Monday, January 29, 1996
MARKET CLOSE

INDEX:

I. Market News: Blue Chip Buying Ahead of FOMC Meeting
II. Heroes: Loewen Group, Echostar, Kulicke & Soffa, Medicis, Sterling Chem, Cholestech
III. Goats: Peak Tech, Smith's Food & Drug, Aldila, Mattson Tech
IV. Investment Perspective: The Digital World---Part Five
V. Calendar: Tuesday's Economic Events

MARKET CLOSE

DJIA: 5304.98 +33.23 (+0.63%) -- RECORD
S&P 500: 624.22 +2.60 (+0.42%) -- RECORD
NASDAQ: 1042.51 +1.55 (+0.15%)

MARKET NEWS

With the Federal Reserve's Open Market Committee meeting tomorrow and Wednesday, traders are speculating that we may get another cut in short-term interest rates because of the weak economic data trickling out of Washington. Fools can't predict these things, of course, but it sure gives us something to say other than, "hey, the market went up today." Oh yeah. . . Hey, the market went up today.

HEROES

Loewen Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LWNGF)") else Response.Write("(NASDAQ:LWNGF)") end if %> got a reprieve a little sooner than anyone imagined when Jerry O'Keefe agreed to $150 million in damages for a merger deal gone wrong, as opposed to the $500 million that a Mississippi jury wanted Loewen to give him. This removed the specter of bankruptcy from over Loewen's head, causing the stock to surge $8 1/2 to $29 after it crashed last week about the same amount. O'Keefe gets $50 million up front, 1.5 million shares of Loewen stock valued at $30 a share and $4 million a year for the next thirty years in the settlement. Loewen, one of the major world-wide players in the deathcare market---funeral homes and cemeteries---grows by gobbling up smaller competitors. We suggested that the fears of bankruptcy were overdone given what happened when Texaco got caught in a similar predicament in the 80s, but were just as surprised as anyone else by today's turnaround.

Recommendations boosted a number of stocks today! Echostar <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DISH)") else Response.Write("(NASDAQ:DISH)") end if %> got pushed up $7 to $32 1/2 when Unterberg Harris analyst Robert Kaimowitz raised it to a "strong buy" from "buy." Because MCI and Telecommunications Inc. have been denied the right to send up their own satellites, Echostar remains the only game in town. On a more local note, MF Boring's recommendation of Kulicke and Soffa <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:KLIC)") else Response.Write("(NASDAQ:KLIC)") end if %> helped it to move up $1 3/8 to $23 5/8 in a down day for chip and chip-related stocks. Medicis Pharmaceutical <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MDRX)") else Response.Write("(NASDAQ:MDRX)") end if %> also got a boost of $2 9/16 to $28 1/8 after the Fool Portfolio announced it was gonna acquire some shares of "the dermatology company." Check the Hall of Portfolios for details on these two transactions. Did the Fools get it cheap or dear?

An ailing chairman and a weakening earnings trend caused Sterling Chemical <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:STX)") else Response.Write("(NYSE:STX)") end if %> to consider putting itself up for sale, a fact which caused the stock to gain $3 1/4 to $12 1/2 today. Exploring those ol' strategic alternatives to "enhance shareholder value," the news drove speculators to acquire the stock in hopes of a buyout at a higher price. Sterling makes, among other commodity chemicals, styrene, a key ingredient in Styrofoam. The company has been involved in a three-year expansion program to boost long-term earnings by lowering costs, but anxious investors cannot wait a whole two years for the process to be finished, preferring their big payoff now.

Cholestech Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CTEC)") else Response.Write("(NASDAQ:CTEC)") end if %> jumped $1 5/16 to $4 9/16 after the Center for Disease Control granted the company a regulatory waiver for its flagship LDX System, a blood analyzer. This move allows all sorts of clinics, physician groups and hospitals to use the device without the onerous regulatory burdens that were begun in 1992. Cholestech's machine measures blood cholesterol (surprise), triglycerides and glucose levels. The problem with the regulations is that the LDX System was created for small practices, but because of the 1992 FDA ruling regarding all hospital and lab equipment, it costs an amazing $2000 a year just to test it for accuracy. This represents a sea change from the time when venture capitalists bailed out of the company because its entire market disappeared.

