It was an extremely interesting close of the trading week for Palm (PALM) stock this week.  Palm saw a downgrade from Ilya Grozovsky, an analyst at Morgan Joseph, on Thursday to “sell” from “hold,” citing the fact that in his view sales of the Palm Pre have slowed.  He lowered his estimates of Pre sales by an eighth to 350,000 units, and does not see the buzz surrounding the Pre having the staying power of rival devices like Apple’s (AAPL) iPhone. 

Shares of Palm slipped just 1% on the news of the analyst’s downgrade, but the Palm bulls rode to the rescue in the face of the downgrade.  Options traders were exceedingly bullish on Palm in Thursday trading action, as 38,000 calls were sold compared to just 17,000 puts.  According to the Wall Street Journal, most of the action was centered around September calls with a execution price of $17.00.  These options contracts sold for $.25 a piece, which means that these traders believe that Palm will appreciate to $17.25 or higher before September 18th.  This is an overwhelmingly bullish statement about a stock that has already had quite a run, because the stock would need to appreciate nearly 30% in order for these contracts to have any value.

Even though the market indexes headed south today, the bullish options activity helped send the stock higher by about 4%.  The lopsided action on Palm is an impressive show of support from the bulls.  Recently, it has been the traders who have had the upper hand on analysts as the last three analysts calls on Palm have been downgrades (two by Morgan Joseph) dating back to mid-April.  The stock has been unfazed by the downgrades and has continued its advance of more than 50% in the past 4 months.  It seems almost as if the traders are playing the opposite of the analysts in this case, and it is working.

At Ockham, we don’t pay too much attention to the options activity or analyst downgrades, but this story seems to be an interesting juxtaposition of Palm bulls and bears.  At least according to our methodology, Palm is Fairly Valued at present levels.  Although, we are never ecstatic about a company that has not make a profit recently, we do appreciate the fact that Palm was very oversold at the end of 2008.  They seem to have a product that consumers enjoy using, and Sprint (S) customers are eager to get their hands on it.  At the current price level, we are closer to a downgrade to Overvalued than we are to an upgrade to Undervalued, but that is not surprising given Palm’s meteoric rise.

On Thursday, Medtronic (MDT), which produces and sells medical devices, announced that the board has accepted a plan to raise the quarterly dividend by 9% to more than 20 cents per share.  The annual dividend now comes to 82 cents per share and at prices as of Wednesday’s close the yield is about 2.5%.  The company’s Chairman and CEO Bill Hawkins was quote as saying,

“Today’s actions demonstrate both the board of directors’ and management’s strong confidence in the long-term strength of the company’s cash-flow generation and continued commitment to returning capital to shareholders. Our on-going commitment to return a minimum of 40 to 50 percent of our free cash flow to shareholders each year allows us to offer Medtronic investors enhanced returns through dividend increases and ongoing share repurchases, while also making disciplined, strategic investments for sustainable earnings growth.”

  The company generated $3.9 billion in free cash flow for fiscal 2009, and the current dividend payments come to about 41% of that or $1.6 billion.  In addition, the company’s management sent a signal to the market that they believe the stock is simply too cheap right now, as they increased the share buyback program to some 60 million shares, or 5.4% of the total outstanding.  This is an aggressive move certainly, but one that seems reasonable based on Ockham’s rating methodology.  Currently, Medtronic receives our most bullish valuation of Greatly Undervalued because the company’s fundamentals would suggest a much higher price.  For example, over the past ten years the market has been willing to pay between 17.2x and 24.3x cash earnings but the current price-to-cash earnings is much lower at 10.7x.  Similarly price-to-sales has normally ranged between 4.2x and 5.9x, but the current metric is 2.3x.  In order for Medtronic to trade back on the low end of its price-to-cash earnings and price-to-sales, given current fundamentals, the stock would trade at around $52!

As you can see from our historical valuation chart, we have been positive on this stock for some time, but as of yet the market has not responded to the apparent value present in Medtronic.  Today’s actions may be enough to spark a little more interest, but as of mid day the shares are trading up only a little more than 2%.

One other thing to take note of is a developing story being reported by the Wall Street Journal.  The article alludes to a former Army surgeon who has been hired as a consultant for Medtronic, and was paid handsomely for his services.  However, a study that he headed has been rejected as it was based on falsified information to the benefit of Medtronic.  The details are still being sourced but Medtronic claims the study was independent of his consulting services and was in no way influenced by Medtronic.  The truth will come out in time, but at this point nothing is explicitly clear about how this will effect Medtronic stock.  The timing of this announcement by Medtronic is interesting though as the share buyback and dividend increase coincides with the same day that the reported conflict of interest is brought to the public.

