. The company has twenty-five years of experience working with chronically ill patients to improve health outcomes and reduce healthcare costs. Through the acquisitions of Health IQ and Axia, Healthways has expanded into wellness services, which include health risk assessment tools and telephone coaching to help people lose weight, exercise or quit smoking.
We believe Healthways has substantial growth opportunities in several markets. Healthways, we think, can continue its rapid growth in the commercial market where demand for its services among self-insured employers is particularly strong as employers seek ways to control their healthcare costs. In our view, Healthways should benefit from its recent strategic alliance with Medco Health, one of the nation’s largest pharmacy benefit management companies, which will offer Healthways’ services to 40 million individuals not currently touched by Healthways’ existing health plan relationships. As one of several companies participating in a Medicare pilot project, we think Healthways also has a large potential market opportunity in Medicare. If the pilot is successful, Medicare will expand the program to a larger population, which could ultimately include more than 20 million chronically ill Medicare fee-for-service beneficiaries. We think Healthways also has opportunity to expand into international markets as certain Western European countries have expressed interest in establishing disease management and wellness programs.
We believe uncertainty related to the success of the Medicare pilot project has created an opportunity for us to own this best-of-breed company at attractive prices. Healthways, in our view, has a solid management team, attractive cash flow characteristics and substantial growth opportunities. (Neal Kaufman)
Allscripts (MDRX) (Market cap $1.5 billion)
We believe the U.S. healthcare system is at an inflection point with respect to the adoption of Electronic Health Records by physicians. There is widespread agreement that Electronic Health Records and e-prescribing lower healthcare costs, reduce medical errors and improve the quality of healthcare. In 2004, President Bush called for the creation of a system of Electronic Health Records within the next decade, and there is bipartisan political support on this issue. To encourage physicians to adopt Electronic Health Records, the government recently amended the Stark Anti-Kickback Law to allow hospitals to help physicians pay for Electronic Health Records and e-prescribing technology. In addition, payors are implementing pay-for-performance standards designed to reward healthcare providers for delivering quality care at low cost. In order to meet these standards, physicians need to easily reproduce data, which requires the use of information technology. Electronic Health Records, we think, are rapidly becoming the standard of care.
We believe Allscripts Healthcare Solutions Inc., a leading provider of Electronic Health Record software for office-based physician practices, is well positioned to benefit from this trend. Allscripts’ software allows physicians to use tablet PCs, wireless handheld devices or desktop workstations for common physician activities, including prescribing, dictating, ordering lab tests and viewing results, documenting clinical encounters and capturing charges. We see the market opportunity for Allscripts as large and untapped. There are roughly 550,000 office-based physicians in the United States, and only 20% have adopted some form of Electronic Health Record technology. In addition to software sales, we think Allscripts has the potential to generate high margin transaction revenue from e-prescribing over time. Moreover, as its installed base of physicians grows, Allscripts can generate additional sources of revenue given its valuable position at the point-of-care. Allscripts also has an emerging e-detailing business, which we believe should benefit as large pharmaceutical companies downsize their sales-forces and seek more efficient ways to market to physicians.
Allscripts has over 30,000 physicians currently using its software, which creates reference sites for potential new clients. Current clients are able to demonstrate return on investment through reduced transcription costs, increased revenue from proper reimbursement coding, and reduced resources in medical records storage. Allscripts offers its software in modules, which allows physicians the option of gradually adopting the technology. Allscripts’ software also works well with other vendor practice management systems, which is important because most physicians already have such systems in place. Combined, we think these factors provide Allscripts with a competitive advantage and position the company well for future growth. (Neal Kaufman)
Helmerich & Payne (HP) (Market cap $3.1 billion)
Helmerich & Payne is the fifth largest land drilling company in the United States with smaller operations in the domestic offshore and international land rig markets. The land drilling industry in the U.S. has expanded significantly over the last three years as exploration and production companies have increased spending to take advantage of record oil and natural gas prices. For the industry, the domestic land rig count and average day rate in the last trough bottomed at 613 rigs and about $6,600 in 2002, and have since climbed to 1,650 rigs and approximately $19,000, respectively, today. Our interest in H&P, however, is based not on a view of the drilling cycle, but on our enthusiasm for the company’s forward looking management, which has it positioned for solid earnings growth over the next several years, we think, in almost any commodity environment.
