Tuesday, February 13, 1996
MARKET CLOSE

INDEX:

I. Market News: Lower Book-to-Bill Deflates Tech Stocks
II. Heroes: Sensormatic Electronics, Bush Industries, Detection Systems, S-K-I Ltd., SFX Broadcasting, Citicasters, Berkshire Hathaway
III. Goats: Discreet Logic, Office Depot, Patterson Energy, New Jersey Steel, KLA Instruments
IV. Investment Perspective: Is The Book-To-Bill Irrelevant?
V. Another Foolish Thing: Oscar Nights Begin in Follywood!

MARKET CLOSE

DJIA: 5601.23 +1.08 (+0.02%) -- RECORD
S&P 500: 601.51 -0.94 (-0.14%)
NASDAQ: 1087.22 -8.16 (-0.74%)

MARKET NEWS

The semiconductor industry book-to-bill numbers came in last night at a chilling 0.93. It looked like Armageddon today when the NASDAQ Composite opened down 15-plus points and technology stocks across the board were lower. Trading overnight on the Instinet, a global system that large institutions use to conclude after-hours trading, indicated that most chip and chip equipment stocks would open two to four points lower. Then, millions of Americans tuned in to the Motley Fool's special feature, "Crisis in the Chip Stocks," and read about how the book-to-bill is not all that great an indicator for investors and how falling memory prices were already discounted into stock prices. A rally ensued and the world was saved.

In today's Investment Perspective, I amplify and abridge the special feature available in the Motley Fool's main screen list box. For our America Online readers, you might want to check the special feature out, as it contains even more information. You can also check out this evening's special feature on the impending Applied Materials earnings, set to be released after market close. (Note: Applied announced earnings of $0.93 per share, markedly up from $0.38 per share last year at this quarter.)

HEROES

Sensormatic Electronics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SRM)") else Response.Write("(NYSE:SRM)") end if %>, a maker of security tags for clothing, rose 2 to 20 after the company reported a massive loss in its fiscal second quarter. Sensormatic's restructuring and special charges of $0.94 per share this quarter and $0.24 per share charges projected for next quarter are designed to lower Sensormatic's operating and manufacturing costs. These moves, in conjunction with a new agreement with Allied Signal <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:ALD)") else Response.Write("(NYSE:ALD)") end if %> to decrease their metal costs, should bring the troubled manufacturer of retail security devices back to profitability. Sensormatic choked dramatically late last year when its rival, Checkpoint Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CKP)") else Response.Write("(NYSE:CKP)") end if %> snagged some serious market share. News yesterday that George Soros had increased his stake to 8.42% of the outstanding stock no doubt helped as well.

Furniture-manufacturer Bush Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:BSH)") else Response.Write("(NYSE:BSH)") end if %> shattered Wall Street estimates by 34% today, causing the shares to surge 1 1/4 to 21 1/4. For the full year, Bush reported earnings of $1.42 per share, clearly above the $1.28 analysts had been expecting and within arm's length of *next year's* estimates of $1.54 per share. Expect to see some upgrades here, we imagine. Bush makes ready-to-assemble (RTA) furniture, a hot item with Generation X-ers and increasingly mobile families. The company's ability to develop niche products that spark consumer demand is evident in their impressive numbers. Slated to grow at an annual rate of 12-15% for the next five years, the shares could climb as high as $25 in the next year, as estimates will probably be notched up to the $1.65 earnings per share range for next year.

A rash of acquisitions generated a lot of Heroes today. Detection Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DETC)") else Response.Write("(NASDAQ:DETC)") end if %> bought out privately-held Radionics Inc. for $17.7 million in cash---a move it says will double its sales. The market pushed the shares up 1 5/8 to 7 3/8 on the news that the manufacturer of security, fire and control equipment would give it enhanced U.S. and international presence. On the other side of the acquisition fence, S-K-I Ltd. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SKII)") else Response.Write("(NASDAQ:SKII)") end if %> received a buyout offer from LBO Enterprises for $18 a share, pushing the stock up 2 3/4 to 17 1/8. A year ago, S-K-I hired Wertheim Schroder to help it "explore potential mergers or acquisitions"---apparently, they have done their job well.

