Amazon Bulls Might Need to Calm Down

Wall Street is apparently thrilled with the third quarter earnings report from online retailing giant Amazon.com (AMZN), as judged by the stock's $4 (12%) jump in today's session. While I am not long the name, if I was, I'd be trimming it. Amazon is a retailer, plain and simple. Therefore, the current P/E multiple the stock garners is quite ridiculous. Back in 1999, the bullish argument for the company centered around the idea that without physical stores, Amazon could earn much higher margins than a Borders, or a Best Buy, or a Wal-Mart.

That thesis, however, has proved to be incorrect. Amazon's margins are not any better than your traditional big box retailers. In fact, Amazon's operating margins trail those of Target, Wal-Mart, and Best Buy. Turns out that warehouses carry the same costs as actual storefronts. With most retailers trading at less than 1.0 times revenue, Amazon trades at closer to 1.5 times.

The company's growth rate does exceed its competitors, for now anyway. Since Amazon has only been around for about a decade, they can roll out new products for a while before becoming mature enough to truly become a one-stop shop for everything. That said, I don't see how the company deserves a P/E multiple of more than 25 or 30 times earnings, as their growth should slow to below 20 percent going forward.

Right now shares of Amazon trade at about 80 times this year's expected earnings. Even if the company can grow the bottom line by 67 percent, as investors are expecting (that sounds optimistic to me), we're still looking at a 2007 P/E of more than 50 times. I just don't know how anyone can justify such a lofty price for the stock. If you think I'm wrong, please share your views. 

A Wildly Bullish Quarter for Buffalo Wild Wings

Sports bar/restaurant chain Buffalo Wild Wings (BWLD) posted an excellent third quarter Tuesday evening, prompting a five point rise in its stock in extended hours trading. Sales jumped 32 percent to $68.3 million, ahead of estimates of $64.9 million, as company-owned same-store sales soared an astounding 11.8 percent. Earnings hit $0.40 per share, nearly 30% above estimates of $0.31 for the period.

The company's conference call was very bullish, as management laid out growth plans for the next three years. BWLD expects annual unit growth of 15 percent, sales growth of at least 20 percent, and earnings growth of at least 25 percent.

Also worth mentioning was the lack of fourth quarter guidance. The company announced that it has decided to abandon giving quarterly financial projections, due mostly to the fact that they have been quite unsuccessful at the task in the past, and with fewer than nine million shares outstanding, a miss or beat of a mere penny per share equates to only a $44,000 difference.

The bears on the stock (and there are plenty of them, as seen by the 18% short interest in the name) will point to the lack of guidance for the fourth quarter as evidence that management expects poor results relative to the market's expectations. However, such a conclusion isn't very likely. Management mentioned on the conference call that Q4 same-store sales are already tracking up 11 percent year-over-year, well above even the most bullish estimates on the Street. Even if fourth quarter results get no bump up from current analyst projections of $0.46 per share, the company will report $1.54 in EPS for 2006. A twenty-five percent jump in 2007 puts EPS for next year at $1.93 per share.

As I have written before, I don't care much at all for quarterly sales and earnings guidance. In the case of BWLD, the company has a growth plan in place that will take form over the next three to five years and beyond. Whether they open a new store in Q3 or Q4 should be irrelevant for long term investors. Investors in the stock, myself and my clients included, will be served quite well if the company hits its growth targets, regardless of how volatile the quarterly fluctuations in financial results turn out to be.

Full Disclosure: I own shares of Buffalo Wild Wings (BWLD) personally, as do my clients. 

Google Still Eating Yahoo!'s Lunch

Shares of Google (GOOG) are soaring about $30 per share, or 7%, today after another very impressive quarterly report. After a profit warning from Yahoo! (YHOO), many Google skeptics postulated we could see some slight weakness in the search leader's business, but they turned out to be very wrong. At least for now, issues are Yahoo! appear to be more company-specific than industry-specific. The way I see it, Yahoo! is simply becoming more and more irrelevant in the portal space.

As I have been doing periodically, I will once again update my views on the long GOOG/short YHOO paired trade I originally recommended at prices of $403 and $32, respectively. Today's huge move up for Google, coupled with a 1 percent drop in Yahoo! brings us to $455 and $23 per share. This results in both stocks trading at about 35 times prior 2007 estimates. After the Google report, 2007 EPS numbers should move from $13/share toward $14/share.

