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Wednesday, June 02, 2004 5:51:02 PM
U.S. stocks rose, sending the Standard & Poor's 500 Index to its highest in five weeks. Concern that higher energy costs may slow the economy eased as oil prices had their biggest decline this year. The S&P 500 added 3 points (+0.3%) to 1,124, a level not seen since April 27. Eight of the S&P 500's 10 industry groups rose. The DJIA gained 60 points (+0.6%) to 10,262, the highest in four weeks. The Nasdaq Composite slipped 1 point (-0.1%) to 1,988, for its first drop in eight days. Three stocks rose for every two that fell on the New York Stock Exchange. Some 1.26 billion shares changed hands on the Big Board, 14 percent less than the three-month daily average. Crude oil for July delivery sank 5.6 percent to $39.96 a barrel on the New York Mercantile Exchange, after jumping to a record $42.33 yesterday.
Strong Sectors: health care facility, casino, airline, biotech, beverage, REIT, aerospace, biotech
Weak Sectors: semiconductor, internet
Top Stories . . . The dollar weakened against the euro, yen and eight other major currencies on concern oil prices near record highs will cool economic growth in the U.S., the world's biggest consumer of oil.
OPEC should pump oil at will in the next few months, Qatar's energy minister said as the group's president called for efforts to cause a ``significant'' drop in record oil prices.
Crude oil futures declined from a record in New York and from a 13 1/2-year high in London after OPEC officials signaled output may reach full capacity to lower prices and ease concern supplies will be disrupted.
Harbin Brewery Group, China's oldest brewer, asked shareholders to accept a takeover bid from Anheuser- Busch Cos. that values the company at HK$5.89 billion ($757 million) and tops a rival offer from SABMiller Plc.
Albertson's, the second-largest U.S. supermarket chain, said first-quarter profit dropped 79 percent after a strike hurt sales and the company shed its New Orleans stores.
Gurus . . . Ed Hyman says his survey of major companies shows a renewal of momentum, following a lull that ended the past few weeks. Most impressive was the improvement in home-building and auto dealers. At the same time, the economy is looking stronger, and inflation is looking faster on all fronts, except for last week's tame core consumption price deflator for April. As for the job figures on Friday, his regression model calls for payroll employment to rise 222,000, with manufacturing jobs up 20,000. Analyst estimates for second-quarter earnings moved up over the past week from 18.1% to 19.0%.
Goldman Sachs says gold may rise this year because of buying by hedge funds, and an expected decline in the U.S. dollar against currencies, such as the euro. The precious metal may rise to $428.00 an ounce by 2005, as the dollar weakens to $1.30 against the euro.
JP Morgan says profit margins may be near their peak, because employment is increasing, and productivity is likely to slow. Fewer companies will report earnings that surpass estimates. In the first-quarter, more than 72.0% of the S&P companies exceeded estimates.
Mortgages . . . The number of applications for mortgages in the United States declined 1.2 percent last week on a seasonally adjusted basis. Applications for purchase loans rose 2.2 percent while applications for refinanced loans fell 6.6 percent. Refinancings fell to 34.3 percent of loans from a 36.2 percent share. The average rate on a 30-yaer fixed loan dropped to 6.24 percent from 6.26 percent.
Inflation . . . Barron's Online discusses oil prices, which has whipped up a mini-hysteria in media. Many news reports note that crude oil is near $42 per barrel and gasoline at $2.00 per gallon are at record highs. But, according to the article, those prices are not records when they're adjusted for inflation. In 1981, following the Iranian Revolution and hostage crisis, oil prices reached an all-time high near $80 in current dollars (roughly $40 per barrel in that year's dollars). Gasoline also reached a peak in the early 1980s of $3.00 a gallon, adjusted for inflation. Today Americans actually are spending less of their household income on energy than they did in the 1980s. Energy spending for the average U.S. household is a mere 4.8% of after-tax income today, according to David Wyss, chief economist at S&P's. Energy costs were 8% of household income in 1981, he says. Mr Wyss says that if gasoline and oil prices remained high for 12 months, it would cut GDP by about $30 bln, only 0.25%. But he says, "We are seeing no evidence that people are driving less or changing vacation plans, which means that gasoline prices are not pinching very much." And, he adds, it all depends on whose ox is being gored. "High oil prices are bad for US Airways' corporate profits, but good for Exxon," Mr Wyss says. Some transportation co's, including FedEx, can pass on higher gasoline costs to consumers. But not UAL, which is "in bankruptcy, so it doesn't have any time," says Philip Verleger, a senior fellow at the Institute for International Economics in Washington, D.C. Mr Verleger also thinks Toyota Motor and Honda Motor would thrive, because they produce a wider range of fuel-efficient models, if energy prices spike higher.
Accounting . . . The Emerging Issues Task Force has issued EITF Issue No. 03-1, containing new guidance on other-than temporary impairments of investment securities. The new rules dictate when impairment exists, provide guidance on determining if the impairment is other than temporary, and direct how to calculate the impairment loss. The impact of expected rising interest rates on fixed income markets, and the related impact on equity markets (as well as other concerns), could result in losses that will have to evaluated under the new rule, and possibly recorded in the income statement. The new rules are effective for periods beginning after June 15, 2004, generally the third quarter of this year. The new rules are backed up by expanded disclosures. Even if an impairment loss is not taken, all investments with unrecognized losses are subject to new annual disclosure rules. Breaking out loss positions between those existing for less than one year and for one year or longer is especially telling. Investments accounted for under the cost method (because there is no readily determinable fair value) will also be subject to the new rules, and will be evaluated in light of impairment indicators. Investments accounted for under the equity method are excluded from EITF 03-1, so they will continue to be evaluated under existing rules
Market Speak . . . The economic backdrop is the strongest we have seen in years and the recent revival of employment now adds a feel-good factor to the recovery. Still, the same data that support the favorable economic outlook also argue that the best of times for equities is behind us. Indeed, the topping patterns seen in many leading indicators suggest that the momentum trade in stocks is likely over. The May release
of the ISM Manufacturing Index is a good example of this. The indicator remained at very elevated levels, arguing for strong growth in the economy, but failed to increase significantly, or, in other words, to provide the conditions typically associated with a rapid rise in stock prices — on the whole, a reading that argues in favor of a noncyclical equity portfolio bias.
The biggest argument on a noncyclical call is that this cycle is very different from prior ones. Indeed, many investors proclaim that this recovery is unusually favorable for cyclical stocks since it is marked by a return of pricing power for basic industries. This alone, many argue, is enough for these stocks to continue to outperform despite signs that many leading indicators may have reached peak momentum. It is important for investors to differentiate between cyclical and secular forces. While a secular uptrend would be supportive for commodity industries, cyclical forces can sometimes savagely punctuate secular gains.
The chart above is a graphic representation of the simulated path of commodity/basic industry pricing during a deflationary period much like that of the past 20 years or so. It is interesting to note that capital goods stocks managed to outperform from 1991 to 1994 despite this so-called secular decline in pricing. If this segment could outperform in such a dire pricing environment, could it not underperform in a favorable pricing environment? Of course, it can, and we believe it will. Indeed, cyclical forces generally prevail over secular ones in the short term. As such, a topping pattern in leading indicators like the ISM Index is a sign that the best of times are behind us for most cyclical segments, regardless of the secular environment.
While it is still premature to say that we are at a truly secular turning point in inflation, it is not too early to study the investment implications of a turn. A return of pricing power would have minor implications for sector positioning over the next 12- 18 months; however, it would have a more profound effect on the outlook for the overall market. Indeed, historically, the stock market has not fared well in periods of accelerating inflation. While pricing power can be a good thing for earnings, the higher interest rates
that come with it often nullify this favorable impact by lowering P/E multiples. Mild inflation is the most desirable outcome here.
