This from Investment U:

It’s not official yet. Apparently the committee of “esteemed” economists at the National Bureau of Economic Research (NBER) doesn’t get paid for timeliness. But the statistics don’t lie… we’re in a recession.

And that’s got me giddier than an Obama supporter scoring an inauguration ticket. That’s right. I’m actually glad the economic data stinks. Because when a recession is here, a small-cap rally isn’t far behind.

Accordingly, I’m loading up on small caps in my own portfolio. I suggest you do the same, instead of joining the lemmings piling into Treasuries.

If you’re reluctant and afraid small caps are too risky, chew on this:

In the year following the six major bear markets of the last century, small cap stocks soared an average of 82%, according to Ibbotson Associates.

If the prospect of an 82% gain doesn’t excite you in these trying markets, check your pulse. If it does, read on…

Any Old Small Cap Just Won’t Do

There’s no denying the strong historical trend, but it doesn’t mean ALL small caps will soar. Nothing in investing is ever that easy. In order to really benefit from the imminent rally, we need to isolate the most compelling and innovative small-cap stocks.

To that end, let me share a disciplined approach that’s always served me well. When it comes to small caps, I focus exclusively on companies with these three characteristics:

• A pioneer on the verge of creating new trends. Companies can create products to compete in existing markets… Or they can create products that are so revolutionary and timely that they launch their own markets and trends. The latter obviously positions the company, and in turn investors, to reap the most profits. If you need help qualifying this factor think Intuitive Surgical (Nasdaq: ISRG), Google (Nasdaq: GOOG), even VMware (NYSE: VMW).

• Within three years of an initial public offering (or major index listing). Smaller and/or newer companies have more room to grow. Plus, Wall Street tends to overlook many of these firms. By focusing on these young and virgin opportunities, we can actually profit ahead of the Wall Street institutions and the trillions in capital they control.
• Increasing earnings by at least 30%. A market panic can only hold back fast growing stocks for so long. Eventually, share prices will follow earnings. By focusing on companies with the strongest growth profiles, we set ourselves up for the most dramatic gains. And yes, even in this market such companies do exist.

Other characteristics worth screening for include: recurring revenue streams, potential applications for products in parallel markets, new products in the pipeline, little or no analyst coverage and management ownership of 10% or more.

Granted, the process of actually finding such companies is tedious and time consuming. But as Abraham Lincoln quipped, “Things [profits] may come to those who wait, but only the things [profits] left by those who hustle.”

In other words, all the hard work we put into indentifying these small-cap stocks will be rewarded. But if we don’t grab the profits while we can, another investor will.

Short on Time? Buy These 2 Small Caps… And Call Me in a Year

I recognize not all of us can scour the markets each day in search of the most compelling opportunities. So let me make it easy for you. Here are two small-cap companies I’m convinced will be 50% higher (or more) a year from now. [Editor's Note: To get all of Lou's small-cap recommendations, you can sign up here.]

• Genoptix, Inc. (Nasdaq: GXDX) The economic cycle doesn’t impact business for this provider of bone marrow and blood-based cancer tests one bit. Sadly, when it comes to diagnosing cancer, people can’t wait for better times. But the company’s focus on community-based oncologists also provides ample growth opportunities. Earnings increased 198% in the last nine months to $26 million. And yet, the company still only controls 4% of the market.
• American Public Education, Inc. (Nasdaq: APEI) This West Virginia-based company provides online, post-secondary education to a very specific market – military personnel. Its niche focus is delivering impressive growth, with revenues and earnings up 56% and 72%, respectively, in the most recent quarter.

Whether you opt for these recommendations or seek out your own, it doesn’t matter. A recession is here, so a small-cap rally isn’t far behind. Before it’s too late, I recommend you position yourself accordingly.

Source: Small Caps: It’s Time to Think Small

JL: So, care to guess what’s on my mind?

CASH: Uh, how about you just tell me, and we’ll pretend I guessed right.

JL: OK. The answer is “burritos.”

CASH: I’m afraid to ask why…

JL: What, you don’t remember? A couple months ago — in early May, to be exact — we talked about one of your favorite stocks, Chipotle Mexican Grill (CMG:NYSE).

CASH: Oh yeah! Chipotle was a major home run. The stock was offered at $22 in early 2006… by the end of 2007 it was well over $150. And investors who didn’t catch the IPO price still had a chance to jump on the rocket ride for huge upside. It’s a powerful example of what the right IPO at the right time can do.

JL: Yep, the early gains were definitely impressive. More than 600% if I recall correctly. But that wasn’t the gist of our conversation in May. The Taipan Daily episode was “Cash Tours the Dark Side,” and you were talking about going short CMG back then.

CASH: Man, you file away everything in that big brain of yours, don’t you? You’re right… CMG was a big winner coming and going for me. Not only was I excited to grab hold of CMG shares for potential 600% gains on the upside, I got excited again when investors took Chipotle too far — making the stock a prime short candidate as it fell back to earth.

JL: Right. So again, looking back on our conversation (which readers can do here), we first started talking about a CMG short on May 6. That was a solid 30 points ago, and CMG shares have coughed up nearly a third of their value since you made that call. Not a bad little short.

