Archive: September, 2007

26 Hot Stock Tips From the U.S. Government

Originally published at RealMoney on September 19, 2007.

Tony Crescenzi says the latest PPI report should be tossed because the benign headline reading will almost certainly be reversed in the months ahead owing to the surge in energy costs that has occurred of late. I say not so fast! If prices are rising, that means some companies out there are likely to see better profits. Before tossing out the report, I’m betting we can figure out who a few of them will be.

The Bureau of Labor Statistics, which prepares the PPI report, provides detailed information on an industry basis. The problem is figuring out how to find it on their web site. Starting at the PPI home page, I scroll down to the headline that says “Get Detailed PPI Statistics” then click on Industry Data. You can then pick out which industries you want to see (I pick ‘em all) and click “Retrieve Data.” Then I select “More Formatting Options” and click on the boxes for 12-month percent change, all years, and include graphs. Once I hit “retrieve data” again I have what I’m looking for – graphs that make it easy to tell which industries are gaining or losing their pricing power.

First up is the fruit and vegetable canning industry. At 5.3% year/year inflation, pricing is clearly better than normal. It is down from a recent peak but still looks to be generally in a rising trend.

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Possible plays on this industry include can makers such as Ball Corp. (BLL), Crown Holdings CCK - Annual Report), or Silgan (SLGN - Annual Report). Or you can go to the food processors such as Campbell Soup (CPB), Del Monte (DLM - Annual Report), Hain Celestial (HAIN), or HJ Heinz (HNZ).

Looking better still are industrial valves, up 9.3% year/year against tough comparisons.

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Some of the industrial valve makers include Flowserve (FLS), Crane (CR) and Curtiss Wright (CW - Annual Report).

But enough with boring “old” industries. How about tech? It is seldom that tech prices actually increase, but sometimes they decline at a slower than usual pace, which can provide a similar opportunity. That may be the case right now with computer storage devices.

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Last month’s 2.9% decline from last year was the smallest price drop on record for this industry, and the ongoing consolidation may help the trend continue. Plenty of ways to play this one, including Brocade (BRCD), EMC (EMC - Annual Report), Iomega (IOM), Hutchinson (HTCH), Quantum (QTM), Sandisk (SNDK - Annual Report), Seagate (STX - Annual Report), and Western Digital (WDC).

By contrast, semiconductors are experiencing the worst pricing on record.

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That could be the signal for a contrarian play (I happen to think the worst will soon be over for semiconductors) or possibly just an excuse to avoid the group for a while.

The PPI clued me in to the opportunity in railroads a year before Buffett bought in. I hestitate to bet against him, but it looks like the industry’s price increases have ground to a halt.

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If you have the guts, I’d count this as bad news for Burlington Northern (BNI), CSX Corp. (CSX), Norfolk Southern (NSC), and Union Pacific (UNP).

Finally, Wired Telecommunications saw pricing decline for years after the 1996 Telecom Act, but recent consolidation is allowing them to raise prices again.

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Winners here would be CenturyTel (CTL), AT&T (T - Annual Report), Verizon (VZ - Annual Report) and Embarq (EQ).

By my count, that is 26 potential stock tips, all courtesy of the U.S. government. I’ll take that over tossing the report any day.

Disclosure: Long Semiconductor HOLDRs (SMH).

Topics: AT&T (T), Ball Corp. (BLL), Brocade (BRCD), Burlington Northern Santa Fe (BNI), CACI International (CAI), CSX Corp. (CSX), Campbell Soup (CPB), Capital Goods, CenturyTel (CTL), Communications Services, Computer Storage Devices, Containers and Packaging, Crane (CR), Crown Holdings (CCK), Curtiss Wright (CW), Del Monte Foods (DLM), EMC Corp. (EMC), ETFs, Embarq (EQ), Flowserve (FLS), Food Processing, HJ Heinz (HNZ), Hain Celestial (HAIN), Hutchinson (HTCH), Iomega (IOM), Miscellaneous Capital Goods, Norfolk Southern (NSC), ProShares Ultra Semiconductors (USD), Quantum (QTM), Railroad, Sandisk (SNDK), Seagate (STX), Semiconductor HOLDRS (SMH), Semiconductors, Silgan (SLGN), Union Pacific (UNP), Verizon (VZ), WDC | 1 Comment

Risk Premium Edged Down After Fed Ease

Last week I talked about how the risk premium for corporate bonds (the difference in rates between treasuries and Baa-rated corporates) has been rising in recent weeks, though not as much as I would have expected given the mortgage meltdown. I said it would be interesting to see whether the Fed’s rate cuts affect long-term rates. The economy could actually do worse following the cuts if the spread widens further.

