All too frequently in recent years I have had nothing but bad things to report and say about Dell DELL, but this week I finally have a bit of good news. Instead of chasing its acquisition target 3PAR PAR to the ends of the earth, Dell pulled out of its bidding war with Hewlett-Packard HPQ. As a reminder, HP agreed to pay $2.1 billion for a company with $200 million in revenue and breakeven operating profitability. All too often I see companies get emboldened by the competitive hunt and ignore the return on investment that an acquisition would likely bring. While I'm not happy Dell made a bid for 3PAR in the first place, let alone how much more it would have paid at its last, best off of $1.9 billion (if nothing else, this is a reminder of just how badly the moat at Dell's core business has eroded), I am very happy that Dell finally paid attention to the price potentially being paid.

Either way, Dell remains a modest position in the Hare (1.4% weighting), and it is not a stock I expect to hold over the long term. It is just a matter of me tactically trying to find an appropriate exit point. Yet with the stock trading at just 9 times forward earnings estimates, at a double-digit free cash yield and having nearly one fourth of its market value represented by net cash, the stock is too cheap today to just let it go in frustration.  

In other news this week, there were no company earnings reports to digest or earth-shattering headlines, just a bunch of run-of-the-mill pieces of news to consider:

--Merger and acquisition activity has definitely picked up in recent weeks, and three Tortoise Portfolio companies announced modest purchases. 3M MMM will be buying Cogent COGT, a maker of fingerprint identification systems, for $954 million. Exelon EXC announced it is purchasing Deere's DE wind-energy unit for $860 million. Finally, Walgreen WAG will be buying 18 pharmacies from ApothecaryRX for an undisclosed price. In my experience, large, expensive, and "transformative" mergers (think Dell/3PAR, Intel/McAfee) tend to not work out so well for the acquisitor. But on the other hand, small, reasonably priced, bolt-on purchases in industries where the acquisitor already operates have far better odds of adding value over time. Thankfully, these particular purchases from 3M, Exelon, and Walgreen appear to be of the latter variety.

--Beyond the ApothecaryRX purchase, Walgreen also announced a smallish asset-swap with Omincare OCR. Walgreen will be selling some of its long-term pharmacies (pharmacies that primarily serve senior-living establishments) and picking up a home-infusion business. In addition, Walgreen announced same-store sale growth of 2.1% for August, which is a slight improvement from earlier in the year. Total sales, including new stores, were up 8.6% in the month, or 5.8% excluding those stores that came with the Duane Reade purchase. In all, Walgreen is not a stock that currently excites me, but I also think it is a fairly low-risk investment that is trading moderately below its intrinsic value. I plan on continuing to hold the shares in the Tortoise for the time being.

--We saw evidence this week of one piece of fallout from recently enacted financial regulatory reforms. J.P. Morgan Chase JPM is closing down its proprietary trading operations, giving notice to roughly 20 of its traders. Though the action won't move the needle at the behemoth financial services firm, it will slightly reduce both risk and profit.

--I receive e-mail alerts when the Tortoise and Hare portfolio companies submit new filings to the SEC, and my heart always skips a beat when I see an 8-K (material news) filing from Apollo APOL, given the seemingly unending drama surrounding the company and its industry. This week there was a filing indicating that a shareholder has filed a class-action lawsuit against the company and its management, alleging the dissemination of misleading information. These types of lawsuits have become almost a matter of course whenever a company experiences a drop in its stock price, and I am not overly concerned with this particular lawsuit. I think the swoon in the stock price has been caused by a simple change in market sentiment, not some material weakness that was hidden and then revealed.

--Enterprise GP Holdings EPE subsidiary Enterprise Products Partners EPD announced a deal with oil & gas company EOG Resources EOG under which Enterprise will build a number of pipelines and processing facilities to service EOG's new production in the Eagle Ford shale play in southern Texas. As I've mentioned before, any growth at the underlying partnerships, even growth that is merely value-neutral for limited partners, should be very beneficial for general partners like Enterprise GP. With low interest rates causing the units to go on a tear in recent months, Enterprise has gone from being very deeply undervalued to finally being near its fair value estimate of $53. I still really like the business and don't mind continuing to hold a modest stake in Enterprise, but the oversized position in the Hare does not currently match my enthusiasm for the opportunity. In other words, I'm considering trimming (but not completely selling) the Hare's Enterprise stake.

--Magellan Midstream MMP is in a similar situation to Enterprise; its stock has done exceptionally well and is now in the neighborhood of its fair value estimate, even after we raised our fair value estimate from $44 to $49 this week. If we are doing our jobs well here at Morningstar and making projections that are on target, our fair value estimates should be increasing for any given company at something close to an annual rate of 10% minus the dividend yield. Thankfully, our expectations for Magellan appear to largely be coming to fruition, in addition to some modestly better news than previously expected.