CASH: Nope, not bad at all. And there are plenty more great plays out there, too — a few of which are on the books of IPO Confidential as we speak. But you said you had burritos on your mind… What’s the reason for bringing this up again here and now? If I know you like I think I do, the hamster wheel is turning.

JL: Is it that obvious? Considering we’ve been pals for nine years, I guess it is. I’d like to know your current opinion on CMG — partly because I just came across a strongly bullish analyst opinion on the stock.

CASH: Well, let’s see… I’m pretty confident in saying that this is a really, really risky time to be dipping into a growth stock like Chipotle. You can certainly buy the stock for less than you would have paid at the beginning of the year — a whopping 50% less, in fact — but there are many external pressures that haven’t been fully realized in the share price yet. Of course, this is just my humble opinion…

JL: I can think of many colorful words to describe you, ol’ buddy, but “humble” isn’t one of them.

CASH: Touché. What about this bullish analyst opinion you cited? What was the main reason for being bullish CMG?

JL: That’s the part that felt sketchy to me. There was the standard long-term reasoning for liking CMG — quality food, quality service, nice atmosphere, etc — but a big reason cited for buying was overreaction from Wall Street.

CASH: “Overreaction”? That sounds like one of those fishy analyst buzzwords.

JL: The guy was saying CMG got crushed because of an earnings miss. When the quarterly numbers were light by a penny, the stock tanked big time, wiping $540 million off the company’s value. The analyst pegged the sell-off as a huge blunder by Wall Street, saying there was no reason for CMG to fall so hard on a miss of one lousy penny. In his view, this made Chipotle a great value buy.

CASH: Ack! You’re kidding me,

right? This guy honestly thinks that the stock sold off just because of a one-penny miss? He really thinks that the rate of growth is healthy? He honestly wants to own the stock at more than 25 times “projected” earnings for this year? In this environment?

JL: Easy there, friendo. No need to spit coffee all over your trading screens…

CASH: I know, it’s not you I’m upset with. But… Hey, wait a minute. You knew that would get a rise out of me, didn’t you? You just wanted to see my reaction…

JL: No comment. Heh.

CASH: OK, I’ll play along. Given all that I’ve seen in the trading and investing game, I still can’t believe the wacky rationale out there sometimes. The penny miss actually had NOTHING to do with why Chipotle sold off so sharply. That analyst apparently has no idea what really moves a high-multiple growth stock like CMG.

JL: So enlighten our readers. What caused Chipotle to crack wide open if it wasn’t the penny earnings miss?

CASH: Well, as you know, anytime a company reports earnings, the headline numbers can be compared with the picture from the rearview mirror. The headline numbers tell us what happened, in the past tense… not what’s happening right now, or more even more important, the outlook for future business.

JL: So Wall Street didn’t pummel CMG because of a single penny. They pummeled them because the outlook for the future was darker than investors could take, especially with the stock trading at a high multiple.

CASH: You got it. Looking out the windshield (as opposed to the rearview mirror) reveals a much uglier picture. Management actually noted that they were seeing weakening trends in the upcoming quarter that bode further ill for CMG’s business.

JL: You’re talking the same ills we covered back in May, when you called out CMG for a potential short. Consumers tightening up, lower cost competitors, high prices for ingredients, and so on.

CASH: Those are the basic factors, yes. They’ve played a big role in taking the stock way down from its $150 high, but none of the downside factors for CMG have been fully “brought to bear” yet.

JL: Groan…

CASH: I couldn’t resist. Anyway, looking at CMG now, and considering the still-high earnings multiple, the most positive thing you could say is that the company is “reasonably priced.” But even that assumes a positive outlook on the economy, a firm grip on what Chipotle will be earning in future quarters, and a lack of better investing opportunities.

JL: That’s a lot of assuming.

CASH: No doubt. And the truth is that we are NOT in a strong economy, we are NOT confident that CMG can continue to grow at its current rates, and I am NOT anxious to put capital to work in growth stories right now. The scenario simply has nothing exciting about it.

JL: You mentioned the “still-high earnings multiple.” So clearly you still think Chipotle is expensive in that regard, even after the big earnings haircut it took. We’ve talked about sky-high earnings multiples in the past. I’m reminded of the short arguments you made against VMWare (VMW:NYSE) and Salesforce.com (CRM:NYSE).

CASH: Yep. Those are a couple of other names that simply got way ahead of themselves — to our bottom-line profit, I might add. The simple reality is, there’s a time and a place for buying high-multiple growth companies. As a trader, I’ve made plenty of money buying hot growth names at a multiple of 50 times earnings, and then selling them for huge gains at a multiple of 150 times earnings. That’s the way to make big gains in go-go bull markets.

JL: But this ain’t no go-go bull market.

CASH: Oh, heck no. That’s why we’re raking in so much dough on the short side rather than the long side right now. If you’re not in a bull market, buying growth stocks at anything more than rock-bottom multiples can be a death wish. Any uncertainty with future earnings can take a huge chunk out of the multiple in a moment’s notice.

JL: I’ll say. We saw VMWare drop from $53 to $40 in just one day, not long after you tipped readers to short the stock right here in Taipan Daily. And Salesforce.com dropped close to 20% overnight as one of the short positions in IPO Confidential. (Our paid subscribers were, no doubt, excited to see that gain.)

CASH: Yep, and that’s where most investors’ danger becomes our opportunity. We can short these growth names during a bear market and make 40% to 60% as the stock declines… or even better, buy puts on the same names and watch profits stack up to 200%, 400% or what have you.

