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

Rather than Panic About Greece and the Euro, Make a Shopping List

I have been holding double-digit cash positions in most equity client accounts for much of 2010 and this week I began allocating some of that cash back into the market. We finally got a 10% correction, after more than a year without one. The market seems to be obsessed with Europe and the Euro exchange rate right now, but honestly we have to keep things in perspective. Most U.S. companies (excluding the large multinationals of course) are not going to be directly impacted by troubles in Greece and neighboring areas. The entire country of Greece has the same population as the state of Ohio, so that really keeps things in perspective, for me anyway.

Accordingly, I do think U.S. stock prices have come down enough in recent weeks to warrant some bargain hunting. I invested about half of my clients' cash balances this week. It is quite conceivable that the market tests the intra-day low reached on the crazy flash trading/1,000 down day earlier this month (1,065 on the S&P 500) and finds some support there. The sentiment is pretty ugly right now, so although I am still keeping some cash onhand in case of further weakness, I do think it is time to nibble at good values.

My suggestion for investors who share those feelings would be to make a shopping list. Come up with a handful of stocks you would like to own and pick a price that you really feel good about. As the market gyrates, you may be surprised which companies you can grab at very attractive price points. If you are a long term investor, try not to panic. There really are some great deals out there right now, as the S&P 500 has fallen below 1,100 and into correction territory.

Chesapeake Energy Swaps One Type of Capital for Another, Creating Little Shareholder Value

Last week Chesapeake Energy (CHK) announced a plan to increase shareholder value over the next 24 months by reducing the company's net debt by $3.5 billion over that time. By doing so, the company hopes to attain an investment grade credit rating, something that has been out of the firm's reach as it has accumulated a sizable debt load as a result of growing the company into one of the largest natural gas exploration and production companies in the United States. The plan is being sold to investors as a way to increase CHK's stock price but it appears to me that they are simply issuing one form of capital to repay another.

Chesapeake's plan has two prongs, so to speak. First, the company expects to raise $5 billion from a combination of asset sales and preferred stock issuances in order to repay $3.5 billion of senior debt. This would reduce the company's net debt position from just under $12 billion to about $8.5 billion. The remaining $1.5 billion in funds will be used to expand the company's oil exploration activities, as crude oil prices have rebounded far more quickly than natural gas prices in recent quarters (CHK currently has about 90% of its reserves in natural gas).

On the face of it, this plan does look promising for shareholders. Reducing net debt will boost equity value in the absence of any dilution from the capital raises. Unfortunately, on Tuesday afternoon Chesapeake announced that it has raised a total of $1.7 billion from the sale of new 5.75% convertible preferred shares. Typically convertible preferred is attractive from a corporate standpoint because it tends to carry very low interest rates (in exchange for having equity-like upside from the option to convert into common stock). However, since this new preferred stock is costing CHK 5.75% per year in interest, it hardly looks like a way to boost shareholder value.

In fact, Chesapeake has also announced that it is using most of the proceeds from the new preferreds to redeem $1.334 billion of senior debt. This debt carries interest rates of between 6.875% and 7.5% with maturity dates ranging from 2013 to 2016. As a result, CHK is replacing $1.3 billion of senior debt (average interest rate: 7.2%) with $1.7 billion of convertible preferred stock (interest rate: 5.75%). How is this helping shareholders? The interest on the new preferred will actually cost CHK $98 million per year, more than the annual interest payments ($96 million) paid out on the senior debt they are retiring! Not surprisingly, Wall Street has yet to cheer these announcements with a higher stock price.

Now to be fair, there are some marginal benefits associated with this capital swap, which I am sure the company would point out if asked. First, if Chesapeake does get a credit rating upgrade over the next two years as a result of this plan, it could possibly see a small decrease in the interest rates it needs to pay on future borrowings. Second, CHK is extending the average maturity schedule of its debt by replacing senior notes due to mature over the next six years with convertible preferred shares that come with no maturity date.

These small benefits aside, this type of capital exchange is not likely to help equity holders. Few people are going to be overly impressed by debt reductions accomplished by issuing other forms of capital to replace them (and in this case, raising more new capital than the amount of the senior debt repayments). If Chesapeake really is serious about increasing shareholder value, they are going to have to use free cash flow from operations to reduce their debt load.

A big reason the stock price has lagged, aside from the fact that natural gas prices are in the tank right now, is because the company insists on using all of its profits (and more oftentimes) to continue to grow the company. As borrowings have grown, even increases in production and operating cash flow have not been enough to increase shareholder value. In fact, consider the data below, which I compiled from CHK's 2009 annual report.

Although the company has grown its oil and gas production and operating cash flow, it has taken a lot of new debt and common equity raising to accomplish these growth objectives. Not surprisingly, equity holders have reaped a negative benefit despite CHK being a much larger company today than at the end of 2005. This latest plan to increase shareholder value seems to me to just be more of the same. The company likes to say it is trying to increase shareholder value, but does not go anywhere far enough to actually make it happen.

