One Page Annotated WSJ Summary: Monday, Sept. 18

by: SA Editors
SA Editors
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How Stock Options Muddle The Relationship Among Wages, Corporate Profits and Inflation

  • Summary: Contrary to the general consensus that wage growth has been sluggish, the Commerce Department's Bureau of Economic Analysis (“BEA”) announced that labor income for the first half of 2006 rose by 1.3% ($95 billion). What was puzzling was that there was no corresponding growth in GDP (i.e., productivity) to accompany the wage growth. Ordinarily wage growth without accompanying productivity will translate to the bottom line as lower profits, but that does not seem to be the case here. Given the stock market’s strong performance during 2006’s first quarter, analysts are suggesting that the increased wages are probably a result of executives cashing in stock options during that period. If the increase in labor income is attributable to stock options, this would help explain why (according to polls) workers are dissatisfied with low wage growth, since stock options (as part of a compensation package) are more concentrated at the management level.
  • Comment on related stocks/ETFs: Figuring out true employee compensation has always been a frustration for analysts. With low wage growth there is speculation that workers (not on the options gravy train) have been withdrawing money from their home equity piggy-bank just to keep up with real inflation (which includes housing and energy – both excluded from the CPI). On Sep. 7, WSJ ran an article puzzling over wages and corporate profits both going up; they don't usually move in tandem. As noted there, executive incentives could be one answer to the conundrum. The slowing housing market could introduce wage pressure into the economy (see SeekingAlpha’s latest in a series of posts on the housing bubble).

Treasury Eases Stance On Fannie, Freddie Limits

  • Summary: The two government-backed sponsors of home loans, Fannie Mae (FNM) and Freddie Mac (FRE), will not be required to drastically reduce their mortgage holdings as the U.S. Treasury had previously proposed. While the Bush administration originally advocated this more aggressive reform following accounting scandals at the two companies, the House of Representatives has passed a bill that required no such reduction of their $1.4 trillion in mortgage portfolios, and the Treasury responded by softening its stance toward working out a compromise. The Treasury now advocates that a new regulatory agency be empowered to ensure the companies 'operate in a "safe and sound" manner... to avoid creating "systemic risks" to the financial markets.' It's still not likely that Congress can reach a final compromise before the November election, as home builders and real-estate broker lobbyists reject any effort to lessen Fannie Mae and Freddie Mac's role in, as those groups see it, rejuvenating the slumping housing market.
  • Comment on related stocks/ETFs: The Treasury's backing down on this issue could mean upside to Fannie Mae and Freddie Mac stock, though both have jumped since early August on expectations to this effect. The mortgage providers are both constituents in the SPDR Financial ETF (NYSEARCA:XLF).

IPod, TheyPod: Rivals Imitate Apple's Success

  • Summary: Microsoft, RealNetworks, SanDisk, and Samsung think they have figured out a key element of Apple's success with its iPod portable music player and iTunes downloadable music store. The strategy is to sell an MP3 player that is designed to work with a specific music download service. Microsoft VP Bryan Lee comments, "That's something that Apple has played up very well. One brand, one device, one service." Over the past two years Apple has held on to its dominant 75% market share with the only serious move being made by SanDisk which has grown its market share to nearly 10% from just 3% in 2005. SanDisk and RealNetworks have teamed up to market the new Sansa Rhapsody device that will have the same sales prices as the original Sansas. Microsoft has worked closely with Toshiba to create the forthcoming Zune portable media player with Toshiba handling hardware manufacturing and Microsoft responsible for design and promoting its online entertainment service.
  • Comment on related stocks/ETFs: It's almost painful to read about some of the mishaps of RealNetworks (NASDAQ:RNWK) and Microsoft (NASDAQ:MSFT), which makes it easy to understand why Apple (NASDAQ:AAPL) has had so much success. Now the iPod wannabes are hoping there are enough people left without an MP3 player and enough people willing to switch, for them to make a dent in Apple's market share. Carl Howe of Blackfriars Communications calls Microsoft's Zune a rebadged Toshiba Gigabeat. See his analysis of how Apple could be the grinch that steals Microsoft's Christmas. Howe also writes on the new iPod pricing saying it "... cut off Microsoft's Zune at the knees." Andrew Schmitt of Nyquist Capital says Microsoft's Zune strategy is incomprehensible. Barry Ritholtz questions Microsoft's innovation but emphasizes its money printing prowess. Whereas some investors might consider buying shares of Apple because of the iPod there's the case being made that one wouldn't buy Microsoft for the Zune. RealNetworks has also been keeping busy with an acquisition and an attempt at home audio.

