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INDEX:

I. Market News: Record String Is Snapped
II. Heroes: TRO Lrning, Diana, Maybelline, Knickerbocker, Bachman
III. Goats: IBP, Avant!, GaSonics, Fieldcrest Cannon, Wonderware
IV. Investment Perspective: The Internet Gets Unplugged
V. Calendar: Friday's Economic Events

MARKET CLOSE

DJIA: 5159.39, down 39.74
S&P 500: 616.17, down 4.01
NASDAQ: 1053.17, down 8.56

MARKET NEWS

As a reminder to investors who have come to expect new records every day for the stock market indices, all three major market averages slid considerably today on moderate volume. Meanwhile, President Clinton presented his own balanced-budget plan today, which excludes the capital gains tax cut approved by both houses of Congress, a move sure to set the Republicans howling, but perhaps a way of leaving some negotiating room between the two plans. Clinton has stated before that he could see agreeing to some form of capital gains tax cut. The budget followers also are saying now that we're looking at an agreement in mid-January rather than mid-December, leaving the question open of whether there will be a continuing resolution or another partial government shut-down.

HEROES

TRO Learning <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:TUTR)") else Response.Write("(NASDAQ:TUTR)") end if %> rose $3 3/4 to $11 3/4 today, the day after reporting an earnings increase of 13% for fiscal 1995. Analyst Alexander Paris at Barrington Research Associates has increasing confidence in his 1996 estimates of $0.90 per share and sets 1997 estimates at $1.25, based on 1995's earnings. "The return on investments made over the last several years [is] beginning to be realized," Paris wrote in his research report. The company develops and markets PC-based instruction systems designed to replace classroom learning. The investment has been in its PLATO Education systems, which they market to schools, colleges, job-training programs, the Armed Forces, prisons and private industry. If Paris's estimates are correct, the company will grow 50% this year and 39% next year, a compound growth rate of 4% compared to the company's current P/E multiple of 18, including a rather massive one-time gain from an accounting change. If the company can deliver on its earnings, it seems pretty cheap here.

Diana Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:DNA)") else Response.Write("(NYSE:DNA)") end if %>, a company transforming itself into a telecommunications equipment concern from a food distributor, continues to surge, rising $1 7/8 today to tack on another 52-week high at $19 1/2. The company refused comment today when the New York Stock Exchange called to ask it about the volume on the shares, which was approximately 2.5% of the outstanding shares. The company announced earnings of $0.04 per share last week, which is difficult to compare to last year given the recent change in their basic business. On Friday, the company announced it was acquiring Valley Communications, one of the largest network installation and service companies in California. The Board of Directors authorized a 5% stock dividend. There was quite a bit of insider buying in the issue in the spring and these insiders are obligated by federal law to hold until next spring. It is pretty difficult to value a situation like this when there is no history to base earnings projections on. There are no estimates on the company right now.

Rumors that Maybelline <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MAY)") else Response.Write("(NYSE:MAY)") end if %> was a takeover target, promulgated by CNBC on-air personality Dan Dorfman, drove the cosmetics giant higher by $3 7/8 to close at $30 1/4. The possible suitor? U.K.-based Unilever Group. . . or at least that is what Dorfman says. The make-up monster was already trading at its 52-week high, partially on the hype surrounding Estee Lauder Group's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:EL)") else Response.Write("(NYSE:EL)") end if %> initial public offering two weeks ago. Valued at 24 times trailing earnings, Maybelline, without a takeover offer, seems pretty pricey considering it has a five-year growth rate of only 11.83%, according to most analysts. The shares are being valued at about 19 times next year's earnings.

Rafi Khan is a California-broker who has been behind the shadowy advances of a number of companies, including L.L. Knickerbocker <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:KNIC)") else Response.Write("(NASDAQ:KNIC)") end if %>, up $1 1/8 to $8 1/8 today. The typical Khan target for hype is a stock with a seemingly incredible story which many people can relate to. L.L. Knickerbocker, which brings 70s celebrity icons, the Internet and home-shopping networks together in an incredible arrangement that seems to spring from an Umberto Eco novel, is a classic Khan play. At one point, more Knickerbocker shares were shorted than existed, a testament to the temerity of many professional short sellers. Aura Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AURA)") else Response.Write("(NASDAQ:AURA)") end if %> is another company whose shares have been pushed higher and lower by Khan's escapades.

