Wall Street Likely to Yawn Despite Another Blowout Quarter for Chesapeake Energy

The hardest thing for value investors oftentimes is to stand by one's convictions, even when Wall Street doesn't seem to take notice of what you see. Shares of natural gas producer Chesapeake Energy (CHK) have been doing nothing for more than a year. Many investors have likely grown tired from Wall Street's yawns and have moved on to more hip names. However, CHK's fourth quarter earnings report issued yesterday afternoon once again shows that the company is clicking on all cylinders.

Chesapeake reported earnings of $0.90, 13 cents above estimates of $0.77 per share. Revenue came in at $1.87 billion, versus the consensus view of $1.52 billion. Spectacular quarters are nothing new for CHK, as they have reported stellar results for many quarters in a row now. However, the stock has merely been tracking the commodity price of natural gas, ignoring the fact that shares trade at 8 times trailing earnings and 5 times trailing EBITDA.

The weakness in Chesapeake shares, relative to its operating results, is likely due to two things. First, CHK has issued a lot of convertible debt to fund increased natural gas production, and continues to do so. In order to hedge their positions, buyers of the convertible debt simultaneously short the common stock in order to lock in the income generated from the convertible securities. The good news is that the land grab that CHK has embarked on is largely over so they are doing fewer acquisitions. In fact, CHK's long term debt actually fell in Q4 for the first time in a long, long time.

Investors also worry about falling natural gas prices when analyzing Chesapeake shares. This explains why CHK has been following spot gas prices for months now. This logic, though, ignores CHK's massive hedging activities (they sport the most aggressive hedging program in the industry). The company has hedged 50% of their gas production above the current market price for both 2007 and 2008. As a result, commodity price risk should not be a large concern for CHK investors.

As value investors know, it often takes a long time for Wall Street to realize that they have mispriced equities. Over the long term, CHK stock has reflected the value of its underlying business, even when short term movements do not. This time should be no different. And if the company's management team grows tired of waiting for their value to be realized, they surely would have numerous options if they were to sell their company outright to get out of the fickle public marketplace.

Full Disclosure: Long CHK common stock, as well as the preferred "D" shares

Busted Dot-com Ideas Breathe New Life

If you remember the dot-com bust pretty well you may recall a company called AllAdvantage. Back in the 1990's this Internet start-up was one of the first to recognize that online advertising really was the wave of the future. AllAdvantage paid you to surf the web. The idea behind it was simply to install a toolbar on the screen, fill it with advertisements, and the company could pay you to surf the Internet with money it got from the advertisers, and still have some leftover for itself.

AllAdvantage caught on with web users quite easily, as one could imagine. Just install this bar on your screen, ignore it when browsing online, and get paid. Since AllAdvantage didn't require you to click on anything, it was quite easy to take advantage of the system. College students would leave their Internet Explorer browsers open on their computers when they left for the day, allowing them to collect money for "surfing" when they were really all the way across campus attending class.

Not surprisingly, AllAdvantage went under along with thousands of other web start-ups, mainly because it paid out more than it collected from advertisers. There was no safeguard to assure that would not happen. However, it appears the business model is making a comeback.

A new company called Agloco has improved upon the model. Again, you install a toolbar and get paid for surfing the web just as you do now. However, web surfers get paid a cut of any ad revenue that is generated, thereby ensuring that Agloco doesn't paid out more than it collects. So, users will need to use the toolbar's search engine or click on ads in order for the model to generate revenue to distribute to users.

Whether or not the idea will work remains to be seen. However, the service is set to go live shortly, and those who made a killing off of AllAdvantage before it went belly-up, or anyone else who is interested, can sign up at Agloco's web site and they will email you when the service goes live.

Is Halliburton's Discount Warranted?

As energy investors are aware, shares of Halliburton (HAL) have been trading near historically low valuations for much of the recent past. I have largely dismissed the discount as being merely a consequence of having a huge amount of U.S. government business due to the Iraq war. Once that is over, or as soon as the Bush Administration was out of office, my thinking went that huge no-bid contracts allowing the company to charge the government anything they wanted would vanish, and Halliburton's financial performance would lag. Hence, the stock is discounting this reality in the marketplace.