Now that their multiples have essentially converged, which was the thesis behind the paired trade, what do I expect? At this point, I think it is reasonable to put Google at 40x and Yahoo! at 30x forward earnings. If Google hits $14 next year and Yahoo! meets their numbers, we are looking at around $20 per share for YHOO and $560 for Google. That would give this trade another 15 or 20 percent upside from here. As a result, I'm letting it ride.

Overbought Market Nears Dow 12,000

The current market rally has exceeded my expectations, both in duration and in strength. After such a move, am I correct in characterizing the U.S. equity market as overbought? Consider this astonishing statistic. We have now gone 66 straight trading days without a 1 percent drop in the S&P 500 in any given session (July 13th marked the last drop of such magnitude). During that three month period, the S&P has rallied more than 10 percent.

Now I have no idea what the record is for consecutive days without a drop of 1 percent, but given the current streak, I have little doubt we are getting quite overbought at these levels. Unfortunately, much like overbought stocks, just because markets are overbought, it does not mean the rise will stop on a dime. Nonetheless, I am waiting to commit new money to the market. Perhaps some quarterly earnings disappointment will provide attractive entry points for certain stocks in the coming weeks.

Lampert/Anheuser Busch Rumors Insane

Have a flat-lined stock like Gap Stores (GPS) or Home Depot (HD)? Why not start a rumor that Eddie Lampert, Chairman of Sears Holdings and general partner of ESL Investments, a Connecticut based hedge fund, is interested in your stock? That seems to be a recurring idea on Wall Street lately.

The latest rumor sent shares of St. Louis based beer brewer Anheuser Busch (BUD) up 2 percent on Tuesday, on reports that Lampert could launch a $56 per share takeover bid. This has to be one of the silliest rumors I've ever heard. At least GPS or HD made a little sense given Lampert's taste for retailers, even though Home Depot is far too big for an outright acquisition.

How exactly could Lampert pay $44 billion for BUD? And even if he did have the money, why would he do such a thing? Maybe those starting these rumors just want the Warren Buffett/Eddie Lampert comparison to ring true. After all, Berkshire Hathaway (BRKA) has a fairly large position in BUD. Regardless of who is responsible for the rumors, please do not buy BUD shares on hopes of this news materializing. There is no way Lampert buys out Anheuser Busch.

Google/YouTube Deal Finalized

Very interesting (and dead-on in my opinion) take on the Google/YouTube deal, courtesy of former Internet analyst Henry Blodget's blog:

http://www.internetoutsider.com/2006/10/youtube_and_seq.html

Google Still An Active Deal Maker

Internet search leader Google (GOOG) remains on the cutting edge, making deals with various web properties and content companies. After locking up an exclusive advertising pact with MySpace, reports indicate the company could partner with, or buyout online video leader YouTube for as much as $1.6 billion. While many people will argue whether or not the potential price tag is too high, investors need to realize that forking over a few billion to secure two of the Internet's most visited sites is chump change for Google.

With $10 billion in cash and a very strong stock price to use as currency for deals, trading 1% or 2% of their company for these deals is merely a drop in the bucket. Not only will these deals allow Google to maintain impressive growth rates in its U.S. business, but it further widens the gap between them and the competition. Today's announcement of a deal with Warner Music and Sony BMG to distribute fee music videos is yet another example of how Google is leading the way in online content innovation and the advertising that will undoubtedly support such initiatives.

With Yahoo's stock stagnant and Google shares jumping again today, I just checked out my long Google/short Yahoo paired trade to see where we stand now that Yahoo has fallen from 32 to 25 and Google has jumped from 403 to 428. Despite the postitive return from the trade thus far, Google still trades at a discount to Yahoo on projected 2007 earnings per share (33 times versus 39 times). As a result, I am keeping the trade on for now.

Same Ol' Sell Side Crap

From the New York Post:

The New York Attorney General's office and the Securities and Exchange Commission have launched full-fledged probes of a small but influential Wall Street firm that fired an analyst who tried to publish a report critical of one of its clients.

Subpoenas have gone out over the past week to Rodman & Renshaw over the departure of Matt Murray, a biotech analyst who said he was not allowed to lower his stock rating of a company once it had reached its price target.

