Qwest: Hang It Up Already

You would think a telephone company would know when and how to hang up a phone. It’s like a telemarketer; they’re going to give it a good shot, but at some point the odds are good the person you called is going to hang up on you and get back to their dinner. Reports indicate Qwest Communications (Q) is preparing a third offer to buy MCI Communications (MCIP). MCI has already agreed to be bought by Verizon (VZ) twice. Does Qwest really think the third time will be the charm?

MCI wants to merge with Verizon for many reasons, and most have nothing to do with price. If price was the main issue, Qwest would be winning this battle since all of their offers have trumped the Verizon deals that MCI accepted. You really can’t blame MCI for continually rejecting Qwest. The companies are like night and day. Verizon is the best telecommunications firm around. Qwest is one of the worst. Verizon has a very healthy balance sheet. Qwest is mired in debt. In fact, according the Qwest’s year-end 2004 financial statements, assets less liabilities equals a negative $2.6 billion.

No wonder they are desperate to do the MCI deal. If they don’t they’re in serious trouble. After going through bankruptcy court, MCI (formerly Worldcom) has cleared its books of billions in debt. Combining their improved finances with Qwest’s mess would make for a stronger, larger company. However, Qwest management didn’t get the memo yet; MCI isn’t going to merge with you. You can make another high-ball offer and go straight to the MCI shareholders for a vote. Only problem with that is, I don’t know a single person who would want to own shares in Qwest-MCI.

These desperation tactics make me want to short Qwest shares, as I don’t see either scenario (another failed buyout offer or ultimately winning by overpaying for MCI) as boosting shareholder value.

IAC/InterActive Blasted for Jeeves Buy

There have been some very interesting developments with the announced purchase of Ask Jeeves (ASKJ) by Barry Diller’s IAC/Interactive Corp. (IACI). You would think they were buying some money-losing start-up based on the backlash from the investment community.

Analysts are mostly negative on the deal, even though Diller is getting a very profitable search company at a discounted price. When you have a vast network of commerce-related Internet sites across the web, it seems to make strategic sense to buy a search company to complement them. After all, web surfers can ask Jeeves where to get a great rate on a cruise and he can send them to Expedia or HotWire, both owned by IAC/Interactive.

Even still, debt agencies Moody’s and Standard and Poor’s are putting IAC’s debt on credit watch, hinting they might cut the company’s bonds to junk status (they currently are rated one notch above junk), citing the cash outlay needed to pay for the acquisition and invest in the business going forward.

The funny thing is that IAC paying for Jeeves with stock not cash, ASKJ is profitable and cash-flow positive, and the deal will be accretive in 2005. Diller actually wanted to pay cash, but Jeeves’ management asked for stock instead. Yes, you heard that right. A second-tier Internet company wanted to take stock, not cash, when it sold out. That is the first time I’ve ever heard of that happening.

Management at ASKJ explained that they wanted to have the ability to capitalize on the prospects for growth at the combined company in the future, and having a stake in the new company would allow for that. If that’s not a ringing endorsement for IACI shares at $21 a share, I don’t know what is. I happen to agree that IACI shares look relatively cheap.

Okay, back to these credit outlook downgrades. It is true that Diller intends to buy back 60% of the shares issued to Jeeves, in order to ensure the deal is accretive to earnings in 2005. Isn’t this a good thing? The rating agencies seem to think that the $1.1 billion needed to do this is going to put the company’s balance sheet in dire straits.

Maybe they are looking at the $1.15 billion of cash on IACI’s balance sheet at year-end and thinking that their cash will be wiped out by this deal. However, the company also has $2.4 billion worth of short-term marketable securities (mostly fixed income) and $1.6 billion of long-term investments (maturities of greater than 1 year) on the books as well. Ask Jeeves even has $110 million in cash itself. This company is hardly scrapping for cash. Yet, the yields on the firm’s 7% notes have widened to 160 bp over treasuries.

All of this negative talk seems to be an overreaction to me. IAC is set to spin off its travel business, to be named Expedia, and the stock is sitting near multi-year lows. If it falls to $20, or if the bonds continue to trade poorly on comments from Moody’s and S&P, I think investors should take a close look if they would like some Internet exposure in their portfolios.

As Predicted, Ask Jeeves Gets Bought

As predicted on this blog about a month ago, Ask Jeeves (ASKJ) has received a takeover bid from Barry Diller’s InterActiveCorp (IACI). InterActive has been purchasing Internet companies for years, having already gobbled up the likes of Expedia, Travelocity, Hotels.com, Ticketmaster, and Lending Tree. Diller’s company paying about $1.85 billion for ASKJ, a nearly 20 percent premium to the stock’s closing price last Friday.