IPO Investors See Busier Week; Tech Comes Back

  • Summary: Following a tepid summer, IPO investors have a busy week ahead of them. Three of the week's 8 new offerings are tech: DivX Inc. ((DIVX) online video compression software), Riverbed Technology Inc. ((NASDAQ:RVBD) network infrastructure appliances), and CommVault Systems Inc. ((NASDAQ:CVLT) a former Lucent Technologies Inc. (LU) unit; data management software). Analysts say the way these IPOs play out should be a good gauge for tech IPOs for the rest of the year. So far IPO tech offerings have been weak; their 5.6% average one-day return is 1.6% below other sectors; volume is down 15% compared with 2005. Other IPOs this week: Hawkeye Holdings Inc. ((HWY) ethanol producer), Warner Chilcott Ltd. ((NASDAQ:WCRX) pharmaceuticals), and Home Diagnostics Inc. ((HDIX) glucose monitors). Hawkeye's deal comes after months of poor performance by two other new stocks in the industry; a positive reception by investors would be notable. Warner Chilcott's offering, which aims to raise up to $1.34B, would put it in the same category as MasterCard Inc.'s debut in May. Home Diagnostics is a rare find among medical-device IPOs this year; steady profits, gross margins of 60%, and a health specialty that is expanding: diabetes monitoring.
  • Comment on related stocks/ETFs: A total of 25 tech stocks IPOed so far this year. The last: Quimonda (QI) on Aug. 8. Techwell (TWLL), a fabless semiconductor company that designs, markets, and sells mixed signal integrated circuits for video applications in the consumer, security surveillance and automotive markets, put in the group's strongest performance (up 56%). Other strong newbies: WNS Holdings (NYSE:WNS) +31%, Systems Xcellence (SXCI) +26%, and QI +25% (in just over a month). Taking up the rear we have (TRFC) -63%, Vonage (NYSE:VG) -54%, and Ascent Solar Technologies (NASDAQ:ASTI) -50%. Justin Hibbard spends some time analyzing the DivX offering. Jonathan Liss takes a look at Hawkeye's IPO in the face of lackluster performances by two other Ethanol producers that went public this year. Evelyn Rubin gives investors comprehensive background information on all of this week's IPOs. Don't forget Seeking Alpha's ongoing coverage of the IPO scene. Some traders feel gaining a solid understanding of IPOs and learning how to trade them is the #1 edge a person can have in the market. And why not? With an average 7% one-day return, savvy investors (who follow strict risk guidelines), and have the inclination to do the research and pre-invest, stand to make nice short-term gains. The less savvy, though, stand to be sheared.

Card Rewards Sweeten, At Merchants' Expense

  • Summary: JP Morgan (NYSE:JPM) plans to announce a 'new' kind of credit card today. The 'Freedom' card allows customers to switch back and forth between reward currencies -- either cash or points redeemable -- for a wide variety of goods and services, and will also dole out a hefty triple reward -- either 3% in cash or triple points -- for purchases at certain merchants, including Dunkin Donuts and 7-Eleven. The card doesn't carry an annual fee and gives customers an assortment of other benefits for using the card for small purchases. The more flexible and exorbitant rewards are indicative of a growing trend among credit issuers to offer sweeter and sweeter deals in order to maintain customer loyalty while hopefully luring new card members. Today, more than 60% of all credit cards issued in the U.S. are tied to a rewards program, according to industry estimates. At the same time, however, the industry's double-digit growth rate of the 1990s has slowed to single digits, forcing the nation's biggest financial institutions to add more costly perks. "For issuers, rewards are table stakes just in order to play the game," says Robert Selander, chief executive of MasterCard Inc. (NYSE:MA). Increasingly, credit-card companies are drilling deeper into their customers' spending patterns to figure out which rewards are most likely to resonate. Visa created a program last year that mines data from 65 million card holder accounts allowing it to customize offers directly to the customer's need. One result has been that merchants are becoming more involved in credit-card rewards programs, and increasingly are chipping in to fund rewards programs, meaning a reduction in their own profits.
  • Comment on related stocks/ETFs: The WSJ recently ran an article on a new MasterCard offering targeting wealthy households, another indication of the many ways credit issuers are marketing their services for the 21st century. Jim Cramer continues to maintain his bullish stance on MasterCard and American Express.

