January 7, 2008

Service sector growth slower than expected

The Institute for Supply Management says the service sector expanded in December but the pace was slightly slower than last month.
NEW YORK (AP) -- The nation's service sector grew in December at a pace slightly slower than the month before, providing more evidence that the U.S. economy is struggling because of higher oil prices and a tight credit market.

The Institute for Supply Management, a business group based in Tempe, Ariz., said Friday that its index measuring performance in non-manufacturing industries slipped to 53.9 in December from 54.1 in November. It was the lowest reading since 52.4 in March.

A reading above 50 indicates expansion, while one below 50 shows contraction.

Analysts surveyed by Thomson/IFR had expected a slightly lower reading for December.

Anthony Nieves, chairman of the institute's business survey committee, said in a statement accompanying the report that respondents "remain concerned about the economy."

Earlier this week, a companion index showed that the U.S. manufacturing economy unexpectedly contracted in December, ending a 10-month growth streak and suggesting the economy may be weakening faster than some analysts expected.

Similar fears were raised Friday when the Labor Department reported that payrolls grew by an anemic amount in December, driving the nation's unemployment rate up to a two-year high of 5 percent. The unemployment rate had been 4.7 percent in November.

Stocks fell sharply on Wall Street on the news, with the Dow Jones industrial average down more than 180 points in morning trading.
Pressure mounting for big rate cut

The latest ISM report on the service sector indicated that new orders and employment rebounded slightly in December. The new orders index registered 53.5 last month, up from 51.1 the month before. The employment index, meanwhile, was at 52.1 in December compared with 50.8 the month before.

Ian Shepherdson, chief U.S. economist with High Frequency Economics Ltd. in Valhalla, N.Y., said in a research note that the rise in the ISM employment reading could signal that the Labor Department's payroll numbers will firm in coming months.

The index reading "is consistent, if maintained, with modest gains in core private sector payrolls, which fell in the December data released this morning" by the Labor Department, he said.

The inventories reading was unchanged at 50.5, while the price index registered 72.7 in December, down from 76.5 the month before.

The report said that five industries reported stronger business activity in December: retail trade; information; professional, scientific and technical services; construction; and health care and social assistance.

Eight reported decreased activity: management of companies and support services; miscellaneous services; accommodation and food services; real estate; finance and insurance; wholesale trade; educational services; and arts and entertainment.

Bank stocks: Buyer beware

They're cheap and dangerous. But analysts say there are opportunities for the right investor.
NEW YORK (CNNMoney.com) -- It's undeniable: Bank stocks are cheap.

Earlier this week, Citigroup (Charts, Fortune 500) stock finished below $30 a share for the first time in over five years. Shares of another troubled Wall Street firm, Merrill Lynch (Charts, Fortune 500), are trading at a 39 percent discount from where they were before the credit crisis erupted a few months ago. And shares of Washington Mutual (Charts, Fortune 500), the nation's largest thrift, are down more than 60 percent since the start of the year.

"There is great temptation looking at some of these prices," said Frank Barkocy, director of research at Mendon Capital Advisors in New York.

As attractive as many financial stocks appear to be, many are likely to fall further. "There is a great deal of uncertainty," added Barkocy. "We don't know where we will see the bottom."

Still, analysts argue that there are plenty of opportunities out there. Some regional banks are attractive because they have sidestepped the credit crunch. And investors in big game like Citi and Merrill could see generous returns if they stick it out for the long haul.

For now, financial stocks remain challenged. Wall Street firms, for example, face the possibility of further writedowns or a surprise development in the credit market crisis.

Lenders with a bigger exposure to mortgages, like Washington Mutual and Wells Fargo (Charts, Fortune 500), face deteriorating home prices and the threat of rising home owner defaults, particularly if the economy slips into a recession in 2008.

And, of course, it's likely that many banks will soon see earnings fall sharply in the fourth quarter, said Jaime Peters, an equity analyst at Morningstar.

"There's every single sign they're not going to look good," said Peters.

Still room to invest

But dismal as the outlook may be, many of these banks are worth investing in.

Shares of regional outfits like BB&T (Charts, Fortune 500) and Regions Financial Corp. (Charts, Fortune 500) are significantly discounted from where they were at the start of the year. But they offer an attractive dividend yield and have largely insulated themselves from some of the problems affecting the big Wall Street banks.

"These companies don't have subprime loans, credit derivatives or structured investment vehicles," said Punk Ziegel's Dick Bove, a famously skeptical analyst who upgraded a number of banks earlier this week based on valuation. "You are not going to see big loan losses going forward."

Other regionals like the Texas-based Sterling Bank (Charts) and Cullen/Frost (Charts) are also attractive because the Texas housing market has held up despite the national housing meltdown, said Morningstar's Peters.

And even though some of the trust banks like Northern Trust (Charts, Fortune 500) or Bank of New York Mellon (Charts, Fortune 500) are trading at a premium right now, they still look fundamentally attractive, said Mendon Capital's Barkocy.

And what about the big boys like Citigroup, Merrill or one of their competitors? That depends on the bank.

A host of stocks - including Wachovia (Charts, Fortune 500) and Bear Stearns (Charts, Fortune 500) - look like bargains compared to competitors when measured on price-to-book value, a gauge of assets minus liabilities that analysts like to use as a preferred yardstick for comparing financial stocks.

But if you have a long-term investment horizon, just about any financial firm is worth snapping up.

"These stocks are cheap right now," said Peters. "We're not promising they won't continue to go down but we are saying if you buy now and hold three to five years, you will have an excellent return."

The best stocks for 2008

We've found ten stocks that will thrive despite - or even benefit from - the troubles facing the markets next year.
Consider the blows it has absorbed just this year. The worst real estate crash since the Great Depression. Pow! Oil prices up from $50 to $90 a barrel since last January. Bam! A subprime mortgage mess metastasizing into a full-blown credit crisis, with banks swallowing billions in losses and cutting back on loans. Baff!

Yet through all the punishment, the economy has barely flinched. "I'm floored by how resilient it has been," says veteran stock strategist Ed Yardeni of Oak Associates. "Had you told me at the beginning of the year this was going to happen, I doubt I would have been very optimistic."

That's why forecasting 2008 is so difficult. History tells us that oil shocks, real estate crashes, and banking crises are harbingers of downturns. Confidence has already plunged as consumers have been pinched by rising energy prices and falling home values.

October saw another bad omen: a decline in discretionary purchases such as books and electronics. Observes Merrill Lynch economist David Rosenberg: "You have to go back to the 1990-91 recession to find a time that this trend has been so weak heading into the holiday shopping season."

Despite all that, the U.S. economy expanded 3.8% and 4.9% in the second and third quarters, respectively - up from 2.4% and 1.1% during the same periods in 2006. That's right: For all the bad headlines, the American economy appears to be getting stronger.

How can that be? The short answer is globalization. Rapid expansion in the developing world - not just in China and India but in Russia, Brazil, and Turkey, for example - has created new markets for U.S. goods and services, and a weak dollar has made them relatively cheap.

As a result, 44% of the Standard & Poor's 500 companies' revenues comes from abroad, up from 32% in 2001. S&P expects that figure to rise to 50% in 2008. Says Bob Doll, who helps manage some $1.3 trillion as chief investment officer for BlackRock: "The boom in exports is almost as big a positive as housing is a negative."

The bottom line: We think the U.S. economy will slow in 2008 but narrowly miss an outright recession. We expect the overall stock market to bounce around, as it did this year, and deliver anemic single-digit returns.

Of course, some stocks will thrive even when the market as a whole is on the ropes. After interviewing dozens of analysts and money managers and poring over reams of Wall Street research, we've identified ten stocks we believe are poised for big gains in 2008.

Five of our picks are growth companies in noncyclical industries, on the logic that in a slowing economy, investors will pay a hefty premium for superior profit improvement. These five aren't cheap - they trade at an average of 22 times 2008 profits vs. a price/earnings ratio of 14 for the S&P, according to Baseline - but they're worth it. Analysts expect their earnings to increase an average of 29% next year, vs. 6% for the S&P.

We've also identified a handful of opportunistic investments - stocks positioned to exploit the ongoing crises in finance and real estate or to rebound once the panic lifts. These are not for the faint of heart, but the opportunity is just too good to let a little apprehension (okay, a lot) get in the way.

For the record, our past Investor's Guide selections have excelled. Our ten stock picks for 2006 returned an average of 26% that year, vs.13% for the S&P. And through Dec. 3, our ten stocks for 2007 have outpaced the S&P 14% to 6%.

Now on to Fortune's best investments for 2008:

Annaly Capital Management

Annaly is a hedge fund disguised as a real estate investment trust that makes its money by investing in mortgage-backed securities. Sounds like a prescription for disaster, right? In reality, there's probably no company better positioned to profit from the ongoing mortgage crisis than this one.

What distinguishes Annaly (NLY) from its out-of-favor Wall Street peers is the fact that it doesn't take credit risk, only interest-rate risk. It buys mortgage-backed securities issued by government-sponsored enterprises like Fannie Mae and Freddie Mac; in other words, it has no exposure to subprime mortgages.

The securities Annaly owns are all guaranteed by Fannie, Freddie, or Ginnie Mae, which means they're implicitly guaranteed by the U.S. Treasury. Yes, there have been troubles at Fannie and Freddie, but trust us when we say that the value of Annaly stock would be the least of your concerns if the federal government ever allowed Fannie or Freddie to default.

What makes Annaly's business model so compelling right now is the widening gap between its borrowing costs (which are sinking as the Federal Reserve cuts rates and banks offer Annaly better borrowing terms) and the yields on the mortgage securities it holds (which haven't fallen nearly as far). In the third quarter, that interest-rate spread more than doubled, from 0.32% to 0.67%. A third of a percentage point may not sound like a lot, but it's huge when you've got a $45 billion portfolio.

This widening spread is fueling massive earnings growth - 57% in the third quarter and a projected 53% in 2008, according to analyst estimates. Schneider Value Fund portfolio manager Arnie Schneider thinks more Fed rate cuts are coming, which would juice Annaly's earnings even more.

Best of all, Annaly isn't priced like a growth stock, as it boasts a 5.2% dividend yield and trades at a mere nine times estimated 2008 earnings. Says Schneider: "It's the perfect recessionary stock."

Berkshire Hathaway

Let's dispense with the obvious. Warren Buffett, Berkshire Hathaway's illustrious chairman and CEO, is 77 years old. The line of succession remains murky. Berkshire's insurance businesses have benefited from unusually benign weather- namely, the dearth of U.S. hurricanes. And Berkshire stock has already risen 22% since August.