The Federal Communications Act is causing radio stations to become prime targets for acquisition. SFX Broadcasting <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SFXBA)") else Response.Write("(NASDAQ:SFXBA)") end if %> rose 2 1/2 to 31 after it snapped up Prism Radio Partners for $105.25 million. SFX now controls 51 radio stations in 16 markets, making itself an attractive property in a multimedia world. Citicasters <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CITI)") else Response.Write("(NASDAQ:CITI)") end if %> surged 1 5/8 to 28 5/8 when it announced it would be bought by Jacor Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:JCOR)") else Response.Write("(NASDAQ:JCOR)") end if %> for about $700 million. This deal will create one of the biggest radio companies in the U.S., with 38 AM stations, 17 FM stations and 2 television stations.

Warren Buffett announced today that Berkshire Hathaway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BRK)") else Response.Write("(NASDAQ:BRK)") end if %> would hold a $100 million public offering to create a new Class B stock. Buffett has reluctantly agreed to this recapitalization to counter outside groups that are attempting to create unit investment trusts of Berkshire Stock to make it affordable for small investors. The Class B shares will have 1/30th of the rights of the Class A shares and 1/200th of the vote. These shares will not be eligible to participate in Berkshire's shareholder-designated charitable contributions program. Buffett recommends that current shareholders stick with the Class A stock, as he will be doing the same. Berkshire was down 200 to 31700, but is still a Hero in Fools' eyes for stopping brokerages from gouging individual investors with high-fee unit-investment trusts.

GOATS

Discreet Logic <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DSLGF)") else Response.Write("(NASDAQ:DSLGF)") end if %> won the booby prize today, shedding almost 53%, or 12 1/2, to close at 11 1/4 after issuing an earnings warning and announcing the resignation of its Chief Executive Officer (CEO). For the second quarter of 1996, Discreet expects revenues of $25 million and earnings of only $0.02 to $0.04 per share Canadian, compared to $0.07 per share Canadian a year ago on $13.7 million in revenues. Analysts had been looking for $0.12 Canadian per share, so this constitutes a major disappointment. Discreet's problems actually stem from woes related to Silicon Graphics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SGI)") else Response.Write("(NYSE:SGI)") end if %>, as their hardware runs Discreet software. A delay in the release of Silicon's Onyx InfiniteReality supercomputer hurt Discreet's business plan, as its Flame, Inferno and Vapour applications all run on the Onyx RealityEngine. Problems with Silicon's Indigo Impact workstations also slowed sales of Discreet's Flint product. CEO David MaCrae has resigned due to this blunder.

Office Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:ODP)") else Response.Write("(NYSE:ODP)") end if %> slumped 1 to 19 1/4 today after they reported earnings of $0.22 per share, two cents below consensus estimates of $0.24. Year-over-year, Office Depot only grew earnings 10%---a major disappointment when compared to the 30%+ quarters the company has been delivering over the past four quarters. There are some vagaries in the numbers that investors should be aware of: for starters, Office Depot's quarter was only 13 weeks long this year, compared to 14 weeks last year, representing 8% less time. Office Depot also spent quite a bit of money on pre-opening costs and expenses associated with opening new stores and warehouses. At 23 times trailing earnings and estimates of $1.15 or so a year out, the stock seems undervalued if it can resume its 25%-or-better annual growth next year.

