Mergers
KAREN GIBBS: They're back in the headlines, big corporate mergers. In fact, we haven't seen this type of euphoria since the go-go days of the 90's. This week it's Cingular swooping up AT&T Wireless. Does this urge to merge signal confidence in the economy or is it just another sucker punch for investors? Money manager and Wall $treet Week with FORTUNE contributor Michael Farr joins us from Orlando with his take on whether the Mouseketeers are going cable. Susan Kalla has been a telecom insider for years. She saw the last disaster coming, but is singing a different tune now. She joins us from Orlando as well. And Roger Aguinaldo tracks mergers for Wall Street and he sees some real opportunities for investors.
Michael Farr, give me your latest take on the Disney-Comcast deal.
MICHAEL FARR: I don't think that the deal is going to happen. It may. If it does, it's going to take a lot of time. The analysts that I spoke to in New York suggest that there's no reason for Comcast to start bidding against itself, and so therefore as they leave that price hanging out there, over time, perhaps as Disney share price falls back a bit, it might seem more attractive over time. In the meantime, patience could be a great virtue for Comcast.
GIBBS: Maybe the deal will happen, so it's not all dead yet, huh?
FARR: It's not all dead yet by any stretch of the imagination. It could be that Comcast will want to launch some sort of other new, preemptive offer, raising the current bid from $26.50 or so to $28, with the notion of getting the shareholders a bit riled and making Mr. Eisner's position a little less comfortable. Any decision by the board, of course, will take a good deal of time longer. But this strategizing and maneuvering, I think, is probably far from over.
GIBBS: Susan, let's turn to the telecommunications sector. Of course the deal this week was Cingular taking AT&T Wireless. Are we going to see more of these mergers and deals in the telecommunications industry?
SUSAN KALLA: Well, our view is this is the beginning of big mergers in the U.S. market, because valuations are still relatively low for the large telephone companies. They're at 20-year lows, and the cash flow has improved. Over the past three years, each of the phone companies has reduced their operating expense, reduced their capital expenditures, and they've improved their cash flow. So now they've got money in the bank, and they're willing to make some acquisitions.
GIBBS: Who are the ones flush with cash looking to make acquisitions and who might the potential targets be?
KALLA: Well, all of the larger players are flush with cash. Each of the Baby Bells, especially Verizon, SBC and Bell South. The long distance players, like AT&T, are also flush with cash, and even some of the wireless players have cash. So it's difficult at this point to figure out who's going to take out whom or whether it's going to be a merger of equals or what management teams are going to end up running the final count of companies.
GIBBS: Your best guess, who's on the ropes and who would be a real good investment to hold right now.
KALLA: At this point, I think you could hold anyone in the sector, because I doubt that -- the managements are all very conservative -- I doubt that they'll pay too much. There's lots of merger synergies that you can get out of acquisitions, and the targets are going to be bought out at premiums over the existing public market values.
FARR: Karen, I think that this particular merger offer for Disney by Comcast does highlight some of the risks in making an offer for another company. In this offer, Brian Roberts has done a couple of things which may backfire on him. He has sort of said, he's made investors I think wonder what does his business look like and does it have a future as a stand-alone operator, or do they need something else? Second, a lot of investors in Comcast and other companies like that are looking for a return of some of that free cash flow, are they now going to commit it to new acquisitions. And finally, by the way they structured this offer, by pegging a certain ratio of shares, he's sort of implicitly said the valuation of my stock is reasonable and it's certainly not undervalued. So if I'm an investor and a shareholder, I need to start scratching my head about some of the terms of this offer, even if it doesn't go through.
ROGER AGUINALDO: I would agree with Michael. I mean Comcast has pretty much publicly admitted they need some content, they need a company in order to make Comcast, I guess, a better company, if you will, Disney being the best of all content.
I think the winner in all this is Disney, Michael Eisner and the Disney shareholders and the board, because they really have to figure out, they're really figuring out what's going to happen next. There's plenty of companies out there that Disney could be acquiring, for instance, that they could be, that they could be putting their content through. A couple of companies that we've been following is a company called Echo Star Communications. They own the Dish Network that has about 9 million subscribers, and that's a distribution network. And right here in New York, there's Cablevision. You know, they have several million subscribers, and that's a distribution network that Disney could potentially acquire or anybody could potentially acquire if Disney is looking for distribution.
GIBBS: Roger, investors have been burned by the merger and acquisition speculation and frenzy before. Give me a compelling reason why we should believe that it's going to be different this time around.
AGUINALDO: The bottom line: An investor should be investing in a company that they believe is going to grow, whether it's an acquisition target or not an acquisition target. They should be investing in good companies with good management.
That said, the icing on the cake is you should be looking at industry sectors that might be ripe for consolidation, and ripe for acquisition and targets, because what you're going to get are not only individual shareholders or institutional investors purchasing your stock, but you're going to be getting larger institutions or corporations purchasing your stock in the form of an acquisition.
