The Federal Reserve

Mr. Bernanke: Have Some Guts, Stop Raising Rates












Fed Chairman Bernanke's handling of the press has been anything but stellar since taking office. Hopefully he does a better job at handling the economy. He started off by confiding in the very ambitious Maria Bartiromo, assuming his comments were off the record, she rushed off to the studio and announced to the world that they were best friends and she would be the self-appointed mouth piece of the Fed.

However, if the Fed chairman wants to get back in good graces with the investment community, his best chance is to do what he says: make decisions that are data dependent and forward thinking. Do not base policy changes on rear-view-mirror data.

Employment

Recent economic data suggests the economy is slowing down. The employment data for May was simply awful. The economy created 75,000 jobs in the month, down from a few hundred thousand per month earlier in the year.

In addition, wage growth is virtually non-existent, with wages increasing $0.01 per hour in the month. That's right, if you work a 40 hour week, the average Joe and Jane got an increase of $0.40 for the week. I don't believe this covers the $20 increase in his or her gas bill. Take out a little extra for FICA, local taxes, some Fed taxes and now you are really living. The chart below clearly shows that real consumer spending has rolled over. The chart actually supports a view that the Fed should start lowering rates.


















Housing Pricing Are Coming Down

The following chart paints a very clear picture: the supply and demand for housing is becoming increasingly imbalanced which is leading to a meaningful drop in prices. The chart shows the increase in the number of homes that are for sale, it clearly shows a big increase in inventory. As one would expect, this is leading to a nice decline in prices.



What Is The Fed Waiting For?

With employment growth now anemic, wage growth a joke and the house bubble now letting out a good amount of air, what is the Fed waiting for before it stops the increases?

Some suggest that the true measure of inflation and too much liquidity is the price of gold. However, even that is now coming down.

The substance of what Bernanki says after cutting through his inexperience at communicating publicly is pretty good. After the last FOMC meeting, he suggested that it might be the end of the rate increases, since Fed policy's impact can often lag. However, after gold started rallying, he panicked and started second guessing his comments.

If the new Fed chairman sticks to his initial instincts and the data, the Fed should be done for quite a while. From looking at the two charts above, along with a lot of other data, the Fed should be ready to lower rates by October. However, does Mr. Bernanke have the confidence to do this and not wait for the data to become much worse before he stops raising rates? From the recent drop in stock prices, the market is saying he does not have that confidence and will continue raising rates.

Don't Forget About Yahoo!

As the market corrects and consolidates, do not forget about adding some Yahoo! to your portfolio. The stocks is down big and has not moved despite a positive article written in Barron's a few weeks ago. It might even be a takeover candidate.

There were even reports a few weeks ago that Microsoft executives have explored the idea of buying a stake in Yahoo!. Heck! Why not buy the whole company? When you dig into the numbers, it may not be a bad idea:

Yahoo! Market Cap. = $ 49.0 Billion
Less: Yahoo! Japan Stake = $ 12.4 Billion
Less: Alibaba (Chinese Portal) = $ 1.4 Billion
Less: Cash - Debt = $ 2.0 Billion
Enterprise Value = $ 33.2 Billion

Yahoo! is expected to generate 2005 EBITDA of $2.0 billion and 2006 EBITDA of $2.6 billion. A 16.6x multiple for 2005 and 12.8x multiple for 2006---not that expensive for a high growth company.
Microsoft has failed in almost every Internet business it has attempted to enter. Yahoo! and Google have destroyed them. And Barry Diller, the great programmer, now owns ask.com, and he plans to enter the search businesses in a big way.
Microsoft still has $34 billion in cash after the huge cash distribution to shareholders last year so it could pay cash. Yahoo! also generates margins that are better than many of the new businesses (outside of its core software business) that Microsoft is investing in. Yahoo! is also a cash generating machine like Microsoft.
While Silicon Valley despises the Redmond-based giant, a Microsoft deal could lead to a mass employee exodus, but the Yahoo! franchise name has already been built. In addition, as Yahoo!'s stock price suggests, Wall Street has not been overly enthusiastic about its performance recently.
Bill, this might be your last opportunity to become an Internet company. Let's see a hostile takeover.

