September 30, 2005
Outsourcing Legal Work
In a story every business lawyer should read, Eric Bellman and Nathan Koppel of the Wall Street Journal (9/28 at C1), researched the growing trade in the outsourcing of legal services to India by United States and British companies and law firms. The practice is brand new, only a few years old, and grown very, very fast. Companies and law firms in the United States are finding that Indian firms can perform, with a high degree of accuracy, the more routine jobs now performed by lawyers -- litigation research and support, patent searches and the like. The next spat of jobs? The first stage development of forms for common business structures and common business deals (including small acquisitions). No doubt the organized bar will mount a challenge in the licensing rules -- worrying about the unauthorized practice of law or lawyer client privilege (the two favorite devices in the bar as a guild mentality)-- to this potential competitive force.
J&J and Guidant??? Will there be a wedding???
Johnson & Johnson (NYSE: JNJ) and Guidant Corporation (NYSE: GDT) entered into an merger agreement on December 15, 2004. Under the terms of the agreement, JNJ will create a subsidary corp and merge it into GDT leaving GDT as a wholly owned subsidary of JNJ (a so-called forward triangular merger). However, the more interesting story with this merger is whether the deal actually goes through.
Yesterday, the New York Times reported that the Food and Drug Administration commenced a probe against Guidant looking at how the company disclosed problems with its defibrillators and pacemakers. (AP story by Ashley M. Heher can be found here). As a result of the announcement of the probe, shares of GDT were down about 3% to close at 68.17 Thursday on the NYSE.
Now under the terms of the merger agreement: "each share of Guidant common stock (other than shares owned by Guidant, Johnson & Johnson and Merger Sub) will be converted into the right to receive a combination of (i) $30.40 in cash and (ii) a number of shares of Johnson & Johnson common stock with a value, based upon the volume weighted average trading prices of Johnson & Johnson common stock for the 15 trading days ending 3 trading days prior to the closing, of $45.60, so long as the volume weighted average trading price per share of Johnson & Johnson's common stock during this period is within the range of $55.45 to $67.09. Outside of this range, each share of Guidant common stock will be converted into the right to receive a combination of (i) $30.40 in cash and (ii) a fixed number of shares of Johnson & Johnson common stock equal to 0.6797 if the volume weighted average trading price is above the range and 0.8224 if the volume weighted average trading price is below the range. Outstanding Guidant stock options at the time of the closing will be converted into options to purchase Johnson & Johnson common stock"
JNJ currently trades within the range of $55.45 to $67.09 at 63.75 as of the close on Thursday. Therefore, assuming that JNJ trades within the stated range of the agreement, JNJ will be paying $76 per share of GDT ($30.40 in cash and $45.60 in stock). With GDT currently trading around $68 and the deal expected to close within the next few weeks (JNJ's website says within Q4 '05 and CNBC reported this morning that the expect the deal to close within the next three weeks), JNJ will be paying $8 a share more than the current share price of GDT if the deal were to go through. Thus, if you believe that the deal will go through, you can make a quick $8 per share or approximately 12% in the matter of three weeks.
Unlike cash deals, such as GE's proposed buyout of IDX Systems yesterday, where the arbitrage spread is quite low because of the high probability of the deal closing, this deal between JNJ and GDT has had many problems and the markets look like they believe that the deal will not go through. The FDA prode will no doubt trigger several escape clauses in the merger agreement and JNJ will have the legal option of walking away from the closing or renegotiating a lower price.
Disclosure: I do not own shares of either JNJ or GDT, nor am I giving any investment advice. I am just trying to note how the markets are not expecting this deal to go through.
