Friday, January 12, 1996
MARKET CLOSE

INDEX:

I. Market News: Volatile End To Volatile Week
II. Heroes: XL, GVIL, ABTI, EPIC, NN
III. Goats: NETM, RIDE, MRRW, SHX, CNMW, SYMM, IRF
IV. Investment Perspective: Rick Whittington Feature, Part Two
V. Calendar: Monday's Economic Events

MARKET CLOSE

DJIA: 5061.12 -3.98 (-0.08%)
S&P 500: 601.81 -0.88 (-0.15%)
NASDAQ: 1008.23 -2.87 (-0.28%)

MARKET NEWS

After opening strong, the stock market sold off some 40 Dow points because of a sell program before scratching and clawing back late in the day. For the week, the Blue Chip index lost 120 points (2.3%) on the uncertainty about the budget battle and interest rates. The technology-laden Nasdaq had an equally violent time of it, finishing up with a similar 2.4% drop for the week.

And for those of you complaining recently about log-on problems at America Online, it could be worse. A fire in the garage of CNBC studios almost forced them to rerun programming from earlier in the morning while everyone was evacuated from the building.

HEROES

EXEL Ltd. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:XL)") else Response.Write("(NYSE:XL)") end if %> rose $4 3/8 to $64 3/4 today after reporting earnings for its fiscal fourth quarter $0.17 a share ahead of expectations. The property and casualty insurer was immediately upgraded to "near-term above average" from "near term neutral" by Merrill Lynch while it maintained its long-term "above average" rating. EXEL's EPS increased 26% rather than the anticipated 11%, suggesting that estimates of $6.16 for next year and the long-term estimated growth rate of 12% might get notched up.

Global Village <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:GVIL)") else Response.Write("(NASDAQ:GVIL)") end if %> is one volatile stock, rising $3 1/2 to $18 3/8 today. The stock has traded as high as $25 3/4 on its prospects as a leading provider of networking and connectivity products and services for Macintosh and PC platforms, focusing mainly on the Mac. The company recently acquired a U.K. ISDN provider and added an ISDN option to its Macintosh networking platform. It has been grouped with the "Internet" stocks because it is also an Internet Service Provider (ISP) for businesses. Slated to make $0.99 a share next year with an estimated 30% growth rate, the only black mark against it is the excessive focus on Macintosh at a time when Apple Computer is having so much trouble.

Biotech stock Alpha-Beta Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ABTI)") else Response.Write("(NASDAQ:ABTI)") end if %> got a boost from Montgomery Securities, rising $2 to $14 1/2 today when analyst David Crossen initiated coverage with a "buy" rating. Crossen thinks the company can earn as much as $3.70 per share in *1999* and sees the stock going to $25 next year in anticipation of these earnings. The company manufactures Betafectin, an immunostimulant used to reduce infection rates in surgical patients. It is currently in Phase III trials and could get approval in 1998 at the earliest.

Epic Design Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:EPIC)") else Response.Write("(NASDAQ:EPIC)") end if %> shot up $3 3/4 to $25 3/4 after reporting earnings yesterday that were $0.02 a share ahead of expectations. The company, which develops software to test and design integrated circuits, is three quarters ahead of its business plan for revenues and earnings and will probably see its estimates raised in the coming weeks. Epic competes with Actel <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ACTL)") else Response.Write("(NASDAQ:ACTL)") end if %>, IKOS Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:IKOS)") else Response.Write("(NASDAQ:IKOS)") end if %>, Cadence Design <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CDN)") else Response.Write("(NYSE:CDN)") end if %> and Avant! <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AVNT)") else Response.Write("(NASDAQ:AVNT)") end if %>. We hope to have an in-depth story on this interesting group of companies sometime next week.

Newbridge Networks <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:NN)") else Response.Write("(NYSE:NN)") end if %> surged $3 1/2 to $47 1/4 today after a blurb appeared in the Wall Street Journal about its intention to make a deal with a telecommunications equipment company in order to upgrade the core voice networks of telephone companies to enable them to handle data and network traffic. Although nothing specific was reported, in light of Bay Networks' <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BNET)") else Response.Write("(NASDAQ:BNET)") end if %> blistering earnings and optimism about the industry, it only made sense to some investors to bid up the price of the lowest valued player in the group.

