Friday, June 15, 2007

Bear Doesn't Sweat Subprime


By Laurie Kulikowski (TheStreet.com Staff Reporter)

Wall Street firms can't agree on what will happen next in the subprime mortgage market. Of the three brokerage firms that reported second-quarter earnings this week, Lehman Bros. (LEH) and Bear Stearns (BSC) -- the two with the largest exposure to the mortgage market -- seem to be encouraged by signs of improvement in the sector. Bear even said it plans to keep growing its mortgage operation, which was hit hard in the latest quarter. The company cited signs that business picked up this past spring.

As credit standards tightened on loans, "the beginning of the quarter was quite difficult and as we got into the quarter, April was better than March and May was better than April," said Sam Molinaro Jr., Bear Stearns' CFO. "What we're seeing are transactions are getting done. New vintage collateral is being well received in the market, spreads are tightening -- business is slowly improving."

Goldman Sachs (GS) , on the other hand, wasn't as optimistic. David Viniar, Goldman Sachs' CFO, said the market for loans made to homebuyers with subpar credit histories is likely to get worse before it gets better, according to the Associated Press. "The subprime business continues to be weak," Viniar said during a conference call for reporters. "We have not seen the bottom in the market. There will be more pain felt by people as it works its way through system."

Much pain has been felt already. Dozens of mortgage lenders that catered to subprime and Alt-A borrowers failed as consumers fell behind on their loans. The spike in defaults and delinquencies caused investors to stop buying bonds that were backed by the subprime mortgages. The sudden shift drove New Century (NEWCQ) , once the nation's No. 2 subprime lender, into Chapter 11 bankruptcy protection April 2.

Bond businesses at the big brokerage firms have taken a hit since securitization volumes of these loans have fallen. Several firms, including Lehman and Bear Stearns, which have origination businesses, were also hurt from a decline in subprime and Alt-A loan originations. Revenue from Bears Stearns' bond business dropped 21% in the second quarter from a year earlier to $962 million, it said Thursday.

Goldman said the same day that quarterly net revenue from fixed income, currency and commodities was $3.37 billion, 24% lower than the second quarter of 2006. The decline primarily reflected lower net revenues in commodities and weak results in mortgages -- particularly because of weakness in the subprime sector. Earlier this week, Lehman said revenue in its fixed income business dropped 14% from a year ago to $1.9 billion as a result of the sour mortgage market.

But Lehman's CFO Chris O'Meara also spoke of recovery in the sector. "Although we believe that the U.S. subprime business will continue to face headwinds for the near term," O'Meara said during a company conference call on Tuesday, "we are seeing some positive signs, such as gradual improvement in pricing power for lenders and a pickup in secondary-market investor activity, including for noninvestment grade positions." Bear Stearns also stumbled on Thursday. The company sold $3.8 billion in mortgage loans after hedge funds managed by the firm made large bets on the subprime market.

During the call, one analyst questioned the impact of the move to Bear Stearns' future earnings. But for the most part, Molinaro shrugged it off. "Our level of capital investment and exposure to the fund," he said, "is very modest and shouldn't have any material impact on results going forward."

Last year, Bear Stearns Residential Mortgage purchased the subprime mortgage origination platform of the Encore Credit unit of ECC Capital (ECROE) , an Irvine, Calif.-based REIT, for $26 million in cash. Molinaro said Thursday that Bear is now ready to bust out of its brief slump. "What we're doing right now is trying to hire a lot more salespeople, expand our sales relations and increase the volume of business that we're capable of putting through the platform," Molinaro said. "If volumes don't pick up -- if that's not successful -- we'll have to address the operating costs. But I think at this point the strategy is clearly on trying to drive more volume through the existing platforms."

Acrobat, Creative Suite give Adobe a boost

By Reuters

Adobe Systems, the top maker of graphic and Web design software, reported that its quarterly net profit rose 24 percent year over year, aided by recent upgrades to its two big product lines.

Net income for the fiscal second quarter to June 1 rose to $152.5 million, or 25 cents per diluted share, from the year-earlier quarter's $123.1 million, or 20 cents per share. Excluding one-time items, Adobe reported on Thursday a profit of 37 cents, a penny above Wall Street's consensus. Revenue rose 17 percent year over year to $745.6 million, in the middle of the range of analysts' forecasts.