GOATS

Peak Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PEAK)") else Response.Write("(NASDAQ:PEAK)") end if %> fell hard from its perch today, losing $7 3/4 to close at $22 3/4. The problem? An analyst at Brean Murray Foster indicated that he thought the company would come in a few cents below his estimate of $0.34 a share for the current quarter. One of Peak's major customers, Norand Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NRNDE)") else Response.Write("(NASDAQ:NRNDE)") end if %>, has imploded recently because of all sorts of problems with fraud and mismanagement at its European division. Peak uses radio frequency equipment made by Norand to build its bar code readers and has had difficulty getting components out of the ailing technology giant. Peak's CEO maintained that this is a one-time development but the market's anxiety about anything related to Norand apparently got the better of it today.

Smith's Food and Drug <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SFD)") else Response.Write("(NYSE:SFD)") end if %> was dealt a harsh blow by Moody's today when it put their debt on review for possible downgrade pending their merger with Smitty's SuperValu. Down $3 5/8 to $26 1/2, investors were concerned that any downgrade would increase the cost of capital for Smith's enough to throw off its cash flow. With monster megacorp Wal-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:WMT)") else Response.Write("(NYSE:WMT)") end if %> slipping into the supermarket game from its position as a dominant U.S. retailer, the stakes are getting higher in the once-conservative grocery business. The disasters that have afflicted Wal-Mart's competitors like Caldor and KMart could easily transfer to some of the weaker grocery chains.

Golf equipment maker Aldila <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ALDA)") else Response.Write("(NASDAQ:ALDA)") end if %> got the shaft today when Merrill Lynch downgraded the stock. Down $1 7/16 to $5 3/8, the optimism that someone will buy out the once-exclusive supplier to Callaway Golf <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:ELY)") else Response.Write("(NYSE:ELY)") end if %> dims by the day. Aldila was crunched last year when Callaway decided that it would seek other vendors for the shafts for its Big Bertha clubs, once all the rage. Callaway itself has not done all that well recently as the trendy sports and leisure market has turned cold on it.

The downgrade by Hambrecht and Quist last Friday of Mattson Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MTSN)") else Response.Write("(NASDAQ:MTSN)") end if %> made these shares all the more vulnerable to today's most recent bout of semiconductor hysteria. Down $1 3/4 to $11 3/4, the manufacturer of photoresist strip equipment recently beat its earnings numbers by about 20%. This guy gets hit particularly hard when people turn bearish on Micron Technology, as Micron is big customer for Mattson's equipment. The gang at Infrastructure (www.infras.com), a website that concentrates on semiconductor and semiconductor equipment stocks, has plenty positive to say about Mattson, citing the Hambrecht and Quist downgrade as lunacy. Check for more details in the Semiconductor area in Industry Research (Keyword:Sector); we have set up a nifty set of Weblinks to take you right there.

INVESTMENT PERSPECTIVE: The Digital World---Online Service Providers (OSPs)

Part V: OSPs---Mostly a Bunch of Losers

The World Wide Web domination of the digital world is a recent story, dating back only a few months. Long before most investing cognoscenti even knew that the Web existed, they were completely preoccupied with real and perceived competition between the Online Service Providers (OSPs). This was the core theme of most research written about the Internet before the summer of 1995, and it is these players that the Street is most familiar with, for better or worse. If you step back and examine the abject failures most of these OSPs have been, the disproportionate amount of coverage from the Street seems laughable.

In short, an Online Service Provider differs from an Internet Service Provider (ISP) in that an OSP allows one to access a private, closed network which is completely proprietary. ISPs simply grant one access to the open network that is the World Wide Web. No matter what ISP one hooks up to, the same stuff is available. In contrast, the choice of OSPs radically alters the menu of available content. To check out the Motley Fool at its most interactive, you have to plunk down the $10 a month for America Online. You cannot get the same, dynamic content out on the Web and you definitely will not hear any belled caps jingling over on the Prodigy MoneyTalk boards.

