Pershing Square Puts Negotiations on Hold

Target Corporation (NYSE: TGT) shares moved lower after Pershing Square Capital Management announced they would defer discussions with the retailer on a potential real estate transaction until after the new year. The hedge fund’s revised transaction addressed issues brought up by Target and its shareholders, but the retailer opted not to pursue the opportunity at this time. As a result, the hedge fund agreed to wait until the pressures of the holiday season were over.

Target made the decision after a comprehensive evaluation of the various real estate structure ideas proposed by William Ackman’s Pershing Square over the past six months. A comprehensive review by the retailer along with its advisor, Goldman Sachs, concluded that the potential value created, if any, is highly speculative and insufficient to merit pursuit of the transaction after considering the cost, strategic and operating risks and loss of financial flexibility.

Pershing Square noted that they respectfully disagree with the company’s and its advisors’ present conclusions. They believe that the revised transaction would provide tremedous value and improve the company’s access to capital with minimal risk. As a result, they intend to pursue the matter in the new year, after the holiday season. Analysts tend to agree with at least one saying that the transaction would merit another careful look by the company and its advisors.

Investors may be looking for some change too as the holiday season isn’t expected to produce much of a boost. Statistics from the so-called “Black Friday” showed better-than-expected traffic with very limited buying. Cut-rate DVDs drew buyers, but worries about the economy seems to have kept a lid on purchases as the holiday season began. Shares of retailers like Target declined on the day as a result, and investors may be interested in seeing a change to unlock value.

Investors interested in placing bets alongside billionaire activist William Ackman may want to consider long-term options called LEAPS. These LEAPS allow investors to purchase stock at a fraction of the cost, which enables not only a lower initial cost but also a more leveraged position. Currently, the $35 January 2011 LEAPS are trading for just $12.90. This means that investors can purchase the right to buy 100 shares of Target at $35 for just $1,290 right now.

Invest Alongside Icahn in Exelixis with Less Risk

Exelixis Inc. (NDAQ: EXEL) shares moved higher after Carl Icahn purchased a 1.3 million share stake in the drug maker. The news comes as the San Francisco company is seeking partners to help develop the cancer-fighting compounds that it is researching. The firm has also been active in working to sell its research to potentially interested parties.

Bristol-Myers Squibb (NYSE: BMY) recently counted itself among these partners. The large pharmaceutical firm picked up development of XL413 - a pre-clinical drug candidate that inhibits a protein required for DNA replication and therefore might be useful in treating tumors that increase production of the protein.

Bristol-Myers exercised its option to continue development via a $20 million milestone payment to Exelixis. The agreement also gives Exelixis two choices: The ability to co-promote the drug and get half the profits in exchange for 35% of the development costs, or give Bristol-Myers the rights to the drug in exchange for future milestone and royalty payments.

Regardless, the $20 million cash infusion will help Exelixis towards its guidance of $200 million in the bank, but will fall short unless they sign another deal. The good news is that management seems confident that it will be able to find partners for one or more of its drugs. And these prospects are likely the reason that Carl Icahn got involved.

So, how can individual investors take a stake alongside Carl Icahn without taking on as much risk? LEAPS, or long-term equity anticipation securities, are long-term options that act similar to regular stock. The difference is that it costs less than buying stock outright while also lowering the risk.

Currently, the January 2010 calls with a strike price of $5.00 are trading for between $0.25 and $0.85. Investors would therefore have the right to purchase 100 shares at $5.00 anytime over the next 415 days for just $25 to $85 down right now. Also, the total loss is limited to those amounts rather than a $300 payment to establish a regular stock position.

Are Apple Shares Undervalued?

Apple Inc. (NDAQ: AAPL) may remain a strong stock fundamentally, but selling continues to plague shares. Analysts are concerned that the current economic crisis will hurt sales in 2009 and lowered their forecasts for the technology company. Apple’s actual sales have shown no significant declines while the company has beat analyst esimtates every quarter since 2005. So, is Apple a good deal? And if so, how can bullish investors place a long-term bet on the stock while surviving the unjustified selling?

Analysts covering Apple stock are making several assumptions about the future when lowering their forecasts. First, they assume that sales will be flat across all of Apple’s product lines, including Macs and iPhones that have performed well thus far. Secondly, they often do not fully take into account Apple’s large amount of deferred revenues that will automatically be realized in 2009. These revenues top $3 billion and are realized from Apple’s subscription services, such as the iPhone and Apple TV.