Wall Street was looking for a net profit of 27 cents per share, according to the average of Reuters Estimates. Excluding stock option expenses and one-time items such as acquisition costs, the consensus profit forecast was 36 cents a share. Analysts, on average, had expected second-quarter revenue of $730.1 million, according to Reuters Estimates. Forecasts ranged from $718 million to $768 million. In March, Adobe predicted quarterly revenue of $700 million to $740 million.

Last fall, Adobe upgraded its Acrobat document management software and the new product cycle is helping to drive revenue growth, analysts said. In April, Adobe released version three of Creative Suite, its collection of design tools that includes Photoshop. Acrobat and Creative Suite together account for the bulk of Adobe's revenue.

For the fiscal third quarter, Adobe sees revenue in a range of $760 million to $800 million, and net profit of 28 cents to 31 cents per share. Excluding one-time items, it is aiming for 39 cents to 41 cents a share. The net profit forecast is contained by the range of analyst estimates for the third quarter, which according to Reuters Estimates was 24 cents to 33 cents a share. But Adobe's profit outlook excluding one-time items exceeds the prior range of third-quarter forecasts of 34 cents to 38 cents a share, according to Reuters Estimates.

Fresh Del Monte Confirms Customs Visit (AP)

CORAL GABLES, Fla. — Fresh Del Monte, a top pineapple seller and banana producer, on Wednesday confirmed agents from the U.S. Immigration and Customs Enforcement office visited its Portland, Ore., plant.

On Tuesday, more than 165 plant workers were detained to be processed for possible deportation, officials said, and three people were indicted on immigration, illegal documents and identity theft charges.

The raid occurred at American Staffing Resources Inc. offices at a Fresh Del Monte Produce fruit and vegetable processing plant, and was based on an investigation by Immigration and Customs Enforcement and the Social Security Administration that began in January, officials said. Separate American Staffing offices also were searched, along with a Fresh Del Monte office.

Fresh Del Monte said it was advised it is not a current target of the investigation and will cooperate with the probe. The company also said it retained American Staffing Resources to provide a contingent labor force at its Portland plant.

Fresh Del Monte shares fell 18 cents to $23.98 in morning trading.

Penn National Agrees to Be Acquired for $6.1 Billion


By Oliver Staley and Chris Burritt

June 15 (Bloomberg) -- Penn National Gaming Inc., the owner of 18 casinos and horse racing tracks, agreed to be taken private by buyout firms Fortress Investment Group LLC and Centerbridge Partners LP for $6.1 billion.

Penn National shares have risen sixfold in the past four years as more states legalize gambling, adding slot machines and table games to boost their tax base. The company acquired in April the Zia Park Racetrack and Black Gold Casino in New Mexico and will open new facilities in Pennsylvania and Maine by 2008.

Investors will get $67 a share in cash, Penn National said today in a statement. That's 31 percent higher than yesterday's closing share price. The firms plan to repay $2.8 billion of the company's debt.

``We'll take it,'' said John Kornitzer, who oversees more than $6 billion, including 1.44 million Penn National shares at the end of March, at Kornitzer Capital Management in Shawnee Mission, Kansas.

Penn National, based in Wyomissing, Pennsylvania, is the latest casino company to be taken private by investment firms attracted to their real estate and ability to generate cash. Since the beginning of 2006, companies including Kerzner International Ltd., Aztar Corp., Station Casinos Inc. and Harrah's Entertainment Inc. have all agreed to takeovers.

``They're buying all of these out because of cash flow,'' Kornitzer said.

Shares of Penn National climbed $11.27, or 22 percent, to $62.41 at 11:53 a.m. in composite trading on the Nasdaq Stock Market in New York.

Higher Bids

The agreement allows the company to seek higher bids for the next 45 days. Chief Executive Officer Peter Carlino and other members of the management team will remain with the company, Penn National said.

``Due to the scarcity of quality regional assets, we can't rule out competing bids at this point,'' Joseph Greff, an analyst at Bear Stearns in New York, said today in a research note.

