Friday Tech Talk

ACS BUYOUT APPEARS LIKELY

It appears the days of Peridot owning shares of Affiliated Computer Services (ACS) may be coming to a close. Rumors have been swirling in recent weeks that the company is up for sale, with a long list of private equity firms in on the bidding process. Reports have pegged potential price tags in the range of $62 to $65 per share.

While a deal seems likely, I am really hoping to get close to $65, as my fair value calculation nets a $66 price objective. Since rumors have been out there, but no deal is in place, ACS has drifted down a couple of points to its current $60 quote.

For short term players looking to make a few points on the announcement, a deal could be announced as early as Monday, and I would speculate that the odds of one falling apart completely are no more than 25%. Even if no buyer emerges, ACS stock trades 10% below what I think it’s ultimately going to be worth later this year.

NETWORK APPLIANCE RALLY GETTING FROTHY

I was selling shares of Network Appliance (NTAP) into yesterday’s strength as the shares jumped as much as $4 (13%) to $34.49 per share. Evidently, rumors of an IBM (IBM) buyout offer were swirling, which led to an upside breakout.

Even though I am very bullish on NTAP’s business prospects, and an IBM bid could very well send the stock even higher, I don’t think the odds of a buyout are very high. On top of that, with the stock at $34 per share, it’s hard for me to justify much upside to the stock without such a deal.

Estimates for 2006 currently stand at about $0.85 per share. That’s a very high multiple, even with the company’s 25% growth rate and solid balance sheet. For me, the risk/reward trade-off at these lofty levels has lost its luster, at least for now.

Using CES Excitement to Trim Google Position

Today shares of Google (GOOG) are hitting all-time highs trading $16 higher, and that’s after closing over $450 for the first time yesterday. I have decided to unload some more GOOG shares today, even though I wanted to wait for one more event; the announcement of S&P 500 inclusion.

I don’t think we’ll see a massive gain on the day of such an announcement, after all, investors have been expecting it since the anniversary of the company’s IPO this past August. Even so, there should be a quick, and possibly temporary, $10 or $15 pop in the shares when Standard and Poor’s pulls the trigger.

For some reason, though, they have yet to do so. I guess since everyone was waiting for it and expecting it, they’ve decided to hold off. However, they just booted Internet software firm Mercury Interactive (MERQ), and Google seemed like a perfect replacement. Instead they went with Estee Lauder. Weird.

At any rate, when the index funds are forced to scramble to buy thousands of shares, I’ll be right there to sell some to them. After all, at $467 per share Google now trades at 21 times 2006 sales. At these prices, it won’t deserve an outsized position in Peridot portfolios for very much longer.

Side notes:

1) This year’s Consumer Electronics Show has been covered by CNBC all week and I must say, the products are really impressive this year. It is pretty clear to me that the consumer technology cycle will have the wind at its back for a long time, and investors should scour the market for potential winners that are attractively priced.

2) I’m generally not a huge promoter, but Peridot’s 2006 Select List is up 6% so far this year. If you haven’t ordered a copy yet, I think it’ll more than pay for itself (only $20.06 for ten stock picks for the new year).

AOL-Google Deal Appears Close

Despite reports that Microsoft (MSFT) was the front-runner to land a partnership deal with AOL, the Wall Street Journal is now saying that Time Warner is in exclusive talks with long-time partner, Google (GOOG), and a deal could be finalized as early as next week.

This news is not surprising to me. If you were running AOL and wanted to make a deal to maximize the potential for you to regain relevancy in the Internet world, who would you partner with? You’d be crazy not to go with Google at this point in time, especially since Google and AOL have already been working together for years.

The market likely won’t boost Google shares very much, if at all, on this news (especially if the financial terms look generous given many people have valued AOL at zero) but I think this is a big deal for Google and will generate meaningful incremental revenue for years to come.

Google Crosses $400

After hitting $398 twice in recent weeks, shares of Google (GOOG) have surpasses the $400 level today. With the run-up continuing, it is becoming harder to justify buying shares at current levels. In fact, should the forward P/E reach 50, I will likely trim my positions in Google for the second time this year. That said, I still think Google will outperform the market for the next several years.

If you are intrigued by Google stock, but are not willing to shell out 47 times earnings, consider this less risky alternative. A paired trade with Google and Yahoo! (YHOO). Despite brigher growth prospects, higher margins, etc, Yahoo stock trades at 55 times forward earnings, a premium that is interesting. Google is expected to grow sales and earnings in 2006 by 60% and 44%, respectively, versus only 28% and 30% for Yahoo.

A common argument for why Yahoo deserves the premium is its diverse product line. It’s true that Yahoo brings in revenue from more areas than Google does, but I suspect Google’s growth strategy will allow for product diversification in coming months and years.

So, if you are skeptical of the valuation gap between these two Internet leaders, a less aggressive way to play them would be going long GOOG and short YHOO. I had success with this strategy when Yahoo’s market cap exceeded Google’s earlier this year, and I think the trade has more room to run.

Intel’s $25B Buyback

Intel (INTC) stock has been suffering recently, so it appears management thought a 25% increase in its dividend and a $25 billion share repurchase program would help. So, should investors be happy?