So far, the spread has narrowed just a smidge, to 2.08 in the week ended 9/21 compared to the 9/14 week.

interestrates.jpg

A lower spread is positive for the economy and for corporate earnings, as it means companies don’t have to pay as much (relative to riskless treasuries) to borrow money that can then be invested in profitable opportunities. In effect, it lowers the bar as to what makes for a worthwhile investment. A low spread has a mixed message for stock market investing – good for earnings/economy per above, but means investors are being paid less to take risks.

Topics: Economy, Risk Premia | No Comments

ADBE: Adobe Goes Up But Gets Cheaper After Earnings

This article was originally published at RealMoney on September 18, 2007.

As impressive as were yesterday’s earnings and stock rally for Adobe (ADBE), perhaps even more impressive is the fact that the stock appears cheaper after going up than it did before. At yesterday’s close, it was trading at 28.5x 2007 earnings estimates. After the nickel beat and three cent guidance increase, based on after hours trading at $44.76 it is only at 28.1x.

That said, 2007 is so this year – most investors are already looking ahead to 2008 and beyond. With no major product upgrades expected until late 2008 at the earliest, there is more than a small possibility that this year’s upside comes out of sales that would otherwise have been made next year. Already growth was expected to slow from 17.5% this year to 12.5% in 2008. If the estimates for next year aren’t raised the growth from the new guidance will be single digit.

I’m quite confident the estimates for 2008 will be raised. But that’s not to say that everything about the earnings report was fine and dandy. License sales are growing slower than total revenue, with the remainder being service and support. Since licenses have to be sold before support can be provided, the slower license sales point to a slowdown in support growth later on. For another thing, deferred revenue is growing at a slower rate (if only slightly) than booked revenue. This indicates that the license revenue will probably continue to slow as well. Furthermore, the growth is in current deferred revenue – long-term deferrals are down 18% since December 2006.

But enough with the forensic accounting. Cash is king, and Adobe’s free cash flow over the last four quarters is about $1.25 billion, giving the company a free cash flow yield north of 5%. Even if the $100 million provided by a reduction in accounts receivable is excluded (as being non-recurring) the yield is still nearly 5%. That cash flow has grown at a double digit pace in each of the last four years and, while it may slow in 2008 due to the product cycle it seems likely to resume at a similar clip in the years following. With a cash flow yield already north of Treasuries, double-digit growth provides a healthy cash on cash return potential.

From what I have observed in the past, Adobe’s P/E multiple usually rises into the mid-30’s immediately ahead of a major new product release, then retreats to the mid-20’s afterward. In early August, with the stock below $40, I sprang into action (sort of.) Since, based on estimates at the time, I was looking for an ideal entry point of $37.50 I sold put options that would force me to buy at that price if the stock was lower when the options expire this Friday. While it looks like the $1.25 option premium I collected will be free money, I also clearly left more on the table. Not that I’m upset about that – the reason I sell the puts is because I know I will usually be wrong, but not the direction in which I will be wrong. The option premium reduces my regret regardless of how things turn out.

With the current news, though, it is time to update the earnings and the “ideal” entry point. Even after the rally, the new earnings estimates leave the P/E multiple in the mid-20’s range I thought it would retreat to – only instead of the stock price falling back a bit the earnings rose to meet it. What’s more, my $37.50 entry seems like little more than a pipe dream. The company bought back more than $700 million worth of stock so far this year, and has the ammo for much more (not to mention ongoing cash flow that would sustain that rate.) It just doesn’t look like management will let me get away with buying that cheaply. While I may continue to follow my regret-minimizing strategy by selling new puts, I’d be willing to do so at the current prices. And those investors who, being less skittish than I, decide to buy may end up with the least regret of all.

Disclosures: William Trent was short naked put options against Adobe at the time of publication.

Topics: Adobe Systems (ADBE), Software and Programming | No Comments

Chicago Fed Index Still in Slowdown Mode

According to the Chicago Fed National Activity Index (CFNAI), August economic growth was below average. The Chicago Fed National Activity Index was –0.57 in August, down from 0.03 in July. The production and employment indicators showed the most significant change from the previous month, though all four categories of data made negative contributions to the index in August.