There are seven main OSPs that try to serve as one-stop solutions for all of your online needs, with varying degrees of success: America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AMER)") else Response.Write("(NASDAQ:AMER)") end if %>, Prodigy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:S/NYSE:IBM)") else Response.Write("(NYSE:S/NYSE:IBM)") end if %>, CompuServe <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HRB)") else Response.Write("(NYSE:HRB)") end if %>, Microsoft Network <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MSFT)") else Response.Write("(NASDAQ:MSFT)") end if %>, e*world <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AAPL)") else Response.Write("(NASDAQ:AAPL)") end if %>, GEnie <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:GE until recently)") else Response.Write("(NYSE:GE until recently)") end if %> and beleaguered Delphi <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DLPH)") else Response.Write("(NASDAQ:DLPH)") end if %>. Beyond these, there are literally dozens of other online services that "narrowcast," that is, focus on one specific group of users, as opposed to "broadcast" which tries to appeal to everyone. Westlaw and Lexis/Nexis, for instance, are the twin terrors of legal information online. AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:T)") else Response.Write("(NYSE:T)") end if %> has experimented with a business service called Interchange, and Dow Jones <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:DJ)") else Response.Write("(NYSE:DJ)") end if %> has its Dow Jones News Retrieval, one of the primary research sources yours truly uses to write the News. It would be difficult to count the total number of exclusive online services available today.

Almost every major company has dabbled with starting some kind of online service because of the real and imagined synergies between their core businesses and an online business. The transforming character of the digital world, as I argued in the first two installments of this series, is that it offers a radical departure from conventional methods of distribution and interaction. Going digital destroys the distance between company and client; consumers can suddenly "visit" retail sites they couldn't get to physically, or bank conveniently at a location a thousand miles away. The downside of the radical character of the digital world is that most conventional companies have either gotten the synergies completely wrong or have choked somewhere along the way by not responding quickly enough to the rapidly evolving marketplace.

America Online is the reigning champion in the OSP world. AOL has five million users who have been online for more than 45 days and this number is accelerating at a rate of 300,000 a month. Although probably the most compelling of the group, I am going to skip over America Online for the most part today as I plan to focus in depth on this complex and misunderstood company in tomorrow's installment of the Digital World. Suffice it to say that America Online offers one of the largest and most diverse OSP products out there, based primarily on the Windows platform with a disproportionately high number of Macintosh users (about 20%)---something you couldn't tell given the priority they have put on developing a Web Browser for the Mac. Although it has many warts, America Online is what a lot of the other networks I am going to describe today are not---a success. America Online, more than any other OSP, has remained flexible, mainly because the company itself is youthful and a late arrival to the big game.

Remember back in late 1994 when it was CompuServe versus America Online? CompuServe, the service you barely hear about anymore, was once the largest online service in the world. It still boasts the most significant number of international users, with one million of its four million members logging on from Europe or Japan. This H.R. Block OSP was launched with two goals in mind, to diversify H.R. Block's core business so that the yearly fluctuation of tax return revenue would not be so dramatic, and to somehow link up Block Financial Services resources with online distribution. CompuServe suffers from an antiquated pricing system, though. Depending on what area a user logs into, the pricing structure changes. The equivalent would be if your cable company started to charge you an hourly rate, with the rate set at different prices for different channels. VH-1 might be 50 cents an hour while ABC was only a dine an hour. The user is forever wondering what kind of bill she's facing each month until the unpleasant news shows up in the mailbox. What? You mean it costs three times as much to watch Friends as it does to watch Masterpiece Theatre?

CompuServe has been out of the limelight for a while lately, with the shares of H.R. Block beaten up in the last year or so. In a market characterized by raging hysteria for anything "online," Block has hung close to its 52-week low. Part of that is the fault of the tax service side, as the lucrative refund anticipation loans it used to push got quashed by the IRS after they were found to be misleading. The other reason is that CompuServe has maintained its idiotic pricing structure in the face of a marketplace moving towards a low and flat-fee pricing scheme. CompuServe's growth has flagged to roughly 100,000 new accounts a month compared to AOL's 300,000, and talk has been that its prices must come down---two things making it hard to be optimistic about its prospects.

CompuServe is set to debut its Wow! service that would have a more "intuitive" interface than CompuServe currently offers. They would be much better off offering a more intuitive pricing scheme on their existing service as far as the market is concerned. Wow! is perceived by most to be a bust and H.R. Block has been curiously silent about the service since announcing it. One hears whispers of "vaporware." CompuServe also fumbled the ball when it overpaid for Spry's Internet-in-a-Box in late 1995 and early 1995 when the online services were racing to offer connections to the Web. The OSP recently announced it was dumping its $100 million hood ornament to license Microsoft's Internet Explorer.