Revlon Corp: Follow Up

Revlon warned it was going to miss its operating margin goals on Friday which led to the stock getting hit pretty hard. Of the six years of writing my newsletter, this is the first time one of the newsletter ideas have gotten hit so badly.

Revlon had six months of excellent performance going into May. The four years of restructuring that Stahl has been part of was beginning to working and it was picking up good momentum with its Vidal Radiance and Almay products. Sometime during the Spring, its competitors reacted to Revlon's success with a slash in prices to keep market share and create a price war.

While price wars are unpleasant, they often signal a bottom in an underperforming industry. Often when a mature industry gets stale, a new management team is brought in to rebuild one of the companies (as in this case with Revlon) and the others fall behind and react to market share losses with a drop in pricing. This is often a short term response (often about six months) driven by competitors weakness which is the result of not being focused on investing in new products.

What is happening with Revlon is almost exactly what happened in the hamburger price wars during 2002 and 2003 when investors thought that the big fast food chains were going to sell hamburger for $0.99 forever. However, from looking at McDonald's price chart, it was a great time to buy. This is most likely the case today for the cosmetics business. (McDonald's stock jumped from $14 to $35 when the price war ended.)

Revlon has done a lot of good things the last four years: restructured its balance sheet, re-invented old products, created new ones, come up with an entire new store format that has shown some success. Well-placed business investment wins out over competing purely on price over time.

Also, remember that it would be cheaper for a competitor to buy Revlon than continuing this price war. A competitor could easily afford paying a big premium for the stock to get access to its distribution network, product names and shelf space. I recommend staying with the stock and shareholders will be well rewarded. I thought Revlon could be a big bagger, but if not, it should get a nice take out price.

Disruptive Forces: The Internet vs. Cable TV

There was a very good article today on gigaOm.com by Robert Young titled "Back To The Future...For Broadcast TV. " Young writes about the disruptive force that cable TV was for the big broadcast networks which is now repeating itself as the Internet disrupts cable TV.

The premise behind his argument is that as on-demand changes viewer habits, both due to the evolution of the Internet and more interactive cable TV services, viewers can more clearly decide what and when they want to watch something. This will place a lot of pressure on the marginally successful cable TV program and on its advertising revenue. Young concludes that there will be a shrinkage of programming, and subsequently cable TV channels, as advertisers continue moving to more targeted advertising platform.

Programming will shift to the Internet as channels like Myspace.com, YouTuBe.com, Veoh and Brightcove begin to gain a bigger audience.

For those of you who do not spend a lot of time on the Internet, it is worth seeing where the future is by looking at these websites. You might not like it, but it is the future.

Happy Mother's Day

A video mother's day card from www.youtube.com

http://www.youtube.com/watch?v=bhcA4Ry65FU

Cramer Likes AES Corp.

AES Corp. was Cramer's focus stock last night on Mad Money. He must have read my blog, he said everything that I wrote about earlier this week.

AES Follow Up

AES reported very strong earnings yesterday. I provided a detailed update on AES in April after its year-end conference call in which management provided a tepid outlook for 2006. However, after yesterday's conference call, management was much more upbeat after a strong first quarter.

• International financial markets are finally willing to open up lending to AES-type of projects which are often located in emerging markets. It has been difficult getting deals financed during the last five or six years.
• Pricing and volume mix are good in many markets.
• AES continues to show it has built itself into a nice free cash flow machine.
• New construction prospects are picking up.

Despite the huge run up in emerging-economy stock markets during the last few years, the available financing for greenfield type of projects that AES normally does is just opening up. I mentioned in the April blog that 2006 earnings would be flat as it reinvests for growth in 2007 and going into 2008, but it appears 2006 might be OK. In addition, it appears management has greater confidence in its ability to complete some large projects during the next few years which will support management's outlook for double-digit earnings growth.

After the year-end conference call, it appeared that this stock might be dead money until the fall, but with Monday's earnings release and the announcement of some big projects, investors will have to get back into this stock now.

Revlon Corp: New Newsletter Idea

Today Mullane Asset Management issued a new newsletter on Revlon Corporation. Executives from Coca Cola joined the company in 2002 and their efforts are about to pay off.

Favorite Stock Idea For 2006: Oracle Corp. UP 20%

Going into 2006, our favorite stock idea was Oracle Corporation. Since publishing the newsletter, the stock is up over 20%. While investors continue to focus on commodity and old-time industrial companies, selected-technology stocks are performing pretty well.

