Driving Down the Middle by Catherine Shu
Highlighted companies: Constellation Brands Inc. (STZ), Continental Airlines Corp. (CAL), AMR Corp. (AMR), Electronic Arts Inc. (ERTS), GameStop Corp. (GME), DaVita Inc. (DVA), Genesis Healthcare Corp. (GHCI), Laboratory Corp. of America Holdings (LH)
Summary: Interview of Will Chester, Chief Portfolio Manager of the Westcore Select Fund. Chester follows and invests in mid-cap stocks, because they're "more established less volatile than their smaller-cap brethren." Stocks he likes: (1) Constellation Brands Inc. (STZ) -- breadth-of-product has helped it capture market in both the restaurant and non-restaurant business. He expects its wine business to accelerate, and likes its beer business too. (2) Continental Airlines Corp. (CAL) and AMR Corp. (AMR) -- has been buying them for the past nine months, in anticipation of substantial industry improvement on the tails of renegotiated labor contracts. (3) Electronic Arts Inc. (ERTS) and GameStop Corp. (GME) -- he has a 9% exposure to video games. Console launches speak of "pent-up demand." (4) Healthcare: DaVita Inc. (DVA), Genesis Healthcare Corp. (GHCI), Laboratory Corp. of America Holdings (LH) -- their common denominator is that they stand to gain from government policy, DaVita through its dialysis which should soon come under serious Medicare, and Genesis should benefit from federal and state programs that offer incentives to companies trying to improve location of care. Stocks he's selling: T. Rowe Price Group Inc. (TROW) -- he likes the company, but feels the current run-up gives it limited further potential.
Related: Stocks With Momentum: Constellation Brands • You Don't Have to be Crazy to Buy Airlines • Electronic Arts: Let the Games Begin! • Electronic Arts' Earnings Exceeds Expectations • GameStop Jumps On Strong Earnings Report • Knee-Jerk Drop in Healthcare May Be Buying Opportunity
Medicine's Cocktail Party by Bill Alpert
Highlighted companies: Vertex Pharmaceuticals Inc. (VRTX), Idenix Pharmaceuticals Inc. (IDIX), Schering-Plough Corp. (SGP), Novartis AG (NVS), Achillion Pharmaceuticals Inc. (ACHN), InterMune Inc. (ITMN), ViroPharma Inc. (VPHM), XTL Biopharmaceuticals Ltd. (XTLB), Wyeth (WYE)
Summary: Hepatitis C virus [HCV] kills over 10,000 Americans a year of an estimated 3,000,000 infected -- 2/3 of which don't know it yet -- and 170 million worldwide. Current treatment involves 6-12 months with interferon and ribavirin (supplied mainly by Roche and Schering-Plough (SGP)), costs over $20,000, cures less than half, and has debilitating side-effects; fewer than 90,000 people a year currently undergo it. Now medical and investment communities are buzzing over drugs in testing that could be more effective and tolerable: offerings from Vertex Pharmaceuticals Inc. (VRTX), Schering-Plough, Achillion Pharmaceuticals Inc. (ACHN) and InterMune Inc. (ITMN) target an enzyme that makes components of the HCV virus; Idenix Pharmaceuticals Inc. (IDIX), ViroPharma Inc. (VPHM), Roche and XTL Biopharmaceuticals Ltd. (XTLB) are testing drugs that sabotage the protein that copies the viral genome. VRTX and its drug VX-950 lead the first race, and its shares have climbed from $10 to $45 over the past 18 months, giving it a rich market cap of $5b. IDIX (56% owned by Novartis AG (NVS)) with its NM283 lead the second race, but its shares are down from a recent $25 to just $8.70 due to gastrointestinal side-effects in patients currently under testing, giving it a valuation of just $500m. While some analysts feel VRTX merits its premium, its current lead giving it "unprecedented opportunity," others argue that the stock could drop once investors realize it will likely be sharing the HCV market with competitors. The latter seems to be the view of the medical community, which is puzzled by the Street's narrow focus on one of many drugs they foresee becoming part of the antiviral 'cocktail' that will ultimately help HCV sufferers. They don't understand, says hepatitis researcher Douglas Dieterich, that the first drug off the block won't necessarily dominate. "This is not a zero-sum game." Liver expert Robert Brown Jr. concurs that Vertex seems overvalued: "I think all the boats are going to float higher."
