Different Paths Taken by Enron's Past Management

Last week Ken Lay and Jeff Skilling were found guilty on numerous charges related to the demise of Enron. Today we hear that Richard Kinder is heading up a bid to take Kinder Morgan (KMI), his energy pipeline company, private in $100 per share deal. It's very interesting that these two events are coming only days apart.

For those of you who are not familiar with Richard Kinder, he was the President and Chief Operating Officer at Enron ten years ago and was seen as CEO Ken Lay's successor. However, Kinder left in 1996 after a falling out with Lay, and Jeff Skilling took his job. We all know how that ended up.

Kinder, however, always saw the future of Enron as a dominant pipeline company. Owners of oil and natural gas pipelines act much like toll booths, collecting fees as energy is transported over their infrastructure, regardless of the price of the commodity. Conversely, Lay wanted Enron to focus on energy trading and much more risky ventures.

Kinder, along with partner Bill Morgan, co-founded Kinder Morgan Inc (KMI) and actually bought Enron's pipelines from Lay. It's not hard to see which strategy turned out to be right. Kinder is the majority owner of KMI and sees so much value in the company that he wants to take it private for $13.5 billion. Enron is, well, completely worthless.

Was the Mastercard IPO Underpriced?

Lead underwriters Goldman Sachs (GS) and Citigroup (C) priced the Mastercard (MA) IPO Wednesday night at $39, below the expected range of $40 to $43 per share. On Thursday shares opened at $40.30 and then soared another $6 to close at $46 each. That trading action is quite baffling if you ask me.

Usually where the IPO is priced tells you how strong demand is, and subsequently, how well the stock will do upon opening for trading. The $39 pricing indicated to me that the smart money wasn't very enthusiastic about the deal. Then less than 24 hours later the stock is fetching $46. If demand was that strong, they easily could have priced it within the proposed range.

The conclusion I draw from this is that the smart institutional money wasn't sold on the price, but retail interest after the stock opened was strong. Following the retail crowd is rarely a good strategy, so I will put more weight into the $39 pricing than the $46 first day closing price. The stock's valuation also supports the cautious view. Mastercard earned about $2 per share in 2005, so the P/E is north of 20x, very high for a financial services company.

Broad Appeal for Broadcom

It's tough to find good, cheap technology stocks these days. I've been underweight the sector for many months due to a lack of good ideas. However, the recent market decline has given the Nasdaq a 9% haircut over the last few weeks.

Earlier this week I saw Broadcom (BRCM) cross my screen at $33 per share. That quote surprised me a bit. Broadcom is a very good chip company but its stock usually reflects that. Growth investors have traditionally been perfectly willing to fork over 30 times earnings for the stock. That's fine, but rarely will I pay up that much for something. In fact, I don't think I've ever owned Broadcom.

My instincts told me that BRCM hadn't traded at $33 for a while, which is why the price alone got my attention even though the stock is not really on my radar screen, so I took a closer look. It last closed there during the first week of the year, so it's been more than 5 months.

Looking at current estimates ($1.47 in EPS for 2006 and $1.66 for 2007) along with the company's pristine balance sheet ($4 per share in cash and no debt), Broadcom trades at an enterprise value to earnings ratio of only 20x for 2006. That seems very reasonable for a 15% long term grower that serves some of the best markets within technology.

I still think the market as a whole goes lower, and tech will get whacked more as well. That said, Broadcom at $33 looks like an opportunity that I'll strongly consider despite a market that has not yet gotten the 10% correction that I'm looking for.

And just in case readers might think I purposely failed to mention the options backdating issue (Broadcom's name has been mentioned as being "at risk"), that is not so. I plan on talking about the issue more broadly (no pun intended), so look for that sometime next week.

Hang Up on the Vonage IPO

One look at the financial statements of Internet phone company Vonage (VG) shows why the stock, which debuted today, is trading down 4% on its first day. In fact, I mentioned we should be cautious with this company back in February. It's rare for an IPO to open down but it's hard to see how their business model will survive in the current competitive environment. They'll likely burn through all of the cash they raised today fairly quickly. The huge red flag was that they offered their customers 100 shares of stock at the IPO price. If that's not a sign that nobody else wanted their stock, I don't know what is.

