COVER STORY: Death of the Floor by Michael Santoli
Highlighted companies: NYSE Group Inc. (NYX), LaBranche & Co. Inc. (LAB), Van Der Moolen Holding NV (VDM), Knight Capital Group Inc. (NITE)
Summary: Investors love the NYSE's (NYX) ongoing electronic transformation and its planned Euronext merger. This month it announced it would lay off another 500 employees (17%) and close one of its five trading rooms. Presently testing a "hybrid market" (with 200 tickers) that still gives specialists some advance notice of incoming orders in exchange for promised liquidity, many see the current situation as a stop on the way to full automation and complete elimination of the floor. In hybrid stocks, clerks save an average 40,000 keystrokes per day per stock, volume is up, and the bid/ask spread is 13% tighter. Partner LaBranche & Co. Inc. (LAB) made no money last quarter in its specialist operations, and specialist Van Der Moolen Holding NV (VDM) took a write-down charge. Specialist participation rates in trades are down 25%. As the NYSE electronic inititiative gains speed, investors are betting so will volume -- some say it will double, and the more conservative peg volume gains at 50%. The market value of all NYSE-listed stocks is more than 3x that of Nasdaq (NDAQ), yet total daily volume is similar, thanks to the black-box players' focus on Nasdaq names due to its full automation. Specialist firms may look towards Knight Capital Group (NITE), whose core business was running breakeven a few years ago. Since spring 2005, Knight essentially automated its order-matching algorithms, which formerly were handled by teams on a huge trading floor; Knight shares have risen to 18 from 7.50 since mid-2005. Specialists once made their money with their quick wits; now they must survive with clever code. (LaBranche has 30 quants toiling away trying to get it right.) NYX currently trades at 40x 2007 earnings -- on hoped-for '08 earnings of maybe $3-4 a share, and more farther out. Investors think CEO John Thain is, "playing a multiyear chess match and is thinking several moves ahead... They're convinced he's underpromising and ready to overdeliver." Barron's: With the stock where it is, a lot needs to break right.
Related: Deutsche Börse Drops Euronext Takeover Bid, Clearing Way for NYSE Group • Internet Coalition Challenges Exchanges Over Exorbitant Data Fees • What Is The Price of Real-Time Worth? • NYSE Eyes Joint Venture with Toyko Stock Exchange • U.S. Exchanges Continue To Trim Expenses Through Consolidation, M&A Activity • Why I'm Long-term Bullish on the Exchanges
Exchanges Are the New Internet Stocks by Andrew Bary
Highlighted companies: Nymex Holdings Inc. (NMX), Chicago Mercantile Exchange Holdings (CME), IntercontinentalExchange Inc. (ICE), NYSE Group Inc. (NYX)
Summary: Friday's powerful Nymex Holdings Inc. (NMX) debut saw its shares surge to $133 from their $59 IPO price, giving the company a $11.5b market cap and causing seat holders to celebrate (each seat holder got 90k shares, worth $12m; seats were going for $5m last month, $1.75m in 2005, and $750k in 2001). Earnings for the first nine-months were $112m ($1.35/share) on revenues of $381m, meanings shares are going for 72x earnings. In comparison, Chicago Mercantile Exchange Holdings (CME) trades at 46x estimated 2006 earnings, and NYSE Group Inc. (NYX) at 57x. Exchanges have the highest P/E ratio for any major industry group in the stock market. Less than 10% (6.5m) Nymex shares were sold publicly. Nymex, with 63% market share, is the top energy futures exchange. Bulls are betting that with free-market incentive to maximize profits, a public Nymex will boast even greater earnings. Nymex Chairman Richard Schaeffer said Friday it would consider a merger with energy-rival IntercontinentalExchange Inc. (ICE), further spurring bulls. But, says Barron's, even if it earns $4/share in 2007, it's still rich at 30x earnings, and tangible book value is just $4/share. "When the CME went public in 2002 at just $35 a share, few recognized its potential. What a contrast from now: Wall Street is assigning an enormous valuation to Nymex as it's just out of the gate. The Internet bubble ended badly, suggesting investors ought to be cautious given the current exchange mania."
