Monday, April 1, 1996
MARKET CLOSE
INDEX:
I. Market News: Merger Mania Drives Dow Up
II. Heroes: Pacific Tel, NYNEX, Scitex, US Healthcare
III. Goats: Coastal Healthcare, Datalogix, IMC Global
IV. Investment Perspective: Tech 5: On Components and the "Wheel Sector"
V. Another Foolish Thing
MARKET CLOSE
DJIA: 5637.72 +50.58 (+0.91%) S&P 500: 653.73 +8.23 (+1.28%) NASDAQ: 1106.57 +5.17 (+0.47%)
Happy April FOOL's Day! The markets were up today, abuzz with merger news. That SBC Communications is merging with Pacific Telesis and that Aetna is buying U.S. Healthcare were among the major headlines. Today's main FoolWire covers Aetna's acquisition of US Healthcare -- check it out at the Stock Research screen.
If you read this in time, Tom and David Gardner are scheduled to appear on CNBC at 7 pm ET tonight. (And they're on the cover of Fortune magazine. And they're in this week's People magazine. And they were on CNN this morning. Geez -- these guys are everywhere! Perhaps they'll be offering taste samples at your local supermarket next!) A very Special Section today is MF Templar's e-mail discussion with Morgan Stanley new media analyst Mary Meeker. She is the co-author of "The Internet report" and despite being a major Wall Street analyst, sports quite a Foolish attitude!
Telecommunications laws have not been off the books for very long but the Baby Bells have already gotten acquisitive. First it was US West Media Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UMG)") else Response.Write("(NYSE: UMG)") end if %> buying privately-held Continental Cable and now SBC Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SBC)") else Response.Write("(NYSE: SBC)") end if %> is buying Pacific Telesis <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAC)") else Response.Write("(NYSE: PAC)") end if %>. SBC Communications, the holding company for Southern Bell, offered $39 a share for Pacific Bell, ringing up gains of $5 7/8 to $33 5/8 for the shares. Why not all the way to $39? Apparently the Justice Department is "looking at" the merger. NYNEX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NYN)") else Response.Write("(NYSE: NYN)") end if %> jumped $3 to $52 7/8 on the news. Speculation has been that this company might be bought out by Bell Atlantic <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BEL)") else Response.Write("(NYSE: BEL)") end if %>, frustrated once at the altar by Telecommunications Inc <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: TCOMA)") else Response.Write("(NASDAQ: TCOMA)") end if %> when a deal to acquire the cable company failed to go through.
Israel-based Scitex Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SCIXF)") else Response.Write("(NASDAQ: SCIXF)") end if %> soared $4 to $17 7/8 after the company revealed it had received a letter from DSP Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DSPC)") else Response.Write("(NASDAQ: DSPC)") end if %> founder Davidi Gilo that purports to make an offer for Scitex. Scitex called the letter "unsolicited" and remarked that it was a "vague and confusing communication." In the body of the letter, Gilo stated that he was prepared to make an offer of $20 cash per share and that the financing for the $856 million deal was "already established." Scitex supplies color-publishing systems.
US Healthcare <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: USHC)") else Response.Write("(NASDAQ: USHC)") end if %> announced its intention to merge with Aetna <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AET)") else Response.Write("(NYSE: AET)") end if %>, giving each US Healthcare shareholder about $57 in cash and stock. Shares of the health maintenance organization surged $6 to $51 7/8, the euphoria somewhat constrained by the fact that the value of the shares Aetna was acquiring US Healthcare with were worth $3 3/8 less, closing at $72 1/8. Investors are afraid that Aetna has abandoned its property and casualty business at the bottom and is buying into an HMO at the top with a premium price. (There is a FoolWire further exploring this issue in the Evening News list box to the right, or in the FoolWire area: Main Screen --> Stock Research --> FoolWires.)