JL: It’s like Jesse Livermore once said: “There is only one side to be on in the stock market. Not the bull side or the bear side, but the right side.” I guess that wisdom rings extra true with high-multiple growth stocks.

CASH: Absolutely. There are some solid long plays out there, even in crazy markets like this one — but there’s no doubt that now is the time for bears to be raking in the dough. And I love how our subscribers are doing just that in IPO Confidential.

JL: You and me both, amigo. We’ll catch up again soon.

Justice Litle, Editorial Director, Taipan Publishing Group

Source: High-Multiple Growth Stocks: When to Hold ‘Em, When to Fold ‘Em, and When to Go Short

JL: Hey, long time no chat. It’s been a few weeks since we last caught up in Taipan Daily.

CASH: Yep, happy to be back. It was great hanging out and meeting readers at the Global Opportunities Summit in San Francisco, too — even though one or two of ‘em tried to take my picture. Heh.

JL: Speaking of the San Francisco conference, you brought up a topic there well worthy of further discussion. I was hoping we could touch on that today.

Do You Qualify to Receive This Exclusive Information?Privately circulated e-letter gives readers “insider” information on worldwide financial opportunities as they unfold. Although this information is reserved for a very select group of readers, I’ll show you how to get it free.

CASH: Sure. We covered a lot of profitable ground at that conference… Which topic, specifically?

JL: Remember the extended panel session on the final day, where we all talked a little bit about anything and everything? One of the things you mentioned was a “growing pressure in the system” that could result in an explosion of profitable new deals. There were some interesting dynamics there. Can you expand on that a bit?

CASH: Sure. I think the analogy that I used was a garden hose connected to a spigot with no pressure control.

JL: Right. You told a story at the conference about your dad warning you not to use a certain faucet in the yard when you were a kid. But you used it anyway, and the result was a big wet explosion (and a very mad dad).

CASH: Good memory. Yeah that’s the idea. If the nozzle is closed and water pressure builds up in the hose, things look very still and calm from the outside. But on the inside, the pressure continues to rise and rise. That can only happen for so long until something bursts.

JL: So that’s your working analogy for the hidden pressures building up in the new-issues market.

CASH: Yep. You can’t see it without observing closely, but there are two primary forces that will drive this explosion in new issues. The first is growth pressure — a dire need for investment capital. The second is private equity pressure — a need for Wall Street players to book profits on deals.

JL: Can you give more detail on these two “pressure forces”?

CASH: Sure. The first one, growth pressure, is all about small companies needing to fund growth expansion or repair a damaged balance sheet. A weak economy accentuates this. Many firms are seeing lower revenues than they expected. This means they have less working capital to expand factories, beef up the sales force, expand research and development and so on. Without investment capital, small growth companies have a hard time sustaining growth — and that’s what small caps are all about. Many of these companies will need new capital to survive, let alone thrive.

JL: So when it comes down to it, many of these guys will have to come to market as a matter of life and death. And what about the second of the two forces, private equity pressure?

CASH: That’s all about the private equity companies that own many of the companies just mentioned. When a new issue comes to market, many times it’s an exit from a private equity player’s portfolio. Selling shares to the public, in part or in full, is how private equity guys (and gals) get paid. These players can be behemoths like Blackstone or KKR or Fortress Investment Group, or they can be more low-key outfits you’ve never heard of. But the uniting factor is that all these private equity players are sitting on privately held investments that must be released to the public eventually. They’ve been holding a lot of deals back because of rough market conditions — but the pressure to book profits is building, and they won’t be able to hold back much longer.

JL: OK, that makes sense. So the sellers have a vested interest in getting stock out the door and sold to the public. They’ve had their hands tied because the market has been so rough. And now the pressure is rising. But if I recall correctly, you brought up some other points at the conference, too. Is there another piece of the puzzle here?

CASH: Yes there is. Once again, good memory. The other side of the coin is the underwriting picture. My boys at Morgan Stanley(JPM), Lehman Brothers (LEH) and Merrill Lynch (MER) are hating life right now.

JL: I can imagine morale is a bit low, at Lehman and Merrill especially. Lehman keeps getting whacked for billions, and Merrill has come out with cap in hand so many times it’s starting to be a running joke. It’s like an old Britney Spears video: “Oops, I did it again.”

CASH: You ain’t kidding! Times are tough. These are shops where even the secretaries are used to getting six-figure bonuses. Good earners get company perks like all-expenses-paid trips to the Caribbean — or at least, they used to — and the really big earners used to have monthly expense accounts that rival normal folks’ annual salary. But all that has changed in 2008, as the music stopped playing and it turned out there weren’t any chairs left. Extravagant lifestyles are being cut way, way back. Some guys are just hoping for a bonus big enough to cover their mortgage on the second house in the Hamptons.

JL: There’s a tear in my beer. Excuse me while I dab my eyes with a tissue… What’s the connection between investment banks’ pain and building pressure in the new-issues garden hose?

CASH: It’s pretty simple really. Just follow the money. These investment houses are dying to get deals done. Their balance sheets are in as rocky a shape as the small companies that need cash and the private equity players needing to cash out. They need the lucrative fees from issuing IPOs in a bad way — and they need those fees right now. Not tomorrow, but today. Heck, they need those fees yesterday.

