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Market Shadows: Group of writers and investors: Paul Price, Lee Adler, and Ilene.
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  • Baxter's Spinoff
    Baxter's Spinoff


    Baxter International (NYSE:BAX) is splitting off its BioSciences division into a new company called Baxalta. Shares of Baxalta will be given as a tax-free dividend, in the ratio of one to one, to BAX holders on record on June 17, 2015. That means, if you want to receive the Baxalta dividend, you need to buy the stock this week (on or before June 12).

    The Baxalta Spinoff

    In its recent filing with the SEC, Baxter provides:

    "This information statement is being furnished in connection with the distribution by Baxter International Inc. (Baxter) to its shareholders of approximately 80.5% of the outstanding shares of common stock of Baxalta Incorporated (Baxalta), a wholly owned subsidiary of Baxter that will hold directly or indirectly the assets and liabilities associated with Baxter's biopharmaceuticals business. To implement the distribution, Baxter will distribute approximately 80.5% of the shares of Baxalta common stock on a pro rata basis to the Baxter shareholders in a manner that is intended to be tax-free for U.S. federal income tax purposes."

    "As a result of the separation, each Baxter shareholder will receive one share of Baxalta common stock for every Baxter share of common stock held on June 17, 2015, the record date for the distribution."

    Trevor Lowenthal at Lowenthal Capital Partners, Paul Price and I have been reviewing Baxter and its upcoming spinoff of Baxalta. We believe that the spinoff will unleash value from the Baxalta BioScience division of the company and that the sum of the BAX parts will prove to be greater than the whole. Baxalta should benefit from growing market penetration for Advate, the number one selling therapy in its hemophilia franchise, along with the approval of important new products. This should enhance long-term value for current BAX shareholders as Baxalta's new products hit the market and as the independent company gets priced more in line with its growth prospects.

    In April, Trevor Lowenthal shared his thoughts on BAX in Going Long On Baxter For An Optimistic 2016. To summarize:

    • Baxter has experienced several lackluster quarters, but the company's revenues are growing and its positive outlook is intact.
    • The Baxalta spinoff in June should drive future shareholder value.
    • While Baxter's core Medical Products business is not growing at the desirable rate, Baxalta is doing well. In addition, Baxter's acquisition and integration of Gambro's dialysis product line should add revenue to its core business in the future:

    (click to enlarge)(click to enlarge)

    (click to enlarge)

    [Images from Baxter's Note to Shareholders]

    "Baxter's acquisition of Gambro has provided it with significant earnings growth potential. Notably, Gambro's dialysis products generated $1.6 billion for Baxter in 2014… With over 2 million dialysis patients worldwide and a projected 5 percent annual rate of increase, Baxter's growing dialysis franchise should continue to add market share. This is already evidenced by the fact that from 2013-2014, revenue generated from Gambro's product line increased from $513 million to $1.6 billion… While it is difficult to predict what revenues will be generated from Gambro products in a few years time, we think it is safe to assume that revenues will increase coinciding with the growing overall demand for dialysis products worldwide.

    "With the Gambro acquisition, Baxter has outlined a five-year plan to increase sales by 7% to 8% on a compounded annual basis."

    Trevor concludes that the high $60s is a reasonable buy level for BAX. (Today's price is slightly lower than Trevor's wait-to-buy price, as BAX closed on Wed., June 10, at around $66.)

    (click to enlarge)

    Not hedging

    Paul Price is also bullish on BAX and has been been buying shares and selling puts. In discussing the valuation of BAX, Price writes:

    "On its own, Baxalta should command a higher multiple than it does as part of the more mundane medical products company. It is likely that the sum of the parts will be worth more than the whole.

    "Both Morningstar and Standard & Poors see BAX with 4-star (out of 5) BUY ratings. Each sees fair value above today's quote [around $68/share, May 20].

    "Standard & Poors noted Baxter's top 1% 'invest-ability' ranking which is in harmony with Value Line's view. The only thing lacking had been the absence of a sustained share price increase. I believe management is spinning off the glamour part of the business to finally accomplish that missing link.

    "Owning BAX today is like getting a free lottery ticket on Baxalta. At worst the combined valuation figure to stay about level. A best-case scenario could see a nice pop once the companies separate."

    (click to enlarge)

    Morningstar, Standard & Poors and Value Line charts courtesy of Paul Price.

    Investment/trade ideas

    Buy the shares. We think BAX and its spinoff at $66/share is priced well right now. We prefer not to write calls which would limit our upside.

    Sell puts. As a long-term speculation, selling the Jan. 2017 puts gives BAX some time to reach its higher potential. Here are two ideas:

    1) Selling one January 2017 put with a strike price of $60 will bring in approximately $3.75 per share and obligate you to buy 100 shares of BAX for $60 if the stock trades below $60 on the put's expiration date, Jan. 20, 2017.

