Bill Ackman vs. Allergan, Inc.: Who Will Win the War of Words?

Irvine, Calif.-based Botox maker Allergan  (NYSE: AGN  ) is desperately trying to fend off a takeover bid from Valeant Pharmaceuticals  (NYSE: VRX  ) , a company with a history of buying rivals and slashing their work forces. In an interesting twist, this deal is being driven by activist investor Bill Ackman, who has viciously attacked Allergan's management for refusing to agree to a deal.

In a recent letter to Allergan's board, for instance, expressing his displeasure, Ackman said, "Your actions have wasted corporate resources, delayed enormous potential value creation for shareholders, and are professionally and personally embarrassing for you."

Allergan's board, on the other hand, responded in kind: "... the Offer is grossly inadequate, substantially undervalues Allergan, creates significant risks and uncertainties for Allergan stockholders and is not in the best interests of Allergan and its stockholders."

To top it off, Allergan's brass has repeatedly called Valeant's business model that focuses on acquiring other companies "unsustainable." 

Who is right in this war of words? 
Valeant has now upped its offer to a reported $200 a share (approximately $59 billion), meaning a deal would come at a stunning 72% premium compared to where Allergan shares were trading prior to this news hitting the Street. I've argued previously that, based on Allergan's projected 2015 sales growth and cost-cutting measures, $64 billion wouldn't be out of the question. Valeant's latest offer gets them close to this number, yet Allergan's board has remained resolute in its attempts to find an alternative buyer, such as Actavis  (NYSE: ACT  ) . In fact, Allergan's board refuses to even consider the offer, according to Valeant's board of directors.

Turning to Allergan's claim that Valeant's business model is unsustainable and overly reliant on acquisitions for growth, Valeant's third-quarter numbers cast serious doubt on this claim. In the third quarter, Valeant saw strong organic growth from segments such as Bausch & Lomb, a company that was acquired over a year ago. 

Allergan's courtship with Actavis also suggests that the concerns over an acquisition-focused business plan are overblown. Actavis has been one of the most active players in the M&A game over the past two years, and has taken on billions in debt as a result.

So the sticking point really looks like Valeant's history of cutting jobs following a buyout, more than a valuation or integration issue. All told, I think Bill Ackman has some valid points, and Allergan's board is simply hoping to delay the deal in hopes a so-called "White Knight" can be found.

Actavis' obstructionist strategy isn't without merit
Even though Allergan's statements about Valeant's offer and business model may not hold up to the light of day, the company does have the right, and perhaps the obligation, to explore any and all options on behalf of its shareholder base. If a deal with Actavis can get done at comparable levels, for instance, this route looks like a more appealing option, given Actavis's stellar growth prospects. In the third quarter, Actavis' non-GAAP EPS grew by an astounding 53% year over year, and this trend looks likely to continue as more branded drugs begin to launch. Put simply, Allergan's board may look stubborn to outsiders, but they appear, to me, to have the best interests of their shareholders and employees in mind. 

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How Will This Downgrade Affect Keurig Green Mountain (GMCR) Stock?

NEW YORK (TheStreet) -- Shares of Keurig Green Mountain Inc.  (GMCR) were downgraded to "neutral" from "buy" at Roth Capital which maintained its price target of $120.00.

The stock is down -1.18% to $112.46 in pre-market trade.

Must Read: Warren Buffett's 25 Favorite Growth Stocks STOCKS TO BUY: TheStreet Quant Ratings has identified a handful of stocks that can potentially TRIPLE in the next 12 months. Learn more.

Separately, TheStreet Ratings team rates KEURIG GREEN MOUNTAIN INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate KEURIG GREEN MOUNTAIN INC (GMCR) a BUY. This is driven by a few notable strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, expanding profit margins, good cash flow from operations and impressive record of earnings per share growth. We feel these strengths outweigh the fact that the company has had somewhat disappointing return on equity." Highlights from the analysis by TheStreet Ratings Team goes as follows: GMCR's revenue growth has slightly outpaced the industry average of 3.0%. Since the same quarter one year prior, revenues slightly increased by 9.8%. Growth in the company's revenue appears to have helped boost the earnings per share. GMCR's debt-to-equity ratio is very low at 0.08 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Along with this, the company maintains a quick ratio of 2.84, which clearly demonstrates the ability to cover short-term cash needs. KEURIG GREEN MOUNTAIN INC has improved earnings per share by 18.4% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, KEURIG GREEN MOUNTAIN INC increased its bottom line by earning $3.16 versus $2.28 in the prior year. This year, the market expects an improvement in earnings ($3.74 versus $3.16). 47.54% is the gross profit margin for KEURIG GREEN MOUNTAIN INC which we consider to be strong. It has increased from the same quarter the previous year. Along with this, the net profit margin of 14.69% is above that of the industry average. Net operating cash flow has increased to $320.94 million or 19.95% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -20.80%. You can view the full analysis from the report here: GMCR Ratings Report STOCKS TO BUY: TheStreet Quant Ratings has identified a handful of stocks that can potentially TRIPLE in the next 12 months. Learn more.