JL: So there are really three big-pressure angles. Everybody needs those dollars… and that means the deals will start rolling, come hell or high water, and waiting for a window of opportunity matters less and less as the clock runs out and the stakes rise.

CASH: Yep, well put. You can bet that as we start to see any glimmer of hope that the market is stabilizing they will push every deal with a pulse and try to get it trading. Investors will get pitched up one side and down the other as to how great all these companies are and how clients should be backing up the truck on every deal.

JL: Something tells me these deals won’t all be home runs. They’ll be bringing out a lot of mangy dogs and trying to pass ‘em off as best in show.

CASH: You’re right about that, my friend. One thing we’ll have for sure is what we traders call a “target-rich environment.” As we’ve talked about before, some of the most important tells about how a stock will trade are the events leading up to and through the actual offering. We could see dozens of names that simply don’t have any business being public companies. But they’ll get pushed out anyways, because all parties are desperate and the underwriters value fees more than reputation at this point.

JL: And their desperation becomes our opportunity, right? You’ve said before that shorting busted IPOs can be like shooting fish in a barrel when the conditions are right.

CASH: Yeah, except traders don’t get paid to shoot fish — but they can make millions shorting dud IPOs. Just like Verso Paper (VRS:NYSE) — remember that one? — became a deathtrap for investors, dropping from $12 to $5 in less than three months. We could see more opportunity to short IPOs in the next four months than we’ve seen all year thus far.

JL: Yowza. That’s a pretty bold prediction. Verso does show the potential, though, along with other short calls you made — like the one on VMware (VMW:NYSE). We beat the drum on that one, and I know some of our readers absolutely cleaned up on it. I imagine our readers would want you to back up your opinions with a bit more than gut instinct.

CASH: On the bold prediction side, it’s not just a gut-level hunch of mine; we’re seeing the data bear this out. The second quarter of 2008, for example, saw more companies file to go public than we have seen in the previous two.

JL: But I thought the second quarter was a lot slower than normal as far as IPOs go.

CASH: Exactly! We saw more companies file, but not actually pull the trigger yet. That means they’re waiting in the wings. So not many companies have actually completed the process…

JL: And thus the pressure is building. Your garden hose analogy again.

CASH: You got it. There are some high-profile names in this pipeline, like KKR, the private equity company that rivals Blackstone. But there are also lots of smaller, less well-known start-ups. Word on the Street is that the fourth quarter could be the strongest this year in terms of actual new issues. That confirms what I’m saying about the target-rich environment we’re anticipating.

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JL: And mixed in with the dogs, it sounds like there are still a few select candidates that could run for tremendous longside gains, too. Plenty of “duds” to play on the short side, with a few home run buying opportunities for good measure.

CASH: Right, both ways as always — shucking and jiving, as you like to say. The best kind of diversification in a crazy market like this is to have opportunity on both the long and short sides. In the next few months, we’ll have lots of both.

JL: And speaking of opportunity, the open positions in IPO Confidential are building now, and we’re starting to see follow-through. I’m excited to see how those trades will play out.

CASH: Me too. It can take a little time for new positions to get rolling sometimes, but patience pays off. We could be ringing that cash register in a big way very soon.

JL: No pun intended, of course. As always, great catching up… We’ll have to do the conferences more often, too, so readers can see and hear the elusive Cash in person.

CASH: Sounds like a plan.

P.S. Read on here for Justice’s introduction to Cash McDash.

Source: Why the IPO Market Could Be Set to Explode

Heavy volumes of options trading – particularly when biased to one side – gives a clear signal that a stock is about to make a big movement.

And Louis says Friday’s huge trade in short-term call options for EMC Corporation (NYSE: EMC) suggests its share price is about to rally big time. Louis says it’s time to long on this stock now…

We all know the adage, “There’s no such thing as a sure thing.” And it’s especially true when it comes to investing. But for me, one indicator comes darn near close…

It’s not insider buying. Sure, company executives forking over millions of dollars to purchase their own stock – like Aubrey McClendon of Chesapeake Energy (NYSE: CHK) continues to do – is decidedly bullish.

And exhaustive research bears this out.

A recent study by Morgan Stanley found companies with heavy insider buying outperform the S&P 500 by an average of 13.7%.

But here’s the rub: Because of strict SEC laws and the fact that insiders tend to be the longest-term investors out there, a considerable lag usually exists between the purchases and meaningful price appreciation. The indicator I’m referring to is not an announcement about a massive stock buyback plan, either.

Here, too, the data favors long-term investors. Companies that announce stock buybacks often outperform the broad market over a four-year period by a margin of 45%, according to studies out of the University of Illinois at Urbana-Champaign.

But again, it can take months or years to recognize the above-average gains.

Blame it on our instant gratification culture, but I prefer an indicator that often delivers outsized gains in a few weeks, days, or even a few hours.

So what is it?

The Holy Grail to Lightning Fast Gains

Abnormal – and lopsided – options activity. Ridiculously lopsided. Like we witnessed Wednesday with EMC Corporation (NYSE: EMC)…

Wednesday, more than 300,000 August $15 options traded hands. That’s 17 times the average daily volume. And the activity was unmistakably lopsided. Call options buyers outnumbered put options buyers by more than three to one.

