Wednesday, April 3, 1996
MARKET CLOSE
INDEX:
I. Market News: AT&T Prepares to Spin Off Lucent
II. Heroes: LSI Logic, STM Wireless, Opta Food, Iomega
III. Goats: Cray Research, Northfield Labs, Lycos, Ride
IV. Investment Perspective: Tech 7: The Emerging Connectivity Industry
V. Another Foolish Thing
MARKET CLOSE
DJIA: 5689.74 +18.06 (+0.32%) <-- RECORD S&P 500: 655.88 +0.62 (+0.09%) NASDAQ: 1115.88 +4.59 (+0.41%)
The market showed a lot of support today for the imminent initial public offering (IPO) of AT&T spinoff Lucent Technologies. The new telecom company will include Bellabs and will be the largest IPO to date. Today's FoolWire cover former Fool Portfolio-holding Ride Inc.'s downgrade and subsequent stock dive.
Economic Indicators covered today by MF Merlin on the Fool main screen include February reports on personal income and outlays and on manufacturers' shipments, inventories, and orders. MF Templar's ten-part Technophrenia series continues today, with a look at connectivity and the incredible growth of the networking equipment industry. Finally, on a sad note, we regret the untimely death of Commerce Secretary Ron Brown, killed in a plane crash in Croatia.
LSI Logic <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LSI)") else Response.Write("(NYSE: LSI)") end if %> rose $1 3/8 to $28 1/8 after the company was upgraded to "buy" from "market performer" by Robertson Stephens and it announced a five-year pact with IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %>. Robertson Stephens analyst Dan Niles cited a book-to-bill of 1.1 for the company and a potential upside of 50% in the coming months as the company returned to strength. As for the IBM pact, IBM will manage LSI's data center and network operations as well as provide desktop computing services.
STM Wireless <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: STMI)") else Response.Write("(NASDAQ: STMI)") end if %> shot up $2 1/2 to $12 3/4 after Boston Group made positive comments on the company's move to sell its RF Microsystems unit to Remec Corp., announced Monday. Boston Group's Mark Bergman started the stock at a "buy" today, stating in a research report that he expects the company's VSAT business to grow "exponentially." STM sells rural and "metro-extended" wireless equipment in the United States and abroad.
QUICK TAKES: OPTA FOOD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: OPTS)") else Response.Write("(NASDAQ: OPTS)") end if %> soared $2 3/4 to $14 5/8 after Adams Harkness and Hill raised the stock from "attractive" to "trading buy". . . Shares of IOMEGA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IOMG)") else Response.Write("(NASDAQ: IOMG)") end if %> stored gains of $1 3/4, rising to $29 1/4 as rumors flew that institutions would soon be forced to cover their short positions by NASDAQ regulations. . . ALASKA AIR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALK)") else Response.Write("(NYSE: ALK)") end if %> soared $1 3/4 to $29 3/4 after it reported a March load factor of 68.5% versus 59.4% a year ago.
Hopes that Silicon Graphics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SGI)") else Response.Write("(NYSE: SGI)") end if %> would increase its bid for Cray Research <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CYR)") else Response.Write("(NYSE: CYR)") end if %> as a result of the precipitous decline in the stock were crushed today when the company reported that 97% of the shares had already been tendered. Cray Research fell $4 1/4 to $24 3/4 after it was finalized that each share in the supercomputer giant would be converted to one share of Silicon Graphics -- meaning that at $29 a share, Cray was trading well above its takeover value. Apparently any mergers and acquisitions strategists betting on a sweetened bid were wrong on this one.
