Anheuser-Busch Chooses to Mimic Yahoo’s Rebuff Strategy

After seeing that Yahoo (YHOO) was able to reject a hostile bid from Microsoft (MSFT), claiming the offer was “inadequate” despite the fact that it clearly was quite adequate, Anheuser-Busch (BUD) has apparently decided to use the same approach in its battle with InBev. BUD officially rejected the deal yesterday, and in a conference call with employees today outlined its own plan to boost shareholder value.

BUD will seek to cut 10 to 15 percent of its workforce through attrition and early retirement offers, as part of a plan to cut costs by $1 billion over the next two years, twice the amount originally planned before InBev’s bid. The company forecasted 2008 earnings per share of $3.13 (roughly in line with current estimates of $3.10), but offered a 2009 target of $3.90 per share, far above the current consensus of about $3.30. As a result, BUD stock is up today, in a down market, to $62 and change.

Does all of this remind anyone of Yahoo? I think both companies were not really being run with shareholders’ interest being of utmost importance. As a result, a hostile bidder came along, knowing full well they could reap some serious operational improvement from the target company. In order to fend off the offer, the target firms claims the offer is inadequate and all of the sudden come up with all kinds of new ways to boost shareholder value.

The frustrating thing about this from an investor standpoint is that both Yahoo and Anheuser-Busch saw no reason to boost shareholder value on their own, despite the fact that such a goal is supposed to be their chief mandate. If A-B can really earn $3.90 next year by reducing its workforce and cutting costs, then why didn’t they announce plans to do so before this InBev bid came along? If you can earn $3.90 and not tarnish your company, then why not do it?

Without InBev, BUD shares hovered around $50 for years. All of the sudden, BUD thinks it can earn $3.90 in 2009, instead of $3.30. If that is actually true (promising something when your company is under attack is different from delivering on the promise), you can easily argue that BUD stock is worth $60 on a standalone basis (15-16 times earnings). All of the sudden InBev’s $65 offer is not as overwhelming as it appears to be.

Why it takes hostile takeover offers to get some management teams to do their jobs is beyond me, but it is quite frustrating to say the least.

Full Disclosure: Peridot clients owned BUD shares prior to InBev’s hostile bid. Since the bid was made, some of those shares have been sold, but partial long positions remained in those clients’ accounts at the time of writing.

Illustrating the Bullish Case for Oil

Those of you who follow the oil markets know that a core bullish argument for rising oil prices over the long term is the growth in demand from overseas, most notably China and India. Those two countries alone represent 36% of the world population, so if their demand rises steadily, the logic goes, lower oil prices are a tough accomplishment.

On Monday a very telling statistic mentioned on CNBC caught my eye. I did not catch the source of the data, so we will have to assume it is correct, but take a look at this:

Barrels of Oil Consumed Per Person, Per Year:

United States: (25) Japan: (14) China: (2) India: (1)

Barring huge oil discoveries in coming decades (highly unlikely) or a dramatic shift to alternative fuels (more likely, but by no means assured), imagine where oil would trade if China and India reach 5-10 barrels of oil consumption per person annually.

As for a more short term view, I have been taking some profits in oil-producing stocks lately. The sudden move to the high 130’s per barrel makes me think the risk-reward trade-off is more balanced now. The next $20 move could be in either direction pretty easily (up if we have a bad hurricane season, or down if it is mild and we get a common correction) and the recent leg higher looks a little extended to me (see the chart of the U.S. Oil Fund ETF (USO) below).


I am not getting into the short term energy price prediction game, but I think taking some profits is a good idea after such a big move, as that matches my investing discipline. Long term, it is pretty hard to justify selling large blocks of energy stocks given that we can look at numbers such as those above and see that without dramatic change, the oil bull market remains intact.

Full Disclosure: No position in USO at the time of writing

Would Offshore Drilling Bring Down Gas Prices?

With gasoline prices nationally surpassing $4.00 per gallon, politicians are revisiting the idea of allowing oil companies to drill off the coasts of the continental U.S. as well as the National Wildlife Refuge in Alaska.