As short-term interest rates continue to rise in many parts of the world, cyclical earnings and commodities are the most exposed to a slowdown. Oracle's business is just beginning to pick up and has a number of years of earnings growth in front of it.

Level 3 Continues Industry Consolidation: Part 2

Level 3 (LVLT) announced another deal to further consolidate the telecom industry yesterday. The stock, once again, was up big. Since I began writing about the stock in September of 2005, it is up about 90%.

As a reminder, Level 3 has acquired WilTel, Progress Telecom, ICG Communications and announced the TelCove deal yesterday. This is a classic consolidation of an industry which came out of a bust period. As I wrote in the September 2005 and November 2005 newsletters, IP traffic is growing 70% per year while the demand for oil grows 2 to 3% per year.

With Level 3 up over 90%, investors are beginning to focus on the real growth industry.

Newell Rubbermaid: More Details

After six years of earnest restructuring by Newell, it appears that the fruits of their labor is upon them. The company grew organic sales 4.8%, the highest level in quite a long time. This drove the stock up over 8% on the day.

Newell was our favorite newsletter idea going into 2005. As usual, I am often early with our investment ideas. However, what is especially attractive about Newell is that it has a market capitalization of about $8 billion which is small compared to other well-recognized franchise name companies such as Coke ($100 billion) and P&G ($192 billion). While some might argue that the franchise names of Rubbermaid, Graco and Sharpie do not compare with that of Coke's and P&G's, however, in the 1980's, Rubbermaid was viewed by the investment community as the Coke and P&G of its day.

What was interesting about today's results is that Mark Ketchum, a former P&G executive, was able to so quickly turn sales around. When Ketchem took the job he emphasized the need to focus on what the customer wanted and then target those products with marketing dollars. It appears he is off to a nice start. If Newell can get the diverse group of business going, this could be a $45 to $50 stock in a few years. This run is just starting.

Newell Rubbermaid: Great Results, More To Follow

Newell Rubbermaid reported great results today. Will follow up with comments later on.

Rumors of Consolidation Of The Online Business

Rumors are circulating that the consolidation of the online travel business is about to begin. The consolidation of the online travel business could prove to be one of the best investment themes for the next five to ten years. The industry has gotten hit pretty hard during the last year as there seems to be too many competitors.

In addition, the industry, at this stage of its life cycle, appears to be counter-cyclical. The online travel business seems to get more inventory when the economy is weak and there is an oversupply of hotel rooms and airplane seats. When things are good, the hotel companies and airlines like to book the customers themselves.

This weakness in the online business may prove the best time for the industry to consolidate. Interactive Corp. laid the foundation for a consolidation by spinning off Expedia and most likely would play the lead role. Henry Silverman, head of Cendant, is breaking his company up which owns online travel distribution businesses with well-known names Orbitz and Cheaptickets in the consumer space, in addition to Galileo which is a leader in the business online travel market.

Expedia, during its existence, has shown great financial metrics with high operating leverage. Combining two industry leaders could create a profit generating machine. The $900 billion world travel business will grow nicely as the global economy booms. Expedia has been growing its online business twenty percent per year. A consolidated online industry will give it more power and more profit potential for shareholders.

Merck & Schering-Plough: The Worst Might Be Over

Well-beaten down pharma stocks Merck and Schering-Plough both held their earnings call this morning. One take away from both calls is that management confidence is improving although analysts remain skeptical.

When Merck was pushed on its 10%-plus EPS growth, management indicated some confidence in its pipeline although did not want to discuss it in great detail. However, management did stick to the guidance provided in its December analyst meeting which should translate into EPS of $4.10 by 2010. Guidance appears to be based on modest revenue growth and cost controls.

From listening to a number of calls, virtually all of the old-line pharma companies expressed better confidence. A CNBC interview with Lilly's head mentioned that a lot of biotech projects initially funded in the 1990s might be coming to fruition.

It has been a tough decade for large pharma. There are hints that the worst is over. It is time to start looking at these companies again.