Blood substitute manufacturer Northfield Labs <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NFLD)") else Response.Write("(NASDAQ: NFLD)") end if %> was bled for $2 3/8 to close at $16 5/8 today, after Dan Dorfman bashed the stock. Normally Fool News would be skeptical of Dan's information, but our own MF Uptrend over in the Healthcare area (Main Screen --> Stock Research --> Healthcare in the listbox on the left) has been skeptical about Northfield's product as well, spurred by some high quality posts from a Fool on the message boards. Another case of Dorfman coming to the scene long after the news had already broken in the online world? Somatogen <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SMTG)") else Response.Write("(NASDAQ: SMTG)") end if %>, a competitor to Northfield also cited in Dorfman's report, was down $1 3/8 to $16 1/4.
Newly-minted shares of Lycos <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: LCOS)") else Response.Write("(NASDAQ: LCOS)") end if %> continued to lose their luster today, falling $1 11/16 to $20 1/4, only a day after the company debuted at $29 1/4 for their first trade. CMG Information <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CMGI)") else Response.Write("(NASDAQ: CMGI)") end if %>, which owns the majority of Lycos, slumped $3 to $35 in sympathy. The Internet catalog firm had a lot of demand by individual investors but apparently all of the institutions who got in early on the IPO are selling out. Is this another Netscape, bound to recover in the coming months, or another General Magic, doomed to be forgotten? Tune in later.
Ride Inc.<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RIDE)") else Response.Write("(NASDAQ: RIDE)") end if %> wiped out today, losing $2 5/8 to fall to $11 9/16 after both Hambrecht & Quist and Ladenburg Thalman downgraded the stock from a "buy" to "hold". Ride's "pre-booking" numbers look to be significantly below the $80 to $85 million that both analysts had been looking for, forcing both to cut their revenue and earnings estimates. Uncertain order levels in Japan combined with increased price pressure in the industry as it consolidates also make the future look dicey. Is this roller-blading all over again?
QUICK CUTS: TREMONT CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRE)") else Response.Write("(NYSE: TRE)") end if %> slumped $2 3/8 to $28 after its Titanium Metals unit filed to make its own public offering. . . MIDWEST EXPRESS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MEH)") else Response.Write("(NYSE: MEH)") end if %> got mashed for $2 1/4 to $36 1/2 after Goldman Sachs cut the stock to "market performer" from "market outperformer". . . Prudential took an axe to BRIDGEPORT MACHINES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: BPTM)") else Response.Write("(NASDAQ: BPTM)") end if %> today, cutting the stock from "buy" to "hold". . . OLICOM A/S <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: OLCMF)") else Response.Write("(NASDAQ: OLCMF)") end if %> was slashed for $2 1/8, falling to $11 after announcing it expects a first quarter loss of $0.15 to $0.18 EPS. . . Shares of ERICSSON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ERICY)") else Response.Write("(NASDAQ: ERICY)") end if %> tumbled $1 3/4 to $18 5/8 after the Scandinavian cellular phone manufacturer reported that cash flow turned negative last year.
INVESTMENT PERSPECTIVE:
Technophrenia 7: Connectivity
The Convergence of Networking and Telecommunications
[WHAT HAS GONE BEFORE: This is the seventh installment in a ten-part series called Technophrenia. In the first three parts, we suggested that much of what is taken to be self-evident about the market and the technology sector is in fact erroneous and that new ways of thinking are required to increase our returns as investors. The fourth installment was dedicated to rethinking the so-called "technology sector" and suggested that much of what has been shoved in the box with that label does not belong anymore.
Part five explored consumer and enterprise computer systems, suggesting that consumer PCs are becoming home appliances like televisions or stereos, whereas enterprise computing focuses on higher powered, more expensive machines targeted at smaller business markets. Parts six and seven took apart the notions of components and peripherals that pervade the industry, instead suggesting that all of these products are becoming like any other conventional commodity or specialty item despite the fact that they are used in "high-tech" systems.]
I. Connectivity = Cable Equipment & Cable Companies
Did it begin with a group of European researchers at CERN in 1992? Or a group of students working at the Illinois Center for Supercomputing in 1993? Whether or not you believe that online communications really started with Hypertext Mark-up Language (HTML) or the first visual Web browser Mosaic, there is no denying that it has completely revolutionized what used to be simply referred to as networking equipment, modems and telecommunications equipment.