H&P was founded in 1920, by the grandfather of the current CEO, Hans Helmerich, and for many years the company successfully operated as a relatively small drilling contractor with a focus on big rigs able to drill the deepest prospects. In 1997, the company made a strategic decision to expand its fleet with a new generation of land rigs that would be more mobile and more flexible in terms of well depth than anything prior. H&P would design and assemble these rigs inhouse, solidifying its position as a pioneer in this area. There were many who questioned H&P’s strategy. After all, there was no shortage of land rigs with many still idle from the last building boom in the early 1980’s when the rig count topped out at over 4,000. In fact, the domestic land rig count averaged about 800 in 1997, and would soon begin a fall to under 400 rigs by the spring of 1999. The company persevered in its strategy, however, ultimately building fifty of its so-called FlexRigs for its fleet by early 2004. This was at the time, of course, when virtually no one else was building new rigs.
Today, H&P’s fleet of about 134 land rigs is the most modern and technologically advanced fleet in the United States. In the cyclical land rig market, H&P’s FlexRigs have always been in high demand and have earned a premium of 25% or more relative to conventional rigs. Their use of modern equipment and quicker well-to-well movement allows customers to reduce the number of days to drill a well. As a result, total well costs are lower despite higher rig day rates and more wells can be drilled in a given period by a FlexRig than can be accomplished with a conventional rig. There is more to H&P, however, than just better equipment. The company takes great pride in its excellent safety record and its highly trained people, without whom its value proposition to customers would be much less.
H&P began a new expansion program in 2005, that to date has added about fortyfive rigs with another thirty to be delivered by early 2008. When all seventy-five newbuilds are delivered, H&P will have increased the size of its domestic land fleet by over 80%. Some observers are concerned about the new order book for the overall land rig industry, which is seeing its first big building program in twenty-five years, but H&P is mitigating this risk by only building rigs with longterm contracts attached to them. Each of its seventy-five new FlexRigs already has a firm contract with a term of at least three years, which the company expects to result in a three-year payback and close to a 20% rate of return on its $1.1 billion expansion program. As a result of the expansion program and the current healthy drilling environment, earnings more than doubled from $0.97 per share in 2005, to $2.60 per share in 2006, and we believe they can reach $4.00 per share in fiscal 2008. We established an investment in this business when its share price fell almost 40% after energy prices weakened last fall.(Geoff Jones)
FCStone (FCSX) (Market cap $0.6 billion)
FCStone Group is a commodity risk management consultancy serving medium-sized companies. Its expertise is in agricultural commodities, energy and renewable fuels. Its customers include commodity producers (e.g., farmers), intermediaries (e.g., heating oil companies) and end users (e.g., food companies). FCStone devises strategies to help its customers mitigate their exposure to commodity price risk and maximize the amount and certainty of their operating profits. These strategies usually involve using futures contracts (contracts to buy or sell specific quantities of a commodity on a specified future date at a specified price). FCStone is also a futures commission merchant (FCM), a brokerdealer of futures. It can, therefore, both develop risk management strategies for its customers and execute these strategies for them. To our knowledge, there is no other firm offering a comparable caliber of risk management services to middle market companies.
FCStone was formed in 2000, by the merger of the Farmers Commodities Cooperative, which focused on risk management consulting for the agricultural companies that comprised its membership, and Saul Stone, a FCMwhich contributed trading capabilities. Since the merger, the combined company has worked to grow its consulting business beyond the membership of the former Farmers Commodities Cooperative. As a result, the percentage of consulting revenues from firms that were not members of the Farmers Commodities Cooperative increased from approximately 25% in 1999, to approximately 70% in 2006. To achieve these results, FCStone expanded into new geographies, particularly Brazil and China, and into the renewable fuels industry, in which FCStone has achieved significant penetration of domestic ethanol producers. Currently, FCStone has 3,500 risk management clients. Management believes there are tens of thousands of prospective client companies that could use FCStone’s risk management services. FCStone plans to grow its customer base both in the industries in which it is already well established—agriculture, energy and renewable fuels— as well as by expanding into related industries such as food processing. We think FCStone also has significant opportunities to grow existing clients as many are not yet hedging all or even most of their commodity risk. Clients typically increase their use of risk management products after seeing positive results from their initial efforts. FCStone is supporting its plans for future growth by growing its consultant base. In 2005, FCStone created a formalized training program for new consultants. New consultants now apprentice with a senior consultant for two years and take classes in risk management, marketing and sales, and financial analysis. Since the implementation of this program, the success rate of new hires has markedly improved.
