With AMD Reeling, Intel Shares Look Attractive

Since I already shared my thoughts on Advanced Micro Devices (AMD), it seems logical to take a look at Intel (INTC) as well. I was pretty neutral on this stock but after thinking about it some more, I think large cap investors might see some things they like in INTC shares.

For large cap growth investors who are looking for nice combination of dividends and decent upside price appreciation potential, Intel stock might be worth a close look.

If the company really is able to take it to AMD during 2007 and regain lost market share, There seems to be upside to the stock. Current 2007 estimates are around $1.10 per share, so investors are dealing with a 19x P/E ratio and a dividend yield of more than 2%. Profits are expected to jump more than 20% in 2008, to $1.35 per share.

Obviously the microprocessor landscape shifts quickly, and predicting margins right now for calendar 2007, let alone 2008, is tricky. That said, if we assume current projections for Intel will likely prove inaccurate, would you feel better taking the “over” or the “under” relative to today’s expectations?

I would think the odds are better than Intel can beat these numbers, given that AMD is on the ropes and Intel is closing the gap technology-wise. Intel was lagging behind for a long time, but now they seem to have turned the corner. As you can see from the chart below, the stock has done nothing for a year.

Full Disclosure: Long INTC Jan ’09 $10 LEAPs

AMD, Intel Price War Revisited

I wrote about the battle in the microprocessor market between Advanced Micro Devices (AMD) and market leader Intel (INTC) twice during 2006 (link: “semiconductors” category archive) and in light of the recently announced earnings miss at AMD, it seems like a good time to revisit the situation.

In March, I suggested that AMD’s lead over Intel, and the corresponding bullishness on Wall Street over the company’s prospects would likely be temporary, as has been the case numerous times over the years. Intel’s size gives them much more financial flexibility to initiate price wars and squeeze their smaller competitor. AMD had smooth sailing for a while because their chips were better than Intel’s. Better performance coupled with lower price points resulted in market share gains at Intel’s expense.

However, Intel is the market leader for a reason, and although they were slightly behind AMD, new chips have finally been released. The result has been a free fall in shares of AMD. As you can see from the chart below, since I mentioned this topic back in March, Intel stock is relatively flat at $20 and change, whereas AMD shares have plummeted about 60%, from $39 to $16 each.

While a turnaround at AMD is still several quarters away at least, value investors likely won’t be able to help themselves by taking a closer look at AMD stock. As I have said before, I do not have a technical background, so you won’t find discussion of specific chip specifications on this site. I simply look at the company’s valuation and decide if, at some level, shares of AMD would be an attractive contrarian investment, despite the fact that the company has gone from being very profitable to now posting losses.

Wall Street analysts have been pummeling the stock in recent days ever since AMD’s warning. We have reached the point now where, thanks to recent downgrades (thanks guys, after a 60% tumble) there are more “sell” recommendations than “buy” recommendations within the sell-side community. Even though the stock is trading at $16, down from $42, analysts have put new price targets as low as $10-$13 per share. As is usually the case, I would expect AMD stock to bottom out before the overall business does.

So, at what level does AMD become a buy? I haven’t purchased shares yet, but it looks to me like with a little more selling pressure, the stock could become pretty darn cheap. Looking at other semiconductor companies and taking into consideration their full menu of issues right now, I think a reasonable price to pay for AMD stock is 1.0x revenue. Even with red ink flowing from their income statement, it would be difficult to argue, based on comparable companies and on historical measures, that AMD should trade below that level.

Surprisingly, AMD stock isn’t trading that far away from 1.0x revenue. With a $16 stock price, the company’s current market cap is about $8.5 billion. Sales estimates for 2007 are now around $7.3 billion, including results from newly acquired ATI Technologies. Obviously we will have to monitor how sales expectations progress throughout 2007, but if the stock hits the $13 to $14 range we will likely be close to 1x revenue, and I would strongly consider making a contrarian bet at that point, when most analysts will still have “sell” ratings on the stock.

Full Disclosure: No position in AMD or INTC at time of writing.

Bill Miller Writes About the End of “The Streak”

If you have read about my investment philosophy on peridotcapital.com you will see that I refer to Bill Miller (manager of Legg Mason Value Trust) in comparing my value strategy to others that are more well known than myself. Miller looks at the market differently than most, and I use many of the same techniques when I manage money, so he is an excellent person to read about if you want to get a better idea of what Peridot Capital is all about.

A logical question would be “If Bill Miller is so good, why should I invest with you instead of him?” If you look at Miller’s performance in recent years, it pales in comparison with his longer term track record. The reason is quite simple; as Miller as gotten more and more publicity, money has poured into his fund.

He now manages billions of dollars, and as a result, is very limited in the stocks he can buy for his fund. Since Miller prefers very concentrated portfolios, he is now limited to investing in very big companies. With a smaller universe from which to choose his investments, Miller’s margin of outperformance is narrowing with each passing year (see chart).

