Financial Information
From Angst to Arbitrage
Tony Crowell

Stocks finished April with a nice gain, then began the merry month of May in a promising manner. Wall Street's return to optimism started with the shotgun rescue of Bear Stearns, leaving a belief that the Federal Government now has a policy of No Bank Left Behind. Main Street is more hesitant with consumer confidencestill low. This is understandable with the housing market still fishing for a bottom and only slight improvement in the employment figures.

It's two months until the next Fed meeting and the next round of quarterly earnings reports. This period is historically bland for stocks but the credit crunch over the last six months has overpowered usual seasonal trends. This probably means that news developments in individual stocks rather than broad market moves will dominate price changes.

Consumer spending drives about 70% of the American economy and sustained market strength will have to await a pickup in consumer confidence. The stimulus checks may spark retail sales and summer may bring a pickup in housing sales. Corporate earnings for the March quarter are showing strong 11% gains on average, provided one excludes consumer and financial stocks. That's a big sector to exclude but it shows the advantages of concentration in energy, metals, agribusiness and companies with strong export sales.

Valuations for stocks are reasonable with priceto earnings ratios around 15 and price-to-sales at the low end of their range for the last ten years. With confidencelow, it will probably take some more positive catalysts for a significantsurge but nibbling at stocks with soundly based prospects for growing earnings will work out.

Reasonable valuations tend to produce takeover attempts, particularly, as now, when lower interest rates facilitate them. These have some market neutral elements, making them more attractive when the market lacks a clear trend.

I recommended Diebold (DBD-$40) in the 3/18 column here on the unsolicited takeover bid on 3/2 by United Technologies (UTX-$75) of $40. Two months later, its price has crept up to the takeover price although it has continued to resist the proposal while UTX has reaffirmedits offer.

Diebold, which makes ATM's, voting machines and security equipment, recently raised its sales outlook and declared a $.25 dividend payable in May. It seems to have few alternatives and I expect UTX will continue its efforts, probably with a sweetened bid and a close this summer.

The merger arbitrage spread went from two points to zero over the last few weeks, price action indicating that the market believes a higher offer will ensue, possibly through a change to a negotiated "friendly" deal. I recommend additional buys, particularly if nervous rumors kick it below $40.

This price action differs from that of the recent Yahoo/Microsoft fiasco when Yahoo stock never made it to the projected takeover price. I took positions initially, as noted in the same 3/18 column, then later scalped a small gain on concerns that Yahoo's earnings would prove disappointing, killing the appetite for the takeover. Yahoo will probably wander in the wilderness for a while, probably making some sort of cooperative advertising deal with continuing recommendation Google (GOOG-$591), which is undoubtedly already hiring Yahoo people.

The most tempting merger arbitrage is Bank of America's (BAC-$40) acquisition of Countrywide (CFC-$6). B of A will pay .1822 shares of its stock, a rather rich premium of over 20% at current prices. Approvals by the regulators and the shareholders will narrow the spread, if and when they are obtained.

The biggest risk is Countrywide's survival until the merger closes, probably in August. The bank really wants this deal, which will make it by far the largest mortgage lender. B of A coolly announced last week that it could give "no assurance" that it would assume or guarantee any of Countrywide's $97 billion debt. This looks like a clever negotiating move to me and

am taking modest positions on this aggressive merger arbitrage.

No column next week as I will be on vacation in Paris experiencing the impact of the weak dollar on exchange rates for the Euro.

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach

since 1993. Tony may be reached at (949) 494-1376; aic@cox.net.