Plus, private equity giants go wild, Medtronic posts a strong quarter, and more.
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Dell's DELL preliminary third-quarter earnings significantly exceeded Wall Street's expectations. As Morningstar analyst Mark Lanyon had earlier predicted, sales growth was again tepid, advancing only 3.4% from a year ago, though operating margins widened by 150 basis points. In Lanyon's opinion, this showing reflects Dell's calculated retreat from certain PC segments in favor of various higher-margin offerings that are emerging. Thus, while this shift damped growth, it drove improved operating profitability. More generally, Lanyon thinks that Dell is in the midst of an evolution away from a PC-centric business model toward a more balanced set of hardware, software, and service offerings to corporate customers. This, he believes, should allow Dell to move past its recent fundamental challenges (such as flagging customer service and reliance on the mature North American PC market) and confer more-respectable growth and operating profit performance than the company's current share price reflects. As such, Lanyon is maintaining his fair value estimate.
Blackstone Pays Through the Nose for Equity Office Properties Trust
Private-equity giant The Blackstone Group announced that it intends to purchase office property REIT Equity Office Properties Trust EOP for $48.50 per share in cash in what would be the largest take-private deal ever. The offer represents an 8.5% premium to the stock's Friday closing price and an even-steeper premium to Morningstar analyst Arthur Oduma's fair value estimate. Oduma thinks investors should take the money and run. Equity Office is the third public office real estate investment trust that Blackstone has bought in the recent past, the other two being Trizec and CarrAmerica. Given the size of the deal, which approximates $36 billion, Oduma doubts there will be many rival offers and, thus, expects the transaction to close as scheduled in early January.
Medtronic Posts Strong Quarterly Results
Medtronic's MDT second-quarter performance yielded some signs that the implantable cardioverter defibrillator market is stabilizing and turning the corner after being rocked by widespread recalls at Guidant (now a part of Boston Scientific BSX) last summer. Following a 6% decline in implantable cardioverter defibrillator sales during this year's fiscal first quarter, Medtronic eked out a 4% sales increase in the second quarter and has solidified its more than 50% share of the implantable cardioverter defibrillator market. As long as Wang doesn't see more recalls issued, she anticipates that the market should regain its low-double-digit growth rate by the end of 2007. In the face of Medtronic's formidable salesforce, Wang believes that Boston faces an uphill battle to regain the market share it has lost in the aftermath of the recalls. Yet, while this is good news for Medtronic, Wang had already built this increase into her projections. As such, she's holding her fair value estimate steady.
Bank of America Scoops Up Wealth Manager U.S. Trust
Bank of America BAC said that it plans to acquire U.S. Trust, a white-glove firm catering to the ultrawealthy, from Charles Schwab SCHW in a $3.3 billion cash deal. In Morningstar analyst Craig Woker's opinion, the deal looks to be quite pricey from Bank of America's perspective, as the deal value implies that the company is buying U.S. trust at a tax-inclusive price/earnings multiple in the range of 35-40, which is steep for a mature, relatively slow-growing business. Even assuming that Bank of America can significantly reduce costs--because of the significant level of corporate overhead that Schwab allocates to the business--Woker doubts that the purchase price is justifiable solely on the merits of U.S. Trust's earnings prospects. Nevertheless, Woker points out that the purchase, set to close on March 31, will have a minimal impact on Bank of America, and thus Woker envisions making no change to his fair value estimate. Conversely, Morningstar analyst Patrick O'Shaughnessy sees the deal as a much-needed move for Schwab. O'Shaughnessy contends that U.S. Trust had never been a good fit with Schwab's "average investor" mantra, and its slow growth and lagging profit margins made it a drag on Schwab's results. Not surprisingly given Woker's concern about the acquisition's price, O'Shaughnessy thinks it's a good deal for Schwab. Given management's previously stated willingness to explore acquisition opportunities, O'Shaughnessy thinks that Schwab will use the $2.5 billion in aftertax proceeds to fund future purchases. His fair value estimate is unchanged for now. PAGEBREAK
More Restructuring for Alcoa
On Tuesday, Alcoa AA announced that it had signed an agreement to dump its underperforming soft alloy extrusion business into a joint venture with Orkla ASA's Sapa Group. The soft alloy business represents about 45% of the $4.6 billion in annual revenue generated by Alcoa's extrusion group. Morningstar analyst Scott Burns observes that the extrusion group has been the laggard of Alcoa's portfolio; operating margins have rarely surpassed 2% over the past several years. Burns thinks that the joint venture, which Sapa is slated to be run, should benefit from increased operating leverage by eliminating redundant capacity and increasing utilization at the most efficient plants. Burns has seen similar moves in other commodity businesses (especially chemicals) generate tremendous results for the contributing parties. Also, by letting Sapa manage the soft alloy business, Burns hopes that Alcoa can focus on improving the fortunes of its aerospace-related hard alloy extrusion segment. Although Burns likes the move, he's maintaining his fair value estimate because he'd already factored improvement in the extrusion business into his assumptions.
