Monday, January 22, 1996
MARKET CLOSE

INDEX:

I. Market News: Dow Surges Ahead in Late Trading
II. Heroes: Woolworth, Harley Davidson, FSI Int'l, Silicon Valley Group, Tencor, Netscape, Verifone, America Online, Caterpillar, Nutrition for Life, SCI Systems, Zycon
III. Goats: First Alert, Alliance Entertainment, FSH Financial, Agouron Pharmaceuticals
IV. Investment Perspective: Synopsys, Epic and IKOS
V. Calendar: Tuesday's Economic Events

MARKET CLOSE

DJIA: 5219.36 +34.68 (+0.67%) --- RECORD
S&P 500: 613.40 +1.57 (+0.26%)
NASDAQ: 1029.44 +10.99 (+1.08%)

MARKET NEWS

Despite a weak day in the bond market as fears of more budget fighting make traders wary, the Dow climbed higher in late-afternoon buying, setting a new all-time closing high. Technology stocks also posted impressive gains on the backs of big moves for the Internet players.

HEROES

Woolworth <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:Z)") else Response.Write("(NYSE:Z)") end if %> rebounded $1 1/4 to $11 1/8 today after one of its largest shareholders, Greenway Partners, suggested that the ailing retailer spin off its Athletic Footwear and Apparel divisions. The company said that it would mull over the proposal, which would put Foot Locker, Northern Reflections, After Thoughts and Champs Sports out on their own as a single, publicly traded company. Investors have been saying for months that a spin-off of the Foot Locker division alone would allow shareholders to realize the intrinsic value of the tattered Dow stock.

Harley Davidson <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HDI)") else Response.Write("(NYSE:HDI)") end if %> is unloading its cash-draining Holiday Rambler unit, causing the shares to rally $3 3/8 to $30 1/4. The motor coach unit has long been a drag on Harley Davidson's earnings and, along with Harley's licensing and merchandise division, caused its last earnings disappointment. Monaco Coach Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MCCO)") else Response.Write("(NASDAQ:MCCO)") end if %> will acquire most of the unit for $50 in cash, stock, notes and baseball cards. Harley Davidson is the lone American motorcycle company with a cult-like following. Investors who like Harley but think that it a little pricey might want to check out Custom Chrome <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CSTM)") else Response.Write("(NASDAQ:CSTM)") end if %>, which makes shiny muffler pipes for Harley hogs.

Semiconductor equipment stocks dotted the list of winners today as the group continues to retrace massive losses from the recent sell-off. FSI International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:FSII)") else Response.Write("(NASDAQ:FSII)") end if %> surged $2 9/16 to $15 3/4 when it got $25 million in new orders for its Chemical Management products. These orders include new business from Japan as well as repeat business in the U.S., Europe and Far East. Silicon Valley Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SVGI)") else Response.Write("(NASDAQ:SVGI)") end if %>, which competes with FSI International in some business segments, rose $3 3/8 to $23 1/4, possibly in sympathy with FSI's news. However, the entire group staged a rally today and it might not have not been at all. For instance, semiconductor factory automator and wafer inspector Tencor Instruments <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:TNCR)") else Response.Write("(NASDAQ:TNCR)") end if %> surged $3 3/8 to $23 7/8 on heavy volume on no news.

Netscape Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NSCP)") else Response.Write("(NASDAQ:NSCP)") end if %> made a massive move today, up $16 3/8 to $161 on the strength of two unrelated deals in the works. Netscape announced today that credit-card processor Verifone <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:VFI)") else Response.Write("(NYSE:VFI)") end if %> would become a reseller of Netscape's software as part of an agreement to develop "Internet payment solutions." The two companies are reportedly working on software that would provide secure transactions over the Internet. Verifone was up $4 3/4 to $31 1/2 for its part. In unrelated news, America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AMER)") else Response.Write("(NASDAQ:AMER)") end if %> was up $4 1/4 to $39 1/4 after news got out that it was in discussions with Netscape to team-up and smash Microsoft. Netscape has been under some pressure from Microsoft lately as Microsoft's Internet Explorer browser has grabbed about 25% of the browser market. A combination of America Online and Netscape's software savvy would present a real challenge to Microsoft, which has been criticized for lacking an "Internet strategy."

Some stories from Friday continue to affect two stocks today. Caterpillar's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CAT)") else Response.Write("(NYSE:CAT)") end if %> surprising earnings and news of an order from Russia caused the blue-chip manufacturer of heavy machinery to get bid up $3 3/4 to $62 3/4. Nutrition For Life <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NFLI)") else Response.Write("(NASDAQ:NFLI)") end if %> recovered $6 3/8 to $25 1/2 after Friday's rout following a negative Wall Street Journal article. Was this rally driven by happy users of Kevin Trudeau's Mega-Memory system or merely the belief that the time has come for a network marketing vitamin supplement maker---Amway for the 90s? Having not been a big fan of Amway in the 80s, we refrain from comment---sort of.

