# Short ExamWorks Group, Inc.: 90.4% Probability Of Making A 20% Return Or Higher

## Summary

90.4% probability of making a 20% return or higher on a short position.

Economic Value continues to take a turn for the worse.

Increased Days Sales Outstanding has negatively impacted the days to convert sales into cash and therefore cash on hand.

Exhaustive 131.4% run up in stock price in the last twelve months is not commensurate with company's ability to create value, making the stock a strong candidate for a correction.

Based on our Economic Value model and Monte Carlo simulation, our probability distribution of "fair value" for ExamWorks Group, Inc. (NYSE:EXAM) affirms that the current share price of \$33.92 is overvalued (as of 3/13/2014). The expected value of the share price based on the mean and median is estimated to be \$21.47 to \$21.25, respectively (Table 1).

Table 1: Monte Carlo Simulation - Statistics

(Figure 1) While GAAP EPS has increased (red line) along with the share price (green line), Economic Value (also known as Economic Profit, Economic Value Added, or EVA) per share (blue line) continues to take a turn for the worse.

Figure 1: Price, EPS, Economic Value Per Share

As a result, we anticipate that a continued decline in Economic Value will result in a share price with a skewed distribution to the downside (Figure 2).

Figure 2: Historical Share Price and Forecast

Hence, the probabilities of realizing a 20% return from either a long or short position is as follows (Table 2):

1. Long: approximately 0% chance of 20% Return or Higher. 100% chance of a loss.
2. Short: approximately 90% chance of 20% Return or Higher. 0% chance of a loss.

Table 2: Monte Carlo Simulation Probabilities

MARKET EXPECTATIONS VERSUS ECONOMIC REALITY

To further validate and provide context to the reasonableness of our analysis, we compare market expectations versus actual operating performance of the company relative to a peer set.

Our peer set includes: Accretive Health, Inc. (AH), Addus HomeCare Corporation (NASDAQ:ADUS), Air Methods Corp. (NASDAQ:AIRM), Alliance Healthcare Services, Inc. (NYSE:AIQ), Almost Family Inc. (NASDAQ:AFAM), Amedisys Inc. (NASDAQ:AMED), AMN Healthcare Services Inc. (AHS), Bio-Reference Laboratories Inc. (NASDAQ:BRLI), BioScrip Inc. (NASDAQ:BIOS), Catamaran Corporation (NASDAQ:CTRX), Chemed Corp. (NYSE:CHE), CorVel Corporation (NASDAQ:CRVL), Cross Country Healthcare, Inc. (NASDAQ:CCRN), DaVita HealthCare Partners Inc. (NYSE:DVA), Envision Healthcare Holdings, Inc. (NYSE:EVHC), ExamWorks Group, Inc. (EXAM), Express Scripts Holding Company (NASDAQ:ESRX), Gentiva Health Services Inc. (NASDAQ:GTIV), Healthways Inc. (NASDAQ:HWAY), IPC The Hospitalist Company, Inc. (NASDAQ:IPCM), Laboratory Corp. of America Holdings (NYSE:LH), Landauer Inc. (NYSE:LDR), LHC Group, Inc. (NASDAQ:LHCG), MEDNAX, Inc. (NYSE:MD), National Research Corp. (NRCI.B), Omnicare Inc. (NYSE:OCR), Providence Service Corp. (NASDAQ:PRSC), Quest Diagnostics Inc. (NYSE:DGX), and Team Health Holdings, Inc. (NYSE:TMH).

Market expectation can be observed through Market Value Added (MVA), which is the Market Value (Debt plus Market Value of Equity) less the Capital invested, and represents shareholders' expectations of the future stream of Economic Value or Discounted Cash Flow (DCF) that the business will generate. Mathematically the Net Present Value of a DCF is always equal to the Present Value of Economic Value. Consequently, we can calculate the Implied Economic Value Growth in MVA (Table 3) embedded in the current share price. EXAM's Implied Growth in MVA is approximately 20%, which is at the high end relative to peers.