    Worse case scenario: if BAX is below $60 on the expiration date, your net cost will be $56.25 per share for 100 shares of BAX. You will only lose money if BAX is below $56.25 - your breakeven point.

    Best case is if BAX is at $60 or above on expiration, in which case you keep the $3.75 per share ($375 total) with no further obligation.

    2) Here's an idea from Phil Davis of Phil's Stock World: Sell a January 2017 put with a strike price of $57.50 for about $3.30, which is as much as the dividend would be over the same period, but you don't have to bother owning the stock and you have a built-in 10% cushion to the downside.


    Disclaimer: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Market Shadows, Lowenthal Capital Partners, PSW Investments, LLC d/b/a PhilStockWorld (NYSE:PSW), Paul Price, or Ilene, or affiliates, warrant its completeness, accuracy or adequacy and it should not be relied upon as such. None of the above contributors are responsible for any errors or omissions or for results obtained from the use of this information. Past performance, including the tracking of virtual trades and portfolios for educational purposes at PSW, is not necessarily indicative of future results. None of the contributors to this article are financial advisers, and they may hold positions in the stock mentioned, which may change at any time without notice. Do not buy or sell based on anything that is written here, the risk of loss in trading is great.

    This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities or other financial instruments mentioned in this material are not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only intended at the moment of their issue as conditions quickly change. The information contained herein does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before investing, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

    Tags: BAX, Spinoff
    Jun 12 2:25 PM | Link | 2 Comments
  • Ben In A Box

    Ben In A Box

    Courtesy of John Nyaradi of Wall Street Sector Selector

    After nearly five years of quantitative easing, Ben Bernanke and his Federal Reserve now find themselves in a box.

    For several years, the only game in town has been "The Reflation Trade," engineered by the U.S. Federal Reserve's quantitative easing program and the Fed's unprecedented effort to jumpstart the U.S. economic recovery. Now it seems that Dr. Bernanke wants to dial back the $85 billion/month in bond buying but finds that market forces and current conditions have him trapped in a spot from which there might be no escape.

    Regarding the potential end of quantitative easing, Warren Buffett has said it would be the "shot heard round the world," and markets got a little taste of what that world might look like when Ben made comments in May that sent markets on a wild ride.

    Equities dumped, gold dumped, interest rates spiked as investors contemplated just the possibility that Ben might pull the punchbowl away.

    Since then, we have seen a parade of Fed Presidents and even the Chairman, himself, saying, in effect, that they were "just kidding" and that their easy monetary policies were here to stay for a long, long time. Clearly, the trial balloon regarding the end of quantitative easing went over like a lead balloon.

    Today's unfortunate situation:

    1. The Fed can't withdraw easily from quantitative easing, if at all. Markets have made this more than clear with the sharp response to even the hint of quantitative easing coming to an end, i.e., the "taper tantrum." All recent market action reflects today's environment which is all about the Fed. Recent assurances that the easy money would continue have been successful--major indexes are now back at levels last seen before Dr. Bernanke's first comments.

    2. The Fed has to withdraw from quantitative easing eventually. The long run of easy money has created asset bubbles and is laying the framework for higher inflation. Continuing down the current path will only make the eventual withdrawal even more painful and dramatic.

    [Economatters argues that QE Policy has been a failure when it comes to the economy, anyway. The economy is not the stock market... Lee Adler predicts "Bernanke will eventually go down as the most reviled Fed chairman in history."]

    3. The Fed is quickly descending into confusion and disarray. Last week saw yet another Bernanke Rally triggered after his mid-week comments, while Friday saw dueling Fed Presidents Charles Plosser and James Bullard presenting conflicting views of "to taper or not to taper." In between, Fed Governor Elizabeth Duke, resigned and her departure further muddies the waters. On top of that, it's now becoming widely accepted Dr. Bernanke will also be leaving the scene when his term expires in January and markets will be eagerly watching to see who his replacement will be. The first hint of this came when Dr. Bernanke announced that he wouldn't be attending the Fed conclave in Jackson Hole in August which is like Santa Claus missing Christmas, and any uncertainty regarding his successor will likely be met with significant volatility in global markets.

    This confusion and disarray within the Fed could prove to be dangerous should investors lose faith in the central bank's seemingly invincible power. The markets will continue to be whipsawed by Fedspeak and "taper talk" and we're due for another significant round this week when Dr. Bernanke treks up to Capitol Hill on Wednesday and Thursday for testimony before the House and Senate.