U.S. Lender Details Expansion Plan and Wal-Mart Will Launch Its First China Credit Card

  • Summary: Kenneth Lewis, Chairman and CEO of Bank of America, said his bank is eying expansion through credit cards and corporate banking in Asia and Europe instead of by acquisitions. BoA has maxed out growth via acquisition in the U.S. due to a regulatory limit of 10% of U.S. deposits. It has a small presence overseas compared to rival Citigroup. In China, BoA will use its almost 10% equity stake in China Construction Bank to enter a joint venture credit card agreement. Lewis comments, "Frankly, that's (the credit card JV) a long-term payback, because you don't have the same spending and borrowing in China as you do in the U.S., so it will take some time for the habits to change." Regarding Europe Lewis says, "We don't see a strategic imperative of being on the ground in Europe." Lewis wasn't very bullish about even being in Hong Kong or India either. In separate but related news on credit cards in China, Wal-Mart announced it will launch its first credit card in China in partnership with China's Bank of Communications. In fact, analysts say it is the first credit card issued in China by a foreign retailer. It's estimated that less than 5% of China's population has credit cards. Wal-Mart's card will be a regular credit card with special discounts when used in-store. It will be offered in conjunction with HSBC, which has a 20% stake in the Bank of Comm. The card will be "dual-currency" meaning it can be used overseas but analysts say releases of such cards to-date by foreign banks forming JVs in China have been unprofitable.
  • Comment on related stocks/ETFs: Bank of America's (BOA) Lewis has been consistent with his comments regarding the bank's growth, noting early this year that acquisitions seemed unlikely in '06, especially considering the earlier MBNA deal. Jim Cramer recently gave BoA a bullish call on his Real Money Radio Recap, saying it was well-run. Shaun Rein of the China Market Research Group wrote last week about e-commerce in China including the increasing use of credit cards. His article is recommended reading if you want to try and make an investment play on credit cards in China. Separately, news earlier this month that China now has its first formal corporate-bankruptcy procedures helps reduce some of the risk of lending to corporate clients in China. It would be helpful to find out what type of personal bankruptcy laws exist and how that might someday impact new card issuers like BoA and Wal-Mart (NYSE:WMT). A positive in this area is the often cited statistic of very high personal savings rates in China. See Wal-Mart's Q2 earnings conference call transcript. Learn how to invest in China's publicly traded banks (see Comment on related stocks/ETFs section).

Fed Is Expected to Keep A Foot on Rate Brake

  • Summary: Wall Street expects the Fed to keep interest rates frozen at 5.25% during the U.S. Federal Open Market Committee [FOMC] meeting this Wednesday. With the economy apparently softening and inflation worries lessening, it is unlikely the Fed will raise rates. A housing market slump and significantly lower gas prices are two more reasons it is unlikely the FOMC meeting will conclude with a rate raise on Wednesday. Still, analysts will be carefully scrutinizing the Fed's accompanying statement in an attempt to determine what the Fed's future plans may hold, and which economic issues it finds most pressing. But while investors will cheer if interest rates stay on hold, they may not rush out and snap up government bonds. Investors need to see, "fresh signs of the economy slowing even more dramatically," according to Thomas Girard, co-head of fixed income at Weiss, Peck & Greer in New York, and, "hints from the Federal Reserve that they are really moving away from raising rates" before taking up new positions.
  • Comment on related stocks/ETFs: Mark Mahorney is bullish on bonds, a position he concludes from his research into the last 3 times the Fed froze interest rates, following long up periods. J. Kyle Rosen, on the other hand, believes that with the VIX (the index that measures market volatility) at an all-time low, the real opportunity is in options right now, with treasury bonds providing a hedge - not an investment opportunity.