Lampert Sells a Third of AutoNation Stake

SEC filings reveal that Eddie Lampert, hedge fund manager and Sears Holdings (SHLD) chairman, has been selling his shares of AutoNation (AN) aggressively over the last month. Between April 19th and May 16th Lambert sold more than 26 million shares between $22.50 and $23.00 each, netting proceeds of about $600 million. Should we go out and short AN off this? There are probably better trades to make. I suspect he is raising cash for reasons other than to avoid an upcoming collapse in AN (after all, he stills owns over 50 million shares). It will be interesting to see where he puts the money.

How Low Do We Go?

Lots of emails coming in saying "good call on the correction." Perhaps, but there's nothing "good" about it if you are long stocks, that's for sure. No matter how many times you've experienced nasty pullbacks in the market, and no matter how well you understand that we need to see this kind of action every once in a while, it still isn't fun to sit through.

When will it stop? I don't know, nobody does. I do think, though, if you had to pin me down, that we will continue to go lower. In fact, I almost prefer to get the whole 10% correction thing out of the way (we are halfway there so far). Let's just take the pullback that we know is coming at some point, and move on to brighter skies.

Three and a half years is a long time to go without a 10% drop. Sure, we went 7 years in the mid 1990's without an official correction, but that ended badly. Heading into 2006, Peridot was up 72% over the prior 3 years. That's a lot. I'm more than willing to concede a pullback, and then we can run again.

As far as how to play this market, I'm not doing anything dramatically different. I did raise cash when I sensed we were setting up for a drop and posted such on this blog, but since I'm a long term investor and not a trader, I'm still very much net long. An above-average cash position for me is between 10 and 20 percent, since despite a near term bearish call, I still like the stocks I own looking out 2 or 3 years, and my investing time horizon is even longer than that.

I have sold my metals stocks (gold and copper) while holding tight on energy because of the upcoming summer driving and hurricane seasons. Economically sensitive areas will get hurt most as GDP growth slows, so try to focus on stocks that have secular trends behind them. Aside from that, relatively cheap (below-market multiples) stocks with solid longer term growth outlooks are the kinds of positions that you should feel okay holding through the correction and for the months and years ahead.

Sears Bears Get Hammered... Again

The bears on Sears Holdings (SHLD), and there are plenty of them, are again getting crushed today. This marks the second straight quarter that shares of SHLD have spiked after posting blowout earnings. As I have been telling everyone since the Sears/Kmart merger closed, Eddie Lampert's strategy for the company is working, despite negativity from retail analysts that still haven't a clue.

Sears Holdings stock is jumping $17 this morning, for a 12% gain. Their first quarter earnings were even better than wildly bullish investors like myself could have hoped for. Earnings came in at $1.14 per share, a stunning $0.50 above the consensus estimate of $0.64 per share. Here's the nail in the bears' coffin; same store sales for the period dropped 4.8%!

The bearish case, which has been laid out by retail analysts on CNBC and in newspapers and magazines nationwide for months, has been that without positive comp store sales and increases in market share, Sears would get eaten alive by Wal-Mart (WMT) and Target (TGT), and their stock would tank as a result.

As I've said before, and I'll say again, the company is not trying to increase same store sales, or overall sales. They care about one thing and one thing only, profits, because they know that over the long term profits are the only thing that matters if you want a stock price to go up. If today's blowout numbers don't back up this theory, I don't know what does.

Sears Holdings is one of Peridot Capital's largest holdings and will continue to be, despite today's $17 move higher.

*UPDATE* 1:59pm

With Sears stock now up $21 on the day, I realized I forgot to mention one thing in my original post. Check out the SHLD share repurchase plan. During Q1 2006 they bought back 3.3 million shares for $413 million. That comes out to $125.65 per share. The stock is at $159 right now. They know what they're doing, on so many levels. Okay, my cheerleading is over... for now anyway.

Dell's Demise?

Dell Computer (DELL) stock has a special place in my heart. It was my single greatest stock purchase, and very well could remain that way for the rest of my life. I bought shares in January 1996 for 94 cents each (split adjusted) after the stock got hammered as the company stumbled with its notebook computer line. Dell peaked at $60 as the Nasdaq passed 5,000 in early 2000.

Why do I bring this up now? I haven't owned the stock in years, but I am now taking a look at it again. Pricing pressures have compressed margins and sent shares down to $24 each. Dell has elected not to use Advanced Micro Devices' (AMD) chips in its boxes, and as a result, they have had a hard time competing with those suppliers that do diversify away from Intel's (INTC) more expensive offerings.