So why are we recommending Berkshire (BRK.B) now? Simple. Warren Buffett knows how to exploit panics. He bought 5% of American Express in 1963, following a financial crisis (involving vegetable oil, of all things) that had cut AmEx's stock price in half. He started buying up shares of Geico in 1976 when claim-cost miscalculations left the auto insurer teetering near bankruptcy. And he picked the pocket of financially troubled energy company Dynegy in 2002, paying $928 million for a natural gas pipeline that Dynegy had bought for $1.5 billion only months earlier.

With $40 billion in cash idling on Berkshire's balance sheet at the end of the third quarter, Buffett looks ready to plunge in should a financial company, bond insurer, or homebuilder with attractive land assets need a white knight. (Indeed, in early December, Buffett bought $2.2 billion in high-yield bonds from Texas power company TXU at a discount.)

"He's going to wait for the fat pitch and pounce," says ace value fund manager Jean-Marie Eveillard, explaining why Berkshire remains the biggest stock holding in his First Eagle Global fund, even though he believes Berkshire's market cap exceeds the value of its businesses. "The current circumstances in the economy and possibly in financial markets are exactly the kind of environment where Buffett will be able to see and seize opportunities."

Dick's Sporting Goods

Retail is tough even in the best of times. Still, if you look at the histories of America's retail category killers- Best Buy, Home Depot, Costco, Staples, etc.- there is always an inflection point at which the chain's geographic reach has not yet caught up with the proven success of its business model.

That's where Dick's Sporting Goods (DKS) is today, and it's why we think now is the time to invest in this emerging category killer. Though well established in the Midwest and Northeast - the company has grown from 61 stores to 341 in the past decade - Dick's has relatively few outposts in Southern and Western states like Florida and Texas and none in California.

Over the next seven years Dick's plans to more than double its store count, to 800. Another plus: It faces competition mostly from mom-and-pops; the top five U.S. sporting goods retailers account for only 17% of sales.

Dick's emphasizes a store-within-a-store sales approach. Each department has its own look and staff, which appeals to the enthusiast who purchases a lot of sporting goods. Then there is its innovative merchandising. Dick's has been phasing out its no-name, private-label apparel and equipment in favor of deals in which Reebok and Nike put their logos on products sold exclusively at Dick's (a strategy that analysts have dubbed "private brand" rather than "private label").

So now, for example, Nike swooshes can be found on Dick's hats, gloves, and outerwear. "What private brand does," explains Michael Baron, an analyst with Baron Growth fund, which owns 3% of outstanding Dick's shares, "is allow them to charge branded-product prices but with margins seven to eight percentage points higher." Through the first nine months of 2007, Dick's earnings per share rose 73% on sales growth of 28%. Another key barometer: Same-store sales rose at a terrific 8.6% clip in the third quarter.

What happens if the economy tanks? Industry experts say that sporting goods have proven resilient in the past. Indeed, in 2008, analysts expect a 19% increase in earnings per share. Says fund manager Thomas Ognar, who has 3% of his Wells Fargo Advantage Growth fund in Dick's: "People cut back on a lot of other things before not buying cleats for their kids."

Electronic Arts

There's a reason you won't find any major technology companies among our 2008 stock picks. More than 70% of tech purchases are made by businesses, according to tech tracker IDC, and spending is sagging. Cisco CEO John Chambers recently warned of "dramatic decreases" in orders from banks.

Still, if there's one tech niche that should be immune to a slowdown, it's videogames. Fueled by the success of the Nintendo Wii and Microsoft Xbox 360 consoles, videogame sales rose 39% in October, according to the NPD Group, after a 64% rise in September. "I can't tell you if corporate spending falls off a cliff or hangs in there in 2008," says Eric Fischman, portfolio manager of the MFS Emerging Growth fund. "But I can tell you with a high degree of confidence that videogame sales are going to be up."

Fischman's top game pick is a turnaround story - Electronic Arts (ERTS). The stock has stagnated since 2004, with earnings falling and critics charging that EA was too reliant on aging franchises like Madden NFL. But things started to look up in early 2007 when ex-president John Riccitiello returned as CEO after a three-year stint with a venture capital firm.

Riccitiello reorganized EA into four divisions (trimming 4% of the workforce in the process) and spent $860 million to acquire BioWare and Pandemic, two smaller game studios known for producing the kind of innovative action-adventure and role-playing games (such as BioWare's hit Baldur's Gate) long missing from EA's lineup. "By themselves, BioWare and Pandemic won't make us market leaders in either action-adventure or RPG, but it takes us from nowhere to being in the top two or three," says Riccitiello.

EA has also worked hard at playing catch-up in the red-hot Wii market. It's now the No. 2 developer of Wii games, behind only Nintendo. The result: Analysts expect earnings to rise 76% next year. "Compared to where they were a year ago," says Fischman, "it's like night and day."


Once the darlings of biotech investors, Genentech shares have been in a prolonged slump since topping out at $96 in 2005. But the company itself remains a standout, and recent news provides the opportunity to buy the shares at a discount.

On Dec. 5, the stock was pounded, plunging 10% in a few hours. The reason: An FDA advisory panel voted against expanding the use of Avastin - a blockbuster Genentech (DNA) drug already approved to treat colon and lung cancer- for breast cancer.

The market overreacted. The advisory panel didn't dispute the core claim that Avastin is effective in fighting breast cancer, notes Sanford C. Bernstein & Co. analyst Geoffrey Porges. "What you heard from the panel," says Porges, "is not that this drug doesn't work in this indication but that we had an imperfect study, one with a lot of missing data." (As it happens, that study was enough to persuade the European authorities to endorse Avastin for breast cancer.)

Genentech has two Avastin studies in the works that are more comprehensive and that Porges believes will help it win FDA approval, eventually leading to a doubling of Avastin annual sales, now $2.5 billion, by 2011.

He arrives at that estimate via a recent Bernstein survey of 108 oncologists. The survey suggests that 80% of oncologists are already prescribing Avastin to treat some later-stage breast cancer, and that that percentage would rise to nearly 100% once there is FDA approval (which Porges now expects to come in early 2009).

The survey also indicates doctors' utilization of Avastin will double, from between 15% and 20% of their breast cancer patients today to between 35% and 40%. Says Porges: "I'd say the valuation upside is even more compelling now than it was before, though you might have to wait until the second half of next year to get that return."

Even with the FDA setback, Genentech is still expected to grow earnings 18% next year. And it's not as if Avastin is the only thing Genentech has going for it. There are early indications that its cancer drug Rituxin holds hope for treating autoimmune diseases like multiple sclerosis and lupus.

Tom Marsico, the growth fund manager whose eponymous firm owns 3.5% of the biotech's shares, is excited about Herceptin - considered a miracle drug for certain types of breast cancers - and Lucentis, which treats macular degeneration and might one day be used for vision loss related to diabetes. "What you're really investing in here," says Marsico, "is the premier pharmaceutical company in the world as far as innovation is concerned."

General Electric

CEO Jeffrey Immelt has been leading a successful makeover at General Electric, though you wouldn't know it from GE's flaccid stock price. Our bet is that in a stormy market investors will gravitate toward the ultimate blue chip and finally give Immelt the credit he deserves.

Since replacing Jack Welch six years ago, Immelt has sold off laggard operations such as insurance and plastics, putting more emphasis on manufacturing and infrastructure businesses. The timing has been excellent. Though achieving double-digit earnings growth will always be a challenge for a company so big and diversified, GE (GE, Fortune 500) seems well positioned to slough off whatever economic challenges may exist in the U.S.

The industrial and infrastructure businesses - which include aircraft engines, locomotives, water-treatment and desalinization plants, green energy (wind turbines and solar panels), and not-so-green energy (coal power turbines and coal gasification) - have all been reaping the rewards of the global economic boom. Half of GE sales now come from overseas.

The infrastructure divisions now account for 34% of total GE revenues, and they're growing at a 17% annualized rate. Better yet, from a shareholder perspective, these businesses are exactly the kind of "late cycle" performers that are awarded higher valuations when economic growth slows.

"Power, water, wind - all those infrastructure businesses are coming together a lot faster than anybody anticipated," says Bob Turner, founder and chief investment officer of Turner Investment Partners, a growth-fund shop with some $27 billion under management (including 8.6 million shares of GE as of Sept. 30).

About half of GE's earnings come from lending and investing, a fact that has weighed on the stock. But Immelt- who's quick to point out that GE has no exposure to troubled assets like collateralized debt obligations (CDOs) - sees GE's financial services exposure as an asset in today's market.

"These are classically the times where our financial service businesses do very well," he says. "This is a great time to be triple-A rated. We have a good cost of funds and availability of funds, and there are things that might have been trading for a 10% or 15% return six months ago that are going to be a 25% to 30% return today."

Goldman Sachs analyst Deane Dray argues that GE's business mix merits a P/E of 17 - a 10% premium to the S&P 500 and up from 15 today. Based on Dray's 2008 earnings estimate of $2.45 a share, a 17 P/E translates to a stock price of approximately $45- which also happens to be Turner's GE target. "You've got the best company in the world growing earnings 12% and a stock with a 3% dividend yield," says Turner. "You could be looking at a 25% return."

Jacobs Engineering

Normally we wouldn't recommend a stock that has doubled since the start of '07. But as we said, in a slowing economy, you want to own companies that can demonstrate superior earnings growth regardless of what's happening around them. Jacobs Engineering is such an enterprise.

Jacobs (JEC, Fortune 500) is one of the fastest growers in an exploding industry: construction and engineering. The company is hired to design and build oil refineries, biodiesel plants, hospitals, bridges, and water-treatment centers.

"These are the strongest markets we've seen in 30 years," says Jacobs CEO Craig Martin. Earnings jumped 39% in the fourth quarter of the fiscal year ended Sept. 30. That makes the company's 26 P/E look reasonable, especially since Jacobs should maintain a 35%-plus growth rate into 2008: It has a $13.6 billion backlog of orders (up 39% from the year before).

"From a global standpoint, the amount of infrastructure spending that's going to occur in coming years is staggering," says David Scott, manager of the Chase Mid-Cap Growth fund, which counts Jacobs as a top-five holding. "As the premier company in its field, Jacobs sits squarely in the middle of that boom."

Merrill Lynch

Question: What do you call it when an $8 billion asset writedown translates into a $30 billion loss in market cap? Answer: an overreaction. Yes, Merrill's shares deserved a punishment for the firm's mortgage-related bungling. But the public flogging has far exceeded the transgression, which is why smart investors should buy this stock before everyone else comes to their senses.

Even if Merrill (MER, Fortune 500) writes down another $6 billion in the fourth quarter, as S&P analyst Jeff Sexton recently predicted it will, stocks are valued on future earnings. There's little reason to believe this will have a big effect on 2008 profits, which analysts estimate at $7.68 a share. That means Merrill is trading at a mere eight times 2008 earnings (with a 2.4% dividend yield).