FCStone’s margins have been on the rise due to leveraging fixed costs and a mix shift towards higher margin services. FCStone’s operating margin was 13% in 2006, up from 8% in 2005. Management has said they believe incremented operating margins could rise to as high as 30%-35%. Management has also indicated they have been approached regarding opportunities to purchase other FCMs. FCStone could realize value from an acquisition by paying a reasonable price and achieving cost synergies by eliminating a trading platform, the acquired company’s or its own. Regardless of any potential acquisition opportunities, we believe FCStone has the potential to more than double its earnings over the next four years. (Katherine Harman)
Glacier Bancorp, Inc. (GBCI) (Market cap $1.3 billion)
Glacier Bancorp, Inc. (Glacier), founded in 1984, and headquartered in Montana, is the holding company for twelve community banks. Glacier has total assets of $4.5 billion, and equity capital of about $500 million. Glacier has eightysix branches in five states —primarily Montana and Idaho where it has operated the longest. These two states represent 70% and 25% of its assets, respectively, and almost all of its earnings. Over the past few years, Glacier has entered the contiguous states of Wyoming, Utah and Washington Under the leadership of Michael Blodnick, who became CEO in 1997, Glacier has posted a superior ROE and ROA of 17% and 1.5% in each of the last five years as well as steady growth in loans, deposits, assets, and net income. EPS has compounded at a 14% growth rate over the past five years. In 2006, despite the challenging operating environment for banks, Glacier posted 18% organic loan growth (over 30% including acquisitions), a rising net interest margin while peers’ were falling, healthy reserves and capital levels, further improvement in its already pristine asset quality, and 15% EPS growth (excluding stock option expense and 11% EPS growth including the charge). This growth was accomplished without securities gains, tax benefits, or drawdown of its loan loss reserves. We expect 2007 to mark another year of greater than 10% growth and believe that as some of the industry’s headwinds dissipate (most notably the flat to inverted yield curve and intense deposit pricing competition), Glacier’s EPS growth rate should accelerate.
Glacier reflects growth in its markets, as well as steady market share gains as it opens new branches and as new branches mature. Glacier has also grown through acquisitions, having acquired one to two banks each year since 2003 — including in-fill, as well as contiguous markets. We think numerous acquisition opportunities remain.
Glacier’s markets as measured by population are projected by the government to grow substantially faster than the U.S. national average. Key drivers are increased tourism and recreation, strong in-migration and job growth related to the healthy economies of this region led by increased demand for energy, commodities and natural resources.
Glacier has an important deposit market share in almost all of its major markets, ranking in the top three in eight of its top ten Metropolitan Statistical Areas (“MSAs”). Unlike most banks, Glacier operates with a multi-bank holding company — a decentralized strategy with the goal to bring big bank product expertise, breadth and loan size to its clients while maintaining the deep roots, strong knowledge and superior customer service of a locally-based and managed community bank.
Glacier believes that this strategy enables it to know its local markets better and thus results in stronger growth opportunities and enhanced risk selection (superior asset quality). Glacier runs efficiently with operating expenses-to-revenues of 52% versus peer at 59%. (David Sochol)
Acadia Realty (AKR) (Market cap $0.8 billion)
Acadia Realty Trust is a real estate investment trust (REIT) that owns or has equity interests in seventy-seven properties totaling in excess of ten million square feet. Most of the wholly-owned properties in the core portfolio are shopping centers anchored by grocery stores, or discounters in the Northeast corridor between Delaware and Boston. The company also focuses on real estate redevelopment opportunities in the boroughs and suburbs of New York City (Brooklyn, Bronx, Queens, Westchester, and Staten Island).