Investors are certainly banking on a major rally in the next two weeks. And as options expert Jon Najarian put it, “I can’t remember seeing a frenzy like this.”

So let’s dissect these bets to fully understand why this is so bullish…

For the call buyers to make money, they need the stock to move above $15… in only two weeks. Based on Tuesday’s closing prices, that means EMC would need to rally approximately 12% for these investors just to break even.

No small feat given the time constraints… and the fact EMC already reported earnings. You see, it’s not unusual to see increased options activity preceding earnings announcements, as investors try to front-run a strong or weak report.

But there’s no known catalyst looming on the horizon for EMC. So in Vegas terms, these options purchases appear to be sucker’s bets. So why would so many institutional buyers be so foolish?

(By the way, I know retail investors weren’t behind the activity because the options contracts were being purchased in blocks of 5,000 to 10,000 contracts, equivalent to trade sizes of $200,000 to $400,000 based on the average contract price yesterday.)

Put simply, they’re not stupid. They know something.

And research out of Yale University on abnormal call options volumes strongly suggests they know a takeover is afoot. (If you’re interested in all the findings, the study is titled “Informational Content of Option Volume Prior to Takeovers.”)

If so, EMC would rally big time on the announcement. Takeover premiums historically average 22%… and in recent history they’re higher, closer to 40%.

No doubt, a 20% to 40% move for EMC’s stock would make the $15 call options much more valuable.

So is EMC about to get bought out? The options activity certainly suggests so, with networking giant Cisco Systems, Inc. (Nasdaq: CSCO) the most likely suitor.

Here’s another, and in my opinion, more likely outcome. EMC is getting ready to announce a takeover or sale of its 85% stake in VMware, Inc. (NYSE: VMW).

And that could be just as bullish…

Recall, EMC owns 85% of VMware. That was a great thing when VMware went public at $29 and quickly ran up 333% to $125.25. (A move subscribers to my Hot IPO service got a piece of, booking a 40% gain in just 14 days.) It brought EMC right along for the ride.

Then Microsoft and Oracle aggressively entered the virtualization space. And the added competition cut the knees out from under VMware, with shares now languishing around $35. Naturally, EMC’s stock followed the misfortunes of VMware.

But most agree EMC’s been overly punished. And a quick way to remedy the situation would be to sell its 85% stake in VMware to the public… or a cash-heavy competitor. As we know, Microsoft and Oracle don’t exactly lack cash or shy away from acquisitions.

So, when can we expect an announcement?

Well, if it’s going to happen, the options activity is betting it will come in the next 15 days. And that’s possible. EMC is set to present at the Pacific Crest Securities technology conference in Vail, CO on August 4. They could make an announcement then. Especially since it’s a Monday and most takeover announcements come on Mondays.

But no matter when an announcement comes, here’s what’s important…

When I see ridiculously lopsided options activity like yesterday with EMC, I get excited. It’s the surest indicator I know of.

As Benjamin Franklin once observed, “Three can keep a secret, if two of them are dead.” And when we see abnormal options activity, we know nobody’s dead… and that the secret is out.

Make no mistake, insiders positioned themselves to profit off EMC before this secret is made publicly known. And we might want to join them.

To be clear, this ranks as a speculative trade. So if you decide to act on the surest indicator I know, you’ll want to ratchet down our recommended position size of 4% to 1% (or less).

And play it one of two ways…

Option 1: Simply buy the stock, using a 25% trailing stop. And wait for the news to break.

Option 2 (more risky): Be like the professionals and buy the $15 call options. If you choose this route, at least increase your odds of success by going with a later expiration date. Say, the October or January 2009 calls. It will cost you a little more, but if the insiders are right about a big development and just wrong about the timing, you still make out like a bandit.

Source: Get Long This Stock NOW… 

• Siemens AG (ADR: SI) announced yesterday (Tuesday) that it would eliminate almost 17,000 positions to prepare for a global economic downturn. The Germany-based industrial giant hopes to achieve $1.9 billion (1.2 billion euros) in cost savings by 2010. Chief Executive Peter Loescher said Siemens needed to be faster, more efficient and have a leaner administration if it hoped to compete, Reuters reported.

• Southwest Airlines Co. (LUV) and Canada-based WestJet Airlines Ltd. yesterday (Tuesday) announced a marketing alliance that is planned to go into effect in 2009. “This gives WestJet exactly what they need in terms of growing their trans-border flights,” Chris Murray, an analyst at CIBC World Markets Inc. in Toronto, told Bloomberg News. “The deal would make sense for Southwest to build its service into Canada, too.”

• Shares of VMWare Inc. (VMW) plummeted yesterday (Tuesday) after the software maker announced it would not meet 2008 expectations, and as a result, replace Chief Executive Officer Diane Greene, an original company co-founder, Reuters reported. VMWare stock dropped $13.00 to close at $40.19.

• Office Depot Inc. (ODP) stock took a hit yesterday (Tuesday) when the office supply retail firm announced North American sales dropped 10% in the second quarter, causing earnings before taxes and interest to be 200 basis points lower than expected. Full earnings for the period will be released July 30. Shares declined $3.29 to close at $7.12.

• U.S. light crude fell more than $6 to as low as $135.14 a barrel yesterday (Tuesday), its lowest level since June 26. Crude oil has now fallen about $10 a barrel since hitting a record high of $145.85 hit last week.