Inflation
A key topic on investors’ minds of late is the inflation outlook. Indeed, a number of important gauges of inflationary pressures have begun to flag cautionary signals. For instance, the prices paid component of the ISM Manufacturing Index continued to hover near a 25-year high last month. Unsurprisingly, perhaps, a number of pundits have now begun to talk about a secular turning point in inflation trends. More importantly, some argue that this could be a good thing for stocks since it would lead to higher earnings. While it is still too early to say whether we have reached a secular turning point in inflation, investors need to note that a return of inflation cannot be assumed to be favorable for equities.
The “inflation is good for stocks” thesis holds up as long as one assumes P/E multiples — an integral part of the valuation equation — remain largely unaffected by rising inflation. Typically, though, rising inflation is accompanied by higher interest rates, and higher interest rates generally compress market multiples. In fact, our analysis has found that at today’s interest rate levels, a 50-basis-point change in bond yields impacts the market’s forward P/E by a full point. Put differently, a rise in inflation that would lead to a 100- basis-point rise in long-term interest rates would shave the market’s multiples by more than two full points. Under such a scenario, earnings would have to rise by over 15% to perfectly offset this effect. So, be careful what you wish for: a turning point in inflation would not likely prove to be that positive for equities.
Financials . . . Goldman Sachs says that while they remain comfortable with their in-line 2nd quarter estimates for U.S. brokers, they believe that the prospect for significant upside surprises to estimates is unlikely given some deceleration in several key securities industry trends the last 2 months and the rising rate environment since early April. Firm also believes that investor's bias towards consensus estimates beyond 2nd quarter will move to more neutral or even negative in 2nd half 2004, and that 2nd quarter will mark the first quarter of a new down cycle in Return on Equity trends. Firm expects this down cycle to be fueled by declines in fixed income trading revs, which they do not believe will be fully offset by growth in M&A and equity-related businesses. Firm also continues to believe that pretax margins have peaked, and given the historical relationship between R.O.E. trends and P/B valuations, they continue to believe recent multiple compression is warranted and that further P/B multiple contraction may be possible.
The WSJ's "Heard on the Street" column discusses Charles Schwab, as stocks have climbed out of a multiyear funk, stock mutual-fund purchases are strong and individuals have a renewed hankering for investing thrills. That should be good news for Schwab, but according to the article recent actions by the co indicate that the road ahead remains far from smooth. To attract more customers, the firm last week announced plans to slash prices for some online stock trades. The firm says the move, aimed in part at narrowing the pricing gap between Schwab and discount online brokers Ameritrade and E*Trade, will help it attract customers while costing Schwab just 2% to 3% of its rev over the next year. But the move has rattled investors, who suspect the pain may be worse than Schwab is predicting. Their concern: The company may not attract nearly as much new business to offset the price cut. Making matters worse, Schwab shares remain expensive, despite dropping more than 30% in the past 8 months, says the Journal. And with the stock market hitting weakness, and the co struggling to boost earnings and still trying to figure out how best to compete with rivals, some investors are concerned a turnaround isn't around the bend.
Oil Prices & OPEC . . . OPEC members should pump oil at will during the next few months to lower record prices, Qatar's energy minister said, joining calls from Saudi Arabia, Kuwait, Indonesia and the United Arab Emirates for more supply. The minister, Abdullah bin Hamad al-Attiyah, said concern of potential attacks on Middle East oil installations or U.S. gasoline shortages have inflated prices by $10 a barrel. "Everybody should produce what they want over the next few months,'' the minister said. The OPEC president, Purnomo Yusgiantoro of Indonesia, told reporters that members want to increase output and have a "significant impact'' on prices.
Oil & Gas . . . First Albany upgrades Devon to Strong Buy from Buy and raises their target to $77 from $66, and upgrades Apache to Buy from Neutral and raises their target to $49 from $42. With DVN, firm notes that the stock is trading at 4.5x 2005 normalized EBITDA vs the large cap peer average of 5.2x, the co has a positive outlook for debt reduction in excess of $1.6 billion this year, and should significantly reduce finding costs this year (an ongoing criticism of the co). With APA, firm says that the new price deck is significantly accretive to 2004-05 EPS, and 2004 F&D costs will benefit from the large Qasr discovery in Egypt.
Restaurants . . . Prudential upgrades Outback Steakhouse to Overweight from Underweight, and downgrades Darden and McDonald’s to Neutral-Weight from Overweight. While same store sales are slowing and historically high commodity costs are limiting flow-through to earnings. The firm believes these factors are already reflected in estimates and valuations, as are higher gas prices and rising interest rate concerns. Firm's favorite ideas are Wendy’s and Outback Steakhouse, and their least favorite is Brinker’s.
Retail . . . Banc of America downgrades Home Depot to Neutral from Buy based on growing concerns about the traffic-ticket gap. The firm says that HD remains attractive on a number of valuation metrics, but after posting two consecutive quarters of 7% comps, the Street is no longer likely to be surprised by good performance from the company. In addition, firm believes that even without an up-tick in rates, it is very unlikely that housing will show increases over the prior year, which could trigger negative comps in 2005. Finally, firm says that recent comps have been heavily weighted towards ticket as traffic has flattened out, and they note that the spike in ticket looks a lot like 1994 and 1999 -- just prior to deteriorating fundamentals and severe underperformance. Target is $37.
Albertson's reported earnings of $0.15 per share, $0.04 better than the consensus of $0.11. Revenues fell 2.5% year/year to $8.69 billion versus the $8.75 billion consensus. The company reits full year EPS of $1.40-$1.50, including Shaw's versus consensus of $1.41. Note: the $0.15 includes a number of charges, which had been included when guidance for the qtr was provided by the co, so it's comparable.
Marquis Research initiating coverage of Netflix with a Buy and a $41 price target. The firm notes Netflix, while best known for its DVD rental service, is a widely misunderstood company. The DVD rental service, while profitable and the main driver of the business to date, is not the primary reason investors should take a look at this company. Rather, the burgeoning Video-On-Demand market is the biggest reason investors should focus on NFLX. The firm notes long term investors should use the DVD rental market as a proxy to determine the expertise of NFLX management. The firm believes the DVD rental business should eventually cede to the downloading or Video-On-Demand market. With many of the moving parts yet to be determined in the Video-On-Demand delivery, Marquis believes that the significant membership presence, solid relationships with big and small movie distributors, and proprietary movie selection /recommendation system will make NFLX the incumbent in the Video-On-Demand market. In terms of valuation, the firm notes NFLX represents a true venture investment in Video-On-Demand that has liquidity and an underlying business that is already performing well. Given this situation, Marquis believes that a traditional tech multiple of 29x '05 EPS yields an appropriate price target in the current market environment.
Healthcare . . . The WSJ reports hospitals across the country are starting to hit up patients for part of their bill before discharging them, and sometimes even before treating them. The aggressive new push is part of a broad effort by hospitals to cut bad-debt expenses. Starting later this month, HCA will begin asking patients to pay their co-payment before receiving non-emergency treatment. If patients say they cannot afford it or don't have the money, the hospitals will ask for at least a down payment. HCA is implementing the new approach in each of its 191 hospitals. Hospitals are increasingly implementing these strategies now, or making them tougher, for several reasons. For one thing, improved technology gives more hospitals the real-time information to figure a patient's deductible and co-payment amounts. For example, at Tenet Healthcare administrators are going online to determine a patient's co-payment, among other tactics as part of a pilot program in Florida to improve collection procedures. According to the article, the more aggressive billing stance is expected to have a significant impact on hospital finances.
Medical Devices . . . icad announced the FDA approval for release of iCAD's new Second Look 200 system for early detection of breast cancer with substantially improved cancer detection software. The co says its new combination of Second Look 200 with iCAD's Version 6.0 cancer detection software represents both the most sensitive cancer detection solution available, and the least expensive.