Intel: Simply Awful

Intel's numbers say it all:

• Revenue down 12% yoy
• Operating income down 49%
• Net income down 45%
• EPS down 43%
• Terrible guidance

Geography also hurt with Europe down 26% and Asia-Pacific (the world's fastest growth region) down 16%.

These numbers simply are awful. Intel holds an analyst meeting in New York next week. We will see if they bring anything new to the table.

JP Morgan Chase: Poor Fixed Income Results Might Portent Good Future

Analysts and the press focused on JP Morgan's weak fixed income results today. JP Morgan has been getting squashed by its competitors from Bear to Goldman to Lehman to Merrill on this front. However, Jamie Dimon has been saying consistently that he has been reorganizing the unit and sees little value in this market and will not expose the company's balance sheet to this risk. But it's competitors continue to plow along with incredibly strong results.

It is hard to imagine how the fixed income results for so many investment banks could be so good. Not since the 1980s and Bonfire of the Vanities with the iconoclastic Master of the Universe bond trader/investment banker Sherman McCoy or in the 1990s when the infallible John Meriwether and the Nobel prize-filled Long Term Capital, who took on risk-free positions with infinite leverage, have bond traders graced the headlines with such stardom and performance. Both the fictional McCoy and the not-so fictional Meriwether came back to earth. We will see if the outstanding fixed income results reverse and bring these big investment firms back to earth during the next few quarters.

Today's call was a refreshing reminder of why the investment community likes Jamie Dimon. He reiterated his position that he will not risk the company's balance sheet to chase the performance of the other major investment banks in fixed income. The bond bull market was very mature when Dimon took control of JP Morgan Chase and he is committed to not getting whipsawed. In addition, Dimon was pretty candid about the outlook on the consumer credit business which appears to be maturing in a number of different ways. Not only in terms of growth in balances but it also appears that as baby boomers age they are beginning to pay down their credit a lot quicker. My guess is this trend began to emerge in the middle of 2005.

To offset this weakness, JP Morgan Chase is going to focus on its branch network and appears to have a lead on the other money center banks in this regard. Growth in sales of mortgage origination, credit cards and other branch-related service were very strong. The company also announced it repurchased $1.6 billion of stock in the quarter and the board approved an $8.0 billion buyback going forward.

All told, JP Morgan's results were pretty solid and this stock has to be owned by portfolio managers who are concerned about what a bear market in bonds will do to the results of the other investment firms. This is Dimon's baby and he wants to prove he can do it on his own. It appears that he is taking a fundamentally sound approach.

Yahoo!: A Value Stock?

Susan Decker, CFO for Yahoo, threw out financial metrics during yesterday's conference call that are usually applied to value stocks. Is she nuts? On the surface, Yahoo trades at 60x 2006 GAAP EPS. How can one suggest 60x earnings falls into the value camp?

Investors should remember that Yahoo is down big from its peak price of $43.66 in January of this year, a 24% decline. This brought the market cap to about $49 billion. The company is expected to end 2007 with about $4.0 billion in cash on its balance sheet after adjusting for debt and owns a 34% stake in Yahoo! Japan worth about $12.4 billion. (Yahoo! Japan is doing very well against competitors in its market.) Take out another $1.4 billion for Yahoo's stake in Alibaba, the Chinese portal, and this brings you down to an enterprise value of about $31 billion. Wow! that is not the bubble valuation that I remember.

Take that $31 billion and compare that to an EBITDA estimate of $2.6 billion and you get an enterprise value to EBITDA valuation of 12x 2007 estimate. That's not too bad for a company growing its EBITDA 20% per year.

In the 1980s and 1990s that was the mid-valuation range for high-growth media companies such as wireless, cable and radio. Maybe CFO Decker was right to subtlely throw out some old-fashioned value-investor metrics.

Whether you want to classify Yahoo as a value stock or not, its operating performance for the quarter was solid. It is going to host an analyst day on May 7th at which time it is going to announce a new ad revenue model. It appears that Yahoo's management feels comfortable enough with its business model to make such an important change. In addition, management mentioned it was confident it can keep Yahoo growing for the next few years. There appears to be plenty of substance behind today's rally.

Level 3: Industry Consolidation Continues

Level 3 announced the acquisition of ICG, which owns quality assets in Colorado and Ohio. This comes on the back of Progress Telecom which is focused in the southeast and the acquisition of Wiltel in 2005.