Shortly after broaching the subject of downgrading Halozyme - a Rodman banking client - he was fired, he said.

A law enforcement source told The Post that a subpoena launching a New York AG investigation into Murray's February departure had gone out to Rodman; this source also said the SEC had also subpoenaed the firm.

Murray told The Post he was "grateful to learn that the Attorney General is continuing the important work on supporting analyst independence."

At the time of his departure from Rodman, which specializes in underwriting controversial PIPEs - or private investment in public equities - Murray was a high-profile analyst of small-cap pharmaceutical companies.

Murray said that once his request to downgrade the shares of Halozyme was turned down, he asked Rodman's compliance chief to remove his name from its coverage.

This set in motion a series of ugly confrontations between Rodman executives and Murray that led to his departure.

Harrah's Apparently Underwhelmed by Offer

While some of the less-knowledgeable anchors on CNBC today were saying that Harrah's was being bought out by private equity, I couldn't help but sit back and consider the odds that the casino giant accepts the $81 per share cash offer from Apollo and Texas Pacific. After all, the company's shares opened at $75.42, jumped to as high as $80.01, and closed back down at $75.62 each.

Since I play arbitrage deals every once in a while, a quote of $75 and change would be intriguing indeed, if the odds of a deal were fairly high. It would likely take 6 to 9 months for a deal to close upon an official agreement, which makes for a nice annualized return for merger arbs. However, after thinking it through, I decided not to pounce yet. And the reasons below might partly explain why the stock is more than $5 below the offer price.

If Harrah's was truly happy with the offer, wouldn't they have accepted $81 per share? Instead they merely issued a press release announcing that they had received the offer and formed a special committee to consider it. The way I see it, there are only two reasons why Harrah's would not have agreed to the proposal. Either they aren't totally sold on the idea of going private, or they are open to it, but want a better price.

Now it's true that by making the offer public knowledge, other interested parties could emerge and a bidding war could push the price up. However, we are talking about a $15 billion offer for the HET equity, plus another $10 billion or so in debt, for a total deal value of $25 billion. How many other buyers can afford a deal like this? Not many, so a bidding war seems unlikely.

A more plausible scenario would be for other private equity firms to join in on the bid, allowing for a second offer to be extended if Harrah's balks at $81 per share. With more investors, the acquiring group can increase their bid, and at the same time, reduce the amount that each must put into the deal.

Who knows exactly what Gary Loveman and the other folks at Harrah's are thinking here. The offer does represent a 22% premium, but is also slightly below the stock's 52-week high. Loveman, the CEO of Harrah's, likely won't have to worry about losing his job, since it is unlikely that private equity firms have a seasoned gaming executive who would be a better fit for the company. Going private does take away the flexibility of paying for future acquisitions with stock, rather than cash, so that could be a consideration as well.

So how should investors play this? Current holders of HET should hold on, since anything is possible and the stock is not most likely not overvalued at $75 per share. If you are considering getting in as an arbitrage opportunity, make sure you do a stand-alone valuation for the company and feel confident that there is not much downside longer term at $75 should no deal materialize. And finally, for you corporate bond investors out there; Standard and Poor's downgraded Harrah's debt to junk status after word of the offer hit the wires. This seems silly to me.

It should be interesting to see how this all plays out and as events unfold, I'll be sure to post my thoughts.

Will Q4 Be Strong Yet Again?

Fourth quarters in recent years have been strong periods for the equity market, but I wanted to put some hard numbers behind my recollections. I went back all the way to 1990 and calculated the S&P 500's performance for each of the last sixteen fourth quarters. The results, shown below, were even stronger than I had remembered.

As you can see, fourteen of the last sixteen years have produced positive S&P 500 returns in Q4. The mean return for the period since 1990 has been 6.5%. The average gain in the positive years is 8.0%, while the average loss in the negative years is only 4.5%.

Does this mean investors should be 100% equities going into October? Surely some will do just that based on these statistics, but I am being more cautious. The market has had a very, very strong third quarter and I want to protect some of those gains.

Stocks simply feel overbought currently. With the average fourth quarter producing a 6.5% gain since 1990, I am going to have to take "the under" and say this year will be less impressive than average. On the bright side, I'll be thrilled if I'm wrong!