• The U.S. Federal Reserve will issue new rules next week aimed at protecting future homebuyers from dubious lending practices, The Associated Press reported yesterday (Tuesday). The rules would restrict lenders from penalizing risky borrowers who pay loans off early, require lenders to make sure these borrowers set aside money to pay for taxes and insurance and bar lenders from making loans without proof of a borrower’s income.

• Anheuser-Busch Cos. Inc. (BUD) is suing InBev NV after calling the Belgian brewer’s takeover attempt an “illegal plan and scheme” to acquire Anheuser “at a bargain price,” Reuters reported. The suit seeks an injunction to stop InBev from furthering its consent solicitation to replace Anheuser’s board until certain alleged false and misleading statements are fixed.

• ConocoPhillips (COP) has signed an interim agreement with Abu Dhabi National Oil Co. to develop the Shah Gas Field in Abu Dhabi, Thomson Financial reported. Under the terms of the agreement, the companies will share the cost of engineering and design and project mobilization for the field’s development. Abu Dhabi National Oil will have a 60% interest and ConocoPhillips will have a 40% interest in the project.

Source: Global Investing Roundups Wednesday, July 9th, 2008

When Microsoft Attacks

by Justice Litle

VMware (NYSE: VMW) is a sexy tech company that made investors a lot of money on the way up. It had a huge IPO in 2007 and climbed to lofty heights.

But a few weeks ago, my friend Cash McDash called out VMW as a strong potential short play. (You can verify the call for yourself. See “This High-Tech Darling Could Crash and Burn.”)

In recommending a short in the $65 area, Cash noted (among other things) that competitors could put a big dent in the VMware story.

Sure enough, one of the biggest and baddest competitors showed up a short time later… none other than Microsoft. News that Microsoft (NASDAQ: MSFT) will be offering a competitive product — at a sharply lower price, no less — has sent VMW shareholders running for the exits. The stock probably has further downside ahead.

This kind of thing happens a lot to hot new issues. Six to twelve months after the IPO, reality comes barging in. If it’s not a bruising competitor like Microsoft, it’s something else that pours cold water on the enthusiasm. You see it a lot with glamor stocks that get ahead of themselves.

As a new-issues trader who goes both ways, my friend Cash McDash loves these situations. He’s got an eagle eye when it comes to spotting high-flier short setups.

If you don’t mind dabbling on the “dark side”… or if you just want an early warning on some of the high-profile longs in your portfolio… you should keep tabs on what Cash has to say. Stay tuned for more on that front soon.

Source: When Microsoft Attacks!

All I knew is that I really wanted to break into commodities… and I really, really wanted the job.

The day before driving up to the lake for my interview, I holed up in my motel room with a fat stack of flash cards. To take a mental break from interview preparations, I switched on the tube and clicked over to CNBC.

To my horror, the Dow was diving. In fact, it was nearly flat-out crashing. (Sound familiar?) As it turns out, my big job interview came right at the onset of the Russian debt default and the Long-Term Capital Management meltdown.

I was horrified because I had visions of Commodity Resource Corp taking it on the chin. What if they’re getting badly hurt in this crash? I wondered silently. What if their clients are all getting crushed? What if they won’t be able to hire me?

My fears were completely unfounded, of course. Commodities and equities run on very different cycles, something I hadn’t quite grasped at the time. My future boss actually laughed when I hinted at my concern. As it turns out, the firm was loving the extra vol in the index futures. Overall, it was a positive turn of events for them.

As I say, that all happened a decade ago. But with the Dow diving once again, chatting with Cash McDash this week fueled my sense of déjà vu.

Given the nature of this market, you would think an IPO and new issues trader would be getting roughed up pretty good. So I had some natural concerns for my old friend… but as it turns out, the concerns were unfounded like before. Cash is rolling right along, and pretty much making a mint on the short side. (Surprisingly enough, he’s got two strong long ideas this week, too.)

As Chuck Berry once sang, “Goes to show you never can tell.” Even when the market feels like pulp fiction, sharp traders like Cash will find a way to stay ahead of the game.

With that said, let’s check in with the man himself…

JL: It’s getting pretty ugly out there. You know we’ve been anticipating this at Taipan, and you rarely get caught by surprise yourself. But still, the carnage in some of these moves… Ay, caramba! How are you handling things?

CASH: Pretty well, actually. I do feel sorry for some of my contacts, though. It can be a little depressing getting calls from hard-up underwriters, knowing how hard a time they’re having getting anyone to place orders. Life is never easy with management breathing down your neck.

JL: But you’re doing all right, eh?

CASH: Yup, I’m trucking along just fine. The shorts are in high gear and racking up good profits.

JL: So what about your underwriting contacts? If business gets bad enough, are you worried about any of your boys going out of business? What happens to your Rolodex if Wall Street becomes a ghost town?

CASH: Heh. It’s rough out there, but not that rough. My guys will make it through. I’m very careful about who I pick to do business with, so I doubt there will be any washouts. And the investment banking business as a whole is very necessary anyway, whether it’s good times or bad. Even if another firm or two goes belly up, there will always be new entrants to pick up the pieces.

JL: I hear you. It’s amazing how resilient free markets can be, and capital allocation is right at the heart of things. But back to matters at hand… Is your phone pretty quiet these days? The funding must go on, but this market can’t be so hot for getting deals done.

