Today's big news was the acquisition of UUNew by MFS Communications, which gave all Internet stocks a boost. We've got a Special Section on the deal on our main screen, complete with a FoolWire and a conference call report. MF Merlin's Economic News today covers the Labor Department's report on employment cost, the Mitsubishi Bank/Schroder Wertheim weekly report on chain store sales, and the results of the Conference Board's April survey of consumer confidence. In tonight's Fool on the Hill, MF Templar takes a deeper look at the buyout of UUNet and what it all means for investors.
If you like The Evening News, you'll probably enjoy our brand-spanking-new Lunchtime News, which is up on the Fool main screen every day now by 12:30 Eastern time (and is replaced in the Evening by The Evening News. We're also offering a free two-week e-mail trial subscription to this tasty new treat, so if you or some non-AOL friends are interested, drop a line to [email protected]. Enjoy!
The ongoing Hambrecht & Quist Technology Conference provided some grist for institutional money's mill. Iomega <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IOMG)") else Response.Write("(NASDAQ: IOMG)") end if %> rocketed up $5 1/4 to $54 3/4 after restating goals announced at its recent annual meeting to bring the price of its removable mass storage products down 40% to 60% over the next few years. MetaTools <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MTLS)") else Response.Write("(NASDAQ: MTLS)") end if %> soared $5 1/4 to $28 after the company unveiled a new product that allowed users to "creatively play with digital images in real time", called Kai's Power Goo. Other than that, ''people are just understanding our story better from the conference,'' said Terance Kinninger, MetaTools' chief financial officer (CFO). The same appears to be true with Iomega as well.
Bashed a few weeks back to within a hair of $10, Zoran Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ZRAN)") else Response.Write("(NASDAQ: ZRAN)") end if %> was up a robust $5 5/8 to $31 3/4 after it reported earnings 12% ahead of expectations. The premiere manufacturer of JPEG chipsets for digital video applications was thrashed in March when IBM announced a package of three MPEG-1 chipsets that would compete with one of Zoran's offerings. Many view Zoran as another version of C-Cube Microsystems -- a company with crucial chips in a new industry with very little in the way of competition and a heck of a lot in the way of demand. The company only recently came public at around $10 a share.
Zenith Electronics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ZE)") else Response.Write("(NYSE: ZE)") end if %> announced some Internet offerings today that sent the stock soaring $2 1/2 to $9 5/8. The company unveiled a system that combines its modems with Cisco's internetworking technology and a Microsoft operating system -- not bad allies if you think about it. The Zenith product is an integrated, end-to-end solution for high-speed, two-way data over cable systems. Zenith only recently dumped its personal computer operations on French-based Groupe Bull. It has been a company looking for a product ever since it stopped making TVs. . . and this sounds like a good one. If some developer of cellular modems can figure out how to make the one-way cable system two-way without having the normal drain a network receives when multiple users pile on, they would have a highly successful product on their hands. Is it Zenith's? Dunno. . . you're gonna have to check this one out on your own, Fool.
QUICK TAKES: Retailer SHARPER IMAGE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SHRP)") else Response.Write("(NASDAQ: SHRP)") end if %> rose $1 1/2 to $5 7/8 on no news. . . Mobile meter-reader ITRON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ITRI)") else Response.Write("(NASDAQ: ITRI)") end if %> surged $7 1/4 to $58 3/4 after Hancock reiterated a buy rating. . . SYKES ENTERPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SYKE)") else Response.Write("(NASDAQ: SYKE)") end if %> opened at $30 7/8 and closed up $5 1/2 on its first day. . . Silicon-salesman MEMC ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WFR)") else Response.Write("(NYSE: WFR)") end if %> rose 3/8 to $49 7/8 after reporting an outstanding quarter highlighted by shrinking inventories of its wafers. . . ELJER INDUSTRIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ELJ)") else Response.Write("(NYSE: ELJ)") end if %> rose $ 1 3/8 to $12 5/8 in spite of the company's contention that it knew of nothing to explain this move. . . NAUTICA ENTERPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NAUT)") else Response.Write("(NASDAQ: NAUT)") end if %> gained $3 3/4 to $46 1/2 after it announced a two-for-one split. . . Electro-optical measurement device manufacturer ZYGO CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ZIGO)") else Response.Write("(NASDAQ: ZIGO)") end if %> added on $5 3/4 to $52 1/4 on better-than-expected earnings. . . WISCONSIN CENTRAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: WCLX)") else Response.Write("(NASDAQ: WCLX)") end if %> earnings were not as bad as expected, causing it to surge $8 1/2 to $84 1/2. . . With its anti-obesity Redux drug approved, INTERNEURON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IPIC)") else Response.Write("(NASDAQ: IPIC)") end if %> added on $2 1/4 to $39 3/8 today.
