The Market Acts Like It's the End of the World


It might not be the end of the world, but the toy market is acting like it is -- and just before Christmas, which should be a time of rising prospects, no? Much of the decline the sector has suffered over the past week boils down to game maker THQ's declaration of bankruptcy, but the tragic shooting in Connecticut is weighing heavily on the rest of the video game market, with TakeTwo Interactive down 10% and social-networking game site Zynga falling 9%. The possibility for greater regulation looms large, though Zynga's decline has more to do with Facebook's repositioning itself than with violence in Farmville.

The Dow Jones Industrial Average was actually up 1% as these stocks were falling, but the market swooned at the end of the week, threatening to wipe out the week's gains. It seems all the world is falling apart -- though a short attack against Herbalife knocked off a quarter off its value suggests there's more at play than just Mayan calendars.

On the other hand, the steel industry was the market's biggest winner for the week, yet that seems like it will be short-lived, as most analysts expect the industry to be bogged down by excess capacity both in the U.S. and in China. Yet U.S. Steel and AK Steel were both up about 10% over the past five trading days, though it was left to telecom equipment maker Alcatel-Lucent to be the real market winner, rising 30% despite giving back some of those gains today.

A palace coup
The notable decline in Herbalife shares must have investors feeling like short sellers are piling on. After hedge fund operator David Einhorn weighed in questioning the operations of the nutritional supplements seller earlier this year -- though he didn't take a position at the time -- Pershing Square Management's Bill Ackman jumped into the fray last week, calling Herbalife "the best-managed pyramid scheme in history of the world."

Multi-leveling market companies like Herbalife, Nu-Skin Enterprises , or Usana Health Sciences have the weight of history working against them. For its salespeople to be really successful, it requires ever-greater numbers of people signing on downstream to sell product. Soon, there's just not enough of a global population to support the ranks.

In the interim, the companies subsist often on having their own people buying their product. In the exchange with Einhorn earlier this year, it was mentioned that as many as 30% of its distributors are "self-consumers." Sure, they can like the products so much they use them themselves, but that's also a large amount of individuals propping up the company's revenues.

As leery as I am of MLMs, I've noted I thought Herbalife's response to a lot of the questions raised after the exchange were examples of responsible management: They didn't duck and hide, they answered forthrightly, and they even became more transparent in what they disclosed to the market. It seems they're going to be doing the same thing again in the wake of Ackman's accusations, as they'll be holding an analyst day conference call to refute them.

Let me know in the comments section below if you agree MLM-based businesses like Herbalife's are inherently a pyramid scheme, or is that a "distorted, outdated, and inaccurate" outlook as management maintains?

A perfect storm
Hanging over its head like a Sword of Damocles is the concern that Alcatel-Lucent will go bankrupt before its growth initiatives can bear fruit, but a lifeline thrown to it by Goldman Sachs and Credit Suisse at least puts the day of reckoning off for a few more years.

The investment bankers are providing Alcatel with 1.6 billion euros, around $2.1 billion, to refinance its existing debt and extend its maturities until 2018. That should give the equipment maker enough breathing room to allow carriers like Verizon , AT&T , and Sprint Nextel to reinvigorate their capital spending plans, which have largely been put on ice.

I noted last month that Ma Bell will be spending $14 billion over the next three years to build out its high-speed networks, relying in large part on the sort of small-cell technology that Alcatel specializes in. It's been my contention for some time the equipment maker will be the primary beneficiary of carriers' deploying of small-cell "towers," and this appears to be the first mass usage of them.

AT&T, along with Verizon, accounts for 10% of Alcatel's annual revenues. It signed an agreement recently with Sprint to deploy its LightRadio small-cell equipment to expand its 4G-LTE coverage, which has become imperative for the carrier after getting Apple's (Nasdaq: AAPL) iPhone. Small-cell technology solves a lot of those problems easily.

With Alcatel's depressed pricing even after the large gains it's made, I still find it a compelling investment.

Stop, look, listen
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Rich Duprey owns shares of Apple and Alcatel-Lucent. The Motley Fool owns shares of Apple and Facebook and has options on Facebook. Motley Fool newsletter services recommend Apple, Facebook, Goldman Sachs, and Take-Two Interactive. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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