Related: Searching for Shorts: VRTX • Vertex May Win Race for Hepatitis C Drug • Vertex Pharmaceuticals Q3 2006 Earnings Call Transcript
Who's Afraid of Leverage? Not the Buyout Kings by Andrew Bary
Highlighted companies: Gap Inc. (GPS), Micron Technology (MU), Bed Bath and Beyond (BBBY), Nike (NKE), Liz Claiborne (LIZ) EMC (EMC), Costco Wholesale (COST), Apache (APA), Valero Energy (VLO), Hess (HES), Transocean (RIG), Avon Products (AVP), Kimberly-Clark (KMB), Estée Lauder (EL), KB Home (KBH), DR Horton (DHI), Lennar (LEN), Toll Brothers (TOL), MDC (MDC), Hovnanian Enterprises (HOV), Linear Technology (LLTC), Maxim Integrated (MXIM), Analog Devices (ADI), Altera (ALTR) and Xilinx (XLNX)
Summary: $227 billion of leveraged buyouts [LBOs] have been announced so far this year -- 34% of all merger activity, and nearly double last year's $119 billion (18%). Now pundits say a $50b LBO is possible, making all but the top 60 publicly-traded companies potential targets. Some large companies that could be taken private: Gap Inc. (GPS), Micron Technology (MU), Bed Bath and Beyond (BBBY), Nike (NKE), Liz Claiborne (LIZ), EMC (EMC) and Costco Wholesale (COST). Potential energy targets: Apache (APA), Valero Energy (VLO), Hess (HES) and Transocean (RIG) -- low price/earnings multiples healthy cash flow make them attractive. Consumer stocks: Avon Products (AVP) has been the subject recent rumors; a Merrill Lynch analyst placed Kimberly-Clark (KMB) and Estée Lauder (EL) at the top of a list of companies that would benefit from the greater financial leverage LBO's bring to the table. Homebuilders: Almost every one has been mentioned as a candidate, including KB Home (KBH), DR Horton (DHI), Lennar (LEN), Toll Brothers (TOL), MDC (MDC) and Hovnanian Enterprises (HOV). Technology: cash-rich analog semiconductor companies like Linear Technology (LLTC), Maxim Integrated (MXIM) and Analog Devices (ADI), as well as Altera (ALTR) and Xilinx (XLNX) are prime targets in an industry that has the healthiest balance sheets of any. But LBO firms are playing with OPM (other people's money) -- many LBO firms buy companies with 35% cash and 65% debt -- and the boom could get ugly if financing dries up.
Related: Takeover Chatter Around Marvell, SanDisk • Fitch: Convergys, CA and Dell Are Buyout Candidates • Five Semi Equipment Buyout Candidates • Investment Banks Have Too Much Money On Their Hands • Bond Bull Funding of LBOs -- No End in Sight
Highlighted companies: Bank of America Corp. (BAC), Wachovia Corp. (WB), Morgan Stanley (MS)
Summary: In early 2005 Barron's published a skeptical piece on Bank of America (BAC). Now they say, "We were wrong; the stock has rallied 16% since then, outperforming not only its financial-services peers, but the broader market, too." BAC's $3.3b buyout of U.S. Trust looks good: its acquisition of a solid name in wealth-management is likely to lift Bank of America's private banking efforts. With combined assets under management of $328 billion, BAC goes to fifth from ninth in Barron's 2006 rankings of the top wealth management firms in the U.S., just ahead of Wachovia (WB) and just behind Morgan Stanley Global Wealth Management. Analysts say the deal demonstrates the bank's willingness to draw on outside expertise to boost key portions of its business, leading a top CIBC analyst to lift her price target on Bank of America's stock to $65 from a previous $59 (shares closed Friday at $54.56). BAC currently trades for 11 times 2007 estimated earnings of $4.94 a share and yields a rich 4.10%, "which ought to keep shareholders happy as they wait for the latest purchase to pay off."
Related: Bank of America , Citibank Takeover Targets On Paper Only • Bank of America Acquires U.S. Trust in Bid To Lure the Uber-Rich • $1.5 Billion Ruling Against Bank of America Overturned • Bank of America Accelerates Free Trading: Time to Short Ameritrade, E-Trade and Charles Schwab?
