Friday, January 19, 1996
MARKET CLOSE

INDEX:

I. Market News: Market Closes Out Positive Week
II. Heroes: Digital Equip, Hewlett-Packard, IBM, Computer Sci, Microsoft, Kulicke & Soffa, Teradyne, Cadence, Ross Tech, C-Cube, Octel, Desktop Data, Credit Acceptance, Boca Research, US Robotics
III. Goats: Nutrition for Life, Cephalon, Chiron, Global Village, Apple, PacTel, Micro Linear
IV. Investment Perspective: Cadence vs. Avant!
V. Calendar: Monday's Economic Events

MARKET CLOSE

DJIA: 5184.68 +60.33 (+1.18%)
S&P 500: 611.83 +3.59 (+0.59%)
NASDAQ: 1018.45 +11.21 (+1.11%)

MARKET NEWS

For the second consecutive day, Blue Chips soared, boosted by a pick-up in the technology sector. Volume was heavy today as Stock Options and Stock Index Options expired. For the week, the DJIA gained 123.56 points (+2.44%), the S&P 500 gained 10.02 points (+1.66%), and the Nasdaq tacked on 10.22 points (+1.01%)

HEROES

The return to prominence of the classic computer manufacturers commenced today, with Digital Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:DEC)") else Response.Write("(NYSE:DEC)") end if %>, Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HWP)") else Response.Write("(NYSE:HWP)") end if %> and IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IBM)") else Response.Write("(NYSE:IBM)") end if %> taking on the mantle of leadership for the flagging technology stocks after Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:INTC)") else Response.Write("(NASDAQ:INTC)") end if %> got the boot on Tuesday. Digital, which now makes red-hot network servers, was up $4 3/8 to $66 7/8 after positive press about how it is poised to post a most dramatic increase in earnings and revenues. Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HWP)") else Response.Write("(NYSE:HWP)") end if %>, dominant in peripherals, is also in the server business and a recent entrant in the heated personal computer sweepstakes. HWP rose $2 1/4 to $77 3/4 on heavy volume. IBM was buoyed $5 3/4 to $102 on the strength of yesterday's earnings report. Rumors have it that Fidelity is buying---although how this affects the fundamental business prospects of any of these companies has not been determined. Computer Sciences <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CSC)") else Response.Write("(NYSE:CSC)") end if %> was up $3 5/8 to $74 5/8 on speculation that one of the classic computer companies, Big Blue, is thinking of acquiring the computer services giant.

Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MSFT)") else Response.Write("(NASDAQ:MSFT)") end if %> delivered where Intel Corp. could not, rising $4 1/4 to $91 7/8 today after it beat estimates by 3.5%. Microsoft posted earnings of $0.87 a share, up from $0.60 in the year-ago period on strong sales of Windows95, WindowsNT and Microsoft BackOffice, its suite of business applications. Microsoft maintained its gross margins and profit margins as well as delivering to the market a reported 15.9 million copies of its new 32-bit operating systems (Windows95 and Windows NT). The business market's adoption of Windows NT over Windows95 has only helped Microsoft, as the company nets about 200% more on licensing fees for its network operating system than from its new-fangled consumer gizmo. The tactical withdrawal from proprietary online services and entertainment have only left Microsoft's image bruised, not its balance sheet.

Kulicke & Soffa <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:KLIC)") else Response.Write("(NASDAQ:KLIC)") end if %> snapped back today, moving $1 3/4 to $20 3/4 on no news. The manufacturer of die, wire and ball bonders for semiconductor manufacturers is expected to report $3.38 a share this year and $4.00 next year, leaving the battered technology company trading at five times next year's estimates. Teradyne <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:TER)") else Response.Write("(NYSE:TER)") end if %> also moved up $1 1/2 to $23 1/2 today. The manufacturer of semiconductor test equipment has been decidedly out of favor in recent weeks as scenarios about the complete and total extinction of semiconductor manufacturers (much like the dinosaurs) scared people out of stocks that had anything remotely to do with semiconductors---even killing off companies that make design software for semiconductor engineers like Cadence Design <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CDN)") else Response.Write("(NYSE:CDN)") end if %>, up $2 7/8 to $38 7/8 (and the focus of our Investment Perspective today).

Ross Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:RTEC)") else Response.Write("(NASDAQ:RTEC)") end if %> moved ahead $3 1/4 to $12 3/4 after it reported absolutely fantastic earnings, booking earnings per share (EPS) of 19 cents versus a loss of 48 cents a year ago. The company, which recently came public, has used the proceeds from its IPO to extinguish all debt and is prepared to focus on making SPARC-based workstations. Some other IPOs from last year doing well today? C-Cube Microsystems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CUBE)") else Response.Write("(NASDAQ:CUBE)") end if %>, which laughed openly at analyst estimates again, beating them by 42% and watching the stock rally $4 1/2 to $57 3/4. C-Cube makes super-cool (that's a technical term, you know) video graphics accelerator chips. Octel Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:OCTL)") else Response.Write("(NASDAQ:OCTL)") end if %> beat estimates by 10% also, pushing its stock price up $7 3/8 to $35. Octel does voice-information-processing stuff (our other technical term for the day).