Related: Press Release • • Did Nymex's IPO Issuers Leave $34 Million on the Table? • Roger Nusbaum on Nymex IPO • Options Trader Likes ICE on Nymex Runup • NYMEX IPO Kicks Off Today, Ready To Sprint
Welcome Back, Bottler by Andrew Bary
Highlighted companies: Coca-Cola Co. (KO), Coca-Cola Enterprises Inc. (CCE), Cadbury Schweppes plc (CSG), Pepsico Inc. (PEP), Pepsi Bottling Group Inc. (PBG)
Summary: Bill Pecoriello, Morgan Stanley beverage analyst, says the probability of Coca-Cola Co. (KO) buying out bottler Coca-Cola Enterprises Inc. (CCE) is growing. Coke's core business is producing concentrate, such as Coca-Cola Classic, which it sells to bottlers who bottle and sell it to consumers. Since Coke's revenue comes from concentrate sales, it favors lower prices and higher sales volume. CCE, conversely, faces pressure to raise beverage prices to recoup costs on corn-syrup, cans, bottles, and other inputs. By owning its primary bottler (CCE accounts for 75% of KO's domestic sales), Coke could develop pricing and marketing strategies without regard for the impact on another company. And Coke is unhappy that CCE is actively pursuing contracts with competitors, such as last week's deal with Arizona Iced-Tea, which competes with Coke's Nestea. With a market cap over $100b, Coca-Cola could easily absorb CCE now valued at $9.5b, with about $10 billion of debt. The problem with Pecoriello's case, says Barron's, is that Coca-Cola has shown no interest in buying CCE -- a company it originally spun off in 1986 to the applause of Wall Street, who saw it allowing Coke to focus on its core business and get out of low-margin capital-intensive bottling. But, "deal or no deal, CCE looks reasonable," at 16x earnings vs. 17x for rival Pepsi Bottling Group Inc. (PBG) and 20x for both Coca-Cola and Pepsico Inc. (PEP). Europe is critical for Coke: 14% of its sales and 28% of its profits come from the EU; North America accounts for 29% of Coke sales but just 20% of profits. Buying CCE would allow Coke to create a giant Western European bottler from Coca-Cola Enterprises' operations in the U.K., France and Holland and Coke's bottlers in Germany and Nordic countries. Barron's Bottom Line: "A deal could bring CCE $27 a share (current price $20)... while helping Coca-Cola to carry out a cohesive growth strategy."
Related: Commentary: Surprise Corn Rally Hurts Coke • Buffett Likes Coke • Time To Buy Coca-Cola? • More On the New Coke Calorie-Burning Drink • Coca-Cola Q3 2006 Earnings Call Transcript
TECHNOLOGY TRADER: Looking for a Pulse by Bill Alpert
Highlighted companies: Medtronic Inc. (MDT), St. Jude Medical Inc. (STJ), Boston Scientific Corp. (BSX), Johnson & Johnson (JNJ), Conor Medsystems Inc. (CONR)
Summary: Sales of implantable defibrillators [ICDs] slumped following a two-year stretch of recalls. But recent news is heartening: Tests last week were better at finding new candidates for ICDs than they were at ruling out implantation -- suggesting doctors may use the test to justify new implants. And last month researchers found no increased long-term risk of heart attack in conjunction with drug-eluting stents. (On Dec. 7 experts convened by the FDA will meet to revisit the issue, a meeting investors will be highly focused on, and sure to be, in the words of one pundit, "a zoo.") All this should be good news for manufacturers Medtronic Inc. (MDT), St. Jude Medical Inc. (STJ) and Boston Scientific Corp. (BSX), who are down 15%, 29% and 33% since last December. Medtronic reports on Monday, and Sanford Bernstein analyst Bruce Nudell says that if Medtronic's sales of ICDs show any strength, "a thrill would run through its shares and those of its rivals."
Related: Boston Scientific Comes Clean on Stent Risk • Medical Device Industry Breathes Sigh of Relief • Jim Cramer's take on BSX, STJ, and MDT.
