Exxon Buy of XTO Could Start Energy M&A Domino Effect

I love Monday mornings for the sole reason that they are often very exciting from a merger announcement prospective. Many have expected lots of merger and acquisition activity in the energy sector but until today there was very little going on there. With this morning's announcement that ExxonMobil (XOM) is buying XTO Energy (XTO) it appears that the long anticipated trend of consolidation in mid-sized North American energy companies (most notably the unconventional natural gas producers) may be under way.

Exxon is paying a 25% premium for XTO Energy, one of the five companies always rumored to be on the short list of possible major oil company targets. Exxon is a conservative dealmaker so the fact that they are shelling out $31 billion ($41 billion including debt assumption) for XTO shows that they not only liked what they saw and the price they got. Other leading oil giants (think the likes of BP and Shell) are likely scrambling to draft their own plans to follow suit to ensure they do not get stuck with inferior growth properties. The majors are lacking an excess of replacement fields for the huge amounts of energy they produce each year, so a large acquisition is really the best way to secure future growth opportunities in a very competitive energy market.

So who might be next? I have compiled a list of the obvious targets, including valuations, to show you exactly why Exxon likely chose XTO (it was the cheapest company in the group), what other firms are likely going to have their tires kicked in coming months, and which of the remaining independent firms may be most attractive from a price tag perspective. Exxon is paying 6.6x trailing cash flow for XTO, so we can expect that to be the yardstick off of which future deal negotiations will be based.

Full Disclosure: Peridot Capital was long Chesapeake and Devon at the time of writing (yeah, unfortunately no XTO) but positions may change at any time.

Housing Market Stabilizing, As Long As Tax Credit Expiration in 2010 Does Not Halt Buying

For some reason I have not updated my long running home inventory chart in recent months, so I figured I would show the most recent data from the National Association of Realtors. As I have long discussed on this blog, inventories are the crucial part to the story because a balancing of longer term supply and demand is the only thing that will halt the home price decline for good.

As you can see below, inventories really took a turn for the better during the recently ended prime selling season (the data here is as of October 2009). The first-time homebuyer tax credit definitely played a big role in that, so the question going forward is "what happens when the extension of the credit expires in 1H 2010?"

I think sales will certainly slip at that point, but if the economy is growing, monthly job gains come to fruition by then, and consumer confidence is reasonable, there is a good chance inventories might not see another large spike higher. In that case, I believe we will see home prices stable in 2010. Long term, home owners should expect historically normal appreciation, which means about 3% annually.

Amazon Now Worth As Much As Target, Costco Combined

This is just one of the market valuations that I have not understood in the past (and still do not at the present). Amazon is one of my favorite companies and I buy stuff on the site all of the time. My caution on the stock in recent years (due to a sky high valuation) has been proven wrong, as the stock keeps moving higher. Amazon continues to steal market share in the retail sector from bricks and mortar storefronts as more and more people spend more online. I would have thought most people who prefer online shopping would have already adopted it as a way of life, but evidently that trend continues unabated.

I would not consider buying the stock at current levels, however, as I simply cannot figure out why Amazon should be worth as much as Target and Costco combined when the latter two firms earn 7.5 times as much money and do so at similar profit margins. It is true that Amazon is growing faster but the valuation discrepancy seems to more than account for that. Of course, if they keep growing market share, perhaps Amazon can grow at current rates for far longer than many ever would have thought. While I surely would have loved to own the stock this year, I am content simply being a satisfied repeat customer.

Executive Compensation Restrictions Work In Everyone's Favor

The core difference between the Bush and Obama administrations in terms of how they doled out government bailout funds was what, if any, terms came with getting the money. Former Treasury Secretary Paulson gave out the first half of TARP funds with no strings attached. Secretary Geithner, conversely, wanted to make sure the government funding came with restrictions, including how much executives of bailed out firms could earn while they still owed the taxpayer billions of dollars. Skeptics argued that this was a way for Washington to gain control of the private sector, but in reality it really was just a way to maximize the odds that the government got repaid.