Next week should be another relatively quiet one. Beyond the Labor Day holiday on Monday shortening the trading week by a day, my calendar is bare in terms of company earnings reports. We should, however, be publishing the September issue of StockInvestor. The electronic version of the issue should be available by lunchtime Thursday at the latest.

Finally, with the unofficial end of summer here this weekend, it is the perfect time to start thinking about events in Autumn, such as our annual Morningstar Stocks Forum. This year's event will be happening Nov. 3-4 at the Palmer House Hilton in downtown Chicago. The first day will be filled with presentations by Morningstar analysts and strategists, including yours truly. The second day will be filled with presentations by top executives from companies that we think have economic moats, including Tortoise and Hare Portfolio holdings CarMax KMX, Fastenal FAST, First American FAF, and Pfizer PFE. It should be an insightful event.

Have a great holiday...

Paul Larson
Equities Strategist
Editor, Morningstar StockInvestor

Disclosure: Paul Larson owns shares of the following stocks mentioned in this e-mail: APOL, DELL, EPE, EXC, FAF, FAST, JPM, KMX, KO, MMM, MMP, PFE, WAG

--------------------------------------------------------------------

Morningstar Stock Analyst Notes

Dell DELL     |     Michael Holt

After raising its offer to $33 per share this morning, Hewlett-Packard HPQ has finally knocked Dell out of the bidding war for 3Par PAR. At $2.1 billion, the final deal price is extracting an aggressive premium, and HP will have to quickly multiply 3PAR's sales to make the numbers work. Nonetheless, the deal makes sense strategically and HP's existing base of high-end storage customers and greater presence in data center sales position the firm to extract greater value from the deal than Dell could.

Looking forward, we expect Dell will continue its aggressive pursuit of enterprise technologies that broaden its product portfolio. As evidenced by other recent acquisitions, the firm is immersed in a strategy to increase focus on data center solutions rather than PCs. Although there is no clear alternative to 3PAR's high-end SAN storage, Dell may look at storage firms such as Isilon ISLN that would provide solid technology in a section of the market not served by its EqualLogic product line or EMC reseller agreement. However, with investors pushing the valuations up for storage candidates, it is just as likely that Dell may choose to pursue solutions to build up its networking or software portfolios.

--------------------------------------------------------------------

Exelon EXC     |     Travis Miller

We are reaffirming our fair value estimate for Exelon after the company announced its plans to acquire Deere's DE renewables unit for $860 million plus as much as $40 million of possible development payments. At $1,170 per installed kilowatt of capacity plus 230 megawatts of capacity in development, Exelon paid a fair price based on current power market fundamentals, in our view. Other significant wind transactions during the past 12 months averaged around $2,000 per kilowatt, but those came before Congress all but killed the potential for a near-term carbon emission cap, which would have significantly benefited wind generation owners. Management said the transaction would be accretive to earnings by 2012.

Even though we are not changing our fair value estimate, we do think the deal is a moderate positive strategically, in that Exelon management paid a fair price and reaffirmed its commitment to maintaining its position as the primary beneficiary of what we believe are inevitable federal regulations tightening fossil fuel emission limits. It also immediately makes Exelon a midtier player among U.S. wind generation owners and could help partially hedge some of the market concerns that Exelon would be most hurt as wind power in the Midwest softened power prices and margins for its core nuclear power plants. Finally, we think the deal should allay market concerns that Exelon would either participate in the industry's recent wave of deal activity with a value-diluting transaction or fail to take advantage of what we think is a cyclical trough in the industry. We think this deal substantially reduces the likelihood that Exelon will pursue another significant transaction in this part of the cycle. The deal is expected to close by the end of 2010. We don't expect the transaction to have any effect on the company's internal growth investment plans, credit profile, or dividend.

--------------------------------------------------------------------

3M MMM     |     Adam Fleck

On Monday, 3M announced that it will purchase fingerprint identification and biometric firm Cogent COGT for roughly $943 million, less Cogent's $514 million in cash and marketable securities--a net acquisition price of about $429 million. The deal values Cogent at about $10.50 per share, an 18% premium to last week's closing price, but a slight discount to our fair value estimate. The premium to Friday's closing price could suggest that 3M is looking to fend off a counter offer, though it is unclear at this point where such an offer would come from. As such, we've put our coverage of Cogent under review. That said, we think 3M is paying a reasonable price, and we're maintaining our fair value estimate for the acquirer.