Highlighted companies: Avon Products Inc. (AVP)
Summary: At $33 Avon Products Inc. (AVP) is up 16% since March. Much of the gain has been due to rumors of an impending leveraged buyout. Q3 results were mixed: total sales were up 9% ($2.1b), but only 4.5% after stripping out the effects of foreign-currency translation and an acquisition. Even the lower figure beat the company's guidance and encouraged investors. But net income fell 47% ($86.4m) and EPS fell to $0.19 cents from $0.35 -- results were hurt by $56m in restructuring charges and a $21m one-time tax increase. Bulls hope restructuring charges will cool off by 2007, allowing earnings to improve. As far as the LBO rumors, it's no sure thing. Barron's: "It's tough to see how a buyer, financial or strategic, could earn an adequate return on investment," seeing as the company already trades at 11.6x Ebitda; consumer sector buyouts have been going for 12x. And the Federal Trade Commission has proposed new rules for multilevel marketers that could take a heavy toll from Avon value if approved. "At 21 times 2007 estimated earnings of $1.61 a share, we see little upside left."
Related: LBO Fever -- Barron's Look at Who May Be Next • MLM Legislation Ignites Short Sellers • Avon Misdirects Ad Spending • Avon Q3 2006 Earnings Call Transcript
Highlighted companies: Snap-on Inc. (SNA)
Summary: In April 2005 Barron's went positive on Snap-on Inc. (SNA) based on new CEO Jack Michaels accelerating SNA's lackluster restructuring, improving operations, and utilizing dealers better; since then shares are up 55%. Q3 sales ($600m) were up 8% and EPS ($0.48) were up 33% and beat analysts' estimates of $0.43. At $47/share, they're trading at 21x 2007 estimated earnings of $2.30. The downside: A weakening economy could take a toll on industrial sales, and dealer sales have not picked up. SNA recently announced a $500m acquisition of ProQuest Business Solutions, which provides tracking software for car companies and dealers and fits well with Snap-on's diagnostic- and information-services group, but may pose "growing-pain" integration problems; conversely, its high-margin business could easily add 10-20 cents to earnings. Margins are up to 7.7% from 6%, but still have plenty of upside before hitting Michael's 10% goal. Bottom line: "If Snap-on can achieve a 10% operating margin, it's easy to envision the company earning north of $3 a share, and its stock climbing to the low- to mid-50s in the next year or so."
Related: Will ValueAct Capital Add Some Snap to Snap-On Inc. ?
A Battle Dripping With Irony by Neil A. Martin
Highlighted companies: ASM International (ASMI), Mellon Financial Corp. (MEL)
Summary: The Mellon hedge fund (MEL), which owns about 8% of ASM International (ASMI), wants the company's to spin-off its money-losing chip-making operations from its highly profitable semiconductor-assembly and packaging-equipment division. Hedge-fund chief Mickey Harley: "Failure to achieve long-promised synergies between the two businesses has eroded investors' confidence." He claims to have the support of 30% of shareholders. Arthur del Prado, president and 22% owner of ASMI, says he wants to maintain the integrity of ASMI's two main operations, especially since its chip division recently went profitable: "To split the company now would be to squander our investment over the years and seriously jeopardize the continued release of value from our chip-equipment-making operations." Tomorrow the two sides will face-off at an extraordinary shareholders meeting Monday near Amsterdam. Even if Mellon activists carry the day and the nonbinding resolution is approved, indications are that management will reject it, forcing a court-battle. Barron's: Regardless of what happens, holders of ASMI should be winners: ASMI shares closed Friday at $21.34, a 52-week high. The chip-equipment division is now profitable, and new digital technologies promise gains; continuing profitability should fuel the stock price -- bulls see another 10%-to-15% rise over the next year. And if the chip operations are sold, that would produce some sort of payout for shareholders.
Related: More Proof Semis Headed in Right Direction • Jim Cramer's Take on MEL
In China, Multiple Mobile-Phone Winners by Jon Ogden
Highlighted companies: China Mobile Limited (CHL), China Unicom Ltd. (CHU), China Telecom Corp. Ltd. (CHA), China Netcom Group Corp. (CN)
Summary: With 400 million subscribers China's mobile-telecom market is the biggest in the world. Yet it houses just two players: China Mobile Limited (CHL) and China Unicom Ltd. (CHU); both are listed in Hong Kong and have American depositary receipts trading in New York. China Mobile is the dominant provider, yet remains a "growth company," piling up profits, cash and new subscribers at a rapid rate. In September, for example, CHL added 4.5m million subscribers (78.4%), taking its client base to 287 million. CHU has suffered since being saddled by the Chinese government with the task of running two separate networks, one based on the European GSM standard, the other on the U.S. CDMA standard. The next big opportunity in China is in the countryside, where people are just beginning to be able to afford mobile phones. Estimates are that only 12% have mobile phones, compared with 60% in the cities; analysts project up to 600 million new rural subscribers in the next few years. China Mobile should win most of these customers because Unicom doesn't have the resources to build two separate networks in the countryside, and has decided to focus on cities. CHL's downside: (1) How much of its strength is already priced in? (2) Will the government license new competitors? Many say for sure one, possibly two. (3) Will CHL be forced by the government to roll out China's unproven third-generation TD-SCDMA technology? The upside of CHU: (1) Some traders are speculating that Unicom's two networks will be sold off to fixed line companies China Telecom Corp. Ltd. (CHA) and China Netcom Group Corp. (CN), and CHU shareholders could get HK$10 for their shares (currently worth HK$8.47). (2) The possibility that CHU will sell one network, allowing it to focus on the other. Barron's: "The dominant provider is still a strong long-term prospect, though its weaker rival could be worth a side bet."
