The War for Potash
Posted by Eddy Elfenbein on August 23rd, 2010 at 10:39 am

If it’s Monday and it’s 2010, then the market is probably up and wouldn’t you know it, it is! Right now, 19 of our 20 Buy List stocks are trading higher and Nicholas Financial (NICK) is unchanged with just 100 shares traded. Once again, the cyclical stocks are trailing the overall market. I think that’s going to be a major theme going forward.
The big news today is that Potash (POT) has officially rejected the $39 billion buyout bid it got from BHP Billiton (BHP) last week. Now Potash is looking around for a “white knight” to rescue them, but it won’t be easy. Billiton’s bid is $130 per share which is pretty rich. The Street expects Potash to make $5.50 per share this year, so the BHP bid is 23.6 times that. Plus, you know the old saying, “$39 billion in hand is better than nothing in the bush.” Interesting tidbit: In any deal, Potash’s CEO will walk away a cool half billion. That’s not bad for saying “yes.’
What will Potash do? Beats me. Maybe some private equity guys will link up. Maybe the Chinese. Maybe the Brazilians. It’s an open game. I also think Billiton will up their bid just to play nice because they may go hostile.
Honestly, I’m not so interested in who will win but who’s willing to play. I still think that the bond market has far outrun the stock market so we should be seeing more aggressive plays like this. The Potash bid is good for the market and I’d like to see some more players join in.
We saw almost the exact same story three years ago when Billiton went after Rio Tinto (RTP), who had just snagged Alcan. Rio shot down the offer so BHP went hostile. Soon after, the world economy exploded and Billiton threw in the towel. When BHP first made the offer in November 2007, shares of Rio surged from $84 to $103. Today, Rio is at $52. Ouch!

Another Down Friday
Posted by Eddy Elfenbein on August 20th, 2010 at 1:02 pm

The market is down again on a Friday which has been the trend this year. And once again, the cyclical stocks are leading us lower.
Every so often I like to look at ratio of the Morgan Stanley Cyclical Index (^CYC) divided by the S&P 500. This is a quick-and-dirty way of telling us where we are—or at least where the market thinks we are—in the economic cycle.
As you might expect, this ratio often moves in a cycle. Cyclical stocks tend to lead the market up out of a recession and conversely, lead us lower at the beginning of a recession.
I’ve said before that cyclical stocks, as a whole, probably aren’t a good place to be right now. This graph of the ratio shows how elevated the ratio is:

You can also see how dramatic the ninth-month period was from September 2008 to August 2009. The ratio closed at an all-time high of 0.803 on April 26 of this year, exactly one session after the market’s highest close in nearly two years. Since then, the S&P 500 has given back about 12% while the CYC is off by more than 16.5%. Although I think the broad market will recover, I still believe that cyclical stocks will be laggards.

Jos. A Bank Clothiers Split 3-for-2
Posted by Eddy Elfenbein on August 19th, 2010 at 6:27 pm

There’s one small housekeeping announcement. Jos. A Bank Clothiers (JOSB) split 3-for-2 today.
For tracking purposes, I assume the Buy List is a $1 million portfolio starting on January 1 of each year. That means all 20 stocks are equal positions of $50,000 each. On January 1, our position on JOSB was 1,185.115 shares at the buy price of $42.19.
With the 3-for-2 split, our JOSB position is 1,777.6725 shares at a starting price of $28.1267.

Is There a Bond Bubble?
Posted by Eddy Elfenbein on August 19th, 2010 at 12:40 pm

Lately, there’s been a lot of talk among financial bloggers of a Bond Bubble. There very well could be but the key question is, a bubble relative to what?
Compared with stocks, yes, I think bond yields are far too low. My hope is that stocks will rise to bring the two into better balance. You can think of investing as a perpetual battle between stocks and bonds. Is it better to raise money by borrowing, or taking on new partners? Understanding that key fact is to see how the market works.
The plus of borrowing is that when you’re done renting someone else’s money, it’s over. Taking on new partners never goes away unless you by them out. The negative of borrowing is that you have to pay interest, so whatever you sell, a few pennies in price goes towards paying interest. The positive of equity financing is that there’s no up-front cost.
Right now, I believe bond yields are very, very low, even adjusting for inflation. Just look at the TIPs yield curve.