Cogent has historically proven highly profitable, and we think the company has carved a narrow economic moat due to sustainable competitive advantages in the biometric arena that have allowed it to build solid relationships with high-profile customers like the United States Department of Homeland Security, or DHS. We believe 3M could initially pair the firm's technology with its passport-security operations, although future applications (in keeping with 3M's propensity to drive a large amount of new products from just a few core technologies) could drive additional synergies in the coming years.

With this deal, 3M continues to march along its recently stated path of increased acquisition activity. Over the remainder of 2010, CEO George Buckley has stated that the company may approach $2 billion in acquisitions. We think smaller, bolt-on purchases such as Cogent make sense, and we believe 3M's strong balance sheet further supports such action.

--------------------------------------------------------------------

Enterprise GP Holdings EPE     |     Jason Stevens

We're unsurprised but nonetheless impressed by the agreement Enterprise Products Partners EPD announced Wednesday to provide midstream services for EOG Resources EOG in the Eagle Ford Shale. EOG has a 505,000 net acre position in this emerging South Texas resource play; under the agreement, Enterprise will provide comprehensive midstream services for all of EOG's production out of the Eagle Ford. In support of the agreement, Enterprise will build a new 140-mile, 350,000-barrel-per-day pipeline to transport EOG's crude-oil production, anchored by a 10-year firm transport agreement. Enterprise expects the pipeline to be in service beginning in 2012, and in the interim will use trucks to provide crude transport services. EOG also signed seven-year contracts for natural gas transportation and processing and natural gas liquid transportation and fractionation. We continue to think Enterprise has a dominant midstream position in South Texas and see the EOG agreement as evidence of that dominance.

--------------------------------------------------------------------

Magellan Midstream MMP     |     Avi Feinberg

We are increasing our fair value estimate for Magellan to $49 per unit from $44 after considering the upside potential of the recently announced $290 million pipelines and storage deal with BP, BP and increasing our future capital expenditure assumptions. While the deal economics at the onset are not particularly compelling to us, with a price tag of at 9-10 times expected EBITDA over the first year or so, we like that these assets position Magellan to capture future volumes in Cushing and the East Houston refining complex as crude oil supplies from Canada and the Eagle Ford shale ramp up. Given our assumption that a good portion of this supply makes its way to Houston, we think Magellan will be able to ramp up pipeline volumes in the area, build additional storage and interconnects at attractive rates of return, and possibly consummate additional deals as majors offload additional midstream assets. Thus, we model capital expenditures of $565 million for 2010, per management's guidance including the BP deal, and $300 million in 2011, which grows steadily in subsequent years. In the spirit of conservatism, we model project returns of eight times EBITDA, the less attractive end of management's 6-8 times target range. These assumptions yield average annual cash flow growth of 14% over the next five years, off a down year in 2009, and support distribution growth of about 7% per year over the same period after factoring in future unit issuance. Magellan's units would yield 6% at our fair value estimate based on a quarterly distribution of $0.7325 per unit.

--------------------------------------------------------------------

PepsiCo PEP     |     Philip Gorham, CFA

PepsiCo announced that it will distribute sports drink Gatorade on its direct store delivery platform in the convenience and dollar store channels in 2011. Although the strategy does not move the needle on our fair value estimate, we think it demonstrates that Pepsi is focused on the long-term growth of its brands, and we support the decision.

Pepsi and rival Coca-Cola KO deliver products to convenience stores both directly and through warehouses. Although direct store delivery is a more expensive distribution method, it allows beverage manufacturers to achieve greater flexibility in their route to market, provides a direct relationship with retailers, and allows the firms to influence in-store product displays. These factors give beverage makers a competitive advantage over rivals that use a warehouse system and help build the strength of high-volume brands. We think the switch to direct store delivery will enhance the revamping of the Gatorade brand, and we expect the brand to regain some market share in the medium term.

--------------------------------------------------------------------
--------------------------------------------------------------------

Join me at the 2010 Morningstar Stocks Forum

You're invited to attend the 2010 Morningstar Stocks Forum, Nov. 3-4, in Chicago at the Palmer House Hilton. At our two-day event, you'll hear Morningstar equity strategists and analysts dissect the current market environment, offer their perspective on the road ahead, and present their current stock picks. Don't miss your chance to meet face-to-face with our analysts as well as the management teams of some of the top companies we cover.

Take your investing knowledge a step further and attend one (or more!) investor workshops on Nov. 5 at Morningstar's headquarters in Chicago.

If you have questions about the 2010 Stocks Forum and Investor Workshops, please call us at 1-866-910-1145.