September 29, 2005
A Thursday of M&A
Today, General Electric (NYSE: GE) announced that its health care unit is buying IDX Systems Corp. (NASDAQ: IDXC) in a deal valued at $1.2 billion. GE agreed to pay IDX shareholders $44 a share in cash, or a 25% premium over IDXC's closing price on Wednesday. In premarket trading, the shares of IDXC were up about 23 percent to $43.24, indicating a high likelihood that this deal will be completed. Also, in premarket trading, shares of GE were up 6 cents to $33.55, a 0.18% gain, indicating that analysts and investors also approve of the deal; however, with a market cap of $335.02 billion, the stock price might be up with market conditions and not because of this relatively "small" transaction for GE. (AP report can be found here) GE shareholders should be somewhat comforted by the fact that cash deals have a better history that stock swap deals. Update 11:15am EST: GE shares are trading down 28 cents, while IDXC shares are trading up 8.08, about 23% still.
Also, E-Trade Financial Corp. (NYSE: ET) announced today that it will purchase rival BrownCo from JPMorgan Chase & Co. (NYSE: JPM) for $1.6 billion in cash. This deal marks E-Trade's second major rival in the past couple months. E-Trade agreed to purchase Harris direct from BMO Financial Group for $700 million in August. The brokerage sector is in rapid consolidation because of slashing fees in an attempt to gain customers and increase trading volumes, and this marks another move by E-Trade to increase its market share against to competitors Charles Schwab (NYSE: SCH) and Ameritrade (NASDAQ: AMTD). Ameritrade had earlier refused a $5.5 billion takeover bid from E-Trade and then announced that it would purchase TD Waterhouse from Toronto-Dominion Bank for $2.9 billion. After the announcementof the E-Trade deal, in premarket trading shares of E-Trade were up 62 cents to 16.95, or an increase of 3.8%, and shares of JP Morgan, which expects to net $700 million from the sale, were up 8 cents to $34. (AP Report can be found here.) The market appears content with both sides of the deal; JP Morgan seems to be getting a fair price and E-Trade can profitably use the new assets.
September 28, 2005
Ronald McDonald Part II
As I noted in my post entitled "Will Ronald McDonald Put on His Smiley Face for the Hedge Funds...", Pershing Square has acquired a 4.9% or nearly a $2B stake in McDonalds. Today in the Wall Street Journal on the front of page C1 (the report can be found here, but a subscription is required), the Journal, in a piece by Jesse Eisinger, discusses what Bill Ackman, the hedge fund manager of Pershing Square, would consider doing with Mickey D's. (MarketWatch.com's coverage on the Journal report can be found here.)
Basically, Ackman sees McDonalds as three separate businesses: A franchising operation accounting for nearly 3/4 of its restaurants, a restaurateur that owns and operates the rest of its operations, and a real-estate company that owns the land beneath nearly 40% of all of its restaurants. According to the Journal, Ackman wants the Golden Arches to sell off a majority stake in the company-owned restaurants as a separate, publicly traded entity, making the entity one big McDonald's franchisee, and keep the franchise operation and the real estate. Ackman would then have McDonald's borrow against its real estate's untapped value and give the money to its shareholders.
Between the two business's that Ackman wants to keep, the franchisor business charges 4% of franchisee revenue generated and the real estate company gets an additional 9-10% in rent. These businesses have high returns and low cost of capital. However, the restaurant management side of McDonald's demands huge capital spending and produces low profit margins.
Ackman values McDonald's real estate assets at $60 billion, based on the cash it produces, yet the company's market cap is approximately than $41 billion.
The Journal report compares Ackman's idea to when Coca-Cola divided its syrup business (NYSE: KO) from its bottling operation (NYSE: CCE). This move created immense shareholder value for Coca-Cola shareholders, and Ackman hopes to do the same for the shareholders of McDonalds.
The Journal article concludes with the statement "Critics of hedge funds deride them as vultures that swoop in for short-term feasts. But Mr. Ackman has been at this since 1997. And now we will see whether he ends up with a happy meal." As I stated here, with regards to Wendy's (NYSE: WEN), and here and here, with regards to Dan Snyder's tender offer for Six Flags, this appears to be another case where the hedge funds are not only giving advice on how to create value -- they are willing to back their advice with skin-in-the-game (cash). Their advice comes with much more weight than the advice of the consultant paid by the hour. Of interest is why McDonald's internal management team does not already have such a plan on the table -- why does McDonald's compensation structure for their managers not give their managers sufficient incentives to unlock shareholder value in sensible restructuring? Why does this kind of restructuring need to come from the outside?? Silly me, sorry, I got carried away -- the obvious answer is that traditional management compensation rewards company size, not company value.