Table 3: MVA and Economic Value Ranking

Conversely, adjusting Economic Value for both size in Capital (-7.6%) and Revenue (-9.7%), EXAM's operating performance is at the low end (Table 4). The disparity between the company's ability to create value and the market's outlook for economic growth is one indicator that expectations may be too high.

Table 4: Economic Value Ranking

ECONOMIC VALUE DRIVERS AND PERFORMANCE

To determine whether the company's recent performance will be a good indicator of future performance, we take a deeper look into the drivers of Economic Value. (Table 5) Although the company ranks high on Revenue Growth (18.2%), it has performed poorly on Return on Capital (5.4%).

Table 5: Drivers of Economic Value

(Figure 3) With signs of EXAM's Revenue Growth decelerating (solid black line), the market will demand profitability in its stead.

Figure 3: Revenue Growth Benchmarked Against Peer Set

However, (Figure 4) EXAM's profitability or Spread (solid black line), which is the Return on Capital less the Cost of Capital, has declined toward the bottom of the 90% confidence interval relative to its peer set.

Figure 4: Spread Benchmarked Against Peer Set

The decline in Spread can be largely attributed to a decline in Return on Capital. Return on Capital is driven by both NOPAT Margin and Capital Turns. (Figure 5) EXAM's NOPAT Margin (solid black line) has declined slightly, but for the most part has stayed within the interquartile range of its peers.

Figure 5: NOPAT Margin Benchmarked Against Peer Set

However, (Figure 6) EXAM's Capital Turns (solid black line) has declined toward the lower quartile range of its peers.

Figure 6: Capital Turns Benchmarked Against Peer Set

The company's decline in Capital Turns has been the key contributing factor in its declining Return on Capital and Economic Value (Figure 7).

Figure 7: Return on Capital Drivers - NOPAT Margin and Capital Turns

In particular, the company's Days Sales Outstanding has increased to approximately 85 days from 35 days in 2011, which is a cause for concern as it will negatively impact the days to convert sales to cash and therefore cash on hand (Table 6).

Table 6: Days Sales Outstanding

VALUATION ASSUMPTIONS

Although past performance is not always indicative of future performance, historical data can provide a good estimate of the range of possibilities. The ranges we use for our key drivers of Revenue Growth, Spread, NOPAT Margin and Capital Turns represents our 90% confidence interval. For each scenario of our valuation, a random value is generated for the drivers of our discounted Economic Value model (Figure 8).

Figure 8: Overview of Economic Value and Monte Carlo Simulation

These random values are based on reasonable ranges derived from Trailing Twelve Month (TTM) 10-year historical distributions of company and peer data. While point estimates are often "precisely wrong," range estimates provide a more realistic view of market variability and have a greater chance of the actual outcome falling within the estimated range. Additionally, we scrutinize the inputs of our Monte Carlo simulation through our Economic Value calculation, where adjustments are made to accounting statements to more accurately reflect the economics of each driver.

In some cases where our initial assumptions generate a valuation substantially different from the current trading price, we attempt to be conservative and create a margin of safety by taking a very optimistic outlook for a short position or a very pessimistic outlook for a long position. In the case of EXAM, despite our optimistic projections for the key drivers, the company remains a clear short (Figure 9).

Figure 9: Monte Carlo Simulation - Fair Value Distribution

Revenue Growth

Our range assumption of 18 to 22% for Revenue Growth is fairly optimistic given the current trend (Table 6).

Table 7: Revenue Growth - Range Assumptions

(Figure 10) Most recently, EXAM's TTM quarterly Revenue Growth has declined, settling at approximately 20% which is around the 25th percentile of its historical performance.

Figure 10: Revenue Growth Benchmarked Against Company's Own Historical Performance

(Figure 11) As a result, we projected that Revenue Growth would remain near the 25th percentile of past performance, ranging from 18 to 22%.

