Fri, 16 Aug 2013
Five stats from the market and the stories behind them. This week: a shakeup in J.C. Penney's board, the DOJ seeks to ground a major airline merger, and BlackBerry mulls a sale.
Jason Stipp: I'm Jason Stipp for Morningstar and welcome to the Friday Five; five stats from the market and the stories behind them. Joining us, as always, with the Friday Five is Morningstar markets editor, Jeremy Glaser.
Jeremy, thanks for being here.
Jeremy Glaser: Thanks, Jason.
Stipp: What do you have for the Friday Five this week?
Glaser: Well, the numbers we're going to look at are $700 million, 80%, 5.7%, $6.8 billion, and 3%.
Stipp: $700 million is the amount that activist investor Bill Ackman has lost in J.C. Penney so far. He's having a rough go of it.
Glaser: Yes, that's his potential loss there based on how the shares have fallen since he took his big stake in J.C. Penney, joined the Board, and really tried to shake things up. The problems with bringing in Ron Johnson, who was the former Apple Store CEO, to J.C. Penney are well-documented across a lot of different places. He tried to transform the business and tried to change kind of the customer base and the merchandizing. That just didn't go very well, and he was forced out fairly quickly. They brought back in the old CEO, Myron Ullman, and Ackman was not very happy about that. He was publicly feuding with the board and trying to get a new CEO in again, hoping that that would really turn the retailer around. And the Board disagreed. In that public disagreement, he decided to step down. He's still, for now, holding on to those shares but could potentially sell those in the future.
I think more broadly, this kind of shows how difficult it is to really make bets on activist investors, that for the individual who might be looking at these different stocks, hearing the news of "this hedge fund is doing this; this hedge fund is doing that," it's difficult to handicap if those activist investors, who may have a pretty good track record, are going to be able to turn around businesses that maybe need to be shaken up a little bit and unlock that value, to use that hedge fund term. Those are difficult assessments to make, and it shows how important it is to really focus on the fundamentals versus getting caught up in some of these soap operas with what's going on with the boards or with the manager du jour.
Stipp: 80% is the amount of the domestic air travel space that the top four carriers would combined hold, if the merger between US Airways and American goes through. But the Department of Justice is saying, not so fast.
Glaser: Yes, this really was the surprise. The American/US Airways merger looked like it was basically a done deal. The European Union had approved it. The bankruptcy judge was about to put his final stamp of approval on it. And the U.S. Department of Justice stepped in very aggressively. They didn't just kind of say "Maybe you can make a few changes here or there." They said that this was going to be a bad move for consumers, that this consolidation was going to raise prices, raise fees across the board, and reduce competition. They were really going to stand in the way. This is a very different stance than the Department of Justice had taken very recently on some big mergers, like United and Continental or AirTran and Southwest, saying that yes [those mergers] increased concentration, but the DOJ wasn't that worried about it.
It's not really clear why they had this change of heart. Part of it could be that the airline industry has done a lot better in terms of pricing power. They're starting to turn a profit now and maybe the Department of Justice is seeing that if they had another player that they were going to be able to potentially raise prices even more. That could be a problem. It could be that the concentration at Reagan Airport outside of Washington, D.C., which is one thing that they mentioned a few times, the DOJ complaint was [that a merger would be] something that was just too big to solve, that there's no amount of gates that could be or [airplane] slots that could be divested that would make that work. Obviously, that's an airport that's near and dear to many federal regulators because they fly out of there quite a bit. That could potentially have been a problem there.
What this means for US Airways and what it means for American Airlines is a little bit less clear. It is possible that they are going to be able to fight this, that they can come up with enough concessions to allow the Department of Justice to back off and to let them merge because as the smaller competitors to these other behemoth airlines, merged airlines, [American and US Airways] really will be at a disadvantage in terms of getting those corporate clients, in terms of having those big networks that will allow them to continue to make those profits. And they are going to have to really rethink the strategies if they are not able to merge. But I think that you are going to see them fight pretty aggressively in order to get that heft that they feel like they need to compete.
Stipp: 5.7% is the delinquency rate on consumer debt in the second quarter. The great deleveraging, though painful, may be good medicine for consumers after all?