The price of $67 a share values Penn at about 10.3 times 2008 estimated earnings before interest, taxes, depreciation and amortization before taking into account construction in progress, Harry Curtis, an analyst at J.P. Morgan Securities Inc., wrote in another note.

That's less than Harrah's and Aztar deals, which he valued at between 11 and 12 times 2008 Ebitda. Using that valuation, Curtis estimated Penn could go for between $73 and $80 a share. Curtis, based in New York, rates shares ``overweight.''

Penn National operates slot machines and table games in 13 states and Canada including New Jersey, Colorado and Illinois.

Deal Completion

Penn said the deal is expected to be completed within the next 12 to 16 months, pending approval from state and federal regulators. The firms will pay an additional 1.49 cents a day per share for each day beyond June 15, 2008, the deal is not finished.

The Carlino family, including Peter Carlino, is Penn's largest shareholder, owning an 11 percent stake through a trust At $67 a share, they will receive about $639 million. Individual family members have additional holdings.

Other regional casino companies climbed as well as investors speculated they may be takeover targets. Boyd Gaming Corp. rose $2.24, or 4.5 percent, to $52.04, Pinnacle Entertainment Inc. gained $2.74, or 9.6 percent, to $31.22, and Ameristar Casinos Inc. increased $2.61, or 8.1 percent, to $35.02.

Harrah's Acquisition

Last year, Apollo Management LP and TPG Inc. agreed to buy Harrah's for $17.1 billion in what would be the largest casino acquisition. That deal is still awaiting regulatory approval.

Founded in 1998, Fortress has about $36 billion under management. The firm said in May it had received $2.84 billion in commitments for a new buyout fund.

Centerbridge is a $3.2 billion investment fund.

Lazard Ltd. served as financial adviser to Penn National. Wachtell, Lipton, Rosen & Katz provided legal advice. Deutsche Bank AG and Wachovia Corp. served as advisers to Fortress and Centerbridge, which received legal advice by Willkie Farr & Gallagher LLP.

U.S. Economy: Core Prices Ease, Letting Fed Hold Rate

By Bob Willis and Shobhana Chandra

June 15 (Bloomberg) -- A measure of U.S. consumer prices rose less than forecast in May, evidence that ebbing inflationary pressures may allow the Federal Reserve to keep interest rates unchanged this year.

The 0.1 percent increase in core consumer prices, which exclude food and energy costs, followed a 0.2 percent rise the prior month, the Labor Department said in Washington today. Separately, the University of Michigan reported that consumer confidence fell, and Fed figures gave conflicting signals on the strength of manufacturing.

Bond yields retreated and stocks gained as the inflation number reduced speculation that a rebound in the economy will be accompanied by a surge in prices.

``The inflation risk is relatively limited,'' said Steven Wieting, managing director of economic and market analysis at Citigroup Global Markets Inc. in New York. ``We have an economy that is right in the middle ground. It just doesn't require much from the Fed.''

From a year ago, core prices rose 2.2 percent, the smallest 12-month gain since March 2006, compared with a 2.3 percent gain in April. Economists had projected a 0.2 percent increase from the prior month.

Overall prices climbed 0.7 percent, the biggest increase since September 2005, led by a jump in gasoline costs. They were up 2.7 percent from the same time last year.

``It's still possible that the Fed may adjust rates lower, though right now the Fed is very comfortable on hold,'' said Peter Kretzmer, senior economist at Bank of America Corp. in New York. ``Underlying demand remains moderate, and inflation pressures are generally receding.''

Empire State

The New York Fed's Empire State index jumped to 25.8 in June from 8 in May, while U.S. industrial production was unchanged last month after a 0.4 percent increase.

The Reuters/University of Michigan's preliminary index of sentiment declined more than forecast to 83.7 this month as home values dipped and gasoline held above $3 a gallon. The index reading was the lowest since August and compared with 88.3 in May.

``Consumers are in a sour mood, with gasoline prices above $3 a gallon,'' said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. ``The good news is that consumer spending seems to be holding up better than we would have anticipated.''