Related: China Netcom Embraces Corporate Governance • How to Play the Delay in China's 3G Rollout • Seeking Alpha's China Telecom/Wireless Site • Jim Cramer's Take on CHL, CHU
Google: 500 Reasons to Worry by Jacqueline Doherty
Highlighted companies: Google Inc. (GOOG), Yahoo! Inc. (YHOO), IAC/InterActiveCorp (IACI)
Summary: Barron's was (wrongly) skeptical about Google Inc. (GOOG) stock at $360; yet it's even more wary today. Google now has the 15th biggest market cap in the U.S., and its P/E ratio (close to 40) is 3x comparable companies'. Earnings estimates for 2007 are $13.70 (+33%), which looks great, but is actually weak compared to 2006 growth of 81% -- and the 2007 number ignores $1/share of stock option expenses and gives earnings-credit of $1/share for interest earned on GOOG's $10b stash of cash. U.S. search revenue growth, its mainstay, was down to 6% growth q/q in Q3, compared to double-digit growth a half-year ago. Competitors Yahoo! Inc. (YHOO) and Ask.com (owned by IAC/InterActiveCorp (IACI)) grew search volume (30% and 25%) by more than GOOG (23%), resulting in a market-share slippage to 49.6% from 50.2% in August. The average price per search keyword is down 11% since the beginning of the year and 34% since April 2005. Net revenue should rise 81% this year, but R&D will go up 133%, sales and marketing 96%, admin expenses 119%, and capital expenditures 129% (to $1.9b), meaning GOOG must continue to grow revenues rapidly to keep up with its spending. A setback in consumer spending, if it materializes, will hurt advertising revenues. "Could Google have a great fourth quarter? Sure. Could the shares soar if it decides to split its stock? Definitely. But, at some point investors will focus on the company's slowing growth rate and bloated expenses. And when that happens, look out below."
Related: How Google Slips To $100 a Share - And Stays There • Google, Yahoo Gain Search Share at MSN's and AOL's Expense • AmTech Likes Yahoo In 2007 • Morningstar: Google Earnings Growth To Settle At 28% • Lessons From Google's Big Run • Jim Cramer's Take on GOOG
Yum by Kopin Tan
Highlighted companies: Yum! Brands Inc. (YUM), McDonald's Corp. (MCD), Chipotle Mexican Grill Inc. (CMG), Starbucks Corp. (SBUX)
Summary: Shares of Yum! Brands Inc. (YUM), which owns KFC, Pizza Hut, Taco Bell, A&W and Long John Silver's, have soared 43% since Aug. 1, more than twice the average of other restaurant stocks and 4x the S&P 500. Up its sleeve: A new KFC logo (with a trimmer colonel), a resuscitated Taco Bell, and plans to turn around a "flat" Pizza Hut chain including a co-branding scheme to sell WingStreet wings together with pizzas. But it's YUM's China foray that has investors buzzing, with 22% projected growth (compared to 10% worldwide and 5% domestic) Yum has 3x McDonald's Corp.'s (MCD) presence in China. But in the short-term YUM may have a hard time producing numbers that can "wow" the Street, having already touted its China growth (which still only accounts for 24% of its 2007 projected revenues) in a September analyst meeting, and the Pizza Hut turnaround presently a long-term project. It is already at 20x earnings -- the top of its range. Given the poor odds for a short-term surge to the upside, and how expensive YUM options are, GS strategist John Marshall suggests selling out-of-the-money calls against the stock to pad yield.
Related: Are Yum!'s China Margins Sustainable? • Yum!'s Quarterly Call Focuses on KFC, Pizza Hut & New Businesses in China • Yum! Localizes China Fast Food Strategy • Jim Cramer's Take on YUM • Yum! Brands F3Q06 (Qtr End 9/9/06) Earnings Call Transcript
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