As Predicted, More Biotech Buyouts

When I wrote about the Merck (MRK) deal to acquire Sirna Therapeutics (RNAI) on 10/31 and predicted more biotech deals were coming, I didn't realize it would only take a week and a half. Last night, Genentech (DNA) announced plans to acquire Tanox (TNOX) for $20 per share in a deal worth more than $900 million. The all-cash tranasaction is expected to close by the end of the first quarter.

Tanox is not a company that has gotten much attention on Wall Street, in terms of product potential or as a possible buyout candidate. Like I said in my last piece, it is very tough to know which of these small and mid cap biotechs will get bids. It appears there are some royalty synergies with this deal, which explains in part why DNA targeted them.

On another note, shares of Genentech have been flatlined for a while now (see the chart below) and are beginning to not look as overvalued as they have in the past. While a 30 forward P/E would rarely be considered extremely cheap, further weakness in DNA shares might allow for an attractive entry point for a firm that can grow earnings north of 20 percent per year.

Dow Hits Record on Democratic Sweep

Doug Kass, managing partner of Seabreeze Partners, predicted a Democratic sweep on CNBC's Kudlow and Company program yestertday afternoon. The result, he thought, would be a severe sell-off in the market. Much like Kass's calls for doom and gloom on Wall Street have been wrong in recent months, they were wrong this time as well. Now you can say that the Rumsfeld resignation helped boost stocks, which I cannot dispute, but the Dow was only down 25 points or so before that news hit the wires.

So why the positive reaction on Wall Street? There are weak spots. Healthcare stocks are down. Pfizer (PFE) down 2 percent is attractive. Sallie Mae (SLM) got hit too, as the Dems want more affordable college loans. But other areas, such as oil, are actually up and in some cases up strongly. Fears of a windfall profits tax are overblown. The idea is silly in a market-based economy. I'm glad that the Dems really aren't pushing hard for it. As much as I don't like the fact that big oil is getting tax breaks (I think that is one place the Dems can try and raise taxes and not take heat for it), passing on some of their profits to the government during good times is not a viable idea.

Anything truly outlandish would likely get vetoed by President Bush. The Dems will want to get things done, and if Bush shows any willingness to compromise on anything, we might get a handful of things done in Congress over the next two years. That is more than we can say about recent memory, so that is a positive development for the American people, and the stock market.

Regardless of what the Republicans say, Democrats are not bad for the economy and stocks. The numbers simply don't support that view, in fact, they show the opposite. My very first post on this blog two years ago looked at the market and the economy under Democratic and Republican administrations. Economic growth, employment, fiscal responsibility, inflation, and stock market returns are all better under Dems. Now I know that Bush is still President, but the point is made merely to refute the idea that Dems having more power with respect to policy means lower stock prices. It's simply untrue. 

Another Golden Opportunity in Citrix Systems

Software maker Citrix Systems (CTXS) was one of the ten stocks I highlighted on the 2006 Peridot Capital Select List (which, by the way, has returned 18% year to date - look for an announcement about the 2007 Select List in early January). After posting a gain of 40% through the first six months of the year, in my Select List Mid-Year Update I recommended investors take their profits as the stock traded above $40 per share. It appears that we are getting another chance to make money in the name.

After an earnings disappointment, Citrix is trading back down to $28 and change, which is where I recommended purchase at the beginning of the year. Given that the company has the ability to grow sales and earnings at a low to mid double digit rate, the current valuation looks very attractive.

Estimates for calendar year 2007 stand at about $1.50 per share. The company's balance sheet is pristine, with no debt and $736 million in cash, which equates to $4 per share in net cash. So, investors buying CTXS at $28 are getting a stock with an enterprise value of only $24 and $1.50 in earnings power. This equates to a 16 forward P/E multiple, which in my view is too pessimistic given Citrix's growth outlook.

I would expect Citrix shares to head well into the thirties again during 2007, and as a result, suggest investors reenter the stock. Evidently, CTXS management agrees the shares are undervalued, as they just announced a new $300 million share repurchase authorization.

