BP, Goldman Sachs, Google, and FinReg... What a Day!

Today is the kind of day that investment managers such as myself love; lots of resolutions on multiple issues that have been holding back certain companies, stocks, and industries. Let me tackle each one briefly.

BP: While it is nice to see the ruptured well capped without any oil spewing out, we have to keep things in perspective. This is a test, this is only a test. The well has been capped for only a couple of hours and leaks could still surface, not to mention the fact that the pressure could further damage the well. Hopefully the relief wells can be paired with this latest cap to finally put a stop to the oil leak, but it is too early to say and the rally in BP shares today (up 3 points) will easily vanish if any issues arise.

Goldman Sachs: News of a $550 million settlement with the SEC is great news for investors. Most were assuming a $1 billion fine to ensure they avoided a fraud charge but it came in at half that amount. Goldman reports earnings Tuesday and the numbers have been ratcheted down a lot due to a weak trading environment early in the second quarter. With the bar set so low, they could surprise on the upside, but the stock is getting a nice bump from the SEC deal, so any further move higher may take some time to develop. I still see GS as the premier firm in the space and earnings should climb back later in the year, which is why I will still be holding the stock for clients.

Google: The stock is down after revenue for the second quarter came in a bit higher than estimates but profits fell short on higher expenses. The company is back in acquisitive mode so free cash flow is on the decline. Without a new, clear growth engine (I am not convinced yet that Android app sales will fit the bill, but they are promising) I would not be willing to pay a premium for the stock. With 2011 earnings estimates around $31-$32, putting a 15 P/E on that gets you to $475 per share, right where the stock is trading after-hours. Color me neutral at these levels.

FinReg: Now that this bill has passed the Senate, we can finally stop hearing about it so much. The banks will see their margins on certain financial products squeezed temporarily (overdraft protection, for instance, is now opt-in, not automatic), but banks will always find ways to recoup the lost income in other ways (free checking accounts, for instance, may become less common in the future). The negative talk today was that the banks and investors are worried because the bill gives regulators a lot of power in forming new rules and this adds to uncertainty. This argument baffles me. Regulators already have the power to make new rules to deal with issues they discover in the marketplace. The bill gives regulators oversight over a few more areas of the financial services industry, but the idea that giving them the power to make rules is a new and overly aggressive idea is simply wrong. That has always been the role of regulators! Now we just need them to do their job, and frankly, that is the part that always seems to let the American people down. I have no reason to think anything will be different this time around.

Full Disclosure: Long shares of BP and GS at the time of writing, but positions may change at any time.

Google TV: Good for Users, Unexciting for Investors

From my perspective Google (GOOG) has become a very difficult company to analyze as an investment. The company has so much money and resources now that it really just seems like they are getting their hands into everything. As their core advertising products (Adwords and Adsense) begin to mature the big question is, where will the next leg of growth come from? Google surely has the people and the cash to reinvent or create new products that actually make the company money, but most of their time nowadays seems dedicated to releasing products that don't make a dime. The Chrome web browser, Android operating system, and the recent unveiling of Google TV are just a few examples.

Along with the rest of the stock market, Google's stock has taken a hit and now trades for around $470 per share, down about 25% from its high of 52-week high of $630. For all of the "growth at a reasonable price" (GARP for short) investors out there, the stock probably looks enticing. Based on 2010 estimates of $28 per share in earnings, GOOG trades at less than a 17 P/E. The EV/EBITDA multiple on trailing results is 12, which is very reasonable for a growth company.

The question in my mind is "Are they just going to keep spending money and resources on innovative products that don't add to the bottom line?" Google TV, for instance, looks very cool but how is the company going to make money by giving out free search software for televisions that allows consumers to find their favorite programs across multiple platforms (cable, web, streaming, etc)? As soon as online advertising market share (as a percentage of total advertising spending) starts to level off, where is Google's growth going to come from? And if this question is really as up in the air as I think it may be, is the stock really even that attractive at 17 times earnings?

I really enjoy buying and selling on eBay, but the company's auction site has matured and now growth is in the single digits. Today investors can buy eBay stock for less than 13 times earnings. eBay hasn't really found another way to boost growth, and as a result the once high-flying stock now trades at a discount to the S&P 500 despite being a dominant player in an attractive and very profitable market segment.