Why are we so confident that the mortgage debacle won't bleed into 2008? Two reasons. The first is Merrill's new CEO, John Thain, formerly CEO of the New York Stock Exchange and Goldman Sachs co-president. Thain used to run the mortgage desk at Goldman, and it's hard to believe he would have taken the Merrill job if the problems were worse than they appeared to be. "You know he did his due diligence," says Anton Schutz, manager of the Burnham Financial Services fund.

The second reason is that financial panics are almost always overblown. In the case of CDOs and other mortgage-backed assets, the problem for Merrill, et. al was not that the mortgages underlying the securities all went bad.

What happened is that the secondary market for these securities evaporated, forcing the institutions holding them to mark down their value. When this market bounces back, as surely will happen, Merrill stands to post sizable gains as it writes up the same assets it was forced to write down. "I've seen my share of credit crises," says Larry Puglia, manager of the T. Rowe Price Blue Chip Growth fund and himself a former bank analyst. "And absolutely that could be the case."


We're on record as saying that $95 a barrel is not a sustainable price for oil. Yet The Hottest Fund Manager in America - a.k.a. CGM's Ken Heebner- now has us hedging our bets.

For those unfamiliar with Heebner, understand that his stock picking over the past eight years has been genius (as it has been for much of his 30-year career). He made a bundle short-selling tech and telecom stocks in 2000. He bet big on homebuilders in 2001 only to get out just before they crashed. He plowed his homebuilder profits into energy stocks in 2005 and eventually doubled down on commodities with a big bet on copper.

The result: His CGM Focus fund was up 66% through early December - while juicing his returns with short positions on Indymac and Countrywide Financial, mortgage lenders whose stocks have been circling the drain.

With that kind of track record, we listened when Heebner laid out an argument that $100 oil is not only coming but will be here to stay. "There is still strong growth in Latin America, China, India, and a host of smaller countries like Poland and Thailand," he says.

That means a need for some 1.5 million more barrels of oil a day. The problem, Heebner explains, isn't just finding another 1.5 million barrels; it's finding them even as some of the most productive oil fields in the world are declining.

Heebner, who is a fanatical researcher, questions the conventional view that OPEC has enough spare capacity to fill much of that void. Heebner cites one Saudi Arabian source whom he declines to name who asserts that output at Ghawa r- a legendary Saudi field that produces about 6% of the world's oil - is declining at 9% a year. (The Saudi authorities vociferously dispute this.)

"So I'm connecting all the dots," Heebner says. "It's a tight situation to start with, but add to that a loss of a million barrels a day for the Saudis, and suddenly it gets very interesting on the upside for the price of oil."

That brings us to Petrobras (PBR), Brazil's largest oil company and the stock Heebner thinks is the best way to play oil right now. With petroleum prices so high, a big risk for oil companies is that host countries will demand a bigger and bigger share of the profits in the form of taxes or royalties. "One way you can avoid this," says Heebner, "is if the government owns half the company you've invested in. That's Petrobras."

Petrobras is cheap enough, at 16 times earnings, that it can be a winning investment even if Heebner is proven wrong about $100 oil. The company just announced a huge find offshore from Rio de Janeiro, a field said to have up to eight billion barrels of recoverable oil. (See correction.)

St. Joe

We have no idea whether the Florida real estate market has hit rock bottom. What we do know is that eventually it will bounce back. Demographics demand it, with the Census Bureau projecting a 33% population increase for Florida- the equivalent of six million new residents- between now and 2020.

And when Florida real estate does rebound, investors will be kicking themselves for not recognizing today's $28 stock price for St. Joe Co (JOE).- Florida's largest private landowner - as a rare opportunity. The stock traded as high as $82 in July 2005.

At $28, says Third Avenue Real Estate Value fund manager Michael Winer, whose firm owns 20% of St. Joe shares, "this is a fire-sale price that basically assumes the Florida market will never come back."

The way to value St. Joe isn't on its current earnings (which are awful) but on its land holdings. The company owns 710,000 acres of Florida real estate, mostly in the Panhandle region, 310,000 of which are situated within ten miles of the coast. The stock market is now valuing St. Joe's property at the equivalent of $3,700 an acre. Winer says a "fire-sale value" would be $5,000 an acre. Keefe Bruyette & Woods analyst Sheila McGrath puts the fair value at $7,200, "at least."

Moreover, St. Joe's Panhandle stronghold looks as though it will recover faster than the overall Florida market. In Panama City, for example, the number of home sales increased 4% between October 2006 and October 2007, vs. a 29% decline statewide.

McGrath sees another bullish indicator in the just-begun construction of a new airport in Panama City that, unlike the old one, will support commercial jets. The airport will give a huge boost to the local economy, she contends, much as the opening of Fort Myers's new airport in 1983 boosted real estate and tourism in southwest Florida. "In the short term, there is some headline risk," she says. "But all in all, I think St. Joe is ridiculously cheap."

Citigroup stock: Cheap chic

Stock Spotlight: The banking giant was one of the worst performers of the Dow last year. But with more trouble lurking, is it worth buying the stock?
NEW YORK (CNNMoney.com) -- Of all the investment tales that have unfolded as the mortgage crisis swept through Wall Street, none has been more engrossing than that of Citigroup.

The financial services giant has shaken up its top management, sold a $7.5 billion stake in the company to a Middle Eastern state investment fund and watched its stock tank - all within the last two months.

Citigroup (C, Fortune 500)'s stock endured one of its worst annual performances on record last year and was the worst performing Dow component in 2007. Its shares finished the year down 47 percent.

But with the stock now trading just below $30 a share, some analysts have argued that the traditionally blue-chip Citi looks pretty attractive right now for long-term investors - given the company's earnings potential and its global presence at a time when overseas economies are enjoying robust growth.

"To me it does look a bit cheap given its international exposure and the growth there," said Adam Compton, head of U.S. financials research at RCM Capital Management in San Francisco.

So is Citigroup stock worth the gamble?

Maybe not. The company is widely expected to post a loss for the fourth quarter on Jan. 15, as well as take another staggering writedown. And there are concerns that newly appointed CEO Vikram Pandit, with his limited experience, won't be able to revive the ailing firm.

Leading the Citi charge

It's unlikely that many Citigroup shareholders shed any tears when former Chairman and CEO Charles Prince stepped down in November amid the company's multi-billion dollar losses on bad mortgage bets.

But the appointment of Pandit to the position of CEO and Sir Win Bischoff as company chairman hasn't exactly soothed Wall Street either, with critics pointing at the new management's lack of experience at running a firm as large and diverse as Citigroup.

"Other than the new CFO, it is unclear as to why any of these people have their positions since none have demonstrated the skill set necessary to function in these positions," Punk, Ziegel & Co. analyst Richard Bove, who rates the stock a "buy," wrote in a research note published earlier this week.

So far, however, Pandit, a former Morgan Stanley (MS, Fortune 500) executive, has shown some courage. Last month, he moved $49 billion in assets from Citigroup's seven troubled structured investment vehicles, or SIVs, onto the company's balance sheet in order to protect their credit ratings and give them time to sell their assets.

Some analysts believe that given his position as a newly installed CEO, Pandit has some leeway to make other, much-needed changes at Citigroup, such as selling some of the company's non-critical assets and slashing the company's bloated payroll on top of the 17,000 job cuts announced last April.

"You would want to make those changes at a time when you were not judged as harshly," said Kris Niswander, banking analyst and associate director at research firm SNL Financial.

Credits and losses

What appears unavoidable for Pandit and the company, however, is a fourth-quarter loss - and most likely another humiliating writedown related to Citigroup's exposure to mortgage-linked securities.

In early November, the company warned it would write down as much as $11 billion when it reports results Jan. 15 because of its exposure to the subprime mortgage market.

But some analysts have warned that number could grow because of tough credit market conditions during the period. Last week, Goldman Sachs analyst William Tanona estimated that Citi could take a $18.7 billion hit in the fourth quarter.

Such a loss could prompt some interest in Citigroup among investors who have been waiting for the firm to finally hit rock bottom. But what also ails Citi is the company's capital constraints, or a lack of available funds to absorb losses.

Abu Dhabi's state investment fund bought a stake of Citi in November in exchange for a $7.5 billion cash infusion. Analysts such as Tanona and CIBC World Markets' Meredith Whitney have argued recently that Citi still needs to take additional action to raise capital, including cutting the company's attractive dividend.

"That would be a concern as an investor, but there is a good possibility they might need to cut it," said Rose Grant, a managing director at Eastern Investment Advisors who is bearish on Citigroup stock even though her firm owns shares of the company.

Forget the bad, buy the stock

It's undeniable that the road ahead for Citigroup is fraught with plenty of obstacles, with few indications that the company will recover any time soon.

But buried underneath all this negative news is an awfully attractive stock that has not traded at these levels in about 5 years.

The consensus on Wall Street is that given its recent swoon, Citigroup shares have become much more attractive lately. According to Thomson First Call, 15 of the 19 analysts following the company have either a "buy" or "hold" rating on the stock.

The consensus 12-month price target is $38.13, about 34 percent higher than its current price of just under $29 a share.

Based on a price-to-book-value ratio - a measure of assets minus liabilities that analysts prefer for comparing financial stocks because of the earnings volatility in the sector - Citigroup is a pretty attractive value compared to its peers.

Citi trades at about 1.1 times book value. That's cheaper than rival JPMorgan Chase (JPM, Fortune 500), which trades at a multiple of 1.2, and Bank of America (BAC, Fortune 500), which trades at a multiple of 1.3. Even embattled Merrill Lynch (MER, Fortune 500) trades at a multiple of 1.3.

Granted Citigroup stock may not be quite the bargain for those investors looking to enjoy a tidy dividend, and there could be some short-term pressure on the stock given the uncertainty surround the fate of the company in the months ahead.

But with a CEO in place who is showing early signs that he is bold enough to save the firm, and impressive earnings potential across the company's domestic and international divisions, long-term investors can be sure that opportunities to snap up Citi stock at these prices are not likely to be around for too much longer.

"Citigroup has a tremendous amount of brand strength and earnings power," said Niswander. "It is a strong company."

Stocks set to take off

Wall Street eyes a rebound after last week's brutal selloff; oil prices slide below $98.
LONDON (CNNMoney.com) -- U.S. stock futures rose early Monday as investors eyed a comeback from the previous session's brutal selloff and crude prices extended their declines.

At 6:06 a.m. ET, Nasdaq and S&P futures were narrowly higher, suggesting gains at the start for Wall Street.

Stocks tanked on Friday, sending the blue-chip Dow lower about 2 percent, after a surge in the unemployment rate and weak jobs data fueled anxiety about a recession in the U.S.

At the same time, the prospect of a U.S. downturn also raised hopes the Federal Reserve will aggressively cut rates when it meets later this month.

