Experiencing a Google Acquisition Firsthand

Undoubtedly, one of the reasons Google (GOOG) decided to go public was to secure a currency (both cash from the IPO and shares to exchange) that could be used to fund strategic acquisitions in order to continue to grow and maintain a leadership position within the Internet services marketplace. The company has taken advantage of that financial flexibility time and time again, as seen with YouTube, the pending deal with DoubleClick, and a smaller deal announced today, the acquisition of FeedBurner.

You always hear about how hard integrating acquisitions can be, from corporate cultures to product lines, but rarely do you get to experience that integration firsthand. This FeedBurner deal is interesting to me on several fronts. Sure, I am a shareholder so I want the deal to make sense, both strategically and monetarily, but moreso this combination is important to me because I am a FeedBurner customer and thoroughly enjoy the company's suite of services. FeedBurner manages this blog's rss feed and email alerts subscriptions from top to bottom.

Accordingly, I am very curious to see how exactly Google integrates FeedBurner into their operation. Will FeedBurner be able to remain autonomous enough that they can continue to innovate in a way that pleases users? Will Google's resources enhance the FeedBurner product offering without replacing it? I am hopeful that this deal was not done simply to secure a user base and migrate them to Google's products.

Oracle (ORCL) has been doing that very thing in recent years, essentially buying up competitors, starving innovation at those companies, and moving users to Oracle products. I can't speak for them, but I doubt customers were all too pleased. One of the reasons I enjoy FeedBurner is because they aren't Google. They are very focused on a single area (distributing online content off-site) and they do it very well.

As both a shareholder and a user of services from both Google and Feedburner, I can say they would be well served to collaborate with the FeedBurner team and innovate alongside them. At the same time they should keep the FeedBurner heart pumping. That little company is alive and well, and users deserve to see that continue.

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

Round Two from Round Rock: 8,800 Layoffs at Dell

Earlier this week I wrote about the push by Dell (DELL) into the retail channel as a way to boost sales and gain traction against Hewlett Packard (HPQ). On Thursday the company beat estimates for their first fiscal quarter and announced the second prong of their turnaround plan; 8,800 layoffs (10 percent of the workforce). Although Dell has perfected the very efficient direct model, evidently the company has some fat it can trim, which should help offset any margin pressure from their plan to sell lower end desktop PCs in Wal-Mart (WMT) locations starting in mid June.

Assuming the consumer experience won't be adversely affected by the job cuts, this appears to be a good decision, from a shareholder perspective at least (some employees obviously might feel otherwise). Dell stock jumped more than $1 in after-hours trading to over $28 per share. The stock isn't cheap enough to peak my interest, but I wanted to take a quick look and see what kind of upside investors should expect if the turnaround proves successful. The moves the company is making have a good chance to give the company some upside to currently low expectations this year and into 2008. But how much is the stock worth?

The reason I say Dell shares aren't that cheap is based in part to where companies like HP and IBM (IBM) are trading (15x and 14x 2008 estimates, respectively). What kind of P/E should Dell get based on those comps? I would say 15 to 16 or thereabouts, but the good ol' days of a 25 or 30 P/E for Dell seem to be over.

As far as earnings go, I decided to be pretty aggressive on this assumption, giving the company the benefit of the doubt regarding its new restructuring plan. Current forecasts call for about 2% revenue growth this year, followed by 6% in 2008. Changes at the company likely won't produce results overnight, so a re-acceleration in sales is likely to be more pronounced in 2008. Let's assume they can grow sales 10% next year, to more than $64 billion.

Furthermore, let's assume that Michael Dell can get the company back to peak operating and net income margins. Profits peaked at 6.4% of sales in 2005 before dropping to below 5% last year. Assuming 6.4% margins on $64.3 billion in sales for 2008, the company gets to earnings of $1.83 in 2008, well above current estimates of $1.49 per share. Assign a 16 P/E and the stock price would be above $29 per share. Even if we stretch the P/E to 18 (Dell used to trade at a premium when they were tops in the industry, so this is plausible if they regain their former glory) there is upside to $33 per share, about 16% above the current quote of $28 and change.

The bottom line: Dell stock could definitely keep rising if their turnaround efforts pay off in coming quarters, but make no mistake, this isn't going to look like the 1990's by any means.