Apple’s balance sheet also remains very attractive. The firm has no debt on its books with $24.49 billion in cash - or roughly $27.50 per share. Apple is not only well capitalized, but also generates strong cash flows from operations that showcase its ability to remain well capitalized going forward. Finally, given its low valuation and strong growth, the stock trades with a PEG ratio of just 0.86, which suggests that it is substantially undervalued given its growth rate.

So, how can bullish investors capitalize on this apparent undervaluation? The answer may lie in long-term options called LEAPS, which enable investors to own the rights to purchase a stock for a fraction of the cost of purchasing the underlying stock outright. Currently, investors can purchase the right to buy 100 shares of Apple stock at $100 per share anytime between now and January 2011 for just $3,105 down compared to $8,941 down purchasing the underlying stock. Ticker Symbol: VAA AT.

Acquisitions May Pay Off Long-term for Bank of America

Bank of America Corporation (NYSE: BAC) opened sharply higher as the markets applauded a Citigroup (NYSE: C) bailout package. The bank is considered to be one of the best performing among its peers thanks to careful money management and a series of acquisitions that could pay off handsomely in the future. Meanwhile, the bank’s recent fundraising efforts have yielded an additional $10 billion in capital that will be used to shore up its reserves and calm fears.

Bank of America acquired mortgage giant Countrywide and Merrill Lynch during the past year, which are two of the most influencial companies in their industries. Luckily, the bank was able to get a deal on both firms thanks to turbulent financial markets. The big question is whether or not Bank of America has enough money to keep the positions held by these firms running smoothly while the markets current themselves. If so, Bank of America shareholders may be in for a pay day.

The mortgages and securities held by Countrywide and Merrill Lynch may not be worth a lot now, but they could increase in value over the next few years. These long-term assets are subject to short-term pricing disparities thanks to mark-to-market accounting, which requires that the value be the current market price. So, even if a security is worth a lot of money (by taking the present value of its future cash flows), it isn’t worth a dime on the balance sheet if no investors want to purchase it. Fortunately, a recovery in the credit market will help these purchasers come back out to play.

Unfortunately, shareholders must deal with the pain in the interim period while a recovery takes effect. Last quarter, bank of America reported a sharp drop in its profits and cut its dividend to shore up capital reserves. Meanwhile, CEO Kenneth Lewis noted in a conference call that the U.S. economy slowed during the past 45 days and has no immediate prospects of getting better. In fact, unemployment is at a 16 year high while consumer confidence is near its lowest level in history.

Investors looking to take advantage of the upside potential of Bank of America without taking on all the risk of purchasing the stock may want to consider long-term options known as LEAPS. LEAPS enable investors to purchase the rights to upside on the stock while only paying a fraction of the cost of ownership. Currently, the $15 January 2011 calls are trading for just $4.90 a piece, which means that investors have the right to 100 shares at $15 during the next 788 days for just $490 down now!

Petrobras’ Future Could Be Bright

Petroleo Brasileiro SA (NYSE: PBR) has uncovered what has been called one of the biggest oil fields in the world, but the retreat in oil prices has led to a sharp drop in the firm’s market valuation. The drop can be attributed to the fact that the majority of this oil is very expensive to get out of the ground and the company’s project assumptions of $40 a barrel oil is at risk of breaking. The big question is: How far will oil drop and will it stay low?

Oil prices hitting $147 were a clear sign of a bubble, but many are saying that $40 a barrel may be too low. So, where is the actual market equilibrium for crude oil prices? The question is difficult to answer due to the nature of the oil market - the supply side is tightly controlled and the demand side is difficult to predict. However, we know that an improvement in the economies of the world would increase the appetite for oil once more and spur prices higher.

So, assuming the current economic crisis doesn’t last forever, oil prices should eventually move higher. The big question is when this will happen. The United States is the largest consumer of oil and the current recession is expected to last for awhile. However, a rebound in oil prices only relies on an increase in spending, which some economists are expecting to see as early as the second half of 2009. So, if oil begins to turn around companies like Petrobras could prove to be quite the bargain.

Petrobras currently trades at just over 4x earnings despite holding rights to one of the largest oil reserves in the world. Its recent discoveries off the coast of Rio de Janeiro have been estimated to contain billions of barrels of high quality light crude oil. The company just recently began commercial production of Brazil’s first subsalt oil a few months ago by linking a subsalt well to an existing production platform that was lifting heavy oil from shallower depths.

Investors confident in oil’s eventual recovery and Petrobras’ impressive line-up of projects over the long-term should consider investing in long-term or LEAPS options. These let investors place bets without committing as much capital up-front, which helps multiply gains when a recovery takes place. Currently, the January 2011 $25 LEAPS are trading at just $5.00 a piece. This means that investors can obtain the rights to 100 shares of Petrobras at $25 per share anytime during the next 791 days for just $500 down!