CASH: Actually, I was a little surprised myself on that front. Secondary offerings came out of the woodwork this past week. There were actually nine different deals pricing, and I was fielding phone calls left and right.

JL: Anything juicy?

CASH: Well, I wasn’t about to bet the farm on any one trade in this environment, but it was hilarious to hear the reactions when I placed even a small order. It was like tossing a golden retriever a doggy treat. “Gee, THANKS, Cash! We’ll do our best to get you those 2,000 shares pronto, and we really, REALLY think this one is going to work! You’ll get a call first thing in the morning to confirm!”

JL: Confirm?

CASH: Yeah, usually I give them an indication a day or two before the deal prices.

JL: Indication?

CASH: Sorry, we’re swimming in lingo today. “Indication” just means a verbal on the amount of shares I’m willing to buy. Then they call me the morning of the deal to “confirm” how many shares I actually received. But in this market, I don’t even need the confirmation call.

JL: Why not?

CASH: Because I know I’m going to get whatever I ask for. They’re desperate to find buyers right now, so anything I “indicate” for, I had better expect to show up on my books the next morning.

JL: Like one of those “everything must go” clearance sales. You ask for it, you got it.

CASH: Exactly. But that’s OK by me. If I’m not too keen on a new position, I’ll just put in an order somewhere else to short, say, 5,000 shares near the close. So assume the stock closes at $32 a share and I go short near that level. Then the secondary prices at $30.50 and I get 5,000 shares from three different investment houses. Now I’ve locked in a $1.50 per share profit, and I’m not going to get hurt if the stock trades lower.

JL: What a game. You make it sound like falling off a log.

CASH: Well, it’s not always that easy, of course. On average, this type of strategy works well in a bear market. But every now and then, a secondary offering throws a curve ball and behaves differently than you might expect.

JL: Got an example?

CASH: But of course. Ever heard of Central European Distribution Corp (CEDC:NASDAQ) ?

JL: I think so… Aren’t those the guys with all the different beverage brands?

CASH: You got it. They’re one of the largest vodka producers, and they distribute 700 different alcoholic brands in Poland. The company is in the middle of a big Russia acquisition, and needed to raise capital to use for the purchase and pay down debt.

JL: So they did a secondary? How big?

CASH: $230 million — not chicken feed.

JL: Man, they picked a heck of a time to raise that much capital. I’d hate to be selling that many shares on the open market when the Dow is getting sucker punched.

CASH: I hear you… but I don’t think anyone was too upset about this particular deal. Pull up a chart of CEDC.

JL: Yowza. So OK, the stock has been working its way higher all year. I guess that makes sense, given the defensive nature of the alcoholic beverage industry and the strength of the euro.

CASH: Yeah, not to mention that this market is driving a lot of folks to drink.

JL: Hardy har har.

CASH: But seriously, the company is making a killing. It’s extremely profitable, and margins continue to be strong. Management also has a great track record of acquiring new brands and working them seamlessly into their suite of offerings. I have a lot of confidence that CEDC will continue to trade well.

JL: Sounds like a name to watch… We’ll have to keep an eye on it for Taipan readers. And speaking of keeping an eye on things, what about downside moves? I know there have been some decent moves in names we’ve talked about here…

CASH: No kidding. Did you see VMware (VMW:NYSE) this week? We talked about VMware just a few weeks ago. I believe I explained how it was a red-hot IPO that was destined to fall back to earth. I added that any bad news could take a serious bite out of its lofty multiple.

JL: And how right you were. On June 10 you said, “I really want to see the stock close below $65… It could be a doozy of a trade.” The stock has been hammered since you called out that warning. If I recall correctly, the news was Microsoft wading into the fray with a competitive product offering.

CASH: That was the gist of it, yes. Mister Softee coming to eat their lunch. That kind of threat should strike fear into the heart of most any tech company. I don’t think we’ve seen the worst of the VMW break, either… Not that I’m thrilled over the idea of investors getting hurt. It’s just that this break could have been anticipated if people had just paid more attention.

JL: But that’s the beauty of the market, isn’t it? Paying attention and doing your homework can pay off in spades — on both the upside and the downside.

CASH: Yes indeed.

JL: So before we run out of time, anything good coming up this week? I know the calendar is thin, but figured I’d ask anyway.

CASH: Believe it or not, there’s an IPO in the works with the potential to trade pretty well.

JL: Wow — that’s surprising. I wasn’t really expecting you to be bullish with this backdrop. What is this mystery company that gets your endorsement?

CASH: It’s called Energy Recovery Inc. The ticker symbol is set to be ERII. These guys have the distinction of operating in two of the very few constructive segments of the market.

JL: Let’s see… Energy has to be one, right? No Sherlock Holmes points for that one. I give up, what’s their other segment?

CASH: Water.

JL: Ah, nice. Energy and water definitely have the spotlight these days.

CASH: Yep, these guys should turn some heads. The process of taking seawater and turning it into usable freshwater is highly energy-intensive. Energy Recovery helps “recapture” some of that expended energy through harnessing the water flow. The details are a tad too complicated for my taste, but the bottom line is that the company is already profitable, and its products are in high demand.

JL: Sometimes that’s all you need to know right?

