In his June 4 blog, what did Jim Goldman call “the only real issue” in the Yahoo-Microsoft drama?

Let’s focus instead on the only real issue that matters: fiduciary responsibility.

In one of my first columns for RealMoney I wrote that Yahoo! (YHOO) looked overvalued.  Microsoft’s (MSFT - Annual Report) takeover offer has left that call looking stupid, as Yahoo! shares have risen 15.2% while the S&P 500 is down 6.4%.

You can’t win ‘em all.

On April 25, Tech Check’s Jim Goldman blogged on Microsoft’s Yahoo bid. How did he describe Microsoft CEO Steve Ballmer’s “rule” ?

Goldman speaks of Steve Ballmer’s decade-long, iron-fisted rule of the world’s largest software maker

A while back I complained that several stocks I had been bearish about had gotten boosts from takeout offers. Namely, Diebold (DBD), Delta Airlines (DAL) and Yahoo! (YHOO).

Delta stock finally broke down, and then agreed to a merger at much lower share prices.

Today I look less stupid about Yahoo, though the stock is still up 5% from the date of my bearish article, compared to a 4.3% decline in the S&P 500.

So that’s two down and one to go.  Each reduction in my apparent stupidity is welcome.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

I should probably learn to take the money and run more quickly. Back in December I wrote about Diebold (DBD) at about $33 per share and said investors should probably look elsewhere due to earnings quality concerns and what I considered to be unsustainable cash flows. That looked good until this morning, when the takeover offer from United Technologies (UTX) sent the shares up from $25 to $39.

In the interest of full disclosure, this is the third time in as many months that a takeover bid has made one of my bearish calls look stupid (at least temporarily.) In September I wrote bearish pieces on both Yahoo (YHOO) and Delta Airlines (DAL) at prices of $23.30 and $17.65, respectively. I no longer look stupid on Delta since their deal appears to have run aground.

Interestingly, of the three Delta was the only one whose management actually wanted the deal. We’ll have to see whether the Yahoo and Diebold hostile bids suffer the same fate.

Position: No financial positions in the stocks mentioned

This article is a reprint of my February 5, 2008 RealMoney column

In the wake of Google’s (GOOG - Annual Report) disappointing earnings results and Microsoft’s (MSFT - Annual Report) premium bid for Yahoo! (YHOO), I started wondering if Google might finally be cheap enough to consider buying on a contrarian/value basis.

Google generated $3.37 billion in free cash flow (cash from operations less capital expenditures) in 2007, sufficient for a 2.5% free cash flow yield based on the latest enterprise value estimate. That isn’t much less than the 2.8% yield on 5-year Treasuries, and the Treasury yield, unlike Google’s free cash flow, is not doubling annually.

It is also significantly higher than the 2.1% free cash flow yield Microsoft will capture if it succeeds in its $44.6 billion acquisition of Yahoo! On the other hand, if Microsoft truly manages to wring $1 billion in annual synergies from the deal and those synergies flow through to cash rather than just accounting earnings the yield for Microsoft would double. Since that is a lot of “ifs,” I’ll stick to the 2.1% number.

At a 2.1% free cash flow yield, Google would trade for $553. And that is assuming the company were truly similar to Yahoo!  In fact, Google is growing its revenue at more than 50% per year rather than Yahoo!’s 8.3%, and is estimated to grow its earnings per share nearly 33% annually over the next five years rather than 23% for Yahoo! If anything, Google should capture a much higher valuation than Yahoo!

For example, assuming both companies were to grow at the expected rate for five years and then at the same rate as the S&P 500 thereafter, they might both decline to a 15x P/E multiple over the five year horizon. In such a situation, the five-year price target for Yahoo! would be $19.50, while the five-year price target for Google would be $886. If anything, that scenario seems a bit conservative for Google and a bit aggressive for Yahoo! in my opinion.

The Downside

While there is no doubt that contextual search ads are a more desirable advertising venue since customers can monitor the results, I don’t buy the notion that Google can see increased ad spending during a recession. If ad budgets are cut, I think the revenue advertisers will be willing to pay for each click will go down. I accept that the search ads might be less impacted than other outlets, but just don’t believe that budgets formerly reserved for TV, for example, will be shifted to search.

I also think Yahoo! offers some insight as to the worst-case scenario for Google in a recession environment, based on what happened to Yahoo! in 2001. Revenues declined 35% in 2001, operating expenses continued to creep up, and free cash flow got hammered.

The comparison to Yahoo! during the tech bust is probably too conservative. Yahoo’s display ads in 2001 did not offer nearly the advertiser measurability that Google’s search ads provide. Further, Yahoo! stock was unfairly tainted by all of the other Internet stocks that didn’t deserve to trade at all, let alone at lofty multiples of sales. Still, I think there are useful comparisons to draw from such recent history.

I could see Google’s revenue declining as much as 20% year/year, which I don’t think many analysts give much credence. Its earnings would plummet in such a situation because Google continues to add operating expense. I don’t see $5.00 in EPS as being out of the question. But in 2001 Yahoo! ended up with a 100x P/E multiple against its 2002 earnings per share (the trailing earnings had gone negative.)

At 100x my recession-trough EPS estimate of $5.00, Google is fairly valued today.

Sure, history never repeats exactly. And sure, momentum could take Google significantly lower regardless of the logic (or lack thereof) in my analysis.

But to me, Google is starting to look like a value stock.

Last September, I said I was skeptical about Yahoo (YHOO) in a post titled YHOO: Not Shouting Yahoo! Over Yahoo!