As you may have heard, 2006 was the first year since Miller took over the fund in 1990 that Legg Mason Value Trust failed to beat the S&P 500 index. Although “The Streak” is now over (it is the longest streak by a mutual fund on record), Miller’s overall investment philosophies remain very relevant. For managers who don’t have the task of investing tens of billions of dollars, continuing to invest according to a contrarian investment strategy will prove very profitable.

Fortunately, for those who aren’t familiar with Bill Miller, he writes quarterly letters that are made available to the public, regardless of whether you own shares of his fund or not. In his latest, Miller discusses the end of “The Streak” and other important value investing concepts.

While I would no longer recommend investors buy shares in his fund for the reasons mentioned, I definitely suggest that those interested in contrarian value investing in general, or Peridot Capital more specifically, should read his quarterly letters. You may access his latest letter here.

Yahoo! Investors Pin Hopes on Early Panama Release

I’m a little surprised that Yahoo! (YHOO) stock is jumping more than $1 today after it reported fourth quarter numbers last night. If you look at the company’s 2007 guidance, most metrics are below current consensus forecasts. Revenue growth for the fourth quarter was 15% and 2007 growth will fall between 9% and 20%, according to the company. Yahoo! hardly appears to be a high growth Internet leader anymore.

That said, the stock is rallying as investors hope that an early release of their new ad system, Panama, will boost the bottom line of their network’s online advertisements. Without actual evidence that Panama will boost Yahoo!’s ad margins (the program launches in February) and help it regain market share lost to Google (GOOG), I’d be cautious going forward. If Panama stops the bleeding, YHOO shares will likely trade well into the thirties, but if the platform’s bark is stronger than its bite, investors might be let down.

Full Disclosure: Long GOOG and short YHOO at time of writing

Yahoo! Report Tonight Likely Won’t Overly Impress

Ever since I suggested a long Google (GOOG), short Yahoo! (YHOO) paired trade here back in July of 2006, it’s been very interesting to compare the earnings reports of both companies to see exactly how the search market is playing out on the web. Yahoo! leads off by reporting its fourth quarter tonight (Google is slated to release results next Wednesday) and I doubt their results will be overly impressive.

The argument for the paired trade, in my mind, is twofold. I believe Yahoo! is becoming less and less relevant on the web, as Google takes market share in search and other competitors eat into their other businesses. In addition, there is a valuation gap that has Yahoo! trading at a premium to Google, despite its slower growth rate. Currently, Google trades at 35 times 2007 earnings estimates, versus Yahoo! at 46 times.

The two most common arguments for why Yahoo! trades at a premium are its more diverse product line (Google gets nearly all of its profit from search, whereas Yahoo! is less concentrated there), and its equity investment in publicly traded Yahoo! Japan (Yahoo! owns 34%, worth approximately $8 billion). I feel these two arguments are lacking in two respects.

First, Yahoo!’s more diverse product line, while evident, will not necessarily translate into better operating performance. Since the bottom line is the most important driver of shareholder value over the long term, I don’t think it warrants a huge valuation gap with the likes of Google.

Second, investors who merely subtract $8 billion from Yahoo!’s market cap to account for their stake in the Japanese company and recalculate the stock’s P/E ratio are being too simplistic. This action does reduce the company’s valuation (YHOO’s 2007 forward P/E would drop from 46x to about 36x if you subtract $6 from YHOO’s share price) but such an adjustment is not enough. The reason is because Yahoo! includes its share of Yahoo! Japan’s operations in its own income statement.

If their 34% share of the Japanese company wasn’t accounted for at all by Yahoo when it reports earnings, then investors would be right in simply adding $8 billion to their valuation models. However, investors in Yahoo! are indeed already paying for Japan’s business. If people want to add the equity value of the Yahoo! Japan stake to Yahoo’s overall valuation, they must also subtract its contribution to Yahoo!’s reported earnings so nothing is double counted.

We’ll see what tonight’s report from Yahoo! brings. Since I put on the paired trade about six months ago, Google shares have risen by 19%, while Yahoo! has dropped 15%. So far, so good.

Full Disclosure: Long GOOG and short YHOO at time of writing

After a 40% Drop, Crude Oil Might Be Nearing Bottom

With warm weather and worries over a slowing economy globally, crude oil has been under extreme pressure in recent weeks. While such a dramatic turn of events has been great for prices at the pump, energy investors likely aren’t too enthused. As you can see from this chart, the U.S. Oil Fund ETF (USO) has fallen more than 40%, or 30 points, from its summer high.

Is oil making a bottom, or do we have a lot further to fall? I have little doubt that part of the recent selling flurry has been from the hedge fund community, and therefore has exacerbated the move downward. I don’t think we’ll see $35 or $40 per barrel crude oil anytime soon, and as a result, bottom fishing might be in order here.Also consider that energy could hold up relatively well in a market correction, so that portion of one’s portfolio could very well limit losses to some degree, if and when we finally get a meaningful correction in the stock market.