Phillips Leads Effort at Oracle To Woo Its Users

  • Summary: Following a strong showing in June, analysts are expecting Oracle (NASDAQ:ORCL) to report strong revenue growth when reports fiscal first quarter results tomorrow. A jump in revenue could be an indication that Oracle is increasing its market share at SAP’s (NYSE:SAP) expense. Oracle’s rising fortunes are regarded as a triumph for CEO Larry Ellison’s “right hand man”, Co-President Chuck Phillips. In the past, Oracle had the reputation of phasing out software products it acquired – pushing companies (using the acquired product) to switch to Oracle’s home-grown competing product. When Oracle purchased PeopleSoft, PeopleSoft users braced for what they felt was the inevitable. Enter Mr. Phillips. In 2005 he promised customers that Oracle would continue development on programs they acquired, thereby not forcing them to switch to Oracle’s products. This change in direction helped Oracle calm the fears of customers as it launched a $20 billion acquisition spree which included Siebel Systems and Retek.
  • Comment on related stocks/ETFs: As updates and product support become an iincreasing source of Oracle’s revenue, “being nice” to their customers becomes crucial to their continued success. Cramer notes that Oracle would really have to make a dire miscalculation to lose points from rival SAP.
    Related: Oracle’s 2006 second quarter conference call transcript.

Intel Claims a Breakthrough In Creating Lasers on Chips

  • Summary: Researchers from Intel and the Univ. of California, Santa Barbara have "addressed the last major hurdle" in creating lasers on computer chips says Mario Paniccia, the director of Intel's photonics technology lab. The researchers figured out how to add a light-generating capability to silicon using a so-called "hybrid approach." Paniccia thinks it could be five years before the technology is commercialized but it's seen as bringing significant cost savings in the fastest of data communications. For instance, comparable lasers currently cost $50 to hundreds of dollars each but could drop to as little as a $1 a laser. Intel is targeting silicon lasers for use in communications between components inside computers and within computer data centers. Connection speeds could double or quadruple from today's 8-10 gigabits per second and could travel over distances of tens of feet versus today's max of 18 inches.
  • Comment on related stocks/ETFs: JDS Uniphase's (JDSU) CTO is quoted in the article saying that switching to silicon is "really important." Providers of data services are seen benefiting by becoming able to offer much more robust services. Andrew Schmitt of Nyquist Capital gives his take on the winners and losers in optical communications. In the silicon segment, Schmitt says, "The problem is these businesses are buried in large companies ... and it's difficult to get investing leverage on this trend." It seems the same can be said of Intel (NASDAQ:INTC). Also see Schmitt on Cisco's (NASDAQ:CSCO) optical business, which he says has a corrosive impact on the profitability of the overall optical module business. Bookham (BKHM), EMCORE Corp (NASDAQ:EMKR), Finisar (NASDAQ:FNSR), and Oplink Communications (NASDAQ:OPLK) are some of the players in the optical components segment. Find out why Tom Jacobs of Complete Growth Investor calls Oplink the best optical equipment play but still wrote a "sell" report on it and sold his position. Investopedia Advisor provides an outlook for JDS Uniphase. See the latest conference call transcripts of Intel and JDS Uniphase.

Oil and Gold May Gain Support After Taking Hits Amid Downturn

  • Summary: Two unique factors are likely to cushion the fall for oil and gold prices amid the recent commodity price downturn. 1) The commitment by several oil-producing countries to defend a price of $60 a barrel. 2) The wedding season in India, during which demand for jewelry fabrication jumps significantly. The overall downturn is due to a combination of several elements, including efforts by the Chinese government to tighten monetary policy and rein in commodities demand; the slowing US housing market, which has left US homeowners "feeling poorer" and thus consuming less; and the easing of late-August tensions over Iran's nuclear program, which has affected energy futures. Last week, the spot Dow Jones-AIG Commodity Index fell 5.7% in response to the losses in crude and precious metals. The New York Mercantile Exchange's Comex gold for September delivery last week fell $33.20, or 5.5%, to $576.40. Crude oil, which fell 4.4% last week, posted a 3.8% rise since Dec. 30. The front-month crude-oil contract closed 11 cents higher Friday at $63.33 a barrel.
  • Comment on related stocks/ETFs: William Trent continues to expect "exorbitant oil prices", while Marc Gerstein agrees that oil has not passed its peak. David Jackson argues that the "easiest way to play a pull-back in oil prices is with the US Oil ETF (NYSEARCA:USO)". J.D. Steinhilber contends that the slide in commodity prices could be a buying opportunity. Morgan Stanley economist Stephen Roach provides an explanation of the commodities cyclical bear case. Roger Nusbaum cites regional holiday demand in Asia as a support factor for gold. Abnormal Returns examines various implications of the commodities downturn.