Mercury Interactive <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MERQ)") else Response.Write("(NASDAQ: MERQ)") end if %> got pounded for $5 1/4 to $13 3/4 today after it announced it would lose $0.04 EPS after a charge in the first quarter even as revenues rose to $11 million from $7.7 million a year ago. Smith Barney downgraded the stock and Oppheimer & Company also cut the stock from "buy" to "market performer". Lone Star Steakhouse <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: STAR)") else Response.Write("(NASDAQ: STAR)") end if %> got slashed by Oppenheimer as well, losing $3 3/8 to $41 3/8 after an analyst moved shares from "buy" to "market perform".
Merrill Lynch broke out its own red pen, cutting its rating on Kemet Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: KMET)") else Response.Write("(NASDAQ: KMET)") end if %> to "near-term accumulate", dropping the stock $2 7/8 to $23 7/8, and slicing Vishay <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VSH)") else Response.Write("(NYSE: VSH)") end if %> to "near-term accumulate", lopping $3 1/4 off the price to close at $30. Unfortunately Intersolv <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ISLI)") else Response.Write("(NASDAQ: ISLI)") end if %> had not one but two brokerages pile up on it today -- both Alex Brown and Wheat First cut their ratings on the enterprise software player, knocking it for a $2 7/8 loss to close at $10 7/8. Intersolv has only itself to blame, though: it admitted during its Hambrecht & Quist presentation today that margins in fiscal 1997 will be lower than many had expected.
Tech Sym Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TSY)") else Response.Write("(NYSE: TSY)") end if %> slumped $4 1/4 to $34 5/8 after CS First Boston downgraded the stock from "buy" to "hold" on its earnings yesterday. The company reported $0.35 EPS versus only $0.18 EPS a year ago, but CS First Boston had been looking for a stratospheric $0.60 EPS. Tech-Sym designs and develops electronic systems used in the oil and gas exploration, communications and defense markets.
QUICK CUTS: ISOLYSER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: OREX)") else Response.Write("(NASDAQ: OREX)") end if %> lost $2 7/8 to $17 3/4 after posting disappointing first quarter earnings. . . REXALL SUNDOWN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RXSD)") else Response.Write("(NASDAQ: RXSD)") end if %> was mashed for $4 1/2 to $28 1/2, although we could find absolutely no news. . . AAVID THERM TECH <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AATT)") else Response.Write("(NASDAQ: AATT)") end if %> dropped $1 1/8 to $8 3/4 after missing estimates by a penny. . . Steak restaurant BUGABOO CREEK <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RARE)") else Response.Write("(NASDAQ: RARE)") end if %> dropped $1 to $8 after releasing disappointing earnings and a same store sales *loss* of more than 6% in the quarter. . . GLOBAL NATURAL RESOURCES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GNR)") else Response.Write("(NYSE: GNR)") end if %> fell $1 1/4 to $14 1/2 on disappointing earnings news. . . RMI TITANIUM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RTI)") else Response.Write("(NYSE: RTI)") end if %> continued in its wacky ways, falling $1 1/4 to $19 3/4 today on no news.
FOOL ON THE HILL:
MFS Communications: Buy-Buy UUNet
UUNet Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: UUNT)") else Response.Write("(NASDAQ: UUNT)") end if %> ended less than a year of being a public company today when MFS Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MFST)") else Response.Write("(NASDAQ: MFST)") end if %> came through with a stock-for-stock deal valued at $2 billion. Each lucky shareholder will receive 1.777776 shares of MFS Communications for each UUNet share they turn in. The new entity represents a union of an upstart local phone service/network management provider with one of the biggest names in network management. UUNet rose $9 1/8 to $57 3/8 today -- still shy of the implied value of $61 3/4 a share -- while MFS Communications closed up $1/16 to $34 11/16.
The story is actually a little more dynamic than the final quotes suggest. UUNet added to its morning gains of $7 late in the day after the conference call broke up. The main beneficiary was MFS Communications -- the stock had been as low as $32 1/4 during the day but gained momentum after the positive spin both CEOs put on the deal in the call. (A synopsis of the call is available in our special UUNet collection on the Fool mainscreen.)
Why is Wall Street excited about today's merger? As far as the companies go, both stand to benefit from the arrangement. With local access accounting for about 40% of UUNet's total telecommunications costs, it stands to benefit quite a bit in the markets where it and MFS both provide service. As both companies have focused on large metropolitan areas with their connectivity networks, there is a lot of this very exciting overlap. MFS Communications now believes that it can become cash-flow positive by the end of the year with the addition of UUNet revenues to its base.
The merged company will be able to bundle local service, network management and Internet access at virtually every speed -- all with custom application and security software to boot. With 1,200 MFS sales representatives selling the merged company's wares, the combined company now provides the same depth of service that AT&T and MCI offer -- vaulting it into the big leagues of telecommunications. Even the numbers don't look too shabby -- the combined company has $678 million in trailing revenues and a current monthly revenue-run rate of $1 billion.
