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Karen Gibbs and Geoff Colvin Karen Gibbs Geoff Colvin Geoff Colvin Karen Gibbs
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Air date: Feb. 13, 2004
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» Disney and Comcast
» Greenspan roundtable
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» Ultimate real estate investor

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Disney and Comcast

GEOFF COLVIN: For business as a spectator sport, it doesn't get much better than this: The Walt Disney Company, a beloved business performing lately like the mouse that snored, suddenly the target of a monster takeover bid from cable guys, Comcast, little known to many Americans yet worth far more than Disney. It's shaping up as one of the all-time great takeover battles, loaded with emotion, politics, human drama, and even a bit of sex, as we'll see. So who wins, who loses, what happens next? And since business is not just a spectator sport, how can you play this fight as an investor? Andy Kessler is an investor, former hedge fund manager, and media industry expert. He joins us from Palo Alto. Al Ehrbar is chairman of BrandEconomics and a partner in the Stern Stewart financial consulting firm. Al, these battles are full of excitement and surprises and drama and so forth, but ultimately they are about money. So how should you feel about this one if you're a Comcast shareholder and if you're a Disney shareholder?

AL EHRBAR: If you're a Disney shareholder, you should be pleased. If you're a Comcast shareholder, you should be worried.

COLVIN: Well, I can see why the Disney shareholders should be pleased, because the stock is way up already, but why should the Comcast shareholders be worried?

EHRBAR: Acquisitions are a very hard thing to do under the best of circumstances. And as a general rule, you can assume that if an acquisition makes the front page of The Wall Street Journal, it's really bad for shareholders of the acquiring company. If it makes The Wall Street Journal at all, it might be okay. If it doesn't make The Wall Street Journal, then it's probably a good deal.

COLVIN: How come? Why are these so hard to pull off, especially big deals, for the acquiring company?

EHRBAR: It's hard to say exactly why. I think part of it's hubris on the part of management, a feeling that they can pull off things that nobody else can. It's hard to find any other explanation for it, because they, the very big deals - we look back and see the 10 biggest deals in U.S. history - and 8 of those have destroyed wealth of the acquiring shareholders.

COLVIN: Well, actually exhibit A is Disney's own acquisition of Cap Cities ABC back in the mid-'90s. It has underperformed the market ever since that deal. Time Warner, AOL Time Warner, another great or terrible example.

EHRBAR: It's one of the worst.

COLVIN: One of the worst.

EHRBAR: Qwest was the worst.

COLVIN: Right.

EHRBAR: But Comcast's acquisition of ATT Broadband, at least in its announcement, was viewed as a very bad one. Comcast stock fared worse that time around than it has this time.
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» $treet Surfer Weblog: Comcast eyes Disney

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COLVIN: Andy Kessler, in light of this terrible record for big deals, why is Comcast doing this?

KESSLER: Well, they don't have a choice. I mean it's not that they want to do this deal; they have to do this deal. This is a defensive move on Comcast's part, really for two reasons. The first is the cozy nature of the cable business, the last protected media business, and the second reason is technological obsolescence. You know, there's a rule that says you're only allowed to own a third of all cable channels, so it's a real incestuous business.

You know, cable companies go, "You carry mine, I'll carry yours." And that's the rule of the day. And Comcast's problem is they have the E Channel and they have the Golf Channel. These are not prime slots on the dial, and so they need some great cable channels under their umbrella or else they're going to be held up. In fact, they already have been held up: Disney goes and raises the prices of ESPN 20 percent a year; it's now over $2 per subscriber per month. I mean it's almost highway robbery. Comcast, even though they're the largest cable operator, they're forced to pay. So they need their channels to be able to fight against Time Warner and to fight against Fox, who know owns DirecTV.

COLVIN: Right. Now you also mentioned technological obsolescence. What's that all about? Is cable becoming obsolete?

KESSLER: Yeah, it sure is. I mean there's funny stuff going on here out in Silicon Valley. There's a new protocol called WiMAX that's going to allow for 55 megabit wireless broadband pipes to be delivered to people's homes without any wires. And so Intel is pushing this. Cisco I think is pushing this.

And what's going to happen is all of a sudden that local monopoly, which is what makes cable so cozy, I think is going to end. And those that are selling cable channels are going to have the ability to sell to more than one cable company. And so Comcast I think, looking down the road, is starting to say we need to own cable channels. We really have no choice here to protect our franchise.