It is for this reason that I find it very difficult to evaluate the investment merits of Google stock today. On one hand the stock is quite inexpensive relative to what Google has accomplished up until this point. On the other hand, if growth continues to slow in the company's core advertising markets and they simply spend excess cash flow producing innovative products that are given away for free, I am not sure that earnings will grow fast enough to net investors sizable returns going forward. And if the P/E continues to contract, as it has for companies like eBay, creating shareholder value becomes even more difficult. While the downside looks limited given how cheap Google stock is today, I have mixed feelings as to whether it warrants the commitment of new capital.

As always, your thoughts are welcomed and appreciated.

Full Disclosure: Peridot Capital had a very small long position in Google and no position in eBay at the time of writing, but positions may change at any time

Even with Palm, Hewlett Packard Faces Uphill Battle in Consumer Electronics

After it was made public that smart-phone maker Palm (PALM) had put itself up for sale, most every rumored suitor was an Asian hardware firm such as HTC or Lenovo. The logic was that Palm had a strong set of assets that would be a good fit for a foreign company looking to make a splash in the U.S. phone market without having to build the business from scratch. When Hewlett Packard (HPQ) surprised the Street this week with an agreement to buy Palm for about $1 billion, some praised the deal while others expressed their doubts. To me, it makes sense that HP would buy Palm as a way to more quickly enter the market for mobile devices, but I really doubt that we will look back two or three years from now and say buying Palm really paid off for HP.

There is no doubt that HP is getting a large patent portfolio, a strong team of engineers, and a proprietary operating system in Palm webOS, and it is reasonable to assume that HP did not have other ways to acquire such assets for less than the price it is paying for Palm. However, the question really is whether HP can gain traction in an already crowded market for smart-phones and tablet PCs. Large hardware makers always seem eager to compete with the market leaders when new hot products come about but I do not think there is room for everyone.

Dell, for instance, is another computer maker that is developing both a cell phone and a tablet PC. HP is widely known to be developing a tablet and now with Palm it will be able to easily enter the cell phone market as well. Owning the operating system will make these products easier to control and produce than they were for HP before the deal (having to use Microsoft's mobile operating system in their products raises HP's costs due to licensing fees and gives them less flexibility in the design of the product), but companies like HP and Dell still face the challenge of bringing to market a product that people want more than a Blackberry, iPhone, or iPad.

The track record of large computer-focused firms trying to invade leading innovators' turf is poor. Both HP and Dell have been trying for a long time to break into other consumer electronics but really have not been successful. Many companies were convinced that they could grab a chunk of the MP3 player market, even with Apple's iPod as the best in class product, but companies like SanDisk (with their Sansa players) failed to gain much ground. Why would this trend change this time around? Do we really think a tablet PC from HP or Dell will be better than the iPad and therefore really hurt Apple? Can Barnes and Noble or Sony really take a bite out of the e-book reader market by dethroning the iPad or the Kindle?

It is highly unlikely that companies, no matter how large, can come along later with a me-too product and succeed. As a result, while we all can understand why HP buying Palm for $1 billion makes sense if their goal is to go after these markets, it is a lot harder to have confidence that such an endeavor will prove even remotely successful. For only $1 billion, which is mere pennies for a company as large as HP, they probably do not think it is a large risk to take. And they are probably right, on that front at least.

Full Disclosure: No position in HP or Palm at the time of writing, but positions may change at any time

Contrary to Initial Reports on CNBC, Garmin Dividend Hike a "One-Time" Event

Despite reports on CNBC yesterday that GPS maker Garmin (GRMN) had doubled its annual dividend from $0.75 to $1.50 per share, a thorough reading of the company's press release shows that this increase is "one-time" in nature, meaning that Garmin has decided to add $0.75 to its dividend this year, but that investors should not assume it will necessarily stay at that level in 2011 and beyond. A few firms choose this type of dividend policy; paying out a standard rate every year and then, based on cash flows at the time, perhaps choose to pay out special dividends as well. Oil driller Diamond Offshore (DO) is another company that uses this policy.