What does that mean? According to the Chicago Fed itself, when the CFNAI-MA3 value moves below 0.70 following a period of economic xpansion, there is an increasing likelihood hat a recession has begun. When the CFNAI-MA3 value moves above +0.70 more than two years into an economic expansion, there is an increasing likelihood that a period of sustained increasing inflation has begun.

So, there isn’t an increasing likelihood that a recession has begun,  but perhaps increasing likelihood that in the near future the likelihood will increase.

Topics: Chicago Fed, Economy | No Comments

DAL: Delta Looks Better When You Don’t Look Too Closely

This article was originally published at RealMoney on September 17, 2007.

When I saw out-of-the-money calls Delta Airlines (DAL) on StockPickr’s stocks with heavy option volume my first thought was that it must have been one of the short squeeze airline plays also mentioned on StockPickr. Nope. So that got me thinking. I typically don’t want to touch airlines with a 10-foot pole, but they do make for the occasional good trade. Is this one of those occasions?

For me, even a speculative trade has to have something underneath it for support. At first glance, it looks like Delta has that. 2008 EPS estimates are at $1.80 and have been marching up steadily, now giving the company a single-digit P/E multiple. Price/Book is also low, but only because they exited bankruptcy with a load of goodwill on the balance sheet. Excluding that, the book value is negative. They have a fair amount of cash, but plenty of near-term liabilities on which to spend it. All in, their total net debt is more than $5 billion, resulting in an enterprise value of $9.7 billion. If they keep generating the cash flow they did during the first half of 2007, the double-digit free cash flow yield could be enticing.

The problem with those valuations, though, is that they rely on the accounting numbers on the face of the financial statements. The last 10Q disclosed that after the June 30 financial statement dates but before July 31, the company issued another $66 million in debt and paid $303 million cash to terminate pension plans and settle some other obligations. Then, on August 28 they were required to issue $650 million in debt to their pilots in exchange for salary concessions they had made. The company has settled $11.4 billion of bankruptcy claims by issuing common stock, but “currently estimate that the total allowed general, unsecured claims in our Chapter 11 proceedings will be approximately $15 billion, including claims with respect to which we have issued or commenced distributions of common stock.” That means that another $3.6 billion are not yet on the books, even assuming their estimate is correct. That brings the enterprise value to $14.3 billion, and the free cash flow yield below 7%. Who knows how many shares will have to be issued to settle the claims, so I won’t even talk about the P/E.

What’s more, airlines are notorious for off-balance sheet and other obligations. Delta has 136 aircraft under operating leases, which make up about a quarter of its fleet but do not appear on the balance sheet. If these were treated as company-owned aircraft, the assets and liabilities would each increase by about $3.5 billion (assuming the leased aircraft are worth about as much, on average, as those that are owned.) Now we’re down to a 5.4% yield on an adjusted enterprise valuation of $18.8 billion.

How quickly we get from something that looks enticing to something that looks like it came out of bankruptcy five months ago. Which, of course, it did. Bottom line, if you want to take a flier on an airline, I’d stick with one of the short squeeze plays. The majors still look like they can cause a major league stomachache.

Topics: Airline, Delta Air Lines (DAL), Forensic Accounting, Fundies, Stock Market, Transportation | 1 Comment

AAPL: I Pare Apple Arguments and Give the Edge to the Bulls

This article was originally published at RealMoney on September 17, 2007 and was featured in the September 24, 2007 Festival of Stocks.

Few stocks boil the blood of both bull and bear as much as Apple (AAPL), and for good reason. The company, richly valued though it is, has come out with more cool products than the rest of the tech industry combined. That helps excite the bulls, and as for the bears, there’s a good chance many of them are jealous for having missed out on the stock’s run. They have sour grapes they hope will someday be pressed into wine. And before you fanboys of some other tech stock get all hot and bothered about my disrespect of your favorite company’s innovation record, allow me to summarily dismiss them.

  • Research in Motion’s (RIMM) Blackberry? Great mobile enterprise email device. But that’s for work. Ewww!
  • VMWare (VMW)? See above. Not to mention it’s hard to show off your virtual server.
  • First Solar (FSLR)? Try this for a pickup line: “Hey, want to go back to my place and see how thin my solar film is?” Unh-uh.
  • Google (GOOG - Annual Report)? Still great at search. Nice email product. So what? They’ve spent more than a billion and a half on research and development in the last 12 months, and I dare you to tell me where it went.

As you can probably tell, I haven’t gotten nearly enough hate mail recently, and I’m trying to kick things up a notch. So back to the task at hand: Apple. Let’s quickly take a look at what I think are the best arguments on each side.