COLVIN: Al, what about you?

EHRBAR: I don't see the logic of that myself. As long as you have competition in the industry, there generally is not anything to be gained by vertical integration. And the very fact that you have competition from DirecTV and competition from Dish obviates the need for any cable operator to own a lot of stations.

KESSLER: But it's not real competition. I mean satellite sells under a cable price umbrella. That's not real competition.

EHRBAR: But it is competition. It's hurting Comcast in a lot of its markets, and it's hurting Cox in its markets.

KESSLER: Yeah, it may be hurting them, but it's not as if local players have the ability to fight on price. You don't see new cable channels coming up and saying, "Okay, gee, do you want to carry me? Do you want to carry me?" They all carry the same things.

COLVIN: Well, one thing we know for sure is that Disney is going to fight back hard against this one way or another. Now I've got to figure that one of their weapons in this is pointing out that Comcast sells video on demand in a lot of its markets, and video on demand is in a significant part pornography. And Comcast is making a lot of money from this. The fact that they are trying to buy Disney, the emblem of family entertainment, is probably going to upset a lot of people, no?

KESSLER: I think that's true, but I think that if you go into the numbers what you'll find is that cable is a very lucrative business. Once you string the wires, you depreciate them over a long period of time and the cash flow is pretty good, but you've got to use that cash flow to buy something else. And so you're right, they're looking at family entertainment to fill in their channels to protect them against other cable operators.

COLVIN: What else do they do to fight back in a case like this?

KESSLER: Well, I think Disney is going to end up independent at the end of the day. Michael Eisner has a lot of strings he could pull, a lot of tricks up his sleeve.

I mean there's two great Wall Street defenses. One is the Nancy Reagan defense and the other is the Pac-Man defense, right? And the Nancy Reagan defense is, just say no. "Who wants to own a cable operator? Don't those guys just string wires on telephone poles? Gee, we're artists here. How dare you?"

And then the Pac-Man defense is, I think you just launch a bid at Comcast. You know, Comcast's stock price is $28. Bid $25, and just say, you know, "This is crazy. You can't buy us, we're going to buy you." And make the fireworks start.

COLVIN: But, Al, isn't the history that once a company is in play it usually gets bought?

EHRBAR: Usually. There are very few companies that have survived. So you have to, I have to assume, without any special knowledge of the situation, that now that Disney's in play the ownership is going to change hands. The interesting thing to me is how these two companies, particularly if it was a Pac-Man defense, because you've already got the crippled chasing the lame...

COLVIN: Expand on that.

EHRBAR: Well, both Disney and Comcast, in terms of profitability, are famous underperformers. Comcast last year had a loss of $5.6 billion in the sense that its earnings were $5.6 billion less than its cost of capital or minimum rate of return on the capital invested in it. Disney had a comparable, similar loss of $2 billion. And Disney, in securing outlets for its programming when it acquired ABC, hasn't earned its cost of capital since then. This diversification basically didn't work for Disney at all, and I doubt it will work for Comcast.

COLVIN: I want to ask, as a strategic matter for an investor, this situation is launched, it's all playing out now. What stocks would you want to buy to take advantage of the situation?

KESSLER: Well, it depends upon what strategy you think Eisner is going to go after. I think -- you know, cable companies are notorious for not wanting to pay taxes, therefore they never make money. They have huge depreciation and huge interest expense so that they don't make money, and what Eisner has to do is turn his company into one of those. And so what I think he's really going to do with Pac-Man or Nancy Reagan is buy time. And then what you do is you join the club that Comcast wants to be the king of, is you turn into a cable operator and you buy the next several companies that are available.

Paul Allen is sinking under Charter (Commnications), buy that; buy Adelphia out of bankruptcy; buy Cox; buy Cablevision. And in effect turn yourself into a cable company with cable channels so that you can fight against Comcast and Time Warner and Fox. And if that's the case, then those cable companies become very interesting takeover plays.

COLVIN: That would be a strategy, a possible strategy...

KESSLER: It's possible.

COLVIN: ...for Eisner, and thus for retail investors.

KESSLER: Correct.

COLVIN: Andy, no matter what happens in this, is Michael Eisner toast?

KESSLER: No, I don't think so. I mean I think he's going to pull this out. I mean he's got a 20-year reign, I think he wants to get his 25-year Mickey Mouse watch, and so he's going to stick around. And like I said, he's hired Goldman Sachs and Bear Stearns to advise him. He's going to pay them $50 to $100 million in fees, and I think he's going to scratch and claw.

