… in which the Inelegant Investor tries his hand with Google’s new custom search engine feature.

Earlier this week, Google(GOOG) announced the availability of a new feature which allows users to build custom search engines. While this isn’t likely to have any immediate material impact on the business, it fits perfectly into Google’s paradigm of providing free tools to others on a rev-share basis. Google doesn’t care what you do with these tools, but they know that users will develop content and then go out and market it and acquire traffic, leaving Google to sit back and develop more tools. One particularly nice part of this model is that it generates low-cost capital. Since most users never get anywhere near the $100 minimum AdSense payout, Google gets to sit on the cash, which by my reading of their most recent report is about $307 million and growing at around $12 million per month. Small change for a company with quarterly profits above $700 million, but a nice little no-interest credit line nonetheless.

But I digress.

The fundamental problem with search is that users expect an oracle. Unfortunately, search engines are deterministic machines, and their input is insufficient to allow them so see inside of the mind of their users. Some attempts at personalization have been made, but even the same person will expect different results at different times. So, while when I search for “java”, I’m more likely to be looking for information on programming, sometimes, I might really be interested in coffee.

One solution to this is breaking search from a monolithic experience into multiple targeted engines, and forcing you to select the one most likely to have your results. To some extent Google and other engines have done this; readers will be familiar with separate tabs for image search or news search. The key here, described succintly by the motto of the Delphic Oracle is: “Searcher, know thyself!”

What this new product does is allow experts in every niche to create focused catalogs designed to return optimal results in those niches. As an example, I have created a quick and dirty catalog to search for stock information which can be accessed through the search box on this page or at www.stockaroo.com. While by no means comprehensive, even with a number of refinements, I find it already gives me a reasonable response to my queries. Please provide feedback on queries that return bad results or sites that ought to be added either in the comments, or by emailing investor@inelegantinvestor.com.

While Google has made it quite simple to set up Custom Search Engines, one thing that could be improved is the collaboration feature. Though there is the ability to allow others to help customize your engine, the interface allows no way that I could find to see what changes they’ve made and modify them. So you’d better entirely trust your collaborators, because they have the power to completely subvert your results. Of course you can remove them and all their modifications, but without being able to see what they’ve done, that’s a rather blunt management tool.

Almost 6 years after filing for bankruptcy under the weight of mounting asbestos liability lawsuits, Armstrong World Industries(AWI) emerged from bankrupty last week and was largely ignored. The manufacturer of flooring, cabinets and other building products averaged volume of only 60,000 shares per day in its first 3 days of trading, and very little has been written about the company’s rebirth.

The company has not released many figures yet, though it will release Q3 numbers and give guidance at the end of October. In addition reports issued during bankruptcy are available and can provide some indication of the company’s state.

The restructuring plan called for the issuance of 56.4 million shares, with two thirds of them going to a trust to pay out remaining asbestos liability claims. The remaining third went to unsecured creditors. In addition, the company received $1.1 billion in financing much of which went to the creditors. At Friday, October 20th’s close of $39.45, I believe the company has a market capitalization of $2.225 billion. Note that all of these numbers are based on my understanding of various company filings and have not been confirmed.

For the first 6 months of 2006, Armstrong reported $68.2 million in net earnings, showing substantial growth form $17.7 million in the first 6 months of 2005.

Q3 should show a benefit from lower oil prices. On the other hand, the slowing housing market should negatively impact revenues and earnings. I haven’t had the time to put together an adequate model, and no analysts have yet put anything together, so for the purposes of simplicity, I’ll treat the first 6 months of year as the current run rate, and say that the company has earnings power of $136.4 million this year. Admittedly this is a poor measure, but we’ll have better numbers next week, and it’ll at least give us an idea of how the company is valued. This number gives Armstrong a P/E of 16.3, substantially higher than competitors like Mohawk(MHK) and Masco(MAS) which both have P/E ratios between 13 and 14.

On the surface, this doesn’t look like a particularly compelling valuation, but companies coming out of bankruptcy can sometimes show strong earnings leverage, so I’ll be watching next week’s earnings carefully.

As an aside, I should mention what first attracted my notice here. Armstrong Holdings(ACKHQ) was the former owner of AWI, but had all of its ownership cancelled on AWI’s emergence from Chapter 11. Though Armstrong Holdings has no other assets, it does have a series of claims against AWI. These include tax refunds and various intercompany charges and credits.