Yield Surge

Yields on 10-year Treasury notes surged to the highest in five years earlier this week as investors reassessed prospects for growth, inflation and interest rates. The 10-year U.S. note yield fell to 5.18 percent at 11:25 a.m. in New York. It reached 5.32 percent on June 13.

Economists had forecast consumer prices would rise 0.6 percent, according to the median of 79 projections in a Bloomberg News survey. Estimates ranged from increases of 0.3 percent to 1 percent.

The CPI is the government's broadest gauge of costs because it includes goods and services. A report yesterday showed wholesale prices rose 0.9 percent in May, matching the increase in the cost of U.S. imports reported a day earlier.

Today's report showed energy prices jumped 5.4 percent after rising 2.4 percent in April. Gasoline prices jumped 11 percent.

Regular gasoline at the pump rose to a record $3.23 a gallon on May 23, compared with an average $2.83 in April, according to the American Automobile Association.

Food prices, which account for about a fifth of the CPI, rose 0.3 percent after a 0.4 percent increase in April.

Housing Costs

Housing costs, which include some energy costs and account for one-third of the total consumer price index, rose 0.2 percent. Owner's equivalent rent, which makes up 30 percent of the core CPI, increased 0.1 percent after rising 0.2 percent. Medical-care costs rose 0.3 percent after rising 0.4 percent. Clothing prices dropped 0.3 percent for a second month.

Almost 60 percent of the CPI covers prices that consumers pay for services ranging from airline fares to movie tickets and laundry charges.

Auto prices fell 0.2 percent.

Increased use of ethanol to fuel cars is raising food costs as demand for corn rises, according to economists such as Richard Yamarone of Argus Research in New York.

Dallas-based Dean Foods Co., the biggest U.S. milk processor, said profit this year will be less than it previously forecast because of soaring raw-milk costs.

Direction

Core inflation has been moderating in recent months. The Fed's preferred gauge, known as the core personal consumption expenditures price index, rose 2 percent in April from a year earlier, government figures showed on June 1. That's the smallest year-over-year gain in 13 months.

The Fed, in its latest assessment of regional economic conditions released June 13, said ``reports generally did not indicate an increase in overall prices pressures.''

Policy makers, including Fed Chairman Ben S. Bernanke, have said they would prefer the rate to be in a 1 percent to 2 percent range. The gauge has been at or above 2 percent since April 2004.

Fed Bank of Cleveland President Sandra Pianalto this week reiterated concerns that inflation was too high. The Fed ``has described our core rate of inflation as being uncomfortably high and has stressed the importance of further moderation.''

Fed policy makers had been counting on weaker growth to cool prices. The economy grew 1.9 percent in the first quarter from a year earlier, the slowest since June 2003.

For all of 2007, the economy is projected to expand 2.1 percent, the least in five years, based on the estimates in a Bloomberg survey May 30 to June 7.

Tax shock for private equity funds (Sydney Morning Herald)

Damian Reece and James Quinn in New York

BLACKSTONE, one of the world's biggest private equity funds, is reeling after its planned $US34 billion stock market flotation was hit by news of a new bill proposed by US politicians that will remove the favourable tax treatment private equity funds receive in the US.

The bill has been put forward by senators Max Baucus and Charles Grassley, the ranking Democrat and Republican respectively in the Finance Committee. It threatens not only the Blackstone float but also other flotations being considered by rival private equity houses such as KKR.

The bill contains a "grandfathering" clause that means Blackstone could float and maintain its current tax status for six years but lose it after that period. However, new private equity flotations coming after Blackstone would not enjoy that privilege and would face a harsher tax treatment immediately. The legislation proposes that private equity funds are taxed as corporations rather than partnerships for federal tax purposes.

Some analysts on Wall Street believe the bill may struggle to see the light of day, as it will need approval from the Finance Committee and the Senate. However, it will send shockwaves through the vast private equity industry on both sides of the Atlantic as it reveals the level of opposition in some quarters to the amount of money that private equity partners are earning.

Investors are thought to have welcomed the planned Blackstone float, showing strong appetite for its shares but this news is bound to temper enthusiasm for Blackstone and other private equity floats until the future tax treatment of private equity is settled. The move by the senators will also give anti-private equity campaigners in the UK more ammunition in their campaign to curb the buyout industry, which has seen some of its own members recently benefit from low levels of capital gains tax.