Sears is selling hundreds of stores. Investors cheer.

NEW YORK (CNNMoney) Sears is deploying its biggest weapon -- its vast real-estate holdings -- in an attempt to avoid a death spiral. So far investors love it.

The core business of Sears (SHLD) is crumbling. Sales have plunged, red ink is mounting and cash is going up in smoke. The once great retailer is a shell of its former self.

Things have gotten so bad that Sears plans to raise cash by selling hundreds of its prized stores to a newly formed real estate investment trust, or REIT. Sears said the move would generate "substantial proceeds" and "enhance our liquidity."

Wall Street loves the move, instituted by CEO and majority shareholder Eddie Lampert. Sears shares rose as much as 48% Friday.

"At the end of the day it was always going to be a real-estate play" by Lampert, said Paula Rosenblum, managing partner at RSR Research.

"The fact he's creating a REIT to raise money tells you the business has tanked faster than he thought it would so he's got to play out his end game sooner," she said.

Sears expects to distribute shares of the REIT to the retailer's shareholders, giving them potential upside to the new vehicle.

A REIT is a security that invests in real estate like shopping malls or skyscrapers. They usually don't pay corporate taxes, but must pay out at least 90% of their income as dividends.

'Slow motion train wreck'

The REIT lifeline is just the latest in a series of moves by Sears to liquidate its real-estate holdings to keep the core business alive.

Last month, Sears announced plans to shut down 77 Sears and Kmart stores just before Christmas, which in retail is the equivalent to raising a white flag.

"We're just watching this slow-motion train wreck. The death of this once-venerable company," said Rosenblum.

That wreck only got worse in the past three months.

Net losses totaled as much as $630 million last quarter, building on a $497 million loss from the year earlier.

Cash on the balance sheet shrank to $330 million, compared with $839 million at the end of the second quarter.

"The core business remains horrible," said retail analyst Brian Sozzi, who is CEO of Belus Capital Advisors.

Sears pushed back against that characterization.

On an adjusted basis, Sears' third quarter losse! s are expected to be comparable to a year earlier, indicating that its "operating performance has stabilized," company spokesman Chris Brathwaite wrote in an email to CNNMoney.

"This represents a meaningful change in the trend of the business," he said, adding that Sears expects this "positive development" to continue into the fourth quarter.

Postponing the inevitable?

And shares of Sears skyrocketed to their best level since December as Wall Street cheered the REIT plan.

Sears said it may sell 200 to 300 stores -- likely some of its most valuable ones -- to a REIT. Sears, which cautioned such a move is not a done deal, would lease back the stores and continue operating them.

The retailer could then use the cash it generated from the sale to keep funding its business.

"This may just postpone the inevitable. Sooner or later they are going to get into this death spiral where they can't sell because vendors won't ship and vendors won't ship because they can't sell," said Rosenblum.

CVS Health Corp Beats Analysts’ Q3 Expectations (CVS)

Before Tuesday’s opening bell, CVS Health Corp (CVS), which recently changed its name from CVS Caremark, released its third quarter results. Despite lower earnings, the company was able to beat analysts’ expectations. 

CVS Earnings in Brief

CVS reported net income of $948 million, or 81 cents per share, down from $1.26 billion, or $1.02 per share, a year ago. Excluding special items, earnings were $1.15 per share – above analysts’ estimate of $1.13 per share. Revenue rose to $35.02 billion from $31.93 billion last year. Analysts expected to see revenue of $34.74 billion. Looking forward, CVS expects to see Q4 earnings between $1.18 and $1.21 per share. Analysts expect to see earnings of $1.21 per share. For FY2014, the company expects to see earnings between $4.47 and $4.50 per share. Analysts expect to see earnings of $4.49 per share.