On Friday, Kellogg Capital Group, which owns 11.7% of Armstrong Holdings filed a 13D which included a letter Kellogg sent to management demanding information on the value and status of these claims. The text of the letter:

Gentlemen:

Kellogg Capital Group, LLC is the beneficial owner of 4,765,326 shares of common stock of Armstrong Holdings, Inc. (”AHI” or the “Company”). We purchased the shares based on our belief that they represented an attractive investment opportunity, particularly in view of claims AHI has against its former subsidiary, Armstrong World Industries (”AWI”), which is emerging from bankruptcy. Currently, little information is publicly available regarding AHI in its current state and the potential for unlocking the value of assets it has vis a vis AWI. AHI’s potential assets as we understand them are:

o An inter-company claim against AWI worth up to $12 million

o An unknown portion of a $37 million tax refund

o Substantial NOLs potentially benefiting both AHI and AWI

o Recoveries of taxes paid by the “Armstrong group of companies” in 2006

We write to you because we wish to learn more about these assets (and any potential others) and your efforts to maximize their value through negotiation with AWI and otherwise. Additionally, we are concerned by potential conflict of interest, independence and other issues at AHI based on the board’s composition. We believe these issues could impair the ultimate value of these assets if they are not resolved. A key factor in maximizing the value of the aforementioned assets will be AHI’s tenacity in negotiating with or litigating against AWI. Currently, AHI’s board has very close ties to AWI. First and foremost, Mr. Lockhart, AHI’s chairman, is also the chairman of AWI. Until AWI’s emergence from bankruptcy, AWI and AHI were integrally intertwined by virtue of AWI being AHI’s sole operating subsidiary. Additionally, AHI and AWI shared board members and executives. As a result, AHI board members M. Edward Sellers and Jerre L. Stead have long-term ties with AWI. Messrs. Sellers and Stead make up the Special Committee charged with negotiating the claims against AWI. Mr. Sellers is the Chairman and CEO of Blue Cross Blue Shield of South Carolina and The Companion Group of Companies and serves on the boards of six other corporations and endowment funds. Mr. Stead is the Chairman of IHS, Inc., a NYSE company, and serves on the boards of four other publicly traded companies. We hope these proven corporate leaders have the time necessary to aggressively pursue AHI’s claims.

Furthermore, it is unclear how the interests of the AHI directors are aligned with those of the stockholders to maximize the value of the foregoing assets. Based on AHI’s Form 10-K for fiscal 2005, as of January 24, 2006, Messrs. Lockhart, Sellers and Stead owned 100,124, 0 and 4,400 shares, respectively, of AHI common stock (not including stock options), constituting in the aggregate less than 1% of the outstanding common stock. With this nominal share ownership, what incentive does management have to maximize value for shareholders? We worry that AHI might be treated as a very small loose end to a historic and massive bankruptcy case that management will be more motivated to expeditiously resolve rather than to maximize its full value for the benefit of the shareholders. At least in perception, we think that the above issues raise legitimate conflict of interest and independence questions. There are remedies - we will offer a few ideas. The board might consider the appointment of an additional director who is a clear “outsider” to overtake or oversee the role of the Special Committee - someone who could authoritatively serve independently in a trustee capacity. We also believe the board should provide more transparency and disclosure to the shareholders it represents regarding its involvement in the AWI bankruptcy. Specifically, the Company should issue a press release or other public filing that provides clear and detailed disclosure about all of AHI’s claims, AWI’s defenses to such claims and estimates of recovery ranges for all claims as well as a timeline for such recoveries. We are particularly interested in understanding the nature of the tax assets in question as well as AHI’s and AWI’s opposing views on their usage. An open forum is all the more important right now as these negotiations will be taking place behind closed doors rather than in the light of the bankruptcy court where shareholder scrutiny is available. To our knowledge, no settlements have yet been reached with AWI on these four claims. We also have no information that would imply that AHI needs a timely resolution to any of its claims. As such, we urge you not to enter into any settlements prior to the installation of greater oversight and accountability measures at AHI either in the form of our recommended actions or otherwise. Please contact us at your earliest convenience to schedule a conference call. Thank you for your consideration.

On this news, ACKHQ was up 121% on Friday to $.35. This leaves it with a market cap of $14.2 million. Depending on the actual value of these claims, it could either be extremely cheap, or a worthless piece of paper. Good luck to the Kellogg Group and any other intrepid speculators, but I’ll be watching from the sidelines.