    So "Ben in a Box" presents the potential for danger as well as opportunity. We've already witnessed the adverse reaction from markets as they threw a temper tantrum at just the thought of the easy-money punch bowl running dry. One can only imagine what market reaction might be if and when the $85 billion per month in Federal support actually starts seeping away.

    Over the past several years, "buy the dip" has been the name of the game, but there could soon be a new game if Ben can't get out of the box and a new age of austerity and even recession is at hand.

    Put options: Just because the "Bernanke Put" might be history, doesn't mean you can't go out and buy your own to protect profits or hedge against potential downside moves.

    Inverse/bear ETFs and mutual funds: Bear ETFs and mutual funds are designed to help investors avoid the risks of falling markets and might also offer downside hedges to long positions should the market continue its recent decline.

    Cash: Cash is the ultimate hedge in times of stress, and when markets go south in a big way, cash is always king.

    U.S. dollar/Treasury bonds: While there will be few safe havens if things get really ugly, the U.S. dollar and U.S. Treasury bonds will most likely be the ultimate flight-to-quality trade. The United States might be a passenger on the Titanic, but it will be the last passenger to drown. If Titanic goes down, we can only hope that the Carpathia will arrive in time.

    I think the easy money party will be coming to end soon, and that Dr. Ben is set to turn out the lights. We'll find out more this week, but no central banker in history has ever attempted to do what he is doing, and nobody can know how this will turn out. But, as always, danger and opportunity arrive hand in hand, and this time will be no different.

    Wall Street Sector Selector remains in "yellow flag" status, expecting a high risk environment ahead.


    For another view on the death of QE and the Treasury market, see Lee Adler's No, Joe, No One Owes Bernanke An Apology.

    John Nyaradi and Lee Adler present somewhat similar views of Chairman Bernanke's unprecedented QE policies. However, their projections of how the game will end are different.

    John speculates that cash and Treasuries will be the last refuge for investors when the SHTF (Ben In A Box).

    Lee believes that Bernanke's foolhardy actions will torpedo the bond market. "As a serial bubble blower, he already should be, but he has Joe Weisenthal and the rest of the Fed apologist crowd spinning the facts and misleading people prone to believe in the tooth fairy, Santa Claus, and helicopter money as a cure for economic ills. Their illusions will face a day of reckoning soon. As the collapse of the US Treasury market, the greatest Ponzi scheme of all time, progresses, it will reach an inflection point that will take the stock market bubble, the latest housing bubble, and the economy with it. Bernanke's legacy will be sealed once and for all." (No, Joe, No One Owes Bernanke An Apology).

    Paul Price of Market Shadows votes to avoid bonds: "Holders of long-term bonds are taking huge risks. A 1% rise at the long end of the yield curve could send 30-year bond prices down 17%. A 2% increase could drop principal values much more. Years of coupon payments could be wiped out on a total return basis." (Death by Leverage.) Paul has no idea of when the bubble will burst, but believes that it will.

    What do you think?

    Picture via: Jr. Deputy Accountant

    Jul 16 9:14 PM | Link | Comment!
  • Say Hello To Inflation, Inflation Is Dead
    Say Hello to Inflation, Inflation is Dead

    By Paul Price with Intro by Ilene

    Quantitative easing (QE or "money printing") will continue despite Bernanke's rhetoric about cutting back. (See Don't Fear the Taper). Funding trillion dollar annual deficits requires monetization of debt. America is almost $17 trillion in debt. Interest rates rising just a few ticks closer to their long-term, normalized levels, would be an insurmountable strain on future budgets.

    Admitting the true rate of inflation would trigger Cost of Living Adjustment (COLA) raises for government workers, pensioners and social security recipients. Private sector unionized labor and nonfederal government employees would likely demand raises too. Bond buyers would insist on higher coupon rates.

    Our leaders have sacrificed integrity over fixing the underlying problems. Paul Price discusses the situation in Inflation Will Never Go Up Again. In his view, there is no plausible exit strategy from QE without risking societal breakdown as lifelong promises get broken (pensions, salary adjustments and social security payments). Civil uprisings have already occurred in Greece, Iceland and Cyprus. The masses are rebelling in Egypt today. The U.S. has avoided riots because QE is holding interest rates artificially low. The Bureau of Labor Statistics' (BLS) manipulation of Consumer Price Index (NYSEARCA:CPI) allows the government to pretend inflation is not serious. When the public realizes the true extent of inflation, bond buyers will likely demand much higher coupon rates pushing up the government's cost of debt service dramatically.

    Inflation Will Never Go Up Again

    By Paul Price

    Really? My health insurance premiums have skyrocketed. My kids' pre-college and university tuitions have been ramping up. The cost of filling my gas tank has soared. Shiny new menus at restaurants mean higher prices - cash-strapped operators do not print them just to offer exciting new entrees.