CASH: Yep. So that’s what I’m dialed in on this week. There’s another IPO on the calendar called Galiot Capital, but that one’s not worth our time. It’s another mortgage-backed securities (MBS) shop. The IPO is the initial round of capital raising, and then they go out and buy the securities later.

JL: Sounds familiar.

CASH: Yeah, this is about the third or fourth IPO to draw from the same well. I’m not opposed to the business strategy, as there could be some genuine value in mortgage land for a talented team to uncover. But I’d rather let the stock trade a few weeks minimum before eyeballing it. Odds are good it’ll trade a bit lower to start with.

JL: Gotcha. So we’ll keep an eye on CEDC and ERII from the long side this week.

CASH: Yep. Sounds a little different to be picking up long names, but these two have very strong prospects.

JL: As do many of the other short plays you’ve mentioned in these pages. Keep racking up those gains!

CASH: Aye aye, Cap’n. We’ll talk again soon.

Source: Two Strong Buys in a Tough Market

“In general, spin-offs let the markets more accurately value the operations separately,” says Louis Basenese, editor of The Takeover Trader. “So it’s important to know the parent companies’ motivation. Are they divesting underperforming assets to revive the parent stock, or breaking out quickly growing operations being held back? In my experience, if you stick to spin-offs of the latter, you’ll be handsomely rewarded.”

There are many reasons a corporate parent might decide to spin-off a subsidiary. And as Basenese said, the parent’s motivations are key to making good investment picks. Here are some examples of investor-friendly reasons for a spin-off:

• Streamlining or consolidating business operations.
• Tying management performance more closely to the subsidiary’s performance.
• Freeing a subsidiary that is being held back by the parent corporation’s regulatory environment or other factors.

There have been numerous studies done on how spin-offs tend to outperform the market as well, if not better, than their former corporate parents. According to a study titled “Restructuring Through Spinoffs,” published in 1993 by Penn State University, spin-off companies outperformed peers and the S&P 500 Index by approximately 10% per year in the first three years after the initial spin-off.

The study, which looked at 25 years of market history, also found that parent companies outperformed peers by more than 6% the year after the spin-off.

A 1999 McKinsey study of 168 corporate restructurings showed that spin-offs substantially outperformed the market. The McKinsey study of companies spun off between 1988 and 1998 showed that the new firms had a two-year annualized total return to shareholders of 27%, versus 14% for the Russell 2000 and 17% for the S&P 500.

Spin-offs tend to outperform because investors often sell when they receive stock in a new company they never intended to own, keeping share prices low initially. Also, index fund managers sell off spin-off shares if the new company is not added to the original parent company’s index. Institutional fund managers will also sell spin-off shares due to lack of liquidity or dividend.

At the same time, management’s performance will have a greater impact on the shares of the spin-off than it had on the parent company, often spurring greater efforts to innovate and succeed.

A Spin-Off that Streamlines

If someone asked: What fast-food company is the world leader in terms of total restaurant locations? Most people would probably guess McDonald’s Corp. (MCD), but the correct answer is fast-food rival Yum! Brands Inc. (YUM), with 34,000 locations.

Yum is the proprietor of such well-known brands as KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W All-American Food Restaurants. Yum also has East Dawning, an Asian-markets chain operated by its Yum! Restaurants International (YRI) division.

The former PepsiCo. Inc. (PEP) subsidiary was spun-off in 1997 under the name Tricon Global, which was later changed to Yum in 2002. In the words of one PepsiCo executive, “restaurants weren’t our schtick,” The Economist reported.

Freed from the beverage giant corporate parent, President and CEO David C. Novak was able to develop economies of scale across Yum’s various restaurant brands. Prior to the spin-off, the chains had acted more like competitors. But Novak was able to unify the various lines and put their combined purchasing power to work to score better terms from suppliers.

Novak also centralized advertising for the chains. Dual locations, where products from two chains were offered at the same location, were opened. Such innovation helped push Yum to the top the fast food industry and have allowed Yum shares to increase almost 400% from its 1997 spin-off.

That growth has been due in large part to a successful overseas strategy. Yum has done exceptionally well in China, where most consumers think of KFC when they think of chicken. And now the company is planning to expand further into India, another emerging market with a rapidly growing middle class.

Yum plans to open several Taco Bell locations in India in the latter half of 2008. India’s Economic Times reported that Yum, which already has KFC and Pizza Hut locations in India, plans to double its revenues from India in the next three years, with most of this growth coming from Taco Bell.

Yum also has been pushing to increase domestic sales by revamping U.S. menus, increasing breakfast options, and reducing company ownership through a re-franchising program of its KFC and Pizza Hut brands, The Associated Press reported. And it looks like that hard work is starting to pay off.

UBS AG (UBS) recently upgraded Yum shares to a “Buy” from “Neutral.” In a note to clients, analyst David Palmer said “while some investors have expressed concerns that the U.S. re-franchising appeared to slow versus company guidance in 2007, we expect to see that trend reverse in 2008 and 2009.”

“We believe the end result for Yum will be a faster-growing, more-international, higher-return company by 2010 – with 40% or more of its enterprise value coming from its rapidly growing China business,” Palmer added.

Yum shares have traded between $28.37 and $40.60 in the past 52 weeks. Yesterday (Tuesday), shares closed at $38.06.

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