First up is whether the “halo effect” from the iPod is helping bread and butter Mac sales. Mac units were up 33% year over year, compared with just 12% for PCs overall. Bears counter that most PC makers (with the exception of industry leader Dell (DELL) had unit growth similar to the growth in Macs. But this ignores the very important point that Mac units sell for much more on average than the typical PC – so in terms of revenue share is likely growing much faster. Edge: Bulls.

Next, is the iPhone a phlop? When 270,000 units were sold in the first two days, I said “the 730,000 they are guiding to for the next three months seem conservative laughably low.” It is now looking as though it was only conservative. It is pretty clear the price cut was driven in part by a significant slowdown in sales – to possibly as low as 5,000 units per day by the time of the price cut according to one convincing analysis. But that would still put the iPhone in the same league as Palm, even if not quite matching their original estimate of being in RIMM’s league next year. But don’t forget – they got where they are now being sold by one carrier in the U.S. As they roll out to other carriers on other continents, they could meet their target yet. It’s not living up to the hype, but it is still a success. Edge: Even.

Finally, the iPod – a product that nobody seems to care about anymore, yet which sold 10 million units last quarter when it hadn’t had a product refresh in ages.

From an accounting standpoint, things are going so well that they are now deferring revenue from their new products rather than booking it up front. This practice will help bake some growth into the cake. True, the company’s earnings were boosted by a penny due to a lower bad debt reserve, but when you are beating quarterly estimates by a quarter that is just chicken feed.

While the stock has nearly doubled over the last year, its free cash flow has more than tripled. As a result, a company that is growing at more than 20% per year on the top line is yielding 3.9% on a free cash flow to enterprise value basis.

About the most significant risk, in my mind, is the possibility of a consumer slowdown combined with increasingly high expectations. Apple is far more consumer-driven than other tech stocks, and a 40x P/E multiple might not hold up if they only beat by a nickel instead of the quarter investors have come to expect. That’s why I think the free cash flow is so important in this case – it provides a solid backstop, and would help justify being patient through a slowdown should it come. If the company can grow at even half the current rate over the next five years, investors are likely to be well compensated for the added risk.

Positions: Short Research in Motion (RIMM)

Topics: Apple (AAPL), Communications Equipment, Computer Hardware, Computer Services, First Solar (FSLR), Google (GOOG), Research in Motion (RIMM), Semiconductors, Technology, VMWare (VMW) | No Comments

ODP: Office Depot Should Pay Off For the Patient

This article was originally published at RealMoney on Sept. 14, 2007.

I’ve always had a soft spot for Office Depot (ODP), where I served my MBA internship. So when I noticed that a sales and earnings speed bump has put the stock in the 50% off bin, I thought I should check it out more closely. After all, at 10x earnings it certainly looks cheap enough. Its primary competitor Staples (SPLS) has weathered the storm far better but trades at a significantly higher earnings multiple. OfficeMax (OMX) has been hit nearly as hard as Office Depot, but also sports a higher valuation.

That comparison begs an obvious question: is Office Depot cheaper than those companies because it is doing much worse than they are? To some extent this is certainly true, as Staples’ same-store sales have been trending down 2% while Office Depot’s are down 5%. OfficeMax has actually seen positive comps, but that is at least partially driven by having closed more than 100 underperforming stores. At any rate, it seems safe to say the whole group is doing poorly but Office Depot’s lower valuation is at least partially merited by virtue of it doing even worse.

At the Goldman Sachs conference last week, management discussed the impact of a slowing housing market, which has apparently been affecting the home-based businesses that constitute a portion of office superstore sales. The company explained that the change in store sales is strongly related to local housing inventory and the number of days houses stay on the market. Since Office Depot has a larger concentration of stores in Florida and California – two of the hardest-hit markets – this may explain much of the underperformance, and is supported by the fact that the biggest drops have been in the furniture category. However, it also suggests that things may get even tougher for all of the office suppliers as the housing decline continues to spread. Fortunately the international business continues to grow, and accounted for more than 25% of total revenue in the latest quarter.

So that brings me to the financial nitty gritty. Is the valuation cheap enough to merit a long-term investment, or is it still time to stay away from a falling knife? Although net income is still up year-to-date, cash from operations is down – and that dichotomy is often a warning sign. The difference has been working capital investments. Inventory on hand has crept up to 54 days from 52 last year, but receivables are down a bit. It looks like the timing of tax payments was the main culprit, which makes me a little less concerned about the decline.

