October 2008 Archive
A hedge fund manager who owns just shy of 10% of Target’s shares is asking the nation’s #2 discounter to consider a plan to spin-off its real estate assets into a separate company as a way to boost its sagging stock price. Once high-flying Target has seen its stock sink more than 40%, from about $59 per share last November to a low of $32-and-change on Monday. (It has since recovered a bit to trade at about $40 per share.) Target recently valued its real estate before depreciation at $25 billion, not too far below its current market capitalization of $30 billion.
Spinning off its real estate holdings to form a separate publicly traded real estate investment trust (REIT) would create long-lasting value for the chain, argues activist investor William Ackman who runs the hedge fund Pershing Square Management. Under his plan, the newly formed tax-free spin-off would own the land under Target’s stores, while the retailer would retain ownership of the buildings and rent the ground underneath them back from the REIT.
Target responded on Wednesday by saying that it has “serious concerns” about the proposal. I should hope so! Target execs need only look at Mervyn’s experience with sale-leaseback deals to see the perils these transactions may present. Indeed, Target, which used to own Mervyn’s, is being sued by the going-out-of-business retailer over a similar type of deal.
In a suit filed in September, Mervyn’s alleged that it was the victim of a plot by its private equity owners to strip it of its valuable real estate assets and then lease the properties back to the company at “substantially increased rates.” Mervyn’s claimed that its rent increased dramatically after the sale. The filing goes on to say that by “separating the firm’s real estate assets from its retail operations, its new owners made sure that any residual value or upside in the real estate assets were reserved for themselves and not for Mervyn’s.” Mervyn’s unfortunate experience should serve as a cautionary tale for Target.
Indeed, Target has cited a long list of concerns, including reduced financial flexibility, the large expense obligation created by the proposed lease payments (subject to annual increases!), and potentially negative effects on its debt rating, borrowing costs, and liquidity. Given the volatile state of the retail industry, the tight credit markets, and depressed valuations for commercial real estate these days, which could limit the selling price of Target’s real estate assets, Target has many good reasons to be cautious.
The company has bowed to pressure from Ackman before by selling 47% of its credit card division to JPMorgan Chase for $3.6 billion in May. But Target should balk at this turkey of a proposal.
“The operation was a success but the patient died.” Sound familiar? We’ve heard much the same excuse from UBS and other banking companies lo these many months. “Our risk assessments and investment strategies were rigorous and accurate and worked exactly how they were supposed to. It’s just that the market didn’t behave properly.”
Now we’re hearing the same thing from the credit ratings agencies, whose executives are getting their turn before Congress. Moody’s, Fitch Ratings, and Standard & Poor’s all gave high ratings to mortgage-backed securities, despite internal misgivings. The following is from testimony from Devin Sharma, president of Standard & Poor’s, on what happened and why:
“We have been in this business for over one hundred years and studies on rating trends and performance … have repeatedly confirmed that S&P’s ratings — whether of corporate debt, municipal bonds, structured finance, or the like — have been highly effective in informing the markets about both deterioration and improvement in credit quality. That legacy — which is our most valuable asset — has been challenged by recent events.”
So did we all get that? It wasn’t their ratings systems or conclusions that were at fault. It was the market’s fault for being “challenging.”
It’s unfortunate that Congress also heard a less formal kind of testimony. Also quoted in these hearings were communications by Standard & Poor’s analysts, to wit,
“rating agencies continue to create an ever-bigger monster, the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.”
Sharma says in response,
“… despite how some may interpret the language in certain of these emails, there is no evidence of any misconduct by our analysts or that the fundamental integrity of our ratings process has been compromised. Indeed, the SEC itself concluded that it found no evidence during its examination that S&P had compromised its standards to please issuers. … Still, the language used in some of the emails is disappointing and we are redoubling our efforts to make sure our people appreciate the importance of professional conduct to our reputation, our business, and the markets we serve.”