The Obama administration's auto task force required that GM CEO Rick Wagoner resign because they knew that under his leadership we would never get our money back, not because they wanted firm control over GM. In fact, the CEO they handpicked, Fritz Henderson, just resigned after the GM board (not the government) insisted he move faster in making necessary changes, something GM-lifer Henderson was unwilling to do.

Executive compensation restrictions have served as another way to increase the chances that TARP funds are repaid. The restrictions made it more difficult for Bank of America to find candidates to be the banking giant's new CEO. As a result, BofA raised $19 billion in new capital last week in order to be in a position to immediately repay its $45 billion in TARP loans. I do not know anyone who expected the entire $45 billion to be repaid this quickly, and therefore it appears the pay restrictions did exactly what they were intended to do; give TARP recipients incentive to repay the money as fast as they could.

This is just one of the many reasons I think Treasury Secretary Geithner has done a very solid job so far. There will always be critics who blame everything they don't like on certain people, but a lot of these decisions are proving to have worked.

Data Shows Trend Clearly Pointing To Job Gains Soon

There will be no way to argue that the job market is healthy until we see sustainable job growth but this morning's monthly non-farm payroll data (preliminary figures for November show net payroll declines of only 11,000 workers, the best monthly performance since December 2007) continues to show that the trend in layoffs is moving in the right direction.

The Obama administration will continue to get heat as long as net layoffs are still being recorded (and they will be in trouble if the jobs picture does not improve by the mid-term elections next year) but if we look at the monthly job figures so far this year, it is hard not to be optimistic about the trend:

From this chart it looks like those predicting net job gains by year-end or early 2010 at the latest may in fact be proved correct, which would be great news for the U.S. economy and stock market alike.

Tesla IPO Hopefully Can Boost New "Green" Economy

From Fox Business:

"Tesla Motors, maker of luxury-all-electric cars, is reportedly planning a stock offering. If the sale occurs, Tesla would be the first U.S. car company to issue shares since Ford Motor Co. in 1956."

This is very exciting news. Not necessarily from an investment standpoint (it will likely be a while before pure electric car companies can prove to investors they have a sustainably profitable business model), but from an innovation point of view. The United States needs to promote the future of a "green" economy, not just to reduce oil imports, but even more importantly to generate a new force that can produce job growth, much like the advent of the Internet has already done. I hope Tesla has a successful IPO, as it may provide a psychological boost for other entrepreneurs out there who would like to get the "green" ball rolling.

Devon Energy Asset Disposition Plan Should Bode Well For Shareholders

Devon Energy (DVN), a leading oil and gas exploration and production company, announced yesterday an asset disposition strategy for 2010 that appears to be very accretive for equity holders should it be completed as planned. Devon announced that it plans to sell its Gulf of Mexico and international operations next year in order to focus on North American onshore energy properties. The sales are expected to bring in between $4.5 and $7.5 billion on an after-tax basis.

Devon's stock rose $3 to $71 on the news as investors realized that Devon simply had too many properties to explore given its finite financial resources. By selling non-core assets and using the proceeds to focus on their strongest properties, Devon should be able to operate in the most efficient and shareholder friendly way.

A deeper look at the numbers shows a very attractive proposition for stockholders. Devon believes it can reap $6 billion from their gulf and international assets, which represents about 20% of the company's current equity market value of ~$30 billion. These same assets only represent 7% of the firm's energy reserves and 11% of current production. Since energy production companies are largely valued by investors based on reserves, selling these assets appears to be a very smart move for Devon. Clearly Wall Street is undervaluing these assets if indeed Devon can get $6 billion for only 7% of the company's reserve base.

In addition, Devon will see its exploration expenses drop meaningfully after shedding these non-core assets. These non-core assets currently account for 29% of Devon's annual capital expenditures. So, not only is Devon trying to unload assets that are undervaluing the company, but they are also the company's most expensive assets to develop.