Had Garmin actually boosted its core dividend to $1.50 per share, it would have been very good news (technology firms typically do not sport 4%+ dividend yields), but without assurances that this is not just a one-time event (the company actually used "one-time" in its own handpicked wording) investors who bid Garmin stock up $2 on Wednesday based on an extra $0.75 of dividends may be a bit optimistic.

I wrote about Garmin recently (Introducing Smartphones Unlikely To Save GPS Hardware Firms Like Garmin) and although the stock is not expensive based on current earnings, I simply do not think the fundamental story for standalone GPS device makers is all that positive. As more and more devices come equipped with GPS capabilities in the future, profit margins are set to decline. If margins do drop, low P/E ratios today may be giving investors a false sense of security, as earnings could fall faster than revenue. Below is a look at some other large cap hardware companies along with their current trailing twelve month price-to-sales ratios.

I use price-to-sales as my preferred metric here because I do not have confidence that Garmin will be able to keep its margins as high as they have been in the past. Traditionally the hardware industry has been characterized by lots of competition and low margins. As you can see from the data provided, only a few unique firms can really maintain high margins in the hardware space (Apple and RIM leading the way right now due to product and brand loyalty). Low price-to-sales ratios indicate low profit margins because investors know that a lot of revenue per share is needed to made good money selling products.

Not only do I continue to be cautious on Garmin from a fundamental perspective, but Wednesday's announcement and investors' reaction to it (with help from some confusing reporting on the dividend hike) made it worth mentioning again.

Full Disclosure: Peridot Capital clients had no position in Garmin at the time of writing, but positions may change at any time.

Steve Jobs Wrong About Stock Buyback Impact

Reports out of the Apple (AAPL) shareholders meeting today are not very encouraging if you are an investor in the company. One of the first questions posed to Steve Jobs during the Q&A session, the first Jobs has attended since his medical leave of absence, concerned the odd decision made by the company to sit on a cash hoard of about $40 billion, earning little or no interest.

Apple has previously taken the position that keeping cash on-hand for acquisitions or large research and development projects made sense. I can buy that for the first $10-$15 billion, but the kind of cash balance held today is not only silly, but a disservice to investors.

So how did Jobs answer when shareholders asked about the possibility of using some cash for a dividend or stock buyback plan? Not well. Jobs said that not only does Apple need to keep that cash for growth opportunities, but even more disturbing, he stated that paying a dividend or buying back stock would not change the stock price.

Given that Peridot Capital has a position in Apple stock, this comment is not only wrong, but it indicates to me that Jobs does not really care about shareholders very much. He is right that paying a dividend would not change the stock price. A dollar of cash is worth the same on Apple's balance sheet as it would be in the pocket of a shareholder, so any transfer of cash from the company to investors would serve merely as a partial cash out of one's investment (and would possibly be taxable for the investor).

To assume the same for a share repurchase plan, however, is simply incorrect. Apple could retire 10% of the company's outstanding shares and only use half of its unused cash balance! How can Jobs argue that a 10% increase in Apple's earnings per share would not positively impact the stock price? That is exactly why companies use free cash flow to repurchase shares; each investors' share of the ownership pie increases, which makes each share of stock more valuable.

For those of us hoping Apple would boost earnings by investing its cash hoard more wisely, it appears our voices won't be heard anytime soon. Unfortunate, but true.

Full Disclosure: Peridot Capital was long shares of Apple at the time of writing, but positions may change at any time

Apple iPad is Nice, Probably Not a Game Changer Yet

After seeing Apple's unveiling of the new iPad tablet yesterday my overall conclusion is that the product is very solid and will probably find a niche with certain users, but it hardly seems to be the game changer for old media that many had hoped for.

Essentially the iPad is a thin, light-weight, extremely mobile device that can be described as a supersized iPhone or a thin netbook computer. You can surf the web, check email, play iTunes, and download iPhone-like apps customized for the device.

The real issue I see is that the iPad is not all that different than a netbook or iPhone, other than its physical design. The only unique feature of the iPad seems to be a new e-book store. In addition to buying songs, movies, and television shows from iTunes you will be able to buy e-books from an e-book store, modeled after the iPhone app store and the iTunes media store. Think thin netbook combined with an Amazon Kindle.