Full Disclosure: I own shares of Citrix Systems (CTXS), as do Peridot clients.

GE to Banc of America: Thanks for Trustreet

GE Capital must be very happy that most Wall Street analysts don't have a clue how to value the companies they follow. On 10/30 they announced a deal to buy Trustreet Properties (TSY) for $17.05 per share in cash. Investors were rewarded nicely, as TSY investors are being paid a 36 percent premium to TSY's closing price of $12.51 on 10/27.

Clients of Banc of America Securities, however, are far from thrilled. The investment bank initiated coverage of TSY in February with a "neutral" rating with the stock trading at $13.85 per share. By August the stock had dropped 17 percent and the analyst covering Trustreet, Ross Nussbaum, downgraded the stock to "sell" with the shares at $11.44 each. Oops.

Less than three months later, GE Capital swoops in and offers 49% more than where TSY was trading at the time of the "sell" recommendation. How these people keep their jobs baffles me. How can an analyst, whose sole job is to value public companies, be off by a whopping 50% when doing so? Clients who sold their shares at $11 and change must be fuming, as are those who shorted it after a rare "sell" call.

Meanwhile, smart value investors are smiling. The sell side analyst community continuously gives them gifts, like TSY at eleven bucks. GE Capital, too, must be thrilled that Mr. Nussbaum keeps his job despite being incredibly bad at it. After all, without so much analyst negativity, TSY shares might have been trading much higher, and GE Capital would have had to offer more than $17 to persuade Trustreet management to sell the company.

As usual, investors who listen to analysts get the worst of it. I know many of my readers are familiar with my advice to avoid paying attention to sell side analysts, and many of you do just that. Still, when things like this happen, I can't help but mention them just in case some of you are suspect of my opinion. 

How the Election Might Affect the Market

Stock markets will always react to elections in some way and this year should be no different. Fortunately, the volatility that is created, either in specific sectors or the broad market, is often overdone. This could create opportunities this coming week.

First, let's tackle the broad market. This is fairly simple to gauge. Markets hate uncertainty, so any result at the polls on Tuesday that brings into question the political climate over the next two years should make some people nervous. However, any short-term weakness we see from this uncertainty should be expected to be fairly short term in nature. Traders always shoot first and ask questions later. Cooler heads usually prevail, and investors will jump in to correct any inefficiencies that were created by quick, emotional, and merely reactionary decision making.

As for individual sectors, the stock price movements will likely be very evident this year. Dems are talking about windfall profits taxes for big oil, as well as healthcare costs spiraling out of control. These two sectors will likely get sold if the Dems turn in a solid performance at the polls. So would contractors who have been making billions over in Iraq. Think Halliburton (HAL).

The question we need to ask ourselves, though, is how will this affect the next two years, really? Even if the Dems take both the House and Senate (I think this is quite unlikely) Bush will show us a new side of his; the veto side. Markets tend to like gridlock because it can result in compromise, which ultimately means things actually get done on Capitol Hill. However, Bush is hardly one to be receptive to compromise, so I wouldn't hold my breath.

Overall, I think we can get some buying opportunities if certain sectors see sharp sell-offs on the heals of the election. Let's keep an eye out for this and if anything peaks my interest, I'll let you all know (and feel free to do the same).

And don't forget to vote on Tuesday! 

CVS/Caremark Deal Creates Pharmacy Powerhouse

Many investors are scratching their heads after the announcement of a blockbuster deal that would, if approved, combine CVS (CVS) and Caremark Rx (CMX) into a pharmacy goliath with a $40 billion market value and $90 billion in sales. Caremark has been very active in the M&A game in the past but this deal in particular surprised a lot of people. There are obvious synergies between a PBM and an actual pharmacy and it will be interesting to see exactly how the deal turns out, both for customers and for shareholders.

What exactly was the motivation for such a deal? Several ideas come to mind. First, Wal-Mart's recent decision to price a 30-day supply of generic drugs for as little as $4 is a real threat to the likes of CVS, Walgreen's (WAG), and Rite Aid (RAD). By merging with Caremark, CVS opens up new, stronger avenues to compete with Wal-Mart (WMT). For one, they can enhance their mail order prescription business (mail order script fills have stronger margins than retail fills). Second, now when Caremark works with corporations and customers on benefit program management, they can steer clients toward CVS retail stores or one of their own mail order pharmacies.

