September 24, 2008: Morning Call

September 24, 2008: Morning Call

Fair Value: SP500 – 1191.19; NDX: 1659.83; DOW – 10867


Technical Levels:

SPX: 1136-1142 support/1250, 1298-1300, 1337, 1365 resistance

NASDAQ: 2020 support /2210, 2264, 2303 resistance:


Events:

10:00: Existing Home Sales (August): 4.94 million; -1.2% MoM
10:00: Bernanke testifies at Congress’s Joint Economic Committee
10:00: LOW Analyst and Investor Conference
10:35: DOE/API Crude Oil and Gasoline Inventories
13:00: CSCO Business Update Call
14:30: Paulson and Bernanke testify on Financial Crisis at House Panel
17:00: NKE Earnings call
Post-Market EPS: NKE (.93/5.18B); BBBY (.46/1.8B)

Foreign Market Summary/Key Macro News/Commentary:


SP futures are trading 8 points above fair value while the NASDAQ futures are trading 6 points above fair value at 7:30 am ET. GS shares are trading 6 points higher after the company raised 5 billion in capital from Warren Buffett (shares are well off the after-hours high of 137-138). Separately, Goldman is pricing a 2.5 billion dollar public offering of common stock (Goldman increased the size of the offering to 5.0 billion). Buffett structured the preferred deal very conservatively and the news boosts confidence in the ongoing solvency of Goldman Sachs and the marks on the balance sheet (CDS have come down 54 basis points to 320; GS bonds indicated higher). According to Mike Mayo, earnings dilution will approach 20% (Mayo cuts 2009 EPS to 11.50 from 14.25 but the dilution will be greater now since they are raising 5 billion). Buffett is probably the only person on earth that could structure a deal this favorable with Goldman Sachs. The bottom line is that Goldman needed Buffett more than Buffett needed Goldman and the deal is structured accordingly. Other catalysts today include: Aug Existing Home Sales at 10 ET. Fed Chairman Bernanke testifies on the economic outlook before Congress's Joint Economic Committee at 10 ET. Bernanke and Treasury Secretary Paulson will testify on the bailout plan before the House Financial Services Committee at 14:30 ET. Bed, Bath & Beyond (BBBY), Nike (NKE) and Paychex (PAYX) are among the companies expected to report earnings after the close. Nov WTI crude +$2.48 to $109.09, ahead of the weekly supply data due at 10:35 ET. European markets are flat to modestly lower (London down 0.40%) in light volume. Markets were initially higher on the news of Buffett’s investment in Goldman Sachs but disappointing German IFO data weighed on sentiment. Breadth is weak with 63 of the 100 components in the FTSE 100 in the red. Asian markets rallied overnight with financials among the best performing groups on the Buffett investment in GS. Macquarie rallied 11% in Sidney.


Impact Research Calls/Market Moving News:

GS (125.05): Goldman Sachs confirms investment from Berkshire Hathaway (BRK.A): Goldman says it has reached an agreement to sell $5B of perpetual preferred stock to Berkshire Hathaway, Inc. in a private offering. The preferred stock has a dividend of 10% and is callable at any time at a 10% premium. In addition, Berkshire will also receive warrants to purchase $5B of common stock with a strike price of $115 per share, which is exercisable at any time for a five-year term. Goldman Sachs said to double size of equity sale to $5B after announcing a 2.5 billion offering last night.

GS (125.05): Goldman Sachs has moved decisively to counter credit concerns, says Bernstein: The firm believes the change in regulations, the raising of capital through Berkshire (BRK.A) and the access to the discount window should put a stop to the debate about GS's capitalization and liquidity. Target reduced to $165 reflecting the raise in capital. Rating remains market perform.

GS (125.05): Deutsche Bank analyst Mike May comments on the Buffett deal: “Reduced Leverage as Part of Transition to Bank: GS announced new equity issuance that should reduce its leverage by about 1/4th, give a boost a confidence to its ongoing solvency (since Warren Buffett is purchasing preferred and warrants), and facilitate its transition to a more conservative bank. Yet, the move also dilutes EPS by about 1/5th (est. '09 EPS goes from $14.25 to $11.50), does not reflect as much confidence by Buffett in the common stock (which he did not purchase), and comes at a time of likely business pressure with non-U.S., hedge funds, private equity, and other stock market sensitive businesses. Maintain Hold. Increased Confidence in Goldman's Solvency: In our opinion, if one thing is for sure, Goldman knows how to reorient itself for a changed environment, and this move is what was needed now. The result should be increased confidence in Goldman as a going concern. Its Tier 1 ratio increases to an est. 14% from 11.6%, which the Fed earlier this week said was "well capitalized." It is possible that Goldman will use the new capital to purchase distressed assets or even consider an acquisition. In any event, the move gives it more strategic options and aids in creating a lower risk profile during a risky time. Valuation and Risks Reflect a Business in Transition: GS is transitioning from a broker to a bank in a very short period of time, raising questions about its future earnings power (will the Fed require some scaling back of activities in trading = 2/3rd of revenues) and risk. The result is that we accord a lower than historical price-to-book ratio of 1.5x times on est. year-end 2009 book value of $106/share to get a price target of $159 (down from $165). Up- and downside risks include a worse/better-than expected economy, a rebound in the housing market, a steeper yield curve, increases in unemployment and bankruptcies (in the U.S. and abroad), and, as a Federally regulated bank holding company, changes in U.S. and foreign laws and regulations.