Bachman Information Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BACH)") else Response.Write("(NASDAQ:BACH)") end if %> rose $1 3/8 to $8 1/4 today after it announced that it will acquire one of its leading competitors, privately-held Cadre Technologies, for five million shares. This acquisition, according to Bachman CEO Peter Boni, establishes a single leading global supplier of modeling, database design and development solutions for the commercial and technical markets. Together, the two companies had about $70 million in revenues in the last fiscal year. This acquisition is potentially dilutive for Bachman, which currently has only about ten million shares outstanding. If the value stays constant, the company will have a market cap of $120 million upon acquisition, which appears reasonable given the trailing revenues and the fact that this is a software company. However, Bachman is currently not profitable and is only expected to break even this year. In unrelated merger news, Softkey Intl <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SKEY)") else Response.Write("(NASDAQ:SKEY)") end if %> rose $1 7/8 to $31 1/8 after Broderbund <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BROD)") else Response.Write("(NASDAQ:BROD)") end if %> cried "Uncle!," letting the software company know it could have the Learning Company <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LRNG)") else Response.Write("(NASDAQ:LRNG)") end if %> and that Broderbund would not match its offer.

GOATS

Massive meat processor IBP Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IBP)") else Response.Write("(NYSE:IBP)") end if %>, formerly known as Iowa Beef Processors, fell $10 7/8 to $48 5/8 today after the company indicated that its beef margins are coming under pressure and that analysts should expect lower fourth-quarter earnings. IBP, spun off from Occidental Petroleum a few years back, was the subject of downgrades from C.J. Lawrennce and J.P. Morgan, both citing the company's comments. Others maintained their current "buy" ratings, emphasizing that that "the immediate worry is the quarter. I would not panic." The question here is when will cattle herds be liquidated, which would pressure margins because the smaller supply after a glut would drive beef prices back up. No one sees that coming, and the slump in the fourth quarter will cause the company to post earnings of about $1.50 per share compared to $1.68 in the year-ago period. The stock has had a tremendous run this year and analysts estimates have already suggested that 1996 will show no real earnings growth. A multiple of 8-12 seems fair given the long-term growth of this company; that would put today's price slightly on the low side of that range.

Avant! <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AVNT)") else Response.Write("(NASDAQ:AVNT)") end if %>, the company that resulted from the merger of ArcSys Inc. and Integrated Silicon Systems, tumbled today in extremely heavy volume, losing $11 3/8 to $23 7/8 as roughly 40% of the outstanding shares traded. Cadence Design Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CDN)") else Response.Write("(NYSE:CDN)") end if %> is suing the company over an alleged patent infringement. At issue is whether or not the developer of integrated circuit design software knowingly used a computer code acquired from Cadence by an ex-employee who came to Avant! as a consultant. Given the merger, it is really difficult to tell what shares of the company should be valued at. Integrated Silicon Systems was estimated to make about $4.62 million before the merger. Given that the merger was accounted for as a purchase, this would mean that it would add earnings of about $0.44 per share of Avant! Arcsys was projected to make about $0.35 for the year, which means that the companies together have earning potential of $0.78 a share, growing to about $1.10 the year after---41% growth. The questions surrounding the potential lawsuit as well as the merger have caused shareholders to bail, but this stock, barring any serious legal damage, is worth somewhere between $35 and $45 based on fundamentals.

GaSonics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:GSNX)") else Response.Write("(NASDAQ:GSNX)") end if %> joined the ranks of semiconductor equipment companies getting hosed on heavy volume for no apparent reason. Down $2 7/8 to $14 7/8, the maker of photoresist removal equipment used in semiconductor equipment fabrication was perhaps the victim of a newsletter "downgrade," like its cousin Helix Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:HELX)") else Response.Write("(NASDAQ:HELX)") end if %> earlier in the week. GaSonics recently split, which makes valuation a little tricky given the fairly inconclusive information we have on the split here at Fool HQ. The company appears to be making some aggressive product transitions, however, and might be worth a look.