A round of upgrades sent fortunate stocks higher today. Alex Brown upgraded Desktop Data <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DTOP)") else Response.Write("(NASDAQ:DTOP)") end if %> to "strong buy" from "buy." Desktop Data provides customized news over networks to "data workers." Once this news got out, Desktop Data shares rallied $4 1/2 to $24 1/2. Credit Acceptance Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CACC)") else Response.Write("(NASDAQ:CACC)") end if %> was moved from "hold" back to "buy" at Robert Baird, the analyst citing the beating the stock took recently. The stock was anything but beaten today, moving up $1 7/8 to $18 5/8. Lastly, Boca Research <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BOCI)") else Response.Write("(NASDAQ:BOCI)") end if %> got the thumbs-up from Robinson-Humphrey, which raised it to "near-term buy." Boca was up $1 5/8 to $17 7/8, partially in sympathy with competitor US Robotics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:USRX)") else Response.Write("(NASDAQ:USRX)") end if %>, which reports earnings on Monday. Boca has been down ever since the proposed merger with Hayes Microsystems was scrapped a few months back. US Robotics was up $7 1/2 to $89 1/2.

GOATS

A Wall Street Journal (WSJ) article (page B2) today revealed that one of the top recruiters for Nutrition for Life's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NFLI)") else Response.Write("(NASDAQ:NFLI)") end if %> network marketing operations has a "shady" past. Kevin Trudeau got 15,000 people to ante up $1000 each for the opportunity to be "distributors" for Nutrition for Life products. As a distributor, these individuals would attempt to secure their fortunes by foisting Nutrition for Life products on their friends and relatives, as well as convincing anyone they could corner to become distributors themselves, getting a fixed percentage of anything they sell. Nutrition for Life, which has been around in various forms for 10 years, sells everything from nutrition supplements to the Mega-Memory set of tapes. Trudeau has done time for writing bad checks, falsifying credit applications, posing as a physician to bank officials and misappropriating the credit cards of people who bought his Mega-Memory home study course. There have been no accusations of wrong-doing at Nutrition for Life, but investors, stung by any hint of impropriety, dove out of the shares today. Nutrition for Life was down $15 7/8 to $19 1/8 while the warrants <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NFLIW)") else Response.Write("(NASDAQ:NFLIW)") end if %> slumped a whopping $13 3/4 to $16, a lesson to people who love leverage.

Cephalon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CEPH)") else Response.Write("(NASDAQ:CEPH)") end if %> got munched for $12 1/2 today, falling back to $23 3/8 after the Food & Drug Administration (FDA) declined to permit expanded tests of its much-touted treatment for Lou Gherig's disease. Cephalon and its marketing partner Chiron <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CHIR)") else Response.Write("(NASDAQ:CHIR)") end if %> have agreed to hold additional discussions with the FDA about whether the incoming data from the European trial supports the positive results found in the North American study of Myotrophin. Lou Gherig's disease, otherwise known as amyotrophic lateral sclerosis (ALS), afflicts thousands of individuals worldwide, including world-renowned physicist Stephen Hawkings. Chiron was down $5 1/2 to $104 on the news as well.

Global Village <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:GVIL)") else Response.Write("(NASDAQ:GVIL)") end if %> continued to plummet in the wake of escalating problems at Apple Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AAPL)") else Response.Write("(NASDAQ:AAPL)") end if %>. Global Village, which gets 85% of its revenues from networking and connectivity products for Macintosh platforms, was off $2 5/8 to $12 1/8 after being pushed as high as $22 last month amid the Internet frenzy. Although the problems at Apple Computer are serious, the company has an ample cash hoard and is not going out of business anytime soon. While Macintosh networking and connectivity products are not a huge market, they are a solid niche market that allows Global Village to maintain generous margins. Global Village recently reported earnings of $0.21 a share versus $0.12 in the year-ago period, 2 cents above consensus expectations. With estimates of $1.00 for next year and estimated growth in the 30% range for the next five years, Global Village is getting back to bargain basement prices. Apple Computer, for its part in this sorry story, was off $2 1/16 to $29 7/8 today, reflecting growing pessimism about a potential buy-out.