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

Wal-Mart is an Unlikely Answer to Dell's Problems

After handing off the CEO post to Kevin Rollins at Dell (DELL) for a few years, founder Michael Dell has returned to try and help his company find its way back to the top. Dell came out of nowhere in the 1990's to overtake the likes of Hewlett Packard (HPQ) and IBM (IBM) in the PC market and earned the number one spot in worldwide market share. However, customer service issues have hurt the company in recent years and a reinvigorated Hewlett Packard (thanks to the entrance of Mark Hurd) now holds the top spot.

So what is Michael Dell's master plan to get back to the top? Last week we learned that the company will begin selling several desktop models in 3,000 Wal-Mart (WMT) stores nationwide. Upon hearing the news I couldn't help but ask myself, "How is that going to help Dell solve its problems?"

After all, the company built its business perfecting the direct distribution model that Dell created in his University of Texas dorm room in the 1980's (he subsequently dropped out). Furthermore, the company focused on the higher end corporate, government, and education markets, leaving the likes of HP, Compaq, Gateway (GTW), IBM (IBM), eMachines, and Packard Bell to fight over the low-end consumer segment. That market didn't turn out to be a very lucrative one. Packard Bell no longer exists. IBM sold its PC business to Lenovo. Compaq was forced to merge with HP. A struggling Gateway bought out eMachines, but still is doing poorly.

Now we hear that Dell is entering the retail channel with what I would have to think (given Wal-Mart's customer base) is a low-end desktop computer. This decision really doesn't make a whole lot of sense to me. The company thrived by shying away from the exact area they now are going to go after. Let's not forget that Dell at first refused to offer desktop models at $300 and $400 price points, instead focusing on higher margin products. They eventually gave in and also began using Advanced Micro Devices (AMD) chips (under Rollins), something they did not do for a long time.

It has been well publicized that Dell has lost market share due to sub par customer service. The company opted to outsource their customer support in order to save money, but the result was consumers waiting on the phone for hours and upon finally getting through, not really getting helpful information. Dell should really focus on what it is that lost them market share in the first place. You can't argue that it was ignoring the low-end PC market, because Dell was number one years back when they were avoiding that segment entirely. If Dell doesn't fix their image of having poor customer support, their market share numbers aren't going to improve dramatically. Even if someone buys a Dell at Wal-Mart, a bad experience will ensure they buy HP or another brand the next time around.

All of that said, you can understand why Dell has decided to go the Wal-Mart route. If they think the key is to regain lost market share at HP's expense, then selling computers at the world's largest retailer would be a great way to boost unit volume. The only problem with that strategy is that profits won't greatly improve and as long as customer support remains lousy, new customers won't result in a high percentage of repeat business, which is really something Dell needs to maintain to sustain any sort of reemergence as the worldwide PC leader.

It seems to me Dell is focused on a short-term impact, something that can score a few points of market share. While that may be attainable, they run the risk of not really improving the overall Dell experience, either as a shareholder or as a computer user. And without that, a Dell turnaround might be very, very difficult.

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

Microsoft Bid for aQuantive Signals Desperation

This stunning bid for online advertising firm aQuantive (AQNT) by Microsoft (MSFT) seems to stem from simply missing out on deals that competitors have made and feeling the need to get something, anything, done. After talks with Yahoo! (YHOO) went nowhere and Google (GOOG) bought Doubleclick for $3.1 billion, Microsoft had two options if they felt they needed to keep up with everybody else; buy aQuantive or Valueclick (VCLK).

Not only did they go with aQuantive, but they paid an astronomical price. Shares of AQNT were trading at $36 yesterday and that quote was pricing in a lot of buyout speculation already. Somehow they got Ballmer and Company to offer more than $66 per share in cash, an 85% premium. Such a bid puts Mister Softy on the hook for a cash outlay of $6 billion. In return it gets a business at 104 times trailing earnings, 86 times current year earnings, and a whopping 67 times 2008 earnings.

Is it a good move, given the price tag paid? I can't see how it could be. Based on 2006 sales figures, AQNT will represent less than 1% of Microsoft's revenue. This deal can hardly move the needle for them, in my view. Sure it will add some expertise in a field that the company is struggling with, but given that this deal is just being done to keep up with acquisitions already announced by competitors, Microsoft is just keeping pace with rivals, not gaining on them.

Buying Yahoo! would have been a better option. There aren't any comparable deals Google could have done to match a Yahoo! purchase by Microsoft, so that would have actually closed the gap. I don't think this aQuantive deal does that. And given the price they paid, I wouldn't be too happy if I was a Microsoft shareholder.

