Fri, 8 Mar 2013
Five stats from the market and the stories behind them. This week: The Dow hits a new high, potential M&A deals continue, Dell's buyout gets activist pushback, and more.
Christine Benz: Hi. I'm Christine Benz for Morningstar.com, and welcome to the Friday Five. Joining me to discuss five key numbers from the past week is Morningstar markets editor, Jeremy Glaser.
Jeremy, thanks so much for being here.
Jeremy Glaser: You're welcome, Christine.
Benz: So, what do you have on tap, Jeremy?
Glaser: We're going to look at the number 2007, $115 billion, EUR 561 million, 10%, and finally $9.
Benz: 2007, Jeremy, I'm guessing that relates to the fact that the Dow Jones Industrial Average found its way to a new high this past week.
Glaser: Yes, it did. This is something that we had kind of seen coming. The Dow has really been on quite a run for years now, and it's clear that it was just a matter time before we kind of recaptured that, at least that nominal high. I think the story certainly created a lot of headlines, but it doesn't really say a lot for investors. Like I said, it's just a nominal high. We can take inflation into account; we're still not quite back to that level. And it's difficult to compare the world in 2007 with the world today. And I think investors need for main focused on what are the fundamentals behind the market, and what does that mean for potential future returns, more than worrying about where it is kind of on a historical tally card.
Corporate fundamentals are much stronger now. We have more corporate earnings, kind of, supporting that index now than we did. We think stocks are almost exactly fairly valued right now. There don't seem to be a lot of big bargains, but equities aren't in this enormous bubble and that was what [many people thought was] kind of propelling the indexes forward. And there are some fundamental reasons, from strength in the U.S. economy, we see the housing market really starting to turn around, and there's kind of that slow growth in employment from the Federal Reserve's policies of the easy money policy kind of helping pop up equities there.
So this doesn't seem like a situation where just because we've reached that high, we need to either celebrate that the recession is over. Obviously, we're still in this slow-growth mode, and that's going to be something we're grappling with for a while. And it doesn't mean we're in a huge bubble and that you should sell all your stocks. I think the idea of having a reasonable asset allocation, thinking about stocks as a long-term investment, there are a lot of worse things in the world than owning some of these great companies at a fairly valued level. And that's where investors should be focused on, that valuation and those fundamentals and less on whatever that headline number is.
Benz: So amid the recovering economy, we've also seen mergers and acquisitions pick up. One number in the news, $115 billion, that's Verizon Communication's potential purchase price of Verizon Wireless. Let's talk about that story. That would be a huge acquisition.
Glaser: This would be a massive deal. Like you mentioned, we've seen a lot of M&A activity in 2013 so far. A lot of that's driven by you have corporate balance sheets that are pretty strong. They have a lot of cash on hand. They want to deploy it. Maybe they are not seeing a lot of reinvestment opportunities internally. Growth is slowing a little bit, so maybe a lot of companies might feel like a good place to look for growth is in the acquisition market.
It was reported this week that Verizon might be jumping on to this bandwagon, in a sense. Bloomberg said that Verizon is looking to buy out the remainder of Verizon Wireless--they own 55% now--from Vodafone, which owns the other 45%, for potentially up to $115 billion, which would really be a massive deal. It would be one of the largest M&A transactions we've seen.
This is, obviously, more of a strategic deal. Verizon sees wireless as really their core asset. They really want to own the whole thing. For its part, Vodafone feels like being just a minority partner in it isn't getting all the value that it would want. It would rather have that cash, either to return to shareholders or to do acquisitions elsewhere for companies that they would be able to wholly control. I think this is a deal that probably would make sense for both sides, if they can come to an agreement on the price and what that would look like.
I think it also, again, speaks to that M&A environment, that the deals of this size can get done, that there isn't a lot of nervousness about that. That even with the uncertainty, the boards [of companies] are still willing to make some of these big moves and have some of the financial flexibility to make big moves. That's a huge change from what we've seen just over the past couple of years. I think it's a trend that we could see play out for some time.
Benz: The next figure, EUR 561 million, that's a fine that Microsoft paid this week. What were they penalized for?