SBC acquired AT&T's long distance business and Verizon has purchased MCI. Supply is becoming less and less as demand for capacity increases and increases.

Telecom reminds me of the housing industry in the 1990s. After the savings and loan crisis of the late 1980s, all the major home builders were on the verge of bankruptcy. Those who survived consolidated the industry during the next decade, making some 30x to 40x investor's money by the middle part of this decade.

Economic Insights

US Reports Another Trade Deficit: What A Waste Of A Stat

The US reported a $65.7 billion trade deficit for the month of February. For all of 2005, the deficit was $724 billion. Once again, the press jumped all over this number--implying we are exporting our way to extinction.

The reality is that since Reagan ignored the trade deficit and opened US boarders to competition, the US and global economies have boomed. With the growth of the trade deficit, inflation has crashed, unemployment dropped, stock markets surged, communism has been vanquished and democracy has flourished.

I recall a speech given in the earlier part of this decade in which a Wall Street strategist did an analysis of what US companies produced abroad. He found that the GDP of all US company's foreign subsidiaries would be equivalent to the 3rd or 4th largest economy in the world. When someone compares this figure of $2 to $3 trillion of GDP produced by US-companies abroad each year, the 2005 trade deficit of $724 billion does not look big at all. It looks like the global market has evaluated the US trade deficit a lot better than talking heads and pontificating tenured professors.

AMD: Great Results

WOW!!! What results! Who would have ever thought this from AMD.

• YOY revenue growth of 20% for 11 consecutive quarters
• Channel partners continue to improve, which is important for this company that has a history of chip durability.
• HP, IBM, and the 3rd largest China PC company are doing more and more business with AMD. And Lenova continues to increase business with AMD.
• Gross margins of 58% and free cash flow of $270 million. Wow!!! Is this AMD?
• ASPs increased.
• Inventories down by 6 days going into a seasonally weaker period which is very good.

The big plus in this semi upturn is that a lot of the growth is occurring in new markets that were not aware of AMD chip problems in the 1980s and 1990s and are willing to try them--sales strong in China, Russia and other Asian countries. In addition, enterprise, data center, blade servers are all doing well—all important high growth market segments.

Gross margin outlook OK and most likely being overly cautious but it appears serious pricing pressure at the high end is still not a concern for 2006. AMD management still believes it can get 30% market share.

With quarter after quarter of good results, large institutional portfolio managers will have to continue getting back into AMD.

GE: Great Results! Great Execution! Who Cares!

Great results for such a large company, but everything is so ho-hum. Everything seems so stable and predictable. One could almost fall asleep during the call.

• For the first quarter, EPS up 19%, cash generation up 100%
• Global infrastructure business doing great
• Financial services continues to execute well
• $10 billion of free cash flow for 2006
• 13% to 17% EPS growth for the year for 2006

The investment community knows we are NOT in an environment of predictability and stability. We are in a period of globalization, creative destruction and boom and bust. While stability is often comforting, with listening to GE’s management, the complacency was discomforting and almost feels like the calm before the storm. The storm might be five years out, but you have a sense it is coming.

When speaking about new high growth business, the comments are so antiseptic. There is little passion associated with pure high growth businesses.

While the company does a great job managing a widely diverse group of businesses, one's gut instinct says it is not sustainable for the long term. That is why the stock is doing little after great results. GE’s valuation has gone from a P/E of 30x at the market’s peak in 2000 and is now down to a P/E of 17x 2006 earnings. No matter how great the results are, this stock will not move. The “Invisible Hand” is telling us there is something wrong.

Citigroup Upgrades AES

After posting the AES blog last Thursday, Citigroup issued a report on Monday upgrading the stock to a buy with a target price of $20. The reasoning behind Citigroup's upgrade are the reasons listed in last week's blog, the most important of which is the massive free cash flow generation potential in late 2007 and going into 2008.

AES Corp. Continues To Rebuild Its Business

AES held its year-end 2005 conference call this morning after releasing results on Tuesday. AES, once a high flyer during the 1990s and a major holding in virtually all growth portfolios, is receiving little attention from the investment community as it rebuilds its business and becomes a free cash flow machine.

