Portfolio Review

6/6/2011


CEO woes obscure Microsoft's strengths

When a company's share price rises after an influential investor calls for the ouster of the CEO, it generally reflects a widespread lack of confidence in leadership. Since a hedge-fund manager and major Microsoft ($25; MSFT) shareholder suggested that the board of directors fire Steve Ballmer, Microsoft shares have risen more than 3%. Given Microsoft's abysmal 10-year returns and recent weakness — down 10% since the end of January, versus a 4.5% gain in the S&P 500 Index — investors are understandably frustrated. However, the company's board reportedly still backs Ballmer, and a near-term change seems unlikely.

While Ballmer grabbed some headlines, Microsoft's real news involves new products. According to some news reports, Microsoft planned to preview its Windows operating system for tablet computers in early June, though the final product will not launch until next year. In addition, an alliance with British semiconductor maker ARM Holdings ($29; ARMH) opens up the prospect for Windows to expand into entirely new realms, such as televisions and cars.

Microsoft remains heavily dependent on the personal computer, a product in danger of being marginalized by tablet computers and smart phones. However, at less than 10 times projected earnings of $2.58 per share in fiscal 2011 ending June, Microsoft shares already reflect plenty of uncertainty. Microsoft is a Long-Tern Buy.

Merger update

NASDAQ OMX Group ($26; NDAQ) and rival NYSE Euronext ($36; NYX) have both made offers to buy LCH.Clearnet, one of Europe's largest clearinghouses for financial derivatives. The exchanges reportedly offered $500 million to $720 million, with NYSE currently the high bidder. Exchanges covet clearinghouses because the combination will presumably give them more control over derivatives trading. NASDAQ is a Buy and a Long-Term Buy.


South Africa's competition tribunal has approved Wal-Mart's ($55; WMT) $2.4 billion purchase of a 51% stake in Massmart Holdings. Wal-Mart agreed not to cut staff for two years and to honor labor agreements for three years. Other government agencies have yet to rule on the merger, but the tribunal's approval suggests a positive outcome is likely. Labor unions oppose the deal and plan to boycott Wal-Mart. Wal-Mart is a Long-Term Buy. 

Corporate roundup

The National Institutes of Health halted a study of Abbott Laboratories' ($52; ABT) Niaspan, a super-strong vitamin B compound, when the drug failed to reduce heart attacks, strokes, or the need for procedures to clear clogged arteries. Niaspan has been proven to boost levels of HDL — the good cholesterol that helps the body dispose of fats. Researchers had hoped that in concert with statin drugs that lower levels of bad cholesterol, Niacin would help limit heart problems. While the Niaspan study setback is disappointing, it should have little effect on Abbott's operating results in the near term. Abbott is a Long-Term Buy.


Drugstore and pharmacy-benefit management giant CVS Caremark ($39; CVS) won a contract to cover 5 million federal employees. The contract, previously held by Medco Health Solutions ($60; MHS), generates about $3 billion in annual revenue. CVS and Medco are rated B (average).


Google ($529; GOOG) has partnered with MasterCard ($287; MA) and Citigroup ($41; C) to offer a digital-wallet service that will allow users of certain Android phones to make electronic payments at physical stores. eBay ($31; EBAY), operator of the PayPal electronic-payment system, promptly sued Google for allegedly misappropriating trade secrets. MasterCard is a Focus List Buy and a Long-Term Buy. Google and eBay are rated B (average). Citigroup is rated C (below average).


General Dynamics ($74; GD) received a $744 million contract modification that fully funds the construction of a new class of ship, a mobile landing platform for offloading equipment and supplies. An option for a third ship boosts the value of the job to $1.3 billion. General Dynamics rose 4% on the news, possibly helped by a brokerage upgrade as well. General Dynamics is rated A (above average).

Tablet computer update — Intels gambit and piling on Apple

Semiconductor giant Intel ($23; INTC) is taking on the tablet computer — without a tablet of its own. On May 31, Intel introduced its 'ultrabook,' a new class of laptop less than an inch thick. Intel says its notebook has 'tablet-like' features, including the ability to start up in seconds. We rated Intel a Buy and a Long-Term Buy before the ultrabook announcement, and this new product could provide additional upside to a company expected to grow per-share profits 12% this year and 4% next year.

While Intel has been slow to crack the tablet market, the company expects its microchips to power 35 tablet models by the end of the year. Intel also appears ready to attack the tablet market from a different direction. In recent weeks, many have speculated that Intel might be willing to deviate from a long-held strategy and manufacture microchips for competitors.

Intel, widely respected for its manufacturing acumen, has already signed some small fabrication deals, though we have yet to see high-profile pacts with household names. The company attempted to quash rumors of a manufacturing hook-up between Intel and Apple ($348; AAPL), saying no such deal was in the works. However, in today's world of tech companies that sign collaboration agreements with one hand and fight for market share with the other, investors should not assume that what was true Friday is still true Monday.

Apple grabs the biggest headlines with its hugely successful iPad, which reportedly comprises about 80% of the fast-growing U.S. market for tablet computers. But when you sit at the top of the mountain, you make a good target, and Intel isn't the only technology company hoping to take a bite out of the same apple.

Research in Motion ($40; RIMM), maker of the BlackBerry mobile phone, launched its PlayBook tablet in April. The device has received mixed reviews, and it is too early to speculate on PlayBook's market share. Hewlett-Packard ($37; HPQ) plans to release its TouchPad tablet this summer, jumping into an increasingly crowded pool.

Given Apple's huge lead and the uncertainties surrounding any new entries into the tablet market, subscribers looking to profit from the tablet craze should stick to the leader, a Focus List Buy and a Long-Term Buy. We rate H-P a Buy and a Long-Term Buy, but that reflects its valuation and its wide-ranging business model. TouchPad could prove an appealing kicker, but don't buy the shares in hopes of such a boost.

Apple is not sitting still while its rivals take potshots. The company announced plans to unveil Lion, the next generation of its Macintosh computer operating system, June 6. Apple also reportedly signed deals with three major music producers to provide online storage as part of its iCloud initiative.

Rank Changes

No changes were made this week in Dow Theory Forecasts.


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