Glaser: Microsoft had agreed to allow European consumers to choose what Web browser they're going to use, kind of a browser ballot. So even though Internet Explorer would be preinstalled, when you ran it, it would say do you want to install Firefox, do you want to install Chrome, in order to give people a clear choice, make it clear that they have options, and that they can download these other browsers.
And when they introduced Windows 7, there was a period there when this didn't work, and the European Commission is fining Microsoft to a pretty substantial amount for not making this happen. Microsoft's not going to appeal this. They're just going to accept it. They said that they take responsibility for it, and they're just going to pay it.
This is, I think, interesting for a few reasons. First is that our Microsoft analyst, Norman Young, thinks that they are just accepting this, not because they really think that they did wrong, but because they're trying to set a precedent, as the EU continues to look into Google, that Microsoft wants to make it clear that a lot of tech companies should be potentially looked at in a very critical way because so far Google has really escaped a lot of regulatory scrutiny. Whenever anyone in the United States or European Union has taken a close look at Google, the company generally gets off with extremely mild penalties, if any at all. And I think Microsoft is trying to maybe ratchet up the pressure a little bit to see if Google really does have a monopoly in search advertising, and maybe get the EU to make some moves there to try to break that monopoly a little bit.
Benz: OK, 10%, your next number, that relates to Time Warner's possible spin-off of its magazine unit. What does the 10% mean?
Glaser: Time Warner only gets 10% of their operating income from Time Inc., which is the magazine-publishing unit, which is smaller than maybe a lot of investors would think. It's such an iconic brand .
Glaser: It's one that produces cash now, but it's obviously not a growing business. So Time Warner confirmed this week that they are going to try to spin off this business. This didn't come as a huge shock. They've been talking to Meredith, which is the publisher of things like Better Homes and Gardens, maybe combining those units and spinning those off. But they said by the end of the year they expect not have a Time Inc. anymore. And even though they've done a good job of trying to keep costs low, continuing to produce cash for the business, print in general is just not an area that they really see as big growth. They're focused on the television networks; they're focused on the movie business, areas that they think that they will be able to produce a lot more value for shareholders over time.
This is a story we've seen play out in a few different places about what's happening with print publications, with newspapers and magazines. It's a story that's far from finished. We just don't know how these publications that succeeded so well in print are going to able to make that transition to digital and if they can get paid to do that. It's going to a big question for media, and it's not surprising to see some of the firms that have an option to kind of maybe get out of these businesses are choosing to do so.
Benz: The last number, $9, this relates to Dell, and I'll admit that I've a vested interest in this story, because I'm a Longleaf Partners investor, and Southeast Asset Management is actually fighting this deal to take Dell private. Let's talk about that $9.
Glaser: The Dell buyout is not going as smoothly as maybe CEO Michael Dell and his partners had hoped, and it's because of some activist investors, as you mentioned. Both Southeastern and now Carl Icahn jumping into the ring, saying that they think that a leveraged recapitalization, so essentially Dell taking on more debt, but remaining a public company, will unlock a lot more value for shareholders than the go-private deal, and that they will be able to get more out of it.
So, Icahn is proposing a $9-per-share dividend that will be funded by cash and new debt, and that would be given to the existing shareholders. And he thinks that between the stump value of what's left in the company plus the value of that dividend that it's a much better deal than shareholders are going to get from being a private concern. I think there is some skepticism about even if it is a private company, will Dell really be able to make the changes? What are those changes that they couldn't make when they are still publicly traded?
This is going to be a big battle. Icahn says that he's willing to litigate this, and I think that he probably will if he feels like he is not getting a fair shake. He really wants the shareholders to be able to have the option between staying public and just changing the capital structure a bit. This is a story that, I think, we're going to be hearing about for a quite a long time. I think Michael Dell is going to have to raise how much that they are willing to pay in his consortium. Either he is going to have to pay more for the company in order to get the activist investors to calm down, or he'll have to acquiesce them and allow some sort of leveraged recapitalization to happen. I think it's going to be challenging to get the deal done at this level right now, given the amount of noise we are hearing from these two substantial investors.
Benz: Jeremy, lots of things to keep an eye on in the weeks and months ahead. Thanks for sharing your insights.
Glaser: You're welcome, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
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