Even in the face of the downturn, the company has generated $636 million in cash from operations over the last 12 months. The pressure is expected to continue into the third quarter but should start to ease next year, if only because the comparisons will be easier. It used up nearly $450 million on capital expenditures and is expected to continue spending about $500 million annually – mostly on store openings and remodels. I estimate that of that, about $200 million is going to new stores and the rest is required maintenance. Since the new stores are presumably expected to boost future cash flows, the “no-growth” free cash flow stands at about $325 million per year, a 5.8% free cash flow yield on the current enterprise value. It doesn’t take much growth from there to get to an enticing total return.

What’s more, if this worst-case scenario does unfold the company has shown that it has the discipline to act on it. Office Depot has already reduced planned store openings to 100 this year (from an initial plan of 150) and 125-150 next year (from initial plans of 200).

Office Depot has also been buying back shares (although in retrospect they were paying too much for them.) The share count is down nearly 6% from one year ago, and further buybacks will help soften the EPS blow during the downturn as well as provide leverage to the recovery.

All that said, an investment in Office Depot will require patience and possibly a strong stomach, as things are likely to get worse before they get better. It looks like a stock that will pay off in the end, but there are probably some names that will pay off sooner.

William Trent currently has a short position in put options related to Office Depot (ODP).

Topics: Office Depot (ODP), OfficeMax (OMX), Retail (Specialty), Staples (SPLS) | 1 Comment

The risk premium for corporate bonds (the difference in rates between treasuries and Baa-rated corporates) has been rising in recent weeks, though not as much as I would have expected given the mortgage meltdown.

A lower spread is positive for the economy and for corporate earnings, as it means companies don’t have to pay as much (relative to riskless treasuries) to borrow money that can then be invested in profitable opportunities. In effect, it lowers the bar as to what makes for a worthwhile investment. A low spread has a mixed message for stock market investing – good for earnings/economy per above, but means investors are being paid less to take risks.

interest-rates.jpg

It will be interesting to see whether the Fed’s rate cuts affect long-term rates. The economy could actually do worse following the cuts if the spread widens further.

Topics: Economy, Risk Premia, Stock Market | No Comments

YHOO: Not Shouting Yahoo! Over Yahoo!

This article was originally posted at RealMoney on Sept. 11, 2007.

As I noted in my Motorola column, I like to take a look at the stocks with unusual option activity on StockPickr to see if there is anything sufficiently interesting to investigate further. Friday’s list was a doozy, with heavy activity listed for deep out-of-the-money October calls for Motorola (MOT - Annual Report), Arch Coal (ACI) and Yahoo! (YHOO). Having found a possible long-term bargain in Motorola I turned my attention to Yahoo! to see if I could pull a two-fer. Alas, it looks as though I may have bagged my limit.

Unlike Motorola, Yahoo! has no chance at a bloodletting fire-the-CEO rally (justified or not) because it has already happened. Instead, any hopes for a short-term pop in Yahoo! shares are probably underpinned by the persistent buyout rumors, with Microsoft (MSFT - Annual Report) and EBay (EBAY) being the buyers most frequently bandied about. But the problem with those rumors is they have been around forever, and so far smoke has yet to signal fire. Anybody buying the name in hopes of a buyout should therefore be prepared (and paid) to wait.

So, will Yahoo! reward a patient approach? It doesn’t look that way to me. Its free cash flow in 2006 was $700 million, half the level achieved in 2005. It is only good for a 2.3% free cash flow yield on the current enterprise value. That means essentially all of the return potential has to come from growth – which doesn’t seem like a safe bet given last year’s decline. Sure, the growth rate over the last five years is nearly 45% – but that is coming off of the lowest lows of the Internut Bust. The consensus five-year growth estimate is 24%, including a 20% decline in the current year. By implication, that means the subsequent four years would have to post average growth of nearly 40% annually. Color me skeptical. With an ROE of just 8.27%, assuming growth will be faster than that implies adding debt or issuing new shares unless they can somehow boost the ROE itself – a feat far easier said than done. Coincidentally (or not) that is about in line with the actual year/year growth rate in the latest quarter.