The majority of Acadia’s core portfolio is in high barrier-to-entry markets in the Northeast (tight zoning requirements and a lack of undeveloped land) which constrain new supply. The company continued to improve the portfolio by redeveloping assets and disposing noncore assets. Acadia’s seven real estate redevelopment opportunities are all in the greater New York area. We expect these projects to come online from 2007 to 2009 at approximately 10% development yields. We think the company’s focus on retail real estate development in the greater New York area is attractive because the New York boroughs and suburbs have low penetration from national retailers, low per capita retail square footage supply, and household income levels above national averages. In its acquisition and redevelopment program, the company focuses on “below-the-radar” screen investments that are often too small for the larger real estate companies. Management has also been active in launching joint venture acquisition funds to fuel growth.
To date, Acadia has formed three joint ventures (with private real estate players such as Klaff Realty) for its main acquisition vehicles. These joint ventures give Acadia a steady source of capital to participate in attractive deals that might otherwise be too large for a REIT of Acadia’s size. The joint ventures have enabled Acadia to be an active participant for opportunistic acquisitions without having to rely on the equity markets for capital. Acadia plans to launch a new $500 million fund in 2007. The economics on the joint venture funds are attractive to us as Acadia earns asset management fees, promoted interest fees, and its equity interest (usually 20%). We expect the company will likely continue to utilize its underleveraged balance sheet (33% leverage) and ramp up its urban infill acquisitions. In 2007, the company has already announced the $120 million acquisition of a real estate redevelopment opportunity in Brooklyn (1.4 million square feet of mixed use redevelopment), and made its first Midtown Manhattan real estate redevelopment acquisition. We expect additional acquisitions in the remainder of the year.
We believe the management team, led by CEO Ken Bernstein, is one of the most talented in the real estate sector. It is a small-capitalization REIT with a management depth and expertise not seen in many larger companies. They have several years of experience in leasing, construction, deal structuring, and shopping center operations. In our view, they think out-of-the-box to create value. We believe our investment return profile will be attractive due to our expectation for management to generate several years of attractive growth fueled by its core real estate portfolio (annual rent increases), redevelopment opportunities, and management fees and to promote income on its joint venture funds, opportunistic dispositions of non-core assets, and a 3% annual dividend. (Jeff Kolitch)
Martin Whitman said he is a growth investor, too. He said “In the financial community, growth is a misused word. Most market participants don’t mean growth, but rather, mean generally recognized growth. In so far as growth receives general recognition, a market participant has to pay up.” He thinks that the companies he owns such as Cheung Kong Holdings, Forest City Enterprises, Covanta and Toyota Industries are growth companies. Just the market does not recognize it, which is a good thing for value investors.
These are the excerpts from Ron Baron’s shareholder letters on a few small cap companies: HLTH Corp (HLTH, Financial), Healthways (HWAY, Financial), Allscripts (MDRX, Financial), Helmerich & Payne (HP, Financial), FCStone (FCSX, Financial), Glacier Bancorp, Inc. (GBCI, Financial), Acadia Realty (AKR, Financial). Emdeon (Currently HLTH Corp: HLTH) (Market cap $2.5 billion)
Emdeon Corp. is the parent company of WebMD, which provides health information services to consumers, physicians, employers and health plans through its public and private online portals. WebMD’s consumer health portal (the flagship site is webmd.com) enables individuals to obtain detailed information on a particular disease or condition, locate physicians, store individual healthcare information, assess their personal health status, receive periodic e-mails on topics of interest, and participate in online communities with peers and experts. WebMD’s professional portal (the flagship site is medscape.com) enables healthcare professionals to access clinical reference sources, stay abreast of the latest clinical information, learn about new treatment options, earn continuing medical education credit and communicate with peers.
We believe that healthcare and consumer products companies, which today spend less than 5% of their marketing budgets online, will in the future spend a significantly greater percentage of their multi-billion dollar marketing budgets online as they increasingly recognize the advantages of online marketing over offline marketing. As the leading online healthcare company with an average number of unique users exceeding 35 million per month in the most recent quarter, WebMD provides its clients with access to a large, health-focused audience and the means to measure the effectiveness of its marketing spending. WebMD’s advertising revenue has been accelerating in recent quarters, and we think this acceleration marks the early stages of a long-term trend.
