M&A Not Slowing Down

Another "Merger Monday" is shaping up nicely today, as deals continue to pour in at record levels. Wachovia (WB) buying Golden West (GDW) for $25 billion is by far the biggest deal of the day, but perhaps the most interesting is the bidding war for Aztar (AZR), casino operator and owner of the Tropicana Casino in Las Vegas.

In March, Pinnacle Entertainment (PNK) agreed to acquire Aztar for $38 per share, more than 20% above where AZR stock was trading at the time. Late Friday, the two parties agreed to a revised price of $51 per share. It's not often that a company has to increase the price of a friendly takeover bid by 34%, but in this case, three other suitors emerged and a bidding war began.

Although Pinnacle has a signed merger agreement with Aztar at $51, it might not be done yet. Two of the bidders appear to be out of the mix, as Ameristar Casinos (ASCA) officially dropped out, and Colony Capital hasn't been heard from since their $41 bid was trumped. Columbia Entertainment, however, saw their $50 cash bid expire Friday afternoon, and could very well come over the top sometime this week.

What is all the fuss over Aztar about? The Tropicana, although fairly old in Vegas terms, sits on prime real estate on the Vegas Strip. The buyer would like to knock it down and build another brand new casino, much like the newest hot spot, Wynn Las Vegas. Vegas is hot, and as a result, Aztar's real estate appears to be worth far more than shareholders thought a couple of months ago when the stock was trading at $30 before the initial bid from Pinnacle.

Not only will it be interesting to see how the Aztar situation is resolved, but the overall theme of an immensely robust M&A market should be a focus for investors. The best way to play this, aside from speculating on which firms get bids next, is to go with the investment banks whose advisory fees are sky-high with the current deal flow.

Analyzing Gradient Analytics

Surely you've heard of Gradient Analytics by now, as it's all the Wall Street media outlets have been talking about lately. In case not though, let's recap. Gradient is a research firm based in Scottsdale, Arizona. They focus on forensic accounting analysis of public companies.

The latest issue that has been getting all the attention has to do with negative reports Gradient issued on Biovail (BVF), a poorly run Canadian drug company. Biovail is suing Gradient claiming their inaccurate and misleading reports caused a 50 percent drop in BVF stock during 2003 and 2004. News broke that Steve Cohen, hedge fund manager at SAC Capital and Gradient customer, actually requested a report from Gradient that focused on negative aspects of Biovail's business. SAC was interested in shorting Biovail shares, or perhaps they already were short at the time of request. Gradient did produce a report, and subsequently distributed it to the rest of its customers.

On the surface, this kind of thing looks very suspicious. If SAC Capital was short BVF and asked Gradient to write a negative report on it so they could profit from their short position, it certainly appears that so-called "independent" research is far from independent. Even still, a Gradient report is not responsible for a 50 percent drop in BVF stock, as the company contends. The company's financial results account for the drop.

In response to the lawsuit, Gradient has said that SAC was requesting a follow-up to a previous report it published about Biovail on its own. If that is true, and SAC was not ghost-writing these reports with false information (as some are contending), then it is hard to reach the conclusion that any law was broken. Unless Gradient and/or SAC knowingly disseminated false information in order to profit from existing short positions, this issue seems to be blowing way out of proportion.

Most are screaming for disclosure of these types of relationships. As a result, Gradient should add some fine print at the end of its reports saying that they might have been published based on a client's request, not because it was the research firm's original idea. I have no problem with such disclosures, but don't think for a second that it will change anything.

Sell side research now discloses how many buy, sell, and hold ratings they have on all of their investment banking clients, but we still see mostly buy ratings on stocks of banking clients. I recently read a report from a boutique firm specializing in healthcare stocks. They had a buy rating on the small cap biotech company I was reading about. In fact, at the end of the report they disclosed that their research analysts cover 11 companies with whom their firm has a banking relationship. All 11 stocks are rated "buy".

How much stock should investors put on Gradient's research anyway? Last week shares of Rackable Systems (RACK) dropped 6 bucks temporarily after Gradient's computer model spit out a negative red flag about increasing inventories. They postulated this was a sign of poor earnings quality.

Unfortunately for Gradient's clients, the computer program wasn't able to research Rackable's business model. Had it done that it would have learned that Rackable, much like Dell (DELL), builds product only after it is ordered. So, all of its inventory has already been sold, thereby making increasing inventory levels a signal of stength in the business, not the opposite as Gradient concluded.

WSJ Exposure and a Stock Pick

Thanks to Kevin Delaney and the rest of the team at The Wall Street Journal for featuring me yesterday in a front page story about my trading in and views on Google (GOOG). It certainly made for a fun and eventful day, most notably a full inbox and a phone ringing off the hook. If you would like to read the story, it can be accessed through wsj.com in addition to March 2nd's hard copy. I also have an electronic copy if you aren't a WSJ online subcriber, so email me if you'd like a copy.

On to the market. I have been pleasantly surprised how well the market is acting so far this year. I am tempted to take some money off the table, but the momentum is clearly strong right now. Hopefully nothing will get in the way of that. What do readers think? Feel free to comment.

As for specific stocks, I would suggest investors take a look at Abercrombie and Fitch (ANF). The stock was down $6 yesterday after weaker-than-expected same store sales for February. A lot of hot money was in the stock, so the decline may have been more than normal. Keep in mind that SSS were still up more than 5% for the month, and February is the second least important month of the year for retailers. The stock looks very cheap down here under $60 per share.