CEO Commentary

President and CEO Larry Merlo commented: “I’m very pleased with our strong results in the third quarter, which reflect better-than-expected revenue growth across the enterprise and expanding retail gross margins. The 2015 PBM selling season continued to be highly successful with a significant number of new business wins across all lines of business.”

CVS Dividend

CVS paid its last 27.5 cent dividend on November 3. We expect the company to declare its next quarterly dividend in December. It is likely that the company will boost its dividend in its next payout.

Stock Performance

CVS Health Corp shares were up 88 cents, or 1.02%, during pre-market trading Tuesday. The stock is up 20.33% YTD.

CVS Dividend Snapshot

As of market close on November 3, 2014

Click here to see the complete history of CVS dividends.

John Deere (DE): Expected Returns And Potential Downside

(Full disclosure: my clients and I own shares of Deere.)

In preceding articles, I've covered Deere's (DE) general situation, competition, economics, management, and opportunities & risks. Now it's time to put those thoughts together with some math to figure out what kind of returns can be expected from John Deere.

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Before I jump in, I want to make it clear that my expected return discussion is based on the long run. For that reason, it is important to read the full article and see the second half, where I talk about how bad valuation can get in between now and the long run. Caveat emptor.

Long term expected return

My approach to projecting long term returns is to look at long term trends and normalize that for cyclical factors. I want to know what long term, normalized sales per share, net margins, growth and multiples are so that I can estimate a five year price (not necessarily as a five year price target, but a normalized level for price in five years).

[Related -Deere & Company (DE) Q2 Earnings Preview: Bulldozing EPS - Again]

Sales per share

In Deere's case, sales growth from 1982 to 2013 (using the exponential fit function in Excel) is quite stable (96.7% R-squared function, Excel). If it weren't, I wouldn't use it. Deviating from this fit would have to assume a secular change in the farming or farm equipment market different from anything seen from 1982 to 2013. A fit from 1982 to 2013 shows a $33.8 billion normalized sales level a year from now. Applying 377 fully diluted shares (I take basic shares and add all options, restricted stock, etc. to that number) to that sales level implies around $90 in sales per share. 

To adjust for the ethanol boom, I also did a fit from 1982-2004, and that showed sales per share of $75. To estimate what things would look like if the last 10 years were the trend going forward, I also did a fit from 2004-2013, and that showed sales per share of $95. Now, I have estimates for normalized sales per share with low, average and high trends in mind.

Net margin

Net margins at Deere have moved a round a lot over the last 32 years. The median net margin over that time was 5.9%, but it has also been steadily trending up (due both to Deere being better managed and a nice tailwind from farming growth scaling up). Below are the the longer to shorter term median net margins:

30 year: 6.1% 25 year: 7.2% 20 year: 7.7% 10 year: 7.7% 5 year: 8.2% 3 year: 9.2% With these numbers in mind, I'll base my estimates on a low end net margin of 6%, mid point of 7.5%, and high end of 9%.

Growth

I break growth into three parts: sales growth, margin growth, and share growth/buybacks. For Deere, the historic growth trend has been 7.5% (the first fit referred to above). Looking at the trend from 1982-2004 (pre ethanol boom), the trend was 6.7%. These numbers were confirmed by looking at long term averages as well, which show and average of 7.6% and a median of 9.8%. For my estimation, I will use a low end sales growth estimate of 5%, a mid point of 6.5%, and a high end of 8% (I'm being conservative on this because I know the ethanol boom of the last 9 years won't be repeated).

Margin growth has varied widely over the last 32 years, but has generally trended up at a median rate of 1.6%. I think it would be imprudent to assume that Deere can recreate that accomplishment in the coming 5 years, so I will use a low end of 0% margin growth, a mid point of 0.5%, and a high end of 1% (I'm still assuming management can bring margins up with scale, manufacturing efficiencies, etc.).

Share count has also varied a lot over the last 32 years. In the more distant past, share count actually grew, but as management has refocused on building shareholder wealth, and been incentivized to do so, share count has declined at a median rate of 2.3% over the last 18 years and 3.9% over the last 10 years. I don't expect that high rate to continue assuming the agriculture market cools off, but I do expect a low end of 0% buybacks, a mid point of 0.5%, and a high end of 1%.