BK (31.81): Bank of New York Mellon sees ~$425M after-tax charge in Q3 related to money market fund encountering problems: As a result of recent market events, BK will provide support to clients invested in money market mutual funds, cash sweep funds and similar collective funds impacted by the Lehman Brothers bankruptcy filing. Company will be issuing support agreements related to five commingled cash funds used primarily for overnight custody cash sweeps and one fund used for the reinvestment of cash collateral within the company's securities lending business. The company expects to incur an after-tax charge of approximately $425M in Q3. This charge includes additional costs associated with previously disclosed capital support agreements that were outstanding at the end of Q2.

GS (125.05): Warren Buffett comments on broader markets and Paulson bailout plan in CNBC interview. Here are some quotes: Buffett on CNBC saying that the system was "very close to go over the precipice last week and the complex nature of what was unfolding could have made what we saw pale in comparison to anything we have seen in history of US financial markets." Buffett says, "A collapse of the institutions that were threatened last week would have caused other industries to grind to a halt." A few more days of "money market funds getting in trouble and bond yields getting close to zero would have caused chaos…. Last week will look like nirvana if Congress does nothing…. This is the time to do something to get the country back on the right track…. You have huge institutions that are all looking to deleverage at the same time so you need one huge institution that has the ability to leverage up and the US Government is the only institution that can leverage up right now. The government has to pay prices that they can get on the open market - not the price banks are carrying on the books or the bank's cost basis. They have to pay market price and this deal could work."

MER (26.20): Merrill Lynch downgraded to neutral from overweight at HSBC

NYX (38.56); NDAQ (33.00); NITE (14.40): Knight (NITE), Nasdaq (NDAQ) upgraded; NYSE Euronext (NYX) downgraded at Goldman Sachs: NITE, NDAQ upgraded to buy from neutral. NYX downgraded to neutral from buy.

GOOG (429.27); BIDU (263.50); YHOO (18.93); MSFT (25.44): Thomas Weisel comments on comScore search data: The firm notes that BIDU's queries were up 187% and 123% y/y in August and July, respectively, which was aided heavily by the Beijing Olympic games, which could also be reflected in the slight drop in GOOG's international query share in August. Thomas Weisel notes that GOOG still dominates the international search market with nearly 59% of the market share with a 31% y/y growth rate. The data indicated that within the U.S., GOOG continued gaining market share from its competitors, further expanding its market leader position with a 49% y/y query growth, while both YHOO and MSFT continue on a downward trend


CNQ (55.95): CONSOL Energy cuts Q3 coal production forecast to 15M tons, below prior guidance of 16.4-18.4M tons: At 15 million tons of production, the company expects unit costs for the quarter to be approximately 8% to 10% higher than the second quarter ended June 30, 2008, in which reported unit costs were $41.60 per ton produced. CNX cites several factors including: several roof falls along mainline belts, where roof conditions were affected by changing humidity levels; delays in resumption of longwall production following equipment moves at several mines because preparation of a new area to be mined was not complete; and increased frequency of inspections related to health and safety regulations which cause a reduction in mining equipment availability, for the reduction.

RIMM (96.97): Goldman’s Option Strategist comments on RIMM ahead of earnings – recommends closing down bear put spreads ahead of earnings release: “Implied vol is up ahead of earnings and shares are down nearly 4%; close RIMM put spreads at moderate profit. Last week we recommended buying Oct $85/$95 put spreads to hedge our analyst’s cautious view ahead of earnings and below consensus EPS estimate. Her concern is based on an expectation for below consensus device unit sales and weakening enterprise trends as reflected in the recent GS IT Survey results. Since last week shares are down 3.7% and 1-month implied volatility (85%, 98th percentile) and skew (99th percentile) are both up, resulting in moderate gains on put spread positions. Given extreme market volatility and macro uncertainty we would close put spreads at a profit ahead of earnings on a risk/reward basis. We estimate that options imply a +/-18.6% move on earnings versus a +/-10.7% average move over the past 4 quarters.

ENER (56.46): Energy Conversion maintained buy at Credit Suisse: Target is $86. The firm says they would be buyers of ENER at the open. Credit Suisse notes that ENER was down 18.5% on 23-Sep on a negative pre-announcement from its US customer Solar Integrated Tech. The firm says after speaking with management after the market close they believe the sell off was overdone. The firm remains confident the company will meet guidance for Sep and full year.

GOOG (429.27): Google maintained buy at Piper Jaffray after checks: Target is $785. The firm notes that although the comScore data was uninspiring, channel checks were positive for the quarter. Piper is anticipating in inline quarter for GOOG, which the firm believes will be a positive for the shares due to current low expectations.

FBI probing Fannie, Freddie, Lehman and AIG - WSJCiting senior law-enforcement officials, the Journal reports that the preliminary inquiries are focusing on whether fraud helped to create some of the problems at the four companies (nice work starting an investigation after everyone was able to carry boxes out of the offices!).