Supreme Court Takes Business Tax Credits Case
The Supreme Court of the United States agreed Tuesday to hear and decide an appeal of DaimlerChrysler Corp. v Cuno and Wilkins v Cuno, two Sixth Circuit cases on business tax credits. The Sixth Circuit had invalidated an Ohio investment tax credit for DaimlerChrysler's modernization of an old Jeep factory in Toledo. The court held that the credit violates the Commerce Clause of the United States Constitution because it interferes with interstate commerce. The credit provides an incentive for in-state investments, discriminating against out-of-state investment locales.
In granting certiorari, the Supreme Court also directed the parties to brief and argue the following question:
Whether respondents have standing to challenge Ohio's investment tax credit, Ohio Rev. Code Ann. §5733.33.
Both of these cases have been consolidated and one hour will be allotted for oral argument. (The Supreme Court Order in .pdf format can be found here.)
I have written here about the tawdry business of negotiating states against each other for tax credits and believe that the country would be better off if state and local governments could collude to end these auctions. recall I doubt, however, that the Supreme Court will find such collusion in the already abused and over-stretched Commerce Clause.
Canaries Part II
To go along with my "Canaries in the Coal Mine" theme, yesterday September Consumer Confidence numbers fell its largest amount in 15 years. The culprits?? Hurricane Katrina and the rising costs of gasoline and heating fuel.
What I find extremely interesting are these comments from the Conference Board:
"Consumers’ overall assessment of ongoing conditions was considerably less favorable in September. Those claiming business conditions are “good” declined to 25.2 percent from 29.7 percent. Those claiming conditions are “bad” increased to 17.7 percent from 15.1 percent. The employment picture was also less upbeat. Consumers saying jobs are “hard to get” increased to 25.4 percent from 23.1 percent, while those claiming jobs are “plentiful” fell to 20.1 percent from 23.6 percent.
Consumers’ outlook for the next six months turned considerably pessimistic. Those anticipating business conditions to worsen increased to 19.8 percent from 10.0 percent. Those expecting business conditions to improve declined to 15.3 percent from 18.7 percent.
The outlook for the labor market also soured. Those expecting more jobs to become available in the coming months decreased to 14.0 percent from 16.4 percent. Those expecting fewer jobs increased to 25.0 percent in September, up from 17.3 percent in August. The proportion of consumers anticipating their incomes to decrease in the months ahead rose to 10.8 percent from 8.9 percent last month."
Also, yesterday Mohawk Industries (NYSE: MHK), maker of carpet and floors, announced that increased energy and raw material costs will cause it to miss earnings expectations. (AP report can be found here). In response to the increased costs, MHK will pass those costs onto the consumer with price increases faster than in the past, including between a 5 and 8 percent increase in the price of carpet on October 3rd. MHK also stated that these increases do not include impact of Hurricane Rita, which also has potential to create increased costs.
Finally, today the American Bankers Association announced that a record number of credit card payments that were past due shot up a record 4.81%; the highest increase since the ABA kept this information. (CNN.com report here and AP report here). The ABA's Chief Economist, Jim Chessen, said in an interview with the AP, "The rise in gas prices is really stretching budgets to the breaking point for some people," the association's chief economist." He continued, "Gas prices are taking huge chunks out of wallets, leaving some individuals with little left to meet their financial obligations." Chessen also stated that with the national savings rate at negative 0.6% in July, people have less of a cushion to absorb big jumps in energy prices.