AES crashed from $86 in 2000 to $1 in October of 2002 before new management was able to convince creditors of its restructuring plans and avoid the bankruptcy plunge. The huge 1990's interest in the company was due to the great international growth prospects for electricity production as democracy and capitalism flourished around the world. Emerging markets needed electricity to participate in this era of prosperity and AES was the one to provide it. With its global reach and experience in the less developed areas of the world, this provided the company with a great competitive advantage to get a leg up on future competitors. Investors went crazy over the growth prospects for this company.

As the world's currencies adjusted, overleveraged industries restructured and economies needed to correct their excesses, AES needed to do the same. After generating no free cash flow for investors during the 1990s, the company in 2003 began generating about $1.0 billion in free cash flow each year and was able to considerably lower its debt levels. In addition, despite a weak earnings outlook for 2006, the company expects to generate in excess of $2.0 billion in free cash per year beginning 2008.

The negative in today's conference call was its earnings outlook for 2006. The company had an excellent 2005, but warned Wall Street of essentially flat earnings for the current year. This is unfortunate considering management has exceeded all the financial goals it set out in its meeting with the investment community in 2003. Management indicated that it will have to pick up some spending to meet environmental standards in the US this year. It is also our belief that management is laying the ground work for higher growth beginning at the end of 2007 and going into 2008. Management hinted that it would begin reviewing these projects in greater detail with the investment community in the fall of 2006.

After avoiding bankruptcy in 2002, AES stock ran up to $8 and hit a plateau until it began to hit its numbers. Today, the stock is around $17 and has moved little since January of 2005, essentially discounting 2006 results. The next big move in AES's stock will be driven by an upsurge in earnings which will be dependent upon investments they are making in 2006. This is a company that is in the sweet spot of the global boom--emerging markets are filled with wireless phones and they all need to be recharged. The political pressures are too great for government not to have the necessary electricity to meet this demand. If AES management can execute in the next growth phase in the post-bubble environment, investors should be well rewarded. We should see evidence of their success or failure this fall.

The Information Age: Interesting Quote

In a speech this week, UK's foreign secretary Jack Straw alluded to a report by leading Arab intellectuals living in the free world.

The report said that Hewlett Packard in one month signs as many patents as the whole Arab world has in the last twenty years.

Once again supporting the view that multi-ethnic societies based on freedom do best.

Level 3's Analyst Day: Playing Chess

As mentioned in Monday's blog, I attended Level 3's analyst meeting on Tuesday in New York. The negativity associated with the post-bubble environment is subsiding as supply and demand come back into balance. Speaking with Kevin O'Hara, Level 3's president, in the beginning of the decade, Level 3 had some 26 networks it had to compete with, now it is down to 6. So a lot of excess capacity is gone.




Another positive from the meeting was Level 3 CEO Jim Crowe's consistency regarding the company's business and its target markets. I focused on this in detail in the our September and November newsletters. Basically, the technological forces that have driven the advancement of the semiconductor and the network is now driving change in the communications industry. Regulation no longer drives network construction, but innovations does.

After five hours of speaking with management, listening to presentations and reviewing over 100 slides, there are certain points that stand out:

• Level 3 is truly the only company that has built a continuously upgradeable network, meaning as new fiber technology comes to market, its conduit approach will provide it with a competitive advantage. (You have to review abovementioned newsletters to understand this.)
• The bandwidth-consumption trend continues: The movement from email to music to video is happening. If you or your child has a video ipod, you see this first hand. An interesting stat--standard television transmission uses 450x the bandwidth of an email. High definition TV will consume 3,000 x the bandwidth of an email. As per unit pricing drops for bandwidth, these newer applications can become available. Level 3 should lead this price-performance curve.
• Comcast indicates that a large percentage of its network capacity is used by bittorrent.com, a video peer-to-peer network, similar to Napster in the 1990s with music. As Napster's distribution method was found to be illegal, there will be issues about bittorrent's distribution of video, but as we see with Apple's perfectly legal success with music, these new technologies (whether legal or not) accurately forecast where the market is going. And the market is moving to higher bandwidth applications. In this case, Comcast provides access to the Internet at the local level, but uses Level 3's network for the longer haul transmission. Network providers cannot afford to build both local and long haul capacity.
• 55% of of network traffic is now peer-to-peer and 20% is streaming video or music. More support of high bandwidth consumption applications.