The only positive coming out of this announcement, unless you are long aQuantive shares (congrats to all of you), is an opportunity for merger arbitrage traders. AQNT is nearly $3 below the $66.50 offer price. Although no other bids are likely, the discount is more than 4% and the deal should close by year-end, so arb players can make an 8% to 9% annual return by waiting six months or so for the deal to close.

Full Disclosure: Long Google, short Yahoo!, and no positions in the other companies mentioned

Google Stock Looks Cheap, Believe It or Not

When looking for places to invest excess cash in an overbought market it is important to not only look at your upside potential, but also how much downside there is as well. If stocks are overdue for a drop, you want to make sure you aren't buying something that has a lot of air in it that could be let out quickly in a selling frenzy.

I have been warming up to shares of Google (GOOG) more and more as of late because the stock has been dead money while the company's impressive growth continues. The result of that dichotomy has been a share price that is getting more reasonable on a valuation basis. On Thursday I began initiating Google positions in some of my accounts that had sizable cash reserves.

Long time readers may know that this will be my second bullish call on Google since the company's IPO in August 2004. Like most people I sat out the IPO after the company indicated the stock would be sold well north of $100 per share. After the first round of their auction, the actual price was reduced to $85 per share, but those who didn't bid in round one were locked out of bidding at the lower price.

After the stock began trading it became apparent to me that investors were dramatically underestimating the company's earnings power and incorrectly associating their misfortunes during the Internet bubble with Google's future. I was late to the party, but began buying Google at around $180 per share.

The stock's ascent continued and by early 2006 I had sold my entire position at prices as high as $467 per share. At the time it appeared the Street was aware of the company's earning power, resulting in a fairly valued stock. Since then I have suggested being long Google as part of a paired trade, but have not jumped back in exclusively from the long side. Let me explain why that changed on Thursday.

There is no doubt that Google has tremendous potential to expand its dominance in coming years. That said, there are no assurances that the company's foray into international markets and domestic markets outside of online search will be successful. So, in order to be willing to make a long bet on the stock, I needed to feel comfortable that my investment downside was fairly limited despite the risks the company faces. At the current price of $461 per share, I feel that is the case. As you can see from the chart below, GOOG sits at the same price it was 16 months ago.

How do I arrive at that conclusion? Some simple math really, no rocket science or anything. Current estimates for Google's earnings are $15.12 per share in 2007 (growth of 43%) followed by a 27% increase in 2008 to $19.25 per share. I decided to use what I consider to be conservative assumptions in order to do a risk/reward calculation. Very simply, what is my downside and what is my upside? If the risk-reward trade-off seems intriguing, then Google shares look attractive at $461 each.

First, what is my downside? Let's assume Google earns $15 this year ($0.12 below current estimates) and only manages 20% growth in 2008, to $18 in earnings per share ($1.25 below current estimates). Let's further assume that Google trades at a P/E of 25 next year. I think both of these assumptions are extremely conservative. A 25 P/E on $18 in earnings gets us a stock price of $450 per share. In my opinion, that is my downside over the next 12 to 18 months, less than 3 percent!

Let's compare that to the upside. Again, I'm not going to make overly aggressive assumptions here. I want the numbers to be in reach and doable, but also want to be realistic as well as conservative. For this scenario I am going to take the current consensus earnings estimate of 27% growth in 2008, to $19.25 per share and assume that the company continues to beat estimates by a modest amount. It would not be surprising at all to see 2007 EPS numbers head to toward $16.00 by year-end and 2008 numbers to actually come in closer to $20.00 per share. Further, let's assume GOOG trades at a P/E of 30.

That multiple may seem high given that the market trades at half that valuation. However, I am fairly confident Google will grow at least 20% per year over the next few years, so assuming that growth investors will be willing to pay 30 times earnings for the stock is fairly reasonable. It would be in-line with valuations given to other leading Internet companies, as well as growth stocks such as Starbucks (SBUX).

Quick math tells us that a 30 P/E on profits of $19.25 to $20.00 in 2008 implies a stock price of $577 to $600 per share. Even if we use a more conservative P/E of 25 instead, we get to $481 to $500 per share. Accordingly, the upside is as much as 30% by the end of 2008. Compare this with downside of less than 3% and you can see why I think Google stock in the low 460's is a good investment, even in an overbought market such as the one we are seeing right now.

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

I'm Not Holding My Breath for a Dell-RadioShack Deal

I get a kick out of some of the ridiculous deals that are rumored on the Street. Did anyone really think Sears Holdings (SHLD) would buy Anheuser Busch (BUD)? The latest story comes to us from Business Week, speculating that Dell (DELL) could buy RadioShack (RSH) in an attempt to reinvigorate its business after Hewlett Packard (HPQ) has kicked their butt for a while now.