FTN Midwest downgraded Boston Scientific to Neutral from Buy. The firm is saying the potential for continued revenue and earnings growth upside stemming from the successful Taxus launch is now "known" and reflected in the stock's valuation. The firm also says the company's revenue and earnings growth outlook for 2006 and beyond continues to depict a significant deceleration in growth, despite yesterday's announcement of the planned acquisition of Advanced Bionics. Maintains $50 target.
Cardiac Science and Chindex jointly announce multi-year distribution agreement whereby Chindex will market DFIB's line of Powerheart-brand AEDs on exclusive basis to hospitals and other medical supply dealers throughout mainland China. Agreement also allows Chindex to distribute DFIB AEDs on non-exclusive basis into other emerging mkt segments such a physician offices, police, fire, EMS, military, corporations and public transportation.
Drugs . . . Morgan Stanley assumes coverage of Medimmune with an Overweight rating and $32 target (former rating Equal-Weight). After the disappointing FluMist launch and facing slowing top- and bottom-line growth, the firm acknowledges that MEDI no longer commands a premium. However, firm believes that the Street is now underestimating the Synagis cash flow potential and discounting the pipeline. Firm assumes coverage of BIIB with an Overweight (former rating Equal-Weight) and $77 target; while their 2004-05 EPS estimates are in-line with consensus, they believe that there is meaningful upside to longer-term numbers, with Antegren driving at least 22% compounded growth between now and 2010. Firm also assumes coverage of AMGN with an Equal-Weight, and DNA with an Equal-Weight (former rating Underweight).
Biotech . . . The WSJ's health section discusses stem-cells, as capitalizing on the emergence of stem-cell therapy as standard treatment for many kinds of leukemia and lymphoma. The article notes a co called NeoStem wants healthy consumers to pay $5K to bank their own stem cells for the future, to be used in the event of disease. Last month, NeoStem opened its first collection center in Los Angeles and plans 60 or more in the U.S. over the next 3 years. Some research suggests stem-cell therapy may one day be useful in treating everything from heart disease to spinal-cord injury to radiation sickness. Indeed, stem-cell research "has the potential to revolutionize the practice of medicine and improve the quality and length of life," according to the National Institutes of Health. NeoStem is betting that well-to-do consumers will pay to maintain their own healthy blood stem cells in the event they become ill or injured. The company's founders think cell banks can become a multibillion-dollar business. "One group that excites us is people who have had an infarction and are at risk for another heart attack," said CEO Denis Rodgerson of NeoStem. So far, some 20 people have undergone the procedure, including Dr. Rodgerson and some of the firm's investors. Researchers are studying whether stem cells can promote growth of healthy heart tissue. From a scientific point of view, stem-cell banking isn't particularly controversial. Transplants using a patient's own cells are less costly than those involving matched donors. And blood stem-cell banking doesn't involve embryonic stem cells, which are at the center of a world-wide ethical debate over their use in drug development and other human experiments.
Media . . . Cable and entertainment stocks have been languishing, as investors question entertainment’s organic growth potential and worry over cable competition. With both groups’ return on capital depressed by consolidation and/or investment, investors are now looking for payback, in the form of growth, return of cash, or some mix of the two. Implied costs of capital suggest either excessive risk in the stocks or too much equity on the balance sheet, and sometimes both. For cable, reassessment of the risk/reward trade-off could result in a repricing of the group, while for entertainment, wealth-sharing and cyclical improvement could be the catalysts
for outperformance. Not all the stocks share the same risk/reward profile. Viacom may provide the best near-term opportunity in entertainment, while Time Warner provides longer-term appreciation potential. In cable, Cablevision after the spin-off could be the best performer, while both Comcast and Cox are expected to outperform the market should investor sentiment change.
The WSJ reports that Sirius Satellite Radio is bolstering its programming lineup to take on rival XM Satellite Radio in the race for subscribers. The company signed programming pacts over the past few months with the National Football League, National Hockey League and National Basketball Association. According to the article, Sirius officials say more deals are on the way. "We want to be the destination for sports, and we've got a pretty good start," CEO Joe Clayton told shareholders at a meeting earlier this week. The programming ramp-up is Sirius's latest effort to narrow the substantial gap between itself and XM. "They have to differentiate themselves," said Jimmy Schaeffler of the Carmel Group. Sirius "must convince listeners that they are worth $3 more."
Yesterday, Marvel Enterprises announced formally that it has settled its lawsuit with Sony Pictures. Marvel alleged that Sony had essentially "hijacked" the Spider-Man character from Marvel. Sony in turn sued Marvel for not properly accounting for Spider-Man merchandise revenues, on which Sony was entitled to a royalty. As part of the settlement, Marvel will consolidate its JV with Sony and record the total revenue associated with Spider-Man non-toy merchandise licensing, along with the corresponding expenses, including royalties to Sony.
Previously this was recorded in equity income on a net basis, with Sony and Marvel splitting the licensing revenue 50/50. Additionally, Marvel will now have total control over both Classic Spider-Man licensing as well as movie Spider-Man licensing. The latter was previously controlled by Sony, and MVL management believes led to a less optimal overall licensing strategy for the Spider-man character. Now, Marvel believes it can better maximize this segment
of its business going forward. Despite the announcement, Marvel maintained its full year operating income guidance, which was probably the reason for the weakness in the stock yesterday. However, Marvel will now receive better than 50/50 splits on the Spidey merchandise and any upside to earnings in 2004 will come on stronger than expected sell through at retail. Overall, the settlement is a positive for MVL, but the benefits are difficult to quantify at this point. As such, analysts are making no changes to our projections. At current levels, Marvel's valuation is not overly compelling, but reasonable. In the near term, while the consensus is that Spider-Man 2 will be a box office success, visibility into 2005 remains low.
The NY Post has learned that representatives for Mel Karmazin are expected to reach out to Walt Disney's board of directors soon about the possibility of the former Viacom president succeeding Disney honcho Michael Eisner. Karmazin has indicated he wants to be a CEO of a big media company, and many in the industry expect him to wind up at Disney. On a conference call with reporters yesterday, Viacom chief Sumner Redstone said, "I don't see a place" for Karmazin at another major media company. In a statement yesterday, Disney Chairman George Mitchell said: "The board has complete confidence in the current management. On the strength of our recent results we believe that confidence has been justified, and will be further validated as our performance continues to improve." The board, meanwhile, has stepped up succession plans in response to the shareholder revolt. At the very least, Eisner is expected to not be given an extension when his current employment contract expires in 2006. Meanwhile, Eisner's top deputy, Bob Iger, is not seen as a potential heir to the Disney throne. Many in the media industry have predicted he would be tossed to make way for a new No. 2 who would be groomed to take the top spot when Eisner's contract ends.
Electronics . . . palmOne upped to Buy from Hold at Stanford Group. Target goes to $29 from $20. The firm believes that Sony's exit from the US PDA market bodes well for PLMO. Whereas Microsoft PDAs will likely capture some of the void left by Sony, firm expects PLMO to take the lion's share. Firm raises 2005 estimate to $0.71 from $0.65 (Reuters consensus $0.72). Firm raises target to $29 from $20 noting that PLMO will benefit from fewer competitors in the US and from increased unit sales. As a result, believes that PLMO could achieve operating margins above firm's previous expectations over the next few years.
Telecom . . . The WSJ reports wireless entrepreneur Craig McCaw is expected to announce today that he is launching a national wireless broadband service to compete with the high-speed Internet access offered by cable operators and telephone company's. The executive will detail his strategy at the Wireless Communications Association International conference in Washington, D.C., though word of his plans has been circulating as he has bought up wireless spectrum licenses. His co, called Clearwire, aims to offer wireless Internet access to consumers in roughly 20 markets over the next year, according to Gerry Salemme, the executive vice president of Clearwire and a longtime executive at various ventures of Mr. McCaw's. It will launch service in two cities this summer, Jacksonville, Fla., and St. Cloud, Minn. Clearwire is seeking to offer a national service that targets not only rural markets but large markets where other wired alternatives are available. Clearwire's service will be marketed to consumers as a fixed product to compete directly against Internet access via cable modems and digital subscriber lines. Mr. Salemme said that Clearwire's service would offer speeds in a range of 1.5 to 2 megabytes per second, potentially slightly faster than home DSL or cable modems, and significantly faster than wireless services being contemplated by cellular carriers. Mr. Salemme said that the network's technology will be compatible with WiMax, a hotly anticipated technology that will provide wireless, high-speed Internet access at ranges of several miles, expected to be available in 2006.