Changing My Tune on Blockbuster

Many of you may recall my negative piece on Blockbuster (BBI) back in August. At the time the stock was $7 and looked pricey given an extremely competitive business environment and a horrendous balance sheet.

While I still believe video-on-demand is the future, and online DVD rental services are not the answer to BBI's profit woes, the stock's swoon to $3.85 as of today's close signals to me that much, if not all, of the bad news has now been fully priced in.

While a turnaround will not be easy, the company's stores clearly have some value. Blockbuster's creditors have been very lenient with respect to possible violations of debt covenants, so bankruptcy in the short-term does not appear to be an issue.

Would I go long now that the stock has dropped 45 percent and could rebound to a decent level? It's not at the top of my list by any means, as there are many better, safer values to be had.

That said, most of the bad news seems to have played out, so short sellers may be wise to take their hefty profit and move on to something else.

Stern Gets 34M Sirius Shares

The jury is still out on whether or not Sirius Satellite Radio (SIRI) got itself a good deal when it signed Howard Stern to a 5-year, $500 million deal in 2004. Shareholders though, have to question if it was smart to offer Stern and his agent shares of stock, in addition to $100 million a year for his show.

Massive dilution is nothing new to Sirius, as they give stock out without a second thought. CEO Mel Karmazin got $14 million of stock in 2004 alone. This trend explains, in part, why the company is valued at $8.5 billion despite only a $6+ stock price. There are more than 1.3 billion shares outstanding today, and that isn't even a fully diluted number.

For those keeping track at home, the 34,375,000 share allotment to Howard and his agent, to be delivered on Monday, will be worth $220 million, or 2.6% of the company's current market value.

Bringing Back Late Fees!?

It turns out that Blockbuster (BBI) franchises across the country are starting to bring back late fees. That's right, after a huge advertising campaign boasting about no more late fees, many consumers will find them coming back. Why have store owners decided to bring them back? With the program in place, people just keep movies out for weeks at a time, and as a result there isn't enough inventory in stock to satisfy new release demand.

In the long term, this will be a non-event. We'll all have a library of thousands of movies at our fingertips via on-demand services at home. In the shorter term though, it will be interesting to see how Blockbuster's financials are affected. Will the increase in high-margin fee income more than offset the loss of customers who came to Blockbuster because of the lack of late fees? Probably. However, even though franchise owners can choose whether or not to charge late fees, company-owned stores will continue without them, for now at least.

Red Flagging Six Flags

In case you missed it, shares of Six Flags (PKS) have been on quite the run ever since the company put itself up for sale in August, rising from $5 to the current price tag of $7.22 each. There was no doubt that a sale would have been a welcomed event for investors. After all, the company hasn't made money in years and has over $1 billion in debt (in fact, their debt load is more than 150% of the current market cap).

There is only one problem though. We learned this week that the company is no longer pursuing a sale. The reason? Nobody wants any part of Six Flags. That's right, after four months of shopping the company, they didn't get a single offer.

Don't worry, though. Washington Redskins owner Dan Snyder is now Chairman of the Board and the company has a new CEO, Mark Shapiro. Recently CEO of Snyder's investment firm, Shapiro, 35, was also formerly an executive at ESPN. What does he know about running a theme park company? I'd presume not much, which can't be a good sign for investors in PKS.

Is Cable A Value Trap?

Many value investors have loaded up on shares of the nation's leading cable companies in recent years as share prices have lagged. The Dolan family even considered taking Cablevision (CVC) private, but then pulled the offer off of the table. While the stock of CVC and others such as Comcast (CMCSA) do look attractive by historical measures, the outlook for these operators has changed meaningfully, in my opinion, over the last few months.

The argument for the Comcasts of the world was pretty simple heading into 2005. The stocks were down big, investors were ignoring them, and cash flow was very strong, growing 10% per year. In addition, cable broadband access seemed to be maintaining its lead over the Baby Bells' DSL offerings.

Since cable modems were faster than digital subscriber lines, and many voice customers were scrapping their landlines, the cable companies stood to benefit greatly by bundling digital cable television, high speed broadband access, and VOIP phone services. Throw in Tivo boxes and video on-demand movies and customers could get everything they needed, on one bill, for $100 to $125 per month.

The stocks have languished this year though, even as financial results have been pretty good. The three-pronged attack of bundling voice, data, and video has hit a snag. Some of these services are simple commodity businesses that anyone can offer. Vonage offers unlimited long distance, just as Comcast does. Since the service is the same, pricing will continue to fall.

Then things got even worse. Companies such as Skype began offering VOIP phone service for free. Rumors began swirling that Google (GOOG) was looking into offering free wireless Internet access in order to drive net traffic to its advertising-based sites.

While pricing for cable television will remain fairly flat, and VoD movie libraries could lead to Blockbuster (BBI) becoming extinct, it is entirely possible that wireless Internet access and VOIP long distance phone service are eventually offered for free. If that happens, the cable companies will be back to only offering one service, not bundling three through a single coaxial cable. If this happens, cable operator stocks will go down in history as a major value trap.

Martha Stewart Living Shares: You're Fired!

Shares of Martha Stewart's company were down as much as 20 percent today, after the company reported a pretty bad earnings report. I've been very bearish on MSO stock for quite some time now on this blog, but even at $17 and change, I can't reverse course just yet. I just don't see how they are going to make any meaningful amount of money, and without consistent profitability, MSO is not worth nearly $1 billion. Even a forward price-to-sales multiple of 3 times (a very rich valuation in my opinion) would mean the stock has further to fall from here.