Moody’s and Fitch come in for their share of embarrassment as well. Turns out that Moody’s CEO was well aware that the ratings game not as pure and objective as it likes to think it is:
“… the real problem is not that the market underweights rating quality, but rather that in some sectors it actually penalizes quality. It turns out that ratings quality has surprisingly few friends. Issuers want high ratings; investors don’t want ratings downgrades; short-sighted bankers let labor short-sightedly game the rating agencies …”
S&P’s Sharma goes on in his testimony to point out that S&P’s credit ratings were being used by debt issuers in ways they were not meant to be used, i.e., as an opinion on a security’s value or liquidity, but if that’s not how a rating is meant to be used, then what good is it?
Hindsight is 20/20 and all that, but what would have happened if the ratings firms had stood pat and refused to rate these problematic CDOs? True, it’s not all on them, but it’s legitimate to look on these firms as a backstop, one level of safety that help keep the wheels from coming off. Too bad they got caught up in the madness too.
Feast or famine — boom or bust as oil workers call it — is the way of the world for the oil industry.
Only a few months ago (in July) the price of crude oil was pushing $150 a barrel and Cassandras like “this is one problem we can’t drill our way out of” T. Boone Pickens were forecasting a dire future, with oil prices hitting $300 within a few years. Global demand was outstripping supply. The burgeoning middle classes in China and India and the growth of car use and industrial output in those countries were, in tandem with strong demand in the US and Europe, threatening to keep prices high, as a thirsty public demanded more crude than producers could get out of the ground or refiners could turn into petroleum products. Concerns about Peak Oil and high gasoline prices led to the cries of “drill, baby, drill” in the US. Big Oil companies like Exxon Mobil, BP, and Royal Dutch Shell were lambasted for making record multi-billion dollar quarterly profits. Venezuela’s Hugo Chavez, Iran’s Mahmoud Ahmadinejad, and Russia’s Vladimir Putin could flex their muscles confident in the petrodollars that helped support their regimes.
What a difference a few months makes.
Now, thanks to the US real estate collapse triggering a meltdown in the financial services, which in turn prompted a stock market collapse and the prospect of a global recession, oil futures have slumped. Recessionary fears have spurred or been reflected in a real decrease in demand, a decrease that is projected to stretch out into the next several months, if not longer. A US Department of Energy report last week showed that demand had fallen in 38 of the past 42 weeks. Instead of sitting pretty on the surplus end of their bounty, oil producers now fear that their commodity will flood the market, leading to a further collapse in the price of a barrel of oil.
Just before an emergency meeting of OPEC last week, oil ministers for Iran and Venezuela urged fellow members to cut OPEC production by two million barrels a day to help stabilize prices, Iran and Venezuela are particularly vulnerable to price cuts as the heavy, more sulfurous crude oil they produce have a lower profit margin than the lighter, less sulfurous benchmark crude. At the meeting Friday, OPEC agreed to cut its members’ collective output by about 1.5 million barrels a day, or about 5% of its total production. (OPEC accounts for about 40% of the oil on the world market).
Low prices have some governments, whose national budgets are based on high oil prices, very concerned. Iran wants the price to be $100 a barrel, Venezuela would settle for $80-$90. Iraq could live with $80.
Oil is now trading in the mid-$60s.
But it may be hard for American drivers to feel too sorry at the plight of Hugo, Vladimir, or Mahmoud while Americans slide into what looks to be a major recession.
The silver lining for American consumers? Maybe you can’t retire just yet, but you can perhaps drive a little farther. Gasoline prices are dipping toward $2 a gallon.
The Sun also rises? Nah, too Hemingwayesque. The Sun will come out tomorrow? Dang, now that song from Annie will be in my head for days. Here comes the Sun? This isn’t about solar power. Shoot, I need a good lede!
Let’s cut to the chase: Sun Microsystems is in a heap of trouble.