Stellar earnings news caused shares of subcontractors for the computer industry to go nuts today. SCI Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SCIS)") else Response.Write("(NASDAQ:SCIS)") end if %> rocketed ahead $5 5/8 to $34 1/4 after it beat consensus estimates by 34.5%, bringing in $0.74 a share in its fiscal fourth quarter. Zycon Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ZCON)") else Response.Write("(NASDAQ:ZCON)") end if %> rose $3 7/8 to $14 after the company said it estimated it would make between $0.38 to $0.39 versus $0.12 in the year-ago period---a full 40% above consensus estimates. The success of both of these contract manufacturers hints that there is underlying strength in the technology sector.

GOATS

First Alert <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ALRT)") else Response.Write("(NASDAQ:ALRT)") end if %> announced over the weekend that it would not meet Wall Street consensus estimates for its fiscal fourth quarter, causing the shares to implode, down $2 1/8 to $9 1/4. The maker of home safety products has had difficulty matching last year's sales of carbon monoxide detectors, driven by the much-publicized death of tennis star Vitas Gerulaitis due to carbon monoxide fumes. Pricing pressure driven by close-outs of old carbon monoxide detectors has caused margins to fray and the company predicts a break-even quarter. Investors might want to take a look at this franchise on home safety products in the midst of a one-time disaster.

PaineWebber dealt a blow to Alliance Entertainment Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CDS)") else Response.Write("(NYSE:CDS)") end if %> today, causing it to sell off $1 1/4 to $8 1/8. The analyst cut his rating to "attractive" from "buy," citing weak sales and "disarray in the music business." The planned merger between Alliance Entertainment and Metromedia International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MMG)") else Response.Write("(NYSE:MMG)") end if %> also caused the PaineWebber analyst to take another look at the company's valuation, given that it is a stock-for-stock deal and Metromedia has been down in recent weeks. For its part, Metromedia was down $1/4 to $11 7/8.

Disappointing earnings at FSH Financial <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:FFHH)") else Response.Write("(NASDAQ:FFHH)") end if %> dragged the shares down $1 1/8 to $12 3/8 today. The company posted earnings of $0.11 a share versus operating net of $0.17 in the same period last year. Relatively high provisions for loan losses suggest that this Minnesota-based bank might be overextended.

Agouron Pharmaceuticals <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AGPH)") else Response.Write("(NASDAQ:AGPH)") end if %> slumped $4 to $38 3/4 today after the company's AIDS drug was rejected by a major medical conference. The company found out about the rejection Friday evening and sent a letter around to the analysts who follow the stock. The conference had the forbidding title of "Third Conference on RetroViruses and Opportunistic Infections." The company was rejected not because of the scientific data to support its drug, but because it did not comply with the conference's criteria for "late-breaking studies." It was enough to scare some investors out of the stock, though.

INVESTMENT PERSPECTIVE: Semiconductor Simulation and Design Automation Software

Part Two of Two---Synopsys, Epic and IKOS

[Ya gotta love the online medium. Virtually minutes after my story Friday about software makers who specialize in systems that design semiconductors, e-mail flooded my box about the fact I was forgetting two of the players in the industry. Although I could not revise my story over the weekend, I wanted to alert you all that Mentor Graphics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MENT)") else Response.Write("(NASDAQ:MENT)") end if %> and Viewlogic <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:VIEW)") else Response.Write("(NASDAQ:VIEW)") end if %> are major players in the industry, with Mentor holding the number one or two spot and Viewlogic easily in the top five. Investors who want to explore these stocks should include these two in the group when they do and know that I will be crunching numbers on them myself. Thanks to MF Chips, Russell638, and Ywchern, among others, for the quick feedback. Rest assured, I will be returning to this subject again in the future and will be glad to include your feedback.]

Friday, we gave a basic description of the "semiconductor software" industry and highlighted the two highest-profile companies in the industry, 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 %>. Today we cover three more companies in the industry whose only recent news has been better-than-expected earnings.

Synopsys <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SNPS)") else Response.Write("(NASDAQ:SNPS)") end if %> creates similar products to Avant! and Cadence Design, focusing on electronic design automation (EDA) products for semiconductor engineers. The company's strong suit is its high-level design automation (HLDA) software, which does everything from synthesizing the chips to simulating and testing them.

Synopsys has been just as acquisitive as Cadence Design, with six major acquisitions in the past three years. This has boosted its trailing twelve-month revenues to $283 million and allowed it to maintain a 67% compound revenue growth since 1987---not too shabby. The stock has done pretty well also, returning an average of 31.1% over the past three years.

Synopsys recently reported earnings of $0.28 a share, a 40% increase over a year ago on a 31% increase in revenues. Recurring service revenues---an annuity attached to the product sales---ran 31%. Overall gross margins were a mind-numbing 89%, flat with the same quarter a year ago. Profit margins were 14.7%, up from 13% in the year-ago period, mostly on increases in "other income" and slight decreases in Sales/Marketing and General/Administrative costs as a portion of revenues.