Lower oil prices helped provide some positive sentiment. U.S. light crude slid below $98 a barrel in electronic trading early Monday after crossing the $100 a barrel threshold last week.

On the economic calendar, President Bush is due to speak about the economy. His speech comes amid word the White House is considering new measures to boost the economy.

Treasury Secretary Hank Paulson is also speaking. He will discuss the capital markets and the economy in New York.

In global trade, anxiety about the U.S. economy roiled stocks in Asia, where markets slumped. European stocks were flat in the early going.

The tech sector is in focus with the kick off of the Consumer Electronics Show in Las Vegas. Microsoft (MSFT, Fortune 500) opened the gadget show by announcing a string of movie and TV deals. Napster (NAPS) also said it would start selling music downloads as unprotected MP3 files.

Jobs: Where the growth is

Healthcare jobs could see boost as boomers age.
NEW YORK (CNNMoney.com) -- Recession fears may take a toll on hiring trends in the near-term, but as baby boomers retire, demand for certain types of workers should see a boost, according to a recent government report.

In addition to continued job growth in the technology sector, healthcare jobs should see a significant boost from 2006 to 2016, according to the Bureau of Labor Statistics.

The number of Americans aged 55 years or older is expected to increase by 20 million - nearly as much as the increase in the total population by 2016, the bureau said.

"A growing elderly population generates demand for services to help them stay in their homes or in residential housing," BLS said in a recent jobs forecast.

The elderly will stay healthier and live longer, and since certain services are difficult to automate, jobs for personal and home-care aides in the United States are expected to grow by 50.6 percent to 1.16 million from 2006 to 2016, BLS reported. Also in that period, medical assistant jobs are expected to grow 35.4 percent.

But while nurses and physician assistants are projected to grow by 23 percent and 27 percent on demand for their services, the number of doctors and surgeons is expected to increase by just 14 percent.

Additionally, as services for the disabled, sick, substance abusers, and individuals and families in crisis increase, community and social services sectors should add 541,000 jobs and grow more than twice as fast as the average for all occupations, BLS said.

And as workers take a more active approach to saving for retirement, personal financial adviser jobs are expected to grow 41 percent, BLS said.

Even after retirement, a growing number of retirees are expected to use an adviser's help to make their savings last.

How Bush may boost the economy

Any short-term push to stave off a recession could face political and budgetary challenges.
NEW YORK (CNNMoney.com) -- Word is that President Bush may propose new measures to boost the economy by the time he gives his State of the Union address later this month.

While he has steadfastly maintained that the economy is fundamentally strong, the fact that the president is considering a so-called fiscal stimulus package is an indication that the Administration is getting worried.

Such a package would aim to ward off a recession, the fear of which has grown stronger in the wake of discouraging data on jobs, rising energy prices and a slowing housing market.

There is also an indication that leading Democrats might be working on a plan of their own. A spokesman for Senate Finance Committee Chairman Max Baucus (D-Mont.) said in an e-mail to CNNMoney.com that Sen. Baucus "already has ideas of his own about the possible need for an economic stimulus package this year and is planning for the Finance Committee to discuss very early in the session what shape such a package might take."
Tax cuts on the table

It's not clear what measures the White House is considering, but it is widely believed that tax cuts are among them. In that realm, there are a number of options the president could propose, but all of them carry political costs, economic costs or both.

One option that economist Mark Zandi of Economy.com thinks might help is a temporary tax cut, much like the $300 tax rebate Americans got in the wake of Sept. 11. "It was well-timed and was significant for lower and lower middle-income households," Zandi said, although he acknowledged that not all economists agree about how successful the rebate was.

But a new rebate will likely draw criticism. In 2001, the government had the advantage of a budget surplus. Now it's operating with a deficit, which could raise concerns about the cost of a rebate. "Where's the money going to come from? [A rebate will] take it from some other place in the economy," said Chris Edwards, director of tax policy studies at the libertarian Cato Institute, which advocates for limited government and free markets.

Zandi thinks it might also make sense to make President Bush's income tax cuts for the middle class permanent, a move that leading Democratic presidential candidates have indicated they'd support. Where they part company with the president, however, is in making those tax cuts permanent for high-income households, too. So if the president did push for an extension of his tax cuts for the middle class, that could undercut his stated goal of making his tax cuts permanent for everyone, Zandi said.

Zandi would also advocate making the lower rates on capital gains and dividends permanent for everyone. Despite his belief that the federal government should not try to control the short-term performance of the economy, Edwards agrees that such a move could help stabilize the markets by giving investors more certainty about their investment tax bill. It also would reduce any pressure investors might feel to sell their holdings before the investment rate cuts expire.

But the cost of making any of the Bush tax cuts permanent is a sore point for fiscal watchdogs, who contend such cuts are unaffordable in the long term, given the growing budgetary demands of Social Security and Medicare as well as the war in Iraq.

Of course, with any tax-based stimulus, the potential benefit of its short-term effect has to be weighed against its long-term cost, said Clint Stretch, a federal tax policy expert at Deloitte Touche. "[You must consider the net benefit] if you have to turn around to the credit markets and borrow the money to pay for it."
Non-tax options

President Bush could also call for measures intended to stimulate the housing market, Zandi said.

Bush has already said Congress should act quickly to pass a number of housing-related legislative proposals that he supports. One key measure would reform the Federal Housing Administration (FHA), which would make the relatively low cost FHA-insured mortgages more readily available to consumers who want to buy homes and to those who want to refinance out of unaffordable subprime loans.

The White House also might consider calling for a temporary increase in the size of mortgages that Fannie Mae (FNM) and Freddie Mac can purchase from mortgage lenders. These two government-sponsored enterprises guarantee the purchase and trading of so-called "conforming" loans, which are those valued at $417,000 or less. Any loans above that amount are considered "jumbo" loans.

An increase in the conforming loan limit would make it easier and less costly for borrowers in high-cost areas to get loans because Fannie and Freddie would guarantee their purchase by investors.

In the past, the Administration has said it would support a temporary increase in loan limits, but only if lawmakers pass legislation that would boost oversight of both Fannie and Freddie, which have been plagued by accounting scandals.

Jobs weak, unemployment soars

Employers add fewer to payrolls than forecast, and the jobless rate hits 5%, a two-year high.
NEW YORK (CNNMoney.com) -- The nation's labor market worsened in December to the weakest level since the shock that followed Hurricane Katrina, as the problems in housing and mortgages took a bite out of job opportunities.

Employers added far fewer jobs in the month than had been forecast, while the unemployment rate shot up to 5 percent, which was a two-year high, according to a government report Friday.

Stocks sold off sharply on rising fears of a possible recession and there was a widespread belief in the markets that the Federal Reserve would have to respond to this report with a sharp drop in interest rates.

"December's bleak jobs report represents the siren call that this business cycle is just about over," said Bernard Baumohl, the managing director of the Economic Outlook Group, an economic research firm in Princeton, NJ. "We're about to tilt over to the other side of the economic curve and begin the downswing."
Pressure mount for big Fed rate cut

But some other economists suggested the report was not as weak as it appears.

"Yes, job creation is slowing, but 5 percent unemployment does not a recession make," said Rich Yamarone, director of economic research at Argus Research.

He said part of the problem with the report was an ice storm that hit much of the central United States the week the Labor Department was collecting data. Many of the tens of thousands of workers unable to get to their jobs due to the storm were not counted as employed if they didn't get paid for their missed work.

David Wyss, chief economist for Standard & Poor's, agreed with Yamarone that unemployment is at a historically low standard. But he said the steady rise in the number of Americans who describe themselves as unemployed is a concern because it could put the brakes on consumer spending going forward. Wyss said he now believes there's about a 50-50 chance of a recession this year, up slightly from his previous estimate of a 40 percent chance of a recession before this report.

"The unemployment rate is key for people. People are going to get nervous," he said. "There were a couple of special factors. But even when you adjust for those factors, this is bad."
Caution: Job losses ahead

The report showed a net gain of 18,000 jobs in the month, down sharply from the revised 115,000 gain reported in November, the Labor Department said. Economists surveyed by Briefing.com had forecast a gain of 70,000 jobs.

The December job gains figure was the weakest one-month gain in jobs since a loss was reported in August 2003. It capped a 2007 that was the weakest for job growth since 2004. The average level of Americans with jobs during the year was up 1.8 million compared to 2006, with the second half of the year seeing much weaker gains than the first half. And even before this report, most economists were forecasting further sharp declines in employment gains in 2008, with an increase of close to 1 million in the full-year average, and many months when there is a net decline in U.S. payrolls.

The weak report raised expectations that the Federal Reserve will make another deep rate cut at its meeting on Jan. 31. While stocks fell, the bond yield also fell sharply. Investors trading fed funds futures were pricing in a 75 percent chance that the central bank would move to cut rates by a half percentage point at the end of the month, up from a 67 percent chance of a cut that deep at the close of trading Thursday.

The 5 percent unemployment rate was the highest reading since November 2005, when job losses from Hurricane Katrina were still being felt. The unemployment rate had been 4.7 percent in November, and economists had expected it to creep higher to just 4.8 percent.

The rise was the biggest one-month jump in the unemployment rate since August 2001, when the nation was in a recession.

The report found a 49,000 seasonally adjusted drop in construction jobs. While home building has been sharply off for most of 2007, the losses in construction as a whole had been limited by strong non-residential building, such as offices and government projects. But this time there were job losses across all of the various sectors of construction.

In addition, manufacturing jobs fell by 31,000. Once again, the losses were spread throughout the sector, not limited to the battered auto industry where job losses were well known, and included appliance makers as well as manufacturers of electronics, computers, clothing and other nondurable goods.

The service sector fared better, adding 93,000 jobs as a whole. But even in that sector there was weakness, as retailers trimmed 24,000 workers in the seasonally-adjusted estimate, as many of them reported weaker-than-hoped December sales ahead of the holiday.

"Now we've seen the lackluster holiday retail season show up in jobs," said Tig Gilliam, CEO of Adecco Group North America, a unit of the world's largest staffing firm.

But Gilliam said for the most part most of his clients not in housing and mortgage lending are continuing to look to add staff. And he said one encouraging part of the report is that some of the job losses in banking seem to have played themselves out.

The group of employers that includes lenders continued to cut jobs, according to the report. They responded to the problems in the mortgage markets by trimming 7,000 more jobs, although that is actually the smallest cut by that group of employers since July. Banks saw employment stay basically unchanged.

"I don't think we've seen the end of problems, but we had previously lost 80,000 [lender] jobs," he said. "This latest report suggests to me a lot of the job adjustments around subprime have been made."

There as also an impact from the writers' strike that hit Hollywood and the nation's television networks, as the motion picture and sound recording industries reported a drop of nearly 12,000 jobs.