WebMD should, in our view, also benefit from the trend towards consumerism in healthcare. In response to increasing healthcare costs, employers have been shifting a greater portion of healthcare costs onto their employees by changing benefit plan designs to increase employees’ out-of-pocket costs. Employers have also taken steps to motivate their employees to make more informed, cost-effective healthcare decisions. Through its private portal business, WebMD offers tools (such as Personal Health Records), services (such as lifestyle education and telephonic health coaching), and information designed to allow employees to take a more active role in their healthcare. WebMD’s private portal business has been growing rapidly. As of the most recent quarter, the company had ninety-nine private portal clients, including Pepsi, Microsoft and WellPoint. We believe WebMD has the potential for hundreds of accounts in this business. We also believe that over time, WebMD will have the opportunity to expand the scope of services it provides to these private portal clients and generate additional revenue.
In our view,WebMD is uniquely positioned in this market, because WebMD has exclusive access to historical patient claims data held by Emdeon Business Services, which allows WebMD to populate its Personal Health Records with this data. In addition, we think clients want an independent third party, rather than their health plans, to provide these services because employees generally distrust their health plans and want to be able to carry their Personal Health Records with them when they change health plans.
We believeWebMD can double its revenue in the next three to four years and generate over 30% incremental EBITDA margins. As a result, we believe WebMD can triple its EBITDA over the same time period. We think Emdeon, as the parent company of WebMD, is an attractive way to participate in WebMD’s growth. Emdeon also owns other assets, which we believe are underappreciated by the market. (Neal Kaufman)
Healthways (HWAY) (Market cap $1.6 billion)
Healthways, Inc. is the leading provider of disease management services to health plans and self-insured employers. The company has twenty-five years of experience working with chronically ill patients to improve health outcomes and reduce healthcare costs. Through the acquisitions of Health IQ and Axia, Healthways has expanded into wellness services, which include health risk assessment tools and telephone coaching to help people lose weight, exercise or quit smoking.
We believe Healthways has substantial growth opportunities in several markets. Healthways, we think, can continue its rapid growth in the commercial market where demand for its services among self-insured employers is particularly strong as employers seek ways to control their healthcare costs. In our view, Healthways should benefit from its recent strategic alliance with Medco Health, one of the nation’s largest pharmacy benefit management companies, which will offer Healthways’ services to 40 million individuals not currently touched by Healthways’ existing health plan relationships. As one of several companies participating in a Medicare pilot project, we think Healthways also has a large potential market opportunity in Medicare. If the pilot is successful, Medicare will expand the program to a larger population, which could ultimately include more than 20 million chronically ill Medicare fee-for-service beneficiaries. We think Healthways also has opportunity to expand into international markets as certain Western European countries have expressed interest in establishing disease management and wellness programs.
We believe uncertainty related to the success of the Medicare pilot project has created an opportunity for us to own this best-of-breed company at attractive prices. Healthways, in our view, has a solid management team, attractive cash flow characteristics and substantial growth opportunities. (Neal Kaufman)
Allscripts (MDRX) (Market cap $1.5 billion)
We believe the U.S. healthcare system is at an inflection point with respect to the adoption of Electronic Health Records by physicians. There is widespread agreement that Electronic Health Records and e-prescribing lower healthcare costs, reduce medical errors and improve the quality of healthcare. In 2004, President Bush called for the creation of a system of Electronic Health Records within the next decade, and there is bipartisan political support on this issue. To encourage physicians to adopt Electronic Health Records, the government recently amended the Stark Anti-Kickback Law to allow hospitals to help physicians pay for Electronic Health Records and e-prescribing technology. In addition, payors are implementing pay-for-performance standards designed to reward healthcare providers for delivering quality care at low cost. In order to meet these standards, physicians need to easily reproduce data, which requires the use of information technology. Electronic Health Records, we think, are rapidly becoming the standard of care.