This next one is almost too good to be true. Wink, wink. Nudge, nudge. :) Sanitation-specialist Zeigletics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ZEIGF)") else Response.Write("(NASDAQ: ZEIGF)") end if %> rose $8 1/16 to $12 7/8 in heavy trading today after the company listed its shares on the NASDAQ exchange. Previously trading on Canada's Halifax Exchange, Zeigletics is up from about $0.57 Canadian since Fools first caught a glimpse of it two years ago on Prodigy's Money Talk boards. The long-awaited release of the Zeig-Lo-Pots -- the company's climate-controlled Porta-Potty -- in Southern Chad has been a big hit with" residents of this Central African country. Joey Roman of "Routine For Roman" commented on CNBC's Buy, Sell or Hold" segment that Zeigletics has received permission to direct market their product to customers rather than going through the government-imposed distribution centers, a major savings. A royal flush for Zeigletics!
QUICK TAKES: COOPER CAMERON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RON)") else Response.Write("(NYSE: RON)") end if %> surged $3 to $45 after the company announced it was in a pact to acquire oilfield service operator Ingram Cactus for $200 million, or about two times trailing revenues. . . Wayne Huizenga's REPUBLIC WASTE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RWIN)") else Response.Write("(NASDAQ: RWIN)") end if %> rocketed up $4 1/2 to $35 1/2 after it acquired trash-hauler AutoNation USA for $250 million. . . WATERS CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WAT)") else Response.Write("(NYSE: WAT)") end if %> continued its rise today, up $2 1/4 to $26 1/2, on news that it had acquired a competitor on the cheap and had been upgraded to "strong buy" by Alex Brown. . . HOMETOWN BANCORP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: HWTN)") else Response.Write("(NASDAQ: HWTN)") end if %> rose $1 3/4 to $13 3/4 after NORWALK SAVINGS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NSSY)") else Response.Write("(NASDAQ: NSSY)") end if %> made an offer to acquire the savings and loan. . . Power generation equipment manufacturer JASON INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: JASN)") else Response.Write("(NASDAQ: JASN)") end if %> rose $1 1/4 to $8 1/4 after Robert W. Baird & Co. upgraded the shares from "hold" to "long term buy".
Striken by more than a year of disaster upon disaster, Coastal Healthcare <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DR)") else Response.Write("(NYSE: DR)") end if %> is crying "Uncle!" The company said today in a statement that they had hired Morgan Stanley to help them devise a plan to divest assets, sell debt or equity, or spin-off units in order to get their act together. The stock was down $1 1/2 to $7 3/8 on this final capitulation. Coastal has been beset for months by its unprofitable Florida emergency room contracts, as well as lower-than-expected Medicaid and Medicare reimbursement.
Process control software developer Datalogix <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DLGX)") else Response.Write("(NASDAQ: DLGX)") end if %> got hammered today, falling $6 5/8 to $6 7/8 when it pre-announced rotten earnings. The company stated that third quarter revenues were "below plan" and that it will only have $10.7 to $11.2 million in revenues. Worse yet, they will lose $0.09 to $0.12 EPS. Companies in this niche, like Wonderware <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: WNDR)") else Response.Write("(NASDAQ: WNDR)") end if %> for instance, have had spectacular falls. Datalogix was viewed as having an edge because of its close relationship with enterprise software giant Oracle Systems, but apparently this was not the case.
QUICK CUTS: Potash reseller IMC GLOBAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IGL)") else Response.Write("(NYSE: IGL)") end if %> dropped $3 5/8 to $32 7/8 after the company revealed third quarter earnings would be flat. . . CINCINNATI BELL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSN)") else Response.Write("(NYSE: CSN)") end if %> fell back on profit taking, down $3 3/8 to $48 3/8, after the company rose more that $8 last week when a deal with AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> was announced. . . GANDER MOUNTAIN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: GNDR)") else Response.Write("(NASDAQ: GNDR)") end if %> tumbled $1 13/32 to $4 1/2 after it announced it was seeking a waiver of its credit facility and "needed new equity because it was running low on cash."
INVESTMENT PERSPECTIVE:
On Components and the Fallacy of the "Wheel Sector", Pt. I
I. Apple Computer: A Fable
People believe that the "technology sector" is a uniform group because it actually has been for most of the industry's short history. Until a few months ago, Apple Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AAPL)") else Response.Write("(NASDAQ: AAPL)") end if %> personified the unified "technology sector" -- it could have been a poster child. Centered around the idea that everyone would someday have an easy-to-use, attractive and comfortable desktop PC and that a company would need to be there to provide stuff for it, a small Cupertino, California-based company became responsible for everything required -- the components, the computer, the peripherals, the connectivity devices, and the software.