DuPont: Ready to Bloom by Thomas G. Donlan
Highlighted companies: E.I. DuPont de Nemours (DD), Monsanto Co. (MON)
Summary: Shares of E.I. DuPont de Nemours (DD) have gone nowhere for much of the decade. This may be about to change: DD is launching one new product after another, and stands to making a real mark in the realm of genetically modified seeds. DuPont's five segments: (1) Agriculture & Nutrition -- seeds, soy products, insecticides. Pioneer Hi-Bred seeds is speedily engineering useful traits into soy and corn products. (2) Coatings & Color Technologies -- auto-industry dependent; 1/3 of sales are to foreign companies. (3) Electronics & Communications -- makes materials for semiconductor manufacturers, refrigerants, Teflon for cookware, insulation. New approaches to making flat-screen displays offer DD prospects for "sudden growth." (4) Performance materials -- resins, films, polymers. (5) Safety & Protection -- Kevlar fiber, Tyvek insulation, Corian table tops; some of DD's fastest growing products. CEO Charles O. Holliday Jr. has made a point of beefing up R&D, going back to DuPont's roots as an inventor/innovator, but using their biological know-how to help them develop their chemical innovations cheaper and faster than previously possible (see the article for an example). It has put strict management controls on R&D spending, concentrating of finding new products, or coming up with new ways to exploit existing DuPont technologies; close to 35% of revenues now come from products that are four years or less from introduction. Bottom line: Shares currently trade at 15x 2007 earnings, far below the 29x enjoyed by biocrop innovator Monsanto Co. (MON), and could easily climb 15-20% in the coming year.
Related: DuPont Reports Profit After Hurricane Woes • So Far, the Dow Dog are Stars • Butanol, an Alternative to Ethanol, Gets a Boost • Cramer's Take on DD
No MGIC Solution by Jonathan R. Laing
Highlighted companies: MGIC Investment Corp. (MTG), AmeriCredit Corp. (ACF), Conseco Inc. (CNO)
Summary: MGIC Investment Corp. (MTG) shares, at $61.50 (8.5x earnings) look cheap -- as long as Street earnings forecasts of $6.70 and $7.20 a share pan out. The U.S.'s largest mortgage insurer currently insures $173b. But with home sales and prices falling, foreclosures and loan-default claims may rise. The bullish case: (1) Rising short-term interest rates have made personal mortgage insurance an attractive alternative to secondary loans to home buyers who can't afford down payments of up to 20% (piggyback mortgages). (2) MGIC's persistency (the length of time insurance policies stay on the company's books) is improving. (3) In the past 18 months the company shrunk its share base by almost 15%. (4) Loan delinquencies fell in Q3 to 5.98% from 6.58%. The bearish case: (1) The deflating housing bubble, which was built, to a large extent, on loose lending practices. Until now, property-price appreciation enabled borrowers in trouble to sell and pay off their mortgages. (2) Two-year "teaser" loans with low-interest rates are coming due next year ($800b worth), which could see borrowers facing 50%+ monthly payment increases. (3) MGIC's portfolio is increasingly heavy with "pay option" adjustable-rate mortgages (5.2% up from 0.8% at the end of 2004), which allow borrowers to pay less than required, the unpaid portion added to the principal. (4) Alt-A mortgages, a.k.a. liar loans given to almost-qualified borrowers without significant due-diligence are up to 17.2% from half that in 1999. (5) Loans of 100% property value are up to 16% from 4.5% over the same period. (6) Average paid claims, known as "severity," are up to $29,600 from $26,700. Bill Ryan of Portales Partners, who predicted the downfall of AmeriCredit Corp. (ACF) and Conseco Inc. (CNO) in the early 2000s: Assuming a 5% decline in home prices and a modest rise in MGIC's frequency rate, the company's 2007 earnings could fall 50% from analysts' current forecasts, to around $3.50 a share. Barron's: "With home prices up nearly 60% in five years, and speculative construction widespread, the current downturn in the U.S. housing market promises to be no ordinary correction, least of all one that "Magic," with its insured loan portfolio of $173.4 billion, will escape unscathed."