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.

The latest earnings and guidance show that the skepticism was justified. The stock fell another 11% after hours, and is now down nearly 22% since my bearish call, compared with a 7.4% decline in the S&P 500.

Revenues were up - whaddya know - 8.3% and the new guidance midpoint calls for another 10% in 2008. Five year growth estimates have not budged but will now be far more difficult to meet.

This article is a reprint of my December 19, 2007 RealMoney column.

An Update of My September 2007 Stock Picks

• My picks in September had winners and losers, but fortunately more of the former
• Closing out my bearish stance on Office Depot (ODP)

I wrote six articles in September that included a bullish or bearish stock opinion, and with three months behind them I thought it was a good time to see how they performed and whether any changes were warranted. On the whole, the picks are playing out more or less as planned.

Motorola

On September 10, I wrote that if Motorola (MOT - Annual Report) could get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there Motorola shares would be worth nearly $23.

Instead, the cash flow position has continued to deteriorate, contributing to former CEO Ed Zander’s recent ouster. The stock is down 7.2% since the article was written, compared to just a 0.5% decline in the S&P 500.

Still, I think the issues at Motorola can be fixed by bringing the costs - particularly research, development and overhead - in line with the current revenue generation. Alternatively, activist shareholder Carl Icahn could push to break the company up into smaller pieces that might be acquired for a higher total than the current company is currently able to garner. Either way, I’m sticking to my guns on Motorola.

Yahoo

On September 11 I made a bearish call on Yahoo! (YHOO), saying I didn’t believe in the consensus growth estimates and that Yahoo isn’t generating enough cash flow today to make waiting for the recovery worthwhile — at least not for me.

Things haven’t gotten any better since then, and the stock has lost 1.1% - although that is a slightly better performance than the 1.7% loss in the S&P over the same period. I remain bearish on Yahoo.

Office Depot

On September 12, I made a bearish call on Office Depot (ODP), saying “things are likely to get worse before they get better.” Things got worse, and after the company missed earnings and delayed filing its required 10Q the stock has lost 23.3%, compared to a 1.7% decline in the S&P 500.

But I also said “it looks like a stock that will pay off in the end,” and I think the current downturn may have taken the worst out of the stock. I have written put options against the shares (a bet that has lost money) and I think there are more reasons to be positive than negative.

Think the worst of the housing downturn is over? Office Depot’s solid cash flow should make it a safer play than homebuilders or financials. Think small-business tech spending will rise? Office Depot’s P/E is a fraction of Dell’s (DELL).

Office Depot could still have some downside, and I don’t expect a quick recovery. But at current valuations I can no longer justify a bearish position, so I’m closing out that call.

Delta Airlines

On September 17 I made another bearish call, this time against Delta Airlines (DAL). Although the stock looked cheap, after I made some adjustments for earnings quality it looked more like a company recently emerged from bankruptcy (which it is.) The stock has lost 17.7% since that call, compared to a 2.1% decline in the S&P.

Short term, anything can happen as airlines have tons of leverage that can lead to wild swings in profitability in pricing. But long-term I don’t think the major airlines have any better prospects than they did before the previous 10 or so bankruptcies, and I remain bearish.

Apple

I weighed in favor of the bulls for Apple (AAPL) on September 17, and was rewarded with a 32.5% increase in the shares, compared to the 2.1% loss for the S&P 500. The share gains cut Apple’s 3.9% free cash flow yield down to 2.9%, so it isn’t the value it was then.

Still, the cash flow rose 250% from the prior year, and Apple’s market share remains small for most of its product lines. The company continues to make desirable products, and if I have to take a chance on a tech name surviving an economic downturn it might as well be Apple.

Adobe

My last September stock pick was a bullish call on Adobe (ADBE) on the 18^th. The stock always seems to sell off after a major product introduction such as the Creative Suite launch in May of this year. Investors tend to sell on that news after buying up the shares in anticipation of it.

Although the sell-off wasn’t very pronounced this year, the shares did get stuck in neutral. My own call may have been a bit early, as the shares are down 6.3% since the article and the S&P is only down 4.9%.

On their earnings call, the company reiterated their guidance for next year. As the next product cycle moves closer, I think my bullishness will pay off.

Disclosure: William Trent owns shares of Adobe (ADBE) and has written naked put options against the shares of Office Depot (ODP).

Note: Sign up for cash back credit cards and earn cash back rewards from your daily spending.

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

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.

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.

With the end of the first quarter approaching, it is time to adjust the names in my Watch Lists. I will price all the new lists as of the close on Friday, June 29.

Today I present my planned updates to the Small Cap Watch List. There was a fairly high level of turnover to the list. 12 of the 24 names from the previous run made it to the current list, which was also 24 names. Performance-wise, the list created in March has returned an unweighted average return of 2.6% through June 28, with 80% of the stocks in positive territory. All of the money-losers from the previous list fell out of consideration.
So without further ado, the names on the chopping block from the previous list are: PW Eagle (PWEI), Insteel Industries (IIIN), Allied Defense (ADG - Annual Report), Hartmarx (HMX), Parlux (PARL), Hansen Natural (HANS), FirstFed Financial (FED), Young Innovations (YDNT), ITT Educational (ESI), Rent-a-Center (RCII), Valassis (VCI), and Travelzoo (TZOO). The castaways include four of the five money losers from the previous portfolio (HMX, PARL, YDNT and TZOO) as well as the biggest gainer (ESI).
The new list is:

I will continue to track both lists on StockPickr.