Where H&R Block has recently shown promise is in their integration of Block Financial Services into CompuServe and the World Wide Web. With 100,000 of its CompuServe subscribers already using CompuServe Visas, Block recently announced that it was debuting an Internet credit card and looking to provide online banking services later in the year. This is a market many believe will drive down costs for both banks and consumers as costly branch offices and personnel are eliminated from the equation. With Block Financial Services getting into the online act, however, the much ballyhooed possibility of a CompuServe initial public offering (IPO) becomes dimmer; the financial side will want to cling to the network even more. Once a champion, CompuServe has become an also-ran and will remain so until it rethinks its policy on creating innovative new content like America Online is doing with the Greenhouse Program and initiating a sane pricing system.

H&R Block is actually one of the smaller companies in the OSP business, however; three Dow heavies---Sears, IBM and General Electric---entered the field as well with two services, Prodigy and GEnie. Prodigy was the first, a joint venture between Sears and IBM in those far-flung days when Sears thought it was a financial services company and IBM thought it was an innovative technology company. With the subsequent divestiture of every financial property from Sears, (Dean Witter-Discover and Coldwell Banker) and IBM's early 90s implosion, Prodigy was not a priority for either of the mega-giants in their tough times. So, even though Prodigy was first into the Web access boat, it commands only a paltry share of the Web Browser market and has actually suffered flat to negative growth during a period when the world has been "getting online."

Most users agree that Prodigy has a clunky interface and too much advertising. Where it does well is in specific services; until recently, for example, Prodigy's investing area was much better than America Online's, and a notch better than CompuServe's. A few areas of strength could not save an inflexible network, however, one designed to sell the user stuff online. The fact that two multinational companies with unlimited capital dumped about a billion into Prodigy and now have been considering throwing in the towel should tell investors a lot about which OSPs are successful---not the big guys, but the smaller guys who are flexible and adaptable.

GEnie is perhaps the most bizarre example of an online service. Nominally, General Electric is into broadcasting and it does have a rather large financial services division that brings most of its profits. But the financial services division is dominated by financing its industrial and technological equipment, not providing consumers with lending services, and the broadcast machine is wholly television; there's no genuine interest in becoming digital. When General Electric's CNBC wanted to partner with someone online, they chose Prodigy rather than GEnie, which never really had any content and stayed securely at about 100,000 users. GEnie was recently bought by a group of investors who are going to try to do something with it. This will probably be the fate of Prodigy as well, given that Sears is sick to death of it and IBM wants to move on to focusing on premium online services for the lucrative business market.

Another heavy that jumped into the OSP business was Microsoft, but it suffered from the all sizzle and no steak phenomenon. Right up until MSN debuted, you couldn't cross the Street without hearing that MSN was gonna eat America Online alive. When Microsoft limited initial membership to 500,000 people, all of whom had to have purchased Windows95, sanity was restored as most computer users stayed securely on Windows 3.1 and most business users switched directly to Windows NT, which does not offer MSN. Four months into the venture, MSN has about 600,000 subscribers---not a bad start, but hardly an AOL killer. The worst part about MSN is the rumors that it has no way to track usage and thus cannot pay content providers based on that, forcing them to rely on transactions to generate revenues. Imagine the Motley Fool Online on MSN---$5 a month plus $0.10 for every Fool Portfolio report, $0.25 for the Evening News (hey, I'm dreaming, right?), ad infinitum. Not a very attractive set-up, is it? No wonder MSN is moving out to the Web and Microsoft is positioning itself as a gateway to the Web rather than a "me too!" version of America Online.

