...That Shareholders Should Refuse.
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Expedia EXPE unveiled plans to buy back up to 10% of its shares outstanding through a tender offer. Morningstar analyst Sumit Desai is thrilled to see the company put its nearly $1 billion cash hoard to use. Desai also points out that the company indicated that its directors and officers and Liberty Media LINTA do not intend to tender any of their shares. In Desai's opinion, this decision to forgo the tender offer reflects management's belief that Expedia has a brighter future ahead of itself. Desai agrees, as the stock continues to trade at a considerable discount to his fair value estimate. For that reason, he recommends that current shareholders follow management's lead by holding on to their shares, as the tender offer price still does not fully reflect the company's intrinsic worth. Desai is maintaining his fair value estimate for now, but could raise it by a few dollars depending on how many shares are actually tendered.
Novartis Sells Part of Consumer Unit
On Thursday, Novartis NVS announced that it was selling its medical nutrition business to Nestle NSRGY for $2.5 billion. In reviewing the deal, Morningstar analyst Heather Brilliant points out that the medical nutrition unit--which includes nutritional products and medical devices used to provide sustenance to patients who are typically unable to consume adequate nutrition on their own--is a small part of Novartis' overall consumer health business. As such, the sale should have no material impact on her fair value estimate. Separately, Novartis also announced that the FDA had extended its review of the company's Tekturna hypertension drug. Novartis provided additional data on the drug in early December, so the FDA probably intends to take extra time to incorporate that new data into Novartis' application. This announcement also does not affect Brilliant's fair value estimate, as she had not expected Tekturna to reach the market until 2008, a timetable she thinks is still achievable.
AirTran Makes Midwest Airlines Bid
On Wednesday, AirTran AAI made an unsolicited offer for Midwest Airlines of $11.25 per share, which represented a hefty 24% premium over Tuesday's closing price. On first look, Morningstar analyst Marisa Thompson thinks the merged airline offers many potential synergies from combining complementary routes and fleets, improving fleet utilization, and eliminating redundancies. However, Thompson points out that Midwest is narrowly profitable while AirTran has been showing significant progress lowering its non-fuel costs as a stand-alone company. Thompson believes that for AirTran to wring significant value out of the transaction, management must find ways to decrease Midwest's non-fuel unit costs, which are currently 40% higher than AirTran's. Thompson thinks that some of these cost reductions will be easier to realize since she expects AirTran to reallocate capacity from predominantly Signature Service toward a mix of coach and business class. Further, she thinks the industrywide trend toward consolidation will firm up yields and improve utilization for all participants. Yet, Thompson contends that the long-term value of a deal like this depends on AirTran realizing sustainable cost efficiencies. She is placing AirTran under review while she evaluates the combined company's prospects.PAGEBREAK
Applebee's Faces Board Challenge
Activist hedge fund Breeden Capital, led by former SEC chairman Richard Breeden, has nominated a slate of four candidates for election to Applebee's APPB board. In a letter to the company's board, Breeden again pushed Applebee's to refranchise a substantial number of company-owned restaurants, reduce corporate and other expenses, dispose of noncore assets, and increase cash returned to shareholders. Breeden, who previously argued that the company should slash capital expenditures, further asserted that Applebee's should stop opening new company-owned restaurants altogether and scale back on renovations of company-owned restaurants pending their sale. Though Morningstar analyst John Owens doesn't endorse such sweeping changes, he believes Applebee's should at least explore its strategic alternatives, given its depressed share price, as well as some of the suggestions that Breeden makes to improve the company's governance practices. For that reason, he looks forward to learning more details regarding Breeden's platform for this undervalued business as well as management's response. In the meantime, he's maintaining his fair value estimate.
Morningstar Makes Trek to TransCanada, Doesn't Change Fair Value Estimate
Morningstar analyst Michael Cumming recently traveled to Calgary to visit TransCanada's TRP management. A few themes emerged. The regulatory regime governing natural-gas pipelines in Canada severely limits the upside potential for these assets as well as the downside risk. The pipes will earn a defined return on the asset base; the key for TransCanada will be to find projects that will allow the company to put capital back into the system to maintain the earnings base. The company hopes to offset recent cuts in its allowed return on equity by convincing regulators to increase the deemed equity component of the pipes, which would lead to higher overall earnings. Faced with this unattractive regulated rate structure, TransCanada has turned to other types of assets, such as power generation, that might offer better upside and plans to negotiate rates directly with customers rather than using a regulatory body on other projects. Finally, TransCanada steadfastly maintains its right to build the Canadian portion of the proposed natural-gas pipeline from Alaska's North Slope. Cumming thinks TransCanada still controls the upper hand in the struggle to determine the winner of the deal, though significant uncertainty remains, which Cumming think is unlikely to be settled anytime soon. While Cumming's conversations deepened his understanding of the company, he didn't come away with any new information that would lead him to change our fair value estimate at this time.
Jeffrey Ptak, CPA, CFA, is a stock analyst with Morningstar. He does not own shares in any of the securities mentioned above.
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