Well, let’s clarify that statement. The company was profitable, and sales were growing. That’s the good news. The bad news is that the financial results are going south, Sun’s stock price is cratering, and it gets a significant portion of its revenues from the financial services industry — you know, Wall Street. Those cats aren’t doing so well, you may have heard. The worse news is that Southeastern Asset Management, Sun’s biggest shareholder, just increased its equity stake to about 21%, and they are not happy about what’s happened to the stock price.
In a filing last week with the SEC, Southeastern noted, “Southeastern has talked to (Sun’s) management, and will have additional conversations with management and/or third parties, regarding opportunities to maximize the value of the company for all shareholders.” That may not sound like much; coming from Southeastern, them’s fightin’ words. O. Mason Hawkins, the respected fund manager of Southeastern, is no Carl Icahn or Kirk Kerkorian, but he will do a lot more than converse to protect the value of his sizable investment in Sun Microsystems.
Sun Microsystems may be getting too big for its britches. It’s made two huge acquisitions in recent years, StorageTek and MySQL. You could argue that these were strategic purchases that extended the company’s capabilities and product portfolio. Whatever the merit of those acquisitions, they burned up a lot of cash ($4B for StorageTek and $800M for MySQL). Sun Micro’s cash fell from $3.6B to nearly $2.3B in the past year. The company has laid off lots of people and cut other costs, but you don’t want to be running low on cash in this economic environment.
Much was made last week about Sun co-founder Andy Bechtolsheim reducing his role at the company to become chairman of Arista Networks, an Ethernet switch startup. I don’t think that’s really a big deal; he’s bailed out of Sun before to do the startup thing. More important is whether Sun CEO Jonathan Schwartz is up to the job. He’s a tech whiz, of course, and he’s got a commendably candid blog out there. The talk now is whether Schwartz can continue to grow sales, drive product development, make money, AND keep shareholders happy in these difficult times. Especially big, powerful shareholders.
The Centers for Disease Control (CDC) reported earlier this month that about 25% of teenage girls in the US have received at least one dose of Merck’s Gardasil vaccine, which is considered a fairly high success rate for a new vaccine. Gardasil gained FDA approval in 2006 for females between the ages of 9 and 26. However, sales of Gardasil have dropped in 2008 due to a variety of criticisms including cost, effectiveness, and potential side effects.
The vaccine is designed to ward off four out of six strains of human papillomavirus (HPV), which are believed to be a primary cause of cervical cancer, and requires three doses at a cost of about $120 per dose. While the CDC recommends the vaccine for girls 11-12 (as well as “catch up” vaccines up to age 26), health insurance companies don’t always cover vaccines, and Gardasil’s newness and cost have many women hesitating to receive the vaccine. State and government agencies that have mandated the vaccine for certain groups (such as immigrants and Texas teens) have also experienced a good level of backlash over requiring such a high-cost and highly debated vaccine.
Also at issue is whether the vaccine will prove to serve its purpose. Scientists wonder whether its effectiveness will wear off and require booster vaccines in later years. And while the vaccine is believed to be effective in preventing HPV, there is a good amount of speculation over whether a cancer prevention vaccine is even possible at this time.
As with all new vaccines and medicines, it is difficult to foresee what side effects could come to light over time. A CDC report released last week stated that, based on an evaluation of adverse event reports, Gardasil is safe to use and is effective against HPV. The report shows that serious events and deaths associated with use of the vaccine have largely been attributed to other causes. While the report is reassuring, the CDC’s continued monitoring of the vaccine is necessary as some side effects can remain undiscovered for years.
GlaxoSmithKline (GSK) also has a cervical cancer vaccine (Cervarix) on the market in other countries that is under FDA review for sales approval in the US. Whether the GSK vaccine has any success in the market partially depends on how much acceptance grows for the Gardasil vaccine. Merck itself has a lot riding on the vaccine’s success.
Whether the vaccine has any effect on cervical cancer infection rates can only be proven over time, but when it comes down to it, the vaccine’s apparent success at preventing HPV is a valuable health benefit on its own and makes it a viable candidate that women in the recommended age group should consider when weighing their health care options.