Newspapers Align with Yahoo
Several newspaper groups, including Belo BLC, Cox Newspapers, Hearst, Journal Register JRC, Lee Enterprises LEE, MediaNews, and E.W. Scripps SSP, have signed a deal with Yahoo YHOO that will allow them to sell ads on Yahoo's HotJobs site, providing additional exposure for their local and regional job listings. The agreement also calls for the newspapers and Yahoo to potentially share content and search capabilities. Morningstar analyst Jim Walden thinks this is an intriguing alliance, providing newspapers with more scope and attractive technology features for their own Web sites. In Walden's opinion, this deal further highlights a rather meaningful shift in strategy for newspaper publishers: teaming up with a dominant Internet player. It comes just after several publishers inked a deal allowing them to sell ads through Google's GOOG site.
Sanmina-SCI Posts Atrocious Results
Sanmina-SCI SANM reported fiscal 2006 results that capped off an atrocious year. Revenue decreased by 6.6% from 2005, primarily because of weak computer demand from Sanmina's largest customer, Lenovo LNVGY. Profitability and revenue should recover from operational improvements in the company's printed circuit board segment, increasing revenue from core electronics manufacturing services (which earn gross margins around 8%, near the top of the industry), and the transition away from the unprofitable original design manufacturing segment. Nevertheless, Morningstar analyst Andrew Golomb remains skeptical about management's ability to convert opportunities into shareholder value. Operational problems, accounting headaches (not the least of which are the company's soon-to-be-restated financial statements, which remain in arrears), and an evolving business strategy cast much uncertainty on Sanmina's future. If additional restructuring charges or operational missteps occur, Golomb will probably lower his fair value estimate, but because he had forecast dismal results, he's maintaining his fair value estimate for now.
ADC Telecommunications Should See Improvement in 2007
ADC Telecommunications ADCT is slated to report fiscal fourth-quarter results on Dec. 12. Although Morningstar analyst John Slack isn't expecting any major surprises in the quarter given management's cautious guidance last quarter, he said he believes that the company is well positioned heading into fiscal 2007. The second half of 2006 saw a spending pause due to carrier consolidation and Verizon's VZ efficiency gains with its fiber deployments, which required fewer equipment cabinets to serve the same number of homes passed. However, looking forward to 2007, Slack said ADC stands to benefit as carriers shift from building infrastructure to connecting homes. In Slack's view, we are still in the early stages of a multiyear initiative by carriers to upgrade their access networks, and these infrastructure upgrades should drive sales growth at ADC for the next year or two. However, the lumpy nature of large infrastructure projects means that ADC has limited quarter-to-quarter visibility. Slack is leaving his fair value estimate unchanged.
Jeffrey Ptak, CPA, CFA, is a stock analyst with Morningstar. He does not own shares in any of the securities mentioned above.