I know, I know – that’s all just academic theory. So let’s consider Yahoo’s businesses to get a feel for what the company can do to boost that ROE and ramp up the earnings growth. According to the latest 10Q, fee-based businesses such as premium mail, web hosting and premium Flickr accounts contribute just 12% of revenue. While they may grow, it is hard to imagine them growing enough to move the needle. That leaves “marketing services” such as HotJobs and display advertising. Somehow, the latest employment report leaves me less than fired up about HotJobs’ prospects. As for display advertising, financial services firms have accounted for anywhere from 12% to 30% of online advertising. A good chunk of that is mortgage refinancing and credit cards – both of which seem likely to suffer as credit standards return to historic norms.

Yahoo! is a great company, with a balance sheet strong enough to carry them through any downturn in the online advertising market. But they aren’t generating enough cash flow today to make waiting for the recovery worthwhile – at least not for me. There are other companies out there that look like safer bets. While Yahoo! could very well return to growth, it just looks too hard to earn a return high enough to compensate for the risk.

Topics: Advertising, E-Bay (EBAY), Microsoft (MSFT), Motorola (MOT), Retail (Specialty), Yahoo! (YHOO) | 3 Comments

MOT: Motorola’s Cash Flow Backstop Confers Confidence

The following article was previously published at RealMoney on Sept. 10, 2007.

Though I consider myself a longer-term investor, I like to take a look at the stocks with unusual option activity on StockPickr to see if there is anything sufficiently interesting to investigate further. Friday’s list was a doozy, with heavy activity listed for deep out-of-the-money October calls for Motorola (MOT - Annual Report), Arch Coal (ACI) and Yahoo! (YHOO). I dug a little deeper on Motorola, and came away thinking it might be worthwhile even for those willing to wait longer than October to see a return.

Motorola was having an investor day on Friday, though it is hard to imagine anyone thinking it would produce an announcement worthy of a 20% up move. In fact, there probably is only one such possible announcement, and that is of Ed Zander’s resignation. The company has struggled to find a follow-up that matches the RAZR’s success, let alone one-ups it. In Zander’s own words, “In Mobile Devices, we did not achieve the level of sales and unit shipments that we had expected, primarily in Asia and the Middle East and Africa. Europe, as we have been saying all year, continues to be a challenge.” The message boards are downright gruesome.

But if all it takes for a 20% up-move in Motorola is a new CEO, the market has gotten awful forgetful. After all, it was just four short years ago that the stock rallied 10% (from a far lower base) on the news that Chris Galvin was resigning to be replaced by Zander. It makes one wonder why they keep them as long as they do – if I could get a 10% rally on every CEO firing, I wish Motorola would do it at least once a year. Zander is credited with putting the RAZR on the fast-track and for… not much else. Why settle for anyone’s second-best idea? Give them a few months to put their best one into action, then sayonara! It’s time to find someone else, with a new best idea. Call it crowd-sourcing for CEOs.

So in case you missed the sarcasm, color me skeptical that Zander’s departure would do much for Motorola over the long term. And don’t tell me they need “compelling products” when Nokia (NOK) consistently produces the blandest, clunkiest, ugliest, bulkiest – and best-selling – phones on the market. The analyst day highlighted a return to cash generation – which will definitely be needed for a turnaround to succeed, regardless of who is behind it.

Motorola generated cash flow from operating activity of $3 billion in 2004, $4.6 billion in RAZR-backed 2005 and $3.5 billion last year. For the last 12 months, however, they are down to $2.2 billion – of which $700 million was used up in capex. Still, in a somewhat depressed year it is enough to make the free cash flow yield on Motorola’s $35.6 billion enterprise value comparable with the current treasury yield. All Motorola needs to do is get cash flow back to 2004 levels and today’s investors will be compensated for accepting the risk. If they can get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there I estimate the stock would be worth nearly $23 – more than 25% above the current price. They could pretty much do that just by trimming R&D expense to the 2004 level (which was all they needed to produce the previous hit product anyway.) This scenario doesn’t require them to create the next RAZR, but if they did it would make for a nice icing on the cake.

The obvious risk to this thesis is that cash flow could move in the wrong direction. It isn’t hard to imagine possible scenarios where this happens, especially given the lukewarm reaction the street is giving the recent comments on cash flow improvement. It wouldn’t be the first time a management team gave up on a promising strategy in order to give investors what they thought they wanted. If you are a buyer on the cash flow story you’ll probably want to flee for the exits if anything is announced that will eat up the cash. Fortunately, however, Icahn is nipping at Motorola’s heels. That might be enough to keep them from doing anything too rash.

Topics: Advertising, Communications Equipment, Motorola (MOT), Nokia (NOK), Services, Yahoo! (YHOO) | No Comments