I am not saying that Dell stock is poised for the late-1990's-like ascent. Those days have long passed. However, Dell now trades at a discount to IBM (IBM) and I think that makes little sense. Dell has $5 in net cash per share on its balance sheet, taking its enterprise value down to $19 per share. That's a trailing P/E ratio of merely 12.

Is Dell going back to $60 anytime soon? Not a chance. However, for those looking for cheap large cap values in technology, the current valuation the market is assigning Dell implies extreme pessimism about the company's future. The January 2008 $20 call options look especially attractive at $7 each.

Is The Correction Finally Here?

Here I sit with the Dow down 130 points, oil up more than $1, and gold jumping $16 an ounce. It has been more than three years since we have had a 10% correction in the market. Is this the start of it? Nobody knows for sure, but it could be.

If you think about it, the 6% rise we have seen in less than 5 months of 2006 defies traditional investment logic. Consider the current economic environment. Interest rates are rising, commodities are soaring with gold at 26 year highs and oil at record highs. Investor sentiment is very bullish. We are a country at war. And yet, the stock market has rallied strongly.

Given that official corrections (10%+) in the market occur about once a year, you would not expect three years to have passed since the last meaningful drop, given what the country is facing and what economic indicators are showing. For some reason stocks have ignored this backdrop. It is a combination of things; strong corporate profits, balance sheets flush with cash boosting M&A and buybacks, many hope that the Fed will stop hiking rates and prevent a recession.

Whatever the reason, it is hard to argue that we are not overdue for a pullback. Our economy is unlikely to withstand all of these pressures forever. Who knows if today is a sign of more things to come in the short term, but I would not surprised if it is, and investors should be on the lookout. There is no need to panic, just be prepared.

Chesapeake Delivers Again

If you are going to invest in a natural gas company, I doubt you can do any better than shares of Chesapeake Energy (CHK). CHK has everything investors should want; a great management team, a low valuation, and strong business fundamentals.

The company did little to sway my opinion after reporting first quarter earnings last week. Net income excluding one-time items came in at $1.07 per share, well ahead of expectations. The conference call was equally impressive, but you wouldn't really know it from the share price. After jumping about 4% after the numbers came out, the stock has barely budged.

I want to point out a few things that I think investors are missing when it comes to analyzing Chesapeake. As is the case with many commodity-related companies, the day-to-day movements of the stock tends to track commodity prices (in this case, natural gas) and not company-specific fundamentals. Of course, the prices energy companies get for their production is a key component of how their financial results will turn out, but focusing simply on daily fluctuations in natural gas prices, and trading CHK shares based on that, is very misguided for long term investors (yes, it does make sense for day traders since we know that is how the stock has been trading lately).

What is interesting about Chesapeake is that they are actively engaged in a natural gas production hedging program that seeks to lock in prices for their gas well into the future, in order to ensure that they can earn returns on capital that are acceptable for shareholders. Amazingly, CHK has hedged 80% of their 2006 natural gas production at $9.45 per mmbtu. Why is this amazing? The current natural gas price is about $6.65, so CHK is getting 40% more for their gas than their competitors who have not hedged. As a result, it doesn't take a rocket scientist to figure out that not ALL natural gas stocks should track natural gas prices.

Let's take this silliness one step further. For some reason (which I cannot explain in a way that makes logical sense) Wall Street analysts exclude any gains from CHK's hedging program in their quarterly earnings estimates. The company's first quarter numbers were reported as $1.07 versus estimates of $0.98 per share. Estimates for 2006 are around $3.40 per share, putting Chesapeake's P/E under 10. But the hedges aren't even factored into these numbers!

Chesapeake made $122 million in Q1 from their hedges, which comes out to $0.29 per share. In reality, the company reported $1.36 in earnings, not the $1.07 that was reported by the press and analysts. Since this is real money that the company is generating, I can't ignore it when valuing the company. After all, investors haven't ignored the hedging program at Southwest Airlines (LUV), which is a big reason they have performed so well even with $70 oil.

Including adjustments for hedging gains, CHK could earn north of $4.50 this year (annualized Q1 hedging), which puts its adjusted P/E at around 7 rather than 10. Yup, that's right, the stock appears cheap and is actually even cheaper!