Disclosure: I own none of the stocks discussed

Increasingly in recent years, Warren Buffett has made a practice of meeting with groups of students and speaking to them about various aspects of his business and his thoughts on various topics. Periodically, one of these students will write a blog post or a college newspaper article about their experience, and though I have read perhaps a half dozen of these, I continue to find interesting new tidibts in each new one. I guess they’re kind of like snowflakes.

In any event, Sarah, a Harvard undergraduate, writes about her visit at lifeatharvard.com. Though I’ve heard it before, I think Buffett’s unique definition of success bears repeating:

We talked about success – real success. Buffett told a story about en elderly lady he met in Omaha, a Polish Jew who had spent years in a concentration camp during the Second World War. She told him, “Warren, I am very careful about making friends. When I meet a potential friend, I always ask myself: Would they hide me?”

“If you get to be 75, and have lots of people who would hide you, you’re a success. That’s really the test. You can’t buy it.” He talked about the importance of awareness of how you treat other people and of thinking about the reverse of your actions. “I know people whose own kids wouldn’t hide them, “Buffett said. “They’d be yelling, “He’s in the attic! He’s in the attic!”

I think this speaks to the essence of why so many people find Buffett worthy of study. It’s not merely that he has perhaps the greatest long-term track record of any investor, but that he has managed to do so without sacrificing his humanity. He has shown that success and ethical behavior are not mutually exclusive. And given the large number of recent counterexamples, our hope requires a Warren Buffett. After all, nobody aspires to be the next Jeffrey Skilling.

Santarus(SNTS) announced today that it had licensed Zegerid, a proton pump inhibitor(PPI) used for treating heartburn and related GI issues, to Schering-Plough(SGP). Schering Plough will develop and release a 20 mg version of Zegerid as an over the counter medication. Santarus will continue to promote and sell the existing prescription version in its various formulations.

Currently, Prilosec OTC is the only PPI available over the counter. The company believes that Prilosec OTC has annual sales of approximately $400 million. Unlike Prilosec, Zegerid, which contains the same active ingredient, is an immediate release formulation and provides quicker relief to patients. Santarus’ patent covering this formulation does not expire until the middle of 2016.

The deal appears to be a huge positive for Santarus. Though Zegerid sales have been climbing, they still only totaled $9.4 million in the most recently reported quarter. Sales should continue to increase as major health plans including UNH have recently added it to their list of preferred drugs. In the $13.4 billion prescription PPI market, small market share can still mean a great deal of money. Schering-Plough, which has extensive OTC experience with drugs such as Claritin, paid Santarus $15 million upfront and will pay up to an additional $65 million in regulatory and sales milestones on top of a “low double digit” royalty.

Under the terms of the agreement, Schering-Plough may not market any other OTC PPI during the life of the agreement. Schering-Plough is also responsible for all development, clinical studies, marketing and any other costs associated with the OTC product. No estimate has yet been given as to when this will hit the market, but the company will need to perform a label comprehension study and provide product stability data. It is not clear whether additional clinical data is needed, but this should become apparent once Schering-Plough meets with the FDA.

A legitimate concern is what impact Zegerid OTC will have on Zegerid RX. On its conference call, Santarus cited data from the Pepcid OTC launch which showed prescription sales continuing to grow after launch. The 40mg already accounts for over 90% of Zegerid sales and the prescription market, so even if 20mg prescription sales were to disappear, the impact would be negligible. Additionally, the patient profile for the RX versions tends to be for chronic use, versus occasional use for the OTC drugs.

The company declined to discuss Q3 performance, deferring such information to their earnings call on November 10, but we can make some reasonable guesses as to their tone. Sales growth should be strong given their increased presence in formularies and preferred status at prominent health plans. Cash position which was $54 million at the end of Q2 has probably dropped to $40-$45 million, but will jump back to $55-60 million range once the $15 million upfront is received. Over the next several quarters, Zegerid sales should move the company towards profitability. The company also has additional capital available under an equity financing agreement.

Unfortunately, there’s not currently anything behind Zegerid. The company stated that it is looking at acquiring or copromoting other GI drugs to take advantage of its existing sales force. In addition the company may license or acquire development products at the Phase I/II stage and use their experience to move those to approval. It is possible that Santarus’ proprietary technology can be applied to other PPIs as well, as a means of extending their patent protection.

Santarus’ management has proven capable of developing a drug franchise, and Zegerid’s future looks bright. Though the stock initially moved up dramtically from yesterday(10/18)’s close of $8.45 to an early high of $9.70, it has subsequently pulled back to just under $9, giving the company a market cap of $430 million. A small price to pay for a great deal of potential.

