M&T Bank Preannouncement Shows Alt-A Mortgages Not Immune

Was anyone else surprised that news of a first quarter profit warning from M&T Bank (MTB) hardly had any effect on the market and received fairly little attention on Wall Street? One of the arguments we have heard from many Alt-A mortgage lenders is that the sub-prime mess is confined to that part of the spectrum, and Alt-A mortgages (given to home buyers with high credit scores but without verification of income, etc)are doing okay so far. M&T's warning directly contradicts that view.

For those of you that missed it, M&T Bank (a regional bank in the Mid-Atlantic) projected first quarter earnings of $1.50 to $1.60 last week, far below consensus estimates of $1.86 per share. The culprit: Alt-A mortgage loans, which make up 30% of the bank's mortgage portfolio. The company was forced to repurchase non-conforming loans and also decided to not sell some new loans due to inadequate pricing and a lack of bidders.

This news did hit MTB shares, which fell about 10 percent on the news, but very few others were affected. Other mortgages lenders heavy into Alt-A offerings such as IndyMac Bancorp (NDE) have come out publicly saying their mortgages are performing fine. The news from M&T, hardly an aggressive lender, show that the odds are good that Alt-A mortgages will become a problem for mortgage lenders as well as more diversified regional banks who make these types of loans.

This trend should continue to show up in first quarter earnings reports when they begin rolling in over the next month or so. As a result, playing the regional banks for a trade going into earnings season seems to be dangerous from the long side. Opportunities to get long may present themselves later, and companies highly levered to Alt-A may be good shorts heading into earnings, but I'd be cautious on the regionals heading into the upcoming reports. A good way to hedge existing positions would be to sell out-of-the-money calls to generate some additional income.

Full Disclosure: No position in MTB and short NDE at time of writing

Sears Holdings Securitizes Its Brand Names

According to a story in Business Week magazine, there is more evidence that Eddie Lampert's Sears Holdings (SHLD) is a lot more than just a company that has supposedly lost its relevance in consumer retailing. A move to securitize the Kenmore, Craftsman, and Diehard brands for $1.8 billion shows just how creative Lampert and Co. are at creating value for shareholders, or in this case, the potential for future value creation. Read about how they could monetize the Sears Holdings brands.

Full Disclosure: Long shares of Sears Holdings at the time of writing

Kraft Shares Still Not Overly Attractive, Even After Altria Spin-Off Selling Pressure

With the Altria (MO) spin-off of Kraft Foods (KFT) completed on Monday, there has been renewed selling pressure on Kraft shares as investors shed their newly claimed small position in the company. Such negative price action will likely be a short term phenomenon, at least as far as it's relation to the spin-off, so a contrarian investor should be asking, "Is this near-term weakness an opportunity?" However, despite the poor performance, Kraft shares are not cheap.

At the recent price quote of $30 and change, they trade at 17 times 2007 profit forecasts. For a company that is growing sales at a low single digit rate annually, and whose earnings are projected to be flat between 2006 and 2008, the stock doesn't at all look like much of a value play, despite what the yield and the five year chart might have you believe.

The way I see it, not really. The one thing Kraft does have going for it is a fat 3.2% dividend yield, but other than that, there really isn't much to like. Buying a stock just for its dividend doesn't really make much sense when you can earn more in a savings account. As you can see from the five year chart below, Kraft shares have been underperforming the market for a long time, so bargain hunters may be drawn to the name.

Full Disclosure: No position in KFT at time of writing

Sam Zell Epitomizes Contrarian Investing

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There is a reason you won't see any day traders, market timers, or technical analysts on the Forbes 400 list of richest Americans. Those strategies simply have not proven to be consistently successful ways to make money over the long term. You will, however, find Sam Zell's name in the 52nd slot on the 2006 list. If you are wondering what type of investment philosophy Zell abides by, you only have to look at the moves he has made so far in 2007.

After building his commercial real estate company, Equity Office Properties, into an industry Goliath, Zell sold it to the Blackstone Group for $23 billion earlier this year. Given that it was the largest real estate investment trust (REIT) deal ever, coupled with Zell's brilliance, many have suggested the deal signaled the top in the red hot commercial real estate market. Regardless of whether or not that proves true, it is certainly apparent that Zell felt it was a prudent time to cash out of Equity Office when times were good. By definition, very much a contrarian move on his part.