With the Halliburton spin-off of its KBR (KBR) subsidiary, all of the sudden we have the division with much of the Iraq war criticism tied to it trading on its own. After Halliburton disperses its majority stake to shareholders, Halliburton will look a lot more like a leading oil services company, and much less like a company being propped up by the Bush Administration, and more specifically, former CEO Dick Cheney. Interestingly, in 2006 KBR represented 43% of sales for HAL, but only 7% of operating income.

The KBR-free Halliburton would once again be a good comparable for Schlumberger (SLB), the other large services company that, before the war in Iraq, traded very similarly on Wall Street. With such a scenario unfolding, there might not be a good reason to have a such a wide valuation disparity between the two largest energy services firms.

Both stocks have similar dividend yields of around 1% per year. HAL trades at 12.3 times 2007 profit forecasts, versus 16.8 times for Schlumberger. As much as I wanted to come to another conclusion, based on political views of the Iraq war, I must admit that the stock is cheap. A purely long play on HAL, or a paired trade with a short Schlumberger position to play a possible narrowing of the valuation gap, could be attractive.

Full Disclosure: No positions in the companies mentioned

Don't Expect Express Scripts to Bow Out of Caremark Bidding

Pharmacy chain CVS (CVS) has increased its bid for Caremark (CMX) by $4 per share in an attempt to secure the pharmacy benefits manager. Rather than simply raise the per-share amount of its merger offer, CVS has chosen the unconventional route of sweetening its offer by promising a special dividend to Caremark holders should the deal go through. With CVS increasing the proposed special dividend to $6 from $2, their offer is now fairly comparable to the opposing cash and stock offer from rival Express Scripts (ESRX).

You may recall I already weighed in on this rare type of deal sweetener in January. I still believe offering a one-time special dividend to CMX holders is more like changing the deal terms from all-stock to cash and stock, since CMX shares will go down after a one-time large dividend is paid.

With the bids more similar now, I would expect Express Scripts to raise its offer shortly, perhaps as early as after the close today. They will not go the special dividend route. They want Caremark badly and realize that in order to convince Caremark holders to merge with a main competitor, and not a retail pharmacy, they will have to pay handsomely.

With consultants having already recommended investors reject the prior CVS offer, Express Scripts may very well land support for an increased bid, as they know that CVS is being very conservative with their special dividend strategy. All in all, I think Caremark prefers to do a horizontal merger with CVS, rather than a vertical integration with Express Scripts, but the offers must be at least comparable for such a move to survive a shareholder vote.

Full Disclosure: No positions in the companies mentioned

Why I Don't Think the Fortress IPO Signals a Top in Hedge Funds

Many people will likely point to today's IPO of Fortress Investment Group (FIG) as evidence that we are nearing a top in the hedge fund and private equity bull market. While I have no opinion on the investment merits of the stock (it is up 73% on its first trading day, and I have not looked at their financials), I do not think that this IPO alone is worrisome for the markets.

While the growth in new hedge funds and private equity funds will likely slow in coming years, both are here to stay given that they are truly viable investment vehicles. Just because these types of funds are newer than investment banks, mutual fund companies, and other buy-side asset managers, it doesn't mean they should not be publicly traded. They are able to do things such as sell short, profit from arbitrage opportunities, and take a long term view with a turnaround situation without the constant badgering from short-term oriented analysts. There is a real market for these strategies, and it is not just a fad.

However, just because they are here to stay, it doesn't mean that hedge fund and private equity growth won't slow. Whenever you have a huge spike in interest for something, you will ultimately have people getting involved who are in over their heads. With more hedge funds being created, there will be more failures in the future. It doesn't mean hedge funds are bad, or just a fad, it simply means that like many other businesses, the strong survive and the weak get weeded out.

While I do think public hedge/private equity funds are here to stay, that is not to say that investors should go out and buy up as many shares as they can. Much like investment banks like Goldman Sachs (GS) and asset managers like Blackrock (BLK), these companies will fall on hard times when markets turn south. Investors will need to compare and contrast a company like Fortress to a Goldman, or a Blackrock, to determine how their financial results will fare in various market environments. Using that information will help them decide how much they are willing to pay for each of their respective stocks relative to each other.

Full Disclosure: No positions in BLK, FIG, or GS at time of writing

Altria to Spin Off Kraft... Shocking!