EMS . . . Flextronics will host a mid-quarter review on Thurs, June 3rd. Revenue and EPS estimates are $3.925B (up 4% Quarter/Quarter and up 26% Year/Year) and $0.14 versus consensus of $3.9B and $0.14. The 4% Quarter/Quarter revenue increase is better than last year's 1.5% increase driven by new wins and the continued ramp of ODM handset programs. On average, over the last 5 yrs (excluding 2000) June rev has increased 1% Quarter/Quarter. Based on our recently hosted meetings with Jabil and Benchmark Electronics managements, business appears on track for the June qtr in EMS. Key customer themes (Sony-Ericsson and Siemens and HP inkjet volume) appear to be holding. Customer comparables analysis shows FLEX's top-ten customers up 3% in June with outsourcing adding 1%. Expect to get an update on the closing and impact of FLEX’s pending NT transaction. NT deal originally expected to close late June/early July and to add over add over $2B in annual incremental rev costing $500 million in cash paid over roughly 9 months. The outsourcing agreement will conservatively be $0.08 - $0.10
accretive to 2005 EPS. Better working capital management key to concerns about a follow-on offering. Given the $500 million required for NT deal, concerns about FLEX needing to raise capital arose after $250 million AP paydown and $80 million AR increase in March which turned CFO negative despite better than expected operating income. Currently FLEX has ~$1.5B in
liquidity including $615 million in cash and ~$900 million in revolver availability.
Storage . . . Merrill Lynch cuts estimates for Seagate Tech, Maxtor, Western Digital, and Hutchinson, and says it's still too early to invest in the U.S.-based hard drive stocks. Firm cites the following factors: 1) recent T.S.R. (hard drive supplier) data, which suggests downside to their prior estimates; 2) distributor checks, which suggest that shipments would be down sequentially in 2nd quarter; 3) their belief that key supplier HTCH has not reached an inflection point in its suspension assembly business; 4) their Taiwan team's estimates that PC motherboard shipments will be down 11% sequentially in 2nd quarter; and 5) slowing growth in Europe due to a declining euro and weakness in continental Europe.
Imaging . . . Deutsche Bank reiterates their Sell and $20 target on Eastman Kodak. The firm is saying the recently released May IRI data shows worsening retail sales growth of -18.1% in the company's core film business. The firm says the negative sales trend is the worst they have seen since they began tracking IRI data in July of 2002, and the steep decline was due primarily to weakness in disposable cameras.
Network Equipment . . . Jefferies said market share erosion at Nokia, the handset maker, has been more pronounced that it has recognized. "The company claimed market share in the order of 35 percent in the first quarter, but subsequent data from competitors suggests that overall first quarter growth was much stronger than Nokia had estimated. Our count of unit shipments is 151.5 million, suggesting growth of close to 35 percent and putting Nokia's market share at 29.5 percent... Most of these rivals continue to make up beat noises," it said. Jefferies reiterated a "hold" rating on the stock.
Digitimes reports Nokia has recently launched 3 new handset models in Taiwan, which include the 6230, the 3120 and the 7200. The company said that sales of the three models are expected to increase its market shares in Taiwan over the 11.3% it recorded in March. The 7200 is Nokia's first clamshell model, and demand has already exceeded supply, according to the co. The three new models have boosted monthly sales in May, the co added. Nokia's market share climbed to 16% in May, up 2 percentage points on month, according to the article, citing sources at Taiwan handset distributors. The sources also indicated that Motorola still led all vendors, with about 20% of the market.
Advanced Fibre announced a new five-year contract extension with SBC Services Inc., a subsidiary of SBC Communications, to provide its AdvancedVoice and UniversalDSL solutions. AFC has been a supplier of broadband access solutions to SBC since 1997. Financial terms of the new agreement were not disclosed.
Based on Nortel's work to date, including the work done since the update provided on 4/28, related to the planned restatements, the principal impacts of the restatements and revisions identified to date to company's results continue to reflect the following: reduction of approximately 50% in previously announced net earnings for 2003. These amounts will largely be reported in prior periods, resulting in a reduction in previously reported net losses for such periods including 2002 and 2001; net loss for the 1st half 2003 compared to the previously announced net earnings for that period; the net income reductions are expected to substantially impact company's continuing operations rather than discontinued operations in 1st half 2003; no material impact to prior period revenues; and no material impact to company's cash balance as at 12/31/03. As previously indicated, company's work to date with respect to the planned restatements and revisions and the expected impacts mentioned above are subject to a number of important limitations, including: Expectations as to the impacts continue to be partial and preliminary; ongoing work of the Nortel Networks Audit Committee independent review; The significant work to be done by the Company, including with respect to the detailed review of 2nd half 2003, accounting documentation and reporting systems issues and the impact of accounting for certain matters, including foreign exchange; The previously disclosed material weaknesses in company's internal controls over financial reporting; and audit of the Nortel Networks financial statements by the company's independent auditors.
Semiconductor Equipment . . . Smith Barney initiates coverage on the Semiconductor Equipment sector; firm says their analysis suggests that chipmakers' capacity utilization will peak for the cycle in Q2, and therefore most equipment stocks have likely peaked for the cycle on an absolute basis; however, they believe that this cyclical top will not fully play out until mid-2005. With many equipment stocks already down 25-30% or more from recent peaks, firm likes a defensive strategy that focuses long positions on names that exhibit some combination of fundamentals that will hold up longer into the top of the cycle, attractive valuation, and/or co-specific drivers that make consensus ests too low. Firm is thus steering investors to stocks like Dupont Photomask, Lam Research, and MEMC Electronics. Firm upgrades WFR to Buy from Hold, upgrades Amkor to Hold from Sell, downgrades Teradyne to Sell from Hold, downgrades Applied Materials and Novellus to Hold from Buy, initiates LRCX and DPMI with Buys, and initiates Brooks Automation with a Sell.
Semiconductors . . . UBS upgrades Nvidia to Buy from Neutral and raises their target to $28 from $25, as they believe that the demand for discrete graphics chips for desktops is strong. The firm says results for 1st quarter and guidance for 2nd quarter show better trends compared to typical seasonal declines, and they expect demand to remain strong due to increased demand in emerging markets, a new product cycle, and stagnant competition from integrated graphics.
Software . . . Lehman raises their 4th quarter estimates for Oracle (EPS estimate now a penny above consensus). They say they would be buyers of the stock ahead of the company's June 15 4th quarter report; based on feedback from their customers. They believe that the company should deliver greater upside from the database biz than the application biz; firm expects Europe to show the strongest traction, and the U.S. to be solid as well.
Banc of America upgrades Siebel to Buy from Neutral. The firm says field checks indicate that demand continues to improve with higher deal sizes and stable prices, and higher software revenues boost the outlook for recent flattish services revenues. In addition, firm believes that Mike Lawrie is the right CEO to improve employee morale and customer satisfaction at SEBL, that the new Siebel 7.7 release boosts the company's competitive outlook, and that the stock's unjustifiably low valuation provides an attractive entry point. Target is $14.
The Los Angeles Times reports Oracle might have a decent chance of prevailing as it begins to fight back in a San Francisco trial set to begin Monday. According to the article, the major reason is the following: Some of the federal government's legal theories haven't been subjected to court scrutiny because so few corporate suitors have stood up to regulators. What's more, when they have been tested, they haven't always passed. "The government is more likely to win," said Lawrence Fullerton, a former deputy assistant attorney general now in private practice. "But there are some issues, both factual and legal, that could lead to a victory for Oracle." The article also notes the policy of opposing mergers when the resulting company would have that kind of market power was adopted by the government in 1992. But it has since lost several cases brought on the basis of so-called unilateral-effects analysis. Because of the legal uncertainty, "unilateral-effects cases are hard to bring," said Stanford University economist Roger Noll. "Some courts have said if you have 40% of the market, that's dominant. Others have said if you have 75%, that's not enough."