The TIP coming due in July 2010 currently yields just 1% over inflation (or rather, over the CPI). In my opinion, that’s awful.
I don’t, however, believe that bond yields will plummet like dot-com stocks did 10 years ago. Rather, I think investors are unduly fond of the security of Treasury bonds. Sure, they’re safe but that safety comes at a price. One percent real yield for 10 years is too rich for me. The good news is that our massive debt can be financed rather cheaply.

Intel Buys McAfee for $7.7 Billion in Cash
Posted by Eddy Elfenbein on August 19th, 2010 at 11:39 am

The stock market is down again today, but the big news is that Intel (INTC) is buying McAfee (MFE) for $7.7 billion in cash. In my opinion, this is an awful move. There are so many better uses for that money, like dividends, rather than an acquisition. According to Yahoo Finance, Intel has $18.3 billion in cash which translate to $3.29 per share.

The boards of both companies have unanimously approved the deal, but it’s still pending McAfee shareholder and regulatory approval. Intel said that the deal “reflects that security is now a fundamental component of online computing.” Intel went on to say that security is now just as important to the company as energy efficiency and internet connectivity.

Sure, I don’t doubt how important security is but Intel is paying a gigantic premium. The acquisition price is $48 per share which is a 60% premium over the closing price from yesterday. Think of it this way: MFE was trading at 10.5 times next year’s earnings. Now it’s trading at close to 17 times next year’s earnings.

McAfee will become a wholly owned subsidiary of Intel, and will report to its Software and Services Group. Both companies are based in Santa Clara, Calif. Founded in 1987, McAfee has some 6,100 employees, and saw $2 billion in 2009 revenue , making it the world’s largest security company.
Intel will benefit from McAfee’s entrenched position in the security field, and McAfee may be able to optimize its notoriously performance-hungry software now that it’s a part of the company that provides the CPUs to many computers.
Intel recently announced its best quarter ever with $2.9 billion in profit, thanks to an influx of delayed computer purchases by businesses.

Despite all press a mega-deal gets, they rarely work out. At best, they’re a wash. At worst, both firms are hurt. The problem is that deals often look good on paper, but the actual merging of two companies is very hard. There are two cultures, two ways of doing things and two histories. That isn’t given up so easily.
What it comes down to is that I think executives like to lead large organizations. They see “large size” as translating to “good for shareholders.”
I think smaller “fold-in” mergers can work very well, but beyond a certain size, you’re asking for trouble. The frustrating part is that Intel looked so attractive here with lots of cash and a low valuation.

Lilly’s Dividend Is Holding Strong
Posted by Eddy Elfenbein on August 17th, 2010 at 10:07 am

This hasn’t been a very good year for Eli Lilly (LLY). The shares are down again today on news that it will halt development of semagacestat, a potential Alzheimer’s treatment.
The preliminary tests just weren’t working out. Lilly said that this will result in a Q3 charge of three to four cents per share. That’s bad but not awful.Lilly confirmed its previous 2010 earnings per share guidance range of $4.44 to $4.59 on a reported basis, or $4.50 to $4.65 on a non-GAAP basis (consensus is for $4.61).
As rough as this year has been, Daniel Lee notes that one bright spot has been the stock’s dividend. Lilly currently pays out a 49-cent dividend. That comes to $1.96 per share per share. At the current price of $34.72, Lilly yields 5.6% which is well more than double the 10-year T-bond yield. Lilly has also paid a dividend for the last 125 years.