What has happened to Apple Computer in the past year is more than just a huge management screw-up. Apple Computer was built around the idea that the desktop PC would be a computer for everyone. They believed that all of the products for it could be created by one company and that everything could be manufactured in the United States. Apple Computer believed it deserved its high margins because it was adding value to an integrated product that could not have been accomplished any other way.
CEO Gil Amelio's Apple Computer is now a company that is getting out of the low-end manufacturing business. Apple will probably contract out to Southeast Asian foundries and assembly plants any remaining production for its high-end Macintosh line. This high-end line will essentially be souped-up digital publishing platforms that can double as servers for an extremely fast-growing niche market. Their product will become more like a Sun Microsystems workstation -- not the kind of thing you would imagine the average family putting in their office, but something that you could make a ton of money off of because the right buyer would be able to pay full freight. With its own "flavor" of UNIX and Java and the notion that "the network is the computer", Apple Computer could quite possibly be the company that could fully realize the proposition that "the Internet is the computer" -- although this is risky at best.
The main point here is not where can Apple go now but what it did wrong. The company fundamentally misperceived the market. Apple believed that the "technology sector" did in fact exist, and that it was just a set of competencies that revolved around one thing -- the desktop PC in everyone's living room. Instead, a different vision is emerging, one that is much more chaotic and fractured, as more components originally developed for desktop PCs become more widely used. As the components emerge as products on their own, not dependents of the personal computer industry, "things fall apart, the center cannot hold, mere anarchy is loosed upon the world."
II. What Is A Computer Anyway?
Does the tiny microprocessor in a new Oldsmobile's transmission need to be an Intel Pentium chip? Does the memory on such a device need to be a 200 meg hard-drive, or can it just be any component that will do the job? What do people really mean when they talk about the "computer" industry, anyway? If my hand-held solar calculator has more computing power than ENIAC, the world's first vacuum tube "computer" (big enough to fill a large room), is it to be included in the high-growth and high-margin technology sector? Webster's tells me a computer is "an electronic machine which, by means of stored instructions and information, performs rapid, often complex calculations". So are all those two-dollar digital watches made in Seoul now part of the technology industry?
Think of a computer. . . except don't think of the traditional, tried-and-true desktop PC. Think of an automated thermostat that regulates the temperature of a building, a VCR you can program to tape two shows at completely different times, or a telephone that you can program with twenty stored numbers. These are all computers as well, in the broadest sense of the word. A computer is simply one of those basic tools like the pulley or the lever that mankind has invented -- it is not an industry. No one talks about the "wheel" as an industry, or looks at everything to do with the wheel as the "wheel sector". Yet we have been saddled with this anachronism in the world of technology and it has been perpetuated by a financial industry that wants you confused and helpless.
A computer is made up of components. Some of these components, like semiconductor chips, need to be put together with other similar components in order to work. Some of these come already built, like hard drives or disk drives, and just need to be fit in. Some of them are even sold as separate products that you can plug in to your existing system with their own hardware and software, almost computers in their own right -- the Zip drive or a laser printer both come to mind. All of these peripherals function as one giant accessory market -- you either buy the machine because it has a certain component (like a Pentium chip) or you buy a peripheral after the fact (your Sportster modem). Traditionally, all of these have been examined with pretty much the same set of criteria, thanks to the mind-numbing "technology sector" label. Individual investors need to take this mass apart and understand the different business dynamics at work within it, in order to find where the real "industry" breakdowns should occur. We should put these products back into the context of the manufactured goods that we are all accustomed to.
III. Two Kinds of Components
A computer is any electronic computational device, whether it is a coffee maker with a timer or one of Silicon Graphics' Indigo-2 workstations. It is put together using components, some of them very cheap and easy to manufacture; some of them very expensive and hard to make. Sometimes, if the very-easy-to-manufacture products come in short supply, their price can rise. But as a general economic principle, you can always bet that when somebody is making money doing something fairly simple, people are going to come in and try to make money in much the same way -- faster than you ever thought possible.