AK Steel Slides on Lower Steel Forecasts

AK Steel Holding Corporation (NYSE: AKS) shares moved sharply lower Thursday after weak demand led to an inventory reduction, sharply lower sales, and falling product prices. Prices have already fallen from $1,100 to $1,200 this summer to recent spot rates of around $650 to $700 per ton. These trends are expected to continue throughout the rest of the year, but just how far can steel stocks fall before the industry bottoms?

AK Steel is currently trading at just 1.08x earning while paying a 3.83% dividend yield. Meanwhile, the steelmaker is expected to earn $3.09 per share next year which puts the forward multiple at 1.68x earnings. The company also noted that steel prices remain under pressure and that the average selling prices will now fall at least 10%. Lower shipments to automotive, appliance and construction markets were the to blame for the declines.

Since the decline began, AK Steel has focused on leaning its operations and streamlining its processes. In addition to its large dividend yield, the firm also agreed to repurchase $150 million of its outstanding common shares in an effort to boost its earnings per share and stock price. Meanwhile, the cheap valuation of AK Steel has sparked some rumors that ThyssenKrupp and others may be interested in purchasing the company. However, ThyseenKrupp denied the reports late last month.

Investors interested in establishing a position without committing a lot of capital may want to consider purchasing LEAPS options. The January 2011 $5 calls can be purchased for just $2.80 right now, which means a position can be established for $280 for the rights to 100 shares compared to $522 for the same amount of underlying stock. Given the volatility, this downside protection may be worth the price while any long-term recovery to the upside over the next 791 days leaves lots of possibilities open.

HP Earnings Poised to Jump by LEAPS and Bounds

Hewlett-Packard Company (NYSE: HPQ) shares moved higher after a solid fourth quarter and LEAPS could be the best way to play the strength. The technology company surprised Wall Street this week with after earnings beat expectations despite other technology giants slashing forecasts and posting weak results. The technology firm also issued better-than-expected forecasts for the upcoming year despite economic headwinds, which has many investors very bullish on the stock.

Hewlett-Packard forecasted top-line revenues of $33.6 billion compared to analyst expectations of $33.09 billion while predicting bottom-line adjusted earnings per share of $1.03 per share compared to analyst estimates of $1.00 per share. The technology giant attributes the better-than-expected forecasts to its global reach, diverse customer base, broad portfolio and numerous cost initiatives. Results were also helped by its $13.9 billion acquisition of Electronic Data systems Corporation.

Hewlett-Packard is expected to release its earnings on November 24th. Investors looking to establish a long-term position in the company may want to consider purchasing LEAPS options over outright stock. Currently, the $30 January 2011 LEAPS calls are trading for $10.90 a piece, which means that investors can buy the right to purchase 100 shares between now and January 2011 for just $1,090 up front. The breakeven on the position would be $40.90 per share.

Ackman: Target Shares Worth $37/Share

Target Corporation (NYSE: TGT) shares fell sharply despite an activist investor’s plan to unlock value. Pershing Square’s William Ackman unveiled plans today to unlock the real estate value by spinning off the firm’s land into a real estate investment trust that would then lease back the land to Target stores via a land lease. The plan initially drew sharp criticism from both the company and investors, but today’s conference call detailed a revised plan addressing the issues raised.

Pershing Square’s plan was designed to improve Target’s free cash flow and access to capital, increase the retailer’s ROIC and lower its cost of capital, maintain its investment grade rating, increase its EPS growth rate, and minimize tax leakage and friction costs while retaining complete control of its buildings, brand, and flexibility with respect to construction, remodeling and relocation plans. Ackman proposed that this could be accomplished through a spin-off of Target’s owned land into an REIT.

Target expressed concerns over the original plan, including concerns about valuation, the reduction in Target’s financial flexibility, credit ratings, borrowing costs, frictional costs, and management diversion. The revised transaction would address these concerns through a six step process: (1) formation of the REIT, (2) primary IPO of <20% of the REIT shares, (3) sale of remaining 53% interest in Target’s receivables, (4) pay down $9 billion of debt using proceeds, (5) spin-off remaining REIT sharholders, and (6) purge retained earnings and profits.

Pershing Square believes that this plan would immediately boost Target’s standalone value to $31 per share while creating a new REIT that would be worth an estimated $37 per share. Therefore, the combined value of the REIT would be $65 per share with the 12-month value being closer to $79 per share. Clearly, this represents a significant amount of value that could be unlocked for shareholders who are now grappling with a share price hovering around $27 per share.