GIBBS: What sectors do you see ripe for acquisitions and mergers?
AGUINALDO: Well, financial services, there can't be more said about financial services. You've seen the Green Point-North Fork transaction earlier this week. You're going to see a lot of activity happening, not only this year, but next year. We track a lot of these sectors in the middle market. These are transactions less than a billion dollars in size. And when all those companies come together, they get bigger and they need, all these banks need footprints in a lot of these different areas.
GIBBS: Do you have any names in the financial service sector you'd like to share with us?
AGUINALDO: Two companies that we have been looking at and we think are ripe are South Trust Corporation and Golden West Financial Corp.
South Trust has branches down in the South, obviously Alabama, Florida. And then Golden West, they own the World Savings Bank, they're the holding company of World Savings Bank, and they have branches in California, Arizona and actually some in New Jersey. But they're a good footprint in the West.
GIBBS: Michael, does all this merger activity bode well for the stock market?
FARR: I think generally it's great for the markets because it does say that corporate leadership is optimistic. They think that this is a good environment in which they can make deals and they can find efficiencies of scale and synergies to grow their businesses. So over the past three or four years of a bear market where corporate management was dour and negative, that seems to have gone by the wayside and we're feeling good enough to reach out and touch someone, not only in the wireless, but also here on cable. So I think it's a positive and I think it's a sign that the emotional side of investing is improving.
GIBBS: Susan, the consolidation that's going on now, do we have some more room to go for that? And what will it mean for the investors and prices of these stocks?
KALLA: It's very, very positive to have consolidation in the telecomm business. You've got a dozen different players that are offering basically the same services: Wireless, local, and long distance. So it makes sense to have maybe six large players, maybe four. So it's healthier because it stabilizes prices, which is not great for consumers, but it allows these service providers to innovate in services which the consumers want. So it's a net positive, and we look forward to it.
GIBBS: Susan, you like AT&T and Verizon. Why?
KALLA: AT&T, we believe the long distance business is a very healthy business. It's had price competition that's been intense, you know, prices going down 25, 30 percent a year for the past three years, but nonetheless it's a high growth business. The volumes grow 15 percent a year. So if you just had prices stabilize a little, as they had over the past 20 years, you'd have positive revenue growth. So we believe that the long distance is solid business, and we believe that Verizon is a solid player in local. They're moving, they've had tremendous performance in wireless, and they're ramping up in broadband, and we believe that the management team is very, very sound there, and we believe that they'll continue to get some concessions from the regulators.
GIBBS: Roger Aguinaldo, Susan Kalla, Michael Farr, thank you very much for joining us.
FORTUNE roundtable
GEOFF COLVIN: Business and politics intersect in all sorts of ways, especially in an election year, and as part of PBS' Election 2004 By the People coverage, we're looking at two of the most fascinating intersections. Jobs, taxes and the economy are critical factors in this election, but who is really setting the administration's economic policy? Anna Bernasek, a FORTUNE writer, says it's not who you think. And we've seen the Internet become a hugely powerful force in this election, but Fortune senior editor David Kirkpatrick says that's just a small part of a giant trend with major implications for companies.
Anna, you've been all over Washington looking into this. Let me ask you about some administration figures that one might reasonably think were setting economic policy. Let's start with Greg Mankiw, chairman of the Council of Economic Advisors. What's his role?
ANNA BERNASEK: Well, Greg's role I think, you know, is he really is the person who is the public face, if you like, of the policy. But is he setting policy at this point? No, he's not really. He's come in at a time when policy has actually already been set. We've had tax cuts number one and number two. So his role in a way is to justify those policies, to say they're working, everything's fine, and that's what he's been doing.
COLVIN: All right. John Snow, Secretary of the Treasury. Now there's someone you might think was really out there setting policy.
BERNASEK: John Snow, if you'll remember, was brought in to be, to replace O'Neill.
COLVIN: Paul O'Neill.
BERNASEK: And the big problem that the administration had with O'Neill was that he wasn't a team player, and that's why Snow has been brought in, and he's done that beautifully. He has been a real team player. He has been really behind Bush's policies, and that's really his role.
COLVIN: Okay. Don Evans, Secretary of Commerce. Not traditionally the most important job, but he is an old close friend of the President. So is he influential?
BERNASEK: I think he is influential in terms of, you know, having a relationship with the President and being able to talk about these issues. But in terms of really setting policy, I don't think, Geoff, we're seeing anybody step forward at this point.
COLVIN: Well, now we're sort of crossing names off the list without getting to whoever is setting policy, so who's really doing it?
