Portfolio Review

3/16/2009


Mergers and deals
Just three trading days after Swiss drugmaker Roche raised its takeover offer for Genentech ($92; DNA) to $93 per share, the two companies have reportedly agreed to do the deal at $95 per share. Roche already owns 56% of Genentech, but the remaining stake has proved elusive. Last summer, Genentech’s board spurned Roche’s bid of $89 per share, seeking a price of $112. Roche’s pursuit turned hostile in February, when it offered $86.50 directly to shareholders. Genentech shares rallied on the news and now trade at less than $3 below Roche’s offer price. Genentech is a Long-Term Buy.


Drug giant Merck ($22; MRK) agreed to buy Schering-Plough ($21; SGP) for $41.1 billion in cash and stock, a 34% premium to Schering’s price at the time of the announcement. Merck will fund the deal with $9.8 billion of existing cash, $8.5 billion in debt, and nearly $23 billion in common stock. The deal will boost Merck’s presence in biologics — drugs made from living cells — while also adding a consumer-health business that includes the allergy pill Claritin and Coppertone sunscreen. Merck is rated Neutral.


Overcoming concerns over financing, Dow Chemical ($7; DOW) agreed to acquire Rohm & Haas ($78; ROH), a specialty chemical maker. Shareholders will receive $78 per share plus proceeds from the fee of $3 million a day that Dow incurred after failing to close the deal in January. In lieu of a cash buyout, Rohm & Haas’ two biggest shareholders will receive $2.5 billion in Dow preferred stock. Dow Chemical is rated Neutral.

Financial report
Federal Reserve Chairman Ben Bernanke breathed hope into the market and reiterated that financial firms are the key to recovery. If the Obama administration can stabilize banks, Bernanke said, “then I think there is a good chance the recession will end later this year and 2010 will be a period of growth.” Bernanke proposed overhauling financial regulation by creating a single entity to oversee the entire financial system. He also suggested relaxing accounting rules for banks struggling to value illiquid assets, though this move could encourage banks to hide losses.

The country’s biggest banks will undergo stress tests through April. Results from those stress tests are supposed to determine whether they receive federal funds, although Bernanke said the largest banks will not be allowed to fail. In related news, details on how the Obama administration intends to remove toxic assets from bank balance sheets could come in the next few weeks.


The Federal Reserve resisted congressional pressure to name 25 financial firms that benefited from the bailout of American International Group ($0.42; AIG). AIG insured investors against risky bets on collateralized debt obligations, then was unable to come up with roughly $50 billion when the investments soured. The Fed said disclosing the identities of the clients could prevent their doing business with AIG again, but some of those names appear to have already been released. News organizations reported the involvement of financial institutions from around the world, including Deutsche Bank ($29; DB) and Goldman Sachs ($85; GS), which each received about $6 billion from AIG, and Bank of America ($5; BAC) and Merrill Lynch, which received undisclosed amounts. American international Group, Goldman Sachs, and Bank of America are rated Neutral.


Citigroup ($1; C) expects to earn $8.3 billion before taxes and special items in the March quarter. The company hasn’t made a profit since the September 2007 quarter. Before the announcement, consensus estimates called for Citigroup to post losses in the first three quarters of 2009. Citigroup is rated Neutral.


General Electric ($9; GE) issued $8 billion in debt backed by the Federal Deposit Insurance Corp, sending the shares up nearly 20%. In other news, the financing unit offered to buy back $1.5 billion of debt. While the price action was encouraging, GE still faces a host of problems both financial and operational, and thus retains its Neutral rating.


Wells Fargo ($12; WFC) slashed its quarterly dividend 85% to $0.05 per share in an attempt to strengthen its capital position and save $5 billion a year. Wells Fargo is rated Neutral.

News roundup
United Technologies ($41; UTX) had expected an economic recovery in the second half of 2009 but now plans to cut 5% of its work force to cope with a potentially longer downturn. United Technologies also said it expects 2009 per-share profits of $4.30 to $4.90 excluding restructuring costs, down from an earlier target but roughly in line with the $4.61 consensus. Shares of United Technologies, a Buy and a Long-Term Buy, rose on the news, most likely because profit guidance could have been much worse . . . General Dynamics ($38; GD) scaled back production of Gulfstream business jets, citing weak sales and a sharp decline in the backlog in February. General Dynamics now expects 2009 per-share profits of $6.00 to $6.10, down from earlier expectations for at least $6.70 and the $6.73 consensus. On a more positive note, General Dynamics hiked its quarterly dividend 9% to $0.38 per share, payable May 8. General Dynamics is a Buy and a Long-Term Buy . . . Chevron ($62; CVX) plans to raise production 4% in 2009, assuming oil prices remain near $50 a barrel. The company will also defer some projects, especially lower-profit wells, as it looks to slash upstream costs 14%. Chevron is a Buy and a Long-Term Buy . . . Wal-Mart Stores ($48; WMT) benefited from heavier foot traffic and larger transactions as same-store sales excluding gasoline rose 5.1% in February. The retailer also increased its quarterly dividend 15% to $0.2725 per share. Wal-Mart is a Long-Term Buy . . . A federal grand jury is investigating allegations that Stryker ($32; SYK) illegally promoted bone-growth products, misbranded medical devices, and submitted false reports to the U.S. Food and Drug Administration. Stryker is a Buy and a Long-Term Buy . . . The Food and Drug Administration alleged that Gilead Sciences ($45; GILD) misled them about the risks of Letairis, a treatment for pulmonary arterial hypertension. U.S. regulators ordered Gilead to halt any marketing that downplays the drug’s risks, which include liver injury and birth defects. Gilead Sciences is rated Neutral.

Automakers need traction
Auditors for General Motors ($2; GM) said the company could face bankruptcy even if it receives more federal loans. The automaker seeks a total of $30 billion in U.S. assistance. GM is rated Underperform.


Ford ($2; F) offered stock and a cash sweetener of $2.2 billion in exchange for $10.4 billion of debt. Ford hopes lowering its interest expense will help return the automaker to profitability as it restructures without federal assistance. Ford appears to be the strongest of the U.S. automakers. But given the sharp downturn in demand for cars and Ford’s still-heavy debt load, the stock remains an Underperform.


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