Why Break Up Citigroup When You Can Just Change the Name?

Investors hoping Citigroup (C) CEO Chuck Prince would break up the company into smaller parts in order to significantly boost shareholder value will have to wait a little while, at least. After calling such break up talk ridiculous and stupid, Prince reportedly has decided to revamp the Citigroup's brand by, hold your breath, shortening the company's name to Citi and having each division's arc on the logo be a different color. Such a move is an attempt to "unify the identity of Citigroup's businesses" according to the Associated Press. Isn't unifying the company's identity the exact opposite of breaking the company up? Will the move do anything for the company's lagging stock price (shares have risen a total of about 5% over the last 5 years)? Highly unlikely.

Without a break up, Citi sports a 6 to 7 percent earnings growth rate and a 12 P/E multiple. Such a ratio seems about right for that type of growth. By breaking up into smaller pieces, it would be much more obvious to investors that some of Citi's businesses are growing much faster than the entire firm as a whole. In that case, higher multiples would clearly be afforded to some divisions.

The result would be increased shareholder value, not to mention better growth prospects given that it is much easier to grow a bunch of separately run, individualized, smaller firms than it is an enormous one. Just giving each business their own colored arc really doesn't accomplish that feat quite as well.

Full Disclosure: No position

Morningstar Analysts Seem Confused

I'll gladly send a complimentary Peridot Capital 2007 Select List to the first person who can explain how this graphic from the Wall Street Journal Online ("When Buying a Stock, Plan Your Goodbye" - 01/14/07) makes sense. Put another way, how can Morningstar analysts justify calculating the fair value of a stock and then recommend investors not sell the shares when they reach that level?

Sears Holdings Issues Upside Guidance

Sears Holdings (SHLD) projected fourth quarter earnings well above consensus estimates Wednesday. The company estimates EPS for the period will be in a range between $4.87 and $5.39, well above estimates of $4.86 per share. Despite reports in the financial press that sounded much more gloomy about the company's core retail business, real estate sales and derivative contracts are expected to contribute only 8 cents to earnings for the quarter.

Chairman Eddie Lampert has decided against share repurchases for the period, which will result in a cash balance of $3.5 billion, or $23 per SHLD share. What exactly he will use the cash for is still unknown, but many are speculating that a lack of share repurchases in Q4 signal that other uses for the money are far more likely in coming months. That seems like a very reasonable assumption.

Shares of SHLD rose 3.5% on the pre-announcement, to $172 per share, but it still appears to be attractively valued. Full year earnings should come in around $9.38 per share, putting the stock's trailing P/E at around 18. With 2007 earnings expected to jump more than 20 percent, a below-market multiple for Sears stock seems quite low. As a result, it remains a large long position of mine.

Full Disclosure: Long SHLD

Blockbuster Lays Out Growth Targets

Blockbuster (BBI) CEO John Antioco, speaking at an investor conference yesterday, said his company could double its online DVD subscriber base to over 4 million during 2007 as its Total Access promotion continues to pay off. Antioco said that in the 60 days since Total Access was unveiled, Blockbuster has signed up 700,000 new subscribers.

These growth numbers are very interesting. Netflix (NFLX) only added approximately 650,000 subscribers in the fourth quarter, which implies that Blockbuster is ahead of its main competitor in grabbing new business right now. Blockbuster stock is reacting positively, as one would expect, jumping 5% to over $6 per share. It will be interesting to see how Netflix's 2007 growth projections are impacted, if at all, from Blockbuster's big push aimed directly at them.

Full Disclosure: No positions

If Your Broker Sells Mutual Funds, Run, Do Not Walk, To The Nearest Exit

In a perfect world, stock brokers would actually earn their money. If they recommend individual stocks to their clients, those stocks would do better than the ones chimpanzees choose by throwing darts at the Wall Street Journal stock tables. If they recommend mutual funds to their clients, those mutual funds would be above-average performers. After all, if you have thousands of options and a professional helping you choose from them, you should be able to tell the good from the bad.