To recap, Devon currently spends 29% of its capital budget to develop only 7% of their reserves and it believes it can sell those assets for 20% of its current equity market value. This looks like a no-brainer for Devon and its shareholders.

As previously mentioned, Wall Street applauded the move, sending Devon shares up $3 to $71 after this strategic announcement. Since I am not fan of buying stocks after a big move up, now might not be the best time to scoop up the stock, but if it drops back to $65 or lower I will likely take a hard look at it based on recent developments.

Full Disclosure: Peridot Capital had a position in Devon at the time of writing, but positions may change at any time

United Airlines: How Not To Run An Airline

I came across this article by John Battelle over on Business Insider and thought I would share it with everyone. I am a loyal Southwest customer so I have managed to avoid the crazy complicated (and irrational) dynamic pricing algorithms that many of the major carriers use. Hopefully there are not too many United shareholders out there reading this...

Thanks For Flying United. Please Give Us All Your Money

Chad Brand Interviewed on "Behind The Spread"

I recently did an interview with the investment site "Behind The Spread" which focused on learning about the backgrounds of various investment professionals.  They are interviewing the genius investors on KaChing and it was my turn in line. If you would like to learn a bit more about me and my investment philosophy, you can check out the Q&A here:

Chad Brand interview on "Behind The Spread"

Analyst Silliness with Research in Motion

In recent days I have been paying special attention to shares of Blackberry maker Research in Motion (RIMM). The stock is one that had decent earnings this quarter but some investors wanted more, which prompted a pretty significant sell off in the stock. Despite the market having recently made new yearly highs, RIMM shares have dropped from the high 80's to the mid 50's. The stock is down several points today after the analyst who covers them for Citigroup downgraded it from "buy" to "sell."

Skipping the "hold" rating completely is pretty rare on Wall Street, but what caught my eye even more was that the analyst lowered his price target on RIMM from $100 to $50. What happened to make the company worth 50% less overnight in his view? The upcoming release of Motorola's Droid smart phone.

Call me skeptical of this bold call from Citigroup's research department. The new Droid is going to be such a huge success that it will translate into a 50% haircut in the value of Research in Motion, which has a stronghold on the corporate smart phone market? Have we not seen dramatic hype surrounding new cell phones recently that only served to disappoint investors? The Palm Pre comes to mind immediately. While it may help Palm get back on the map, the Pre is certainly not looking like a genuine iPhone challenger like many were expecting. Should we believe that the Droid will similarly make a huge dent in RIMM's Blackberry franchise?

I haven't made the plunge into RIMM stock yet, but the odds are getting higher each day the stock continues to slide. At a current $55 quote RIMM trades at 11 times 2010 estimates ($4.85 per share), which seems reasonable even if that figure proves too high due to increased competition. Right now I might just be willing to make the bet that the Blackberry retains its lead in the corporate market for years to come. If so, the stock looks pretty cheap here.

How have this analyst's past calls on the mobile sector turned out? Pretty lousy, which is par for the course on the sell side. Today the analyst upgraded Motorola to a buy and downgraded Palm and RIMM to sell. He initiated coverage for all three back in September 2007. Here is how the calls since then have turned out:

His track record on Palm has been decent; initiated at sell at $8, upgraded to hold at $6, and now back to sell at $11.

How about RIMM? Dismal. Recommended as a buy twice at $99 and $69, and now says you should sell in the mid 50's.

Lastly, the Motorola record isn't all that impressive either; hold at $18, buy at $12, hold at $6, buy today at $9.

All in all, the current negativity on Research in Motion looks overdone to me and as a result I am considering a contrarian investment. As always, please share your own thoughts if you care to join the discussion.

Full Disclosure: Peridot Capital had no position in RIMM at the time of writing, but is certainly taking a very close look at current prices.