Fieldcrest Cannon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:FLD)") else Response.Write("(NYSE:FLD)") end if %> broke it to the Street today to expect a fourth-quarter loss, sending shares plunging $2 7/8 to $18 1/4. The manufacturer of cotton clothing and other fabric products cites weak retail demand as the culprit. The company previously announced that the fourth quarter would be below last year's; now they are saying it will only be break-even. The company will also have a fourth-quarter charge on top of all of this for the closure of two of four yarn facilities; the company will now purchase yarn from outside vendors.

Wonderware <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:WNDR)") else Response.Write("(NASDAQ:WNDR)") end if %> continued to plummet today, down $2 7/8 to $17 1/8, based on yesterday's announcement at a Montgomery Securities conference that analysts should expect between 13-19% growth next year, opposed to previous models that called for more than 20%. The company, which lost its CEO two weeks ago, has been under pressure from this revelation. Exar Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:EXAR)") else Response.Write("(NASDAQ:EXAR)") end if %>, down $1 3/4 to $14 1/4 in unrelated news, also continues being hit by a story released earlier this week that revenue will be down 7% from the prior quarter, prompting some high-profile analyst downgrades.

INVESTMENT PERSPECTIVE: Popping the Internet Bubble

Smith Barney analyst Jonathan Cohen was out early this morning with a big ol' needle, all set to pop the Internet "bubble." Although he will probably not be vilified in the corridors of Fooldom like well-known chip guru Rick Whittington, what he has to say was a marked break from what industry peers like Goldman Sachs's Michael Parekh and Robertson Stephens's Marshall Senk said literally only days before. With yet another in a series of skeptical "Heard on the Street" articles in the Wall Street Journal to back up his negative comments, chaos reigned on the exchanges today.

Cohen initiated coverage today on five online and Internet-related companies. Here is a snapshot of the ratings and how the stocks subsequently fared today:

Netscape Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NSCP)") else Response.Write("(NASDAQ:NSCP)") end if %> -- SELL -- down $28 3/4 to $132 1/2
UUNET Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:UUNT)") else Response.Write("(NASDAQ:UUNT)") end if %> -- Underperform -- down $7 5/8 to $58 3/4
NETCOM On-Line Comm. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NETC)") else Response.Write("(NASDAQ:NETC)") end if %> -- Underperform -- down $8 3/4 to $54 3/4
Spyglass Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SPYG)") else Response.Write("(NASDAQ:SPYG)") end if %> -- Underperform -- down $14 3/4 to $95 1/4
America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AMER)") else Response.Write("(NASDAQ:AMER)") end if %> -- Neutral -- down $3 1/4 to $41 3/8

A number of other Internet "related" issues took it on the chin as well:

Bolt, Beranek & Newman <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:BBN)") else Response.Write("(NYSE:BBN)") end if %> -- down $3 1/8 to $43 3/4
Checkfree <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CKFR)") else Response.Write("(NASDAQ:CKFR)") end if %> -- down $7/8 to $26 1/2
CMG Information Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CMGI)") else Response.Write("(NASDAQ:CMGI)") end if %> -- down $7 to $83 1/2
Fulcrum Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:FULCF)") else Response.Write("(NASDAQ:FULCF)") end if %> -- down $1 1/2 to $30 1/4
Global Village Comm. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:GVIL)") else Response.Write("(NASDAQ:GVIL)") end if %> -- down $1/4 to $21 7/8
Intuit <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:INTU)") else Response.Write("(NASDAQ:INTU)") end if %> -- down $3 5/8 to $79 3/4
Macromedia <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MACR)") else Response.Write("(NASDAQ:MACR)") end if %> -- down $7 to $50 1/2
Mecklermedia <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MECK)") else Response.Write("(NASDAQ:MECK)") end if %> -- down $1/2 to $16
Performance Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PSIX)") else Response.Write("(NASDAQ:PSIX)") end if %> -- down $2 5/8 to $25 7/8
And the most recent addition to the Internet "stable,":
Open Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:OPEN)") else Response.Write("(NASDAQ:OPEN)") end if %> -- down $2 7/8 to $15 3/8