PaineWebber analyst Richard Klugman downgraded shares of Pacific Telesis <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:PAC)") else Response.Write("(NYSE:PAC)") end if %> to "unattractive" from "neutral" today, plunging shares of the Baby Bell down $2 5/8 to $29 7/8. Klugman cut his fiscal 1996 estimates to $2.48 a share from $2.50 and more importantly, slashed his 1997 numbers from $2.54 to $2.30. Income investors, attracted by the stock's 7%-plus yield, had pushed the shares to a 52-week high recently. Pacific Telesis has long been the slowest-growing, highest-yielding of the Baby Bells.

Tensions are running high for semiconductor companies these days; the slightest blemish on the balance sheet and all hell breaks loose. Micro Linear <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MLIN)") else Response.Write("(NASDAQ:MLIN)") end if %> was smashed, down $3 3/8 to $7 3/8, after Robertson Stephens analyst Dan Klesken cut his rating and estimates on the stock. Klesken, preoccupied by a lack of visibility when it comes to future revenues, cut the stock to "long-term attractive" from "buy" and reduced his 1996 expectations to $0.75 a share from $0.97. Micro Linear's backlog was lower than in prior quarters and order rates have been slowing, Klesken maintained. Montgomery Securities analyst Tommy Thornhill disagreed, however, calling today's sell-off an overreaction.

INVESTMENT PERSPECTIVE: Semiconductor Simulation and Design Automation Software

Part One of Two---Cadence vs. Avant!

When Fools talk about industries, they are talking about groups of companies which manufacture, market or provide the same broad product line or service. Industries are useful because they allow investors to make apples-to-apples comparisons between companies in the same general business category. An industry can contain hundreds of individual companies competing in a variety of well-defined niches. Within these niches, it often pays for a Fool to do thorough analysis of each company, both public and private, get market share data, and then look for the most compelling values.

Occasionally there are small groups of companies that float between industries. Not full-blown industries in and of themselves, they are actually hybrids---grounded in one line of business but absolutely dependent on demand from another industry. An example of a "cluster" like this is the five publicly traded companies that provide simulation and electronic design automation (EDA) software to semiconductor manufacturers.

As semiconductor chips have become more complex with smaller geometries, it has become more important for the engineers who build these chips to do so with the assistance of highly specialized design and development tools. Unlike classic software houses though, these companies actually trade more like semiconductor equipment stocks because they provide one form of "semiconductor equipment."

The five companies that I am aware of are Avant! <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AVNT)") else Response.Write("(NASDAQ:AVNT)") end if %>, Cadence Design Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CDN)") else Response.Write("(NYSE:CDN)") end if %>, Epic Design Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:EPIC)") else Response.Write("(NASDAQ:EPIC)") end if %>, IKOS Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:IKOS)") else Response.Write("(NASDAQ:IKOS)") end if %> and Synopsys <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SNPS)") else Response.Write("(NASDAQ:SNPS)") end if %>. As of last week, almost all of these companies were trading at compelling valuations relative to their growth, having sold off recently on other semiconductor-related concerns. Because these companies are stranded between two industries, they are pushed about for reasons that do not reflect directly on their company-specific business concerns, but rather, worries from the broader market about the supposed impending semiconductor and technology crash. The Street's panic has created some interesting opportunities.

The two highest-profile companies in this group are Cadence Design and Avant!, mainly because of the nasty legal battle these two competitors are locked in right now. Cadence Design (http://www.cadence.com) is the 800-pound gorilla of the industry, with $506.3 million in trailing revenues and $1.18 in 12-month trailing earnings per share. Cadence was the result of the merger of ECAD and SDA Systems in 1988 and is currently the world's largest supplier of EDA software. The company has been quite acquisitive, with at least five major buy-outs in the last seven years.

As the largest and best known EDA provider in the industry, Cadence is the most richly valued in the group. At $36, the stock trades at 31 times earnings with a long-term estimated growth rate of 20.3%. With estimates at $1.28 a share for FY 96 and $1.62 for FY 97, the company has a PEG ratio of 1.06 and a YPEG ratio of 1.10---a pretty fair value. With $125 million in cash, but only $20 million in working capital and $8 million in long term debt, the only reason the shares could be considered compelling now is because Cadence has beaten estimates by more than 12% each of the last two quarters and might be willing to take on some long-term debt in order to make another acquisition. Profit margins are currently running at 14% and book value is somewhere around $2 a share, according to Zacks.

Cadence is a maturing company that derives a growing portion of its revenues from servicing and maintaining its products rather than simply selling them. In fiscal 1994, Cadence brought in 37% of its $429.1 million in revenues from maintenance and 63% came from product sales. The company took its eye off the ball in 1993 but has been riding high ever since (if you overlook the recent 33% correction where it sold off in sympathy with the semiconductors). According to Dataquest, Cadence currently commands 41% of the $60 million semiconductor-design software market---down from 56% only three years ago. The reason Cadence's trailing revenues are substantially larger than the size of the market is because many of its products are targeted at electronics systems and not semiconductor design.

