Summary of selected articles from this morning's Wall Street Journal with comments on related stocks. Key topics: Detailed overview of ethanol competition, BP manipulated heating oil prices, Symantic hit by transfer pricing claim, Honda expands in the US, Japanese retail sales OK, net neutrality amendment fails, Google Checkout launches today, 3Com, Micron and Red Hat earnings results, Yahoo click-fraud settlement, video sharing challenged, Pfizer attacks Teva, portable alpha explained.
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- Summary: Adult video producer Io Group has sued online video sharing company Veoh for providing access to, and sharing of, Io's videos without permission. The suit is important for the other online video sharing companies, YouTube, Yahoo and Google. Until now the video sharing companies have relied on the proceedure outlined in the Digital Millenium Copyright Act, which stipulates that companies are liable only if they fail to remove material after being informed by the owner of a copyright violation. Io claims that Veoh knew that its users were violating Io's copyright.
- Comment on related stocks/ETFs: A victory for Io would have broad ramifications for sites that aggregate user-generated content. Stocks at risk: News Corp (NWS), which owns My Space; Yahoo (YHOO) which owns Flikr and is moving further into user generated content.
- Summary: Zoloft, the best-selling anti-depressant in the US and Pfizer's third biggest product, loses US patent protection tomorrow. Pfizer has announced plans to offer a discounted generic version of its own, produced by its Greenstone subsidiary. Greenstone, which sells only generics of Pfizer drugs, is the 7th largest generic drug producer in the US and generated $722 million of sales in the US. A generic drug maker can challenge patents when they expire and win a six month period of exclusivity to sell the generic version. Introduction of "authorized generics" cuts the profits of generic drug challengers and can restrict competition over the long term by discouraging patent challenges. Teva Pharmaceutical Industries planned to introduce a generic version of Zoloft this week, since it acquired Ivax Corp, which won exclusive rights to sell the drug in a settlement with Pfizer.
- Comment on related stocks/ETFs: Not clear that Pfizer (PFE) will really benefit from this financially, but Teva (TEVA) certainly seems to be the loser. Pfizer and Merck's recent actions seem to suggest that they are taking competition from the generic manufacturers more seriously.
- Summary: EMI and Warner Musis both agree they should merge, but are in deadlock over who should be the acquirer and who the seller. Warner and EMI are about half the size of the two leaders, Vivendi Universal's Universal Music Group and Sony BMG Music, and believe there are compelling synergies in combining back office and international operations. Warner Music recently made a bid to purchase EMI for about $4.4 billion. On Friday, EMI rejected that offer and instead issued a counter-offer to buy Warner Music for $4.6 billion in cash. Warner Music was sold by Time Warner in 2004 for $2.6 billion to a group of private equity investors including Thomas H. Lee Partners LP, Bain Capital LLC and Providence Equity Partners Inc., together with Warner Chairman Edgar Bronfman.
- Comment on related stocks/ETFs: Both stocks rose by 3-4% yesterday; Warner Music trades in the US (WMG). If it becomes the acquirer, its stock could fall. Meanwhile, the real loser of this deal is Time Warner (TWX), which it's now apparent sold Warner Music for too little in 2004. But Time Warner's chronic mis-management and failure to monetize its assets is arguably priced-in to its stock already.
- Summary: Google is today unveiling its new online payment service, called Google Checkout. Merchants that accept Google Checkout are highlighted by a green shipping cart symbol in Google searches, and receive payment processing fee discounts depending on the volume of pay per click ad business they do with Google. Users enter their credit card numbers, name and address and Google forwards payments to the merchants. Separately, Google has selected Cairo as its Middle East hub and is not courting potential content partners, particularly in government and academia. Google chose Egypt, the article claims, because it has the largest population in the region with 78 million people. Egypt has 5.2 million Internet users, and Google predicts that the number of Internet users in Arab countries should rise to 50 million by 2009.
- Comment on related stocks/ETFs: Short term positive impact on Google's stock (GOOG). The article speculates that Google may damage its relationship with eBay (EBAY) by competing with PayPal, but eBay has no alternative to buying ads from Google so that concern is likely overstated. In the long term, Google and PayPal may be able to replace the credit card companies for online transactions, a negative for Mastercard (MA).