Putting together these pieces, I'm estimating 5% (5+0+0), 7.5% (6.5+0.5+.05) and 10% (8+1+1) growth rates at the low, mid and high ends.

Multiple

What multiple of earnings has the market been willing to pay for Deere? That has fluctuated widely, too. Because Deere is a cyclical business, investors have been willing to pay high multiples when earnings were low and low multiples when earnings were high. Multiples have also trended up over time as Deere has become a better business with wider profit margins. Given that, the median, low and high multiple to earnings over the last 32 years has been 10.5x and 16.5x, with 13.5x in the middle, so that is what I will use.

Expected returns

If you put together all the low, medium and high end assumptions above over a five year period, plus dividends growing at the same rate as sales per share and an $85 price tag on Deere, you get return expectations (annualized) of -2.9% 11.2% and 23.2%. Now, I assign a range of probabilities to those returns to come up with expected returns. Assuming a probability of 45% and 20% for the low end, 50% to 65% for the mid range, and 5% to 15% for the high end, I come up with a return expectation of 5.5% to 10.2%. (If you plug different numbers into the framework above, you can come up with vastly different results, so a lot depends on your assumptions being valid, or at least reasonable.)

This may not be the barn-burning return you expected, but it looks good compared to my projection of a 3.4% annualized return from the S&P 500 (at $1,982.30) over the next give years.

Keep in mind that my 5-10% return expectation on Deere is a long term projection. The path to that return may be bumpy, as I highlight below in my section on how bad things can get.

How low can you go?

To buy a cyclical company like Deere, it's not enough to have an idea what average future returns may be. You must also be ready to ride the cycle down to an uncomfortably low point, and be willing to buy more on that difficult trip down. This is particularly important with Deere because a long agricultural boom is coming to an end and farm equipment sales are clearly already tumbling. So, how bad can things get for Deere's stock price in between now and the long term?

One way to look at how low Deere's stock price can go is to look at multi-year sales per share (I use sales per share to account for the fact that earnings per share can get so low as to make earnings multiples meaningless) compared to the lowest multiples that have been experienced historically. Looking at an average of 3 year of sales per share relative to lowest annual prices, I can see that Deere got down to a 0.2x multiple of sales per share in 1986. Looking at 5 year average sales per share, 7 year, and 10 year, I see multiples of 0.4x, 0.5x and 0.5x. Below are the prices that Deere could get to, accordingly, from around $85 today:

3 year sales per share, 0.2x multiple: $17 5 year sales per share, 0.4x multiple: $29 7 year sales per share, 0.5x multiple: $33 10 year sales per share: 0.5x multiple: $29 I'm not predicting such low prices, but I am saying that Deere could get that low if history is a guide and an equivalently bad downturn occurs.  As I said above, caveat emptor. It should be noted, though, that I don't think the 1986 scenario is likely because this farm boom did not include the debt binge of that period (Kansas City Fed study), but it is best to consider all empirical evidence.

Another way to think about how low Deere's price can get is to look at prior peak to trough sales declines and apply low end multiples. Between 1982 and 1986, Deere's declined peak to trough by 24%. From 1990-1992, 16%; from 1998-1999, 19%; from 2008-2009, 21%. The 1982-1986 scenario, the worst I have on record, would see Deere's 7/31/13 LTM peak sales go from $35,250 to $26,920, or to $71 per share. The 1990 drop, the least bad drop, would pull sales down to $29,573 or $79 per share. Applying the 25th-percentile low multiple (0.5x in both cases) to those figures gives share prices of $35.50 and $39.50. 

A final way to prepare for low prices is to look at my normalized sales fits above and compare them to the lowest multiples of sales seen historically. The trough multiples on normalized sales were 0.2x sales per share in 1986, 0.4x in 1992, 0.6x in 1999, and 0.4x in 2009. Applying those multiples to the fitted sales per share above of $75, $90 and $95 gives price bottoms of $15-19, $30-38 and $45-47.  (Once again, keep in mind I consider the 1986 scenario quite unlikely.)

As I hope I've made clear, although I expect Deere to provide good long term returns, the path to those returns may be quite uncomfortable. Such is the nature of cyclical companies.

The upside is that Deere's price getting that low would likely generate truly amazing returns going forward (as they did for smart investors who bought in 1986, 1992, 1998 and 2009). Prices may never get that low, but it is best to prepare for such an eventuality even if it never occurs. Forewarned is forearmed.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.