The Haiku of Finance for 03/05/10

Jobless report out
More permanent jobs go temp
Still tough to find work

Unemployment Posts Positive Surprise

My headline may be a bit disingenuous.  The financial blogosphere was expecting this week's unemployment report to be a massive disappointment to the downside.  The fact that the numbers were little changed is an encouraging sign:

Nonfarm payroll employment was little changed (-36,000) in February, and the unemployment rate held at 9.7 percent, the U.S. Bureau of Labor Statistics reported today. Employment fell in construction and information, while temporary help services added jobs. Severe winter weather in parts of the country may have affected payroll employment and hours; however, it is not possible to quantify precisely the net impact of the winter storms on these measures. For more information on the effects of the severe weather on employment estimates, see the box note at the end of the release.

The fall in construction employment is not surprising.  Big drops in existing home sales this year translate into even lower demand for new homes from homebuilders.  The increase in temp employment, as the press release notes father down, reflects cutbacks in hours worked by employees who previously worked full time.  That means consumer demnd will continue to be slack for some time until prospects for permanent employment improve.  This is not good for the prospects of long-term recovery.

Mr. Market is happy that this news is not as bad as expected.  Getting a bull market restarted will take reports that are a lot better than this one. 

Merck KGaA Makes Merger Maneuver With Millipore

Merck KGaA (that's the original German Merck, not to be confused with the U.S.-based Merck trading as MRK) has offered $107 cash per share for Millipore (MIL) to beef up its life sciences product line.  MIL currently trades at a P/E over 33, which looks expensive until you compare it to the average P/E of 37 for the entire medical instruments and supplies industry.  MIL's results also look better than average:  its ROE of 12.73% beats the industry's 9.8%, and its net profit margin of 10.31% surpasses the industry's 8.4%. 

However, MIL trades far in excess of P/Es of direct competitors like Alcon (ACL) at 24, Baxter International (BAX) at 16, or Covidian (COV) at 27.  Merck is paying this premium to earnings presumably because MIL's product line fits its own strategy well.  Would other acquisition targets be superior fits for Merck KGaA?  The firms named above have far larger market caps, so Merck KGaA is playing within its league by acquiring MIL. 

Nota bene:  Anthony J. Alfidi has no position in MIL, MRK, Merck KGaA, or any other company mentioned at the time this post was published. 

Coca-Cola Plans Sweet Combination With CCE

Coca-Cola (KO) and its largest bottler, Coca-Cola Enterprises (CCE), are planning a complicated merger.  CCE's current shareholders will receive a $10 cash payment per share in exchange for new shares in the part of CCE that will retain control of its European bottling operations.  If CCE's price remains near $25, as it has in recent days, the $10 payment will result in an ex-dividend adjusted share price around $15 for the "new" CCE after the transaction closes.  Shareholders should find this acceptable provided CCE can successfully institute its planned $1B share repurchase and proposed $0.50 annual dividend (an increase from the current $0.36 dividend).  Note that the transaction's announcement qualifies this plan by making it subject to funding from continuing operations. 

Furthermore, KO's assumption of $8.9B worth of CCE debt and $0.6B in unfunded pension obligations relieves CCE of a significant financial burden.  Subtracting this consideration from CCE's enterprise value of $20.68B leaves the new CCE (before new debt issuance) with a notional enterprise value of $11.18B, a discount to its present market cap of over $12B.  KO probably believes structuring the transaction this way is a bargain compared to an outright takeover of CCE followed by a separate sale of its European business units.  This looks like a very smart, efficient deal for both KO and CCE shareholders.

Nota bene:  Anthony J. Alfidi has no position in KO or CCE at the time this post was published.

Germany Holds Fast to Denials of Greek Aid

Rarely do we get to watch the death of multinational regimes in real time.  The last artificial empire to fall was the Soviet Union.  Now we get to watch the European Union come apart:

Greece’s pledge to ramp up planned budget-deficit cuts by half failed to yield commitments of financial assistance from Germany, Europe’s biggest economy, to help solve its financial crisis.

Given what looks to be a likely Greek default on its bonds, followed by departure from the EU, followed by similar dramas in Spain and elesewhere, a relevant question would be . . . why not short the euro?  I'm not sure that's a viable investment strategy simply because the largest European economies may choose to remain in Euroland to keep the currency viable. 