In fact, if he doesn't, if he just gives up the company and says, pay me 35 bucks and you can have it, then as an investor I'd run for the hills, because he would then be signaling to you that Disney has got a lot worse problems than anyone knows and he doesn't want to bother fixing it.

COLVIN: Andy Kessler and Al Ehrbar, thanks so much.

KESSLER: Thank you.

EHRBAR: Thank you.

Greenspan roundtable

KAREN GIBBS: But we all know that rates will rise eventually and investors who are proactive instead of reactive will be the ones who profit. Tim Backshall of Barra Inc tells some of the biggest players on Wall Street how to play and profit from the Greenspan effect. He'll show us as well. Ned Riley of State Street Global Advisors says forget about the Fed and watch for smoke signals from the bond market. Well, what are the signals you're seeing right now, Ned, for the bond market?

NED RILEY: Well, it's funny. When I start to look at Greenspan's speech, I think I need an MRI to scan my brain, if they can find it, because I actually understood what the man said. Clearly when we start to look at the speech, what he was implying was simply that the economy has enough slack so the Federal Reserve doesn't really have to worry too much for the time being.

When he started to refer to that 1 percent federal funds rate, he was really saying that the Fed is not going to take any action until he sees more of a healthy growth in employment and also some signs of possible inflation. I really think that people should look toward bond rates, bond interest rates, 10-year, 30-year Treasuries, to get an inclination as to where the market's going to go, because that will show us first, before the Fed actually moves. The Fed is going to be reactive, not proactive, again, and the bottom line is clearly the market will probably react after bonds have started to rise in yield and decline in price.

GIBBS: Well, let's take a listen to Greenspan on The Hill this week.

(video clip begins)

ALAN GREENSPAN: The real federal funds rate will eventually need to rise toward a more neutral level. However, with inflation very low, and substantial slack in the economy, the Federal Reserve can be patient in removing its current policy accommodation.

(video clip ends)

GIBBS: Well, Tim, that was pretty straightforward, and in fact the stock market rallied over 120 points, at least the Dow did, in response to that testimony. What is the market trying to tell us?

TIM BACKSHALL: I believe the rally was really just a little bit more certainty around some of what Greenspan said. But fundamentally what we've been trying to do at Barra is understand a little better what will be the impact of a Fed rate hike on the equity markets inevitably when it happens. In doing that, that work, what we've really seen, a specific effect would be a 6 to 8 percent drop in the value of the S&P 500 over a sort of limited time span, given a 50 to 100 basis point rise in federal funds rates, which I think most of the market is now starting to believe is pretty much inevitable.

GIBBS: Tim, are there any sectors that are vulnerable with a rate hike?

BACKSHALL: Utilities and financials are going to be particularly affected by a Fed rate hike across the curve, and consumer cyclicals and technology are probably less likely to be directly impacted by a rate hike.

GIBBS: Ned, what's your take on that?

Relevant Links
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» Karen Gibbs:
An apolitical Fed
» Anyone heard from Greenspan lately?
» February 13, 2004 stock picks

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RILEY: Well, actually I can't disagree too much with Tim, but I will point out that we have had bull markets in the face of rising interest rates. This market has not responded typically to a decline in interest rates. We have had rates declining for 2 years, and clearly the market was falling during that period of time. So again, I think we're going to reverse the roles. I don't dismiss the fact we're going to have a correction, but investors long term should focus on value and focus on the dips and actually add to their portfolios when that happens.

GIBBS: What should they be buying then, even in the face of rising interest rates, Ned?

RILEY: Well, I think we're going to get to a more defensive mode in the market itself. I agree on the technology side. I've loved it for a year and a half, and clearly it's come a long way. I wouldn't dismiss it, though. I'd keep that in the portfolio.

I liked Dell before; I like Dell now. Last night's report on the quarter was extremely encouraging. Yeah, it's come a long way fast, but I'll still revert back to what I said before.

Instead of trying to rifle shoot, instead of trying to pick one versus another, I like buying the QQQs. I own them personally, and it gives you diversification. The QQQs are the top 100 stocks in the Nasdaq index, and they move together obviously. And therefore people have diversification, they have a participation in a high volatile, high beta area, and I think most importantly in an area that's going to have secular growth, i.e. long-term growth that's in excess of the economy, in excess of the S&P, and basically in excess of most other companies.