Although many pundits like to write off the pell-mell rush to get online as simply a fad, any investor knows that as a result of the worldwide network of smaller public and private networks, they have more access to investment information than at any time in history. With that little tidbit of understanding, it is pretty easy to extrapolate what can eventually happen in other fields of human endeavor.
Becoming digital takes more than just a computer. You need a machine that has the hardware and software capacity to hook up to a tributary network, which will lead you to some larger network backbone and finally to your ultimate destination. For the consumer this runs from modem to router to dedicated line. For the business user whose network can be directly connected to the Internet, they might be able to skip the modem and shoot information directly out of their own router. Regardless of the path, you need all of these parts working together to achieve the end goal -- the connection. This connection is established with some sort of content aggregation standard, whether it be an open system like the World Wide Web or a closed, proprietary system like America Online.
The oppressive notion of the "technology sector" demands that investors perceive all connectivity-related stocks through the single peephole of the desktop personal computer. The inability of most "technology" pundits to relinquish the notion that the PC is only a delivery system for networked and online content has blinded many to the convergence of these product categories into an industry of their own. Much like cable television and cable equipment stands outside of the burgeoning consumer electronics industry that is required to watch their content, so does the connectivity and content aggregation move outside of the PC dominion and become an inviolate industry of its own.
My case for connectivity and content aggregation being much more similar to the cable industry than anything going on in the computer industry is clear when you consider the following analogy. The cable industry (connectivity and content aggregator industry) is composed of three separate but interrelated segments that fold into one dynamic group that is independent of the television manufacturers (the PC industry). Cable equipment manufacturers develop everything from small set-top boxes (modems), local products that connect individual homes to local nodes (routers, switches, hubs). They also develop large scale equipment enabling the cable providers to channel broadcast content from its origin, whether it be broadcast from satellites, recorded, or scooped from the airwaves (large scale telecommunications equipment). The cable companies just provide packages of cable channels to consumers in a specific geographic region where they have an installed set of lines (much like the Internet service providers). The cable channels that produce or replay ready-made content (just like the content aggregators, such as America Online) are viewed as an entirely separate group, although many have cable companies as their main distribution source.
II. Modems, Network Equipment & Telco Equipment = Connectivity Equipment
After one backs away from the PC-centric view of the universe that the so-called "technology sector" imposes on investors, one thing becomes clear -- all computer system sales could end tomorrow and connectivity equipment companies would still do blazing business until the end of the decade. This supposition is premised on the fact that demand for truly interactive online services will only increase in the coming weeks and months as more and more people realize the power of this new medium and more businesses involved with it learn to exploit its unique characteristics and stop simply re-purposing print content because they think it is a cheaper way to do a magazine.
For the mass of consumers cueing up to get digital, companies like US Robotics, Boca Research, Zoom Telephonics and Global Village Communications will be there to sell them modems that integrate directly into their platform of choice. A modem is more than just an accessory you slap on a computer to get online -- it is an integrated package of hardware and software that must interface with your chosen machine. Many people mistakenly believe that modems are like hard drives -- all basically the same and in the end it's just a question of how much you spend for speed and bandwidth. Specialty modems that allow remote access of secure networks, wireless hook-ups to the Internet or super-fast cable, ASDL or ISDN connections all require even more specialized knowledge, with companies like Microcom, Hewlett Packard and Motorola among the many developing products for what might be extremely profitable niches.
For businesses that want to create networks in order to enhance productivity or enable multi-user applications, networking equipment of varying capabilities is vital. Whether it is a complete, integrated solution like a dedicated set of Sun Microsystems workstations, or a piecemeal local area network (LAN) patched together from equipment made by the likes of Cisco Systems, Cabletron Systems, Bay Networks, 3Com or Madge, all of these companies have sustained growth rates far above net computer system sales for years now. Why? Because people are establishing and upgrading their computer networks independent of whether or not they are buying new stand-alone computer systems.