The Haiku of Finance for 03/02/10

Another report
Finds nothing at all has changed
Nobody listened

Nothing Has Changed, Economically Speaking

I've been syaing lately that the U.S. economy is not out of its crisis.  If you won't believe me, maybe you'll believe a bunch of supposed notables and geniuses:

Even as many Americans are still struggling to recover from the country's worst economic downturn since the Great Depression, another crisis – one that will be even worse than the current one – is looming, according to a new report from a group of leading economists, financiers, and former federal regulators.

Note the language used in the report warning of a "calamitous global collapse."  Go back and search my posts tagged with the keywords "economic annihilation" and you'll realize that Establishment analysts are catching on to what the blogosphere has been chirping about for some time.  The intrepid bloggers in my link list and beyond are vindicated.  At a minimum, the report's finding that bank balance sheets are lies should give investors pause when considering bank stocks as investments. 

AIG Takes First Step Out of Hole

AIG, that massive money pit that all American taxpayers have tried to make whole on behalf of Goldman Sachs, has begun to pay back what it owes us:

American International Group Inc. is selling a cornerstone of its business, Asia-based life insurer AIA Group, in a government-approved $35.5 billion deal. The sale to British insurer Prudential PLC could reduce by nearly one-fifth the amount of federal bailout money still invested in struggling AIG.

But officials and analysts say it's not clear whether taxpayers will eventually recoup all the money AIG drew from a $182.5 billion rescue package the government committed to at the height of the 2008 credit crisis. In return for that package, the government got a nearly 80 percent stake in the insurer.

Read the last paragraph again if you're one of those folks who bought AIG stock in the pennies thinking it was a sure thing. Profit margins and operating margins continue to be negative. The company continues to lose money, so any future asset sales are a race against wasting assets. The longer it takes to sell off the next chunk, the less the whole firm will be worth. The firm is worth about $52B once liabilities are netted out, so even if the firm's remaining assets are sold at a premium the taxpayer will still lose about $130B from the rescue package.

Nota bene; Anthony J. Alfidi has no position in AIG at this time, thankfully.

The Limerick of Finance for 02/28/10

The pace of buyouts is increasing
Multiple synergies they're releasing
They'll close a big deal
Then it's time to get real
Fire some people with cost-cutter squeezing

Buyout Action To Kickoff March '10

Two probable merger deals I'll be watching this week . . .

Coca-Cola (KO) is buying one of its distributors, Coca-Cola Enterprises (CCE). Coke's betting on vertical integration. This is a complicated transaction and not a complete merger.

Merck (MRK) is buying Millipore (MIL) in an all-cash deal to branch out into broader life science type stuff.

I'm no specialist in either retail beverages or pharmaceuticals, so anything I have to say about either deal will treat them as short term special situations. The MRK-MIL deal looks more appealing since it's all cash.

You Tell 'Em, Warren

Warren Buffet once again hands the world some common sense. Unfortunately it's no longer common:

Buffett used most of his letter, released Saturday, to reiterate the business basics that have made his company a juggernaut. But it did include a section about how corporations should manage risk. Buffett said CEOs and the boards that hired them should pay a steep price if their companies get into trouble with risky investments.

Buffett lamented that shareholders, not CEOs and directors, have borne most of the burden of company failures during the economic crisis.

He's describing what's known in academic circles as the agency problem. Agency problems are now a permanent fixture of corporate governance because a hereditary class of perpetual Peter Principle executives has captured boards of directors. Why do people join boards anyway? Ostensibly they should enjoy working for shareholders and helping CEOs fix problems. I suspect they just want the prestige value of board membership for networking and resume padding.

Grow some spine, board members. Put me on a board and watch sparks fly as I insult some Harvard MBA CEO for buying a private jet. Then watch me get voted off the board for making waves. Wheeee! Business is fun.

The Haiku of Finance for 02/26/10

Home sales declining
Good luck trying to sell one
Just cut the price down

Homes Sales Flushed, Fannie Floundering

Did my headline grab your attention? That was my intent. If that didn't work, perhaps this article will grab you:

Sales of previously owned U.S. homes unexpectedly dropped 7.2 percent in January to a seven-month low, indicating a lack of job growth is undermining government incentives to bolster the housing market.

Lack of sales will surely force existing sellers to drop their asking prices, further sinking home values in your neighborhood. This will put more homeowners underwater on their mortgages and force more foreclosures. The vicious cycle will soon pick up speed, and yet another sign is the Fannie monster's continuing hunger for bailouts:

Fannie Mae, the mortgage-finance company under federal conservatorship, said it will seek $15.3 billion in aid from the U.S. Treasury after posting a 10th straight quarterly loss.