Patterson Energy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PTEN)") else Response.Write("(NASDAQ:PTEN)") end if %> slumped 1 3/4 to 12 1/4 today after it forecast lower-than-expected earnings for its fiscal second quarter. The oil field services and equipment concern has suffered from weak demand as a result of low natural gas prices. The most they expect to make in the quarter is $0.02 per share, compared to $0.40 per share a year-ago. Analysts had been looking for somewhere between $0.16 and $0.26. Patterson Chief Financial Officer (CFO) James Brown was quoted as saying he believed that oil and gas prices would firm in 1996, which would increase equipment usage. Patterson is taking the opportunity of the disappointing quarter to take $330,000 in write downs.

A larger-than-expected loss caused shares of New Jersey Steel <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NJST)") else Response.Write("(NASDAQ:NJST)") end if %> to melt today, falling 1 to close at 8 1/4. Analysts had been expecting a loss of $0.04 per share, but the actual loss was $0.18 per share---ouch!

In other news, KLA Instruments <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:KLAC)") else Response.Write("(NASDAQ:KLAC)") end if %> got mashed 2 5/8 to 29 1/8 as UBS Securities downgraded it to hold from buy based on. . . guess what. . . the weaker-than-expected semiconductor book-to-bill ratio. Continue on to the Investment Perspective, dear reader, to find out why MF Templar thinks this is akin to downgrading it because of an inauspicious pig-entrail reading.

INVESTMENT PERSPECTIVE: Is The Book-To-Bill Irrelevant?

I. The Book-To-Bill Ratio: The Holy Grail?

The Semiconductor Industry Association's (SIA) book-to-bill number is treated by the market as if it is the two tablets Moses brought down from Mount Sinai. Billions of dollars trade in tandem with this oft-quoted metric. The fates of many a portfolio appear to ride on whether or not the general book-to-bill signifies solid or sagging demand---it must therefore be important, right?

Errrrrr. . . no.

The book-to-bill ratio is a loose measure of American semiconductor demand. The "book" in "book-to-bill" refers to orders booked. An order is booked when a company calls up a semiconductor manufacturer and orders some chips. The "bill" in "book-to-bill" refers to orders billed. An order is billed when it is sent out to the company that ordered it and they have to pay for it. The book-to-bill ratio is therefore a measure of the total orders booked to participating U.S. semiconductor manufacturers over the total orders those same companies billed. Thus, a book-to-bill ratio of 0.93 means that for every $1.00 of orders that was billed, only $0.93 of orders was booked.

Many investors in technology stocks extrapolate from the book-to-bill numbers a sense of overall supply and demand for semiconductors. When the book-to-bill is below 1.0, as it was yesterday for the first time in five years, investors tend to head for the hills, crying that the sky is falling. These Chicken Littles perceive a glut of chips on the market and fear demand is low and that prices will fall even lower. This is why the NASDAQ Composite was off the equivalent of 75 Dow points this morning.

II. Why the Book-to-Bill Is Not Relevant

The SIA's book-to-bill ratio is computed when member companies report to the SIA their own internal book-to-bill ratio. The book-to-bill ratio only consists of American companies that belong to this organization. By focusing simply on U.S. companies, this leaves about 45% of the world's semiconductor manufacturers out of the equation.

Member companies reported a net $5.01 billion in bookings for the month of December. Measuring this against the fact that the world semiconductor industry is now measured at $150 billion, or about $12.5 billion on a monthly basis, this book-to-bill ratio accounts for less than half of aggregate orders for the entire industry in the month of December. Investing based on the book-to-bill ratio is painting the entire industry with a very broad brush. In reality, the book-to-bill ratio has an uncertain correlation with the general health of the industry and, in particular, the health of individual companies.

The book-to-bill ratio is seasonally adjusted by some unknown algorithm to account for seasonal variations, making the number and its significance even harder to decipher. The fact that this seasonal adjustment is made to the number in spite of the fact that this has become a less-seasonal growth industry (showing 15% growing in bookings in spite of a cruddy book-to-bill) makes the number even more in question. On top of this, the recent strength in the dollar affects the book-to-bill as well, as it makes U.S. chips more expensive to foreign buyers than they were during last year's weak dollar episode. There is a seasonal adjustment but no adjustment for wayward currencies, muddying up the number even more.