Don't get me wrong; MSN has a lot of promise, and in fact, it can probably chew up all of the little ISPs out there as it comes in with a built-in consumer operating system and eats their lunch. Given that it is in Microsoft's best interest to encourage users to download software and upgrades rather than package them for sale in the stores or through the mail, it can offer cut-rate prices and still make out well by improving its overall OS and application margins. Content is not, however, going to be Microsoft's business, and it is almost unfair to call the darn service an OSP. They do have some proprietary stuff, but it's slow and sparse. (Read: There is no Motley Fool on MSN!)

e*world is another in a long litany of Apple Computer marketing disasters. I continue to question whether management can ever get anything right. By refusing to offer free trials and pinning their hopes on online interactive games as the way to make the big bucks, e*world has fizzled at roughly 100,000 users, representing another of those high-quality, commercial flops that big ol' Worm-Eaten is famous for. Why the marketing for e*world was a disaster is almost unfathomable; integrating the darn thing into the OS and getting those 10-20 million fanatic Mac users to sign on (and away from the Wintel thugs) would seem to have been a slam-dunk. Instead they threw up a brick.

It is almost painful to mention Delphi, given that the service has basically been left behind by the major operating system upgrades of the past two hundred years. Okay, I am being a little harsh to the little fellow, partially owned by Robert Murdoch's News Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:NWS)") else Response.Write("(NYSE:NWS)") end if %>, but there doesn't seem to be much hope in resuscitating this dead dog, despite the loyal following of a 100 to 150 thousand. The best plan here would be to smash GEnie, Delphi, e*world and Prodigy together and maybe you would have something approaching the critical mass needed to generate profits for an online service.

The thing about the OSPs catering to the mass consumer market is that size *does* matter because it provides the cash flow to fund marketing and research & development efforts. The reason why the big are getting bigger and the small are getting smaller is the same reason why the rich get richer and the poor get poorer; users, like dollars, beget more. The magic of compound interest works in the user world because of word-of-mouth advertising; when you have five million users rather than 500,000 talking about your service, the odds are that you will bring in more people willing to give the service a try. This, as well as major marketing Waterloos, seem to be the reason why all commercial services right now, except America Online, seem to be total disasters. CompuServe is the only other service with a leg to stand on, but even it is held back by a lack of vision and an adherence to the old status quo.

As for the "narrowcast" ISPs, a lot of them are lucrative businesses right now, but they have no idea how threatened they really are by America Online, Microsoft and the World Wide Web (in that order). Dow Jones News Retrieval's nice little business was the best thing going until America Online debuted Company Research and added Reuter's wire stories to their PRNewswire and BusinessNewswire feeds. Having written a daily news recap every day for the past year and a half or so, I can tell you with confidence that I find as much on America Online now as I do on DJNR, with one sometimes scooping the other. DJNR lacks a convenient way to get to historical quotes and still remains prohibitive for the user since it charges by the character downloaded---a bizarre, archaic way of doing business. It's akin to demanding gold coins at the supermarket when the cashier goes to give you change. Lexis/Nexis and Westlaw have just as much to be worried about; their duopoly that rings of Coke's and Pepsi's hold on the soft drink market does not look as secure now that America Online is partnering with various professional services to create private networks. What America Online is doing for Century 21 Realtors could easily be duplicated for the American Bar Association. That would drive down Lexis/Nexis' and Westlaw's prohibitive fees to a more market-based rate if they can shake a lot of those exclusive agreements out of them. Don't get me wrong; narrowcast OSPs can and will make money. The barriers to entry in their markets are lowering, however, as the 'Net becomes more pervasive and entrepreneurs more aggressive.

It is interesting to look out at online services and see either total basket cases or fat and lazy hogs waiting to be slaughtered. To hear all the buzz about being online, you would think that the major players would be focused and directed, dominating their markets and limiting the ability of others to come late to the party. With MCI today effectively ditching InternetMCI for a partnership with Microsoft's MSN that could grow into a content-based OSP (given News Corp.'s involvement), the market actually does look ripe for a credible alternative to America Online's effective domination and huge market share. At the very least, it will be fascinating to watch how it all shakes out.

TOMORROW: The Digital World, VI: America Online Firing On All Cylinders

CALENDAR: Tuesday's Economic Events

---December Retail Sales (8:30), tentative
---Mitsubishi Bank & Schroder Wertheim Weekly US Chain-Store Sales (9:00)
---January Conference Board's Consumer Confidence Index (10:00)
---December Treasury Budget Statement (2:00)
---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)
---Federal Open Market Committee meets in closed session

Byline: Randy Befumo (MF Templar)