Technology success has been obtained by understanding the philosophical forces behind it. As with Moore's Law and Metcalfe's Law, Level 3 seems to understand this better than anyone else in the industry. It is a game of chess, can the relatively new up-start lead by Jim Crowe out maneuver the old-time baby bells. I think he will. This most likely is the very early stages of an industry recovery, even though the stock has moved up considerably the last week, this stock should be held on to for a long time.

Momentum Building With Newell Rubbermaid's Stock

After writing about NWL in last week's blog and being mentioned on thestreet.com and our newsletter, NWL was upgraded this morning by an investment firm. The momentum continues to build for this forgotten consumer staples company.


Tomorrow I will be at Level 3's analyst meeting in New York. I wrote a full newsletter on Level 3 in our November 2005 newsletter and also wrote a bunch of comments on the evolution of the internet in the September 2005 newsletter.

If You Are Looking For A New Broker (Some Friday Fun)


I found this on thecodyblog.blogspot.com while surfing the net. A little Wall Street humor.

A New Broker In Town.

Meeting With Cendant

On Tuesday, March 21, Cendant held an analyst meeting with portfolio managers in New York. Cendant is a ridiculously cheap stock but its chairman is being punished by the investment community for his excessive compensation of over $100 million plus per year--if you can call making over $100 million-plus per year punishment.

In addition to Henry Silverman's excessive compensation, there are also concerns about so-called revenue synergies between the number of different businesses that Cendant owns. Many of the businesses are in similar industries and are dependent on one another in one form or another. However, even with these two concerns, Cendant is a cash flow machine.

To address these concerns, Cendant is breaking up its vast array of businesses into four groups. The breakup will occur serially during 2006. The four businesses are real estate, travel distribution, hospitality and vehicle distribution (rental cars--owns Avis and Budget).

The real estate business is a great business but has peaked in 2005 and will be on the decline for the next year or so. The travel distribution business consists of internet-related startups that are having some difficulty finding a profitable position in the marketplace and will most likely be part of a consolidation process after these businesses are independent. The hospitality is an excellent business but is most likely approaching a cyclical peak in the next twelve to eighteen months. And the final business group is the vehicle distribution business which appears to be bottoming and could be in good shape by 2007.

Cendant sells for about 7.2 x its operating cash flow, for those not in the finance business, that is pretty cheap for a company that owns such well-recognized names such as Coldwell Banker, Sotheby's, Wyndham, Ramada, Howard Johnson, Avis and Budget to name a few. It is also a cheap valuation relative to its low debt level, its growth prospects and its free cash flow generation.

Investors should not be hurt by chipping away at this stock at current levels. This stock has been dead money for a while and downside risk is most likely limited. There is the risk that a real estate slowdown could considerably hurt the operating performance of the company for a while, but the balance sheet is in great shape and from conversations with management, they have limited exposure in some speculative markets such as Las Vegas and Florida.

My approach will be to slowly chip away over time. We have plenty of investment prospects for 2006 and Cendant could turn into a much better investment idea in 2007.

The Street.com Agrees

Soon after posting today's blog on Newell Rubbermaid, I was made aware of this piece by thestreet.com

Newell Rubbermaid: Quietly Coming Back To Life

Newell Rubbermaid (NWL) is coming back to life. Newell was our first newsletter idea for 2005, and as usual with most ideas that I write about, I was a year too early in forecasting their turnaround. As the chart shows, investor interest in the stock has picked up, driving it from $24 to $25.50 during the last month. In addition, CNBC mentioned earlier this week that the stock was one of the more widely accumulated stocks in 2006.














It has been a rough road for Newell Rubbermaid. Newell and Rubbermaid combined in the 1990s as the fortunes for both companies were deteriorating. Rubbermaid was the poster child for great shareholder returns and excellent management during the late 1980s and Newell was a well-respected roll-up during the 80s and 90s.

To solve the multiple problems the company had, new management was brought in in 2000 to turn it around. The company has a chock full of well-respected brand names and was a nice free cash flow generator. But Newell had too many plants spread out across the country; Rubbermaid had lost its edge at creating new products that could command a premium price and could not be easily knocked off by Asian competitors. In addition, the company got hit hard by higher natural gas prices (which drove up the cost of resin) and a strong dollar from 2000 to 2002. This led to margins contracting and little to no revenue growth.

