This Week's Market Moving Earnings Calls

It's a difficult task to narrow down this week's list of earnings calls/reports from 280 to a manageble 5; however, each day of the upcoming week has reports critical to short to near-term markets. The picks below are concentrated in financials, consumer goods, residential construction, and energy due to their impact on the consumer (consumer spending equals 70% of GDP)--notice the aversion to tech, though AMZN's numbers should be important. The five companies have an equally-weighted return of -33.4% for the period 1/1/07 to 1/25/08. vs. -6.1% for the S&P 500.

Monday - American Express	AXP
Tuesday - Countrywide Financial	CFC
Wednesday - Kraft	KFT
Thursday - Pulte Homes	PHM
Friday - Exxon Mobil	XOM

Merger Arb Plays

BofA put it's $4B+ offer on the table for beleagured mortgage lender Countrywide Financial.

Terms:
-.1822 shares of BofA (40.57) = 7.39 per share for CFC holders
-2Q2008 closing target according to BofA CEO
-Spread: 23.4% for a 3-5 month closing.

Bottom line:
-Faro outlook is positive for small portion of current cash position


FCC and shareholders approved the Bain/Thomas H. Lee buyout for Clear Channel Communications; pending DoJ's nod.

Terms:
-$39.20 cash per share
-Feb 2008 closing target
-Termination fee of $500m or 12% of equity commitment
-Spread: 21.7% for 1 month closing

Bottom line:
-Faro outlook is positive for small portion of current cash position

Reading Expectations through Stock Prices: Discover Financial Services

DFS is a company that generates ~$1B per year in free cash flow and currently trades at book value. Of the underlying drivers of firm value (i.e., top-line growth, ROIC, and cost of capital) the most concerning to me is ROIC. This begs the question: at today's price, what is the market's assumption for free cash flow growth over the next four years? If we assume a near worst-case scenario (widespread fraud and bankrupcty would be the worst--though my opinion does not support this) of 4 consecutive years of only $500m in free cash flow--a fifty percent reduction driven mainly by a huge increase in the current charge off ratio of 5%, followed by a return to $1B of cash flow generation followed by a valuation of 10x cash flow in year 10, the value of the company would be ~$10B vs today's current value of $6B. Clearly, the market is seeing a longer period of uncertainty since the implied cash flows out 4 years are being valued at zero! Or, DFS is being overly discounted during the current economic crisis. My guess it that the charge off ratio will grow as high as 10% but in the end most folks will pay their bills.

Quick Snapshot
Pricing Power: yes
Oligopoly: yes
Recurring Revenue: yes
Brand Strength: so-so
ROIC > Cost of Capital: yes
Balance Sheet Strengh: A

Faro Portfolio Performance

Faro: (9.8%)
S&P: (8.6%)

Highlights: positions have been reduced and shift to cash has slowly occurred throughout Nov. and Dec. 2008 economic stance is flat to slightly down.


inception date: 10/15/2007

2008 Predictions

Predictions for the coming year are all the rage in financial journalism, especially among the more populist publications: BusinessWeek and Fortune. It seems the more intelligent people (read: The Deal, The Economist) understand flaws in seeking exactness and are much more cautious when asked about what the future will hold. Many journalists are publishing their stories of the year and their predictions for 2008. One would be wise to just gloss over these for the most part and ask one important question: how much of this year's 'credit crunch' is actually a crisis and how much of it is actually a return to historical risk premiums and reasonable mortgage lending standards--such as as actually proving income and not falling into the pits of esoteric neg-am loans. In theory, home values don't fall nationwide, but then in theory, financial journalists and economic 'experts' are the real experts.

Happy Investing,
Faro Research

Fallen Spinoff Tracker

Company Name	Ticker	Spin Date	Price	Current
Opnext	OPXT	2/14/2007	$15.00	$8.11
Babcock & Brown Air LTD	FLY	9/26/2007	$23.00	$19.35
Quest Energy Partners	QELP	11/8/2007	$18.00	$15.15
Encore Energy Partners	ENP	9/11/2007	$21.00	$19.26
Cal Dive International	DVR	12/13/2006	$13.00	$12.74
MF Global Ltd.	MF	7/18/2007	$30.00	$29.78

Virtues of Basic * Cash Flow Analysis

Since John Burr Williams' Theory of Investment Value in the 1930's clarified the idea of firm value, a discounted cash flow (DCF) analysis has been a pillar in finance theory and practice. Though simplicity is touted by using simple multiples, this does not eliminate the implied DCF of a financial asset. The value of any asset is the present value of all future cash generated.This raises some basic questions: when will I get my cash? How much will it be? How likely is it that I'll get it? What discount rate should I use for my estimate? Though this is far from science, and the model for analysis changes depending on the type of business (e.g., banks, manufacturers, et al.) in question, this forces one to question the future growth and profitability assumptions implied in an asset's price. Below are some key points to any simply DCF analysis:

Cost of Capital: risk-free rate + risk premium, or, opportunity cost of capital

Cash Flow Forecasting Period: long enough for the company’s top-line growth rate to be less than or equal to that of the economy.

Free Cash Flow: Operating Cash Flow – Capital Expenditures



*should be very basic and conservative