Google Still Eating Yahoo!'s Lunch

Shares of Google (GOOG) are soaring about $30 per share, or 7%, today after another very impressive quarterly report. After a profit warning from Yahoo! (YHOO), many Google skeptics postulated we could see some slight weakness in the search leader's business, but they turned out to be very wrong. At least for now, issues are Yahoo! appear to be more company-specific than industry-specific. The way I see it, Yahoo! is simply becoming more and more irrelevant in the portal space.

As I have been doing periodically, I will once again update my views on the long GOOG/short YHOO paired trade I originally recommended at prices of $403 and $32, respectively. Today's huge move up for Google, coupled with a 1 percent drop in Yahoo! brings us to $455 and $23 per share. This results in both stocks trading at about 35 times prior 2007 estimates. After the Google report, 2007 EPS numbers should move from $13/share toward $14/share.

Now that their multiples have essentially converged, which was the thesis behind the paired trade, what do I expect? At this point, I think it is reasonable to put Google at 40x and Yahoo! at 30x forward earnings. If Google hits $14 next year and Yahoo! meets their numbers, we are looking at around $20 per share for YHOO and $560 for Google. That would give this trade another 15 or 20 percent upside from here. As a result, I'm letting it ride.

Overbought Market Nears Dow 12,000

The current market rally has exceeded my expectations, both in duration and in strength. After such a move, am I correct in characterizing the U.S. equity market as overbought? Consider this astonishing statistic. We have now gone 66 straight trading days without a 1 percent drop in the S&P 500 in any given session (July 13th marked the last drop of such magnitude). During that three month period, the S&P has rallied more than 10 percent.

Now I have no idea what the record is for consecutive days without a drop of 1 percent, but given the current streak, I have little doubt we are getting quite overbought at these levels. Unfortunately, much like overbought stocks, just because markets are overbought, it does not mean the rise will stop on a dime. Nonetheless, I am waiting to commit new money to the market. Perhaps some quarterly earnings disappointment will provide attractive entry points for certain stocks in the coming weeks.

Lampert/Anheuser Busch Rumors Insane

Have a flat-lined stock like Gap Stores (GPS) or Home Depot (HD)? Why not start a rumor that Eddie Lampert, Chairman of Sears Holdings and general partner of ESL Investments, a Connecticut based hedge fund, is interested in your stock? That seems to be a recurring idea on Wall Street lately.

The latest rumor sent shares of St. Louis based beer brewer Anheuser Busch (BUD) up 2 percent on Tuesday, on reports that Lampert could launch a $56 per share takeover bid. This has to be one of the silliest rumors I've ever heard. At least GPS or HD made a little sense given Lampert's taste for retailers, even though Home Depot is far too big for an outright acquisition.

How exactly could Lampert pay $44 billion for BUD? And even if he did have the money, why would he do such a thing? Maybe those starting these rumors just want the Warren Buffett/Eddie Lampert comparison to ring true. After all, Berkshire Hathaway (BRKA) has a fairly large position in BUD. Regardless of who is responsible for the rumors, please do not buy BUD shares on hopes of this news materializing. There is no way Lampert buys out Anheuser Busch.

Google/YouTube Deal Finalized

Very interesting (and dead-on in my opinion) take on the Google/YouTube deal, courtesy of former Internet analyst Henry Blodget's blog:

http://www.internetoutsider.com/2006/10/youtube_and_seq.html

Google Still An Active Deal Maker

Internet search leader Google (GOOG) remains on the cutting edge, making deals with various web properties and content companies. After locking up an exclusive advertising pact with MySpace, reports indicate the company could partner with, or buyout online video leader YouTube for as much as $1.6 billion. While many people will argue whether or not the potential price tag is too high, investors need to realize that forking over a few billion to secure two of the Internet's most visited sites is chump change for Google.

With $10 billion in cash and a very strong stock price to use as currency for deals, trading 1% or 2% of their company for these deals is merely a drop in the bucket. Not only will these deals allow Google to maintain impressive growth rates in its U.S. business, but it further widens the gap between them and the competition. Today's announcement of a deal with Warner Music and Sony BMG to distribute fee music videos is yet another example of how Google is leading the way in online content innovation and the advertising that will undoubtedly support such initiatives.

With Yahoo's stock stagnant and Google shares jumping again today, I just checked out my long Google/short Yahoo paired trade to see where we stand now that Yahoo has fallen from 32 to 25 and Google has jumped from 403 to 428. Despite the postitive return from the trade thus far, Google still trades at a discount to Yahoo on projected 2007 earnings per share (33 times versus 39 times). As a result, I am keeping the trade on for now.

Same Ol' Sell Side Crap

From the New York Post:

The New York Attorney General's office and the Securities and Exchange Commission have launched full-fledged probes of a small but influential Wall Street firm that fired an analyst who tried to publish a report critical of one of its clients.

Subpoenas have gone out over the past week to Rodman & Renshaw over the departure of Matt Murray, a biotech analyst who said he was not allowed to lower his stock rating of a company once it had reached its price target.

Shortly after broaching the subject of downgrading Halozyme - a Rodman banking client - he was fired, he said.

A law enforcement source told The Post that a subpoena launching a New York AG investigation into Murray's February departure had gone out to Rodman; this source also said the SEC had also subpoenaed the firm.

Murray told The Post he was "grateful to learn that the Attorney General is continuing the important work on supporting analyst independence."