Oil at $100 a barrel? No sweat

The price of today's crude may sound frightening, but the U.S. economy should be able to absorb it, many experts insist.
NEW YORK (Fortune) -- Crude's surge last week took its price to an eye-popping $100 a barrel. The rise comes on top of a 57 percent jump for 2007 and puts oil within reach of its all-time inflation-adjusted high above $102, hit back in 1980.

The latest jump means that Americans can expect to pay more for everything from gasoline to food and clothes. Those rising prices threaten to constrict consumer spending, which is repsonsible for more than two-thirds of domestic economic activity.

A sharp consumer slowdown would be bad news indeed, because the economy is already showing signs of strain. The government reported Friday that only 18,000 jobs were created last month, a mere fraction of the number needed to keep up with population growth. The Institute for Supply Management's factory index dropped below 50 in December, a sign manufacturing work is contracting.

So will $100-a-barrel oil be the straw that breaks the economy's back? Probably not.

After all, growth has persistently chugged along now for four years despite ever-increasing oil prices. Obviously, another huge rise in oil prices this year wouldn't help the economy - but it's not at all apparent that it would break it either. "We must accept the notion that at some point there's a price people won't pay" for oil, says Howard Simons, an oil industry veteran who has been measuring oil's impact on the economy for 30 years. But crude oil has seen its price rise fivefold in just six years, he adds, and "we haven't even approached the point of crimping consumer spending."

Simons notes that unemployment, at 5 percent, remains historically low, and that consumer spending hasn't fallen off a cliff even as foreclosures spike and house prices plunge. Moreover, history shows that trying to predict a recession is daunting.

Simons notes that just four years ago, a spike in oil prices took the price tag on a barrel of crude oil to $40 - a level many observers viewed as unsustainable. Voices predicting imminent recession grew louder as crude surged past $50, $60 and $70 a barrel. Yet as weak as parts of the economy now look - house prices are in free fall in much of the country and wage growth has been anemic - a sharp pullback in economic activity has yet to manifest itself.

Indeed, despite Friday's weak labor report, "These jobs gains indicate the economy did not enter a recession in the fourth quarter of 2008," writes Peter Morici, an economist at the University of Maryland's Robert H. Smith School of Business.

The economy's resilience is due in part to gains in energy efficiency over the past quarter-century, since the last oil shock. Ken Medlock, a fellow in energy studies at the Baker Institute for Public Policy at Rice University in Houston, also notes an energy-saving shift from a manufacturing-led economy in the 1970s and 1980s to today's service-oriented economy. He says that the price of crude oil would need to soar to $140 a barrel in order to bring the per-mile cost of driving, for example, back to 1980 levels.

Efficiency gains and economic flexibility are two reasons Medlock, for one, doesn't expect to see triple-digit crude prices throw the economy into contraction. "I don't think we're going to see a pullback like in the 1970s and 1980s," he says. He adds that while the housing and auto markets are showing clear signs of an economywide slowdown, he believes the United States will avoid a deep recession unless there's some sort of unexpected shock.

For his part, Simons believes the rising price of crude will come to be seen as a footnote in a history of this era. He expects coming years to be dominated by the cleanup of the housing mess. Even aside from the foreclosures sweeping the nation and wiping out homeowners, he points to billions of dollars of bad loans that threaten the health of the banking system. Banks that are busy raising money to sop up their losses will be inclined to tighten the reins on lending, possibly starving business expansion.

"We dodged one deflationary recession" after the tech bubble burst in 2000, he says. "Now the question is whether we can dodge another."

Retire Rich: Learn from someone who did

This former engineer and self-taught expert learned firsthand how to prosper after you leave your job.
NEW YORK (Money Magazine) -- When Henry "Bud" Hebeler was winding down his career at Boeing nearly 20 years ago, he was appalled at the advice he got from retirement planning software.

"The assumptions about returns, inflation, longevity and expenses were highly simplistic," says the 74-year-old Hebeler. With his engineering degrees from MIT and his experience - first as Boeing's chief forecaster and planner and later as president of Boeing Aerospace - Hebeler figured he could do better.

He has. His Web site, AnalyzeNow.com, is a compendium of advice and tools (mostly free) that can help you tackle topics ranging from how to create a retirement budget to whether to buy an annuity.

What distinguishes Hebeler from the typical retirement "expert" is that he combines a strong quantitative background with real-life retirement experience - his own and that of fellow retirees.

Hebeler took time out from his hectic schedule of skiing, golf, travel and running a site to share his thoughts.

Q. What's the most popular misconception about retirement planning?

A. That your spending will drop as you age and you become less active. My father played golf until he was 95. My wife and I are in our seventies and we ski the expert slopes at Park City, Utah.

My friends who have reduced their spending didn't do so because of lack of energy or physical ability. It doesn't take much effort to get into a taxi and go to the theater. They're cutting back because they know they're going to live longer than they thought they would. They spent too much too early and now they're worried about running out.

Q. So what can you do to assure that your money will last?

A. If you have enough savings to live on, consider delaying taking Social Security until full retirement age or even later. Holding off can be especially worthwhile if you have a spouse who didn't work or had a low income, since the higher payment you get by waiting can be passed on to your spouse when you die.

I also think retirees should consider putting some, but not all, of their money in an immediate annuity. Look at inflation-adjusted immediate annuities, since they provide a lifetime income that, like Social Security, goes up with inflation.

Q. How did your work at Boeing influence the advice you give?

A. It made me more conservative. In business you see how often things don't work out as you planned. Projects cost more to complete than you estimated.

The same is true of retirement, but retirement plans seldom call for setting aside reserves for unforeseen events. There are a lot of surprises, usually more bad ones than good.

Q. What kinds of surprises?

A. For one thing, your expenses are likely to be very different in retirement than during your career. Things that were probably covered by your company insurance - dental work, vision care, a variety of medical tests - typically aren't paid for by Medicare. My hearing aids alone cost $6,000, which wasn't covered at all.

People also don't anticipate the impact of inflation. In the first 10 years of my retirement, the purchasing power of my company pension declined by 30%. And then there are obligations people rarely plan for, such as having to help parents or adult children who are struggling financially.

Q. If you could advise people to do just one thing to improve their retirement prospects, what would it be?

A. People who aren't retired need to know how much to save. My father used to tell me that you should always save at least 10% of your income.

That's more like 15% to 20% today because you're less likely to have a pension.

Coming soon: Social Security debit cards

Treasury Department's upcoming Direct Express program aimed at cutting costs and problems associated with mailing paper checks.
NEW YORK (CNNMoney.com) -- A pre-paid debit card aimed at making Social Security and other federal income benefits simpler and safer to receive was announced Friday by the Treasury Department.

The department said the Direct Express debit cards will be rolled out beginning this spring and come into full circulation by the end of the summer. They will be issued by Comerica Bank.

Each card is FDIC-insured and can be used to retrieve benefits at ATMs and make purchases at retail locations or online, the department said. Since transactions are electronic, there are no paper checks to become lost, delayed or stolen.

"We ultimately would like to see an all-electronic Treasury," said Judy Tillman, commissioner of the department's Financial Management Service division, in a statement. "If every unbanked federal check recipient signed up to use the card, it would save taxpayers about $44 million per year."

The department estimates that four million program beneficiaries do not hold bank accounts, and said that 90 percent of the problems with Social Security payments are related to paper checks.

Comerica (CMA, Fortune 500) has issued similar cards on behalf of state governments, Treasury said.


Liz Claiborne close to deal for apparel brands
Rumblings from inside Liz Claiborne (LIZ) suggest an announcement is imminent regarding the fate of several apparel brands it has put up for sale.

Liz Claiborne is expected to announce, perhaps as soon as Friday, the sale of Ellen Tracy to the private equity firm American Capital Strategies, a person close to the negotiations said. Speculation is also swirling about Sigrid Olsen. Two people familiar with the situation said that one of the brand’s original investors, a longtime apparel executive named Ed Jones, had been interested in buying the brand, but a deal is believed to have fallen through prior to Christmas, one of those people said.

A Liz Claiborne spokeswoman declined to comment.

Liz Claiborne has decided to keep several other brands it had put on the block, including Dana Buchman and possibly Enyce, after bids came in below expectations. The auction was complicated by potential suitors wanting to bid for brands individually, rather than as a package, as Liz Claiborne had initially hoped.

The divestitures are part of a plan announced by Liz Claiborne CEO William McComb in July that would see the $5 billion apparel maker shed laggard divisions to focus on its most promising brands: Juicy Couture, Lucky Brand Jeans, Kate Spade and Mexx.

As Fortune reported in late December, Liz Claiborne is also on the hunt for big name designers to revive its namesake Liz Claiborne sportswear brand. The company has had advanced negotiations with runway designer John Bartlett about a men’s line for Liz Claiborne and is also looking for a designer for the women’s label, sources said.

Building playgrounds is serious business

A nonprofit called KaBOOM galvanizes corporations and communities to build playgrounds in underprivileged neighborhoods. Here's a look inside the vital work behind the play.
PHILADELPHIA (Fortune) -- As the sun rose over the vacant lot in North Philadelphia, the light of day could do little to brighten the scene. Strewn with trash and leftover bricks from row houses that had been torn down, it was a depressing, unusable backyard for the neighborhood charter school, Alliance for Progress.

But this dawning day would not be like any other here. As if organized by some invisible, beneficent force, about 300 parents, teachers, and employees of IBM and software giant SAP descended upon the scene, an army equipped with hand tools. In just seven hours, the eyesore was transformed into a gleaming, state-of-the-art playground featuring a huge metal play dome, a multicolored slide, a rock-climbing wall, and three basketball hoops of various heights. The school's walls were emblazoned with freshly painted murals.

As students decorated a fence with colorful tiles they had made, a group of sweaty volunteers surveyed their handiwork with satisfaction. Said Jim Goldfinger, senior director, SAP's CRM Value Network, who shoveled mulch and helped build large outdoor easels: "This has been a great way to get out. My kids now have more respect for the company I work for because they can see something like this."

While local politicians stood about claiming credit for the wondrous transformation, a few people in purple T-shirts with the KaBOOM logo darted through the crowd, supervising the final touches. These were the agents of the hidden force: an 11-year-old nonprofit that has brought together volunteers to build 1,361 playgrounds, skate parks, and ice rinks in North America. While each project depends on the sweat equity of people in the community, these "BOOMers" - many of them just out of college - are highly organized project managers who supervise every aspect of a play space build, from choosing the sites to coordinating the volunteers to making Band-Aids available for scratches incurred in the line of duty. They are part of a remarkable organization whose mission comes from the heart - "a great place to play within walking distance of every child in America" - but whose tactics are highly systematic and insightful about human nature.