Some leading private equity players are also under scrutiny in Britain as to where they are domiciled for personal tax purposes.

The furore in the UK claimed its first scalp on Thursday. Peter Linthwaite, chief executive of the British Private Equity and Venture Capital Association, resigned after a grilling from MPs on the Treasury Select Committee.

Senior UK private equity figures are now coming out in support of raising the rate of capital gains tax applied to private equity partners. Duke Street Capital's Peter Taylor became the first active professional to admit publicly that some of the current tax rates it enjoys are "unnecessarily low" and could be higher without unduly harming investment.

Mr Taylor, speaking independently from his role as managing partner of Duke Street, said of the capital gains tax rate of 10 per cent on investments held for just two years: "Personally, and this is my view, not that of Duke Street, I think 10 per cent is unnecessarily low. It could be a little higher than 10 per cent without deterring people. Something in the region of 15-20 per cent would seem fair."

May consumer prices rise but core prices tame


Glenn Somerville, Reuters

WASHINGTON (Reuters) - Reports showing a moderate rise in a key U.S. inflation gauge and continued manufacturing gains helped fire investor optimism on Friday, despite signs consumers' spirits were dampened by higher gasoline prices.

A steady rise in food and energy costs pushed overall U.S. consumer prices up 0.7 percent in May, the sharpest rise in 1-1/2 years, a government report showed on Friday.

However, the core measure of the Labor Department's Consumer Price Index, which removes food and energy, rose just 0.1 percent, below Wall Street's median forecast of 0.2 percent.

With volatile food and energy costs out of the picture, the muted price gains reassured financial markets that inflation remain under control. U.S. stock and bond prices rose solidly in early trading, while the dollar was pressured by the soft inflation data.

A year-on-year rise in core CPI of 2.2 percent was the lowest since 2.1 percent in March 2006.

"It's good news for the Fed. I still think they (will) worry a bit about inflationary pressures if growth were to pick up, but there is probably a bit more concern about the housing market given the rise in long-term (interest) rates over the last few weeks," said Scott Brown, chief economists at Raymond James & Associates in St. Petersburg, Florida.

The Federal Reserve has held benchmark U.S. interest rates steady at 5.25 percent since last August, though a sell-off in the U.S. bond market over the past week has pushed yields to five-year highs and renewed concerns about inflation.

Bond prices and yields move inversely.

The Fed reported that May industrial output was flat and that businesses were running at 81.3 percent of capacity last month, partly because utility companies cut output and auto producers turned out fewer new vehicles.

There was no sign of letup in foreign interest in investing in U.S. securities, according to a Treasury Department report that showed a net $111.8 billion were bought in April, up from $30.1 billion in March.

Net long-term capital inflows rose to $84.1 billion in April from $51.2 billion in March. The United States needs to attract foreign capital to cover its large budget and trade deficits.

One sour note came in a Reuters/University of Michigan consumer sentiment survey showing reduced optimism in June that potentially reflects growing strain on household budgets from costlier food and energy.

The consumer sentiment index slipped to 83.7 in June from 88.3 in May and was far below forecasts for a reading of 88.

In a separate report, the Commerce Department said the U.S. current account deficit widened in the first quarter of 2007 to $192.6 billion from a downwardly revised estimate of $187.9 billion for the final three months of 2006.

Analysts surveyed before Friday's report called for a bigger first-quarter shortfall of $201 billion.

The current account is the broadest measure of U.S. trade with the rest of the world. It includes trade in goods, service and capital and financial flows such as foreign purchases of U.S. Treasury bonds to help finance the U.S. trade deficit.

Elsewhere, the New York Federal Reserve Bank said New York state factory activity in June rose to its highest in a year after languishing for the prior three months.

The Empire State general business conditions index jumped to 25.75 in June from 8.03 in May. Economists polled by Reuters had expected a 10.8 reading for June.

(Additional reporting by Doug Palmer and Mark Felsenthal in Washington and Dena Aubin and Vivianne Rodriguez in New York)