HEROES
LOCTITE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LOC)") else Response.Write("(NYSE: LOC)") end if %> soared $11 7/8 to $58 1/8 as German company Henkel is bidding $56 per share for the 65% of the company that it does not already own. Loctite, which makes specialty coatings and sealants, reported an increase in operating margin of 1.1% in its third quarter even as sales growth hit a comme-ci comme-ca rate of 5% measured in dollars. By shedding operations, the company has grown more efficient -- when coupled with the company's stock buybacks, the result is a pretty potent value-building combination for shareholder return. The company generated free-cash-flow (earnings + depreciation and amortization - capital expenditures) of $49 million in the first six months of 1996. At the same time, the company also bought back $84 million in stock (net of issuances), after buying $91 million of its stock last year. Topping it off, the company paid out $17 million in dividends. Looking at the margins and free cash flow off about $400 million in revenues, it's easy to see why Henkel might want to cap off its investment at 100% here.
Midwestern bank and financial services company MARK TWAIN BANCSHARES <% if gsSubBrand = "aolsnapshot" then Response.Write(":NYSE" & CHR(34) & ">(NYSE: MTB)") else Response.Write("" & CHR(34) & " onClick=" & Chr(34) & "openWindow('http://quote.fool.com/uberdata.asp?symbols=MTB', 'quotebox', 640, 460); return false;" & CHR(34) & ">(NYSE: MTB)") end if %> added $3 5/8 to $46 after MERCANTILE BANCORP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MTL)") else Response.Write("(NYSE: MTL)") end if %> and the company agreed to merge. The stock swap, in which 0.952 shares of Mercantile will be exchanged for each Mark Twain, puts the merger price at $49.50 based on Mercantile's Friday close. At this price, Mark Twain has come into the valuation range of another hot Midwestern bank, BOATMEN'S BANCSHARES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: BOAT)") else Response.Write("(NASDAQ: BOAT)") end if %>, for which NATIONSBANK <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:NB)") else Response.Write("(NYSE:NB)") end if %> has made a bid. Boatmens is trading around 16 times 1996 earnings estimates and 14.5 times 1997's estimate. Possibly the hottest bank in the region, however, is Cincinnati-based FIFTH-THIRD BANCORP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: FITB)") else Response.Write("(NASDAQ: FITB)") end if %>, which is trading at 3+ times book value and about 19 times 1996's earnings estimates. While there is lots of growth potential in financial services, such as opening retail brokerages or trust services for wealthier individuals and institutions, the level of growth being priced into the sector across the board is not insubstantial.
SERVICE EXPERTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SERX)") else Response.Write("(NASDAQ: SERX)") end if %> blasted upward by $4 1/2 to $26 3/4 as the heating/ventilation/air-conditioning (HVAC) service company announced a pretty neat acquisition plan this morning. The company will issue stock and pay cash amounting to $85 million, based on today's trading, to 18 privately-held HVAC companies, all of which are members of the company's "Contractor Success Group (CSG), a national association of 275 HVAC businesses formed in 1991 to bring proven operating systems and marketing strategies to HVAC companies." By operating a trade group, the company can get to know which companies are the best-run and most successful. That's pretty smart. On the other hand, the company is now trading at more than twice its projected annual revenue, which looks kind of rich for a company generating the low earnings and cash flow numbers indicated in its prospectus. If the company can grind out good numbers through economies of scale and through building a recognizable brand name, the valuation might come into line. However, if one examined the company's rapid-fire financing deals since its summer IPO, one might want to wait to see some operating statements as the company digests these acquisitions to see if the company can demonstrate that it's a value.
QUICK TAKES: Australian filtration company MEMTEC LTD. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MMTCY)") else Response.Write("(NYSE: MMTCY)") end if %>, which had signed a definitive merger pact with GELMAN SCIENCES <% if gsSubBrand = "aolsnapshot" then Response.Write("SC:NYSE" & CHR(34) & ">(NYSE: GSC)") else Response.Write("SC" & CHR(34) & " onClick=" & Chr(34) & "openWindow('http://quote.fool.com/uberdata.asp?symbols=GSC', 'quotebox', 640, 460); return false;" & CHR(34) & ">(NYSE: GSC)") end if %> earlier this year, traded up $5 1/2 to $34 3/4 as filtration systems maker PALL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PLL)") else Response.Write("(NYSE: PLL)") end if %> cut in on the merger dance with a $33 merger offer of its own... FORASOL-FORAMER NV <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: FSOLF)") else Response.Write("(NASDAQ: FSOLF)") end if %> jumped $2 to $15 7/8 after the much-larger PRIDE PETROLEUM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PRDE)") else Response.Write("(NASDAQ: PRDE)") end if %> made a bid for the oil services company... INNOVASIVE DEVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IDEA)") else Response.Write("(NASDAQ: IDEA)") end if %> jumped $1 1/4 to $8 3/4 after Alex. Brown's analyst issued a "strong buy" on the medical device manufacturer, upping the rating from "buy."