Finally, the book-to-bill ratio looks backward, not forward---investing based on it is kind of like driving while looking in your rearview mirror. It simply affirms something for which Mr. Market has already been relentlessly pounding these stocks. If weakness in memory prices as well as some other commodity chips has already been discounted into many of these prices over the past three months, why would it need to be discounted *again*?.

III. Units/Units as Opposed to Revenues/Revenues

A more reliable indicator for whether or not demand for chips is growing is a look at units-over-units as opposed to the revenues-over-revenues number that the Street prizes. With semiconductor equipment continually decreasing the per-unit cost of semiconductors, and these savings being passed on to the customers of the semiconductor manufacturers, looking purely at revenues-over-revenues ignores the value of technology that decreases the cost of production.

Revenue-over-revenue numbers are impacted by price decreases much more dramatically than unit-over-unit numbers. For instance, the price of 4 meg DRAM has collapsed in the spot market in recent months from $14 at the end of last summer to $8 today. Although there is only one company involved in DRAM that the SIA polls for the book-to-bill numbers, the fact that their prices dropped 43% means that they are booking revenues at almost half of what they are billing---even while their unit volume may have risen. As well, DRAM sales are impeded by falling prices because companies are much less likely to want them in their inventories---if the price further collapses to $5, that would result in a hefty write-down no manufacturer wants to take.

In spite of a book-to-bill significantly out of whack, overall bookings increased 15% in December---in the face of a slight downward pull from the one participating DRAM company, as well as the drag from the SRAM manufacturers counted in the numbers. Fifteen percent may seem small compared to the growth we saw last year, but it is hardly a disaster. Semiconductor chips remain in demand enough to drive revenues 15% higher year over year in spite of the albatross of falling prices.

IV. Looking Forward: Three Rays of Hope

Three developments bode well for the semiconductor industry, making today's negative reaction to the book-to-bill numbers too pessimistic.

(1) The Telecommunications Reform bill passed in Congress with much fanfare last week bodes well for chip demand. The proposed $5 billion venture between AT&T and MCI Communications, for instance, would consume quite a bit of high-margin, application-specific semiconductors. With long distance providers, local phone companies and cable operators all freed up from regulations restricting with whom and where they can do business, demand for infrastructure in order to open up new markets should increase. Telecommunications applications consume quite a number of very powerful, high margins chips and the demand for these should be exceptional in the coming weeks and months.

(2) As I talked about at length in the Digital World series, the expansion of the Internet as a new method of distribution and interaction will continue to drive the sales of networking and networking-related products. The Internet comes fully formed with 151 million potential customers---the ramp up to full-functionality has occurred much faster than any pundit anticipated and will continue apace. Chips are integral to the digital world and it is impossible to be positive on one without being remotely positive on the other. The companies that manufacture equipment to make chips are even better situated, as their sales are unit-driven and not revenue-driven. It is their machines that allow chipmakers to earn money in spite of decreasing revenues. Equipment that decreases costs by increasing throughput and yield should continue to do well.

(3) Intel's radical price cuts, putting a Pentium-based machine in anyone's hands for a mere $1250, raise the question of whether or not demand for chips is elastic. In the past, since most PC consumption was focused on commercial businesses and not consumers due to high price tags, cutting prices did not always result in huge upswings in demand. But now that the PC has become a home appliance like the television or the VCR and its price tag is rapidly decreasing to that same level, might cheaper memory and cheaper CPUs cause consumer demand to expand, particularly as it relates to accessing new online services? It is not clear yet whether or not this will come to pass, but it has not been figured into these stocks' prices. With PCs accounting for 40% of semiconductor chips, any upswing in demand due to lower prices would definitely reverberate throughout the industry.

Byline: Randy Befumo (MF Templar)