The clear loser here is Amazon, whose Kindle overnight gets a strong competitor. The clear winners were supposed to be the content publishers, including magazine and newspaper companies, not just book publishers. On that end, I think the expanded distribution of e-books will be good for those publishers, but the gains for newspapers and magazines is less apparent.

The problem those publishers face today is that most are giving away their content on the web and the advertising revenue they earn from web visitors pales in comparison to the subscription revenue they used to collect. Some have been able to charge for web content (Wall Street Journal) and others are starting to put pay walls on their sites (New York Times) but with so many free news sources on the web, it will be hard for most publishers to convince consumers to pay a monthly fee for their content.

I am not convinced the iPad solves this problem. The content companies will build apps for the iPad, just as they did for the iPhone, but the core issue is the same; will people pay for the content when there are other free options? If the answer is yes, then the publishers will get stronger going forward. If not, nothing will change.

If you put your content on the iPad for free, that is no different than the free web site people are using to access your content. If people are not willing to pay to use your web site today, why would they be willing to pay for an iPhone or iPad app with the same content?

Even after seeing the iPad in action, I think the content game is unchanged. If you truly have valuable content that is unique and in strong demand (Wall Street Journal), you can make good money with online content. If not, people will simply go to free news sites and your profits will evaporate as subscription revenue continues to decline.

Where does this leave Apple stock? They will likely sell a good number of iPads going forward so the product is certainly an incremental positive for the company and the stock. Believe it or not, the shares have been treading water for a while now, and therefore are not overly expensive. At $207 per share Apple sports a P/E ratio of about 18x based on $11-$12 of earnings power this year. Add in the $27 per share ($25 billion) of cash that is wasting away on their balance sheet and you can see that the stock is not super-cheap but is not overly expensive by any means.

Full Disclosure: Peridot Capital was long shares of Apple at the time of writing, but positions may change at any time

Second Tier Smart Phone Makers Likely To Struggle With Profitability

When shares of Palm (PALM) were trading in the mid single digits I was quite bullish on the company's stock simply because a revamped product line and a private equity capital infusion would likely serve to keep the company afloat and give it a chance to reverse a declining sales trend. We now find ourselves in round two of the story. Palm and the other second tier device companies are trying to grab market share in a rapidly growing smart phone market but the Blackberry and iPhone are unlikely to give up their leadership positions.

With a market growing so rapidly (3-5 years from now pretty much everyone is likely to have a smart phone device) selling devices is one thing, but making good money on them is quite another. Last week Palm reported that it shipped nearly 800,000 phones in the latest quarter, but the company lost a whopping $50 million in the process. Gross margins are only around 25-27% despite about 80% of sales coming from the new Pre and Pixi phones.

That does not leave much room for profitability when second tier firms have to spend so much on marketing to be noticed by a consumer who may be focused on the iPhone or Blackberry. The introduction of a Google phone into the mobile market (rumored to be early next year) will only make it harder for second tier players. In fact, Palm stressed on their conference call last Thursday evening that they are focused on gaining market share, not margins, so there is little reason to expect them to even care about profits in the short to intermediate term.

To me this makes the investment merit of companies like Palm a lot less attractive. I would add a company like Motorola (MOT) to this list too. Sure they have the new Droid phone, but the competitive landscape is so crowded that sustainable profitability seems difficult. Again, a rapidly growing market can lift all boats in terms of device sales, but future stock price performance will be based on profits, not sales, now that the market believes (correctly) that Palm and Motorola will survive to compete in the marketplace.

At Peridot Capital I was a buyer of Palm early in 2009 but pared back the position a lot as the stock rose into the mid teens. Now that the story has played out I will be less bullish on the shares unless they can reach sustainable profitability. And I do not think the prospects for Motorola are any more promising.

Full Disclosure: Peridot Capital has just a small long position in Palm and no position in Motorola at the time of writing, although positions may change at any time.

Amazon Now Worth As Much As Target, Costco Combined

This is just one of the market valuations that I have not understood in the past (and still do not at the present). Amazon is one of my favorite companies and I buy stuff on the site all of the time. My caution on the stock in recent years (due to a sky high valuation) has been proven wrong, as the stock keeps moving higher. Amazon continues to steal market share in the retail sector from bricks and mortar storefronts as more and more people spend more online. I would have thought most people who prefer online shopping would have already adopted it as a way of life, but evidently that trend continues unabated.