I like the pharmaceutical industry. I like Merck because it's really been bashed in the marketplace lately. I like Pfizer as well. The financial stocks, I don't disagree. They're very interest rate sensitive. But also you've got to look at what helped those companies, and basically it was a decline in the cost of funds and the mortgage market that was just scorching. Look for those banks that don't have as much mortgage exposure and I think you'll get some opportunity as well, because they're selling at 10, 11, and 14 times earnings, and I think they still have a lot of potential to grow. Profits will dominate over interest rates.

GIBBS: Are there any banks that don't have any interest rate exposure?

RILEY: Well, no, but clearly there have been those that have been much more successful. Those that have had 30, 40, 50 percent of their portfolio in mortgages and/or with lending are clearly the most vulnerable. Housing is vulnerable in that particular scenario as well, and I do agree that when you start to look at it, utilities too. But last year utilities were the worst-performing group in the S&P. So as I said, the apple cart's been tipped upside down, and I'm not sure if right is wrong or black is white. So I still think the longer term is going to be good for equities, and we can fight off an interest rate rise because we are still going to have low inflation.

GIBBS: Do you have any names of companies that may benefit facing this rising interest rate headwind?

BACKSHALL: Consumer cyclicals might be an example where we are pretty comfortable that autos will be somewhat unaffected in general by an interest rate rise. Yet we have to be very careful of the large autos, the Fords, the GMs, specifically GM actually, that has large exposures to the interest rate side of the business. In other words, these guys are making interest-free loans to you and I to buy our cars, and they have to fund that somewhere. And as that cost of funding rises, it eats directly into their profitability. So I think specific names we've got to beware of is the larger autos. Maybe Toyota is a good name in that side of the business as having a strong balance sheet and not too much long-term debt. And then GM and Ford that maybe we have to be a little wary of.

GIBBS: Well, then thinking outside the box as you do, Ned, what else are you buying?

RILEY: Well, for the average investor, I would prefer to buy a whole pool and, you know, they've got what we call specific dedicated funds to utilities and technology and to health care. And for diversification's sake and for people to avoid what I call the single-shot bet on the market, to buy these typical type funds because they'll get diversification, participation in the move, and they won't have to worry every night about what my one stock is doing.

GIBBS: Tim Backshall and Ned Riley, thanks for joining us.

BACKSHALL: Thank you.

RILEY: A pleasure.

Trump


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» The Donald's fame Trumps his fortune
» Wall $treet Week with FORTUNE, July 26, 2002: Donald Trump interview
» FORTUNE, Apr. 1, 2000: What does Donald Trump really want?
» Geoff Colvin: Ex-CEOs should learn from The Donald

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COLVIN: One of the wackier questions we've received from viewers lately asks how tall is Donald Trump. The viewer's mom has a bet going that he's 5'11". I'm sorry to report that Mom loses her bet - Trump is 6'3". More important, it got us thinking about how the world's most famous real estate investor is doing. In some ways, better than ever. His TV show, The Apprentice, is the No. 1 reality show of the season and he's probably making millions of dollars a year from it.

By contrast, the one corner of the Trump empire you can invest in, Trump Hotels and Casino Resorts, is not a winner. The stock is down from $34 to just $2.50.

And then there's Trump's personal real estate portfolio, impossible to value precisely but apparently doing well as the New York real estate market continues to boom.

Plus, through all the ups and downs, there's still no one who can say to him:

(video clip begins)

DONALD TRUMP: You're fired.

(video clip ends)

Ultimate real estate investor

GIBBS: Donald Trump is hot, but not just because he has a hit TV show. While we can't all be big time developers like the Donald, investors are trying to mimic his success by pouring billions of dollars into real estate; specifically real estate investment trusts or REITs, and for good reason. Over the past four years REITs have returned over 100 percent while the S&P has lost more than 21 percent. But with high returns come high risks, and not all REITs are created equal. Herb Greenberg of TheStreet.com joins us to point out some of the dangers that lurk in the REIT world. Herb, what's the difference between a traditional REIT and a mortgage REIT?

HERB GREENBERG: A traditional REIT or an equity REIT invests in shopping centers, office buildings, apartment houses, anything that's real property. And that's what you really think of when you think of a REIT, and that's what REITs really, where the real history is. A mortgage REIT, by contrast, invests in mortgages, not real property. And some of them, about a handful of them, actually make loans and are lenders themselves. And then you have hybrid REITs, which are sort of a combination of the two.