A turn in the economy would also be good news for Target’s new structure. Improved retail sales would generate explosive earnings growth at Target given recent expense reductions. Meanwhile, heightened inflation expectations would increase demands for the REIT given the inflation-protected income stream. In the end, Pershing Square believes that the revised transaction addresses all of Target’s concerns and achieves enormous value creation.

Investors interested in taking advantage of today’s low prices may want to consider purchasing Target LEAPS. Currently, the $27.50 January 2011 LEAPS are trading for just $12.34 a piece. That means that for just $1,234 down now, you can have the right to purchase 100 shares of TGT at $27.50 per share anytime before Janaury 2011. The breakeven would then be $39.84 per share during the next 793 days. Considering the potential value of this transaction, this may represent a good risk/reward trade.

Capitalizing on Target’s Future

Target Corporation (NYSE: TGT) shares dropped sharply over the past month as concerns about the economy weighed on the retail sector. Consumer spending has fallen sharply going into a holiday season that is expected to be the worst in more than 20 years. However, many experts believe that the sharp decline in retailers is overdone while at least one activist investor presented a plan designed to unlock substantial value in the retailer.

William Ackman unveiled a plan last month designed to unlock value in Target’s real estate assets. The activist investor believes that the land beneath Target stores is worth around $40 billion with an additional $20 billion of unencumbered buildings. As a result, the investor recommended that the firm spin-off its land assets into an REIT that would then lease-back the land to Target. The transaction would result in an estimated $70 per share in value with substantial upside going forward.

Target’s critics point to their credit card portfolio as a cause for concern, however. The retailer sold approximately half of its receivables to J.P. Morgan for $3.6 billion in a deal last year that was supposed to mark the beginning of a long-term relationship. Unfortunately, the turbulant credit markets since the deal was inked has caused concern that the remaining half of the portfolio may have lost its value. Target bulls, however, insist that these concerns are overstated.

Income from Target’s credit card portfolio accounted for 3.3% of total sales last quarter with net charge-offs expected to rise to 9% of its receivables for the full year. Despite these rising delinquency rates, the segment still showed earnings of $74 million during the last quarter. In fact, bad debt expense could rise another 28% before the segments profitability would be diminished. The retailer is also taking action to curb rising deliquencies by tightening its standards on new and inactive card holders. These trends are not good for Target as it raises its loan loss reserves to catch up to delinquency rates, but many experts suggest that the charges won’t affect earnings as much as some investors fear. 

Investors interested in taking advantage of a retail turnaround over the next couple of years, combined with the possiblities of value being unlocked at Target, may want to consider long-term options called LEAPS. Currently, the $35 January 2011 calls are trading for just $10.85. This puts the breakeven point to $45.85 per share with the initial position costing just $1,085 to setup for the rights to buy 100 shares at $35 per share between now and January 2011.

Covidien LEAPS: A Good Investment?

Covidien Ltd. (NYSE: COV) shares may be trading well off of their 52-week highs, but some investors believe the medical equipment maker may be overdue for a rally. Barron’s Online recently published an article highlighting the firm’s improving fundamentals, low multiples, and mountain of cash, calling it a quality stock for uncertain times. So, is now the right time for investors to pick up shares in this company?

Covidien was originally a spin-off from troubled conglomorate Tyco Internation (NYSE: TYC) and now stands as one of the world’s largest makers of disposable medical products and a leading surgical equipment maker with annual sales of $10 billion. After years of neglect, Covidien’s efforts to improve profitability and its pipeline are starting to pay off. Management continues to execute with good earnings visibility over the next year given the stability of the business.

In September, Covidien announced that it would implement a restructuring program beginning in fiscal 2009 to improve its cost structure and deliver improved operational growth. The program will result in a pre-tax charge of $200 million in the beginning in the first quarter, but will save $50 million to $75 million on an annualized basis while complete. Howevever, sales themselves are doing very well with 2008 sales expected to come in at the high end of their original forecast.

Covidien is set to report its next earnings on November 17th with analysts estimating $0.68 per share on the average. However, the company has beat estimates for the past four quarters with earnings surprises ranging from 5.7% to 12.6%. Meanwhile, trading at a PE of just 17x and a PEG ratio of 1.08, many investors are hoping that continued surprises will help to jump the share price to a higher 20.8x multiple that its medical equipment peers are seeing.

Investors looking to get into Covidien without committing much capital and limiting risk may be interested in the LEAPS on the stock. The Covidien January ‘10 $45 calls are currently trading at just $7.30 per contract. This means that investors can purchase the right to acquire 100 shares at $45 per share, anytime between now and January 2010, for just $730. This compares to a cost of $4,451 if the stock were purchased now. Maximum losses are also capped at just $730 while gains are leveraged up.

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