MORE QUICK TAKES: Ultrasound equipment maker ACUSON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ACN)") else Response.Write("(NYSE: ACN)") end if %> rose $1 5/8 to $21 1/4 after the company posted record third quarter revenues, a decrease in operating profit (but better-than-expected net earnings), and the introduction of a new ultrasound system... BRE-X MINERALS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: BXMNF)") else Response.Write("(NASDAQ: BXMNF)") end if %> jumped $2 1/2 to $18 1/8 after announcing that it has reached a a strategic alliance with an Indonesian company which can help it develop its large mineral assets in that country, as well as carry out future exploration... ATLAS AIR INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ATLS)") else Response.Write("(NASDAQ: ATLS)") end if %> rose $3 1/2 to $32 3/4 after reporting a 53% increase in per-share earnings (net charges) in its third quarter... CFI PROSERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PROI)") else Response.Write("(NASDAQ: PROI)") end if %> added $2 1/8 to close at $19 5/8 after the software company announced that IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> will distribute its software to small banks.
GOATS
GATEWAY 2000 <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: GATE)") else Response.Write("(NASDAQ: GATE)") end if %> slipped another $3 to $47 1/4 today as direct-seller MICRON ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MUEI)") else Response.Write("(NASDAQ: MUEI)") end if %> joined it with a sizable fall of its own, from $17 7/8 to $14 5/8. Last week, Lehman Bothers analyst Kim Alexy lowered her investment rating on Gateway to a rather bland "outperform" from a "strong buy." Dow Jones newswire reported that Alexy is concerned that PC prices are at their lowest level since 1993 and have declined 12.5% from their 1995 fourth quarter peak. Some believe that the spread on PC pricing -- the difference between consumer price inflation and wholesale price inflation -- may narrow. This is the same reason why financial services companies sell off in environments where interest rates are rising. Though Alexy is measuring from peak prices, which makes it a little hard to know her exact thesis, one interpretation can be posed that the seasonal or cyclical cycle is peaking. Checking out the website of Dr. Ed Yardeni, of Deutsche Morgan Grenfell, one can see that producer price deflation in the PC industry has run close to negative 20% this year, going below the rough 1990s trend of negative 15% inflation. With capacity utilization running over 95% and inventory/sales ratios dropping after a correction, Alexy may be concerned that price flexibility and profitability may have run their courses for the next three to six months (the regular sell-side analyst's "watch and wait" time horizon) if consumer price deflation is catching up with producer price inflation.
ELECTRONIC DATA SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EDS)") else Response.Write("(NYSE: EDS)") end if %> dropped $5 to $41 1/8 when the Morgan Stanley analyst that upgraded the shares to "strong buy" last Thursday downgraded them to "neutral" after studying the situation over the weekend. EDS plunged more than $11 to the $46 range last week when the consulting and outsourcing giant announced that slow revenue growth with the government and its old parent, GENERAL MOTORS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GM)") else Response.Write("(NYSE: GM)") end if %>, would cause the fourth quarter to come in below expectations. Wall Street's concern is that the company is a 15%-to-20% grower headed towards becoming a 10%-to-15% grower, causing many to revise their valuations. During all of this fuss, the firm has fallen to early 1995 levels, wiping out 18 months of gains.