How does this rumor get published? There is no evidence whatsoever that Dell would even consider buying an electronics retailer. Did RadioShack shares really jump 6% Monday on this story? It's insane. Remember the Gateway Country store concept? Huge bust. That was nearly as bad as waltzing into large corporations trying to sell computers in cow boxes.

The current market environment is very conducive to spreading M&A rumors. After all, the sheer volume of deals right now is astounding. That said, don't put stock into the stories that don't really make any sense. If you are looking to sell some stock, use these temporary bumps to sell into the rumors if you don't think they have merit. A client of mine did that with BUD when merger rumors surfaced, and it proved to be the top in the stock.

I didn't sell any RSH Monday into the rally, but that is because I like the stock for other reasons, not based on a silly buyout rumor. If anyone was going to buy RSH, you'd think it would be Sears, not Dell.

Full Disclosure: Long shares of RadioShack and Sears Holdings at time of writing

Microsoft and Yahoo! Have Little to Lose in Tying the Knot

There are plenty of reasons why the rumored deal that would have Microsoft (MSFT) acquiring Yahoo! (YHOO) for $50 billion is not a good idea. In general, large tech deals rarely work. The history of failures is very long; Compaq-HP, AOL-Time Warner, Symantec-Veritas to name a few. Company cultures in Silicon Valley are typically very hard to mesh. Going from evil competitor to lifelong companion doesn't happen overnight too easily. In fact, for AOL Time Warner it never worked. The two sides hated each other from the start and the result was, according to many, the biggest failed merger of all time.

Add to that Microsoft's preference against big deals and an outright merger of the two companies seems pretty unlikely. Not to mention a price of $50 billion is outrageous and would be extremely dilutive. However, given where they both are right now, I can't help but think that there would be nothing to lose. Sure, the odds are high that the deal would never bear the kind of fruit that the optimists would hope for. But that doesn't mean it is a bad idea.

From Microsoft's perspective, they are probably shocked that despite having a near monopoly on the computer desktop, they still have yet to become an integral part of the user's online experience. Windows and Office represent nearly all their profit. An inability to smoothly integrate their desktop applications and online applications is a huge failure on their part. Instead, people are using Google (GOOG) and other software to manage their online activities and search for content they need. You can certainly argue that just adding Yahoo services won't necessarily change that, but perhaps the two sides working together can be more successful at turning Internet Explorer users into money-making customers.

From the Yahoo angle, they are obviously trying hard to regain some of the market share they have lost to Google. Combining with Microsoft would give them more reach and added capability to try and regain their relevancy. The potential of a Microsoft-Yahoo! team is obviously overwhelming.

Given the history of failed tech mergers and difficulty integrating vastly competitive corporate cultures, there are certainly reasons to believe that Microsoft and Yahoo! together would be no more adept at boosting their online presence than the two firms were able to accomplish alone. That said, I have to think that they have very little to lose by giving it a try. The worst case scenario, in my mind, would be no progress. And who knows, just because something is difficult doesn't mean it is impossible.

Talks of any kind are clearly in the early stages, so it's way too early to speculate on a deal happening, despite the move in Yahoo stock today. At this point I'd put the odds of a deal at no better than 50/50 but if I were advising them, I would make sure they thought long and hard about it. If they just dismiss it as joining with the enemy, which appears to be how talks between the two sides have gone in the past, it could be a missed opportunity to eat into Google's lead.

Full Disclosure: Long Google and short Yahoo! at the time of writing

Five Reasons to Sell Your Yahoo Stock

Shares of Yahoo! (YHOO) are falling 5 percent in after-hours trading tonight after the company reported first quarter earnings of 10 cents per share, a penny below analyst estimates. If you are an investor in the company, here are five reasons to sell your stock:

1) They are overhyping Panama

CEO Terry Semel and company have been hyping their new ad platform, Panama, ever since it launched. Yahoo! stock has risen 25% so far in 2007 mostly due to the fact that it appeared the new system would really boost results. With first quarter profits below expectations and second quarter guidance in-line with projections, it appears they are overhyping Panama's potential and any benefits from it are clearly priced into the shares already.

2) Growth in the U.S. is over

I was amazed when I saw this figure in their press release. Revenue in the United States for the first quarter was $1.1 billion, growth of zero percent over 2006. This should be a red flag. It's true that international market opportunities trounce those domestically, but Yahoo! stock is selling for prices that reflect a high growth Internet leader. With no growth in the U.S. it will hard for the company to deliver superior results going forward.