Cost synergies seem inevitable with this deal as well. Computer systems can be made far more efficient with the company adjudicating the claims and the pharmacy filling the scripts on the same team. Cash collections will also likely be improved since the pharmacies and the PBM will not be trying to squeeze each other for their own cash flow gains.

All in all, the combination of bricks and mortar pharmacy, mail order pharmacy, and pharmacy benefits manager makes logical sense. The size and scope of the deal, along with its associated integration, might have made some leery in the past to make it happen. However, Caremark has shown a willingness to make game-changing deals (they acquired AdvancePCS, a large competing PBM several years ago and it proved a very successful transaction).

It will be interesting to see what, if any, response Express Scripts (ESRX) and Medco Health (MHS) decide on. I could also imagine that many Caremark shareholders will be upset with this deal and might even vote against it. Will they be able to halt the deal entirely? Perhaps, but it's too early to tell. Caremark and CVS will definitely have to sell the deal to naysayers though, and do so convincingly.

Merck Paying $1B for Sirna, More Deals Likely

Pharmaceutical giant Merck (MRK) is clearly looking for ways to boost growth. It's no secret that big pharma companies face increasing competition from generic drugs and pressure to keep rising healthcare costs in check. Small to mid size acquisitions of biotechnology companies are a solid way for companies like Merck, Pfizer (PFE), and Glaxo SmithKline (GSK) to strengthen their product pipelines.

On Monday we learned that Merck is paying more than $1 billion for Sirna Therapeutics (RNAI). It's is quite possible that they overpaid. After all, MRK is paying $13 per share in cash, a premium of more than 100 percent over Monday's closing price. However, overpaying by a couple hundred million dollars isn't a big deal for a company the size of Merck if several of Sirna's products eventually reach the market.

There is no doubt that deals like this one will continue. I am generally leery of trying to predict which firms will get taken out next. So, I would suggest that biotech investors pick stocks that have solid fundamentals, not just those that some speculate could get a bid from big pharma.

As for the pharma companies themselves, I like Pfizer at current levels ($27 per share). It trades at a discount to most of the other pharmaceutical companies and yields well over 3 percent. Pfizer has done mid size deals before and likely will do so in the future. In fact, I made a ton on a company called Esperion Therapeutics when it was bought out by Pfizer for $1.3 billion.

With a hefty yield and a below-market multiple, conservative, defensive, income-oriented investors should take a look at PFE. A recent analyst downgrade has knocked the stock down a buck.

Full Disclosure: I own shares of Pfizer personally, as do some of my clients. 

Chesapeake Energy Delivers Again

The chart above hardly looks like a company that has been clicking on all cylinders for the last 12 months. However, it serves as an example for investors that short-term stock movements oftentimes do not reflect the true fundamentals at publicly traded companies. Shares of Chesapeake Energy (CHK), as you can see, have been moving sideways for a year.

It is interesting to note, however, that CHK management has been doing an exceptional job at creating value for shareholders. During this time, Chesapeake's book value has risen by more than 140 percent, from $4.2 billion on 9/30/05 to $10.2 billion on 9/30/06. The company's public enterprise value, though, has only risen by about 10 percent during that time, leaving one to conclude that the stock price has a lot of catching up to do in coming months.

Note: the stock price has dropped slightly over the last year, but the enterprise value of the company has risen due to share count dilution, both from the issuance of convertible preferred stock and additional equity used to fund CHK's expansion.

Chesapeake reported another excellent quarter last night, as Q3 earnings hit $0.83, 11 cents above consensus estimates and 3 cents higher than the most bullish projection on the Street. Revenue hit $1.93 billion for the period, versus estimates of $1.47 billion. Most impressive of all, CHK raised its production growth targets for 2007 and 2008, from 11% and 6%, to 16% and 12%, respectively.