While some may express concern that InterActive is overpaying, as I talked about in mid-February, one look at ASKJ’s financials shows how they are able to pay such a price and still see the deal as strategically sound. Even at $28 per share, ASKJ is only being valued at 20 times 2005 earnings.

Okay, so that deal is done. If you own ASKJ, well done. If not, are there any other similar opportunities? Well, the other stock I mentioned along with ASKJ last month was InfoSpace (INSP). Shares of this company have actually dropped a bit since I highlighted them, as they now fetch $38 instead of $41 each. InfoSpace is trading at an enterpise value-to-earnings multiple of 16.4x 2005 estimates. Looking at 2006 numbers, that multiple drops to 12.6x!

Interestingly, even though Ask Jeeves is getting all the headlines today, InfoSpace shares are actually cheaper. In fact, they look like a steal to me at $38 each.

Tibco Software Falls Victim to Wall Street’s Short-Term Thinking

In less than two weeks, shares of Tibco Software (TIBX) have been decimated, falling from $11.88 on February 18th to $7.00 this morning. Rumors have been swirling that weakness in Europe would lead to a profit shortfall in Q1 2005. Sure enough, TIBX issued a press release last night saying that first quarter sales and earnings per share would likely come in at $100 -$102 million and 4-5 cents, versus prior guidance of $116-$120 million and 8 cents.

Tibco shares had been one of the few bright spots in the software sector in 2004. The shares soared from under $6.00 last August to hit a high of $13.50 in December. Not surprisingly, with such enthusiasm for the company heading into 2005, this quarter’s miss has caught investors by surprise. Most have chosen to sell.

Wall Street too often focuses on the short-term, and can punish companies (especially those of the small cap technology variety) in extreme ways after an earnings warning. While the Q1 hiccup is undesirable, have the company’s fundamentals gotten so bad that it warrants a $13.50 stock getting cut nearly in half over the course of a couple months? Not in my opinion. There is a ton of stock for sale today. Take advantage of it.

So Much for the Google Lock-Up Expiration

Google (GOOG) shares are up another $3 this morning after rising nearly $6 yesterday, the first day every share of the Internet search company was available for sale. It appears that demand for the shares is more than adequate to soak up a little extra supply (little because any shares that will be sold by company insiders will be unloaded in a slow and orderly fashion, as opposed to all at once).

What lies ahead for Google in the short to intermediate term? How about inclusion in the S&P 500? With a market cap of more than $50 billion, Google would find itself in the top quintile of companies in the index (based on market cap) upon its addition. With so many mergers and acquisitions being announced recently (AT&T and Gillette are two examples of S&P companies that will need to be replaced), it is only a matter of time before index funds will have to gobble up Google shares.

The largest S&P 500 fund, Vanguard Index 500, had $106.6 billion in assets as of 12/31/04. If Google was added to the S&P today, that fund alone would need to purchase more than $500 million in stock, about 1% of the company’s total outstanding shares. As a result, the announcement of Google’s inclusion in the S&P 500 will only serve to further buoy the stock price, and help to absorb the recently increased float.

More Tech Talk

I feel as though my recent writings are all about technology stocks. They shouldn’t be though. All of the portfolios I manage are fully diversified and none of them have more than a market weighting in TMT (tech, media, & telecom). That could be changing though, if recent events are any indication.

The reason why I am typing away about tech more often these days is simply because that’s where I’m finding value. There are still a decent amount of undervalued investment opportunities in energy and other commodity-related companies. But aside from that, I’ve been uncovering tons of ideas within the software space, as well as Internet companies.

You’re probably thinking “yeah right.” He thinks Google (GOOG) is a value at 47 times forward earnings, but that’s not really “value.” I do still like Google because it’s the fastest growing tech company around and despite rising 100% since its IPO, it still trades at a discount to eBay (EBAY) and Yahoo! (YHOO), with stronger fundamentals. The fact that the stock was up $6 today, the very day 177 million shares were free to be sold by company insiders and early investors, shows that I’m not alone in that thinking. However, let’s assume that a 47 multiple is high enough to still scare most people away. That’s perfectly understandable, even if I think that will prove to be the wrong decision.