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

Despite Having No Chance of Passing, Bob Corker's Homeowner Responsibility Amendment is a No-Brainer

When people ask me who was primarily responsible for the credit crisis, I give the typical "well, it was various groups acting together" answer but there is no doubt in my mind that the core of the problem was the emergence of poor home lending in this country. While I believe that both the bankers and the borrowers need to share in the blame for enabling millions of bad loans from being originated, it should be pretty clear to everyone (across the political spectrum) that if the United States had reasonable mortgage underwriting standards in place, the credit crisis would have been prevented. If I could rewind the clock to the early 2000's and legislate underwriting standards that mandated income verification, the inclusion of a down payment, and forbade interest-only loans and mortgages where the borrower could pick from several payment amounts each month, I have no doubt the country would have looked a lot different over the past few years.

So imagine my surprise to learn that Bob Corker and four other senators have proposed an amendment to the current financial regulation debate (number 3955), which despite having obvious, reasonable, and necessary underwriting standards, has absolutely no chance of passing. The Homeowner Responsibility Amendment would, within five years, impose federal mortgage underwriting standards including a 5% down payment requirement, verification of income and employment history, private mortgage insurance for loans above 80% of the home's value, and consideration of ability-to-repay metrics such as a borrower's debt-to-income ratio.

Even more concerning than the fact that this amendment will be defeated handily is that one would have thought just by reading it that Republicans would be the side that had come out against it. Can't you envision them claiming that this is over-regulation by the federal government and that it gets in the way of our capitalist, free market system? Instead, this amendment is being introduced by five Republican senators and is likely to get more Republican votes than Democrat votes. It may turn out that a majority of Republicans oppose the amendment for the reason stated above, but regardless I think it is a shame that after all our country has been through in recent years, our politicians cannot even agree that reasonable underwriting standards are needed in the mortgage industry.

If you cannot afford to buy a house, you should not be allowed to. You are not entitled to a home simply because you want one. And if you cannot put down a modest 5% down payment, verify your income, and demonstrate an ability to pay back a traditional 30-year fixed mortgage, then you should not be buying a home. And if the government wants to mandate that to avoid a future filled with billions in taxpayer bailouts and deep recessions, I don't see why it shouldn't, or why the American public should not be demanding such action.

What Can Happen When Markets Are Run By Computers? Stock Trading Might Go Nuts Like Today!

This afternoon the U.S. stock market went bananas and I decided to sit down in front of the television, watch, and enjoy myself. When the entire market is run mostly by computers, not only can traders control the minute by minute action but they can even set the computer up so that once certain price levels are reached, their trades get executed automatically, so actual human action is not even necessary. What happens when the computers are overloaded or someone makes a mistake? Well, watch this short segment from CNBC and see how the Dow Jones can drop 500 points and then make it all back in less than five minutes.

This is why many people think short-term trading in the market is nothing more than gambling. Literally anything can happen on any single day, in a single hour or minute, or in this case, a few seconds. Market watchers will tell you to use limit orders as a way to specify your exact desired buy and sell prices to avoid getting taken to the cleaners when markets react violently like this.

The problem with that, of course, is that your order may hit in a moment of panic, and had you known that was happening, you never would have made the trade. Imagine if you came home today to learn that you sold 100 shares of Proctor and Gamble at $50 (a limit order you had set) because it traded there for a brief second based on computer malfunction, but rebounded to $61 within seconds. You would be furious. Limit orders are not always the answer. Investors, especially those who are novices, need to be very careful. As we saw today, the market can be a landmine.

Sardar Biglari Mimicking Warren Buffett's Berkshire Hathaway? The Proof is in the Web Site

Yesterday I  wrote my second post about Sardar Biglari, the man who took over the Steak 'n Shake restaurant chain and has since decided to change the company name to Biglari Holdings (BH) to signal his intention to branch out into other areas, a la Warren Buffett and Berkshire Hathaway (BRK). As you may know, Berkshire Hathaway probably has the most simple corporate web site of any publicly traded company. Simple text links to the documents investors would want to see and that is about it, along with a plug or two for some of his companies.

Here is a condensed screenshot of Berkshire Hathaway's home page as of Monday:

Since the Steak 'n Shake corporate name was changed recently, I decided to see if Biglari had published his own web site yet. Sure enough, here is a screenshot of the Biglari Holdings home page:

Needless to say, I was pretty stunned to see a design so obviously similar and simplified. But maybe the history of Biglari Holdings up to this point should have resulted in me being a lot less surprised. At any rate, it is pretty clear what to expect from this company going forward. Biglari definitely wants to follow in Warren Buffett's footsteps.