    Obamacare's implementation will make matters worse. Franchisees won't be able to absorb the added cost of healthcare coverage, or the $2,000 per worker penalty. This expense will be passed along as higher prices.

    Despite these anecdotal experiences and predictions, the government's Bureau of Labor Statistics (BLS) tells us each month that the Consumer Price Index (CPI) is barely above neutral year-over-year. It all comes down to how 'inflation' gets defined.

    People generally think of annual inflation as the cost of a basket of goods and services today versus the cost of the identical basket one year earlier. While that makes sense, it is NOT what the BLS measures and reports.

    If you want the details of the BLS report, read the fine print (below). The CPI-U is said to represent the index for all urban consumers.

    (click to enlarge)

    Core CPI specifically excludes food and energy costs, reflecting reality only for people who don't move, eat or buy any products requiring transportation.

    Rapidly rising income, property and sales taxes are not included in any of the BLS inflation numbers. Taxes add to the cost of living.

    I traveled to Iceland last September. Part of that country's post-2008 crisis management was the imposition of a 25.5% VAT (value added tax) on almost every retail purchase. Paying 25.5% in sales tax means each Krona can buy only 74.5% of the currency's face value in real merchandise or services. Money unspent does not go towards paying VAT. But never spending money is the same as not having it.

    Iceland imposed currency controls due to its banking industry failure. Citizens cannot move their wealth outside of the country; they cannot buy non-Kronur denominated securities without prior government approval. In practice, Icelanders will either pay the prohibitive 25.5% tax or forfeit spending their already-taxed earnings.

    The same plan, with slightly lower rates, is in effect all over the Eurozone. When VAT rates move higher, inflation - defined as the cost of living - increases. (Imposing a national sales tax in the U.S. is a terrible idea. Taking money away from those who need it or could use it productively, and giving it to government, will allow politicians to do more damage. Deficits and spending won't drop.)

    As an aside, 'temporary' taxes are rarely temporary. The June 29, 2013, Philadelphia Inquirer recounted the story of the Johnstown Flood Relief tax of 1936. A 10% surcharge on all alcoholic products was levied to help the townspeople. 76 years later the tax has risen to 18% and is built into all Pennsylvania liquor sales. None of it is earmarked for Johnstown. The hidden tax is part of the final retail price that then becomes subject to PA's state level 6% sales tax. After compounding both taxes, the final cost is 19.08% at the register. The price of booze is not included in official inflation lists even though government policies may be driving us to drink.

    Excluding food, energy and taxes from core CPI allows the BLS to understate increases in the true cost of living. After high inflation years in the late 1970s, the government changed how it calculated CPI. This happened again in 1990. Each time, the BLS manipulated the measurement techniques to downplay the extent of cost increases. This lessened the government's need to increase Cost of Living Adjustment (COLA) applied to employees and retirees.

    The excellent ShadowStats website provides monthly updates on what CPI would read if the rules were still the 1980 rules. The difference is startling.

    (click to enlarge)

    Some BLS tricks are even more devious.

    The BLS uses other tricks to lower reported inflation rates. The 'substitution principle' says that when the price of a particular item, e.g. rib-eye steak, rises, consumers will switch to lower-priced alternatives like ground beef. Under that scenario a 20% rise in rib-eye steak prices disappears completely if it can be offset with ground beef costing 20% less. If Lexus or Porsche MSRP's go up 30%, it doesn't matter because the consumer can buy a Kia or Hyundai instead. No inflation adjustment required.

    Our leaders also call improvements in quality with unchanged pricing 'deflationary'. The first iPads were crude by today's standards but cost $600. The newest iPad with Retina Display still costs $600 but packs more power and features. The BLS counts that as a drop in price even though the price is the same.

    Until consumers are walking to work and eating cat food, the substitution principle allows the BLS to call CPI anything it wants.

    A real-world consumer poll showed very large increases in the out-of-pocket cost of living over the period from Q1 2001 through Q1 2013. The official change in CPI is almost invisible over that same period.

    (click to enlarge)

    Anyone who pays their electric, tuition or grocery bills, or funds their own health insurance plan, is painfully aware that the CPI and CPI-U numbers do not reflect reality.

    The cost of living has been rising at a fast pace. Inflation, as measured by the CPI, will never go up significantly unless politicians abandon their deceptive practices. Unfortunately, Washington D.C. has a strong interest in keeping the public uninformed.

    (Featured in Market Shadows Newsletter, Fables and Fairy Tales. Also in the newsletter: The Crow and the Pitcher, Paul's recent selling of puts, an indicator turning bullish, Lee Adler with data on bond buying/selling, and more.)

    Jul 05 8:13 PM | Link | Comment!
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