Investors looking to participate in an oil play could go with the USO exchange-traded fund, or turn to individual oil stocks to collect dividend payments in addition to any share price appreciation. Canadian oil trusts tend to offer some of the highest yields in the industry.

Full Disclosure: No positon in USO at time of writing

Sears Isn’t Ignoring the Retail Operations After All

Critics of the Sears and Kmart turnarounds have long argued that if Sears Holdings (SHLD) Chairman Eddie Lampert ignored the retail business by cutting capital expenditures and marketing expenses, the company would begin to die a slow death. Well, the skeptics have proven to be very wrong, as shown by the stock’s move from $15 several years ago to nearly $180 today.

After the bell on Wednesday we learned that Sears has hired John Walden, an eight-year veteran manager from Best Buy (BBY), to become Chief Customer Officer, with core responsibilities including customer-focused strategies and new business development. Such a move certainly doesn’t seem to imply that Lampert and Co. are not focused on the retail operations.

This is not to say that Sears will become Target (TGT) or Wal-Mart (WMT), because the window for that opportunity has long been closed. However, if they can earn similar profit margins to other large retailers over the next several years, the earnings power of the company will be much higher than it is today.

Full Disclosure: Long SHLD at time of writing


Caremark Investors Shouldn’t Get Too Excited About Sweetened CVS Bid

Shares of Caremark (CMX), a leading pharmacy benefits manager, are jumping today after the company received a sweetened takeover bid from drug store chain CVS Corp (CVS). Caremark has already agreed to a merger of equals with CVS in a stock deal worth 1.67 CVS shares, but arch rival Express Scripts (ESRX) has entered the mix by making a hostile cash and stock bid that is worth about $4 more per share (~$57 versus ~$53).

Worried that Caremark shareholders would vote against the agreed upon deal in its present form, CVS announced yesterday that it would pay a $2 special dividend after the deal closes. The financial press is reporting how this dividend closes the gap between the two outstanding offers (the ESRX offer worth about $57 is now only about $2 higher than the sweetened offer). However, it is correct to assume that this $2 special dividend really equates to a $2 increase in the CVS offer?

Let’s recall what happens when special dividends are issued. The stock price reflects the payout (which is a reduction of net asset value to the paying firm) and the stock trades lower by the amount of the dividend. This prevents arbitrage investors from buying company shares right before the record date and earning a $2 profit when the dividend is issued several weeks later. When cash is transferred from the corporation to the shareholder in the form of cash, the company’s shares are worth less and market forces reflect that.

Think back to the much talked about $3 special dividend Microsoft (MSFT) paid out in November 2004. Microsoft stock dropped from ~$30 to ~$27 after the payout. Investors do benefit by being able to cash out some of their position (assuming they don’t reinvest the dividend), but the shares aren’t worth any more by paying a dividend because the stock price reflects the payout right away by trading down in price afterwards. In fact, investors face a taxable event when special dividends are paid out, whereas they wouldn’t have if the money was kept in the company’s bank account.

If you own Caremark shares and are thinking about this CVS merger and how you would vote, consider that the newly added $2 special dividend really doesn’t cut the gap between the CVS and ESRX offer in half. It merely gives you some cash to go along with the 1.67 CVS shares you would receive in exchange for each Caremark share you own.

Full Disclosure: No position

Why Break Up Citigroup When You Can Just Change the Name?

Investors hoping Citigroup (C) CEO Chuck Prince would break up the company into smaller parts in order to significantly boost shareholder value will have to wait a little while, at least. After calling such break up talk ridiculous and stupid, Prince reportedly has decided to revamp the Citigroup’s brand by, hold your breath, shortening the company’s name to Citi and having each division’s arc on the logo be a different color. Such a move is an attempt to “unify the identity of Citigroup’s businesses” according to the Associated Press.Isn’t unifying the company’s identity the exact opposite of breaking the company up? Will the move do anything for the company’s lagging stock price (shares have risen a total of about 5% over the last 5 years)? Highly unlikely.

Without a break up, Citi sports a 6 to 7 percent earnings growth rate and a 12 P/E multiple. Such a ratio seems about right for that type of growth. By breaking up into smaller pieces, it would be much more obvious to investors that some of Citi’s businesses are growing much faster than the entire firm as a whole. In that case, higher multiples would clearly be afforded to some divisions.

The result would be increased shareholder value, not to mention better growth prospects given that it is much easier to grow a bunch of separately run, individualized, smaller firms than it is an enormous one. Just giving each business their own colored arc really doesn’t accomplish that feat quite as well.

Full Disclosure: No position

Morningstar Analysts Seem Confused

I’ll gladly send a complimentary Peridot Capital 2007 Select List to the first person who can explain how this graphic from the Wall Street Journal Online (“When Buying a Stock, Plan Your Goodbye” – 01/14/07) makes sense. Put another way, how can Morningstar analysts justify calculating the fair value of a stock and then recommend investors not sell the shares when they reach that level?