It's amazing how many people have been quoted saying the Altria (MO) spin-off of its 89% ownership of Kraft Foods (KFT) will send the shares of MO to between $100 and $110 each. If we've known about the spin-off forever (we have, even though the exact date was just announced) why has the stock been trading in the mid 80's? I guess I'm just not convinced that something like a spin-off, that surprised absolutely no one, will result in a 20% move in the shares of a company that, let's face it, makes cigarettes.

Altria shares, ex-Kraft, trade at about 15 times 2007 earnings. Is this a bargain for the leading maker of so-called "cancer sticks?" Doesn't seem to be. How much will investors be willing to pay for a company that sells a product that kills people and is hardly a rapidly growing market opportunity? Although the decline won't be as rapid as many of us would like, I have to think that over the long term the number of people who smoke will go down, not up.

For this reason, shares of cigarette firms, including MO, traditionally have traded at a discount to the market. With shares of Altria trading at about a market multiple, it's hard for me to understand why the actual spin-off of Kraft will cause a huge stock price spike. Such a move would require either 1) investors paying an above-average multiple for a business with a below-average growth rate, or 2) a dramatic increase in future earnings due to the financials flexibility that the spin-off provides.

The latter seems more likely than the former, but I still think Altria shares are fairly valued at current prices. In fact, it's interesting to note that MO stock has actually dropped from above $87 to $85 since the company announced the details of the Kraft spin-off. The stock remains an excellent dividend play, but investors expecting an immediate move up to $100 or more might have to wait a little longer than some are predicting.

Full Disclosure: No position in MO

Kodak Sets Out to Change Printing Landscape

Eastman Kodak (EK) stock has been a value trap for years as increased sales of low margin digital photo products have struggled to make up the cash flow lost from declining traditional film sales. The next step in Kodak's digital reinvention is aimed directly at Hewlett Packard (HPQ) and Lexmark (LXK). The company has unveiled its own line of inkjet printers complete with their own ink cartridges.

How does Kodak think it can compete with the established big guys in the printer market? By changing the rules of the game. For years, the hardware companies sacrificed margins on their printing hardware in order to secure the bulk of their profits from overpriced ink cartridges. Think of it as the Gillette business model. Get everyone using your razors and make your money selling replacement blades.

Kodak is going to try and take a slightly different approach, since low-priced ink recycling stores have popped up everywhere, aimed at customers frustrated by paying $30 for a plastic container of ink. Kodak will price their printers slightly above average, but simultaneously is slashing the prices of their replacement ink. Black cartridges will fetch $10, with color versions costing $15 apiece.

Will this strategy work? Well, it's hard to say. Ink cartridge prices will most likely fall even further but that trend has already been in motion ever since ink recycling retailers like Cartridge World have gone ahead with rapid nationwide expansion plans. As a result, it is definitely bad news for HP and Lexmark, who will have to either lower prices to maintain market share, or give up some share to preserve profit margins.

But is this lightning in a bottle for Kodak? I'm not convinced yet, until I see what kind of margins the company can really get from this strategy. Hardware prices are always under pressure, so how long will Kodak be able to price their printers at the high end of the market, and how long will those prices hold? Will the total margin on a $250 printer and a $10 cartridge for a new entrant into the market be meaningfully higher than that of a $200 printer and a $30 cartridge from a company like HP that already possesses a low-cost production process?

It is surely a bold move from Kodak, and one they needed to make to reinvigorate their company and really take aim at a large consumer complaint; the high price of ink. However, even if they can take a nice chunk of the home printing market, it remains to be seen how much of that ink will really flow through to their bottom line. And that is really what will be important for Kodak investors going forward.

Full Disclosure: No position in EK, HPQ, or LXK at time of writing

Is RadioShack the Next Kmart?

Ask the average person on the street to compare RadioShack (RSH) to Kmart and you will likely hear a lot of similarities posed from people who have no investment background at all. Both retailers were a lot more popular with shoppers many years ago, but were run poorly and new chains have stolen their customers. It's not hip to go to either place to buy something. Kmart shoppers now visit Wal-Mart (WMT). RadioShack's customers likely prefer Best Buy (BBY). So, in that sense RadioShack is Kmart.