For the first time ever, I’ve been finding Internet stocks that trade at a discount to their growth rates. That’s pretty rare in any industry, but especially in tech. Nasdaq stocks will always trade at a premium to the S&P 500, as investors look there in hopes of finding the next Microsoft (MSFT). So you can imagine what happens when Internet stocks that trade at market multiples begin to pop up on my radar screen. These companies are growing 20% to 30% percent a year, have loads of cash on their balance sheets (which is mostly being used for small acquisitions as opposed to dividends), and like many technology companies, no debt to speak of.

Let me give you a couple of examples. As always, assume that if I am saying bullish things about certain stocks that I either own them already, or am strongly considering a purchase. The first is Ask Jeeves (ASKJ: $23). Now some people will just laugh at this. Why would you want to buy Ask Jeeves? I must be kidding, right? Rather than think about who Jeeves is (which I must admit doesn’t scream “buy my stock!”) let’s look at what really matters; the numbers. ASKJ is expected to grow earnings 30% in 2005 and 20% in 2006.

Normally I would guess a stock like this would be trading at 40 or 50 times earnings and I wouldn’t even consider buying it. However, the P/E on 2005 numbers is 16.9x. That’s right, the same multiple as the S&P 500 index, only with more than twice the growth. Two things jump out a me about this company. One, it shouldn’t be trading at a market multiple. And two, if another Internet search company bought ASKJ, it would be ridiculously accretive to earnings.

The next stock is InfoSpace (INSP: $43). A very similar situation to Ask Jeeves. INSP is in paid search, as well as services for mobile phones, like ring tone downloads. Earnings are expected to jump 32% in 2005 and another 31% in 2006. The company has no debt and $9 per share in cash (which has been used for several small acquisitions in recent years and will likely continue). Strip out the cash and you get a share price of $34 and a 2005 P/E of 18.7x. Again, if someone like Yahoo! was to buy a company like this, it would add to earnings immediately, given that Yahoo! trades at over 50 times earnings.

The best explanation for why these lesser known Internet stocks are so cheap compared with the likes of giants Google and Yahoo! is that they are second tier players. Many growth investors simply go with the biggest company in the area they want to invest in. However, smaller firms like ASKJ and INSP have proved that there is room for them too and they continue to grow handsomely under the radar.

I really think eventually Wall Street will realize this and give them a higher market value. They may still trade at a discount to the industry bellwethers, but a 25 or 3o P/E seems attainable as soon as the Street realizes how cheap these stocks are and that these companies can survive. I wouldn’t be surpruised if other companies realize this first, and scoop them up before they are in higher demand.

The Internet Bubble Revisited

As we approach the five year anniversary of the end of the greatest bull market ever, it still confounds us how crazy valuations actually were back in March of 2000. Metrics were being created on the fly by analysts to justify price targets since traditional price-to-earnings and price-to-book ratios could not be determined without profits or tangible assets. Page views actually seemed like the perfect means to value shares of Yahoo (YHOO) to many people. After all, the company was an Internet portal, not an online store or auction site.

I was not immune to this either, of course. I recall a favorite metric of mine at the time was to look at relative price-to-sales ratios. If you had three companies in the same market, but one traded at 12x sales and the other two traded at 20x, you could pretty much assume that if you bought the cheaper one some analyst would come along and point out the “mis-pricing” and before you knew it your stock was fetching 20x as well.

I bring this up, not to blast buyers of Sirius at $9, Taser a $30, or Travelzoo at $100, but instead to point out that some of these profitless companies actually did survive. Most have changed business models (or businesses for that matter) several times since 2000, and very few have the same management teams in place. Those former Internet entrepreneurs have long since cashed in their stock options and left the spotlight.

An example of the aforementioned transformation is Ariba (ARBA). Now, Ariba has a special place in my heart. I never owned the stock, but I went to college with the daughter of one of the company’s earliest employees. My discovery that my dorm room neighbor’s dad had worked for and knew the company’s co-founder and former CEO, Keith Krach, actually was the launching pad for our friendship.

How is this important, other than to rekindle my college memories and remind me that I haven’t talked to that very friend in a couple of years? Well, it appears even though I missed out on the stock’s tremendous run in 1999 and 2000, I may be getting a second chance to make money on the shares of the business-to-business software company. After hitting a high of more than $1,140 per share (split adjusted) five years ago, the stock currently trades at $8, down some 99.3 percent.

With $130 million in cash, no debt, and $360 million in sales expected in fiscal 2005 (ending September 30th), the stock looks very cheap. Ariba just completed the acquisition of Free Markets (another former Internet high-flier) and is in fact growing again. Net of cash, investors today are paying about $6.25 per share and 1.1x revenue for $0.35 in earnings per share in 2005 and $0.56 in 2006. If the company can indeed hit its numbers, there is little chance the stock will continue to trade at 11 times projected 2006 profits.