Disclosure: I own SNTS

It was announced this morning that Berkshire Hathaway’s National Indemnity unit would be buying the US assets of Swiss reinsurer Converium for $95 million in cash and $200 million in assumed debt.  The unit has $1.06 billion in reinsurance liabilities. It is unclear how much worth of reserves are included to back up the liabilities.

Converium had run into serious trouble in 2004 when it discovered a $500 million shortfall and stopped writing new insurance in America. The company needed to sell this asset to a strong buyer in order to improve its credit rating. The circumstances of the deal would imply that Berkshire is buying this at a fire sale price, but even with the rosiest projections, this will be barely material to a company the size of Berkshire. What this should do is further improve the results of a reinsurance unit already poised to have a great year with dramatically increased premiums and no major disasters.

Bank of America(BAC)’s announcement today(10/11) that it would offer 30 free trades per month to customers with combined balances of $25,000 or more was greeted by investors in online brokers with a stampede for the exits. E*Trade(ET) and TD Ameritrade(AMTD) were both trading down around 10%, and Charles Schwab(SCHW) was down more than 5%. Bank of America’s announcement comes just days after the launch of Zecco, a new online broker which also offers free commisions. Past attempts at commissionless sites(i.e. freetrade.com) have failed to take market share and have been shut down.

At least for the moment, the market believes this is different. And it is. Bank of America is a behemoth, having relationships with over 50 million American households, 40% of which will already qualify for free trades. ETrade can scarcely afford to eliminate commisions; commision revenue consistently exceeds net income.

So what’s an online broker to do? Relax.

When discount brokers emerged and online stock trading was America’s new national pastime in the late 1990s, it was a widely held belief that full service brokerages would be forced to cut commisions or face the disappearance of their business. Despite the fact that commisions haven’t been cut these companies are at record stock prices and making record profits. Apparently, commision costs aren’t the only factor driving investor behavior. Full service brokerages also began to shift clients towards non-commision based fees, charging many customers a flat percentage of assets.

The market’s reaction is overdone. ETrade, Ameritrade and Schwab already face lower-priced competitors and have continued to grow. For most investors, the difference between $13, $7, and $0 is not sufficient to motivate them to go through the hassle of switching brokers if they are otherwise happy with the service they’re receiving.
Commisions will not disappear overnight. There is a cost to executing trades, and everyone, even Bank of America, needs to pay it. If brokers aren’t making money off commisions, they’ll need to make it up elsewhere. Whether that’s through higher margin interest rates, lower interest paid on cash accounts, or additional fees, remains to be seen. Commisions have been consistently falling for the past 10 years, and online brokers have only become more profitable. Is that a guarantee that continued drops will not reduce profit? No, but Bank of America’s move is the beginning of the end. After all, you can’t get cheaper than free.

Disclosure: I have no positionin BAC, ET, AMTD, or SCHW

“Everybody else is doing it.”

Inspired by recent option backdating scandals, and the criminal leak investigation at Hewlett Packard(HPQ), Warren Buffett sent out a memo to his top managers at Berkshire Hathaway(BRKA), reminding them of the importance of ethical behavior. Buffett said that while bad behavior is inevitable,

we can have a huge effect in minimising such activities by jumping on anything immediately when there is the slightest odour of impropriety… Berkshire’s reputation is in your hands

…..

A lot of banks and insurance companies have suffered earnings disasters after relying on that rationale. Even worse have been the consequences from using that phrase to justify the morality of proposed actions

Buffett acknowledged that “everybody else is doing it” is a “seductive argument”, but said use of the phrase should be a “huge red flag”.

Despite some bad press resulting from General Re’s sale of “earnings smoothing” reinsurance products that didn’t invlove a real transfer of risk, Buffett has a well-deserved reputation as an ethical businessman, and one whose track record doesn’t seem to have been hurt by his unwillingness to do anything he wouldn’t feel “comfortable about being printed on the front page of our local paper.”

Buffett made use of a similar policy when he briefly became CEO of Salomon Brothers in the wake of a scandal that threatened to sink the firm. Unfortunately, too many others base their behavior on what they feel they can get away with. The Hewlett Packard board is a case in point. Even after details of the scandal came to light, they allowed Patricia Dunn to remain on the board. Though Dunn finally resigned, the board members who showed such terrible judgement are still there.