We believe Allscripts Healthcare Solutions Inc., a leading provider of Electronic Health Record software for office-based physician practices, is well positioned to benefit from this trend. Allscripts’ software allows physicians to use tablet PCs, wireless handheld devices or desktop workstations for common physician activities, including prescribing, dictating, ordering lab tests and viewing results, documenting clinical encounters and capturing charges. We see the market opportunity for Allscripts as large and untapped. There are roughly 550,000 office-based physicians in the United States, and only 20% have adopted some form of Electronic Health Record technology. In addition to software sales, we think Allscripts has the potential to generate high margin transaction revenue from e-prescribing over time. Moreover, as its installed base of physicians grows, Allscripts can generate additional sources of revenue given its valuable position at the point-of-care. Allscripts also has an emerging e-detailing business, which we believe should benefit as large pharmaceutical companies downsize their sales-forces and seek more efficient ways to market to physicians.
Allscripts has over 30,000 physicians currently using its software, which creates reference sites for potential new clients. Current clients are able to demonstrate return on investment through reduced transcription costs, increased revenue from proper reimbursement coding, and reduced resources in medical records storage. Allscripts offers its software in modules, which allows physicians the option of gradually adopting the technology. Allscripts’ software also works well with other vendor practice management systems, which is important because most physicians already have such systems in place. Combined, we think these factors provide Allscripts with a competitive advantage and position the company well for future growth. (Neal Kaufman)
Helmerich & Payne (HP) (Market cap $3.1 billion)
Helmerich & Payne is the fifth largest land drilling company in the United States with smaller operations in the domestic offshore and international land rig markets. The land drilling industry in the U.S. has expanded significantly over the last three years as exploration and production companies have increased spending to take advantage of record oil and natural gas prices. For the industry, the domestic land rig count and average day rate in the last trough bottomed at 613 rigs and about $6,600 in 2002, and have since climbed to 1,650 rigs and approximately $19,000, respectively, today. Our interest in H&P, however, is based not on a view of the drilling cycle, but on our enthusiasm for the company’s forward looking management, which has it positioned for solid earnings growth over the next several years, we think, in almost any commodity environment.
H&P was founded in 1920, by the grandfather of the current CEO, Hans Helmerich, and for many years the company successfully operated as a relatively small drilling contractor with a focus on big rigs able to drill the deepest prospects. In 1997, the company made a strategic decision to expand its fleet with a new generation of land rigs that would be more mobile and more flexible in terms of well depth than anything prior. H&P would design and assemble these rigs inhouse, solidifying its position as a pioneer in this area. There were many who questioned H&P’s strategy. After all, there was no shortage of land rigs with many still idle from the last building boom in the early 1980’s when the rig count topped out at over 4,000. In fact, the domestic land rig count averaged about 800 in 1997, and would soon begin a fall to under 400 rigs by the spring of 1999. The company persevered in its strategy, however, ultimately building fifty of its so-called FlexRigs for its fleet by early 2004. This was at the time, of course, when virtually no one else was building new rigs.
Today, H&P’s fleet of about 134 land rigs is the most modern and technologically advanced fleet in the United States. In the cyclical land rig market, H&P’s FlexRigs have always been in high demand and have earned a premium of 25% or more relative to conventional rigs. Their use of modern equipment and quicker well-to-well movement allows customers to reduce the number of days to drill a well. As a result, total well costs are lower despite higher rig day rates and more wells can be drilled in a given period by a FlexRig than can be accomplished with a conventional rig. There is more to H&P, however, than just better equipment. The company takes great pride in its excellent safety record and its highly trained people, without whom its value proposition to customers would be much less.