GOATS

Providers of TCP-IP connections to businesses have had a hellish quarter, with the last of the bunch, NetManage <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NETM)") else Response.Write("(NASDAQ:NETM)") end if %> finally knuckling under and pre-announcing a bad quarter. The stock was down $3 11/16 to $10 7/8 today after its CFO, Walt Amaral, said the company would earn less than $0.15 a share in its fiscal fourth quarter. Analysts had been looking for $0.20. Amaral said "order rates are still very solid---we just couldn't recognize all the revenue" because of financial accounting policies. One wonders whether the company might be getting hit because Microsoft has started offering a more primitive connection for free with its OS. Check MF Yakko's Software folder in the Industry Research area for details.

Ride, Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:RIDE)") else Response.Write("(NASDAQ:RIDE)") end if %> shares fell off the mountain today, plunging $8 1/2 to close at $25 on very heavy volume. The story? Apparently Hambrecht and Quist analyst Shelley Young is shifting her quarterly estimates for next year. Young still rates Ride a "buy," but she has back-weighted her estimates for 1996, weighting the third and fourth quarters more heavily while keeping her full-year estimates constant. Dain Bosworth made a similar move, chopping estimates for the first, second and fourth quarters and raising estimates for the third quarter, changing estimates for all of 1996 a measly 4 cents a share. The analysts did warn of higher Sales, General and Administrative (SG&A) expenses next year, however. Competitor Morrow <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MRRW)") else Response.Write("(NASDAQ:MRRW)") end if %> had rough sledding as well, down $1 1/4 to $12 1/2 in sympathy. Crack contributor MF ETurkey had already interviewed Ride's CEO before we went to press. You can read about it in the Ride folder on the Stock Boards.

Shaw Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SHX)") else Response.Write("(NYSE:SHX)") end if %> canceled merger discussions with Maxim Group Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MAXM)") else Response.Write("(NASDAQ:MAXM)") end if %> today, pushing Maxim Group down $2 11/16 to $10 1/16 today on heavy volume. The president of Maxim said the companies could not come to agreement on a price and the president of Shaw stated that they had no intentions of speaking about a merger again. Despite the halted talks, the companies will maintain their relationship as carpet/rug supplier and customer.

Cincinnati Microwave <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CNMW)") else Response.Write("(NASDAQ:CNMW)") end if %> lost $1 3/8 to $2 1/2 today after it defaulted on the terms of a bank loan from Huntington National Bank. As a result, Huntington has cut off the company's credit facility. Cincinnati Microwave has been plummeting in recent weeks on negative announcement after negative announcement about future profit potential for its line of wireless products. Once a hot company because of its radar detectors, the company reached too far and has toppled as a result.

Symmetricom <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SYMM)") else Response.Write("(NASDAQ:SYMM)") end if %> lost $2 3/4 to $10 7/8 in spite of the fact that it posted earnings that were above consensus expectations. The fly in the ointment? The company had lower-than-expected sales at its Linfinity unit that may result in a decline in orders in the third quarter. Since stocks are priced not on what they *have* earned but on what the market believes they *will* earn, it makes sense that the expected lower sales would put a damper on the earnings report. Symmetricom makes a variety of telecommunications equipment.

International Rectifier <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IRF)") else Response.Write("(NYSE:IRF)") end if %> was another recent graduate of the earnings surprise school that flunked the market today, losing $2 3/4 to $21 1/8. UBS Securities analyst Jonathan Joseph lowered his rating on the company from "buy" to "long-term attractive," citing "sharply decelerating worldwide order trends'' for integrated circuits and "decelerating order trends at the company." Ere. . . unless he has some inside information, the quarterly revenues increases have progressed from 30% to 33% to 32% to 37% to 38% in the last five quarters, hardly a "decelerating trend." As for the "sharply decelerating worldwide trends," all we can say is that demand cannot stay at 50% forever. Leveling off from 50% to a long-term growth rate of 15-20% in worldwide chip demand is still pretty nice.

INVESTMENT PERSPECTIVE: Part Two of Three

When the Chips Are Down, Or Rick Whittington: Not a Chip Off the Old Block, but the Old Block Itself

Part II. Semiconductor Equipment and the Digital World.

<<We are talking about the digital world here. [The telephone and cable companies] are now being forced to offer consumers compelling reasons to be a customer. The semiconductor manufacturers and the semiconductor equipment companies are the linchpin in this whole scheme. Without these companies, the telecom, automotive and computer industries are dead in the water.>>

---Carl Johnson of Infrastructure, http//:www.infras.com

Virtually everyone who bought semiconductor equipment stocks over the past four to six months is sitting on a loss. As prices for "commodity" chips have crumbled, fears that semiconductor manufacturers would postpone or defer commitments to purchase semiconductor equipment have dropped shares of the companies involved mercilessly.