Alaska is probably not going to happen for environmental reasons, but what about the idea of allowing the states to decide if they want to allow offshore drilling in their areas or not? I think that plan has some merit, since it takes into consideration the potential negative impact on tourism and other issues in certain areas. States that feel the benefit will be outweighed by the costs can take a pass, but other states can allow it if they see fit. Localized decision making on this issue seems better than a federal mandate.

That said, just how much benefit would be gained from such drilling? Unfortunately, not much.

From the AP:

“The 574 million acres of federal coastal water that are off-limits are believed to hold nearly 18 billion barrels of undiscovered, recoverable oil and 77 trillion cubic feet of natural gas, according to the Interior Department.”

If we assume it will take 5 years to get the first drop of oil out of the ground and into our gas tanks, that the fields discovered have a useful life of 20 or 30 years from that point, and that we will be able to collect every single barrel of oil that is projected to be there (not a certainty by any means), we are looking at an incremental increase in domestic production of ~700 million barrels per year, on average. The U.S. is expected to consumer 7.45 billion barrels of oil in 2008, so 700 million represents about 9% of our consumption.

Given that world demand for oil is rising so much, the offshore oil we may be able to drill out of the ground would have little impact on gas prices because the oil market is a worldwide exchange. If we just had a U.S. oil market, then yes, it would have a decent impact, but that is simply not the case.

As a result, it is hard to see how more offshore drilling would impact gas prices at the pump in any measurable way. Even if world oil consumption was held constant, we could potentially increase global supply by about 2%. An equal drop in price would bring $4.09 gasoline down to $4.00 per gallon. It just does not help solve the real problem.

That said, it would certainly prevent our energy dollars from being shipped to the Middle Eastern oil-rich countries, so we could keep that money here. Of course, that means our oil companies in the U.S. will make even more money than they are right now, and people are already complaining about record profits for the energy industry even without offshore drilling.

Investment Banks Nothing More Than Black Boxes

Bear Stearns is gone. Lehman Brothers (LEH) is fighting to stay afloat as an independent company. Merrill Lynch (MER) is right up there with the investment banking operations of Citigroup (C) as the domestic firms with the most bad mortgage exposure. Goldman Sachs (GS) is seen as the cream of the crop, but they surely are being dragged down with everyone else too even though they reported pretty good numbers this morning.

Although the investment banks are down a ton, I have not been taking the contrarian side of that trade and scooping up any shares. And I do not plan to do so either. There are two main reasons I just do not feel comfortable investing in pure investment banks.

First, the highest margin products for these firms have either peaked this cycle already or have disappeared completely and will take years to recover. Structured products carried the highest levels of profitability, but many are no longer going to have a place within the industry. Others will take months or even years to regain their luster.

M&A activity has also peaked with the private equity boom. Deals are still going to get done, but 2007 was the peak of the cycle. As a result, overall margins at investment banks will decline as they de-lever and no longer sell as much of their highest margin products.

Second, the balance sheets at these investment banks really are black boxes from an investor prospective. Even though disclosures have improved in many cases over the last few quarters, we really do not know exactly how these firms make their money and what they are holding. Their financial statements break out categories such as sales and trading or principal transactions, but that really does not tell us what exactly they are selling and trading. Balance sheets remain quite opaque.

Without transparency and high margin products to keep profits growing (ROE’s will decline as leverage comes down) and investors informed, it is really hard for me to justify investing in these firms that have no core banking deposits like traditional banks do. The Wall Street business model is just a lot more complicated than a traditional bank. As a result, the latter group is far more attractive to me when bargain hunting in financials.

Full Disclosure: No positions in the companies mentioned at the time of writing

Honda Previews Future of Compact Vehicles

It will take time, but this kind of introduction shows we do have the ability to transform our domestic vehicle fleet in order to greatly reduce oil consumption from transportation, which represents the vast majority of our energy use. As 5% of the world’s population using 25% of the world’s oil, even a 10 or 20 percent drop in our consumption would meaningfully impact the global supply and demand picture for crude oil, which is hitting new highs today at nearly $140 per barrel.