BERNASEK: Look, I think with this administration policy was set at the beginning during Bush's campaign. That's the whole thing. The whole tax-cutting agenda was set then. And what we've seen is that policy has been implemented, and that's over and done with. And now we're basically waiting for the sort of election in November.
COLVIN: So you're saying if it was set really during the campaign, Karl Rove, the chief political consultant to the President, may be the main economic policy setter.
BERNASEK: Have you been reading Ron Suskind's book? That's exactly right. If you believe that book, and what it suggests is that Carl Rove and Dick Cheney are really the masterminds behind economic policy.
COLVIN: Let me ask you about somebody else, Martin Feldstein, famous economist, who has no official role in the administration. Does he have an influence?
BERNASEK: He does, and he is one of the big people behind the scenes. He has a tremendous intellectual influence on policy, and he really has been there all along the way. He's no stranger to the White House. And he, if you remember his work, he is really the top conservative economic mind in the country, really the original thinker in terms of the importance of tax cuts on the economy.
COLVIN: Well, he was Chairman of the Council of Economic Advisors for Ronald Reagan.
BERNASEK: That's right. That is exactly right.
COLVIN: Is he the next Fed chairman?
BERNASEK: He very well could be if Bush is reelected in November. He is thought to be the top choice.
COLVIN: When does Greenspan's term expire? Remind us.
BERNASEK: In 2006, June 2006. And he really has to step down at that point.
COLVIN: So is there a big-picture economic plan beyond tax cuts?
BERNASEK: Good, very, very good question. I think, look, I think that if Bush wins reelection again in November, the big issue is going to be Social Security, and that's something that Bush has said he favors, he wants to do something about. He favors this idea of privatizing Social Security, and that's what you're going to see happen.
COLVIN: A lot of people think President Bush's father lost to Bill Clinton in large part because he didn't think he needed a big-picture economic plan. The economy seemed to be doing okay. Could it be that this President Bush is making the same mistake?
BERNASEK: I think he would argue no, because he got out in front of this recession. He brought in these tax cuts, which not only he would argue are good for the long term, but they helped in the short term boost the economy. So I would say I don't think there's a danger of that.
COLVIN: David, you have said that the president of South Korea, American Idol, and eBay all have something in common.
DAVID KIRKPATRICK: I have.
COLVIN: Could you please explain this?
KIRKPATRICK: Well, what I'm really trying to say is that one of the fundamental promises of the Internet that we heard from the beginning is now being fulfilled, and we're entering what I call a bottom-up economy, which is really all about the empowerment of people from below. And we're seeing that change affecting politics and business in dramatic ways.
COLVIN: Well, of course there was the Howard Dean campaign, which didn't work out as he would have hoped, but still he came from nowhere largely on the strength of Internet support, right?
KIRKPATRICK: Well, he got tremendous Internet support just in terms of creating the ability to get people out to rallies and also amazing fund raising capability. And also it's important to look at General Clark whose campaign arguably would never have happened had he not seen what amazing enthusiasm there was for his candidacy on the Internet before he ran. So that's a great example of people coming from below, getting together, using the tools of the Internet, and affecting what happens at the top.
COLVIN: And on the business level, one obvious example, American Idol, on television. Instead of having network executives choosing pop stars, you have the audience choosing their own pop stars.
KIRKPATRICK: Well, there you go. This trend is moving offline too, although I think it's the Internet and the connectivity that it gives and the ability that it allows people to connect with other people and to organize groups to lobby for things that's the greatest force here.
COLVIN: So are big companies being transformed by this?
KIRKPATRICK: Well, I think a lot of big companies are being transformed in their business model. Certainly companies like eBay wouldn't exist were it not for this phenomenon. Ebay is all about the leveling of the playing field between the large and the small, so that a small Mom & Pop store really can sell the same product to you as Wal-Mart or Sun Microsystems can. It's changing companies in a lot of other ways. There's certainly new companies coming along that wouldn't exist without this phenomenon, companies like Meetup or Upoc. Meetup is a company that allows individuals to organize in-person meetings. It's been a big tool in all the political campaigns and is now being used by the Bush campaign as well. Upoc is a tool that allows people to get communication to groups on cell phones.
COLVIN: Upoc. Upoc.com?
KIRKPATRICK: Right. Yeah, both Meetup and Upoc are private startups, but they're doing very well. Then you have another way that this is affecting business. At a company like IBM, Sam Palmisano has said that really...
COLVIN: The CEO.
KIRKPATRICK: He says in today's environment the CEO cannot dictate values from the top. The values of the company and its entrepreneurship have to arise and bubble up from below. So he's made a lot of changes inside IBM to empower the employees around the company to get their ideas out, to communicate with each other, and to create a situation where he ultimately becomes the servant of the employees. I think that's his end goal.
COLVIN: You've said presuming that you know what the customer wants is the ultimate error.