Related: Housing Bubble and Real Estate Market Tracker • Housing: What Does "Return to Mean" Really Mean? • MGIC Investment's Book Value Growth Better Than I Predicted • MGIC Investment Corp.: An Undervalued, Minimal Risk Long Pick • Weak Housing Will Bring This Market Down -- Barron's
The End of Hunger by Alan Abelson
Highlighted companies: iShares Dow Jones US Financial ETF (IYF)
Summary: Feeding the current "merger mania," aside from general bull-market euphoria, are "the enormous gobs of cash and credit hot for deals of every imaginable kind." The best sign of current speculative enthusiasm is investor's change in sentiment from bearish to bullish: Recent surveys show bulls surging to 56.4% from 52.1%; bears, by contrast, shriveled to 22.3%. Pollster, Investors Intelligence: "The sentiment readings are now bearish." While it doesn't necessarily signal an imminent decline, the "bubbling optimism" suggests it may be a good idea to consider an exit strategy. Alan Newman of CrossCurrents watches ETFs to take the insider pulse of various sectors. He thinks he's spotted an insider shift in the financial sector, using iShares Dow Jones US Financial ETF (IYF) as its indicator: In mid-October he calculated 24 shares sold by insiders for every share bought; now total shares bought has tripled, but total shares sold is up 12x. If insiders are selling financial stocks in quantity, he advises, you shouldn't be buying them. While exiting the current bull run may be costly, concludes Barron's, "exiting late could be disastrous."
Related: Two Takes on Corporate Earnings - Stock Implications • Market Red Alert: Oprah Guest Says 'Buy' • Barron's Interview: The Preconditions for Recession Are In Place • Bull Rally May Continue, Buy Only If Key Sectors Cooperate • Good Times May Not Roll Much Longer
Hitting a Gusher by Kopin Tan
Highlighted companies: Consumer Discretionary SPDR ETF (XLY), Clear Channel Communications Inc. (CCU), Reader's Digest Association Inc. (RDA), Google Inc. (GOOG)
Summary: Retail stocks have blossomed on the tails of a 25% slide in crude oil prices; Consumer Discretionary Select SPDR ETF (XLY) is up 22% over the period to all-time highs. But last week's retail sales data, showing 4.1% growth (vs. recent averages of 6%) has some investors questioning its continued potential. Admitting self-promotion, Barron's likes media stocks, and "traditional media" in particular, as the "least consumer-credit-sensitive" retail sub-sector. Last week's buyouts of Clear Channel Communications Inc. (CCU) ($19b) and Reader's Digest Association Inc. (RDA) ($1.6b) seem to say traditional media still has its place, and that traditional companies will adapt to the new paradigm -- overcoming their current "identity crisis." As Natexis Bleichroeder analyst John Roque observed, "A gauge of several newspaper stocks last week began nudging above its 40-week average after declining steadily over 30 months -- a hint the group may have bottomed and could begin to turn around."
Related: Online Ads Steal the Show From Traditional Media • NY Times' Predictions Aside, Click Fraud Won't Slow Online Ad Spending • Reader's Digest Agrees To $1.6 Billion Buyout • Newspapers : Another Slide Coming? • Barron's Buries the Lede on Newspaper Stocks
Vital Signs by Kopin Tan
Highlighted companies: Idearc Inc. (IAR), Verizon Communications Inc. (VZ), RH Donnelley Corp. (RHD), Yahoo! Inc. (YHOO), Google Inc. (GOOG)
Summary: On Friday Verizon Communications Inc. (VZ) spun-off its yellow pages business, called Idearc (IAR), as a dividend to shareholders; IAR shares begin trading on Monday. Directories are often seen as sedate businesses, and under Verizon revenues were declining. Of particular interest, though, its IAR's online directory, SuperPages.com, which had revenues of $200m last year and holds the promise of faster growth; rival RH Donnelley Corp. (RHD) is expanding its online presence. While capturing the online market could mean rate-cuts in the short term, yellow pages' stronghold on local listings give it a stable foundation for expansion. And directory units have been in the radar of LBO firms since 2004 for their stable, growing cash flows. Shares were trading last week at $26.60 on a when-issued basis, but analysts feel they could be worth up to $33, and even $39 in a buyout."When a corporate parent casts off a vexing unit with unpromising growth, the natural inclination is to steer clear of this forsaken offspring. But the yellow pages business Verizon Communications is spinning off may merit a second glance."
Related: Verizon's Idearc Spinoff Looks Good For Shareholders • Trouble Ahead For Verizon? • Verizon Q3 2006 Earnings Call Transcript
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