Computers are made of components that have varying degrees of value added to their manufacture. All components can be placed somewhere on the following continuum:
Commodity or Price-Based <---------> Specialty or Value-Added
Pretty much any chip made falls somewhere along this line. Early on, when more than 75% of semiconductors manufactured went into what we now call sophisticated computers, most of the chips actually tilted toward the value-added end of the spectrum. Now this number is lower than 40% and is getting smaller every day, as it is cheap and easy to add computing devices to consumer electronics, home appliances and vehicles of all kinds. The components that make up a computing device -- memory, storage device, core logic, circuit board/motherboard, ad nauseam -- these all tend to become cheaper and easier to manufacture as time goes on, but you also end up not being able to charge all that much for them.
With goods, there are two ways you can compete. You can try to add some value to the product via specialty techniques or by simply putting your brand name on it, or you can try to compete based on price, cutting costs as fast as you can. These are all classic capital goods and they behave just like rolled steel, refined flour or other products that go into consumer goods. Most capital goods compete on price, since it is hard to brand or add value to basic goods. (Intel is a rare company which was able to brand its components, via its very-effective "Intel Inside" advertising campaign. ) The problem with competing based on price is that there is always someone who will try to do it for less. In fact, as DRAM manufacturers found out in the '80s, there are people who will do it at a loss in order to build market share.
IV. Commodity Products
Even products like hard drives, which are a good deal more difficult to manufacture than pin-compatible DRAM, in the end are difficult to brand. Quantum, Western Digital, Conner and even the higher-end storage technology products like those made by Seagate, EMC and Storage Technology are all characterized by terrible price competition that in the end comes down to who can give the most bytes for the buck. Some hard lessons were learned by investors who believed that high margins were the norm in the "technology sector" and simply went around buying low price/earnings (P/E) ratio stocks, such as most of the storage technology players, the DRAM and SRAM manufacturers, and most peripheral manufacturers making printers, modems or any number of gadgets you can integrate into a machine.
In price-based competition, all of the margins tend to drop a level. For consumer PCs this means that the company that made the central processing unit (CPU) is the one that made all of the money -- if you are buying the most recent generation of CPU. If you are buying back a generation or two, the basic reality is that no one is really making any money. For component manufacturers, this means the profits trickle down to those who can make capital equipment that will cut costs and increase output. In the semiconductor industry, they have cool buzzwords for this like "yield" and "throughput", but the basic theme is making more and making it cheaper. Companies increase their volume and sell for lower prices by leveraging their fixed costs on more units, requiring a lower sale price per unit to make a profit (or break even).
I don't believe that semiconductors should be privileged in the world of components -- they are no more or less sophisticated on average than hard drives, motherboards and similar products. Although it is manufacturers of proprietary or semi-proprietary chips like Intel Corp. or C-Cube Microsystems that get most of the air time, the stark reality is that most of the chip business is pretty brutal and completely lacks any real chance to add value. This is the reality that Apple failed to recognize when they convinced themselves that their brand name could justify their higher cost of manufacturing and still allow them to maintain fat margins. They believed that their products could somehow escape being commodities even though they wanted to make something that everyone would want and could afford. If you think this through, you suddenly come to the realization that any product that is adopted by the masses has to be cheap. The reason some of the most successful companies in the world, like Coca-Cola or McDonald's, are so successful is because what they make is so cheap that they can charge five to ten times what it cost them and still have you think you got off easy. When your product costs five hundred to a thousand to make, you are way past that magical price where consumers really start to scratch their heads and wonder if they *really* need it.
Essentially, we need to rethink our technology-related assumptions, and to realize that some peripherals have become components and some components have become peripherals. By seeing which parts of the "technology sector" have retained their value and promise, we can make more intelligent investment decisions.
TOMORROW: Technophrenia 6:
On Components and the Fallacy of the "Wheel Sector", Pt. II
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Byline: Randy Befumo (MF Templar)