Perhaps even more interesting was the news on Monday morning that Zell had been victorious in launching an $8.2 billion takeover bid for Tribune (TRB), owner of the Chicago newspaper that bears its name and the Chicago Cubs, among many other businesses. The deal is striking because of how many people have called the newspaper business dead, or on the brink of death anyway. Again, Zell is showing an extreme bias toward contrarian investing; selling Equity Office when everybody loved it and buying Tribune when everybody hates it.

Following what Zell is doing is important because the guy is one of the smartest investors around. His place on the Forbes 400 is notable, not just because he is rich, but because the tactics he has used to accumulate wealth are exactly the ones that have proven to be the most successful over time. It's a very important lesson for everyone, especially if you are a proponent of contrarian investing.

Full Disclosure: No position in Tribune at the time of writing

The Rising Cost of Healthcare Taken To Another Extreme

LOS ANGELES, March 26 (Reuters) - Shares of Alexion Pharmaceuticals Inc. (ALXN) rose more than 9 percent on Monday after the company told analysts that its treatment for a rare blood disorder would be priced at $389,000 per year.

The drug, Soliris, was approved earlier this month as the first product to treat paroxysmal nocturnal hemoglobinuria (PNH), a condition that affects fewer than 200,000 people in the United States.

"We considered many factors when establishing a price for Soliris. These included the rarity of this disabling and life threatening disease, the compelling clinical benefits that PNH patients experience with Soliris ... the cost of discovery, development and production, and of ongoing research ...," David Keiser, the chief operating officer said on the call.

The company's shares rose $3.71 to close at $43.78 on Nasdaq.

Imagine you are one of those approximately 200,000 people in the U.S. who have PNH. Finally, a drug has been approved by the FDA that may help you tremendously. You would likely be exuberant, for a little while anyway, until you learned how much the drug will cost. And that price is at the wholesale level.

This isn't a political blog, so I'm not going to get into a discussion about what our country should do about healthcare costs that are spiraling out of control. No matter your view on the subject, investors should realize that until something changes, until a drug that is the first one approved to treat a condition doesn't cost $389,000 per year, healthcare companies are probably going to have an easy time making money.

Some people won't care, some people will be outraged and refuse to buy a stock like Alexion, and others will be outraged but will also separate their inner beliefs and politics from their investment strategy for the sake of reaching their financial goals. I have no opinion on the investment merit of Alexion stock, as I haven't done work on it. It's no shock though that it reacted well to this news.

Full Disclosure: No position in the company mentioned at the time of writing

Response to Iran Rumors Shows that Energy Should Be Owned as a Geopolitical Hedge

In case you haven't heard yet, oil prices spiked more than $5 per barrel late Tuesday on rumors that Iran had fired shots at U.S. warships. Although the gains were pared once the news went unconfirmed, one only needs to imagine what would happen if heightened geopolitical actions were indeed reality. In such an environment, energy stocks will serve as a hedge for your portfolio and as a result, avoiding them is not advisable given the global political situation we currently find ourselves living in.

The energy sector represents 10% of the market cap of the S&P 500, so it isn't difficult to determine if you are dramatically underweight these stocks or not. When you couple shrinking global supply with increasing demand worldwide and geopolitical instability, it's pretty hard to make the case that oil prices are headed back to $30 per barrel. Add in the fact that the summer driving season is right around the corner and it's not hard to imagine gasoline back over $3 per gallon and oil prices back in the 70's.

Investors can play the group via the crude oil exchange traded fund (symbol USO) or any number of exploration and production companies. As for individual stocks though, if you want to get exposure to rising oil prices, make sure the company you buy doesn't have a large amount of their future revenue hedged at lower prices. Such companies will likely see less movement than those who are mostly unhedged.

Patient Investors: Take A Look at Amgen

As a value investor, it is often easier to find undiscovered or unloved stocks in the small and mid cap universe. After all, bigger companies are well known, followed by more analysts, and are very popular with retail investors. Those three factors lead to fairly high valuations more often than not within large caps. 

That is not to say, however, that I shun large cap stocks all the time. If a bigger company has fallen upon hard times and is being beaten up by Wall Street, it often represents an excellent opportunity for a contrarian investment. Expanding on this theme, shares of Amgen (AMGN), the largest biotechnology company in the world, have been slammed in recent weeks and the stock is trading at valuations not seen in years, if ever.