Investors should follow Mr. Buffett’s lead. Companies that behave well should be assigned a valuation premium; those that don’t get it, like Hewlett Packard, should be trading at a discount to compensate for the risk of future scandals.

Read my Basket of Biotech Introduction

Anesiva(ANSV) is a company that focuses on the development of pain management products. The company is tiny, with a market capitalization of just $135 million, and has no revenues. As of June 30, the company had $67 million in cash, but the company is spending $14-15 million per quarter and will have only $35-40 million left by year end. Adding in $30 million in committed equity financing, the company has sufficient capital to operate until year-end 2007 at the current burn rate.

What prospects does the company have for increasing the value of its pipeline by the end of 2007?

1. Zingo
Zingo, until recently known as 3268, is Anesiva’s closest product to a market. Zingo is a fast-acting local anesthetic which Anesiva is planning to market for pediatric venous access procedures. The company has already completed phase III pediatric trials and has stated that it will file a New Drug Application with the FDA in September or October of 2006. Unlike competing products which are primarily creams, Zingo is not messy to apply, and is effective in 1-3 minutes as opposed to 15-60 minutes. Zingo has an opportunity to both take away business from existing drugs, and, because of its ease of use and fast action, to expand the percentage of venous access procedures which make use of an anesthetic. As the company has not partnered this drug, it will be responsible for all marketing costs and receive all products. While this is not a blockbuster, if approved, it could be sufficient to support development of additional products. Revenue could be seen as early as late Q2 2007, or sooner if the signing of a partnership results in milestone payments.

2. 4975
4975 is a drug that’s further away from the market, but shows much greater potential. A long lasting, non-opoid, site specific analgesic, 4975 can provide pain relief for weeks or even months with a single treatment. Successful Phase II trials have been completed in several indications, including post-surgical, total knee replacement, and elbow tendonitis. While there is still significant risk that this will not make it to market, the size of the opportunity will allow for rapid stock appreciation as this advances towards approval.

3. 1207
A treatment for neuropathic pain, the company is currently planning a phase I trial. Not much here yet, but additional data could have an impact.

Anesiva’s pipeline webpage also lists Avrina, an anti-inflammatory drug that had been tested in early trials for eczema, but development appears to have stopped, and I would be shocked if any value were created from this.

Anesiva’s history is a cautionary tale of the danger of investing in development stage pharmaceutical companies. Anesiva came public early in 2004 as Corgentech. At the time, the company had a promising compound in Phase III to treat vein graft failure, with which it partnered with Bristol Myers Squibb(BMY). It also had development programs in inflammatory diseases and cancer. When its lead candidate failed, the company retrenched and eventually merged with private AlgoRx Pharmaceuticals. AlgoRx was the developer of Zingo, 4975, and 1207. Earlier this year, Corgentech changed its name to Anesiva to indicate its new focus on pain relief.

At today(10/05)’s close of $6.73, I believe this makes sense in our basket. The data that has already been released seems sufficient to support approval of Zingo, and the huge potential market for 4975 could result in big gains as it progresses through the clinic.

Read my Basket of Biotech Introduction

What other stocks should I include in the basket? Comment below, or email investor at inelegantinvestor dot com

Disclosure: I own stock in ANSV

Investing in development stage biotech companies is risky business. We’re talking about companies with no material product revenues, high cash burn rates and fairly high failure rates. At the same time, successful drugs can generate huge returns. And if you can find a stock that gives you a 500% return, that supports a lot of failures.

An effective strategy here begins with realizing that it is nearly impossible to predict the success or failure of a given drug in development. At any time during trials, a drug may fail to show efficacy or may be found to be too dangerous for use. The company may be insufficiently funded to complete development. The FDA may choose not to approve the drug or require additional costly trials. Even once the drug is approved, there may prove to be no significant market for it, or other competing drugs may show greater efficacy and limit sales.

Given this, we can come up with a set of characteristics to look for in a development stage biotech, and buy a basket of such stocks meeting our criteria. We know we won’t hit a home run with all of them, but if we can manage to succeed with some and bail out of others before we lose 100%, we can ensure a good rate of total return.

Questions to ask when evaluating development stage biotechs:

1. How long will the company’s cash last?
Developing drugs is expensive. Running clinical trials is expensive. Launching a new drug is expensive. Will the company be able to move drugs forward in the pipeline with existing cash to the point where additional equity or debt can be sold, or a partnership entered into with a larger drug company to fund development?

2. Does the company have multiple drug candidates?
Is the company betting its entire future on one drug, or are there multiple drugs with promise in the pipeline? One-drug companies are coin tosses; a failure in a trial will often mean the end of the company.