But let's look at this from an investment perspective. Followers of Kmart's emergence from bankruptcy and subsequent merger with Sears (SHLD) know that good management led to a stock surge from $15 to $175 in a few years' time. RadioShack isn't quite in as bad a shape as Kmart was (the company is not close to going under, but profits have tumbled and the stock price has followed suit) but the outlook is bleak and shoppers likely have a long list of stores they'd prefer to go to before RadioShack for most electronic products.

The similarities don't end there. RadioShack has embarked on a turnaround plan that is being led by CEO Julian Day, who has been running the retailer since July. Kmart/Sears fans may recognize this name. Day ran Kmart upon its exit from bankruptcy, leading the company's comeback, which ultimately allowed Kmart to buy Sears outright. Now at RadioShack, Day is trying to revive the company (and its stock price) using the same methods that brought Kmart back from the dead.

The similarities, in fact, are striking. RadioShack is closing down unprofitable stores, focusing on profits and not sales (and as a result, comp store sales are declining, much like Sears Holdings), and has even discontinued quarterly conference calls, a favorite move of Eddie Lampert. Though Day has only been at RSH for about six months, early indications are that the plan could very well work. On January 8th, RSH preannounced a positive fourth quarter and the stock jumped more than 10 percent.

Now I'm not saying RadioShack shareholders are in for some sort of parabolic ride, on the order of the 1,000 percent gain in shares of Sears Holdings. Far from it, in fact. However, investors have seen this concept play out before. RadioShack appears to be just another retailer that got in trouble by chasing unprofitable sales, hoping that revenue would solve its problems. However, on Wall Street earnings are what matter and earnings growth has never been boosted by selling product for less than one paid for it.

It will be interesting to see how well newly crowned CEO Julian Day can turn around this seemingly dead company. Many investors don't seem to be very enthused, as short interest in RadioShack is about 15% of the company's float. However, with 6,000 stores worldwide and a proven plan in place, there seems to be a lot of potential.

Full Disclosure: Long RSH and SHLD

Can Dell's Founder Bring the PC Giant Back from the Dead?

The news that founder Michael Dell is coming back to lead his company again is quite interesting. Normally, a CEO change alone wouldn't totally alter an investment thesis for a stock such as Dell (DELL), but in a commodity business like tech hardware sometimes a new face can really rally the troops.

We all know what Mark Hurd has done for Hewlett Packard (HPQ) and it's interesting that HP has really been the thorn in Dell's side during the Kevin Rollins era. Bringing back Michael Dell to lead the company might not seem like a big deal, but he is the company. He started it out of his dorm room before dropping out of college and his name is on these computers. Dell isn't getting his corner office back for the money or anything like that. HP has been kicking their butts lately, after they did the same thing to HP in the 1990's, and Mr. Dell has likely had just about enough.

Could this move signal the top of HP's comeback? That would be a bold statement to make, but I think it could. Check out this two-year chart of DELL vs HPQ:

I doubt Michael Dell would come back if he didn't have a plan to regain the market share his company has lost to HP. Any success in doing so would likely alter the trend that the above chart shows, which has really gotten embarrassing for the former PC leader.

Does this mean DELL shares are a buy? Well, the stock isn't that cheap, and even if the company can take back some market share, it will be tough to get margins back to where they were in 2005 and also gain ground on Hewlett Packard. Dell stock has likely put in a bottom, but I wouldn't expect a turnaround overnight.

If you have been fortunate enough to own HPQ lately, however, I would consider taking some profits. While Dell might not regain its former glory quickly, it could certainly halt Hewlett's momentum at the very least.

Full Disclosure: No positions in DELL or HPQ

Despite Strong Results, Amazon Shares Sink

If you are long Amazon.com (AMZN) shares you are probably pretty disappointed by today's price action in your stock. The online retailing giant reported a very strong fourth quarter last night and predicted first quarter sales above estimates. And for that you get a stock dropping 4 percent in pre-market trading.

The Amazon story isn't always about financial results. It reminds us that investing isn't about picking stocks that will beat their numbers, but rather about picking stocks that are undervalued relative to what their results will be. With shares of Amazon trading at 57 times 2007 profit estimates, even a strong earnings report is already priced into the company's shares.

Until the multiple comes down, or Amazon's margins expand like the bulls on the stock think they eventually can, the shares as an investment are going to be disappointing. Strong sales are one thing, but on Wall Street it's all about earnings and multiples of those earnings.

Full Disclosure: Short shares of AMZN at time of writing