I would not consider buying the stock at current levels, however, as I simply cannot figure out why Amazon should be worth as much as Target and Costco combined when the latter two firms earn 7.5 times as much money and do so at similar profit margins. It is true that Amazon is growing faster but the valuation discrepancy seems to more than account for that. Of course, if they keep growing market share, perhaps Amazon can grow at current rates for far longer than many ever would have thought. While I surely would have loved to own the stock this year, I am content simply being a satisfied repeat customer.

Analyst Silliness with Research in Motion

In recent days I have been paying special attention to shares of Blackberry maker Research in Motion (RIMM). The stock is one that had decent earnings this quarter but some investors wanted more, which prompted a pretty significant sell off in the stock. Despite the market having recently made new yearly highs, RIMM shares have dropped from the high 80's to the mid 50's. The stock is down several points today after the analyst who covers them for Citigroup downgraded it from "buy" to "sell."

Skipping the "hold" rating completely is pretty rare on Wall Street, but what caught my eye even more was that the analyst lowered his price target on RIMM from $100 to $50. What happened to make the company worth 50% less overnight in his view? The upcoming release of Motorola's Droid smart phone.

Call me skeptical of this bold call from Citigroup's research department. The new Droid is going to be such a huge success that it will translate into a 50% haircut in the value of Research in Motion, which has a stronghold on the corporate smart phone market? Have we not seen dramatic hype surrounding new cell phones recently that only served to disappoint investors? The Palm Pre comes to mind immediately. While it may help Palm get back on the map, the Pre is certainly not looking like a genuine iPhone challenger like many were expecting. Should we believe that the Droid will similarly make a huge dent in RIMM's Blackberry franchise?

I haven't made the plunge into RIMM stock yet, but the odds are getting higher each day the stock continues to slide. At a current $55 quote RIMM trades at 11 times 2010 estimates ($4.85 per share), which seems reasonable even if that figure proves too high due to increased competition. Right now I might just be willing to make the bet that the Blackberry retains its lead in the corporate market for years to come. If so, the stock looks pretty cheap here.

How have this analyst's past calls on the mobile sector turned out? Pretty lousy, which is par for the course on the sell side. Today the analyst upgraded Motorola to a buy and downgraded Palm and RIMM to sell. He initiated coverage for all three back in September 2007. Here is how the calls since then have turned out:

His track record on Palm has been decent; initiated at sell at $8, upgraded to hold at $6, and now back to sell at $11.

How about RIMM? Dismal. Recommended as a buy twice at $99 and $69, and now says you should sell in the mid 50's.

Lastly, the Motorola record isn't all that impressive either; hold at $18, buy at $12, hold at $6, buy today at $9.

All in all, the current negativity on Research in Motion looks overdone to me and as a result I am considering a contrarian investment. As always, please share your own thoughts if you care to join the discussion.

Full Disclosure: Peridot Capital had no position in RIMM at the time of writing, but is certainly taking a very close look at current prices.

Google Recaptures 5th Spot On Most Valuable U.S. Companies List

Nearly two years ago I wrote about internet search giant Google (GOOG) seeing its stock price surpass $700 per share, and as a result, become the fifth most valuable U.S. company in terms of equity market value. Shortly thereafter the recession hit and Google shares tumbled with everything else. The stock is making a comeback though, after reporting strong third quarter earnings last night. Analysts are once again very bullish, boosting their target prices today.

With the stock up $21 today, Google has reached $550 per share and has now returned to fifth place on the most valuable company list, as you can see below.

My main question has not really changed over the last two years. Does Google deserve to be number five, or will we look back five or ten years from now and realize that being a leader in internet search and advertising (while certainly an impressive feat) doesn't really translate into a company being valued nearly the same as some of the others on this list.

Full Disclosure: Some Peridot clients have been long Google over the last two years, and some still own it, but I have been cutting back the positions as the stock's forward P/E ratio has gotten back over 20 (currently about 22).