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Strong Sectors: health care facility, casino, airline, biotech, beverage, REIT, aerospace, biotech
Weak Sectors: semiconductor, internet
Top Stories . . . The dollar weakened against the euro, yen and eight other major currencies on concern oil prices near record highs will cool economic growth in the U.S., the world's biggest consumer of oil.
OPEC should pump oil at will in the next few months, Qatar's energy minister said as the group's president called for efforts to cause a ``significant'' drop in record oil prices.
Crude oil futures declined from a record in New York and from a 13 1/2-year high in London after OPEC officials signaled output may reach full capacity to lower prices and ease concern supplies will be disrupted.
Harbin Brewery Group, China's oldest brewer, asked shareholders to accept a takeover bid from Anheuser- Busch Cos. that values the company at HK$5.89 billion ($757 million) and tops a rival offer from SABMiller Plc.
Albertson's, the second-largest U.S. supermarket chain, said first-quarter profit dropped 79 percent after a strike hurt sales and the company shed its New Orleans stores.
Gurus . . . Ed Hyman says his survey of major companies shows a renewal of momentum, following a lull that ended the past few weeks. Most impressive was the improvement in home-building and auto dealers. At the same time, the economy is looking stronger, and inflation is looking faster on all fronts, except for last week's tame core consumption price deflator for April. As for the job figures on Friday, his regression model calls for payroll employment to rise 222,000, with manufacturing jobs up 20,000. Analyst estimates for second-quarter earnings moved up over the past week from 18.1% to 19.0%.
Goldman Sachs says gold may rise this year because of buying by hedge funds, and an expected decline in the U.S. dollar against currencies, such as the euro. The precious metal may rise to $428.00 an ounce by 2005, as the dollar weakens to $1.30 against the euro.
JP Morgan says profit margins may be near their peak, because employment is increasing, and productivity is likely to slow. Fewer companies will report earnings that surpass estimates. In the first-quarter, more than 72.0% of the S&P companies exceeded estimates.
Mortgages . . . The number of applications for mortgages in the United States declined 1.2 percent last week on a seasonally adjusted basis. Applications for purchase loans rose 2.2 percent while applications for refinanced loans fell 6.6 percent. Refinancings fell to 34.3 percent of loans from a 36.2 percent share. The average rate on a 30-yaer fixed loan dropped to 6.24 percent from 6.26 percent.
Inflation . . . Barron's Online discusses oil prices, which has whipped up a mini-hysteria in media. Many news reports note that crude oil is near $42 per barrel and gasoline at $2.00 per gallon are at record highs. But, according to the article, those prices are not records when they're adjusted for inflation. In 1981, following the Iranian Revolution and hostage crisis, oil prices reached an all-time high near $80 in current dollars (roughly $40 per barrel in that year's dollars). Gasoline also reached a peak in the early 1980s of $3.00 a gallon, adjusted for inflation. Today Americans actually are spending less of their household income on energy than they did in the 1980s. Energy spending for the average U.S. household is a mere 4.8% of after-tax income today, according to David Wyss, chief economist at S&P's. Energy costs were 8% of household income in 1981, he says. Mr Wyss says that if gasoline and oil prices remained high for 12 months, it would cut GDP by about $30 bln, only 0.25%. But he says, "We are seeing no evidence that people are driving less or changing vacation plans, which means that gasoline prices are not pinching very much." And, he adds, it all depends on whose ox is being gored. "High oil prices are bad for US Airways' corporate profits, but good for Exxon," Mr Wyss says. Some transportation co's, including FedEx, can pass on higher gasoline costs to consumers. But not UAL, which is "in bankruptcy, so it doesn't have any time," says Philip Verleger, a senior fellow at the Institute for International Economics in Washington, D.C. Mr Verleger also thinks Toyota Motor and Honda Motor would thrive, because they produce a wider range of fuel-efficient models, if energy prices spike higher.
Accounting . . . The Emerging Issues Task Force has issued EITF Issue No. 03-1, containing new guidance on other-than temporary impairments of investment securities. The new rules dictate when impairment exists, provide guidance on determining if the impairment is other than temporary, and direct how to calculate the impairment loss. The impact of expected rising interest rates on fixed income markets, and the related impact on equity markets (as well as other concerns), could result in losses that will have to evaluated under the new rule, and possibly recorded in the income statement. The new rules are effective for periods beginning after June 15, 2004, generally the third quarter of this year. The new rules are backed up by expanded disclosures. Even if an impairment loss is not taken, all investments with unrecognized losses are subject to new annual disclosure rules. Breaking out loss positions between those existing for less than one year and for one year or longer is especially telling. Investments accounted for under the cost method (because there is no readily determinable fair value) will also be subject to the new rules, and will be evaluated in light of impairment indicators. Investments accounted for under the equity method are excluded from EITF 03-1, so they will continue to be evaluated under existing rules
Market Speak . . . The economic backdrop is the strongest we have seen in years and the recent revival of employment now adds a feel-good factor to the recovery. Still, the same data that support the favorable economic outlook also argue that the best of times for equities is behind us. Indeed, the topping patterns seen in many leading indicators suggest that the momentum trade in stocks is likely over. The May release
of the ISM Manufacturing Index is a good example of this. The indicator remained at very elevated levels, arguing for strong growth in the economy, but failed to increase significantly, or, in other words, to provide the conditions typically associated with a rapid rise in stock prices — on the whole, a reading that argues in favor of a noncyclical equity portfolio bias.
The biggest argument on a noncyclical call is that this cycle is very different from prior ones. Indeed, many investors proclaim that this recovery is unusually favorable for cyclical stocks since it is marked by a return of pricing power for basic industries. This alone, many argue, is enough for these stocks to continue to outperform despite signs that many leading indicators may have reached peak momentum. It is important for investors to differentiate between cyclical and secular forces. While a secular uptrend would be supportive for commodity industries, cyclical forces can sometimes savagely punctuate secular gains.
The chart above is a graphic representation of the simulated path of commodity/basic industry pricing during a deflationary period much like that of the past 20 years or so. It is interesting to note that capital goods stocks managed to outperform from 1991 to 1994 despite this so-called secular decline in pricing. If this segment could outperform in such a dire pricing environment, could it not underperform in a favorable pricing environment? Of course, it can, and we believe it will. Indeed, cyclical forces generally prevail over secular ones in the short term. As such, a topping pattern in leading indicators like the ISM Index is a sign that the best of times are behind us for most cyclical segments, regardless of the secular environment.
While it is still premature to say that we are at a truly secular turning point in inflation, it is not too early to study the investment implications of a turn. A return of pricing power would have minor implications for sector positioning over the next 12- 18 months; however, it would have a more profound effect on the outlook for the overall market. Indeed, historically, the stock market has not fared well in periods of accelerating inflation. While pricing power can be a good thing for earnings, the higher interest rates
that come with it often nullify this favorable impact by lowering P/E multiples. Mild inflation is the most desirable outcome here.
Inflation
A key topic on investors’ minds of late is the inflation outlook. Indeed, a number of important gauges of inflationary pressures have begun to flag cautionary signals. For instance, the prices paid component of the ISM Manufacturing Index continued to hover near a 25-year high last month. Unsurprisingly, perhaps, a number of pundits have now begun to talk about a secular turning point in inflation trends. More importantly, some argue that this could be a good thing for stocks since it would lead to higher earnings. While it is still too early to say whether we have reached a secular turning point in inflation, investors need to note that a return of inflation cannot be assumed to be favorable for equities.
