Portfolio Review

5/26/2014


DirecTV sells itself to AT&T

First Comcast ($51; CMCSa) and Time Warner Cable ($138; TWC) decide to pair off, and then comes AT&T ($36; T) and DirecTV ($83; DTV). DirecTV agreed to be acquired by AT&T for $48.5 billion, or $95 per share, with cash of $28.50 per share. Including the assumption of debt, the purchase will cost $67.1 billion. DirecTV investors stand to receive $66.50 per share in AT&T stock as long as AT&T shares trade between $34.90 and $38.58. DirecTV shareholders will receive 1.905 shares of AT&T per DirecTV share if AT&T's price is below the range at closing and 1.724 shares if the deal closes with AT&T's price above the range. AT&T expects to complete the deal within a year.

Together, AT&T and DirecTV would have 26 million U.S. pay-TV subscribers, roughly 25% of the market. Comcast would have a leading 30 million subscribers upon completing its $45 billion acquisition of Time Warner Cable and subsequent divestitures. Comcast would still enjoy a significant edge in the number of internet subscribers, though AT&T could try to close that gap by bundling its phone and internet services for sale to the DirecTV subscriber base.

DirecTV shares fell on the announcement and trade well below AT&T's offer price, as investors handicap hurdles that could jeopardize the deal. AT&T and DirecTV may have more overlap in geographic markets than Comcast and Time Warner. Regulatory pressure squashed AT&T's $39 billion bid to acquire T-Mobile USA in 2011, which would have combined the country's second- and fourth-largest wireless carriers. AT&T paid a $3 billion breakup fee for that failed deal; the DirecTV pact features no breakup fee. Moreover, AT&T can back out of the deal if DirecTV fails to renew its contract for the popular NFL Sunday Ticket.

The longest-tenured member of our Focus List, DirecTV has risen 313% since we added it in October 2008, nearly triple the S&P 500's 106% gain. We can't fault investors for sticking with DirecTV if they are confident regulators will ultimately approve the deal, as the stock trades at a 12% discount to the value implied by AT&T's bid.

However, we are removing the stock from the Focus, Buy, and Long-Term Buy lists. We confine these lists to our best capital-returns picks for the next 12 months, or the next 24 to 48 months for the Long-Term Buy List. Given the deal's inherent risks, DirecTV shares will likely trade on regulatory speculation rather than fundamentals in the coming year. And we think we can find better stocks. DirecTV is now rated A (above average), as is AT&T. Comcast is a Buy and a Long-Term Buy.

Two new stocks . . .

Ameriprise Financial ($108; AMP), a provider of investment advice and wealth-management services, is being added to the Buy and Long-Term Buy Lists. The stock earns a Quadrix® Overall score of 96, with above-average scores in all six categories. Strong March-quarter results helped lift the Momentum score to 84, as operating earnings rose 20% on an 8% revenue increase. The core wealth-management unit saw solid inflows from customers, while outflows at the mostly acquired asset-management unit have slowed. Streamlining efforts and efficiency gains should help near-term profit margins, and an increase in short-term interest rates could lift interest income considerably.

In late April, Ameriprise added $2.5 billion to its share-repurchase program and boosted its quarterly dividend 12%. Considering the company's solid balance sheet and improving cash flow — with free cash flow of more than $8.50 per share over the last 12 months — continued dividend growth seems likely. Ameriprise, among the cheapest 25% of U.S.-traded stocks based on forward P/E and trailing price/free-cash-flow ratios, seems capable of reaching $130 to $135 over the next year. The stock, yielding 2.1%, is a Buy and a Long-Term Buy.


ManpowerGroup ($79; MAN) offers staffing and work-force solutions, with an emphasis on servicing industrial companies. It draws about 15% of sales from the U.S. and 65% from Europe, a region where once-fragile labor markets are showing signs of improvement. The company's operating profit margins have expanded in five of the last six quarters, while cash from operations surged 53% in the 12 months ended March. The consensus expects ManpowerGroup to grow per-share profits 16% to $5.13 this year, and the estimate has risen more than 7% in the past month.

Shares rallied on improving results and favorable indicators for near-term staffing demand, yet still earn a Value score of 74. At 15 times estimated 2014 earnings, the stock trades 18% below the median for S&P 1500 industrial stocks. At 17 times trailing earnings, the stock trades 29% below its own five-year average. ManpowerGroup, earning a Quadrix Overall rank of 96, is being added to the Buy and Long-Term Buy lists.

… and another downgrade

DirecTV isn't the only stock coming off our buy lists this week. BlackRock's ($296; BLK) Overall score has dipped to 61 from 73 at the end of April and 90 at the end of March, dragged down by weakening operating momentum, price action, and profit-estimate revisions. The money manager delivered decent March-quarter results, lifted by unusually high performance fees and a real estate-related gain; investors can't count on a repeat of either. While BlackRock enjoyed solid fund flows in the March quarter, much of the new money went into passively managed strategies, which charge lower fees and face stiffening competition.

At 17 times trailing earnings, BlackRock still trades at a discount to its five-year average. However, it is slightly more expensive than the median asset-management stock, not cheap enough to for us to risk the slowing operating momentum, falling Quadrix scores, and potentially less-profitable business mix. BlackRock is being dropped from the Long-Term Buy List and given a B (average) rating on the Monitored List.

Corporate roundup

Apple ($605; AAPL) and Google ($540; GOOGL) called a truce, ending all litigation against each other. They had about 20 lawsuits outstanding in the U.S. and Germany alone. Separately, Google is reportedly nearing an acquisition of Twitch, a service that streams live video, for about $1 billion. A popular destination for watching video games, Twitch receives more than 40 million visitors a month and could bolster Google's YouTube business. Apple is a Buy and a Long-Term Buy. Google is a Focus List Buy and a Long-Term Buy.


AstraZeneca ($74; AZN) rejected Pfizer's ($29; PFE) sweetened takeover bid of roughly $120 billion, up 13% from an offer made earlier this month and a 45% premium to the drugmaker's shares before reports of a potential deal surfaced. AstraZeneca reportedly questioned the strategic benefits of a deal and sought a 60% premium. AstraZeneca's stock dove 12% on the news, though it has since recovered a third of the lost ground. Pfizer is rated B (average). AstraZeneca is rated C (below average).


Abbott Laboratories ($40; ABT) agreed to acquire CFR Pharmaceuticals, based in Chile, for $2.9 billion. Abbott is rated B (average).


Rank Changes

Ameriprise Financial ($108; AMP) and ManpowerGroup ($79; MAN) are being initiated as Buys and Long-Term Buys. DirecTV ($83; DTV) is being dropped from the Focus List, Buy List, and Long-Term Buy List, while BlackRock ($296; BLK) is coming off the Long-Term Buy List. The Vanguard Short-Term Corporate Bond ($81; VCSH) fund now accounts for 2.5% of the Buy List and 6.6% of the Long-Term Buy List.


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