Joe Galli ran the company from 2000 to fall of 2005. Galli did a good job at lowering costs, consolidating facilities and moving manufacturing to Asia when it made sense. He also did a good job at getting product innovation going again. If anything was accomplished under Galli's rein it was product innovation. In its meeting with analysts last fall, the company had tons of new products to bring to market.

After last fall's analyst meeting, it became apparent that the company had to do a better job at lining up its marketing dollars with fewer products and begin to drive revenue growth again. The board turned to a fellow member Mark Ketchum, a long-time executive at P&G with some good areas of success.

After a shaky conference call when first appointed interim CEO, Ketchum appears to be getting a good grasp of Newell's businesses. In addition, it appears that no major shake up is required. Most of what occurred during Galli's tenure was pretty good stuff, but now they have to get more targeted with the products they decide to bring to mass market and market them appropriately.

Newell earned about $2.50 per share early in this decade. In 2004, earnings bottomed at $1.39 per share and, in 2005, EPS equaled $1.54, so earnings are back on the upswing. Also, in 2006 the company should begin to benefit from more stable, or even possibly, lower resin costs as natural gas prices are way off their peak. And further, the company is not dealing with a blind strong US dollar policy of the 1998 to 2002 period.

All told, Newell which has been facing one brutal headwind after another may finally have the wind at its back. From all the work the company has done, they should be able to surpass the $2.50 in EPS of the earlier part of this decade. This is a stock to hold on to and let the benefits of the restructuring take hold.

Cigar Butt Investing & IDT Corp.

Cigar-butt investing came into being during the Great Depression. The thinking behind this strategy is that it is best to find something for free than to pay full price. Rather than going into a cigar shop and paying $12 bucks for an Ashton Reserve, you are much better off walking along the streets of New York, picking up a cigar butt out of the curb and taking a few puffs for free.

The same idea would be applied to investing--find a stock that was not doing well operationally but had a great balance sheet, buy it for a certain price below the value of the assets less the liabilities, and you have little risk and some nice upside potential.

The father of cigar-butt or deep-value investing was Benjamin Graham--investor, Columbia professor and author of The Intelligent Investor, the bible of deep-value investing and security analysis. The impression that one has of people who still religiously follow the strict interpretation of Graham's work is that of a curmudgeon, cheap and misanthropic--not the type of person you want to spend much time with. You might make money, but not a lot of fun.

One stock that has come close to meeting the pure interpretation of Graham's cigar-butt definition of value is IDT Corp, a Newark, New Jersey-based telecommunications company. IDT and its Chairman, Howard Jonas, did one of the great deals of the late 1990s. By being years ahead of the curve in undestanding the transition of voice communications to IP networks, he formed Net2Phone which he sold to AT&T for over $1 billion plus (if memory serves me correctly).

Jonas' IDT group owned Net2Phone so a lot of money went on to IDT's balance sheet. For the last bunch of years, with little to no debt, IDT has traded at the value of the cash on its balance sheet. Essentially, the market is giving no value for management's ability to deploy the cash into future profitable ventures. Here comes the cigar-butt investor: "No management team could be that bad as to waste $1.0 billion bucks."

Reporting results this week, IDT is burning through cash at a nice clip. The company is run by Jim Courter, former New Jersey candidate for governor and very much wired like a politician. IDT's results support this--it runs a deficit every year. Cash has gone down from $1.0 billion to around $700 million in the most recent quarter. And the operating metrics completely collapsed during the quarter. In addition, the fixed wireless business that IDT owned and sold some parts of recently (which it attempted to dump on the public but had to pull from the market) is a financial disaster.

Also IDT is getting more into the movie production business, an industry notorious for losing money. While it seems that the company has some interesting projects coming to market in 2006, whether they can earn a profit to offset the losses in the other businesses appears unlikely.

All told, IDT has a lot of things going on, but most of them are consuming huge amounts of cash.

This is one cigar-butt stock I would stay away from. I would rather pay the premium price for the Ashton Reserve.

A Beautiful Sunrise



There is a great sunrise somewhere in the US to get out and go skiing. However, not in New Jersey, too many clouds and it's getting too warm