How News Corp., Liberty Can Save $4.5 Billion

  • Summary: New Corp. (NASDAQ:NWS) and Liberty Media Corp. (LCAPA), in talks over an asset swap that would give Liberty control of DirecTV Group Inc. (DTV), likely plan on structuring the deal in such a way as to avoid paying taxes through a legal loophole that would save the two companies as much as $4.5 billion in combined taxes. The structure of the deal would essentially be the same as that used in "cash-rich" deals -- but with a relatively small portion of cash. News Corp. would likely transfer its DirecTV stake, valued at about $9 billion at current market values, along with about $2 billion in cash, to a new corporation created specially for the deal. It would then swap that corporation to Liberty in exchange for Liberty's roughly $11 billion stake in shares of News Corp. Such a move is likely to renew the spotlight on the controversial tax-related structure, used in the past by companies selling stock in other companies. The White House had sought to make it illegal, but backed down after pressure from large corporations.
  • Comment on related stocks/ETFs: The WSJ recently ran a piece on News Corp.'s attempts to dump its share in DirecTV. John Bethel has been arguing the merits of a News Corp.-Liberty Media split for some time now.

HEARD ON THE STREET: EchoStar May Chart New Path

  • Summary: With Rupert Murdoch's announcement last week that News Corp. (NWS) may trade its stake in DirecTV (DTV) to Liberty Corp (LCAPA) in exchange for their holdings in NWS, the satellite media industry took a beating from analysts and the market. Liberty Corp's John Malone has apparently been looking for a satellite holding for years, and is expected by analysts to invest heavily in subscriber growth if the deal goes through. Increased competition from DirecTV, the cablecos and telcos compounded by a recent loss in a patent infringement suit to TiVo make some analysts think that it will be difficult for Echostar (NASDAQ:DISH) to avoid a takeover. EchoStar and its CEO Charles Ergen have a loyal following on Wall Street, particularly among institutional investors. But as Jimmy Schaeffler, California satellite consulting firm Carmel Group says, a $100 million partial settlement with the television networks and an unsettled sum to be paid out to TiVo (NASDAQ:TIVO) mean that Ergen "is more hemmed in than ever".
  • Comment on related stocks/ETFs: See Rob Zenilman's analysis of the rationale behind the Murdoch-Malone deal. Andrew Schmitt looked at the implications of the EchoStar-TiVo infringement suit. See DTV's DISH's quarterly conference call transcripts.

AHEAD OF THE TAPE: Listen to Your Analyst

  • Summary: Wall Street appears to be listening to its analysts again: last week, DuPont (NYSE:DD), XM Satellite Radio (XMSR), Applied Materials (NASDAQ:AMAT) and Gap (NYSE:GPS) moved up on analyst upgrades, while Boeing (NYSE:BA) dropped on a UBS downgrade. Analysts fell out of favor during the tech bubble burst, and with the initiation of the SEC's RegFD ruling, which prevented analysts from receiving preferential status. According to a study by Paul Bukowski from Hartford Investment Management's quantitative strategy group, an investor who bought into the 200 companies in the Russell 1000 with the largest upward revisions to earnings estimates while betting against the 200 largest downwards revisions would have had annualized returns that were on average 4.8% better than the index in the 1990's. This strategy would have underperformed the index by 9.3% between 2000 and 2004, but since the beginning of 2005 would have outperformed it again by 5.9%. While analysis may be improving, as the article concludes, "It might also be that companies have gone back to their roots, and are tipping Wall Street off again."
  • Comment on related stocks/ETFs: Analysts may be creeping into favor, but in blogosphere they are viewed with caution at best. Dave Fry takes issue with the way their records are gauged, and Shlomo Greenberg thinks they just don't get it with Teva (NYSE:TEVA), Checkpoint (NASDAQ:CHKP), Alon (NYSE:ALJ) and Delek (NYSE:DK).

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Notable articles on Seeking Alpha today: Eric Savitz explains why the Street is enchanted with Adobe; in Adobe's fiscal Q3 earnings conference call, execs discuss why they feel Microsoft Vista's PDF integration is not a threat and the effects of Acrobat 8's launch on Creative Suite products; Goldguru sees blatant manipulation in the recent gold-stock selloff; today's earnings calendar; Phil Davis' latest update on his Google call; our one page summary of Barron's weekly magazine; Jim Cramer's latest stock picks.

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