Proxy battles are all the rage these days.  On the heels of a major proxy battle between Bill Ackman and Target (TGT) last week (Ackman Missed His Target), the results of the fight between Biogen Idec (BIIB) and Carl Icahn appears to have ended in a draw.  Icahn, a well known activist investor, was trying to get four board members elected to BIIB’s Board of Directors, and after preliminary results were released it appears that two of them were elected in a contentious battle.  Icahn had been busy with a similar attempt to replace members of the Amylin (AMLN) board last week, he succeeded in getting two of his appointees seated as well. 

The two newest directors of Biogen will be Dr. Alexander Denner and Dr. Richard Mulligan, who are the same two that Ichan put on the board during his 2006 proxy fight with ImClone.  ImClone was later sold to Eli Lilly (LLY) for $6.5 billion.  Icahn envisions splitting Biogen and Idec into two companies, but that will likely be difficult with only two likely advocates on the board.

Not everyone was prepared for the fireworks that the Biogen shareholder meeting would produce.  Reportedly, the actual meeting did not disappoint for drama, according to the Wall Street Journal.

“Wednesday’s meeting was marked with unexpected acrimony. The company’s chairman, Bruce Ross, recessed the meeting for more than three hours over shouted objections from Mr. Icahn’s nominees.

In an interview, Mr. Icahn called the delay “despicable.” “What’s wrong with Biogen is, they just run it as a country club,” Mr. Icahn said. “They can’t have the class to say we won one or two seats.” He issued a news release saying Biogen was “hijacking the election.”

A Biogen spokeswoman said the company’s actions involved “absolutely no procedural foul.”

During the recess both sides began to lobby major shareholders to support their side.  This is the second such attempt by Icahn to get his preferred board members installed at Biogen.  Last year, Icahn was roundly defeated garnering just about 20% of the votes.  This year however, more shareholders shared Icahn’s distaste for the performance of the company.  Through the turbulent year so far in the stock market, Biogen Idec’s share price has been fairly range bound between $44 and $52.  This is unacceptable to Icahn who owns more than 5% of the biotech company’s stock.  For Icahn, BIIB has simply too much potential as they have nine drugs in the late stages of development.

As you can see from the historical valuation chart for Biogen Idec, Ockham has been positive on the shares for nearly two years and it currently receives our most bullish rating of Greatly Undervalued.  The strong fundamentals of Biogen are easily apparent, earnings are expected to come in at about $4.15 for this fiscal year and growing slightly to $4.33 in FY2010.  The company earned $3.66 per share last year, and BIIB has met or beaten earnings expectations each quarter dating back to 4th quarter 2007.  Currently, we find it somewhat surprising that the vast majority of Wall Street analysts that cover Biogen Idec have a neutral or hold rating on the shares and the average price target is right where shares are currently at $53.

The market is not trading on fundamentals, at least not at for the time being, but at Ockham, we believe that Biogen Idec has strong earnings and sales trends.  If the company, now with more influence from Icahn, can start to rollout some of its new products successfully its likely the market will start to look more favorably on BIIB.  The proxy battle has dominated the headlines, but analysts being lukewarm on the shares could be an opportunity to buy into this stock with significant appreciation potential.

“That I’ve been following a lot of headlines crossing related to Nasdaq traded point out what is going on with Biogen. Carl Icahn waged a proxy fight to win board seats on the company board. The “Wall Street Journal” confirming that Carl Icahn has won two board seats on Biogen Idec board. Trying to not only sell the company but shape up the company, and the investors liking the prospect he is will bring to their future.” Fox Business Network 6/3/2009

The Wall Street Journal has polled some leading economists on how the tax breaks included in the stimulus would be best put to use.  The latest calculations of the tax break suggest that the $116 billion in tax credits would amount to an extra $8 weekly in each paycheck.  The responses range from serious attempts to quantify where the money would have the most beneficial effect to tongue in cheek humor.  The responses were just so entertaining that we wanted to select some of our favorites for our readers.  See the full blog here.

Tyler Cowen, George Mason University: In my view, fixing the banking sector is more important than getting the stimulus right. So if you can afford to lose the money, go to a large bank (more likely to be insolvent), find their most overpriced service, and buy as much of it as you can. That way you are doing your part to recapitalize our banking system.

If you’re stuck for ideas, just keep on using ATM machines, owned by other banks, so you can pay large fees to take out small sums of money from your checking account. When you need to, take all of your withdrawals and deposit them back in the account once again and start all over with the process

Ethan Harris, Barclays Capital: Get a haircut. It is a purely domestically produced service with extremely high labor content. This means no drain in spending power out of the country: it is “Buy American” without violating any trade agreements. It also has a high impact on employment due to the high labor content. Finally, an $8 haircut–as opposed to the $100 variety– is probably being done by a low income person who is likely to spend rather than save the 8 bucks, ensuring strong second round spending effects. We will groom our way to recovery…

Paul Kasriel, Northern Trust: I would use the extra cash to start a hedge fund, which would purchase newly-issued asset-backed securities. I would finance my position through the Fed’s TALF program.