Glaser: Yes, this was another sign from the New York Fed this week that the consumer balance sheets really are getting stronger. Like you mentioned, delinquencies on loans fell to the lowest levels from before the height of the financial crisis in early 2008, at 5.7%; $78 billion of consumer debt was paid down--that includes mortgages, credit cards, auto loans, things of that nature. I think that this really is a sign that consumers are--if not totally retrenching over the last couple of years--taking this time to really put money away to save more, to make sure that they are not taking out new loans, and that they don't really necessarily need to be more judicious with new credit.
I think that, though, like you mentioned, this can be painful in terms of slower consumer spending and in terms of kind of short-term economic gains, I think it sets a good platform for longer-term gains. When consumers have a clean balance sheet. It gives them the ability to borrow for the things that they actually need and to borrow for maybe that new home down the line, for a new car down the line. I think that's a good sign for the economy. Obviously, deleveraging is not just a consumer phenomenon. Government deleveraging is something that is happening and will happen as well and will continue to be a drag. But in the same way there, as that deleveraging happens, it should help set a good stage for growth, so this is, I think, pretty good news.
Stipp: $6.8 billion is the amount that Cisco spent on acquisitions in fiscal 2013. It seems like a lot of money for a Company that has a mixed record on the acquisition front?
Glaser: Yes, it really is. Cisco had their fiscal 2013 results that they reported this week, and even though the quarter was actually fairly decent, their outlook and some of their commentary was actually quite negative. They are expecting only 3%-5% revenue growth next year, and this really speaks to a lot of softness in the IT market, generally the corporate IT market, probably less to any specific issues that Cisco has. But one tidbit that Grady Burkett, who covers Cisco for Morningstar, pointed out was that they did spend quite a bit of money in acquisitions this year; $6.8 billion doesn't even include the over $2 billion they are going to spend for Sourcefire, which is a security acquisition that they have announced, but haven't closed on yet.
This is a lot of money for them, in that if they continue to make acquisitions kind of at this very high level, particularly as valuations in the tech sector get frothier and frothier, particularly for some of these smaller companies, that really could raise some concerns about capital allocation, which is something that had been a concern for some Cisco investors for some time and had been getting a lot better. I think that, obviously, there is no need to panic right now or to be concerned right now. They are still paying out a pretty sizable dividend. A lot of free cash flow is going there. They are still producing a lot of free cash flow. Their competitive advantages look intact, but that acquisition number definitely does kind of raise--if not a red flag--but certainly a point that investors should keep a watch out to make sure that Cisco really is being prudent and really is doing a good job with that capital allocation.
Stipp: 3% rounded up is the market share for the BlackBerry handset. BlackBerry was exploring its options in news this week. Can anyone, a private equity firm, turn this company around?
Glaser: It's going to be hard for BlackBerry to come anywhere close to the kind of dominance they had in the smartphone market before. The BlackBerry 10 product has been doing OK but has not exactly been hitting the cover off the ball in terms of sales. They are now under 3% market share compared with Android which has the lion's share across the world. Apple iOS is in that premium spot, and the new BlackBerry is struggling. I think that even though the company is now putting itself up for sale, saying they are going to explore strategic options, that's not going to change that competitive positioning very much.
Now, the real question is, who is the buyer potentially going to be? It seems like a lot of industry players may not be that intrigued by BlackBerry at this point. I think that the Palm acquisition by Hewlett-Packard is probably bit of a cautionary tale that you can take a product that might be a good product, like Palm was-- BlackBerry 10 is a solid product--but that there just isn't so much you could do, that just putting it as part of a bigger organization isn't going to all of a sudden make it popular. If that were the case Windows phone would be a lot more popular. Obviously, Microsoft is spending a lot of money on that platform.
A private equity buyer might be more interesting. Potentially it would give BlackBerry the ability to make it easier to take a shift from really being a handset maker to being more of a business-services company. It's a shift that people have been advocating for BlackBerry for a while, potentially to get them out of that hypercompetitive business and get them into one where they have some more competitive advantage, get them into one where they have a lot of brand equity built up with corporate IT people. Private equity might be able to do that better than the public markets. But it's going to be a challenge for them no matter what happens, and I think for most individual investors, it's probably better to look elsewhere than try to make some bets that there is going to buyer who is going to pay some huge premium to today's price.
Stipp: Friday Five is always a good call for investors. Jeremy, thanks for joining me again.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.