From the Associated Press:

Honda rolls out new zero-emission car
Monday June 16

TAKANEZAWA, Japan (AP) — Honda’s new zero-emission, hydrogen fuel cell car rolled off a Japanese production line Monday and is headed to Southern California, where Hollywood is already abuzz over the latest splash in green motoring.

The FCX Clarity, which runs on hydrogen and electricity, emits only water and none of the noxious fumes believed to induce global warming. It is also two times more energy efficient than a gas-electric hybrid and three times that of a standard gasoline-powered car, the company says.

Japan’s third biggest automaker expects to lease out a “few dozen” units this year and about 200 units within three years. In California, a three-year lease will run $600 a month, which includes maintenance and collision coverage.

The fuel cell draws on energy synthesized through a chemical reaction between hydrogen gas and oxygen in the air, and a lithium-ion battery pack provides supplemental power. The FCX Clarity has a range of about 270-miles per tank with hydrogen consumption equivalent to 74 miles per gallon, according to the carmaker.

The 3,600-pound vehicle can reach speeds up to 100 miles per hour.

John Mendel, executive vice president of America Honda Motor Co., said at a morning ceremony it was “an especially significant day for American Honda as we plant firm footsteps toward the mainstreaming of fuel cell cars.”

The biggest obstacles standing in the way of wider adoption of fuel cell vehicles are cost and the dearth of hydrogen fuel stations. For the Clarity’s release in California, Honda said it received 50,000 applications through its website but could only consider those living near stations in Torrance, Santa Monica and Irvine.

Initially, however, the Clarity will go only to a chosen few starting July and then launch in Japan this fall.

Spallino, who currently drives Honda’s older FCX and was also flown in for the ceremony, said he will use the Clarity to drive to and from work and for destinations within the Los Angeles area. The small number of hydrogen fuel stations is the “single limiting factor” for fuel cell vehicles, he said.

“It’s more comfortable, and it handles well,” said Spallino of Redondo Beach. “It’s got everything. You’re not sacrificing anything except range.”

 

Bid For Anheuser-Busch Really Hits Home

After being born and raised in Baltimore, I traveled out to St. Louis for college and subsequently spent a decade there. The long rumored InBev hostile merger offer for American icon Anheuser-Busch (BUD) came true on Wednesday, as the maker of Budweiser confirmed they had received an unsolicited $65 cash bid.

InBev has a reputation for buying up competitors and slashing costs (read: jobs) to boost efficiencies, profit margins, and as a result, its stock price. As a result, news of this bid really hits home and comes with very mixed emotions. My company owns shares of BUD for some of its clients, so that is good from an investment standpoint, but that about the only positive I can see from my perch.

I have friends who work at the A-B (as it’s known locally) global headquarters in St. Louis so their job security is in question all of the sudden. Whether it be Busch Stadium (home of the Cardinals), Grant’s Farm, or the St. Louis Zoo (free to the public thanks to subsidies from BUD), the city really would take a hit if an InBev/A-B combination resulted in dramatic change.

Upon seeing the press release yesterday afternoon, I quickly sent off an email to a client and close friend working there, to which he replied with a single line:

“Top 5 worst news I’ve received in my life.”

This hostile battle is going to get ugly. BUD will have shareholders who want to take the deal and employees, supporters, and customers who will be firmly against it. After seeing another company with very little leverage turn down an excellent bid (Yahoo), it is certainly possible that A-B could rebuff InBev, although doing so will draw lots of commotion within the investment community.

As you can see from the chart below, BUD shareholders have not had much to smile about this decade, and this deal certainly would boost earnings and the combination’s share price.

The question is, at what cost? Would the brand be tarnished in any way if InBev’s cost cutting managers arrived on the St. Louis campus? It is hard to know.

Normally, as an investment manager I would be jumping for joy at the possibility of getting $65 for shares that not too long ago traded in the high 40’s. But this is far from a normal situation for many of us with direct or indirect ties to the company.