Prudential analyst Laura Conigliaro was not quite as sanguine about the results though, as she downgraded Synopsys to "hold" from "buy" after the report. Her reasoning is that there are a "few cracks" in the quarterly report; they must have been pretty fine, though, as we could not find them. Even despite Synopsys's high backlog, the Intel imbroglio and "nervousness about PC demand and its repercussions for the semiconductor industry" will cause the stock to be more volatile. Of course, this description could fit the reported earnings of any technology company, so we take it with a grain of salt. (This downgrade was enough to kick the stock in the teeth, though, taking it down four points. One wonders what would have happened if Ms. Conigliaro had not been so vague.)

The stock does look fully valued, though, trading at 31 times earnings with a 31.5% estimated growth rate over the next five years. Pushing it out a little, though, if Synopsys can make its estimated $1.20 this year and its $1.55 next year, and maintain the same multiple, it could be a $37 stock this year and a $48 stock next. Keeping in mind the nasty recent volatility, however, it might be one to watch rather than one to run out and buy right now.

Epic Design Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:EPIC)") else Response.Write("(NASDAQ:EPIC)") end if %> is another one of the volatile semiconductor software stocks, having pushed up $4 or so recently when it reported estimate-busting earnings of $0.14 a share. A niche player, Epic develops simulation and analysis software that helps integrated circuit designers manage timing and power characteristics. Epic only has 11 million shares outstanding, making its $272 million market cap small potatoes compared to Synopsys's $1.09 billion market value.

Earnings have gone from $0.07 to $0.09 to $0.11 to $0.14 a share over the last four quarters, for consecutive increases of 28.5%, 22.2%, and 17%. There are no solid numbers for the stock, but based on the long-term growth rate of 41% and the fact that the company was a quarter ahead of previous projections, $0.62 for this year and $0.88 for next year seem reasonable. Even with those aggressive numbers, though, the stock has a PEG of 1.10 and a YPEG of 0.66, making it as risky as Synopsys.

So what is there to buy in this segment that isn't either incredibly volatile and has a lawsuit hanging over its head? IKOS Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:IKOS)") else Response.Write("(NASDAQ:IKOS)") end if %> would come the closest to fitting that bill. IKOS manufactures logic-simulation software and related hardware with some EDA applications for semiconductors. IKOS's logic simulation allows electronics designers to "simulate electronic circuitry, and to test that circuitry for design flaws before going to the trouble and expense of making a prototype." The company also makes products for designers of computers, communication equipment and consumer goods.

IKOS's products have market acceptance, given the fact that it has received two $5 million orders for EDA products in the last two quarters. Given that revenues for the last quarter reported were only $9.3 million, these orders represent a lot of business. Only 18% of IKOS's revenues currently come from maintenance and service, an area that is bound to increase as the company gets a larger installed base. Gross margins are impressive at 77%, compared to 73% in the year-ago period. Profit margins have almost doubled, from 7.8% to 15.2% in the last period reported on a revenue increase of 51% and an EPS increase of 125%.

The company has consistently come in above generous estimates, reporting $0.12, $0.14, $0.17 and $0.18a share in the last four quarters. At $10 5/8, the shares trade at the bargain basement valuation of 17 times earnings, having traded as low as 14 times earnings last week. The company has a 40% long-term growth estimate, a PEG of 0.42 and a YPEG of 0.21 based on its estimates of $0.71 for this year and $1.01 for next year. The stock trades at 10 times next year's earnings and grew earnings at a rate of 125% last quarter with a full quarter's revenue for EDA products pending.

Despite the lofty valuations of some of these companies, the valuations are the lowest they have been in months. This is not to say they cannot get lower, but rather to say that these high-margin, high-growth companies have been thrown in the dumpster along with everything resembling semiconductor chips. The prospects of the "semiconductor software" companies have been viewed by the Street through the dimmest of lenses and it would appear for many of them there are better days coming. Companies that compete in such a limited and growing market can maintain a return on equity over the next few years that would probably make a Fool smile.

TOMORROW: "The Digital World," our next multi-parter on the "Internet."

CALENDAR: Tuesday's Economic Events

---October-December Personal Income & Outlays (8:30)
---Mitsubishi Bank & Schroder Wertheim Weekly US Chain-Store Sales (9:00)
---Treasury auctions $18.25 bln in 2-Year Notes (about 1:30)
---Treasury announces size of 13- & 26-Week Bills (2:30)
---Johnson Redbook Weekly Survey of US Retail Sales (2:55)
---American Petroleum Institute's Weekly US Oil Statistics (after 4:00)
---President Bill Clinton delivers annual State of the Union to Congress (9:00)

Byline: Randy Befumo (MF Templar)