At the time of his departure from Rodman, which specializes in underwriting controversial PIPEs - or private investment in public equities - Murray was a high-profile analyst of small-cap pharmaceutical companies.

Murray said that once his request to downgrade the shares of Halozyme was turned down, he asked Rodman's compliance chief to remove his name from its coverage.

This set in motion a series of ugly confrontations between Rodman executives and Murray that led to his departure.

Harrah's Apparently Underwhelmed by Offer

While some of the less-knowledgeable anchors on CNBC today were saying that Harrah's was being bought out by private equity, I couldn't help but sit back and consider the odds that the casino giant accepts the $81 per share cash offer from Apollo and Texas Pacific. After all, the company's shares opened at $75.42, jumped to as high as $80.01, and closed back down at $75.62 each.

Since I play arbitrage deals every once in a while, a quote of $75 and change would be intriguing indeed, if the odds of a deal were fairly high. It would likely take 6 to 9 months for a deal to close upon an official agreement, which makes for a nice annualized return for merger arbs. However, after thinking it through, I decided not to pounce yet. And the reasons below might partly explain why the stock is more than $5 below the offer price.

If Harrah's was truly happy with the offer, wouldn't they have accepted $81 per share? Instead they merely issued a press release announcing that they had received the offer and formed a special committee to consider it. The way I see it, there are only two reasons why Harrah's would not have agreed to the proposal. Either they aren't totally sold on the idea of going private, or they are open to it, but want a better price.

Now it's true that by making the offer public knowledge, other interested parties could emerge and a bidding war could push the price up. However, we are talking about a $15 billion offer for the HET equity, plus another $10 billion or so in debt, for a total deal value of $25 billion. How many other buyers can afford a deal like this? Not many, so a bidding war seems unlikely.

A more plausible scenario would be for other private equity firms to join in on the bid, allowing for a second offer to be extended if Harrah's balks at $81 per share. With more investors, the acquiring group can increase their bid, and at the same time, reduce the amount that each must put into the deal.

Who knows exactly what Gary Loveman and the other folks at Harrah's are thinking here. The offer does represent a 22% premium, but is also slightly below the stock's 52-week high. Loveman, the CEO of Harrah's, likely won't have to worry about losing his job, since it is unlikely that private equity firms have a seasoned gaming executive who would be a better fit for the company. Going private does take away the flexibility of paying for future acquisitions with stock, rather than cash, so that could be a consideration as well.

So how should investors play this? Current holders of HET should hold on, since anything is possible and the stock is not most likely not overvalued at $75 per share. If you are considering getting in as an arbitrage opportunity, make sure you do a stand-alone valuation for the company and feel confident that there is not much downside longer term at $75 should no deal materialize. And finally, for you corporate bond investors out there; Standard and Poor's downgraded Harrah's debt to junk status after word of the offer hit the wires. This seems silly to me.

It should be interesting to see how this all plays out and as events unfold, I'll be sure to post my thoughts.

Will Q4 Be Strong Yet Again?

Fourth quarters in recent years have been strong periods for the equity market, but I wanted to put some hard numbers behind my recollections. I went back all the way to 1990 and calculated the S&P 500's performance for each of the last sixteen fourth quarters. The results, shown below, were even stronger than I had remembered.

As you can see, fourteen of the last sixteen years have produced positive S&P 500 returns in Q4. The mean return for the period since 1990 has been 6.5%. The average gain in the positive years is 8.0%, while the average loss in the negative years is only 4.5%.

Does this mean investors should be 100% equities going into October? Surely some will do just that based on these statistics, but I am being more cautious. The market has had a very, very strong third quarter and I want to protect some of those gains.

Stocks simply feel overbought currently. With the average fourth quarter producing a 6.5% gain since 1990, I am going to have to take "the under" and say this year will be less impressive than average. On the bright side, I'll be thrilled if I'm wrong!

Has the Housing Bubble Burst?

All I've heard recently in the financial media is that the housing bubble has finally burst. It's really quite comical. First of all, there was never a housing bubble. Everyone just threw around the bubble term because we had experienced one in Internet stocks a few years back and it was easy to categorize a very strong housing market as a bubble.

It's true that the housing market of the last five or six years was one of the strongest we have had in this country. The same can be said of the broad stock market from 1982 to 2000. We had the biggest equity bull market ever. However, it was not a bubble for all stocks, only one sector of the economy. Technology and telecom names fell by 90, 95, even 100 percent.

Outside of tech though, there was no bubble in stocks. The S&P 500 fell 50% when the "bubble burst" but the Nasdaq fell 80% and tech made up 30% of the index. As a result, half the S&P 500 loss was from tech stocks. Without the bubble, the market would have been down 25%. That classifies as a bear market, not a bubble.

Markets don't experience bubbles every five or ten years. It's a much rarer phenomenon than that. People are also calling the bull market in commodities as a bubble. It's not. It's a bull market. Markets are cyclical and when they rise they do so very quickly, but bull markets and bubbles are not synonymous terms.

So, yes, the housing market is very weak, but let's stop saying how the bubble is bursting. The mean home price in the U.S. remaining flat or only rising 1 or 2 percent does not classify as a bubble bursting. Not even a 20% drop in housing prices on the coasts qualifies. That's just a bear market, which is what typically follows a bull market. When housing prices in certain markets fall by 90% or more, then we can start calling it a bubble. Not going to happen.