For non St. Louisans, the key question is what to do with the stock (now trading at 63 and change in pre-market trading). Given the local disapproval of a deal, coupled with it being an election year and oversea buyouts/job loss being a hot button political issue, I would say the odds of a consummated deal are no better than 50/50 at this point.

Given that the stock was hovering around $50 before InBev rumors started, and an eventual deal could range between $65 and $70 (if they are forced to sweeten the offer to secure BUD), an expected value on the stock sits in the $58-$60 range. With a current price in the $63 area, it seems reasonable to consider selling a portion to lock in gains and guard against a blocked deal, which could certainly happen.

Full Disclosure: Long shares of BUD at the time of writing

Sears Needs To Do More

A couple people have asked about Sears, including a comment on my last post, so I decided to copy my reply here for all to view:

“As for Sears. my last comment was after they decided to split the management of the company into a holding company structure. My take home message was that such a move would hopefully allow for faster decision making and unlocking some shareholder value, but we would have to wait and see if that actually was the result.

Since then, very little has changed. The retail environment remains very weak and yet the company has made no meaningful moves to unlock value or diversify its business. They just keep buying back stock, which is fine with me, but more needs to be done with the core business.

I have not been adding shares of SHLD and in some cases have actually been cutting back the position. With the weak retail market, stocks like TGT have gotten cheap enough that new money might be better served going there until SHLD shows signs they really are more than just a sub-par retailer.

Until they show some life in that regard, I likely will not become more bullish on the stock. There is value there, but if management does not unlock it adequately, Wall Street won’t take notice.”

Full Disclosure: Long shares of SHLD (just in less quantity than previously) at the time of writing

Large Caps on New Low List

In addition to Verizon (VZ), mentioned in my last post, there continue to be attractively valued large cap stocks hitting new lows in the latest market drop. Both of these names sell for about 13 times this year’s earnings and 12 times next year’s estimates. Pretty cheap valuations for both of them.

 

General Electric (GE) ~$30

Fortunately for those who have owned the stock for a while, the days of investors paying 30 or 40 times earnings for this industrial conglomerate are over. With a far more reasonable valuation at hand, investors can actually get some value out of GE shares. Due to the company’s high exposure to financial services (they lend money to many big ticket customers to aid in financing equipment purchases), GE stunned analysts by missing first quarter earnings estimates and ratcheting down its outlook for the full year. As a result, GE shares made new lows under $30 per share, yield a dividend of over 4%, and now trade at a discount to the overall market.GE followers are used to the stock fetching a premium to the market, but value investors finally have an intriguing market bellwether to consider adding to their portfolios.

Microsoft (MSFT) ~$27

The Yahoo hangover seems like it will never end, but it will at some point this year. Before the Yahoo offer was made, MSFT’s business was clicking on all cylinders and the shares had reached the mid thirties. We can argue whether getting Yahoo would boost MSFT’s financials or not, but even if we assume no incremental benefit one way or the other, it is hard to make the case that MSFT shares are only worth 27 bucks. Either way, a move back into the thirties is likely. While it would happen pretty quickly if Yahoo finally decided to remain independent and the end of the saga finally arrived, even a MSFT/YHOO combination would likely result in a higher stock price in the intermediate term, as Yahoo has little bargaining power to extract an excessive purchase price above the $33-$34 offered previously.
Full Disclosure: Peridot clients are long shares of the companies mentioned at the time of writing

Verizon Buying Alltel, Stock Drop Short Lived

When CNBC’s David Faber broke the news that Verizon (VZ) was in discussions to purchase Alltel for north of $27 billion, Verizon shares tumbled to $36 on Wednesday. I was getting ready to write that such a drop looked to be a good entry point for fans of the deal (count me as one). Wall Street acts fast though, and today the deal was officially announced and Verizon is up $2 to around $39 per share. Quite the change in sentiment.

The buying opportunity is less attractive now, but Verizon remains an excellent large-cap telecommunications investment on similar pullbacks in the future. They are arguably the most well-run telco and consumers continually rank their wireless network the best in the country.

As for other stocks that have gotten cheap recently, I’ll have more details on two other large caps shortly.

Full Disclosure: Peridot clients were long shares of VZ at the time of writing