GIBBS: Tell me which REITs are best for investors, or is there such a thing?

GREENBERG: Well, it depends on the market. I would say the equity REITs are probably the most common, and they show because their dividend yields are not as high as the ones right now that all the investors are flocking to, and that's the mortgage REITs. I mean these are the Holy Grail right now of REITs. They are the Internet stocks of REITs, I would go so far as to say, because they have tremendous stock appreciation, and more than that, Karen, they have phenomenal dividend yields.

GIBBS: Well, you know there's the saying that if it sounds too good to be true, it might be too good to be true, so how does that apply to REITs?

GREENBERG: Well, I think with mortgage REITs especially right now the concern is that, and my concern, Karen, is that after years of doing this is that people just have absolutely no regard or respect for risk. And what I'm worried about is people see10 percent, and then they look at 1 percent that they're getting, and they run to the REIT that has a 10 percent yield. Now, some that have 10 percent yields are better than others that perhaps have 10 percent yields, but there is a risk. There's that old saying, you know, that with high reward comes higher risk, and people have to understand that and remember that when they're investing in some of these stocks.

GIBBS: Well, what are some of the risks that are associated with mortgage REITs?

GREENBERG: With the mortgage REIT you have the risk of, right now really of rising interest rates. One day with some of these, especially the REITs - remember, some of these originate and make loans to, sub-prime loans, those are loans to people who are at the low end of the credit quality scale. Others make loans to good people but, or to good credit risks, excuse me - but the issue here is if interest rates rise, we all know what's going to happen.

The mortgage market is not going to go to the moon. And if you're tied to mortgages or these companies are tied to mortgages, there's a risk that their earnings could just plummet. And in that case, as has happened in past cycles, Karen, dividends have been suspended, and people are in these for the dividends. And you have to look at which ones perhaps have higher risk of the dividend being wiped out, perhaps some others maybe have a history of paying their dividends. So you might want to look at the history, look at the management of these companies. And this is critical right now, and I don't think people are considering this risk.

GIBBS: Well, give us some examples of the mortgage REITs.

GREENBERG: Okay. Mortgage REITs, the one I've written perhaps the most about with big red flags for a year - I look absolutely foolish having written about this company - is NovaStar. NovaStar's stock has more than tripled in the past year. It pays almost a 10 percent yield. But if you look at the company when I started raising red flags about it, earnings quality has been on the wane.

They're digging deeper into the credit, they're going downscale on credit to try to get new customers. And as they do this, I have to tell you something, you look at it and you say they're in it, you know, this is all about getting enough of what they call net operating income to throw off a big dividend so people will come and invest and this thing will pay a good dividend.

This is all about the dividend. Now that's a REIT that I would say has a potential risk, okay, one that is a higher risk. One that has a less high risk that actually people who are known as nervous Nellies tend to like, which has a nice yield, is called Annaly.

The difference between Annaly and NovaStar is that Annaly just invests in mortgages and it does not make mortgages. At the same time, Annaly does not use any derivatives at all to hedge its interest rate risk. Annaly is positioned for interest rates to rise. That's its bet, in past cycles its dividend has never been cut, so the key here is its dividend may fall somewhat if the whole group falls, the stock price may fall, but it will still have a respectable return. And that's what's going on right now, so you have to consider, there are a lot of different moving parts here, but you have to remember, remember the risk.

GIBBS: Well, you said respectable returns, and Annaly is up 21 percent. But when you compare it to the almost 200 percent, 260 percent rate of return over the past year for NovaStar, it's awful hard to tell people to wait a minute and back up.

GREENBERG: But this is the time to back up, because is this the time you really want to get into something with a higher risk? Now listen, these things may continue to rise. The stock appreciation may go for another six months, another year, who knows? None of us can tell you how long it will last. Maybe it will last until eternity and I'll look like the ultimate fool. But the fact of the matter is, you have to understand that nothing ever goes up forever.

GIBBS: And the bottom line for investors, should they avoid REITs?

GREENBERG: No. They shouldn't avoid REITs. They just should know what they're buying. And if they don't understand what we're talking about in a broadcast like this about the REITs, they shouldn't be there in the first place.

GIBBS: All right. Herb Greenberg, always a pleasure. Thanks for joining us.

GREENBERG: Sure.

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