3. Do the company’s drugs address a market need?
The drug may get approved, but as with any other product, there may not be a market for it. It may target too small a niche, not be cost-effective compared to older drugs, or address a condition that people are willing to tolerate without treatment.

4. How soon might the company expect to begin marketing a product?
If we’re still 5 years away from having a product in the market, we’re probably too early. If product revenues aren’t close, are there any potential milestone payments coming up? Releases of new study data that might lead to a partnership?

5. How enthusiastic is the market about the company?
Has the market already decided that the company’s new cancer drug will be a blockbuster even though it’s only in Phase I? We’re not looking for $1 Billion plus market capitalizations unless a substantial portion of it is in cash.

In light of all this, I plan to post a series of short writeups over the next few weeks on small biotech companies that I feel look interesting and can be bought using a basket approach to mitigate the risk of each individual company. Each of these is highly speculative and carries a substantial risk of significant losses, but I believe that in the aggregate they offer an attractive opportunity.

I have to admit, sometimes I can be a bit of an ambulance chaser. One of the guiltier pleasures I indulge in my search for stocks is a periodic check of top percentage losers. Here’s a list of stocks owned by legions of hopeful investors who were wrong. Very wrong. In a single day, 10, 20, 30, even 50 percent of their investment- wiped out. Humbling as this is, I’m not here to dwell on the vanity of man. I’m here to find the glimmers of hope that remain in the ashes, dust them off, and if they appear to have value, place them in my own pocket.

Quest Diagnostics(DGX) was down 17.90% today(10/3) to $50.00 after announcing that it had lost a long term contract with UnitedHealth Group(UNH). UnitedHealth opted to give the 10 year, $3 Billion deal to a smaller rival, Laboratory Corporation of America(LH). Quest revealed that United Health had accounted for 7% of its buisness, and was its largest customer.
Though Quest did not address Q3 performance which it will be releasing on 10/19, the current contract runs through the end of the year, so impact on 2006 numbers should be minimal.
Quest did not release any information on what impact this will have on 2007. Though Quest will continue to be under contract to UnitedHealth in 2 small markets, and will continue to compete for non-contract work, it is probably reasonable to assume a worst case in which 7% of Quest’s revenue disappears.
Though Quest gave no guidance on earnings impact, they did reveal that margins on UnitedHealth business were not significantly different than the rest of the business. Without knowing what percentage of costs are fixed, it’s difficult to estimate what the earnings impact might be. It’s almost definitely greater than 7%. Jeffrey Loo at S&P lowered his 2007 EPS estimate $0.05 to $3.38, but I haven’t seen the report and it’s difficult for me to see why he sees the impact as so minimal, unless he believes that Quest will initially retain more of this business on a non-contract basis. Quest is set to earn (according to their guidance of 9/6) between $2.95 and $3.05. With next year’s estimates previously showing 10-15% earnings growth, and assuming a drop of 7-10% in earnings from the loss of UnitedHealth business, it’s hard to see how Quest can grow earnings by more than a few percent.

Quest has been making small, focused acquisitions of companies that manufacture propietary tests. In July, it purchased Focus Diagnostics, a maker of tests for diseases such as Lyme Disease, SARS, West Nile Virus and Herpes Simplex Virus, for $185 million in cash. Last month, it purchased Enterix, which produces a test for colorectal cancer, for $43 million in cash.

Quest’s liberal use of cash may be some cause for concern. In addition to acquisitions, the company has spent significantly to buy back shares. In the first 6 months of 2006, the company bought 4.6 million shares for $254 million. During the same time period, the company reissued 3.2 million shares for employee benefit plans, so despite the big outlay, the share count is not getting much smaller. The company also pays a $.10 quarterly dividend at a cost of nearly $20 million per quarter. At the same time, the company’s long term debt continues to hover above $1.2 billion.

Quest trades at 16.7 times 2006 earnings, and the company seems on track to earn at least as much next year, for a forward P/E of under 16.7. Obviously, there’s risk here as the numbers are unclear.

Quest isn’t an expensive stock, but at this point, for me at least, the potential reward doesn’t support the risk. While the stock is likely to move higher, the uncertain earnings impact of the Quest deal, questions surrounding the company’s ability to continue to grow earnings at a 10-15% rate, and questions surrounding balance sheet and share dilution are keeping me away.
Disclosure: I own none of the companies mentioned(DGX,LH, UNH)