Cadence is probably best know these days because of its ongoing legal battle with its competitor, Avant!. Avant! was founded when ArcSys bought out Integrated Silicon Systems last year, only a few months after it went public. ArcSys itself was started by a group of ex-Cadence employees. The combined company only started to trade in June of last year when the merger went through, making most of the basic information about the company (like trailing earnings per share (EPS) and cash flow) difficult to find.

When Avant! was beset by a lawsuit from its foe, Cadence Design, the shares of the company crashed in a week-long disaster that left many shareholders bloodied. The lawsuit alleges that Avant! software contains proprietary code stolen from Cadence Design by former employees who later went to work for Avant!. Cadence says that an ex-Cadence consultant, Mitsuru Igusa, currently free on bail, was hired by Avant! and provided the suspect code. Avant! denies that they hired Igusa at all and contends that the allegations are a "smoke screen" because Cadence "cannot compete." Avant!'s market share has gone from 1% to 7.5% in the past three years, suggesting that, whether it has stolen code or not, it has stolen some of Cadence's lost market share.

The real story with Avant! is the pummeling by the December storm that hit the West coast. The violent squall took out its phones and sparked a rumor that the company received an injunction against operating until the suit was cleared up. This rumor spiraled into another that the company was actually going out of business and the share price crumbled 60% in that week alone.

I got a chance to trade e-mail with the director of Investor Relations at Avant! before the Christmas holiday to get their side of the story. The first thing I got was the real financial statements for Avant! This was especially helpful since most of what I have seen in Zacks and Daily Graphs did not jibe with each other. Avant! currently has $33.3 million in trailing revenues and $0.44 in trailing EPS. The company has 15.8 million shares, putting its market cap at $229 million. Only 8.5 million of those shares actively trade, however; the remainder are closely held by "insiders." Avant! has no long-term debt and is currently cash-flow positive. Their profit margins are roughly 20%---generous even for a software house.

The specifics of the lawsuit are difficult for non-technical Fools to grasp, but the important questions for investors are what products are in question and will this potentially drive Avant! out of business. Avant! currently sells ArcCell, ArcCell-XO (recently released), ArcGate, VeriCheck, LTL, and some six other products. All but VeriCheck, which is a hierarchical verification program, compete directly with Cadence's offerings. (Cadence does not offer a hierarchical verification product.) Verification is a group of software programs that "check" the artwork or layout of a planned chip. Hierarchical verification allow the verification process to run faster, with much less computer memory, than with "flat" verification tools.

VeriCheck brings in over half of Avant!'s total revenues and is not part of the lawsuit. So, even if some of its products fall under an injunction, Avant! can still continue to book solid revenues and is in no danger of being driven out of business. Avant! announced that it had booked $3 million in orders in December, in spite of the lawsuit---10% of their trailing revenues.

Despite these positive notes, there are still some unanswered questions vis a vis the lawsuit that are dragging the stock price down. Lois DuBois of Avant! wrote, "No one has refused to buy our products because they were 'too similar to Cadence's.'" This is contrary, however, to an article printed in the San Francisco Chronicle which suggested that T.J. Rodgers of Cypress Semiconductor <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CY)") else Response.Write("(NYSE:CY)") end if %> did just that. Rodgers was told by a vice-president at Cadence that Avant! was using Cadence code and reportedly had his own people verify this. Cypress, however, has refused to confirm this story. DuBois maintains that Avant!'s "customers [will] see through the Cadence smoke screen and fully support our current products as well as the new ones we are developing." The truth is for the courts to decide.

Given the uncertainty surrounding the shares, it is not a complete surprise that they have fallen from a high of $51. The recent insider sales of 55,000 shares, right when the suit was announced during the worst selling, have done nothing to assuage market fears. At $14 1/8, however, given that over half of its revenue stream is completely free from the dreaded long-shot injunction, the shares trading at 34 times trailing earnings with a long-term growth rate of 41.7% present a nice opportunity---provided the suit doesn't put them out of business. That's doubtful, but one never knows. The PEG ratio is 0.74 and the YPEG ratio is 0.35, confirming that the company trades at a significant discount to Cadence. The cloud hanging over the stock, however, makes it tough to pin your hopes on it.

On Monday: Part II, with Synopsys, IKOS Systems and Epic Design Tech

Starting Tuesday: "The Digital World," a multi-part series on the "Internet."

CALENDAR: Monday's Economic Events

---November Wholesale Trade (9:00), tentative
---Treasury announces results of 13- & 26-Week Bill Auction (about 1:30)

Byline: Randy Befumo (MF Templar)