Until now, analysts at the major brokerage houses had been making positive comments about the potential market that Netscape and its brethren would serve, focusing on Netscape's dominance in the browser market as the potential stepping-stone to a new operating system that could unseat Microsoft's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MSFT)") else Response.Write("(NASDAQ:MSFT)") end if %> Windows. Comments by industry analysts suggesting that Microsoft lacked an Internet "strategy" heightened the attraction to these speculative issues, suggesting a real opening akin to Microsoft's IPO nearly a decade ago. A lot of secondary issues with questionable relations to the entire Internet phenomenon also rose in the general frenzy.

The numbers surrounding these stocks were pretty bold, with Robertson Stephens saying "Netscape is a compelling growth story with projected F1996 revenue growth of 97 percent and F1996 earnings growth of 503 percent." The Journal today reported a bunch of revenue forecasts for the industry at large made by the larger brokerage houses. Alex. Brown & Sons forecasts Internet revenues of $15 billion by 1998; Hambrecht and Quist is looking for $23 billion by the year 2000 and Montgomery Securities was the bear, suggesting only $10 billion by 2000. However, what really counts as Internet "revenues" is always in question, since some people focus more on software and some stick a lot of quasi-retail numbers in there.

Basically, these are all "soft" numbers; no one knows what the heck is going to happen, which is why these issues are all so volatile and hard-and-fast valuations are near impossible to determine. The questions that surround the emergence of a truly "new" medium open up a host of arguments on basic ways to value a stock and raise the question of just how far in advance the market can effectively discount earnings and revenues.

One way to address this question---the way Smith Barney used today---is to look at total revenues for the industry and compare this number to the market valuations of the companies involved. Once the market caps of the companies begin to outpace the total revenues possible for the next two to four years, you start to have some real problems. Jonathan Cohen was quick to point out that all of these stocks are being valued as if they are the single "winner" of the Internet, getting the lion's share of the revenues, which obviously cannot possibly happen.

Looking at Montgomery Securities' valuation of the Internet at $10 billion by the year 2000 and looking at Netscape's market capitalization yesterday of $6.5 billion, this valuation problem is beginning to make itself pronounced. Throwing in America Online's $4.5 billion, Spyglass's $600 million, UUNet's $2 billion and Netcom's $600 million, something has to give somewhere. Another thing to keep in mind for Netscape is that insiders will be able to dump their first shares in two days, which might put some further downside pressures on the shares.

Not all Internet stocks were losers today. Sun Microsystems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SUNW)") else Response.Write("(NASDAQ:SUNW)") end if %> managed to go against the Internet grain today, benefiting from Microsoft's announcement of an Internet strategy which emphasized Sun's Java language. The company was up $3 3/8 to $93 1/8 after the chairman, Scott McNealy, said the company was positioned to grow "aggressively" over the near-term. It was actually the news that Microsoft is working with Java that helped to pressure a lot of the other Internet stocks down; this went against the earlier comments by industry analysts about Microsoft's lack of an Internet "strategy." Microsoft is rolling out programs code-named "Blackbird" and "Gilbraltar" for application creation and Internet transactions, as well as linking up with Java when applicable, decreasing Netscape's window of opportunity.

Essentially, the reality of the potential size of the market is impacting the potential growth in the shares of these companies. Even paying attention to this, though, some interesting discrepancies make themselves apparent. Spyglass, a legitimate competitor to Netscape, has one-tenth Netscape's market cap right now. America Online, which owns a vertically integrated network, is still worth less than Netscape, which just has a browser. Opportunities still seem to exist here, but much like the semiconductors, the easy money has been made; this is now a stock-picker's market.

CALENDAR: Friday's Economic Events

---November Employment Report (8:30)
---October Wholesale Trade (9:00)
---October Home Sales (10:00)
---October Housing Completions (10:00)
---November Columbia University Leading Inflation Index (10:30)
---Gross Domestic Product Revisions for 1959 to 1992 (2:00)

Byline: Randy Befumo (MF Templar)