Wall Street analysts are currently projecting Chesapeake's earnings in 2007 to be flat, followed by a drop in 2008. However, given the production growth that the company seems comfortable in forecasting, natural gas prices would have to fall meaningfully for such an outlook to prove accurate. I suspect that Wall Street is overly pessimistic about Chesapeake's earnings power over the next couple of years (and beyond). As a result, I would not expect the stock to continue to trade sideways indefinitely, as it has for the last 12 months.

Full Disclosure: I own shares of Chesapeake Energy (CHK) personally, as do my clients.

Amazon Bulls Might Need to Calm Down

Wall Street is apparently thrilled with the third quarter earnings report from online retailing giant Amazon.com (AMZN), as judged by the stock's $4 (12%) jump in today's session. While I am not long the name, if I was, I'd be trimming it. Amazon is a retailer, plain and simple. Therefore, the current P/E multiple the stock garners is quite ridiculous. Back in 1999, the bullish argument for the company centered around the idea that without physical stores, Amazon could earn much higher margins than a Borders, or a Best Buy, or a Wal-Mart.

That thesis, however, has proved to be incorrect. Amazon's margins are not any better than your traditional big box retailers. In fact, Amazon's operating margins trail those of Target, Wal-Mart, and Best Buy. Turns out that warehouses carry the same costs as actual storefronts. With most retailers trading at less than 1.0 times revenue, Amazon trades at closer to 1.5 times.

The company's growth rate does exceed its competitors, for now anyway. Since Amazon has only been around for about a decade, they can roll out new products for a while before becoming mature enough to truly become a one-stop shop for everything. That said, I don't see how the company deserves a P/E multiple of more than 25 or 30 times earnings, as their growth should slow to below 20 percent going forward.

Right now shares of Amazon trade at about 80 times this year's expected earnings. Even if the company can grow the bottom line by 67 percent, as investors are expecting (that sounds optimistic to me), we're still looking at a 2007 P/E of more than 50 times. I just don't know how anyone can justify such a lofty price for the stock. If you think I'm wrong, please share your views. 

A Wildly Bullish Quarter for Buffalo Wild Wings

Sports bar/restaurant chain Buffalo Wild Wings (BWLD) posted an excellent third quarter Tuesday evening, prompting a five point rise in its stock in extended hours trading. Sales jumped 32 percent to $68.3 million, ahead of estimates of $64.9 million, as company-owned same-store sales soared an astounding 11.8 percent. Earnings hit $0.40 per share, nearly 30% above estimates of $0.31 for the period.

The company's conference call was very bullish, as management laid out growth plans for the next three years. BWLD expects annual unit growth of 15 percent, sales growth of at least 20 percent, and earnings growth of at least 25 percent.

Also worth mentioning was the lack of fourth quarter guidance. The company announced that it has decided to abandon giving quarterly financial projections, due mostly to the fact that they have been quite unsuccessful at the task in the past, and with fewer than nine million shares outstanding, a miss or beat of a mere penny per share equates to only a $44,000 difference.

The bears on the stock (and there are plenty of them, as seen by the 18% short interest in the name) will point to the lack of guidance for the fourth quarter as evidence that management expects poor results relative to the market's expectations. However, such a conclusion isn't very likely. Management mentioned on the conference call that Q4 same-store sales are already tracking up 11 percent year-over-year, well above even the most bullish estimates on the Street. Even if fourth quarter results get no bump up from current analyst projections of $0.46 per share, the company will report $1.54 in EPS for 2006. A twenty-five percent jump in 2007 puts EPS for next year at $1.93 per share.

As I have written before, I don't care much at all for quarterly sales and earnings guidance. In the case of BWLD, the company has a growth plan in place that will take form over the next three to five years and beyond. Whether they open a new store in Q3 or Q4 should be irrelevant for long term investors. Investors in the stock, myself and my clients included, will be served quite well if the company hits its growth targets, regardless of how volatile the quarterly fluctuations in financial results turn out to be.

Full Disclosure: I own shares of Buffalo Wild Wings (BWLD) personally, as do my clients.