The “inflation is good for stocks” thesis holds up as long as one assumes P/E multiples — an integral part of the valuation equation — remain largely unaffected by rising inflation. Typically, though, rising inflation is accompanied by higher interest rates, and higher interest rates generally compress market multiples. In fact, our analysis has found that at today’s interest rate levels, a 50-basis-point change in bond yields impacts the market’s forward P/E by a full point. Put differently, a rise in inflation that would lead to a 100- basis-point rise in long-term interest rates would shave the market’s multiples by more than two full points. Under such a scenario, earnings would have to rise by over 15% to perfectly offset this effect. So, be careful what you wish for: a turning point in inflation would not likely prove to be that positive for equities.
Financials . . . Goldman Sachs says that while they remain comfortable with their in-line 2nd quarter estimates for U.S. brokers, they believe that the prospect for significant upside surprises to estimates is unlikely given some deceleration in several key securities industry trends the last 2 months and the rising rate environment since early April. Firm also believes that investor's bias towards consensus estimates beyond 2nd quarter will move to more neutral or even negative in 2nd half 2004, and that 2nd quarter will mark the first quarter of a new down cycle in Return on Equity trends. Firm expects this down cycle to be fueled by declines in fixed income trading revs, which they do not believe will be fully offset by growth in M&A and equity-related businesses. Firm also continues to believe that pretax margins have peaked, and given the historical relationship between R.O.E. trends and P/B valuations, they continue to believe recent multiple compression is warranted and that further P/B multiple contraction may be possible.
The WSJ's "Heard on the Street" column discusses Charles Schwab, as stocks have climbed out of a multiyear funk, stock mutual-fund purchases are strong and individuals have a renewed hankering for investing thrills. That should be good news for Schwab, but according to the article recent actions by the co indicate that the road ahead remains far from smooth. To attract more customers, the firm last week announced plans to slash prices for some online stock trades. The firm says the move, aimed in part at narrowing the pricing gap between Schwab and discount online brokers Ameritrade and E*Trade, will help it attract customers while costing Schwab just 2% to 3% of its rev over the next year. But the move has rattled investors, who suspect the pain may be worse than Schwab is predicting. Their concern: The company may not attract nearly as much new business to offset the price cut. Making matters worse, Schwab shares remain expensive, despite dropping more than 30% in the past 8 months, says the Journal. And with the stock market hitting weakness, and the co struggling to boost earnings and still trying to figure out how best to compete with rivals, some investors are concerned a turnaround isn't around the bend.
Oil Prices & OPEC . . . OPEC members should pump oil at will during the next few months to lower record prices, Qatar's energy minister said, joining calls from Saudi Arabia, Kuwait, Indonesia and the United Arab Emirates for more supply. The minister, Abdullah bin Hamad al-Attiyah, said concern of potential attacks on Middle East oil installations or U.S. gasoline shortages have inflated prices by $10 a barrel. "Everybody should produce what they want over the next few months,'' the minister said. The OPEC president, Purnomo Yusgiantoro of Indonesia, told reporters that members want to increase output and have a "significant impact'' on prices.
Oil & Gas . . . First Albany upgrades Devon to Strong Buy from Buy and raises their target to $77 from $66, and upgrades Apache to Buy from Neutral and raises their target to $49 from $42. With DVN, firm notes that the stock is trading at 4.5x 2005 normalized EBITDA vs the large cap peer average of 5.2x, the co has a positive outlook for debt reduction in excess of $1.6 billion this year, and should significantly reduce finding costs this year (an ongoing criticism of the co). With APA, firm says that the new price deck is significantly accretive to 2004-05 EPS, and 2004 F&D costs will benefit from the large Qasr discovery in Egypt.
Restaurants . . . Prudential upgrades Outback Steakhouse to Overweight from Underweight, and downgrades Darden and McDonald’s to Neutral-Weight from Overweight. While same store sales are slowing and historically high commodity costs are limiting flow-through to earnings. The firm believes these factors are already reflected in estimates and valuations, as are higher gas prices and rising interest rate concerns. Firm's favorite ideas are Wendy’s and Outback Steakhouse, and their least favorite is Brinker’s.
Retail . . . Banc of America downgrades Home Depot to Neutral from Buy based on growing concerns about the traffic-ticket gap. The firm says that HD remains attractive on a number of valuation metrics, but after posting two consecutive quarters of 7% comps, the Street is no longer likely to be surprised by good performance from the company. In addition, firm believes that even without an up-tick in rates, it is very unlikely that housing will show increases over the prior year, which could trigger negative comps in 2005. Finally, firm says that recent comps have been heavily weighted towards ticket as traffic has flattened out, and they note that the spike in ticket looks a lot like 1994 and 1999 -- just prior to deteriorating fundamentals and severe underperformance. Target is $37.
Albertson's reported earnings of $0.15 per share, $0.04 better than the consensus of $0.11. Revenues fell 2.5% year/year to $8.69 billion versus the $8.75 billion consensus. The company reits full year EPS of $1.40-$1.50, including Shaw's versus consensus of $1.41. Note: the $0.15 includes a number of charges, which had been included when guidance for the qtr was provided by the co, so it's comparable.
Marquis Research initiating coverage of Netflix with a Buy and a $41 price target. The firm notes Netflix, while best known for its DVD rental service, is a widely misunderstood company. The DVD rental service, while profitable and the main driver of the business to date, is not the primary reason investors should take a look at this company. Rather, the burgeoning Video-On-Demand market is the biggest reason investors should focus on NFLX. The firm notes long term investors should use the DVD rental market as a proxy to determine the expertise of NFLX management. The firm believes the DVD rental business should eventually cede to the downloading or Video-On-Demand market. With many of the moving parts yet to be determined in the Video-On-Demand delivery, Marquis believes that the significant membership presence, solid relationships with big and small movie distributors, and proprietary movie selection /recommendation system will make NFLX the incumbent in the Video-On-Demand market. In terms of valuation, the firm notes NFLX represents a true venture investment in Video-On-Demand that has liquidity and an underlying business that is already performing well. Given this situation, Marquis believes that a traditional tech multiple of 29x '05 EPS yields an appropriate price target in the current market environment.
Healthcare . . . The WSJ reports hospitals across the country are starting to hit up patients for part of their bill before discharging them, and sometimes even before treating them. The aggressive new push is part of a broad effort by hospitals to cut bad-debt expenses. Starting later this month, HCA will begin asking patients to pay their co-payment before receiving non-emergency treatment. If patients say they cannot afford it or don't have the money, the hospitals will ask for at least a down payment. HCA is implementing the new approach in each of its 191 hospitals. Hospitals are increasingly implementing these strategies now, or making them tougher, for several reasons. For one thing, improved technology gives more hospitals the real-time information to figure a patient's deductible and co-payment amounts. For example, at Tenet Healthcare administrators are going online to determine a patient's co-payment, among other tactics as part of a pilot program in Florida to improve collection procedures. According to the article, the more aggressive billing stance is expected to have a significant impact on hospital finances.
Medical Devices . . . icad announced the FDA approval for release of iCAD's new Second Look 200 system for early detection of breast cancer with substantially improved cancer detection software. The co says its new combination of Second Look 200 with iCAD's Version 6.0 cancer detection software represents both the most sensitive cancer detection solution available, and the least expensive.
FTN Midwest downgraded Boston Scientific to Neutral from Buy. The firm is saying the potential for continued revenue and earnings growth upside stemming from the successful Taxus launch is now "known" and reflected in the stock's valuation. The firm also says the company's revenue and earnings growth outlook for 2006 and beyond continues to depict a significant deceleration in growth, despite yesterday's announcement of the planned acquisition of Advanced Bionics. Maintains $50 target.
Cardiac Science and Chindex jointly announce multi-year distribution agreement whereby Chindex will market DFIB's line of Powerheart-brand AEDs on exclusive basis to hospitals and other medical supply dealers throughout mainland China. Agreement also allows Chindex to distribute DFIB AEDs on non-exclusive basis into other emerging mkt segments such a physician offices, police, fire, EMS, military, corporations and public transportation.