The tables have turned very quickly on Amgen shareholders. The stock hit a new yearly high in January of $78 per share. Since then though, they have seen a 25 percent haircut on several negative news events. 

First, the FDA ordered the company to alter its warning label on Amgen's lead products for Anemia, Aronesp and Epogen, in order to warn doctors and patients about increased risks when using the drugs for off-label uses. Investors are worried that Amgen could lose as much as 10% of their sales of these drugs if people currently using them in off-label doses cut back. 

The current stock price seems to suggest that Amgen not only will lose a sizable chunk of Anemia franchise sales, but also will not be able to make that up with any new drugs. Although that seems to be very unlikely over the long term, even if we assume the company does not grow, and their profits level out at around their 2006 level of $3.90 per share, the stock seems to have little downside. This is not to say it can't go lower in the next few weeks or months, but long term, I really can't see a world-class biotech company like Amgen trade at much less than 14-15 times earnings.

There are also concerns about Amgen's product pipeline, which many view as weaker than some other large cap biotechnology stocks. In fact, the company announced just last week that they stopped a clinical trial for one of their cancer drug candidates that they were testing in combination with Genentech's Avastin and chemotherapy.

Despite the short-term setbacks for the company, Wall Street's current valuation seems to be pricing in all of the negatives, giving very little chance that Amgen will be able to continue to grow. With the stock down $20 from its recent highs made earlier this year, the stock now trades at an astounding 14.9 times trailing earnings, cheaper than the S&P 500. As you can see from the chart below, biotech stocks traditionally trade at a premium to the market, and today is no exception, except for Amgen.

Obviously, a huge downward revision in earnings forecasts would make the current P/E outdated, but with a strong stock buyback in place, and the ability to make acquisitions to fill up their product pipeline (They bought Abgenix last year), an earnings collapse seems unlikely. Growth may slow, but the stock already reflects much, if not all, of that expectation.

If anything positive happens with the company, investors will likely realize fairly quickly that they became way too negative. With 25 drugs currently in development, the days of successful discoveries in Amgen's laboratories shouldn't be over by any means, but judging by the stock price, you'd think the company was on life support.

In cases like this when the market is assuming the worst, oftentimes it turns out that things will play out better than people are fearing. In my opinion, contrarian investors should consider adding Amgen to their list of stocks that warrant a closer look.

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

Blackstone IPO Signals Private Equity Market is "As Good as it Gets"

Throughout history, what has been one of the worst types of investments to buy? If you answered IPOs, you're correct. Before commenting on the $4 billion IPO of private equity behemoth Blackstone Group, let's review why exactly IPOs are such bad investments.

Companies sell stock when demand for shares is high, and they buy stock when interest is lacking. If things are going great, demand will be high and an IPO is the preferred way to cash in. The "smart money" as it's called, sells to the dumb money.

Well, guess what? Steve Schwarzman and the rest of the Blackstone Group gang is very "smart" money. If they want to sell a piece of their management company to you, it's probably for a good reason. If they thought the bull market in private equity had a few more years left in the tank, they certainly wouldn't choose to sell now.

This event, unlike the Fortress Investment Group (FIG) IPO (which I don't think marks a top in hedge funds), signals that the bull market in private equity, and perhaps in the stock market in general, is running thin. Think back to the Goldman Sachs (GS) IPO. Like Blackstone, Goldman refused to go public for years, but when things got so good, they couldn't resist anymore. In case you don't remember, Goldman's IPO was in 1999 and the market peaked less than a year later.

Much like the bull still ran a bit after GS went public, I don't think the market will necessarily peak coincidentally with the Blackstone IPO. However, it's important to understand that IPOs are traditionally bad investments for a reason, and it's that reason and that reason alone that explains why Blackstone has chosen to go public. Also, be aware that Blackstone is selling a piece of its management company, so investors in the IPO are buying ownership of their 2-and-20 fee income. The IPO proceeds is not going to be used to fund more private equity deals.

Of course, the irony is that private equity's whole game is convincing companies that the public market isn't worth the trouble and they would be better suited going private. You know if Blackstone wants to go public there is a pretty good reason why. In this case, that reason is dollar bills. Four billion of them, in fact.

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

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