One of the Street's more outspoken proponents of this viewpoint is SoundView Financial semiconductor analyst Rick Whittington. It is because of Mr. Whittington's vision of "profitless prosperity" for the semiconductor manufacturers that he has downgraded his opinion of the semiconductor equipment makers. Whittington has gone as far as to ignore the guidance of the management of many of these companies when setting his own estimates, believing that they don't anticipate the coming downturn.

The fear is real and not completely irrational; any student of history can examine a graph of the collective revenues of the semiconductor industry over time and see massive peaks followed by deep valleys. But just because the anxiety can be justified by reason does not make it the truth. The evidence for such a conclusion is shaky, at best. Let's examine why.

The Chief Financial Officer (CFO) of Applied Materials held a bullish conference call with investors on Tuesday, sponsored by Prudential Securities. CFO Gerald Taylor reiterated that Applied was "on track" to meet the Street's consensus estimates of $3.80 to $3.90 a share for the fiscal year ended October 1996. The company anticipates $4.5 billion in revenues and increased gross margins of 2-3%. For the last fiscal year, Applied Materials booked $3.06 billion in revenues and made $2.56 a share. The company, then, anticipates about a 50% increase in both revenues and earnings.

The company has been on a roll for the past twelve months, gaining worldwide market share in all of its product categories: Chemical Vapor Deposition (CVD) rose 7% to 51%, Etch rose 8% to 35%, Physical Vapor Deposition (PVD) rose 6% to 56% and thermofilm and implant rose 4% to 28%. The company has just entered the booming Chemical Mechanical Planarization (CMP) market at a price-point 40% below its competition (OnTrack Systems and Integrated Process Tech), suggesting that Applied will grab sizable market share in this category as well. CMP is especially exciting since it is required for higher functionality in Central Processing Units (CPUs) like Intel's x686 Pentium Pro.

"[Applied Materials] does not believe there's any kind of significant over-investment [in wafer fabrication equipment] in the 1996-1997 time frame to fulfill memory requirements," Taylor told investors. In order to meet demand in the personal computer industry alone, for every major fab built you need six memory fabs, five DRAM fabs and one microprocessor fab. Given Intel's plans for five major fabs in the next three years, a total of 65 fabs will be required to support them. With Intel representing only two-thirds of the personal computer market, the total fabs required to meet the total demand for the decade is 98. If we consider the fact that personal computers only represent about 60% of chip consumption, the number of required fabs can jump to 164 pretty quickly. With only 42 new fabs announced so far (according to Dataquest), a significant number of new fabs will have to be forthcoming just to meet industry demands into the end of the decade. Even if the number ends up being only half of that projection, the 200 fabs currently being revamped and built throughout the world (according to Lam Research's most recent quarterly report) should make for sufficiently strong demand for semiconductor equipment makers.

According to Carl Johnson and Ron Leckie at //http:www.infras.com, a fab costs between $1.1 and $1.8 billion initially (not counting Automatic Test Equipment (ATE), ordered after the fab has been constructed). Of this price, 65% to 70% goes directly to front-end and back-end equipment. Working only with the 42 fabs currently planned, there is $30 billion in revenues already in the pipeline over the next 3-4 years for the equipment companies. If that number goes anywhere near the projected 164 fabs, $117 billion in revenues would be forthcoming by the year 2000, or about $29 billion a year. This total compares favorably to the equipment revenues as measured by Solid State Technology ($9 billion for 1995) and Dun & Bradstreet ($17.9 billion for 1995), suggesting that the 36% growth Dun & Bradstreet sees for the industry seems reasonable. These numbers assume $1.1 billion per fab and only 65% of that going toward equipment. Increase the price of fabs, add in trailing ATE revenues and increase the percentage of capital devoted to equipment and you could conceivably justify even higher numbers.

"If [the semiconductor industry] is going to be an industry growing to $300 billion or $350 billion by 2000 [from about $180 million], then continued fab investment is required and it can't be all done in one year," Taylor concluded. Applied Materials is not just talking about this stuff; they are acting decisively on it. The company plans significant capital investment totaling about 11% of next year's projected revenues as the company completes technology centers in Taiwan and Korea. To support this growth the company plans to increase the number of people it employs by 3,000 (30%).