Biglari Exchange Offer Signals Inflated Stock Price of Warren Buffet Follower

Biglari Holdings (BH), in the company's first major move since changing its corporate name from Steak 'n Shake (read my last post about Biglari and Steak 'n Shake), has chosen an uncommon method for completing its next public market transaction. Rather than use the company's cash to acquire a minority stake in Advance Auto Parts (AAP), Biglari has offered to exchange shares of his own stock for shares in AAP at a ratio of 0.1179. Such a move is rare, but more importantly, it signals to investors that Biglari feels that his stock is at least fully valued and at most overvalued. Otherwise, he would have preferred to use cash rather than stock to invest in AAP. Smart capital allocators such as Biglari only have a reason to dilute their ownership stake if they are using prime currency. In this case, BH shares at nearly $400 each were certainly on the expensive side, at nearly two times book value.

Unfortunately, the market has reacted appropriately to this move by shedding nearly 10% from Biglari Holdings' market value. Trading down into the mid 350's, the exchange offer to Advance Auto Parts shareholders went from being an attractive option (originally representing a premium of about $1 per share) to being very unattractive (about a $3 per share discount). The markets in general are quite smart and they appear to have sniffed out Biglari's intention of swapping an expensive stock for a cheaper one.

Why he did not opt to make this offer privately to one or a handful of existing AAP shareholders is baffling. By going public with the offer, he essentially ensured that his stock would get hit hard and reduce any interest in his exchange offer. Of course, the more Biglari makes headlines the more investors might start to read up on him and decide to invest in his company. That exposure could result in a fairly quick rebound in the stock price of Biglari Holdings, prompting more offers like this one.

Full Disclosure: No position in AAP or BH 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

Thomas Weisel Buyout Only Helps Bullish Case for Goldman Sachs Stock

Yesterday Stifel Financial (SF) agreed to acquire investment banking competitor Thomas Weisel Partners (TWPG) for about $7.60 per share in stock, a premium of about 70% for shareholders. This deal got my attention because I have written positively about Goldman Sachs (GS) lately and this deal reinforces my view on the undervalued nature of the investment banking sector. As is the case with houses, stock values are largely determined based on what are known as "comps" or comparable sales. You see how much your neighbors' houses have sold for and use that as a yardstick for valuing your own house, or in this case, your own company.

One of my arguments for liking Goldman Sachs stock is that investment and commercial banks typically fetch between 2 and 3 times book value. The former figure is often used with gross book values, with the latter coming more into play when firms look at net tangible book values. In the 150's, Goldman Sachs shares are trading at around 1.25 times book value, which to me seems like a very attractive price given their strong global franchise.

Anyway, back to the Stifel/Thomas Weisel deal. Stifel is paying $7.60 per share in stock, which equates to about 1.85 times book value and 2.1 times net tangible assets. Given the economic and political climate, it was not surprising to see this deal get priced at the lower end of the historical range, but I was still very happy to see that the range remained relevant in a deal that actually got done in 2010.

I think it is hard to argue that Thomas Weisel Partners, a small specialized investment banking firm, should fetch more than the leading global franchises such as Goldman Sachs or Morgan Stanley (MS). As a result, both of those large cap investment banks look attractive at today's prices. To reach a price-to-book ratio of 1.85, Goldman Sachs shares would need to rise about 50% from current levels. Morgan Stanley is even cheaper and would need to rise by more than 60% to reach that valuation level. All in all, yesterday's Thomas Weisel buyout offer only strengthens my bullish convictions on Goldman and it appears that Morgan Stanley fits the same mold as well.

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

Current Bull Market Now More Than 400 Days Without 10% Correction

For several months I have been holding elevated cash levels (above 10%) in most client accounts, due to the fact that the stock market appears overbought and has gone a very long time without a standard 10% correction. In fact, we have now gone more than a year without a 10% drop which is a long time historically. I decided to look at the data to see exactly how overbought this market is relative to other bull markets.

It turns out that the current streak of more than 400 days without a correction represents only the 14th time this has happened since 1928. Of those instances, the current bull market (up more than 80% from the March 2009 intra-day lows) places fourth on the list. The three stronger bull market streaks (1953-1955, 1990-1996, and 2003-2007) ranged from +97% to +131%.

Depending on your time frame, the current streak could be either alarming or unimportant. One could argue that the fourth longest streak in 82 years indicates near term problems on the way, but one could also conclude that the last streak of this length was only a few short years ago, so maybe it is becoming more and more common.

I prefer to look at the longest set of data we have, which is why I continue to hold above-average cash levels. The fewer data points you consider, the less reliable the data will actually be. This can explain a lot of things in various topics, including why there is such a heated debate about global warming right now. If you look at the last 5 years you might conclude that global warming is no longer happening. Conversely if you look at the temperature trends over the last 100 years, it is pretty obvious that global warming is occurring.

Looking at historical stock market data tells me that the current bull market is near the top of the list historically, but of course that does not mean stocks are going to fall anytime soon. Just three years ago the S&P 500 went 4 years without a 10% correction. Today it has only been a little more than 1 year. As a result, I prefer to hold extra cash to use should the correction come, but still have most of my clients' capital invested in attractively-priced stocks.