"The secret sauce with KaBOOM is not the playground," says Brad Shaw, senior vice president of corporate communications at Home Depot and a KaBOOM board member. "It's really the project management and the fun."

The organization is deeply serious about communicating the fun factor. At KaBOOM headquarters in Washington, D.C., the waiting room has a tire swing, a slide - and no chairs. The whole place is painted in bright purple and orange, with the company's logo - chosen because it evokes an explosion of energy - splashed everywhere and written as a comic-book sound effect. But little is left to chance at KaBOOM, from the branding to the dress code to the strict process by which play spaces are designed and built. "KaBOOM is one of the best-run nonprofits," says Robert Nardelli, CEO and Chairman of Chrysler, who has worked with KaBOOM for seven years, starting when he was CEO of Home Depot. KaBOOM has also tapped into a deep desire on the part of corporations to give back while also finding a way for its own employees to connect. "It's bringing people together in multifunctional teams, working on a project, seeing success and gratification," says Nardelli. "All the things you want to do in business you accomplish within eight hours in building this playground."

Central to KaBOOM's philosophy is giving everyone a stake in the outcome. Unlike many nonprofits, KaBOOM makes the local community a full participant in its projects by requiring it to raise part of the money for the play space - usually about 10% of the cost, which for a typical playground ranges from $70,000 to $125,000 in total - and also by providing much of the physical work. Corporations raise most of the rest of the money, but they can't just write a check either. Employees work side by side with the locals to assemble jungle gyms.

"It's a way of engaging the community to solve its own challenges," says Darell Hammond, 36, KaBOOM's co-founder and CEO. "This isn't a handout, this isn't pure philanthropy. This is an investment on everybody's part." Hammond, who resembles a big teddy bear, doesn't fit the usual profile of a philanthropist. His childhood was marked by poverty, not privilege. Born the seventh of eight children to a truck driver and nursing-home worker in Jerome, Idaho, Hammond quickly learned the value of a safe haven. His father abandoned the family when he was just two years old; his mother two years later became incapable of taking care of the family. All eight children were sent to live at Mooseheart Child City & School near Chicago, a home for poor children funded by the Moose fraternal organization.

"I didn't have a bad upbringing," he says. "I had what I considered to be a normal, happy upbringing. But I do what I do, no doubt, because of it." At Mooseheart, Hammond was called "the lawyer" because he was always standing up for kids in need. But law school never really interested him. He wanted to help kids - and after dropping out of college and discovering that he was dyslexic, he decided to do just that. In 1995, after he and KaBOOM co-founder Dawn Hutchison read an article about two Washington, D.C., boys who suffocated while playing in the trunk of a car, they decided to start a nonprofit that would use play to further social change. Hammond and Hutchison (who left KaBOOM in 1997) began fundraising the usual way, seeking money from large foundations.

But not everyone saw jungle gyms and slides as the best use of grant money. "They saw play as a luxury," Hammond says. So the BOOMers turned to the business community, which they figured had both the money and the manpower to help. Says Hammond: "It was not by great design or strategy, frankly, but where we lucked into it was that we executed well, and when we executed well, people wanted to take care of us."

While play spaces are built in a day, the actual process begins as much as six months earlier, when a funding partner is identified. From there, KaBOOM looks for an appropriate site, considering the economic needs of a neighborhood. About ten weeks before the build, KaBOOM's project managers host a Design Day, when kids help to choose the types and colors of equipment. The equipment manufacturer, Playworld Systems, comes up with three designs, and the community chooses one. In the remaining weeks, volunteers join such committees as "safety and maintenance" and "recruitment" and carry out tasks including getting food and water for the build and prepping the site. Every project is done the same way - and that's why, barring acts of God, they generally come off without a hitch. KaBOOM has created partnerships with the likes of Kimberly-Clark, Ben & Jerry's (which created a flavor to benefit the organization, KaBerry KaBOOM), Fannie Mae, Target (TGT, Fortune 500) stores, and many others.

But its deepest relationship is with Home Depot (HD, Fortune 500), whose head of community affairs met Hammond on a panel and contributed time and money for KaBOOM's first build, in Washington, D.C. The company has assisted in building some 600 play spaces over time, and the relationship has endured through several leadership changes, peaking in 2005 with a $25 million three-year grant to help KaBOOM build 1,000 play spaces. "We looked at it and said, This is exactly what our people love to do," says Shaw, "build things fast with a tangible outcome." Some of the companies that take part also view the projects as a way to help identify potential leaders. "Think how many consultants you'd have to hire to put blindfolds on and spin you around somewhere," says Bill McDermott, president and CEO of SAP Americas & Asia Pacific Japan. "We don't have to. We're out there with the real people."

Hammond spends some 75% of his work life attending builds, wooing donors, speaking at conferences, and trying to persuade lawmakers of the social value of play. "Darell is undaunted," says Michelle Nunn, CEO of Points of Light & Hands On Network, a group that helps match volunteers with projects. "He has a personal magnetism and a drive, and he understands the marketing value of that too." While KaBOOM has won kudos from nonprofit watchers, Hammond still seems dissatisfied when he discusses his accomplishments, noting that while KaBOOM will build 229 play spaces this year, it has received more than 6,000 requests. So Hammond decided several years ago to make KaBOOM's project handbooks, best practices, and guidelines available on the web, free, to anyone with the passion to build a playground. "We are giving away our intellectual property," Hammond says. "We deliberately decided that we could go further, faster, in a dissemination model than we could by starting more chapters and affiliates."

Now KaBOOM is amping up its strategy, thanks in part to people like Pierre Omidyar, founder of eBay and founding partner of the Omidyar Network. Omidyar contributed $5 million to build out the nonprofit's website and also to support KaBOOM's RALLY effort, which aims to bring the importance of play - as both a health and a community benefit - to the attention of lawmakers and policy experts. Says he: "KaBOOM's platform allows anyone to go online, access resources and a walk-through of the KaBOOM process, connect with other communities, and share ratings of playground equipment."

Beyond this, KaBOOM is trying to raise $106 million over the next three years to facilitate the building of 6,000 play spaces by 2010. Only 1,500 of them will be built through corporate partners; the rest will be built by self-starters who adopt the KaBOOM method and do it themselves. Back in Philadelphia, the playground is complete. "The kids never had any place to play," said Tyhesha Williams, a volunteer at the build whose daughter is in fourth grade at the Alliance for Progress. "And you know what? At the end of the day, we will say, 'We built this' - and we did. I've never been a part of anything like this."

Now a group of about 30 students stops dancing the "Cha-Cha Slide," the unofficial anthem of a KaBOOM build, and gathers eagerly in front of the playground for the official ribbon-cutting ceremony. They stare at the "triple racer" slide as if it's a giant, tempting ice-cream cone. "Pleeeeease," they beg Stacey Hill, CEO of the school. "Can we play?" Not tonight, Hill says, because the concrete has to dry. But thanks to KaBOOM, they can tomorrow morning - and every morning after that.

Melinda Gates goes public

... about living with Bill, working with Warren Buffett, and giving away their billions.
(Fortune Magazine) -- Years before Melinda French met and married Bill Gates, she had a love affair - with an Apple computer. She was growing up in Dallas in a hard-working middle-class family. Ray French, Melinda's dad, stretched their budget to pay for all four children to go to college. An engineer, he started a family business on the side, operating rental properties. "That meant scrubbing floors and cleaning ovens and mowing the lawns," Melinda recalls. The whole family pitched in every weekend. When Ray brought home an Apple III computer one day when she was 16, she was captivated. "We would help him run the business and keep the books," she says. "We saw money coming in and money going out."

Of all the tricks that life can play, it's hard to imagine any stranger than what befell Melinda French. Today she is living in a gargantuan high-tech mansion on the shores of Lake Washington, married to the richest man in America - and giving billions of dollars away. When she married Bill Gates 14 years ago, she bought into a complex bargain. On the one hand, she became half of what has turned out to be the world's premier philanthropic partnership. The Bill & Melinda Gates Foundation has assets of $37.6 billion, making it the world's largest. In that total is $3.4 billion that Warren Buffett has already given, and still to come are nine million Berkshire Hathaway B shares, currently worth $41 billion, that he has pledged to contribute in coming years. Assuming that Berkshire (BRKA, Fortune 500) shares continue to rise and that the Gateses continue to bestow their own wealth on their foundation, Melinda and Bill will very likely give away more than $100 billion in their lifetimes. Already the foundation has disbursed $14.4 billion - more than the Rockefeller Foundation has distributed since its creation in 1913 (even adjusted for inflation).

Along the way, Melinda has sacrificed privacy, security, simplicity, and normalcy. In the late 1990s, during the Microsoft antitrust trial, her husband was widely regarded as the biggest bully in business. And isn't anyone married to Bill Gates susceptible to losing her identity - to being perceived as the ultimate accessory?

Forgive her if she overcompensates. One day this past fall she spent many hours at her children's school (the Gateses have two daughters, ages 5 and 11, and a son, 8) and then hosted a dozen dinner guests, including four African health ministers who were in Seattle for the Bill & Melinda Gates Foundation Malaria Forum. By 10 P.M., after everyone had left, she was feeling frazzled and panicky about her speech the next morning. "Just go to bed!" Bill told her. "You know so much about malaria." Melinda dreads the spotlight, but the following morning she faced more than 300 scientists, doctors, and health officials. She unveiled an audacious plan to eradicate malaria - a disease that kills more than one million people annually and has eluded a cure for centuries - and then answered questions with Bill. Afterward the crowd buzzed about this woman whom even they, recipients of the Gateses' billions, hardly know.

Today, at 43, Melinda Gates is ready to reveal her full self - to go public, so to speak. "I had always thought that when my youngest child started full-day school I'd step up," she says, sitting down with Fortune for her first-ever profile. Although she admits she would prefer to stay out of public view forever, her older daughter got her thinking. "I really want her to have a voice, whatever she chooses to do," she says. "I need to role-model that for her." She is spending more time on foundation work, up to 30 hours a week. "As I thought about strong women of history, I realized that they stepped out in some way."

She is stepping up also because her husband is doing the same. Beginning in July, Bill, who is nine years older than Melinda, plans to spend more than 40 hours a week on philanthropy, leaving 15 or so for his duties as chairman of Microsoft. Friends of the couple say that he wouldn't be shifting gears if it weren't for Melinda. Moreover, they say, she has helped Bill become more open, patient, and compassionate. "Bullshit!" he bellows. Nicer, perhaps? "No way!" he shouts, grinning because he knows it's true. One thing he admits readily: Thanks to Melinda, he is easing comfortably into his new role. About the philanthropic work he says, "I don't think it would be fun to do on my own, and I don't think I'd do as much of it."