Greg Mankiw, Harvard: How about buying a good economics textbook? (Eds. note: Might the authors of this textbook have a higher propensity to spend their royalties, making it a more stimulative purchase, than the author of this one?)

As funny as the economists were, here are some of the choicest comments.  Clearly, this stimulus has a lot of people riled up!

“Insanity, I am so happy Uncle Sam will be confiscating $8 less of income from commoners per week, at least BO must have a good sense of humor.”

Comment by Kafka

“Since the 8 dollars is borrowed, we will be paying interest on it forever. BO just keep the 8 dollars. Don’t force me to borrow money.”

Comment by Thanks, but No Thanks

“Wisconsin is proposing to increase its state income tax level (to cover a deficit - foretelling for America as a whole…), so I doubt I’ll ever even see that $8.”

Comment by Sad

“Dear Mr Mankiw,
I will be delighted to purchase one of your textbooks for $8. Please post your address so I can order it right away!”

Comment by Susan Stromvall

“Let them eat $8 cake. The bills will be paid by the grandchildren and who cares about them if we can eat cake now?”

Comment by As Marie Antoinette said

“Take the $8 cash and BURN IT to stave off the oncoming waves of inflation we are about to see.”

Comment by MichaelJ007

While the deployment of the second iteration of TARP is being discussed on Capitol Hill, there were a couple of very distressing pieces of news that I read today.  The first piece from the Wall Street Journal showed that based on banks own reports, 10 of the 13 largest beneficiaries of TARP are lending less now that they have $148 billion in TARP funds (see the WSJ chart).  Amazingly, with more than $90 billion dollars in TARP funding between them, Citi (C) and Bank of America (BAC) are keeping those funds in reserve as they are more risk averse in this environment.  We are not advocating loosening lending standards, but perhaps it is a scary picture of the fact that there isn’t anywhere to put these funds to use.  However, the article quotes a finance professor from Duke University, whose study claims that 59% of U.S. companies surveyed felt constrained by a lack of credit.  Perhaps the risk aversion of banks has swung to far and is now stemming growth.

So, the idea was that the TARP program would recapitalize banks and allow them to lubricate the credit markets and thus help everyone from Wall Street to Main Street continue about their business has not been the case thus far.  We are seeing that the credit markets are still sluggish at best, and the WSJ study shows that they have not put those funds to good use, at least not yet.  There are no easy answers and we can hope that banks become more inclined to lend responsibly soon instead of keeping the funds as reserve for defaults.  There were few strings attached to these funds in the first place, so I guess we will all have to wait for banks management to decide that they are ready to lend again.

The Wall Street Journal study was looking to the short but unimpressive history of TARP, but this week’s newsletter from John Mauldin at Investors Insight looks forward at what could be ahead.  There is significant concern from Mauldin and the now infamous Nouriel Roubini that TARP II will not be sufficient,

Professor Nouriel Roubini and his team at RGE Monitor (www.rgemonitor.com) have been noting in speeches in various venues around the world that they estimate that losses from the financial world could be as high as $3.6 trillion. That is composed of $1.6 trillion in loan losses and another $2 trillion in mark-to-market losses of securitized assets.

“U.S. banks and broker dealers are estimated to incur about half of these losses, or $1.8 trillion ($1-1.1 trillion loan losses and $600-700bn in securities writedowns) as 40% of securitizations are assumed to be held abroad. The $1.8 trillion figure compares to banks and broker dealers capital of $1.4 trillion as of Q3 of 2008, leaving the banking system borderline insolvent even if writedowns on securitizations are excluded.”

Roubini argues that banks will need an additional $1-1.4 trillion dollars in private- and public-sector investments. Then he and colleague Elisa Parisi-Capone lay out in detail how they come up with their numbers. They argue:

“Thus, even the release of TARP 2 (another $350 billion) and its use to recapitalize banks only would not be sufficient to restore the capital of banks and broker dealers to internationally accepted capital ratios. A TARP 3 and 4 of up to $1.05 trillion (assuming generously that all of TARP 2 goes to banks and broker dealers) may be needed to restore capital ratios to adequate levels.”

Everyone knows that Professor Roubini has earned his nickname “Dr. Doom” but he also has also been right more than wrong in the last few quarters.  He presents an incredibly depressing view of where our financial system could be headed.

As we said before, there are no easy answers to this problem, but we wanted to pass along these interesting notes regarding the so far opaque world of TARP.  There is a powerless feeling regarding these funds that have been appropriated so rapidly.  However, it is important to remember that the Treasury (and tax payers) have only loaned this money to the banks, and with any luck we might be able to reclaim some of it, although these reports give me some serious doubts.