Applied Materials is not the only company making bold moves in the face of market uncertainty. Novellus Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NVLS)") else Response.Write("(NASDAQ:NVLS)") end if %> announced a one-million-share buyback yesterday, which amounts to 6.2% of its 15.9 million outstanding shares. The company has already completed a 700,000-share buyback. Novellus makes CVD equipment, competing against the 800-pound gorilla Applied Materials in this very competitive segment. With $163 million in cash on the balance sheet and not a speck of long-term debt, it can easily afford to buy back three times as many shares. At $49 a share, the company trades at 11.5 times trailing earnings of $4.27 a share. This seems cheap for a company that has made an average of 30.5% over the past five years and is anticipated to make 29.1% over the next five. Estimates for 1996 sit at $5.89, but if they get notched up 6.2% to account for the share buyback, the figure becomes $6.25 a share, putting the current price at only 8 times forward earnings.

Fusion Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:FUSN)") else Response.Write("(NASDAQ:FUSN)") end if %> also has made bold moves recently, expanding factory capacity by 60% for its Semiconductor Systems segment. The company is moving its UV Curing Systems unit to another site and letting Semiconductor Systems take over its old space---especially gutsy considering that until this year, UV Curing represented more than 50% of Fusion's revenues. Fusion Systems makes both traditional capital equipment for curing and drying of labels and packaging as well as making semiconductor equipment. The company makes photostabilizers and ashers which are used to "mask" the circuits onto semiconductor chips by hardening the photoresist stencil, thereby increasing yield and throughput. Chip equipment that enhances yield (the number of chips you can get from a single wafer of silicon) and throughput (the volume of chips you can produce in a given time period) is exactly the kind of equipment even cash-strapped semiconductor manufacturers will buy because it will allow them to reduce raw materials costs while increasing output.

It is no surprise that Fusion is choosing now as the time to expand capacity; it has $40.4 million in cash, $66.9 million in working capital and no long-term debt on its balance sheet. Fusion, which earned $1.73 a share in the last four quarters is expected to earn $2.40 next year and grow at 21.5% over the next five years. Trading at $24 3/4 intra-day, the company is being valued at 14 times trailing earnings and 10 times next year's earnings. Although not in the lowest tier of valuations for the chip equipment stocks, Fusion is nicely diversified, with a significant portion of revenues coming from non-semiconductor companies, and thus still represents an attractive possibility.

The bear case is that these projected earnings will never materialize because the semiconductor manufactures are set to go belly-up. This makes it sound as if the semiconductor equipment industry is some "weak sister," ready to knuckle under at the slightest sign of pressure. The semiconductor equipment industry is not some bizarre, peripheral niche market in the capital equipment industry. This blossom ain't gonna wilt! The semiconductor capital equipment market is already 2.5 times the size of the traditional capital equipment market which supplies the airline, auto and machine tools industry. (This figure is courtesy of www.infras.com).

Even in Rick Whittington's worst-case scenario of flat growth for the industry, they would have ample cash to finance much of the planned expansion plus any money they managed to pull in during the period. Six of the largest chip companies in the US (Motorola, Texas Instruments, Intel Corp., Micron Tech, LSI Logic and VLSI Logic) have $6.2 billion in cash and $10.7 billion in working capital between them---enough to fund five to ten new fabs without making another dime in profit. The companies, anticipating demand into the year 2000 rather than being preoccupied with potential gullies between now and then have no reason not to expand---unless they want to be driven out of business by competition.

So why is Rick Whittington willing to stake his reputation on calling a "top" in semiconductor equipment stocks as well as "semiconductor" companies (failing to distinguish between commodity and specialty chips)? A more Machiavellian take on Whittington is that he is staking his reputation in "calling the top," knowing that the payoff for being right is incredible and the punishment for being wrong is minuscule given the sad state of accountability on the Street.

On Monday, I will finish my three part series by focusing on these so-called "specialty" chip companies. For information for this series of articles, I am indebted to MF Chips in the Motley Fool's Industry Research area (Keyword:Sector) and Carl Johnson and Ron Leckie of Infrastructure (http://www.infras.com). For more information on these topics, check out both sites.

CALENDAR: Monday's Economic Events

---Treasury Announces Results of 13- & 26-Week Bill Auction (about 1:30)

Byline: Randy Befumo (MF Templar)