Drugs . . . Morgan Stanley assumes coverage of Medimmune with an Overweight rating and $32 target (former rating Equal-Weight). After the disappointing FluMist launch and facing slowing top- and bottom-line growth, the firm acknowledges that MEDI no longer commands a premium. However, firm believes that the Street is now underestimating the Synagis cash flow potential and discounting the pipeline. Firm assumes coverage of BIIB with an Overweight (former rating Equal-Weight) and $77 target; while their 2004-05 EPS estimates are in-line with consensus, they believe that there is meaningful upside to longer-term numbers, with Antegren driving at least 22% compounded growth between now and 2010. Firm also assumes coverage of AMGN with an Equal-Weight, and DNA with an Equal-Weight (former rating Underweight).
Biotech . . . The WSJ's health section discusses stem-cells, as capitalizing on the emergence of stem-cell therapy as standard treatment for many kinds of leukemia and lymphoma. The article notes a co called NeoStem wants healthy consumers to pay $5K to bank their own stem cells for the future, to be used in the event of disease. Last month, NeoStem opened its first collection center in Los Angeles and plans 60 or more in the U.S. over the next 3 years. Some research suggests stem-cell therapy may one day be useful in treating everything from heart disease to spinal-cord injury to radiation sickness. Indeed, stem-cell research "has the potential to revolutionize the practice of medicine and improve the quality and length of life," according to the National Institutes of Health. NeoStem is betting that well-to-do consumers will pay to maintain their own healthy blood stem cells in the event they become ill or injured. The company's founders think cell banks can become a multibillion-dollar business. "One group that excites us is people who have had an infarction and are at risk for another heart attack," said CEO Denis Rodgerson of NeoStem. So far, some 20 people have undergone the procedure, including Dr. Rodgerson and some of the firm's investors. Researchers are studying whether stem cells can promote growth of healthy heart tissue. From a scientific point of view, stem-cell banking isn't particularly controversial. Transplants using a patient's own cells are less costly than those involving matched donors. And blood stem-cell banking doesn't involve embryonic stem cells, which are at the center of a world-wide ethical debate over their use in drug development and other human experiments.
Media . . . Cable and entertainment stocks have been languishing, as investors question entertainment’s organic growth potential and worry over cable competition. With both groups’ return on capital depressed by consolidation and/or investment, investors are now looking for payback, in the form of growth, return of cash, or some mix of the two. Implied costs of capital suggest either excessive risk in the stocks or too much equity on the balance sheet, and sometimes both. For cable, reassessment of the risk/reward trade-off could result in a repricing of the group, while for entertainment, wealth-sharing and cyclical improvement could be the catalysts
for outperformance. Not all the stocks share the same risk/reward profile. Viacom may provide the best near-term opportunity in entertainment, while Time Warner provides longer-term appreciation potential. In cable, Cablevision after the spin-off could be the best performer, while both Comcast and Cox are expected to outperform the market should investor sentiment change.
The WSJ reports that Sirius Satellite Radio is bolstering its programming lineup to take on rival XM Satellite Radio in the race for subscribers. The company signed programming pacts over the past few months with the National Football League, National Hockey League and National Basketball Association. According to the article, Sirius officials say more deals are on the way. "We want to be the destination for sports, and we've got a pretty good start," CEO Joe Clayton told shareholders at a meeting earlier this week. The programming ramp-up is Sirius's latest effort to narrow the substantial gap between itself and XM. "They have to differentiate themselves," said Jimmy Schaeffler of the Carmel Group. Sirius "must convince listeners that they are worth $3 more."
Yesterday, Marvel Enterprises announced formally that it has settled its lawsuit with Sony Pictures. Marvel alleged that Sony had essentially "hijacked" the Spider-Man character from Marvel. Sony in turn sued Marvel for not properly accounting for Spider-Man merchandise revenues, on which Sony was entitled to a royalty. As part of the settlement, Marvel will consolidate its JV with Sony and record the total revenue associated with Spider-Man non-toy merchandise licensing, along with the corresponding expenses, including royalties to Sony.
Previously this was recorded in equity income on a net basis, with Sony and Marvel splitting the licensing revenue 50/50. Additionally, Marvel will now have total control over both Classic Spider-Man licensing as well as movie Spider-Man licensing. The latter was previously controlled by Sony, and MVL management believes led to a less optimal overall licensing strategy for the Spider-man character. Now, Marvel believes it can better maximize this segment
of its business going forward. Despite the announcement, Marvel maintained its full year operating income guidance, which was probably the reason for the weakness in the stock yesterday. However, Marvel will now receive better than 50/50 splits on the Spidey merchandise and any upside to earnings in 2004 will come on stronger than expected sell through at retail. Overall, the settlement is a positive for MVL, but the benefits are difficult to quantify at this point. As such, analysts are making no changes to our projections. At current levels, Marvel's valuation is not overly compelling, but reasonable. In the near term, while the consensus is that Spider-Man 2 will be a box office success, visibility into 2005 remains low.
The NY Post has learned that representatives for Mel Karmazin are expected to reach out to Walt Disney's board of directors soon about the possibility of the former Viacom president succeeding Disney honcho Michael Eisner. Karmazin has indicated he wants to be a CEO of a big media company, and many in the industry expect him to wind up at Disney. On a conference call with reporters yesterday, Viacom chief Sumner Redstone said, "I don't see a place" for Karmazin at another major media company. In a statement yesterday, Disney Chairman George Mitchell said: "The board has complete confidence in the current management. On the strength of our recent results we believe that confidence has been justified, and will be further validated as our performance continues to improve." The board, meanwhile, has stepped up succession plans in response to the shareholder revolt. At the very least, Eisner is expected to not be given an extension when his current employment contract expires in 2006. Meanwhile, Eisner's top deputy, Bob Iger, is not seen as a potential heir to the Disney throne. Many in the media industry have predicted he would be tossed to make way for a new No. 2 who would be groomed to take the top spot when Eisner's contract ends.
Electronics . . . palmOne upped to Buy from Hold at Stanford Group. Target goes to $29 from $20. The firm believes that Sony's exit from the US PDA market bodes well for PLMO. Whereas Microsoft PDAs will likely capture some of the void left by Sony, firm expects PLMO to take the lion's share. Firm raises 2005 estimate to $0.71 from $0.65 (Reuters consensus $0.72). Firm raises target to $29 from $20 noting that PLMO will benefit from fewer competitors in the US and from increased unit sales. As a result, believes that PLMO could achieve operating margins above firm's previous expectations over the next few years.
Telecom . . . The WSJ reports wireless entrepreneur Craig McCaw is expected to announce today that he is launching a national wireless broadband service to compete with the high-speed Internet access offered by cable operators and telephone company's. The executive will detail his strategy at the Wireless Communications Association International conference in Washington, D.C., though word of his plans has been circulating as he has bought up wireless spectrum licenses. His co, called Clearwire, aims to offer wireless Internet access to consumers in roughly 20 markets over the next year, according to Gerry Salemme, the executive vice president of Clearwire and a longtime executive at various ventures of Mr. McCaw's. It will launch service in two cities this summer, Jacksonville, Fla., and St. Cloud, Minn. Clearwire is seeking to offer a national service that targets not only rural markets but large markets where other wired alternatives are available. Clearwire's service will be marketed to consumers as a fixed product to compete directly against Internet access via cable modems and digital subscriber lines. Mr. Salemme said that Clearwire's service would offer speeds in a range of 1.5 to 2 megabytes per second, potentially slightly faster than home DSL or cable modems, and significantly faster than wireless services being contemplated by cellular carriers. Mr. Salemme said that the network's technology will be compatible with WiMax, a hotly anticipated technology that will provide wireless, high-speed Internet access at ranges of several miles, expected to be available in 2006.
