United's Smooth Takeoff

BW's Gene Marcial talks with analysts who say after airline parent UAL beat earnings forecasts, it could draw private equity interest

United Airlines' parent UAL (UAUA) sprang a surprise in July when it posted second-quarter earnings that handily beat Street forecasts. Another surprise was how the stock has bounced up after UAL emerged from bankruptcy in February, 2006--despite high oil prices, rising competition, and public outcry about the airlines' disruptive flight cancellations and delays. The stock climbed from 21 in February to 49 on July 23, 2007, the day before the market's plunge. Analysts see the stock, now at 44.44, rising to 52-58 on strong revenue growth and continued cost cutting. Another plus that could kick up the stock: private equity interest.

"We believe UAL is a potential private equity play, given the $4 billion we estimate it can earn in free cash flow over the next four years," says Daniel McKenzie of Credit Suisse (CS) (it has done banking for UAL and owns shares), who rates UAL "outperform." He says such groups "could take UAL private today, collect dividends, and go public when the industry consolidates, thereby capturing the valuation arbitrage." At the end of the second quarter, UAL had $5.1 billion in cash, matching its market cap. Given pressure from the growth of low-cost carriers and other industry challenges, McKenzie sees more consolidation as nearly certain. The analyst also believes UAL may spin off its Mileage Plus program and/or pay a dividend later this year. If the Mileage Plus is spun off, he says the proceeds could be used to pay down additional debt or for repurchasing shares. McKenzie figures UAL will earn (fully diluted) $2.55 a share in 2007 and $4.30 in 2008. His 12-month stock price target is 58.

Vincent Carrino, president of Brookhaven Capital Management, which owns shares, says UAL brass has expressed interest in an alliance or merger. He thinks UAL is worth 60 to 80 in a deal, which he expects would be on a stock-for-stock basis. Another airline, says Carrino, may propose a merger even before private equity makes a move.

Frank Boroch of Bear Stearns (BSC) points out that UAL, which runs 3,600 flights a day to 210 U.S. destinations and in 28 other countries, is one of the "more vocal proponents of consolidation among the airlines, even pointing out that [greater] East Coast presence and a Southern U.S. hub could complement its existing network."

"Despite the negative fuel environment, the company exceeded its cost-reduction targets," says Ray Neidl of Calyon Securities, who recommends the stock as a buy. The company, he figures, is on track to meet its goal of reducing costs by $400 million this year. A big advantage to major carriers is that additional airline capacity is unlikely to occur, according to Standard & Poor's, even though demand for air travel is likely to remain robust in 2007.

Vending Machines Are Learning To Love Plastic

Credit-card companies are targeting 11.5 million U.S. vending machines in stores, factories, colleges, hotels, and offices. USA Technologies (USAT) is the largest maker of the e-port devices that enable vending machines selling soft drinks, snacks, and laundry products to accept plastic. So far, only 12,000 machines accept cards. MasterCard Worldwide and Coca-Cola Enterprises, major distributors of Coca-Cola products, are big supporters of fitting vending machines with e-port devices. In April, six large vending companies agreed to install 5,000 e-ports to accept MasterCard PayPass (MA) in their machines. And several prominent bottlers, including Coca-Cola Bottling Co. and Cadbury Schweppes Americas Beverage, whose brands include Dr Pepper, 7UP, and Snapple, have also signed up.

SAC Capital Associates, led by billionaire trader Steven Cohen, was so impressed with USAT's e-port devices that it bought $10 million worth of USAT stock, for a 15% slice.

Another big stakeholder is Wellington Management, which owns an 8.1% stake. Credit-card transactions could hike vending sales by 32%, says Michael Shonstrom of Emerging Growth Equities. He rates the stock a hold, but says USAT has "substantial upside if major industry adoption develops." Luis Martins of Taglich Brothers figures sales will rise to $16.2 million in 2008, from $9.8 million in 2007. He sees the stock, now at 7.90, at 11 at yearend. CEO George Jensen says that vending machines, excluding laundry and kiosks, produce cash transactions of $46 billion annually. "We have only begun to penetrate this huge market," he says.

From SemBiosys, A New Kind Of Insulin

Insulin from safflower? That's what SemBiosys (SBS) Genetics, which trades in Toronto under the symbol SBS, is developing. In a June presentation to the American Diabetes Assn. in Chicago, the company demonstrated that plant-produced insulin is "physically, structurally, and physiologically indistinguishable from pharmaceutical-grade human recombinant insulin," according to Chief Executive Officer Andrew Baum. These results, he says, validate the feasibility of plant production technology for the large-scale manufacture of human insulin, where capacity is in short supply. Baum believes plants offer unprecedented capacity and flexibility for low-cost biopharmaceutical manufacturing and provide by far the most attractive economics in terms of capital and cost of goods. SemBiosys makes protein-based pharmaceuticals and non-pharmaceutical products, using genetic engineering and a proprietary technology. Baum sees demand for insulin rising to 16,000 kilograms in 2012, a big jump from 6,000 kg in 2006, when sales were $7.5 billion worldwide.

Neil Maruoka of Canacord Capital, who rates the stock, now at 3.51 Canadian dollars, a buy, with a target of 7.70 in Canadian dollars, says the results presented by SemBiosys at the American Diabetes meeting were "incrementally positive" and compare favorably with U.S. pharmaceutical-grade insulin. He expects that SemBiosys' next move will be into human testing to get approval from the Food & Drug Administration. Based on the preclinical evidence of functional equivalence, Maruoka anticipates the company could file an investigational new drug application with the FDA to begin clinical trials before the end of the year. With a shortened path to commercialization in the U.S., "we believe SemBiosys recombinant insulin could be launched by 2010, if approved," he says.

Brian Bapty of Raymond James (RJF) in Toronto says SemBiosys has a diversified pipeline of new products that includes food additives, cosmetics, animal health items, and pharmaceuticals. He rates the stock "outperform," with a target of 6.60 ($1 U.S. equals 96 cents Canadian). Karen Boodram of Pacific International Securities says SemBiosys is well funded, with $30 million Canadian on its balance sheet. She rates it a buy.

Note: Unless otherwise noted, neither the sources cited in Inside Wall Street nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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