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Troubled Pairings?

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to the Friday Five. There were signs of troubled pairings in the market this week, maybe even some "gruesome twosomes." Here to offer the details is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: Jason, glad to be back.

Stipp: So, what do you have for the Friday Five this week?

Glaser: Well, we're going to talk about Barnes & Noble, the Fed, the fiscal cliff, Google, and finally a new food combination.

Stipp: So, the first trouble pairing, Barnes & Noble on the new digital world. Perhaps it's not going as well as management would like?

Glaser: Yes, that seems to be the case.

Last week, Barnes & Noble announced that they had sold a 5% stake in their NOOK digital business to Pearson for about $89.5 million, but had also warned that they had missed on sales in the December holiday sales season, and that they were going to be providing more information on that this week. And we got the grim news that they had seen a 12% decline in NOOK sales, that they had only seen a 13% in digital content growth, which is a big deceleration in growth for the company.

And this is really bad news. Barnes & Noble was betting their future on NOOK and betting their future that they'll be able to make that transition from the retail stores--from brick-and-mortar--into selling books, into selling different types of content, to consumers directly through those devices. And some big names like Microsoft, who also has taken a stake in this NOOK business, and Pearson, who publishes a lot of textbooks and other content, think that this is plausible--that they will be able to build an ecosystem that can compete against Amazon, that can compete against Apple.

But it's just not gaining a lot of consumer traction, despite new products, despite pretty well-reviewed products that have been deemed to be fairly well-designed. It's going to take a lot to get people to feel like it's a true competitor to really go out and buy them.

Given that the retail business is not exactly doing great, either, it just means that there is not a lot of excitement there. Our analyst Pete Wahlstrom thinks [Barnes & Noble] shares are about fully valued right now--maybe slightly undervalued--but there are just not a lot of interesting things happening on the investor side, or interesting opportunities for investors in Barnes & Noble right now.

Stipp: One pairing that's definitely unusual and could be troubling to the market is the Fed and a tighter monetary policy. It's not something we've seen for a while, but when the Fed released some information this week, we got a sliver of a hint of what a tighter monetary policy could look like, or at least they are thinking about it?

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Glaser: We really did just get a sliver of talk from the Fed about how they're going to eventually get out of these extraordinarily loose monetary policies and move into a more normalized state. In the Fed minutes that were released this month, which were from the meeting where they had increased the bond buying and they had tied it to the unemployment rate, trying to get it down to 6.5%, several members of the FOMC said that they thought that bond buying would cease in 2013. Now, that didn't mean that the Fed would start selling, that their balance sheet would actually start to contract, but it meant that it would stop growing sometime this year as the economy was beginning to get strong enough to really survive without that extra stimulus.

And this is really the start of a conversation that's been going on for years about the best way to make that transition. It's going to be challenging, because on one hand, the Fed wants to make sure that it doesn't hurt the recovery. It's still relatively weak. We look at the global economy. There is a lot of weakness across the world. The Fed wants to be very careful. But at the same time, they don't know the impact of having such an enormous balance sheet. They don't know when that inflationary pressure could start to pick up, and they don't know if they'd be able to exit out of it quickly.

They are trying to plan a judicious exit--something that would be more managed. We are starting to see the beginnings of that, and this is going to be the big story, at least on the monetary policy side, for the years to come.

Stipp: A pair of issues that we hoped would get settled together ended up not getting settled together. It was apparently too troublesome to get it all done at once: That's the fiscal cliff, which we got a quasi-solution to, but it still leaves many things, including the debt ceiling. How bad is the debt ceiling still looming over us here?

Glaser: We did get some clarity on tax rates. I think that's something that was a big part of the fiscal cliff was that side: What's going to happen? Are taxes going to go up on everyone? And the answer to that is no. Congress was able to come together at the last minute to really avert tax increases for most Americans, with the exception of the payroll tax expiring, and also added some provisions, such as making the AMT fix permanent, keeping dividends and capital gains rates at the same permanently, that that are nice prize for investors. But on the other side, like you said, it didn't deal with really handling some of the sequester cuts; those have just been pushed off by few months.

I think the debt ceiling is the more immediate issue. As early as February, we're going to hit the statutory limit. And remember the debt ceiling is basically the permission for Treasury to go out and issue more bonds in order to get the money to pay the bills for money that's already been authorized and that has already been spent. And the president is saying that he just wants a straight debt ceiling bill, that he wants the House and the Senate to send him an increase. He doesn't want any other cuts attached to it; he doesn't want anything else attached to it. And he's not going to negotiate that point. Meanwhile, House Republicans in particular are looking for other budget cuts, changes to entitlement programs, in exchange for that debt ceiling increase.

In August 2011 we saw this escalate to the point where S&P downgraded the United States' credit rating, and it seems like we're in for another contentious battle here. The lines are really drawn, and someone's going to have to give in order to get that debt ceiling raised. Without it, there could be some pretty negative consequences for the economy: We could see a partial government shutdown; we could see a big drop-off in spending very quickly. And that could potentially push the economy back over the edge and back into recession.

Stipp: Investors who are worried about the pairing of Google with increased regulatory scrutiny got some clarity on Thursday.

Glaser: Google really got almost a complete clean bill of health from the FTC this week. The FTC had been looking into some alleged anticompetitive practices of Google for a couple years now, and the gist of the complaints were that, because Google has such a huge market share in search, they are able to send people to different products of theirs and really squeeze out other competitors, like Yelp or Kayak, and send people to their own services instead.

And the FTC said that they were doing that just to improve user experience and not to try to drive others out of business, and Google is just going to have to make some very small tweaks in order to stay in compliance with the anti-trust regulations--some little things about the way advertisers can interact with the Google system and the way that patents are handled on the Motorola phone side--no big changes.

Now, regulatory risk is not completely over for Google. The Europeans are still looking into some of these allegations. Google has an even bigger market share in Europe than they do in the U.S., and Europe is known for being a little bit more aggressive on the anti-trust front. So we could see some more action there that could result in them having to make some changes in the way their sites work.

But so far, it seems like [Google's] "do no evil" mantra is really helping out with regulators. They don't see the company--even though they are enormous, even though they have this huge share--as one that's going to take advantage of their position, and certainly that's been helpful in dealing with these regulators.

Stipp: The last item on the Friday Five menu is an unusual pairing between two food companies that came together; what's the deal there?

Glaser: We might see some new taste sensations on the shelf possibly sooner rather than later, as Hormel said there were going to spend about $700 million to buy the Skippy peanut butter brand from Unilever.

Hormel famously makes SPAM and has other products in their meat business, including Jennie-O Turkey, and they want to expand outside of meat. They really feel like the peanut butter is something that helps diversify their portfolio. Skippy has a very large presence in China. Hormel hopes that helps them gain traction and gain shelf space in China as that market continues to mature and continues to grow.

If the SPAM and Skippy sandwich, the Skam sandwich, really takes off, I think will be up for consumer pallets and consumer preferences, but for Hormel this seems like an interesting deal. Ken Perkins, who is our analyst who covers it, doesn't expect a change to Hormel's fair value based on this deal. It will be a relatively small portion of sales, but it does show that the management team is really thinking about their capital allocation, thinking about expanding their brand and expanding the company in intriguing ways.

Stipp: Well, I don't think I'll be trying the SPAM-Skippy sandwich, but I do know a good combination is Jeremy Glaser and The Friday Five every Friday. Thanks for joining me again.

Glaser: Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.