I continue to believe the writing is appearing on the wall that a downturn in the economy is coming, as the consumer will no longer be able to or want to spend as freely as he/she has in the past ten years or so. And as I have already stated here and here, I believe that the stock market is preparing for a major correction. Nevertheless, Investors Business Daily is stating that a drop in consumer confidence may not mean a drop in spending, but I still believe that a downturn is looming.
September 27, 2005
Ellison Settlement Rejected by Judge
Ellison's offer to settle a shareholder derivative suit over allegations of insider trading, which I discussed previously here, hit a snag. A sensible state superior court judge in Redwood City California asked the simple question: Why should the company pay $23 million to plaintiffs' lawyers when the firm itself is not getting a dime?" The $100million offered will go to a charity picked by Ellison. The judge has asked for briefs and a hearing on the question, scheduled in November. I suspect that the judge's request will change the nature of the settlement before the hearing. I personally hope that Ellison submits to his famous stubborn side and tries to justify the settlement in the November hearing. The argument will be high comedy as the very clever try to convince us that black is white (or vice versa).
SEC Chairman Cox Recuses Himself From Frist Investigation
After a reminder by Political Money Line that Cox had donated $1,000 to Frist's reelection campaign, Cox recused himself from the SEC's investigation into whether Frist engaged in insider trading when selling his stake in HCA earlier this year. Cox is a former Republican congressmen from California; Frist is the current Republican Majority Leader of the Senate. The SEC investigation is left to the four remaining commissioners, two Republican and two Democrats. Cox's recusal is a reminder that Cox will face a serious of questions over the SEC's regulation of companies and individuals that may have participated in Cox's political campaigns or otherwise joined Cox in his political activities. Frist is in deep political trouble over these stock sales folks.
September 26, 2005
What Does It Take to Fire a Bad Board of Directors?
It is easier to fire a CEO than to fire an incompetent board of directors. The article today in the NYT (C1) on the board of Hollinger International is sobering. Conrad M. Black is under criminal investigation for cheating Hollinger shareholders. He was pushed out. The guts of the old board that let Conrad misbehave, per the findings of a subcommittee of new independent directors of the firm itself announced over a year ago (!!), and that agreed to pay $50 million to settle a shareholder suit, is still in office collecting $50,000 a year in fees ($3,000 per meeting). It included Richard Perle (former assistant secretary of defense and philosophical darling of the right), Henry Kissinger (yes, that one), Richard Burt (former ambassador to Germany) and James Thompson (former Governor of Illinois). One realizes how little control shareholder have over board selection and retention when you see something like this. I would favor an immediate shareholder vote on retention, at the firm's expense and with detailed information, whenever a special board subcommittee announced findings of board inattention or whenever board members pay to settle a shareholder suit. Companies ought to include such a procedure in their bylaws; a federal rule should not be needed. Something, anything is better than this system of board retention.
Markets as Forecasters
I have always been a big fan of the Iowa Electronic Markets, trading markets that predict the outcomes of major elections in the United States. Traders buy and sell futures in various candidates for real returns and the market prices predict the eventual outcome. The past presidential markets started with the primaries and ended with the final election; it was more accurate at any given time than the many political polls. It is one thing to play games with pollsters; it is quite another to bet your money on your beliefs. Between elections, Iowa offers markets in other things. At present there is a market predicting the moves of the Fed (even money on whether the Fed target rate goes up or stays the same next month).
Google has created a similar market in house, with its employees. The system accepts bets in 10 cent increments up to a dollar in "parlor money." Something priced at 50 cent reflects a 50 percent likelihood that an event will happen. The Iowa market is more sophisticated, using true market futures with real money (you pay for getting $1.00 if you projection is correct). The Google market is broader the the Iowa market, including the weather, and narrower, including projections on Google specific events (office openings and product introductions). They are having a great time with their market and it is useful for making internal company decisions.
Will all large companies soon have one??
Postscript: John Roberts McDonald writes to remind me that there is a book on markets as forecasters: James Surowiecki, "The Wisdom of Crowds"