This is not exactly a marriage of equals. Melinda is better educated than Bill, having graduated from Duke University with a BA (a double major in computer science and economics) and an MBA. Harvard's most celebrated dropout, Bill was awarded an honorary degree last June. Melinda also outperforms him athletically. She runs once a week with a few friends - seven miles in an hour, a brisk pace - and tries to exercise five days a week. She has completed the Seattle marathon and climbed, with ropes and crampons, to the peak of 14,410-foot Mount Rainier. As for Bill, Melinda says, "He's finally started to run in the last year." To give him credit, he is an aggressive tennis player and a decent golfer - sometimes playing with Melinda. Beyond that, though, running on the treadmill while watching DVDs three nights a week is all Bill can do to keep up with his fit wife.

Melinda also understands people better than he does, Bill admits. In fact, he uses her as a sounding board, sometimes for personnel matters at Microsoft (MSFT, Fortune 500). In 2000, when Steve Ballmer, with whom Bill has worked for 28 years, replaced him as CEO, Melinda helped ease the awkward transition. "Melinda and I would brainstorm about it," Bill says. "You always benefit from your key confidante telling you, 'You think so-and-so stepped on your toes? Well, maybe he didn't mean to. Maybe you're wrong.'" Says the couple's close friend Warren Buffett, who has known them since 1991: "Bill really needs her."

When it comes to investing their philanthropic assets, Melinda wields even greater influence. Early on she and Bill agreed to focus on a few areas of giving, choosing where to place their money by asking two questions: Which problems affect the most people? And which have been neglected in the past? While many philanthropists take the same tack, the Gateses, who love puzzles, apply particular rigor. "We literally go down the chart of the greatest inequities and give where we can effect the greatest change," Melinda says. So while they don't give to the American Cancer Society, they have pumped billions into the world's deadliest diseases - most importantly AIDS, malaria, and tuberculosis - and failing public high schools in the U.S. And while Bill is drawn, naturally, to vaccine research and scientific solutions that may be decades away, Melinda is interested in alleviating suffering right now. "You can't save kids just with vaccines," she says. "I'd go into rural villages in India and think, 'Okay, we saved this child. But the cows are defecating in the stream coming into the village. There are other things we need to be doing.'"

Those other things include funding insecticide-treated bed nets to ward off malaria-carrying mosquitoes, providing microbicides to prevent the transmission of AIDS, and offering microloans and insurance to help the poorest of the poor start businesses and farms. The Gateses' latest mission, which developed out of a trip Melinda took to Kenya two years ago, is to recreate for Africa a green revolution similar to the program that increased crop yields in Latin America and Asia beginning in the 1940s. In 2006 the Gates Foundation formed a $150 million alliance with the Rockefeller Foundation. "Melinda is a total-systems thinker," says Rockefeller president Judith Rodin. "She and Bill dive into issues. They care deeply, deeply, deeply about making a difference, but they don't get starry-eyed. They demand impact."

The impact comes from the combination of Melinda's holistic vision and Bill's brainpower. Bono, the rock star-humanitarian who is both a friend of the Gateses and a grantee (through his One antipoverty campaign), calls their relationship "symbiotic." Noting Bill's fierceness, Bono says, "Sometimes I call him Kill Bill. Lots of people like him - and I include myself - are enraged, and we sweep ourselves into a fury at the wanton loss of lives. What we need is a much slower pulse to help us be rational. Melinda is that pulse." Buffett also believes that Melinda makes Bill a better decision-maker. "He's smart as hell, obviously," Buffett says. "But in terms of seeing the whole picture, she's smarter." Would Buffett have given the Gates Foundation his fortune if Melinda were not in the picture? "That's a great question," he replies. "And the answer is, I'm not sure."

If you are successful, it is because somewhere, sometime, someone gave you a life or an idea that started you in the right direction. Remember also that you are indebted to life until you help some less fortunate person, just as you were helped. - Melinda Gates, valedictory speech, Ursuline Academy, 1982

Unlike William H. Gates III, whose parents, Bill and Mary, were civic leaders in Seattle, Melinda French grew up not knowing privilege or wealth. Her father worked on the space program at LTV. Her mother was a stay-at-home mom who didn't go to college and regretted it. Says Melinda, who has one sister 14 months older and two younger brothers: "My parents told us, 'No matter what college you get into, we will pay for it.'"

That Apple III was actually the family's second computer; when Melinda was 14, her father brought home an Apple II, the first consumer computer on the market. "I finagled it to be in my bedroom so I could play games on it," she says. She learned BASIC, the programming language, and taught it to other kids during summer vacations.

Life was a test, and Melinda believed she had to ace it. Susan Bauer, her math and computer science teacher at Ursuline Academy, an all-girls Catholic high school in Dallas, recalls, "Every day she had a goal." Melinda laughs, a bit embarrassed at the mention: "The goals were run a mile, learn a new word, that sort of thing." During her freshman year she looked up recent graduates' college choices. She discovered that only Ursuline's top two students had gotten into elite schools. "I realized that the only way to get into a good college was to be valedictorian or salutatorian. So that was my goal," she explains. She hoped to go to Notre Dame.

Didn't we all know this girl in high school? The star student, captain of the drill team, candy striper in the hospital, tutor at the public school on the other side of the tracks? Melinda was all that. At Ursuline, where the motto is Serviam (Latin for "I will serve"), volunteerism was a requirement. Her ambition, insists Bauer, "was never abrasive. Never. She was always lovely and charming, and she would win people over by being persuasive."

She made valedictorian and got into Notre Dame. But Notre Dame did not get her. When she and her dad visited, she recalls, officials at the university told them that "computers are a fad" and that they were shrinking the computer science department. "I was crushed," Melinda says. Duke, which was expanding in computer science, got her instead. She earned her BA and MBA in five years. Then a helpful recruiter from IBM, where Melinda had worked as a summer intern, directed her to Microsoft. "I told the recruiter that I had one more interview - at this young company, Microsoft," she recalls. "She said to me, 'If you get a job offer from them, take it, because the chance for advancement there is terrific.'"
Dating the boss

Arriving in Seattle in 1987 as a marketing manager for a predecessor of Word, Melinda, 22, was naive about what Microsoft held for her. "There were a lot of idiosyncratic people. They were all so smart, and they were changing the world," she says, unfazed that she was the youngest recruit and the only woman among ten MBAs. The culture, though, did faze her. "It was a very acerbic company," she recalls. That culture trickled down from the top, where Gates and Ballmer badgered and harangued managers. Melinda thought about leaving Microsoft.

But four months after she started, during her first trip to New York City, for the PC Expo trade show, she went to a group dinner and sat next to the CEO. "He certainly was funnier than I expected him to be," she recalls. What attracted Bill to Melinda? "I guess her looks," he says.

Later that fall, on a Saturday afternoon ("Everybody worked on Saturday," she says), Melinda and Bill ran into each other in a Microsoft parking lot. "We talked awhile, and then he said, 'Will you go out with me two weeks from Friday night?' I said, 'Two weeks from Friday? That's not nearly spontaneous enough for me. I don't know. Call me up closer to the day.'" Bill called Melinda later that day, rattling off his lineup of meetings and commitments. "I promised I would meet him later that night," she says.

The scrawny brainiac had just become a billionaire from Microsoft's 1986 IPO. Yet even that kind of money can't buy you love. Asked if Melinda played hard to get, Bill replies, "She was hard to get!" Both Melinda and her mother decided that dating the CEO was not a good idea. But, says Bill, "we found ourselves deeply emotionally connected." Melinda was adamant that their relationship would not affect her work. "I wanted no public exposure. And I drew this line in the sand that I would never, ever, ever go to him on anything related to work." She explains, "It reached the point that Bill would say to me, 'You never tell me what you're doing.'"

The CEO's attention notwithstanding, Melinda French was a hotshot. In nine years at Microsoft she rose to general manager of information products (Expedia, Encarta, Cinemania) and oversaw 300 employees. Her record wasn't perfect. Remember Microsoft Bob, the version of Word for people afraid of computers? That was Melinda's baby. ("Too cute," she says.) But even on troubled projects, Melinda was seen as a strong team builder. Says Patty Stonesifer, Melinda's former boss at Microsoft and now CEO of the Gates Foundation: "No question, if she had stayed, she would have been on the executive team at Microsoft."

Melinda worried about marrying Bill. "Bill had money," she says. "To me, it was like, Okay, Bill has money. Big deal." She saw what success was doing to him - robbing him of his privacy and a normal life. Both Melinda and Bill, in fact, questioned whether his conquer-the-world capitalist nature could co-exist with a family. "I thought, 'What would it be like to be married to someone who works that hard?'"

A friend from Omaha juiced the relationship. On Easter Sunday in 1993, Bill and Melinda were visiting his parents at their vacation home in Palm Springs when he announced that it was time to head back to Seattle. They returned to their private jet. The pilot announced the route. Bill drew the shades. To distract Melinda he pulled out a jigsaw puzzle. ("Bill's very good at complicated jigsaw puzzles, but she's unbelievable," Buffett says.) When the plane touched down and the doors opened, "There's Warren with a bugle," Melinda recalls. (This isn't Seattle, Melinda. It's Omaha!) As Buffett drove them to Borsheim's, a jewelry emporium owned by Berkshire Hathaway, he kept ribbing: "Bill, there's a metric of love here. I spent 6% of my net worth on Susie's ring. I don't know how much you love Melinda, but 6% is the yardstick in Omaha." Bill, worth $7.3 billion by this time, inquired about sales per square foot while Melinda checked out the goods. "I said an emerald. Bill said a diamond is more appropriate," she recalls. She chose a diamond scandalously shy of Buffett's price target.

Around that time Bill and Melinda started talking about giving his money away. They both figured they would wait until Bill was in his 60s, despite flak he was getting about his miserliness. "He had been advised by lawyers and accountants that he should have a foundation," recalls his father, "but he refused. He said he didn't need another entity." Melinda's wedding shower in December 1993 shifted the thinking. Bill's mother, Mary Gates, who was fighting breast cancer at the time, read a letter she had written to Melinda. "From those to whom much is given, much is expected" was its essence. Mary Gates passed away the following June. Her message spurred the creation of the first Gates charity, the William H. Gates III Foundation. Bill's dad ran it out of cardboard boxes in his basement.

Initially, Melinda recalls, the idea was to put laptops in classrooms - which was derided by many as a self-serving gesture by a software tycoon. But at the time, she was volunteering in a couple of schools in Seattle, and she realized that "there's a much bigger problem" than a technology divide. She and Bill decided to take on education reform broadly, focusing on secondary schools. "The piece that looked so intractable and no one was touching was high schools," she says.