- Summary: Large companies are entering the market to produce gasoline substitute ethanol. Ethanol is usually made from the sugar in corn, but celluslosic ethanol can be made by micro-organisms consuming crop residue, wood chips and garbage. The economic incentive comes from high oil prices and US government support. The energy bill passed in 2005 mandates use of 250 million gallons of cellulosic ethanol by 2013 and permits Federal loan guarantees for the construction of cellulosic "biorefineries". Each gallon of ethanol is subsidized by a $0.51 Federal tax credit, The Energy Department is now holding a $160 million competition to build the first 3 biorefineries. Leading contenders include private company Iogen, which has partnered with Royal Dutch Shell and Goldman Sachs, Archer-Daniels Midland, Abengoa Bioenergy, a subsidiary of Spanish conglomerate Abengoa S.A, and DuPont. DuPont has genetically modified an enzyme so that it eats the sugar in cellulose. A commercial plant should produce cellulosic ethanol at $1.35 a gallon, versus corn ethanol at about $1 a gallon. Challenges: (1) The ethanol industry consumed 14.4% of the US corn crop in 2005 and is now pushing up the price of corn. (2) Ethanol can't be transported in pipes because it mixes with water, leading to dilution, and must therefore be carried by truck or train and blended close to where it's sold. (3) Ethanol contains 30% less energy than gasoline, leading to lower milage for cars.
- Comment on related stocks/ETFs: Strongly negative for the small ethanol stocks, as the article highlights the capabilities and resources of the large players without mentioning the smaller companies. They include: Pacific Ethanol (PEIX), Xethanol (XNL), VeraSun (VSE), MGP Incredients (MGPI), Aventine Renewable Energy (AVR), Green Plains Renewable Energy (GPRE), Andersons (ANDE), Veridium (VRDM) and SunOpta (STKL). Neutral for Archer-Daniels Midland (ADM) as the article highlights the opportunity but also the limits of corn ethanol and increasing competition. Positive for DuPont (DD), which appears as a significant ethanol player but whose stock hasn't run up with the other ethanol stocks; chart here. Royal Dutch Shell (RDSA) and Goldman Sachs (GS) are investors in Iogen.
- Summary: BP has been charged by federal investigators with causing a 50% rise in the price propane in early 2004 at the height of the home heating season by manipulating the market. BP managers attempted to purchase secretly nearly all the propane stored along a major Texas-New York pipeline, and then withheld its own propane from the market. A BP trader was taped saying "In terms of whether we should do this or not, what we stand to gain is not just that we'd make money out of it, but we would know from thereafter that we can control the market at will". BP claims that it has dismissed some employees and strengthened supervision.
- Comment on related stocks/ETFs: Negative for BP (ADS: BP); probably no fall-out for other energy stocks.
- Summary: A federal judge approved a settlement in which Yahoo will pay legal fees of $5 million and agree to extend the period for reviewing click-fraud complaints. Google settled a click-fraud suit in March for $90 million in legal fees and advertising credits.
- Comment on related stocks/ETFs: Marginally positive or zero impact on Yahoo (YHOO) as the issue is settled at low cost.
- Summary: Lukoil's Q1 profit of $1.69 billion, while up 43% year over year, missed analyst estimates by $203 million due to accounting for the cost of options. Revenue rose to $15.04 billion versus $10.62 billion a year earlier. Lukoil said it profit growth was capped by tax increases as the Russian governement links taxes on oil companies to the price of oil.
- Comment on related stocks/ETFs: Lukoil doesn't trade in the US.
- Summary: The IRS is attempting to collect over $750 million in back taxes from Symantec's Veritas unit, plus over $300 million in penalties. The dispute is over transfer pricing: Veritas has an Irish subsidiary (which pays low taxes) and pays licensing fees to its US parent; the IRS claims the licensing fees were too low.
- Comment on related stocks/ETFs: Negative for Symantec (SYMC). But numberous other US tech companies have Irish subsidiaries and could be vulnerable to increased scrutiny of transfer pricing. They include Microsoft (MSFT) and Google (GOOG).
- Summary: Honda has announced its intention to build a $550 million plant in Indiana to produce fuel efficient cars. This is Honda's 6th US plant, and will raise the companies capacity to 1.6 million from 1.4 million. Honda is considering using the new plant to produce the Honda Fit, a subcompact, and the Honda Civic. Honda's US expansion contrasts with GM's recent announcement that 35,000 workers had accepted buy-out packages. Honda says that it believes "demand for fuel-efficient small cars will continue to surge in the U.S., as consumers trade in big gas-guzzling light trucks for smaller vehicles".
- Comment on related stocks/ETFs: The Japanese car companies, with stronger sales in Europe and Japan, are ahead of their US competitors in compact and fuel efficient cars. Positive for Honda (HMC), negative for General Motors (GM) and Daimler Chrysler (DCX).