Well, INTC stock now yields 1.6% per year, comparable to the S&P 500 index. Decent, but hardly something to get excited about, especially given Intel’s margins and balance sheet position are much better than the typical S&P company.

How about the increased buyback program? Upon perusing their press release, I find it entertaining that they took time in it to brag that since 1990 they have bought back 2.5 billion shares for $49 billion. They seem to think this is a good thing and shareholders should be impressed by that.

By my math, $49 billion divided by 2.5 billion shares come to $19.60 per share. Intel’s current stock price is around $25, so basically their ROI on their buyback, since inception, totals 25 percent. That’s 25 percent over a 15 year period! Average annual ROI? Less than 2% per year. If investors are impressed that their company has invested a whopping $49 billion over the last decade and a half at an interest rate of less than 2%, they should reassess the situation.

It’s true that investors who bought the stock in 1990 have done amazingly well, but don’t think for a second that it is in any way due to their stock buybacks. In fact, had they not wasted that $49 billion, I bet the stock would have done even better.

The Publishing Industry Should Have Learned from the RIAA

Just as the Recording Industry Association of America sued Napter in the late 1990’s, we now have the book publishers suing Google (GOOG) over digital book cataloging. The big point that the RIAA missed many years ago was that technology was changing the way people learn about, access, and listen to music.

CD sales have crumbled and the iPod has been invented. That’s quite a shift in 6 or 7 years. Had the RIAA adjusted to the shift back then, perhaps they could have better insulated themselves from the sales hit they have taken as traffic in Best Buy’s music aisles continues to diminish.

In hindsight, the RIAA should not have cared if they got their cut from the sale of a CD or the download of an album online. Unfortunately, those executives spent too much time huddled with their lawyers, and not in meetings figured out how to change with the times. With the success of iTunes, the recording industry is doing okay (online sales net them less money than a retail CD sale), but I’m sure they are still miffed at the digital revolution, and continue to spend time suing college students for illegal downloads.

It appears the publishing industry is going to follow the same lead, as seen from its lawsuit against Google for scanning copyrighted material. If we simply looked at the publishers’ reaction to the launch of Google Print, you would think Google is taking books, scanning them, and posting them on the Internet for everybody to read for free. The funny part is they are doing nothing of the sort.

Google is organizing book titles and creating an online reference tool for searching the world’s vast array of published works. Think of it as a digital card catalog, but rather than just your local library’s collection, it encompasses (or more accurately strives to one day encompass) every book ever written.

Does this mean that readers will be able to read books without buying them, thereby hurting the profits at the major publishing companies? Not at all. What it does mean is that people will have better access to the world’s books, and therefore will be more likely to find a work they want to read (and therefore, buy).

Fed Meeting & Dell’s Numbers

The recent rally has been long overdue. Going into tomorrow’s FOMC meeting, I would not be surprised to see a small rally into the decision, followed by a sell-off after the language of the statement shows no slowing of interest rate hikes on the horizon. So, if the Dow is up 30 or 40 in the morning, it might be a good idea to take some chips off the table for the afternoon.

That said, after seeing Dell’s surprise earnings warning tonight, a small rally tomorrow might be overly optimistic. Dell stock has been very weak lately, so a shortfall isn’t totally shocking, but disappointing for tech investors nonetheless. Although Peridot does not have a position in Dell right now, a move down to, or even below, $30 per share could be an attractive entry point based on the notion that a corporate upgrade cycle will start taking shape next year.

Why I’m Not Selling Google

It isn’t an easy decision by any means, but when people are paying you to make investment decisions for them, you have to step up and figure things out.

Peridot has had a decent sized long position in Google for many months now. What makes the decision even more complicated today is that I decided to put on a trade yesterday to play the GOOG earnings release. I bought the Dec 300 Puts and the Dec 320 calls, with the stock at $308. The logic was that GOOG would probably move drastically after the Q3 report, but the direction of such a move was hardly assured. Fortunately, we did get a huge move after the blow-out report that has some analysts pegging the company’s 12-month price target at $450 per share.

Even with Google shares up $40 today, I’m not selling. Of course, my first instinct was to sell, given that my strategy is to buy when others are selling and sell when others are buying. After all, the only reason Peridot is long GOOG now is because the crowd was selling immensely when the company’s IPO lock-up period expired early this year, presenting an opportunity for those who prefer go against the consensus view.

My rationale for not selling today isn’t very complicated. Yesterday the company was trading at 41x next year’s estimates, a level investors were willing to pay based on an assumption of how fast they thought Google could grow. Today we know that the company is growing at an even faster rate than we figured just 24 hours ago. However, now the stock trades at 40x 2006 earnings.

Google’s growth rate has gone up, and the stock’s valuation has gone down. In this particular case, I can’t justify selling the stock, despite today’s $40 gain.

The Google Numbers

Are pretty amazing. If you are wondering why the stock is up $29 in after-hours trading, consider the following. Google (GOOG) grew revenue 14% sequentially from Q2 to Q3. During the same period, Yahoo (YHOO) grew sales 6%. So, right now GOOG is growing more than twice as fast as YHOO. And yet when you look at today’s closing prices, GOOG is 41x 2006 EPS with YHOO trading at 47x. Another point to think about is Google grew 14% sequentially in the 3rd quarter (which equates to 69% annualized), which is seasonally the weakest quarter of the year.