H&P began a new expansion program in 2005, that to date has added about fortyfive rigs with another thirty to be delivered by early 2008. When all seventy-five newbuilds are delivered, H&P will have increased the size of its domestic land fleet by over 80%. Some observers are concerned about the new order book for the overall land rig industry, which is seeing its first big building program in twenty-five years, but H&P is mitigating this risk by only building rigs with longterm contracts attached to them. Each of its seventy-five new FlexRigs already has a firm contract with a term of at least three years, which the company expects to result in a three-year payback and close to a 20% rate of return on its $1.1 billion expansion program. As a result of the expansion program and the current healthy drilling environment, earnings more than doubled from $0.97 per share in 2005, to $2.60 per share in 2006, and we believe they can reach $4.00 per share in fiscal 2008. We established an investment in this business when its share price fell almost 40% after energy prices weakened last fall.(Geoff Jones)
FCStone (FCSX) (Market cap $0.6 billion)
FCStone Group is a commodity risk management consultancy serving medium-sized companies. Its expertise is in agricultural commodities, energy and renewable fuels. Its customers include commodity producers (e.g., farmers), intermediaries (e.g., heating oil companies) and end users (e.g., food companies). FCStone devises strategies to help its customers mitigate their exposure to commodity price risk and maximize the amount and certainty of their operating profits. These strategies usually involve using futures contracts (contracts to buy or sell specific quantities of a commodity on a specified future date at a specified price). FCStone is also a futures commission merchant (FCM), a brokerdealer of futures. It can, therefore, both develop risk management strategies for its customers and execute these strategies for them. To our knowledge, there is no other firm offering a comparable caliber of risk management services to middle market companies.
FCStone was formed in 2000, by the merger of the Farmers Commodities Cooperative, which focused on risk management consulting for the agricultural companies that comprised its membership, and Saul Stone, a FCMwhich contributed trading capabilities. Since the merger, the combined company has worked to grow its consulting business beyond the membership of the former Farmers Commodities Cooperative. As a result, the percentage of consulting revenues from firms that were not members of the Farmers Commodities Cooperative increased from approximately 25% in 1999, to approximately 70% in 2006. To achieve these results, FCStone expanded into new geographies, particularly Brazil and China, and into the renewable fuels industry, in which FCStone has achieved significant penetration of domestic ethanol producers. Currently, FCStone has 3,500 risk management clients. Management believes there are tens of thousands of prospective client companies that could use FCStone’s risk management services. FCStone plans to grow its customer base both in the industries in which it is already well established—agriculture, energy and renewable fuels— as well as by expanding into related industries such as food processing. We think FCStone also has significant opportunities to grow existing clients as many are not yet hedging all or even most of their commodity risk. Clients typically increase their use of risk management products after seeing positive results from their initial efforts. FCStone is supporting its plans for future growth by growing its consultant base. In 2005, FCStone created a formalized training program for new consultants. New consultants now apprentice with a senior consultant for two years and take classes in risk management, marketing and sales, and financial analysis. Since the implementation of this program, the success rate of new hires has markedly improved.
FCStone’s margins have been on the rise due to leveraging fixed costs and a mix shift towards higher margin services. FCStone’s operating margin was 13% in 2006, up from 8% in 2005. Management has said they believe incremented operating margins could rise to as high as 30%-35%. Management has also indicated they have been approached regarding opportunities to purchase other FCMs. FCStone could realize value from an acquisition by paying a reasonable price and achieving cost synergies by eliminating a trading platform, the acquired company’s or its own. Regardless of any potential acquisition opportunities, we believe FCStone has the potential to more than double its earnings over the next four years. (Katherine Harman)
Glacier Bancorp, Inc. (GBCI) (Market cap $1.3 billion)
Glacier Bancorp, Inc. (Glacier), founded in 1984, and headquartered in Montana, is the holding company for twelve community banks. Glacier has total assets of $4.5 billion, and equity capital of about $500 million. Glacier has eightysix branches in five states —primarily Montana and Idaho where it has operated the longest. These two states represent 70% and 25% of its assets, respectively, and almost all of its earnings. Over the past few years, Glacier has entered the contiguous states of Wyoming, Utah and Washington Under the leadership of Michael Blodnick, who became CEO in 1997, Glacier has posted a superior ROE and ROA of 17% and 1.5% in each of the last five years as well as steady growth in loans, deposits, assets, and net income. EPS has compounded at a 14% growth rate over the past five years. In 2006, despite the challenging operating environment for banks, Glacier posted 18% organic loan growth (over 30% including acquisitions), a rising net interest margin while peers’ were falling, healthy reserves and capital levels, further improvement in its already pristine asset quality, and 15% EPS growth (excluding stock option expense and 11% EPS growth including the charge). This growth was accomplished without securities gains, tax benefits, or drawdown of its loan loss reserves. We expect 2007 to mark another year of greater than 10% growth and believe that as some of the industry’s headwinds dissipate (most notably the flat to inverted yield curve and intense deposit pricing competition), Glacier’s EPS growth rate should accelerate.