- Summary: Japan's Ministry of Economy, Trade and Industry [METI] said that retail sales rose 0.1% year over year in May, after falling 0.8% in April and rising 1.1% in March. Economists said that May retail sales may have been depressed by poor weather. METI's interpretation: "while signs of a mild recovery can be seen, the trend remains largely flat".
- Summary: A Senate committee yesterday failed to agree on a "net neutrality" amendment to the telecom bill which would allow telecom and cable companies to bypass local authorities in offering paid subscrption TV services. The amendment would have guaranteed equal treatment for all internet traffic, regardless of its source. Supporters of the amendment say they will filibuster the telecom bill; the key losers may therefore be the telecom companies which are relying on the new bill to pass to roll out national TV services.
- Comment on related stocks/ETFs: Negative for Verizon (VZ) and AT&T (T).
- Summary: 3Com's results for the quarter ending June 2nd: Revenue up 45% to $255 million, net loss of $15.2 million versus a loss of $58.3 million a year earlier. 3Com will close 21 facilities and cut headcount by 250 from its secure, converged networking unit.
- Comment on related stocks/ETFs: Full 3Com (COMS) conference call transcript here.
- Summary: Micron's results for the quarter ending June 1st: Revenue up 24% to $1.13 billion, net income $89 million versus a loss of $128 million a year earlier, when DRAM prices were low. EPS of $0.12.
- Comment on related stocks/ETFs: Micron (MU) is moving into NAND flash and higher margin chips including image sensors for digital camera. Details in the full Micron conference call transcript, or experpts specifically about the NAND flash market here.
- Summary: Red Hat's results for the quarter ending May 31st: Revenue up 38% to $84 million, net income of $13.8 million versus $12.4 million a year earlier, EPS of $0.07, unchanged from a year earlier, missed consensus estimates of $0.09.
- Comment on related stocks/ETFs: Red Hat for the first time included stock options expenses, of $7.6 million. Details in the full Red Hat conference call transcript.
- Summary: J. D. Power released its latest survey of consumer satisfaction after 90 days of ownership. The leaders were the luxury brands BMW, Mercedez, Lexus, Infinity, and Audi. US car manufacturers showed progress, with Ford coming in 11th place with two of its cars best-in-class.
- Summary: The Fed will likely decide to raise interest rates by another quarter point today. The yeild curve inverted late last year, usually suggesting increased risk of recession. But Fed Chairman Ben Bernanke argued in March that a model which more accurately uses interest rates suggests that the propability of a recession is just 27%. If rates rise today, the probability rises to 30%. Despite rising recession risk, futures place the probability of another rate increase in August at 80%.
- Comment on related stocks/ETFs: Discussion of the Fed's move today here. Meanwhile, if you're concerned about rising rates or a falling dollar, consider hedging long positions by shorting a small cap index ETF. Note the underperformance of the Russell 2000 versus the S&P 500 over the last three months (click on chart to enlarge):
- Summary: A new investment strategy is attracting significant capital and generating substantial fees. Called "portable alpha", it consists of ensuring that most capital is indexed to the market, but by using index derivatives frees up capital for strategies that can beat the market, for example by investing in hedge funds. This increases the potential for market-beating returns but also increases leverage, risk and investment fees. Critics say that academic studies have proven that it's hard to beat the market in the long run, so the strategy increases risk and costs for no long term gain. A study by Duke University professor David Hsieh suggests that there are only about $30 billion of market-beating returns available to investors each year although the hedge fund industry manages over $1 trillion. Despite that, pension fund managers are allocating significant percentages of their assets to "portable alpha" strategies.
- Summary: Penford (PENX), a producer of specialty ingredient systems for food and industrial applications, said it would invest $42 million in ethanol production capacity. Its stock rose 15%. Stocks moving on earnings results or guidance: Park Electrochemical (PKE) down 10%, Workstream (OTCPK:WSTM) up 12%, Omni Energy Services (OMNI) up 6.1%, Hexcel (HXL) down 2.9%.
- Comment on related stocks/ETFs: Jim Cramer picked Hexcel (HXL) as a "buy" in the Mad Money Lightening Round on May 11th after a director made a significant insider stock purchase. Look at the stock chart since then.
Notable articles on Seeking Alpha today: Today's earnings schedule, and Rob Black's Tech Stock Report, Retail Stock Report and Transport Stock Report. Conference call transcripts from Red Hat, 3Com, Micron and Biomet. Perspectives on the sale of Intel's communications chip businesss by Shlomi Cohen and Carl Howe. A look at the Bidz.com IPO and analysis of consumer electronics stock Harman International. Jim Cramer's Mad Money recap. Tucow's discusses domain name parking, and Andy Neff previews RIMM's earnings.
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