Merck Paying $1B for Sirna, More Deals Likely

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

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

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

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

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

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


Chesapeake Energy Delivers Again

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

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

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

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

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

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

Amazon Bulls Might Need to Calm Down

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

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

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

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


A Wildly Bullish Quarter for Buffalo Wild Wings

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

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

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

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

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

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


Google Still Eating Yahoo!’s Lunch

Shares of Google (GOOG) are soaring about $30 per share, or 7%, today after another very impressive quarterly report. After a profit warning from Yahoo! (YHOO), many Google skeptics postulated we could see some slight weakness in the search leader’s business, but they turned out to be very wrong. At least for now, issues are Yahoo! appear to be more company-specific than industry-specific. The way I see it, Yahoo! is simply becoming more and more irrelevant in the portal space.

As I have been doing periodically, I will once again update my views on the long GOOG/short YHOO paired trade I originally recommended at prices of $403 and $32, respectively. Today’s huge move up for Google, coupled with a 1 percent drop in Yahoo! brings us to $455 and $23 per share. This results in both stocks trading at about 35 times prior 2007 estimates. After the Google report, 2007 EPS numbers should move from $13/share toward $14/share.

Now that their multiples have essentially converged, which was the thesis behind the paired trade, what do I expect? At this point, I think it is reasonable to put Google at 40x and Yahoo! at 30x forward earnings. If Google hits $14 next year and Yahoo! meets their numbers, we are looking at around $20 per share for YHOO and $560 for Google. That would give this trade another 15 or 20 percent upside from here. As a result, I’m letting it ride.

Overbought Market Nears Dow 12,000

The current market rally has exceeded my expectations, both in duration and in strength. After such a move, am I correct in characterizing the U.S. equity market as overbought? Consider this astonishing statistic. We have now gone 66 straight trading days without a 1 percent drop in the S&P 500 in any given session (July 13th marked the last drop of such magnitude). During that three month period, the S&P has rallied more than 10 percent.

Now I have no idea what the record is for consecutive days without a drop of 1 percent, but given the current streak, I have little doubt we are getting quite overbought at these levels. Unfortunately, much like overbought stocks, just because markets are overbought, it does not mean the rise will stop on a dime. Nonetheless, I am waiting to commit new money to the market. Perhaps some quarterly earnings disappointment will provide attractive entry points for certain stocks in the coming weeks.

Lampert/Anheuser Busch Rumors Insane

Have a flat-lined stock like Gap Stores (GPS) or Home Depot (HD)? Why not start a rumor that Eddie Lampert, Chairman of Sears Holdings and general partner of ESL Investments, a Connecticut based hedge fund, is interested in your stock? That seems to be a recurring idea on Wall Street lately.

The latest rumor sent shares of St. Louis based beer brewer Anheuser Busch (BUD) up 2 percent on Tuesday, on reports that Lampert could launch a $56 per share takeover bid. This has to be one of the silliest rumors I’ve ever heard. At least GPS or HD made a little sense given Lampert’s taste for retailers, even though Home Depot is far too big for an outright acquisition.

How exactly could Lampert pay $44 billion for BUD? And even if he did have the money, why would he do such a thing? Maybe those starting these rumors just want the Warren Buffett/Eddie Lampert comparison to ring true. After all, Berkshire Hathaway (BRKA) has a fairly large position in BUD. Regardless of who is responsible for the rumors, please do not buy BUD shares on hopes of this news materializing. There is no way Lampert buys out Anheuser Busch.

Google Still An Active Deal Maker

Internet search leader Google (GOOG) remains on the cutting edge, making deals with various web properties and content companies. After locking up an exclusive advertising pact with MySpace, reports indicate the company could partner with, or buyout online video leader YouTube for as much as $1.6 billion. While many people will argue whether or not the potential price tag is too high, investors need to realize that forking over a few billion to secure two of the Internet’s most visited sites is chump change for Google.

With $10 billion in cash and a very strong stock price to use as currency for deals, trading 1% or 2% of their company for these deals is merely a drop in the bucket. Not only will these deals allow Google to maintain impressive growth rates in its U.S. business, but it further widens the gap between them and the competition. Today’s announcement of a deal with Warner Music and Sony BMG to distribute fee music videos is yet another example of how Google is leading the way in online content innovation and the advertising that will undoubtedly support such initiatives.

With Yahoo’s stock stagnant and Google shares jumping again today, I just checked out my long Google/short Yahoo paired trade to see where we stand now that Yahoo has fallen from 32 to 25 and Google has jumped from 403 to 428. Despite the postitive return from the trade thus far, Google still trades at a discount to Yahoo on projected 2007 earnings per share (33 times versus 39 times). As a result, I am keeping the trade on for now.

Same Ol’ Sell Side Crap

From the New York Post:

The New York Attorney General’s office and the Securities and Exchange Commission have launched full-fledged probes of a small but influential Wall Street firm that fired an analyst who tried to publish a report critical of one of its clients.

Subpoenas have gone out over the past week to Rodman & Renshaw over the departure of Matt Murray, a biotech analyst who said he was not allowed to lower his stock rating of a company once it had reached its price target.

Shortly after broaching the subject of downgrading Halozyme – a Rodman banking client – he was fired, he said.

A law enforcement source told The Post that a subpoena launching a New York AG investigation into Murray’s February departure had gone out to Rodman; this source also said the SEC had also subpoenaed the firm.

Murray told The Post he was “grateful to learn that the Attorney General is continuing the important work on supporting analyst independence.”

At the time of his departure from Rodman, which specializes in underwriting controversial PIPEs – or private investment in public equities – Murray was a high-profile analyst of small-cap pharmaceutical companies.

Murray said that once his request to downgrade the shares of Halozyme was turned down, he asked Rodman’s compliance chief to remove his name from its coverage.

This set in motion a series of ugly confrontations between Rodman executives and Murray that led to his departure.