Thank You, Europe

 | May 31, 2012 | 12:30 PM EDT
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It's now official. Sell in May and go away was truer than ever this year. Absent what happens today, the S&P 500 is down more than 6% in May as investors have been pulling money out of stocks all month long. Europe's financial mess is undoubtedly spilling over in the U.S. causing mild panic among many investors here.

But the mess in Europe is likely going to be a very different animal than what we had here in 2008. It will be different not in severity per se, but very different in the ability to craft a solution. We have a central bank and a central government with a central monetary system. Europe has the EU but no central government, so adopting reform quickly and aggressively is very difficult.

But when the dust settles, investors will be thankful to Europe for the opportunities it's leaving in its wake here in the U.S. While many U.S.-based hedge funds are flocking to Europe to take advantage of will likely be very favorable prices of distressed banking assets, the patient U.S. investor will surely get his or her opportunity to pounce.

Yesterday, automotive service company Pep Boys (PBY) fell 20% to $8.90 after its deal to be bought for $15 a share was terminated. The buyer, private equity firm Gores Group, got scared after Pep Boys' results starting falling and sought to delay the deal. Pep Boys' refused to delay and further refused to renegotiate terms. The company will walk away with a $50 million break-up fee. The market cap is now $450 million. Pep Boys will use the $50 million to pay off debt, which currently stands at around $400 million. A few weeks ago, I opined that PBY may be a great merger arb play, but even if the deal fell through the company was a good buy alone.

Shares now trade below where they stood before the buyout offer. First-quarter results, out next Thursday, are going to be worse than expected, but that's likely built into the price. Keep an eye on this business if the share price gets any lower.

Chesapeake Energy (CHK) is off 50% in the last year and now has a duo of heavy-hitting large shareholders who see tremendous value in the shares. The largest shareholder is highly respected investment company Southeastern Asset Management, founded by Mason Hawkins. The second largest shareholder is activist Carl Icahn.Chesapeake is trading at 6x earnings. The market cap is $10 billion against an EV of $24 billion. Operating cash flows are enormous ($5 billion last year alone amidst a historically weak natural gas pricing environment).

Excessive capital expenditures have clouded the free cash flow generating ability of this company, but these shareholders and others are as committed as ever. A few steps in the right direction by these shareholders probably boosts the share price by 20% in short order, but the intrinsic value of CHK is likely an upside of 75% or more at these levels.



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