Ah, but the world is far from perfect. Research has shown that sell side investment recommendations provide investors with more volatility and lower returns than a broad market index. In addition, a study done by a trio of college professors from the Harvard Business School and the University of Oregon shows that between 1996 and 2002 brokers who sold mutual funds actually cost their clients billions of dollars. This conclusion was reached by comparing returns for two groups of funds, those that brokers sold and those that individuals picked on their own.

If we take a step back and think about brokers who sell mutual funds, and how they are compensated, we can understand why they might not provide the best advice to their clients. Brokers get paid to sell certain funds. Those funds are not chosen based on how good they are, but rather on which fund companies give kickbacks to the brokers selling them. So, if brokers are getting paid to sell "Fund X" and that decision has nothing to do with how good Fund X is (but because Fund X is throwing money at the broker), there is little reason to think Fund X would be any better than alternatives such as "Fund Y" or "Fund Z." As a result, logical minds might conclude that mutual funds sold by brokers will perform no better and no worse than the average mutual fund. If performance is not a yardstick that is being given any attention, how well the fund does in the future will be pretty much a coin flip.

Interestingly, the aforementioned study (which tracked more than 4,000 mutual funds over a seven year period) showed that broker-sold funds actually do far worse than average. How striking were the results? Very striking indeed. Investors working on their own to pick mutual funds earned an average return of 6.6% per year. Investors who used a broker and bought the funds they recommended earned 2.9% annually. The public outperformed supposedly "knowledgeable" brokers by more than 100 percent. To make matters worse, the people working with brokers actually lost money after factoring in inflation and taxes.

If you are using a broker and are invested in mutual funds that they recommended to you, you might want to take a close look at your results and make sure your broker is working for you, not the mutual fund company subsidizing their paycheck.

Playing the Online DVD Rental Market

After years of trailing Netflix (NFLX), movie rental giant Blockbuster (BBI) has finally realized that it might have a competitive advantage over its main rival; about 8,500 storefronts worldwide. By integrating in-store and online DVD rentals into its new Total Access movie rental program, Blockbuster is finally making some gains at Netflix's expense.

However, looking at the share prices of both companies, one has to wonder if Wall Street is too optimistic about Netflix's future and too pessimistic about that of Blockbuster. Despite having annual revenue that trounces NFLX by a factor of four, Blockbuster's market cap ($1.09 billion) trails that of Netflix ($1.75 billion) by nearly 40 percent. Netflix's EBITDA for the first nine months of 2006 came in at $46 million, only 25% of Blockbuster's $188 million.

So, Blockbuster at first blush appears to be a much cheaper stock with 60% of the market cap of Netflix, but with 4 times as much revenue and EBITDA. Even using a P/E ratio, which hurts Blockbuster given they have a fairly high debt load, BBI shares trade at more than a 10% discount to Netflix based on 2007 projections.

Given these numbers, there has to be some explanation for the wide valuation disparity. Growth investors would surely point out that Netflix is focused solely on the high growth online DVD rental market, whereas the bulk of Blockbuster's business comes from the storefront, which is a deteriorating market.

That said, Blockbuster's 8,500 stores are worth something, even if it is far less than five or ten years ago, and Netflix has no stores. Going forward, does NFLX have an advantage over Blockbuster when it comes to securing incremental online DVD rental customers? Making the case that they do is difficult, especially since BBI is now allowing customers to return their online DVD rentals at local stores.

Another way to look at it is to analyze the online DVD rental market itself. I have made the point before on this blog that five or ten years from now it is very possible that nobody will be renting DVD's on a web site and returning them through the mail. The cable companies seem to have a powerful distribution network via the on-demand model, and there is no reason to think that every movie that Blockbuster and Netflix have could be part of a mass digital library, accessible to every customer who has a cable box.

If the online mail order model does indeed go away, it would be hard to argue that Netflix is better positioned than Blockbuster. Both companies could very well die under such a scenario, but Wall Street seems to be unfairly down on Blockbuster's prospects versus those of Netflix. The current valuation disparity seems pretty drastic to me, and I'm not sure it makes any sense.

As always, your comments and opinions are welcome.

Full disclosure: No positions in BBI or NFLX.