Seeking Alpha
Profile| Send Message|
( followers)  

In a few years, Paulson & Co. has catapulted itself from relative Wall Street anonymity into the upper echelon of finance. In its most recent 13F filing, Paulson & Co. reported long equity positions worth $34.27 billion. With such a large asset base, the fund's portfolio decisions are market-moving news.

Here is a list of companies that investors should take a closer look at. We think they could be great additions to the Paulson & Co. portfolio.

1. American International Group (AIG) - Negative headlines have swirled around AIG since the financial crisis. While there continues to be a negative perception, the U.S. government commencement of its plan to divest its 92% stake in the insurer is a possible turning point. In the meantime, Paulson & Co. has likely welcomed the recent sell-off from around $52 (adjusted for the warrant) to less than $30 this year. The best investments are often made during the depths of market sentiment and it is under these conditions that investors could finally step up to purchase AIG.

AIG has risks, but it's a cheap stock. With a price/book ratio of 0.61, it trades at a discount to other Paulson holdings like MetLife (MET), which has a price/book of 0.93 and trades in line with Hartford Financial Services Group (HIG), which has a price/book of 0.58. Because of AIG's size and diversity of businesses, it would be plausible for AIG to eventually trade at a premium to these other competitors once investors become more comfortable with the insurance giant's future prospects and underwriting.

In 2010, nearly half of AIG's revenues came from its Chartis property and casualty business. Chartis' own revenues have global reach. In 2010, only 54% of revenues were from the U.S. and Canada. Among the rest, 18% of revenues were from Asia, 18% from Europe and 10% from developing economies. Total revenue growth at AIG has struggled in recent years because of decreased premiums written, decreased investment income and increased capital losses. But AIG trades at such depressed levels that the company does not necessarily need revenue growth for meaningful upside in the near future. Modest revenue changes could actually be seen as a positive if the insurer is seen as sacrificing top line growth for better underwriting.

There is no doubt that AIG has less earnings power post-crisis. In order to repay the government, AIG sold off prized assets that included a global life insurance operation, Colombian assets, Japanese life insurance assets as well as a large stake of American International Assurance through an initial public offering. But critics make a common mistake by assuming that being worth less is the same as being worthless. This is not true. Even after the asset sales, AIG has a tremendous international insurance business.

Paulson & Co. has been one of the gutsiest funds in the marketplace. During the housing bubble, it bravely stood against the crowd and in troughs of the financial crisis, turned aggressively bullish during the stock market lows. Once again, Paulson & Co. has an opportunity to flex its contrarian conviction by making a large investment in the distressed insurer. Paulson & Co. is very comfortable with distressed financial names. In addition to Citigroup (C) and Bank of America (BAC), it also owns a large stake in Hartford Financial Services Group.

2. Apple Inc (AAPL) - Hewlett-Packard (HPQ) was one of Paulson & Co.'s largest recent acquisitions. The technology company has struggled under current market conditions to expand its its personal computing business and develop its software operations. Following Mark Hurd's tenure aggressively cutting costs, the new CEO is believed to be shifting the focus on growth through acquisitions. As we previously wrote about Hewlett-Packard's hidden risks, it is a value stock based on previous earnings, but management's delusion of past high growth grandeur almost ensures future shareholder value destruction.

Apple offers a sharp contrast to HPQ. Despite a sharp contrast in market sentiment between HPQ and AAPL, it is hard to ignore that both companies trade at low valuations relative to their trailing and expected performance. While Hewlett-Packard struggles with the personal computing segments, Apple is clearly the global industry leader.

Apple seems to present a stunning investment opportunity. Not only does it trade at a trailing P/E of 16.07 and a forward P/E of 11.80 (before adjusting for excess cash), the company produces profit margins of 22% and returns on assets of 20%. In addition, the company's revenues have grown sharply and consistently over the past few years despite new product launches. Over the last 12 months, Apple's sales have soared to $85.7 billion from $65.2 billion in fiscal year 2010, $42.9 billion in fiscal 2009 and $32.5 billion in fiscal 2008. Technology is a face-changing industry. As such, many successful investors avoid the industry all together (like Warren Buffett), but Paulson & Co.'s stake in HPQ illustrates its willingness to invest in technology.

3. Dell Inc (DELL) - Inspired by Paulson & Co.'s investment in Hewlett-Packard, we think the hedge fund could also see value in DELL shares. The well known computer and technology company was one of the best returning stocks during the mid to late 1990s. But since then the company has had a hard time replicating its success. To add insult to injury, investors have naturally tried to juxtapose Apple's meteoric rise against Dell's relative stagnancy. Despite these perceptions, DELL offers interesting opportunities and at the current valuation, they appear to be a good investment.

DELL trades at a trailing P/E of 9.45 and a forward P/E of 8.27. It has a price/sales of 0.49 and a return on assets of 7.15%. This actually offers a slight discount to HPQ, which has a price/sales of 0.62 and a return on assets of 6.92%. DELL could continue to improve sales and profitability as it expands its enterprise services business, which grew from $5.35 billion in fiscal 2008 to $7.67 billion in fiscal 2010. In addition, DELL offers interesting growth in cloud computing. According to Bloomberg, it provides 70% of servers for U.S. data centers and about 60% of servers in Chinese data centers. With these factors in mind, DELL appears to be a cheap stock with lots of upside potential.

4. Cisco Systems (CSCO) - The networking and technology giant has struggled to find new growth opportunities, but at current valuations, it is every bit as interesting as Hewlett-Packard.

CSCO trades at a trailing P/E of 12.85 and a forward P/E of 9.51. While its return on assets is a pedestrian 6.75%, its profit margins are more than 15%. This discrepancy is attributed to its more than $40 billion of cash and investments and excess liquidity of closer to $25 to $30 billion. Excluding this "excess liquidity," the tech giant trades at a trailing P/E of around 8.9 and a forward P/E of around 6.7. Considering CSCO's market leading position and higher margin business, it is reasonable to argue that CSCO is a better relative value than HPQ.

5. EXCO Resources (XCO) - The natural gas company is the subject of a management led buyout offer. Considering that John Paulson cut his teeth as a risk arbitrage specialist, the fund could view XCO as an interesting investment opportunity. The stock currently trades modestly below the $20.50 per share cash offer. Not only does XCO offer a risk arb spread, there is also potential for upside if management increases its buyout offer or if another party steps in with a competing bid. If for no other reason, Douglas Miller could increase his bid to ensure that the buyout is completed since a failed bid may lead to his eventual ouster from the company.

There are several potential catalysts that favor investors. First, in July 2010, the company offered investors a presentation that estimated EXCO Resources' NAV at $25 to $37 per share. It continued by saying that if natural gas prices increased to $5 to $6, the NAV price could rise to $50 to $60. In addition, institutional investors have swarmed the stock. Wilbur Ross purchased a 7.5% stake in the company at an average price of $18.53 shortly after the buyout offer was announced.

Douglas Miller has previously stated that he hopes for a resolution by July 4, 2011. This presents a short window that potentially produces a healthy annualized return.

Summary

The companies listed above are only the result of speculation on our part. We can't be sure that the companies are of any interest to Paulson & Co., but based on its current holdings we think we have compiled a good list of candidates.

Source: 5 Stocks That John Paulson Should Buy