Breakin’ Up Is Hard To Do

It is always interesting to watch a stock price jump 10 percent on news that the company’s CEO has resigned. Although the headlines will use the word “resign” it is clear that Hewlett Packard (HPQ) chief executive Carly Fiorina was forced out after she orchestrated a horrendous Compaq acquisition.

Maybe now Hewlett will do what they should have done long ago; spin off their crown jewel printing business. Rather than focus on higher margin products (such as plastic containers of ink that sell for $30), Fiorina opted to add scale by gobbling up Compaq, forming (at the time) the largest personal computer maker in the world. The only problem was that with razor thin margins, tech companies were trying to flee that business, and for good reason.

Fiorina thought she could get bigger, take market share, and make money selling computers through various channels such as retail outlets and large tech distributors. As she would find out later, there was a reason why no other company had been able to accomplish that feat. Dell (DELL) continued to take market share as players in the PC market diminished. Gateway bought eMachines, IBM sold its PC biz to Lenovo, Packard Bell disappeared.

So, what should HP focus on now? How about the printer business? Hewlett’s printing division accounted for 90 percent of HPQ’s operating income in fiscal 2004. Using Lexmark (LXK) as a guide, the unit as a stand-alone company would be worth two-thirds of HPQ’s current market value, despite only representing a third of total sales. With shareholder value unlocked, the new CEO would focus on the rest of the company’s operations and hopefully find a way to be a profitable number two player behind Dell in personal computers, servers, and storage.

It won’t be easy, but with Carly gone, the transformation that should have been attempted years ago can finally get started, if the board chooses to go in that direction.

Google Delivers

Updating last week’s piece on Google (GOOG), it appears the bullish stance was the correct one. The company blew away Q4 profit estimates last night, and the stock opened up $23 a share as 2005 EPS numbers will be revised from $3.40 to $4.00. Worries about the Valentine’s Day lock-up combined with some investors lightening up positions after today’s huge move could very well cause GOOG to give back some of the gain short-term. However, don’t think that a 200 handle on Google is far-fetched.

In another wonderful analyst call, the Internet analyst for Jefferies & Co. raised his rating from hold to buy this morning, at $215 a share. Hardly a helpful call, given that the same guy pulled his buy rating last year when the stock was $135. I guess $135 didn’t warrant an investment, but a $215 price tag does.

Oddly enough, Jefferies’ 2005 and 2006 EPS estimates are of some value to investors, as they try to determine fair value for GOOG shares. His 2005 EPS number goes to $3.99, with 2006 upped to $5.40 per share. His price objective of $230 sounds about right to me. I’m using a 60x multiple on $4 EPS, to get to a $240 price target. Any near-term weakness for the rest of the month will allow investors to get in before we get there.

Tech Bargains Can Be Had… Finally

Peridot Capital has been underweight technology stocks for a while. The highly cyclical sector traded at a premium for years, even after the bubble burst, and investors expecting decades of consistent double-digit earnings growth were, and still are, in dreamland. The Nasdaq as a whole still looks expensive, but for the first time in a long time, tech stock bargains have been popping up lately.

The timing isn’t clear to me, as we haven’t had a dramatic correction. The Nasdaq rose nearly 9 percent in 2004, and even though 2005 has been weak thus far, most stocks haven’t seen eBay-like haircuts. It’s becoming easier to find tech leaders trading at or below market valuations nonetheless.

For example, Cisco (CSCO) looks cheap. After buying the networking giant in 1994, I haven’t wanted to put new money into the stock in years. However, at $18 a share the stock looks like a conservative, fairly low risk tech value. After subtracting $7 billion in cash, Cisco trades at about 18 times calendar 2005 earnings. When was the last time that happened? Juniper (JNPR) might have better business fundamentals right now, but you’ll pay at least twice as much for such growth.

Another attractive candidate for purchase is Symantec (SYMC). The stock was crushed after it announced plans to acquire Veritas (VRTS). Both companies have stunning balance sheets and are leaders in their spaces. Investors should question how two companies that sell completely different product lines will be integrated, but the combination at 20x earnings could prove a good value if the deal meshes better than some people think.

Tech isn’t a place to jump in with both feet. That said, large cap leaders used to trade at a premium but now seem to have lost their luster. P/E’s of 17-20 for the industry’s dominant players now seem fair, fair enough to at least have a market weighting and not feel nervous about significant downside risk.