Figure 11: Revenue Growth -Historical and Projections

The distribution of Revenue Growth in our Monte Carlo simulation (black solid line) overlaid against the distribution of the peer set (dark blue dotted line), CRVL (light blue dotted line), and the company's historical performance (orange dotted line), shows how our overall Revenue Growth estimates compare to different benchmarks (Figure 12). The Monte Carlo distribution is clearly more optimistic than the industry and one of its peers, and is in line with its historical performance.

Figure 12: Revenue Growth - Forecast Monte Carlo Distribution versus Historical

Again, our estimates of Spread exhibit a fairly optimistic view, when compared to historical performance (Table 7).

Table 8: Spread - Range Assumptions

(Figure 13) Most recently, EXAM's TTM quarterly Spread has bounced around the 25th percentile of its past performance.

Figure 13: Spread Benchmarked Against Company's Own Historical Performance

(Figure 14) Despite largely historical negative Spread, we optimistically forecasted that Spread would climb to a range of 0 to 3% into perpetuity.

Figure 14: Spread - Historical and Projections

The distribution of Spread in our Monte Carlo simulation (black solid line) overlaid against the distribution of the peer set (dark blue dotted line), CRVL (light blue dotted line), and the company's historical performance (orange dotted line), shows how our overall Spread estimates compare to different benchmarks (Figure 15). The Monte Carlo distribution is clearly more optimistic than the company's historical performance and in line with the industry.

Figure 15: Spread - Forecast Monte Carlo Distribution versus Historical

NOPAT Margin

Our range assumption for NOPAT Margin is also optimistic (Table 8).

Table 9: NOPAT Margin - Range Assumptions

(Figure 16) Most recently, EXAM's TTM quarterly NOPAT Margin has bounced between the 25th and 75th percentile of its historical performance of 7.1 to 7.8%.

Figure 16: NOPAT Margin Benchmarked Against Company's Own Historical Performance

(Figure 17) We optimistically forecasted that the NOPAT Margin range would be between 8 to 12%, with the low, mid, and high trending above the 90% confidence interval.

Figure 17: NOPAT Margin - Historical and Projections

(Figure 18) The NOPAT Margin distribution in our Monte Carlo simulation (black solid line) overlaid against the distribution of the peer set (dark blue dotted line), CRVL (light blue dotted line), and the company's historical performance (orange dotted line), shows how our overall NOPAT Margin estimates compare to different benchmarks. The Monte Carlo distribution is clearly more optimistic than the company's historical performance and its peer set.

Figure 18: NOPAT Margin - Forecast Monte Carlo Distribution versus Historical

Capital Turns

Our range assumption for Capital Turns is generously optimistic (Table 9).

Table 10: Capital Turns - Range Assumptions

(Figure 19) Most recently, EXAM's TTM quarterly Capital Turns has declined close to the 25th percentile of its historical performance.

Figure 19: Capital Turns Benchmarked Against Company's Own Historical Performance

(Figure 20) We optimistically forecasted that Capital Turns would increase after the first projected year to a range of 1.20 to 1.30x.

Figure 20: Capital Turns - Historical and Projections

(Figure 21) The Capital Turns distribution in our Monte Carlo simulation (black solid line) overlaid against the distribution of the peer set (dark blue dotted line), CRVL (light blue dotted line), and the company's historical performance (orange dotted line), shows how our overall Capital Turns estimates compare to different benchmarks. The Monte Carlo distribution is in line with the company's historical performance and its peer set.

Figure 21: Capital Turns - Forecast Monte Carlo Distribution versus Historical

Conclusion

EXAM remains a short despite a generously optimistic outlook. Further support for our short position can be observed through two key strategic forces, namely the industry's market economics (average Industry Spreads) and the company's competitive position (Company Spread minus Market Economics). The analysis concludes the following (Figure 22):

1. Market economics has worsened.
2. EXAM's competitive position is negative.
3. CRVL's competitive position is stronger.

Figure 22: Market Economics versus Competitive Position

Lastly, EXAM has experienced an exhaustive 131.4% run up in stock price in the last twelve months (as of 3/13/2014), which is not commensurate with its ability to create value, making it a strong candidate for a correction.

Disclosure: I am short EXAM, HWAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am long BRLI, LHCG.