The CRA Didn’t Cause of the Crisis
Posted by Eddy Elfenbein on August 17th, 2010 at 9:17 am

Eric Falkenstein argues that the Community Reinvestment Act didn’t cause the financial crisis but the mindset driving it sure did:

The zeitgeist suggested that lowering underwriting criteria for homeowners was costless, turn renters with their various social and economic deficiencies into homeowners with their various social and economic proficiencies, and be morally just. The mindset that underlay the CRA, not the CRA itself, caused the housing crisis. The CRA was joined by the Fair Housing Act and other explicit legislation. The regulators from the OFHEO, OCC, FDIC, SEC, and Federal Reserve were all on board with the tactics consistent with the strategy, meaning that bankers weren’t criticized for lowering their standards in regards to home lending, but rather congratulated. The US Department of Housing and Urban Development, and Department of Justice had similar objectives and initiatives to those in the CRA. The CRA, in this context, was unnecessary.

That mindset hasn’t gone away. If anything, it’s now spread to education financing.

Math Nerds Have Taken Over the Bond Market
Posted by Eddy Elfenbein on August 16th, 2010 at 3:58 pm

The 10-year T-bond just broke below the mathematical constant e — 2.719.
The 30-year is closing in on pi — 3.142.
The 5-year is now below phi — 1.618.
This alignment is unprecedented! Do you have any IDEA WHAT THIS MEANS???
Seriously, do you? Cause I sure as hell don’t.

Sysco Misses by a Penny
Posted by Eddy Elfenbein on August 16th, 2010 at 1:33 pm

After opening lower today, the stock market is rallying off its lows. Before the opening bell Sysco (SYY) released earnings for its fiscal fourth quarter. The company earned 57 cents a share which was a penny below forecasts but four cents more than a year ago.
Sysco is a consumer staple so it’s usually good stock to own during a recession. Still, times are tough and the company’s CEO said, “We have seen no consistent pattern of improvement on a week to week basis.”
Looking at the numbers, Sysco is still doing well. Not great, but well enough. For the quarter, revenue rose 14% to $10.35 billion, up from $9.09 billion last year. For the full year, Sysco earned $1.99 per share which is up from $1.77 per share.
Sysco is your classic slow-and-steady stock so I’m not too concerned about it missing earnings by a penny. The company should probably make another $2 a share this year so the current price is a pretty good value. The shares are down about 3% today.

Will the Dems Dump Pelosi After a Defeat?
Posted by Eddy Elfenbein on August 16th, 2010 at 12:59 pm

With the mid-term election only three-and-a-half months away, I noticed that the Intrade contract for the GOP to retake the House is up to 64.7. Of course, those are just odds but it does mean that “the market” sees a GOP takeover as slightly probably.
I’m curious that if the Republicans do take control of the House, would Nancy Pelosi have to depart as Minority leader? I really don’t care one way or the other but I think it’s interesting scenario, and I’m guessing she would have to depart. Taking your party to parliamentary defeat happens a lot in other political systems but it’s fairly rare in the United States.
For example, after taking his party to defeat this past May, Gordon Brown had to step down as leader of the Labour Party. The party is currently deciding who the next leader will be.
We really haven’t established much of a precedent in the U.S. When the Republicans won the House in 1994, the issue of what former Speaker Tom Foley would do wasn’t an issue since he lost his House seat as well. When the Democrats took control in 2006, former Speaker Dennis Hastert resigned his seat mid-session. But Hastert had already said that 2006 was going to be his last election so he was a lame duck anyway.
When the GOP lost the House in 1954, former Speaker Joseph Martin hung on as Minority leader until the Democrats big victory in 1958. In January 1959, he was ousted by Charles Halleck by a vote of 74 to 70. Six years later, after another big GOP defeat, Halleck was ousted by the Gerald Ford.
I guess that in the U.S. system the “Shadow Leader,” if you will, isn’t an official position although it’s often clear what people are important to listen to and they usually aren’t in the House of Representatives. I remember when Mario Cuomo was treated as the faux Shadow Leader for a few years in the late 1980s. Ronald Reagan held that position for perhaps as long as 15 years. Is Sarah Palin the current Shadow Leader? I really don’t know. But I think having those people outside of the House takes some of the heat, and light, off what the Party Leader does.