3) Their time has passed

There was a time when Yahoo! was hot. Those days are over. Their email is still popular and I pay them 20 bucks a year for their fantasy sports program, StatTracker, but Google is eating their lunch in search and other properties Yahoo! bought a long time ago to diversify out of search (HotJobs, etc) just are not going to be growth engines. They just can't stand out from the crowd anymore.

4) Google is eating their lunch

When Google reports first quarter numbers on Thursday, you won't see U.S. growth anywhere near zero. Google has taken over Yahoo!'s leadership position in search and internet advertising and has the cash stockpile to continue to innovate and grow faster than Yahoo! can. There is certainly room for more than one player in this market, but without major changes at Yahoo! it is hard to see how they will reinvent themselves.

5) Google shares are cheaper

This is best reason of all to sell the stock. Google has the momentum, more growth, more resources, and amazingly, a cheaper stock! Google shares trade at a 2007 p/E of 33, versus 59 for Yahoo. Why not just sell your Yahoo! shares and buy Google? There is more growth potential and even if you believe the potential to be a little overhyped, you are paying a lower multiple of earnings to get a faster growing business anyway.

Full disclosure: Long Google and short Yahoo! at time of writing

AMD Warning Brings Out Buyers

Whenever a company issues an earnings warning and its stock jumps on heavy volume, it is usually a signal that an abundance of bad news has already been priced into the shares and a bottoming phase might be underway. I can't help but think that Monday's trading action in Advanced Micro Devices (AMD) falls into this category. I've been bearish on AMD stock for a while, but its freefall may be coming to an end. The shares rose 4 percent Monday after the company slashed guidance and announced a restructuring plan.

I have had a ballpark price target on AMD of $12 for a little while and the stock got very close to that level recently, trading at a new low of $12.60 in recent weeks. The pop this week has taken it back over $13 but I think any move back down to $12 would be an intriguing entry point for investors who are fans of the company. In my most recent post about AMD, I suggested that paying one times revenue would represent good value. Of course, with each passing earnings warning their revenue projections drop, but I stand by that assumption.

Given that AMD's price war with Intel is quite fierce, this is not a situation where I would jump in with both feet because bottoms are very hard to call. However, if the recent buying pressure subsides, the stock goes back to the $12 area, and their annual revenue level can stabilize about where the stock's market cap is, I think a bottom in AMD could be made.

This isn't a long term investment by any means given the company's operational disadvantages versus its main competitor, Intel (INTC). However, given the dramatic sell-off we've seen and the reaction to Monday's announcement, I can no longer strongly endorse the long Intel, short AMD paired trade that I proposed a year ago back when AMD was trading over $30 per share. Intel still looks like the better bet from the long side, but gains from shorting AMD may have run their course.

Full Disclosure: At the time of writing, the author was long Intel's $10 January 2009 LEAPS and had no position in AMD

Motorola Earnings Warning Highlights Failure to Find Next Hit After RAZR

Shares of Motorola (MOT) are getting smacked in pre-market trading after the mobile phone giant shocked Wall Street yesterday by forecasting a first quarter loss. After having failed to find another hit after the wildly popular RAZR phone, rumors are swirling that Motorola may buy handheld maker Palm (PALM) to boost its product offering. As you can see from the chart below, shares of MOT are nearing multi-year lows.

Is it worth it to bargain hunt in this stock? After all, shareholder activist Carl Icahn recently purchased a stake in the company and his calls for increasing shareholder payouts in the form of dividends and buybacks will likely only get louder with yesterday's announcement.

Motorola has always had a ton of cash on its balance sheet and that is still the case. After netting out $4.4 billion in debt as of December 31st, the company has $12.3 in cash. That equates to a stunning $5 per share (Motorola is indicated to trade at $17 and change at the open this morning). With trailing earnings of $1.19 in 2006, MOT shares are pretty cheap.

That said, given how hard the cell phone business is, perhaps Motorola deserves a below-market multiple during tough times. After all, exciting new products aren't right around the corner, and if they go ahead with an acquisition of Palm, it's hard to think Wall Street will be drooling over the move.

Although shares of Motorola are down significantly, I probably wouldn't want to step in yet. As you can see from the chart, the stock got down to the $14-$15 area the last time the company hit hard times. If we got back down to those types of levels, I would be more inclined to bargain hunt in the name.

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