Soon after their wedding came the calling to global health. Melinda read a front-page New York Times story about children in developing countries dying of diseases that most Americans have never heard of - rotavirus, which kills more than 500,000 children every year - and others like malaria and tuberculosis that barely exist in the U.S. "I thought, 'This can't be happening,'" Melinda says, and she attached a note to Bill. ("This is how we work," she says. "We constantly put stuff on each other's desks.") Reading the article, Bill learned about the World Bank's 1993 Development Report, which calculated the cost of these diseases. He got the 344-page document and read it several times. "That is not something I will do," notes Melinda. "I learn in a different way. I learn experientially."

Buffett's gift

"Yes, we're a couple that has fun discussing fertilizer while we walk on the beach," says Bill proudly. We are sitting in the chairman's office at Microsoft, and Bill, in an armchair, is rocking forward and back - an old habit that Melinda has not broken. "Melinda is more scientific and reads more than 99% of the people you'll ever meet," he says. When the couple reviews grants (of the 6,000 or so requests that the foundation receives annually, they personally evaluate only those asking for $40 million or more), they typically meet in a study or hash out their views during long walks. They discuss grant requests without notes in front of them because, as Melinda says, "You'd better have it in your head. That's a good discipline."

Former President Bill Clinton, who paid tribute to Melinda at a Save the Children dinner in New York City in September, said that two years ago, when he went to Africa with the Gateses, he and Bill "thought we were so smart. We showed how much we knew about all these issues, you know, and we asked all the right questions. Melinda just sat there patiently. And then when we shut up, she bored in and said, 'What are you doing in education? What are you doing on prevention? How many people are using condoms?'" The two Bills wilted. "Melinda showed that in the end, women are stronger than men when it counts," Clinton said.

As Melinda has handed him AIDS babies with dirty pants, her husband has developed a noticeable compassion. But hers seems natural. Her close friend Charlotte Guyman, a retired Hewlett-Packard and Microsoft executive who is now on Buffett's Berkshire Hathaway board, recalls a trip to Calcutta in 2004. One day, when Melinda had foundation meetings to attend, Guyman and a few in their group spent a half-day at Mother Teresa's Home for the Dying. There, they were captivated by one young woman suffering from AIDS and tuberculosis who was "just bones," Guyman says. No one could break the woman's zombie-like stare. The next day Melinda visited. "Melinda walks in, pauses, and goes right over to this young woman," Guyman recalls. "She pulls up a chair, puts the woman's hand in her hands. The woman won't look at her. Then Melinda says, 'You have AIDS. It's not your fault.' She says it again: 'It's not your fault.' Tears stream down the woman's face, and she looks at Melinda." Guyman can't forget the connection. "Melinda sat with her. It seemed like forever."

Seeing such suffering up close has led the Gateses to direct more money to what they call intervention: those bed nets, condoms, microbicides (clear, odorless gels that women apply vaginally) that help ward off illness and death until the magic bullet, vaccines, arrives. As AIDS among women has exploded in the developing world, Melinda, who goes to church regularly, feels no guilt about funding programs that more conservative Roman Catholics question. "Condoms save lives," she says.

As mighty as the Gates Foundation is, Melinda insists that it needs partners. Relatively speaking, she says, "our pocket of money is quite small. The NIH budget is $29 billion. The state of California spends $60 billion in one year. If we spent that, our entire foundation would be out of business." So the Gates Foundation has allied with other charities - Rockefeller, Michael and Susan Dell, Hewlett - and with companies such as GlaxoSmithKline and Procter & Gamble on various projects. The most successful joint venture is the GAVI Alliance, formerly called the Global Alliance for Vaccines and Immunization, which the Gateses helped start with donations of $1.5 billion. With 17 donor governments and the European Union in the fold, GAVI has distributed vaccines (including tetanus, hepatitis B, and yellow fever) to 138 million children in 70 of the world's poorest countries. Thanks largely to this alliance, immunization rates are at all-time highs in the developing world, and more than two million premature deaths have been prevented.

Closer to home, where just 70% of American ninth-graders graduate on time from high school, reforming education has been a slog. Melinda admits that she and Bill were initially naive. "I thought that if we got enough schools started, people would say, 'Let me build schools just like that.' Just the opposite is true. You could get 1,000 schools up and running, and the system would pull them down." In Denver and even in Seattle, the Gateses' backyard, some of their education efforts have failed for want of community engagement or the right leadership. So now the Gateses are working with 1,800 high schools and aligning with superintendents, mayors, and governors wherever they can. "It's always been one step forward and one step back," Melinda says.

New York City, though, shows what Gates money can do. At 43 new small high schools funded by the Gates Foundation, graduation rates are 73%, compared with 35% for the schools they replaced. The Gateses' partner here happens to be Joel Klein, who led the government's antitrust case against Microsoft a decade ago and now runs New York City's public schools. Klein appreciates the irony of their alliance, calling the progress "a tribute to Bill." For his part, Bill claims that it was no big deal to give his money to his former nemesis. And Melinda won't say a word about the tension that stemmed from that period. "That's part of our relationship that I need to keep private," she says. But clearly she helped her husband get his head around the notion of working with Klein. "This is one of the great things about Bill," she says. "Bill looks forward." Buffett observes, "When Bill gave $50 million to New York City schools with Joel Klein in charge, I thought, 'This guy can rise to the occasion.'"

Now, with another key partnership - the one with Buffett - the Gateses have more to spend and do than ever. Buffett had planned to hold onto his money until his death, but he changed his mind after his wife, Susie, died in 2004. In the spring of 2006, after lots of hinting, he broke the news to Bill. When Bill went home and told Melinda, they went on a long walk, and both cried. Melinda recalls, "We said to each other, 'Oh, my gosh, do you know how responsible we're going to feel giving someone else's money away?'"

Buffett, who requires that the Gateses spend his annual contributions in full the following year, has given them just one piece of advice: "Stay focused." He considers the Gateses "the perfect solution," he says, because they are experts in philanthropy and also because he sees himself in Bill and his late wife in Melinda. "Bill is an awkward guy. He's lopsided, but less lopsided since he's with Melinda," he says. "Susie made me less lopsided too." Perhaps proving the point, Bill is quite touching when he explains his delight in disbursing Buffett's billions. "Warren knows how lucky I am to have Melinda. It makes him look back at his time with Susie and wonder what it would have been like to be doing the giving with Susie."

Bill and Melinda are only now figuring out their new division of duties - crucial in a 500-person outfit that will probably double in size in two years. Bill, no organization geek (that would be Ballmer), intends to spend more time with scientists and academics, explore technology in education, and egg on the pharmaceutical companies that are not working on vaccines for the developing world. "Nobody gives them a hard time," he complains. "That job is natural for me to do." Melinda, meanwhile, intends to focus on personnel and culture. Some critics of the foundation contend that only managers who are close to the Gateses have the clout to get things done. Melinda says she wants to push decision-making further down the organization. Asked whether criticism about the Gates Foundation's bureaucracy is valid, she replies, "You bet, some of it is." Still, she says, "years ago we got compliments about how fast we reviewed grants. Those grants were swift, but they were not all as effective as they could have been. I'd rather be a bit more methodical and effective." She also believes that the foundation must respond better to charges that its assets are invested in companies, including BP and Exxon Mobil, whose business interests can conflict with its altruistic goals. In May, Melinda and Bill directed endowment managers to divest stocks of companies invested in Sudan.

Housing crisis

Melinda and Bill married on Jan. 1, 1994, in a small ceremony on the Hawaiian island of Lanai, with Willie Nelson, one of her favorite singers, performing - a surprise arranged by Bill. Afterward, Melinda says, she had "a mini sort of personal crisis." This crisis was over the house Bill was building on Lake Washington outside Seattle. It was a bachelor's dream and a bride's nightmare: 40,000 square feet with several garages, a trampoline room, an indoor pool, a theater with a popcorn machine, and enough software and high-tech displays to make a newlywed feel as though she were living inside a videogame. "If I do move in," she recalls telling Bill, "it's going to be like I want it to be - our house where we have our family life." After six months of discussions about shuttering the project, Melinda hired a new architect to redesign the place. They worked together to create intimate spaces, an office for her, and staff quarters out of sight and on the periphery.

The couple moved in before construction was finished, which might have been a mistake. "Having a hundred workmen there gave her the message, 'This is what your life is going to be like,'" Bill says. He used to tell Melinda: "Every day I want to hear one thing you like about this house." She recalls: "I'd say, 'Okay, I like the laundry chute.' Or 'Okay, here's what I like and ten things I don't like.'"

The house is, of course, a metaphor for Melinda's desire for normalcy. Her foremost concern is that the kids lead lives as normal as possible. She insisted on booting all hired help on weekends except for the security people and a sitter who arrives late in the day in case she and Bill want to exercise or go to dinner or a movie. Wednesday night is family swimming night. Friday night is family movie night. Bono, who has stayed with the Gateses several times, says, "That home has a stillness to it. It's got a sort of Zen-like quality. Melinda has created that." When they congregate in the light-filled kitchen overlooking the lake, Bono says, "they're fun to hang out with. And they're funny. She plays the straight man to his dark humor."

Melinda appreciates Bono's description. But does she like the house? "Now I like it," she says, smiling. "I still wouldn't build it. But I like it."

The Gates children are reaching the age where they want to understand their parents' passions. In 2006, Melinda and Bill took the two oldest children to South Africa, showing them slums and an orphanage in Cape Town. But the value of their work is often difficult to translate. A few years ago when they showed a documentary about polio, the kids asked about a crippled boy featured in the film: "Did you help that kid? Do you know the name of that kid? Well, why not?" On and on. "We don't know that boy," Melinda told the children, "but we're trying to help lots of kids like him." Bill's explanation: "I'm in wholesale. I'm not in retail!"

As Bill says about their children, "They know the money is overwhelming." And of course the kids have asked whether their parents will provide for them as generously as they do for those poor people who receive their billions. "We say, 'You'll be fine. You'll still be very well-off,'" Bill says. While he and Melinda plan to give away 95% of their wealth in their lifetimes, they have not yet decided how much of what's left will go to the children. Melinda says they will follow Warren Buffett's philosophy: "A very rich person should leave his kids enough to do anything, but not enough to do nothing."


"My fatal flaw?" Melinda says, laughing, during our third and final interview. She sometimes wishes for a simpler life, she admits. "It depends when you catch me. Most days, no. But if you'd asked me yesterday if I would like a much simpler life, I would have told you yes." Yesterday was that night before the Malaria Forum, when she went to bed feeling unprepared. This morning, as she sat onstage and scrutinized the audience of renowned doctors and health experts, she says, "I was telling myself, 'I know that person ... I know his work ... I know her work.'" She was giving herself a pep talk. "I told myself, 'But I do know enough.'" She completed her goal for the day: calling for the eradication of one of the worst diseases the world has ever known. Tomorrow, another goal. Maybe it will be even bigger.