EMS . . . Flextronics will host a mid-quarter review on Thurs, June 3rd. Revenue and EPS estimates are $3.925B (up 4% Quarter/Quarter and up 26% Year/Year) and $0.14 versus consensus of $3.9B and $0.14. The 4% Quarter/Quarter revenue increase is better than last year's 1.5% increase driven by new wins and the continued ramp of ODM handset programs. On average, over the last 5 yrs (excluding 2000) June rev has increased 1% Quarter/Quarter. Based on our recently hosted meetings with Jabil and Benchmark Electronics managements, business appears on track for the June qtr in EMS. Key customer themes (Sony-Ericsson and Siemens and HP inkjet volume) appear to be holding. Customer comparables analysis shows FLEX's top-ten customers up 3% in June with outsourcing adding 1%. Expect to get an update on the closing and impact of FLEX’s pending NT transaction. NT deal originally expected to close late June/early July and to add over add over $2B in annual incremental rev costing $500 million in cash paid over roughly 9 months. The outsourcing agreement will conservatively be $0.08 - $0.10
accretive to 2005 EPS. Better working capital management key to concerns about a follow-on offering. Given the $500 million required for NT deal, concerns about FLEX needing to raise capital arose after $250 million AP paydown and $80 million AR increase in March which turned CFO negative despite better than expected operating income. Currently FLEX has ~$1.5B in
liquidity including $615 million in cash and ~$900 million in revolver availability.
Storage . . . Merrill Lynch cuts estimates for Seagate Tech, Maxtor, Western Digital, and Hutchinson, and says it's still too early to invest in the U.S.-based hard drive stocks. Firm cites the following factors: 1) recent T.S.R. (hard drive supplier) data, which suggests downside to their prior estimates; 2) distributor checks, which suggest that shipments would be down sequentially in 2nd quarter; 3) their belief that key supplier HTCH has not reached an inflection point in its suspension assembly business; 4) their Taiwan team's estimates that PC motherboard shipments will be down 11% sequentially in 2nd quarter; and 5) slowing growth in Europe due to a declining euro and weakness in continental Europe.
Imaging . . . Deutsche Bank reiterates their Sell and $20 target on Eastman Kodak. The firm is saying the recently released May IRI data shows worsening retail sales growth of -18.1% in the company's core film business. The firm says the negative sales trend is the worst they have seen since they began tracking IRI data in July of 2002, and the steep decline was due primarily to weakness in disposable cameras.
Network Equipment . . . Jefferies said market share erosion at Nokia, the handset maker, has been more pronounced that it has recognized. "The company claimed market share in the order of 35 percent in the first quarter, but subsequent data from competitors suggests that overall first quarter growth was much stronger than Nokia had estimated. Our count of unit shipments is 151.5 million, suggesting growth of close to 35 percent and putting Nokia's market share at 29.5 percent... Most of these rivals continue to make up beat noises," it said. Jefferies reiterated a "hold" rating on the stock.
Digitimes reports Nokia has recently launched 3 new handset models in Taiwan, which include the 6230, the 3120 and the 7200. The company said that sales of the three models are expected to increase its market shares in Taiwan over the 11.3% it recorded in March. The 7200 is Nokia's first clamshell model, and demand has already exceeded supply, according to the co. The three new models have boosted monthly sales in May, the co added. Nokia's market share climbed to 16% in May, up 2 percentage points on month, according to the article, citing sources at Taiwan handset distributors. The sources also indicated that Motorola still led all vendors, with about 20% of the market.
Advanced Fibre announced a new five-year contract extension with SBC Services Inc., a subsidiary of SBC Communications, to provide its AdvancedVoice and UniversalDSL solutions. AFC has been a supplier of broadband access solutions to SBC since 1997. Financial terms of the new agreement were not disclosed.
Based on Nortel's work to date, including the work done since the update provided on 4/28, related to the planned restatements, the principal impacts of the restatements and revisions identified to date to company's results continue to reflect the following: reduction of approximately 50% in previously announced net earnings for 2003. These amounts will largely be reported in prior periods, resulting in a reduction in previously reported net losses for such periods including 2002 and 2001; net loss for the 1st half 2003 compared to the previously announced net earnings for that period; the net income reductions are expected to substantially impact company's continuing operations rather than discontinued operations in 1st half 2003; no material impact to prior period revenues; and no material impact to company's cash balance as at 12/31/03. As previously indicated, company's work to date with respect to the planned restatements and revisions and the expected impacts mentioned above are subject to a number of important limitations, including: Expectations as to the impacts continue to be partial and preliminary; ongoing work of the Nortel Networks Audit Committee independent review; The significant work to be done by the Company, including with respect to the detailed review of 2nd half 2003, accounting documentation and reporting systems issues and the impact of accounting for certain matters, including foreign exchange; The previously disclosed material weaknesses in company's internal controls over financial reporting; and audit of the Nortel Networks financial statements by the company's independent auditors.
Semiconductor Equipment . . . Smith Barney initiates coverage on the Semiconductor Equipment sector; firm says their analysis suggests that chipmakers' capacity utilization will peak for the cycle in Q2, and therefore most equipment stocks have likely peaked for the cycle on an absolute basis; however, they believe that this cyclical top will not fully play out until mid-2005. With many equipment stocks already down 25-30% or more from recent peaks, firm likes a defensive strategy that focuses long positions on names that exhibit some combination of fundamentals that will hold up longer into the top of the cycle, attractive valuation, and/or co-specific drivers that make consensus ests too low. Firm is thus steering investors to stocks like Dupont Photomask, Lam Research, and MEMC Electronics. Firm upgrades WFR to Buy from Hold, upgrades Amkor to Hold from Sell, downgrades Teradyne to Sell from Hold, downgrades Applied Materials and Novellus to Hold from Buy, initiates LRCX and DPMI with Buys, and initiates Brooks Automation with a Sell.
Semiconductors . . . UBS upgrades Nvidia to Buy from Neutral and raises their target to $28 from $25, as they believe that the demand for discrete graphics chips for desktops is strong. The firm says results for 1st quarter and guidance for 2nd quarter show better trends compared to typical seasonal declines, and they expect demand to remain strong due to increased demand in emerging markets, a new product cycle, and stagnant competition from integrated graphics.
Software . . . Lehman raises their 4th quarter estimates for Oracle (EPS estimate now a penny above consensus). They say they would be buyers of the stock ahead of the company's June 15 4th quarter report; based on feedback from their customers. They believe that the company should deliver greater upside from the database biz than the application biz; firm expects Europe to show the strongest traction, and the U.S. to be solid as well.
Banc of America upgrades Siebel to Buy from Neutral. The firm says field checks indicate that demand continues to improve with higher deal sizes and stable prices, and higher software revenues boost the outlook for recent flattish services revenues. In addition, firm believes that Mike Lawrie is the right CEO to improve employee morale and customer satisfaction at SEBL, that the new Siebel 7.7 release boosts the company's competitive outlook, and that the stock's unjustifiably low valuation provides an attractive entry point. Target is $14.
The Los Angeles Times reports Oracle might have a decent chance of prevailing as it begins to fight back in a San Francisco trial set to begin Monday. According to the article, the major reason is the following: Some of the federal government's legal theories haven't been subjected to court scrutiny because so few corporate suitors have stood up to regulators. What's more, when they have been tested, they haven't always passed. "The government is more likely to win," said Lawrence Fullerton, a former deputy assistant attorney general now in private practice. "But there are some issues, both factual and legal, that could lead to a victory for Oracle." The article also notes the policy of opposing mergers when the resulting company would have that kind of market power was adopted by the government in 1992. But it has since lost several cases brought on the basis of so-called unilateral-effects analysis. Because of the legal uncertainty, "unilateral-effects cases are hard to bring," said Stanford University economist Roger Noll. "Some courts have said if you have 40% of the market, that's dominant. Others have said if you have 75%, that's not enough."
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