UUNet's focus on the enterprise segment of the Internet business is where most of its value to MFS Communications comes from, although UUNet's sweet five-year contract with Microsoft probably spiced up the price. For those unfamiliar with the company, Microsoft has borne the brunt of the capital expansion costs of rolling its soon-to-be defunct proprietary network out to targeted metropolitan areas. It can't be too bad for old Bill Gates, however -- despite the fact that MSN is fleeing to the Web, the 13% stake Microsoft got of UUNet at the offering price of $14 last year is now worth $228 million. A mere 340% rise which probably dulls the sting of MSN's expenses to date.
With the purchase of UUNet Technologies at four times its initial offering price and almost three times what it went for the first day, many might be asking the same question: How the heck could anyone have predicted the value another company would ultimately pay for an Internet service provider (ISP)? I think that two themes come to the fore as a lesson from today's acquisition -- distrust authority and adapt the methods of valuation to the industry in question.
The main problem with "authority" has been the tone of the coverage. The words "hype" and "hysteria" have rarely been far from the phrase "Internet service providers" since it first broke out onto the front page of the financial dailies in 1994. Without fail, almost every single individual who has commented on these companies has been extremely skeptical of their valuation, whether they were simply a stringer for one of the wire services or Director of Research at a major Wall Street firm. Unfortunately, I cannot even exclude myself from this survey until fairly recently. Fool Search (a searchable database available at the bottom of any Fool screen) revealed a few Evening News articles written in early- to mid-1995 that were pretty skeptical.
Why has almost all coverage been uniformly negative? For myself, I can say it has been simply a matter of understanding the market, the specific companies involved and their business plans. This is where flexibility with valuation comes in. How would an acquiring company value an enterprise in a truly new industry? We are not talking hype and lack of substance here, we are talking about genuinely new businesses that *many* companies are going to get involved in. The learning curve for how acquirers are going to value targets is pretty steep. Although the old default measures of value such as price/earnings and price/sales retain some degree of utility, when you are talking about a growth business that established companies might want to get involved with, some other metrics unique to the industry are useful.
The metrics I proposed in POP Go The ISPs! (2/27/96) and UUNet or UU-Not? (3/22/96) involved determining the value of the installed network by figuring out how much it cost to build and then applying a multiple to account for labor and convenience. A pretty astute article by Kara Swisher in the Washington Post a few weeks ago supported this, suggesting that AT&T and MCI were interested in taking a stake in or outright buying UUNet or PSINet. By looking at the Internet service providers as a situation analogous to the cable or cellular companies -- which they have been buying for a while -- they are interested in established networks with regional dominance and revenue-generating subscribers that would have value in perpetuity.
"There is a long lead time to buy and configure equipment out in the field," UUNet CFO Jeffrey Hilber said in an interview in February, "A lot depends on how quickly the local telcos respond -- to procure the circuits can take some time." How about the costs for a POP? "POPs can cost as little as $50,000," depending on who is building them, Hilber added. A company focusing purely on the consumer market, like Netcom, only needs POPs like this to provide service. These POPs are normally found in residential areas. However, dedicated networks serving high-end customers requiring more bandwidth call for something more.
A hub, or "superPOP", is "a major point where there are sophisticated routers and switching equipment---it can cost anywhere from $450,000 to $500,000," Hilber continued. "This normally includes Cisco 7000 routers, Cascade switching equipment, and one or more Ascend HP-Max box." Any way that you slice it, the costs can be tremendous.
Given that UUNet has over 500 POPs today with roughly 50 of them being "superPOPs", the equipment for the network alone costs about $100 million. If you figure that UUNet has substantial overseas penetration, which adds even more value to many of those POPs, and that this network is all put together, working and generating revenue right now, twenty times the actual equipment cost can seem fairly reasonable -- if you want to get in the business in a hurry and don't want to have to ramp up to the same level over a year or two.
"You are going to see a lot more consolidation of various Internet service providers to deliver service to businesses," said James Barksdale, CEO of Netscape. This is all because this business is going to be growing pretty fast and many companies will not be able to wait the necessary year or two to come up to speed. Many on the Street agreed today, buying PSINet <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PSIX)") else Response.Write("(NASDAQ: PSIX)") end if %>, up $2 3/8 to $14 1/8, Netcom On-Line <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NETC)") else Response.Write("(NASDAQ: NETC)") end if %> up $3 3/8 to $35 7/8 and to a lesser degree BBN Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBN)") else Response.Write("(NYSE: BBN)") end if %>, rising $5/8 to $28 1/4. This is actually pretty strange, because if you understand the businesses, the one most like UUNet is actually BBN Corp. Both companies focus on the business end and the deal between BBN and AT&T is pretty similar to the deal between UUNet and Microsoft. Any way you slice it, though, companies buying are using valuation metrics similar to cable and cellular companies. Perhaps if some of the permabears on the industry can come out of their state of denial, they can start to offer more useful commentary.
Foolish investing requires that we take into account how companies would be valued by potential suitors as well as how they stand up against conventional measures. What specifically happened with UUNet and how that unfolded today should serve as a helpful guide for how the other ISPs will be valued in the future.
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