KIRKPATRICK: Well, I think what we're seeing is that companies are finding when they really pay attention to what customers are saying, with the new voice that customers now have using the Internet and other tools, many times the decisions that they made unilaterally in the past proved to be wrong. A great example of this and a smart way of taking this approach is Ducati, the motorcycle maker, which recently came up with two prototypes for new motorcycles, but rather than simply putting them into production or conducting conventional market research, they put all the specs and photographs online and asked potential customers and just their fans to fill out a lengthy survey online. I think something like 20,000 people did so, and as a result of the enthusiasm they saw, they decided to put these products into production. That's a new way to go.
COLVIN: So in fact the customers designed the motorcycle before the designers designed it.
KIRKPATRICK: Well, the product would never have been made if the customers didn't have input. I think that's the new way we're seeing this go.
COLVIN: Let me ask you both about something, actually that you have both written about and thought about lately, shipping jobs overseas. Because Greg Mankiw, Chairman of the Council of Economic Advisors, got himself into some trouble by saying actually there's nothing wrong with it. Anna, what was going on?
BERNASEK: Well, he was giving the economist answer, which everybody really believes, that free trade is the way to go, you know, and nobody really disputes that. The question is whether he should have been a bit more political in his approach, and probably he should have.
COLVIN: He probably should have. David, you've taken the view that there really isn't anything wrong with this, right?
KIRKPATRICK: Well, I wrote that in a recent FORTUNE that really, the evidence is that on balance, if you look at the good of the overall economy, offshoring and global trade in all its forms is beneficial. Now someone like Mankiw they say was politically tone deaf. I know when I wrote my column in FORTUNE I was flamed by innumerable e-mails, people telling me to move to India. This is not a popular thing. And as one person wrote to me who was a supporter of my view, he said, you know, when you write something like that, all of the 5.8 percent Americans that are unemployed believe that offshoring is the cause of their unemployment, and they're going to come right down on you. So it is not popular to say, but the fact is this is probably a good thing.
COLVIN: And we're going to be hearing a lot more about it for a long time to come. Anna Bernasek, David Kirkpatrick, thanks a lot.
KIRKPATRICK: Thanks, Geoff.
BERNASEK: Thank you.
Biotech
GIBBS: Well it's not all politics, and mergers in the business world these days. There are also handcuffs. The latest executive to make that infamous walk from the corner office to the courthouse, former Enron CEO Jeffrey Skilling, pleading not guilty to charges of fraud and insider trading.
Meanwhile, in a New York City courtroom, Martha Stewart continues her bid to stay out of those tacky jailhouse-orange jumpsuits. But you have to wonder what the decorating diva was thinking when the FDA finally approved Imclone's Erbitux, the cancer drug at the center of her scandal.
Erbitux is just one of a number of breakthrough cancer drugs expected to hit the market. We asked top biotech analyst Alex Hittle to size up the industry for us.
ALEX HITTLE: We really do have a kind of breakthrough era that we're just in the opening phases of here with the fight against cancer.
The old line chemotherapy drugs basically revolve around the notion that you feed a poison to a patient and you feed that poison to the point where you are able to kill tumor cells, but you don't quite kill the patient. The new therapies that we're seeing they're all actually targeting unusual characteristics of cancer cells. And so they go after cancer directly and lack some of these broader toxicities that you have with the traditional chemotherapies.
Some companies here that are going to benefit would be, first of all, Genentech, which is waiting for the Avastin approval.
Then you have this Amgen/Abgenix partnership that has a drug similar to ImClone's drug.
ImClone, obviously.
Then you've got a number of smaller companies that are also doing fairly innovative approaches to cancer. Another one that's within our coverage would be Onyx.
So you've really got a whole array of firms out there that are making plays on targeted cancer therapies.
GIBBS: Another way of investing in these important drugs is to buy a mutual fund, or a basket of stocks such as the Nasdaq Biotech iShares index fund, up over 60 percent for the past year.
Trading specialists
In November, we took you on to the floor of the NYSE to explain just how a stock trade is made and we told you about some of the problems the SEC has with the specialist system.
Now this where the really big problems exist. The whole idea of specialists has come under fire. Wall $treet Week with FORTUNE has learned that the SEC is investigating whether several companies illegally made trades by "trading ahead" of customers' existing orders.
The specialists would see interest in a stock, hold customer orders and buy the stock for themselves. Then the specialist waited for the price to go up and quickly cashed out at a profit to one of the waiting customers.
The specialist firms might only make pennies by cheating on a large stock trade, but those pennies add up. The SEC says the illegal trades cost the investor -- you and me -- $155 million dollars.
Well, earlier this week the five largest specialists firms agreed to pay $240 million dollars to settle the SEC's civil charges. The firms won't have to admit or deny guilt. And the money? Well, the money will go to pay fines and $155 million dollars in restitution to investors.
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