With the onset of the Digital World sending many companies scurrying towards new stuff like groupware or Intra-nets to solve problems such as information sharing or employee access to details about benefit plans, more and more businesses are going to get wired, independent of whether or not they are buying PCs. Niche companies like Shiva that develop special remote networking solutions also have a lot of potential here.
Finally, the infrastructure of Points of Presence (POPs), dedicated lines and equipment to build the Internet backbone, puts networking equipment and large scale telecommunications equipment right next to each other in one nifty package. As telecommunications and cable companies look toward online communications as another avenue of growth, sales of this equipment will have increasingly less to do with computer systems sales, just like no one ties the sale of telephones to how much potential revenue a long distance carrier is going to generate.
The companies that build these networks in various regions and sell the access, whether UUNet Technologies or MCI Communications, start to look a heck of a lot more like a Comcast or TCI. The companies that supply equipment to these guys -- whether Cascade Communications, ADC Telecom, Ascend Communications or Cisco Systems -- have a much different market do deal with here than people who are buying computer systems. They have to connect to established networks based on multiple platforms, having very little to do with the price of DRAM or the overall capital spending plans for most businesses.
III. Valuing a Business
In the end, these points are significant because they dramatically affect how one approaches valuing a business. A cable provider like Comcast is valued based on the cash flow it produces and the number of subscribers that use its various cable systems, with some ancillary attention paid to how much advertising revenue it generates and what sort of new technologies it might be producing. If UUNet Technologies walks like a cable company, talks like a cable company and acts like a cable company, it might make a heck of a lot more sense to think about it in those terms when trying to come up with a fair value rather than applying the standard earnings-based metrics that the uniformity of the "technology sector" cause so many to use.
In the end, it is the company's core business that is being valued. Earnings, although important, become only one modality for arriving at a fair value. A company like UUNet, just like Comcast, has a valuable installed equipment base, a geographic franchise and an established customer base that is loathe to change around -- something that applying a standard multiple to earnings just does not capture.
The differences are much more subtle as we go further up the chain. The equipment companies in the end all deal with earnings growth, product line, customer mix and market share, as well as the brand name premium attached to one-stop solution centers like Cisco Systems. However, the significance of separating this part of the connectivity group out from the PC-centric "technology sector" is that it reinforces the basic premise that the prospects of these companies have a lot more to do with what businesses are doing to provide networking solutions and not with how many PCs have been sold to consumers or businesses in the past month.
The companies that operate in all the areas of what I am calling connectivity become at once the most easy and most difficult to value. Although mainly a Macintosh-centered company, Global Village Communications exemplifies a company that has seen the need for integrated suites of modems, network equipment and Internet access packaged as a single solution for businesses. They have customers for their ISP service and are building a network. They have a hammerlock on the Macintosh network market -- something that is pretty significant when you find out that 17% of all Web sites run off of a very graphical powerful Macintosh with a built-in firewall providing security. They also sell modems for the Macintosh platform for consumers and businesses, to a lesser degree selling some items for IBM-compatible PCs. A company like this should be judged on earnings growth, certainly, but with the understanding that it has some businesses that would be lucrative to sell off or spin off.
At the risk of harping on this point, the single greatest failing of the notion of a "technology sector" has been to make investors look at independent industries as tributaries of the PC river, when the actual connections are becoming much more tenuous than they originally were. This outdated mindset encourages investors to look at these stocks in one staid way rather than appreciating the different business environments that these emerging industries operate in. I believe that an investor who looks at what I am calling the connectivity industry and who builds a portfolio composed of the leaders will be able to make much better decisions than an investor who wants to build a PC-centric "technology" portfolio and who picks the "leaders" there.
TOMORROW: Enterprise Software and Content
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Byline: Randy Befumo (MF Templar)