The U.S. economy is not in recovery because mortgage-related debt has not been flushed into default. We've probably just crossed through the eye of the hurricane and are about to be hit by the next wave of the storm. The trouble with this hurricane is that poor public policy will prolong its duration. Batten down your hatches.

California Busting Bonds

California is the Golden State. Its credit rating, unfortunately, is not so golden. Its general obligation bond rating is the lowest in the nation and has shown a steady deterioration throughout 2009. How did this happen? A recent article outlines the unfolding tragedy:

Federal law prohibits states from declaring bankruptcy and without a legal framework, assertions about California's solvency are left to interpretation. But persistent multibillion-dollar budget deficits, cash crises, tens of billions of dollars in debt and other obligations have blurred the legal distinction.
(snip)

Over the next 16 months, the state has a $20 billion deficit in the general fund budget. That's the equivalent of nearly a quarter of the current spending plan of $84.5 billion. Much of that spending is locked in because of voter initiatives and federal mandates, limiting options for lawmakers. The deficit this year is more than the state spends on higher education and prisons combined.

The state's pension fund, CalPERS, has $16.3 billion more in liabilities than assets at the latest calculation, although that number fluctuates with the system's investment portfolio. Adding to that, a state report released this month calculated that California also faces a $51.8 billion bill - in 2009 dollars - for the health and dental benefits of state retirees and future retirees.

The Governator's plan to balance his state's budget in 2010 relies heavily on a federal subsidy of $6.9B. There is no assurance that this subsidy will be forthcoming in an era when one of every three dollars in federal spending is itself borrowed from the bond market. Note further that the non-partisan Legislative Analysts's Office has published a pessimistic analysis of proposals to reduce the state budget deficit. The LAO assesses a significant part of the Governator's "trigger proposal" estimate to be unreconcilable; it further assesses many business subsidies and tax exemptions as ineffective and unjustifiable. This sets the stage for further political wrangling and puts the passage of a balanced budget for 2010-11 at risk.

The excerpted article above notes further down that the state's net assets exceed its net liabilities by $34B. If the state is unable to resolve its budget crisis, would it sell state parks and government buildings to pay its bills? The Governator floated just such a trial balloon last year, probably as a political ploy to force a budget solution. A budget crisis this year may see such proposals become reality.

The risk to California muni bond investors from prolonged budget inaction is significant. In addition to individual and pension plan holdings of Cal munis, three ETFs hold state bonds - PowerShares Insured California Muni Bond (PWZ), SPDR Barclays Capital California Muni Bond (CXA), and iShares S&P California Muni Bond (CMF). The ETFs hold about $290mm worth of munis, all with medium to high interest rate sensitivity. Any further downgrades to California's credit rating will raise the state's borrowing costs, posing an immediate risk to holders of those ETFs.

Nota bene: Anthony J. Alfidi does not own any California muni bonds or any of the ETFs mentioned in this post. He is a resident of San Francisco, California and thus a state taxpayer.

Smith International Has Few Alternatives To Schlumberger

Boards of publicly held companies have a duty to maximize shareholder value. Attorneys are wondering whether the board of Smith International (SII) has done all it can:

The investigation concerns whether the Smith Board of Directors breached their fiduciary duties to Smith stockholders by failing to adequately shop Smith before entering into the merger agreement, and whether Schlumberger is underpaying for Smith shares, thus harming Smith stockholders.

The first question is easier to answer than the second. Baker Hughes (BHI), a major competitor, is preoccupied with its acquisition of BJ Services (BJS) and would be hard pressed to make a competing bid for SII. Halliburton (HAL) has a much larger market capitalization than SII and could presumably make a stock offer that has less of a dilutive effect than Schlumberger's (SLB) offer. However, HAL seems to be more focused on pursuing organic growth rather than acquisitive growth as a strategy. It is thus easy to give SII the benefit of the doubt for taking SLB's offer.

The second question of whether the offer represents best value is more difficult to assess. SII's P/E ratio is currently over 61, pricing this company at a massive premium relative to its peers. SII shareholders should be impressed that the market is valuing its prospects as if it were a growth company rather than a seasoned producer in a mature industry. SLB is arguably paying a huge premium for SII's topline revenue, betting that its decline in revenue last year is temporary and can be ameliorated in a combination. Failure to complete this bid would relegate SII to competing against three super-large competitors with stronger balance sheets and operating margins. Only a surprise offer from another firm can definitively prove that SLB's offer for SII is too cheap.

Nota bene; Anthony J. Alfidi is short puts under SII at the time this post was published. He has no position in any other stock mentioned in this post.