Glacier reflects growth in its markets, as well as steady market share gains as it opens new branches and as new branches mature. Glacier has also grown through acquisitions, having acquired one to two banks each year since 2003 — including in-fill, as well as contiguous markets. We think numerous acquisition opportunities remain.
Glacier’s markets as measured by population are projected by the government to grow substantially faster than the U.S. national average. Key drivers are increased tourism and recreation, strong in-migration and job growth related to the healthy economies of this region led by increased demand for energy, commodities and natural resources.
Glacier has an important deposit market share in almost all of its major markets, ranking in the top three in eight of its top ten Metropolitan Statistical Areas (“MSAs”). Unlike most banks, Glacier operates with a multi-bank holding company — a decentralized strategy with the goal to bring big bank product expertise, breadth and loan size to its clients while maintaining the deep roots, strong knowledge and superior customer service of a locally-based and managed community bank.
Glacier believes that this strategy enables it to know its local markets better and thus results in stronger growth opportunities and enhanced risk selection (superior asset quality). Glacier runs efficiently with operating expenses-to-revenues of 52% versus peer at 59%. (David Sochol)
Acadia Realty (AKR) (Market cap $0.8 billion)
Acadia Realty Trust is a real estate investment trust (REIT) that owns or has equity interests in seventy-seven properties totaling in excess of ten million square feet. Most of the wholly-owned properties in the core portfolio are shopping centers anchored by grocery stores, or discounters in the Northeast corridor between Delaware and Boston. The company also focuses on real estate redevelopment opportunities in the boroughs and suburbs of New York City (Brooklyn, Bronx, Queens, Westchester, and Staten Island).
The majority of Acadia’s core portfolio is in high barrier-to-entry markets in the Northeast (tight zoning requirements and a lack of undeveloped land) which constrain new supply. The company continued to improve the portfolio by redeveloping assets and disposing noncore assets. Acadia’s seven real estate redevelopment opportunities are all in the greater New York area. We expect these projects to come online from 2007 to 2009 at approximately 10% development yields. We think the company’s focus on retail real estate development in the greater New York area is attractive because the New York boroughs and suburbs have low penetration from national retailers, low per capita retail square footage supply, and household income levels above national averages. In its acquisition and redevelopment program, the company focuses on “below-the-radar” screen investments that are often too small for the larger real estate companies. Management has also been active in launching joint venture acquisition funds to fuel growth.
To date, Acadia has formed three joint ventures (with private real estate players such as Klaff Realty) for its main acquisition vehicles. These joint ventures give Acadia a steady source of capital to participate in attractive deals that might otherwise be too large for a REIT of Acadia’s size. The joint ventures have enabled Acadia to be an active participant for opportunistic acquisitions without having to rely on the equity markets for capital. Acadia plans to launch a new $500 million fund in 2007. The economics on the joint venture funds are attractive to us as Acadia earns asset management fees, promoted interest fees, and its equity interest (usually 20%). We expect the company will likely continue to utilize its underleveraged balance sheet (33% leverage) and ramp up its urban infill acquisitions. In 2007, the company has already announced the $120 million acquisition of a real estate redevelopment opportunity in Brooklyn (1.4 million square feet of mixed use redevelopment), and made its first Midtown Manhattan real estate redevelopment acquisition. We expect additional acquisitions in the remainder of the year.
We believe the management team, led by CEO Ken Bernstein, is one of the most talented in the real estate sector. It is a small-capitalization REIT with a management depth and expertise not seen in many larger companies. They have several years of experience in leasing, construction, deal structuring, and shopping center operations. In our view, they think out-of-the-box to create value. We believe our investment return profile will be attractive due to our expectation for management to generate several years of attractive growth fueled by its core real estate portfolio (annual rent increases), redevelopment opportunities, and management fees and to promote income on its joint venture funds, opportunistic dispositions of non-core assets, and a 3% annual dividend. (Jeff Kolitch)