Healthcare informatics providers are a specialized form of computer software and hardware developers that enable the healthcare industry to keep track of patient billing and clinical data. TRANSACTION SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: TSIX)") else Response.Write("(NASDAQ: TSIX)") end if %> became the latest one of these firms to plunge after it announced fourth quarter revenues earnings would come in below estimates, falling $5 to $8 3/4 in one particularly bloody session. With over 300 of these companies selling incompatible systems, the level of risk among the smaller names is huge. The same is apparently true of physician practice management concerns, as PHYSICIAN RELIANCE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PHYN)") else Response.Write("(NASDAQ: PHYN)") end if %> dropped $4 5/8 to $4 7/8 after the company missed third quarter estimates. The cancer management concern's fall also dragged down already-battered AMERICAN ONCOLOGY RESOURCES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AORI)") else Response.Write("(NASDAQ: AORI)") end if %> $1 11/16 to $7 5/16, MEDPARTNERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MDM)") else Response.Write("(NYSE: MDM)") end if %> $2 1/4 to $20 3/4, PHYCOR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PHYC)") else Response.Write("(NASDAQ: PHYC)") end if %> $2 to $30 3/4, FPA MANAGEMENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: FPAM)") else Response.Write("(NASDAQ: FPAM)") end if %> $2 1/8 to $21 3/8 and PHYMATRIX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PHMX)") else Response.Write("(NASDAQ: PHMX)") end if %> $1 7/8 to $17.
QUICK CUTS: AIRBORNE FREIGHT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ABF)") else Response.Write("(NYSE: ABF)") end if %> continues its 1996 slide, getting cut for $1 1/8 to $19 7/8 after reporting earnings per share of $0.22 in its third quarter, far below the First Call mean estimate of $0.43 per share. The company blamed the results on a drop in the rate of domestic revenue growth... ACCLAIM ENTERTAINMENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AKLM)") else Response.Write("(NASDAQ: AKLM)") end if %> was slammed for a $1 5/16 loss to $3 15/16 as the company rolled out its worst release of the quarter: a loss of $140 million, or almost $3 per share... FUISZ TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: FUSE)") else Response.Write("(NASDAQ: FUSE)") end if %> free-fell $5 7/8 to finish at $8 as the drug delivery company said that JOHNSON & JOHNSON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JNJ)") else Response.Write("(NYSE: JNJ)") end if %> was giving it the Heisman on a developmental deal... Wireless communications company OMNIPOINT CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: OMPT)") else Response.Write("(NASDAQ: OMPT)") end if %> lost $2 3/8 to $27 5/8 as the company is making its way through the high bid levels at the FCC auctions.
MORE QUICK CUTS: CABOT CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CBT)") else Response.Write("(NYSE: CBT)") end if %> slid another $2 3/8 to $24 1/8 even as the auto industry, which uses its market-leading carbon black compound, is generating record sales... MERCURY FINANCE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MFN)") else Response.Write("(NYSE: MFN)") end if %>, on the other side of the auto market as the largest independent provider of used car loans, dropped $1 7/8 to $10 1/8 after the company reported that it will take a $20.5 million charge for loan reserves... Kidney treatment maker AKSYS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AKSY)") else Response.Write("(NASDAQ: AKSY)") end if %> moved down $1 7/8 to $7 3/8 after reporting a loss of $0.15 per share today... Telecommunications outsourcing provider ICT GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ICTG)") else Response.Write("(NASDAQ: ICTG)") end if %> continues to fall after last week's earnings report and analyst downgrades, including a Smith Barney downgrade to "hold" (Fool-vision-equipped readers see "sell" there). ICT was off $1 5/8 to $4 3/4... Aerospace and industrial controls company MOOG <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: MOG.A and B)") else Response.Write("(AMEX: MOG.A and B)") end if %> slid $1 1/2 to $17 1/2 after announcing the completion of the purchase of its Moog Controls subsidiary... BLAIR CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: BL)") else Response.Write("(AMEX: BL)") end if %> fell $1 3/4 to $17 3/4 after the retailer reported a drop in third quarter earnings.
FOOL ON THE HILL
An Investment Opinion by MF Templar
The Economics of a Flat Fee
Rumors surrounding online industry megalith AMERICA ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> hinge on the company's pending analyst meeting in New York tomorrow. Shares of the ol' Big Blue Triangle dropped $1 to $24 5/8 today on pretty light volume, suggesting that the company's measures to keep the pending news a secret have paid off well. America Online did host a small analyst meeting last week, primarily emphasizing upcoming new product offerings, but there has been no indication from the company or any conventional sources what tomorrow's announcement is all about. Given the secrecy, however, and the fact that America Online just hosted an event four days ago covering new product introductions, it would seem that some sort of pricing announcement that could impact the analytical models would be the logical alternative.
Two weeks ago FoolNews ran a two-part screed on America Online called AOL's Media War. Concluding that the prevailing public opinion about what pricing for online services should be is overwhelmingly in favor of flat fee-style offerings, the piece argued that some sort of flat-fee offering from America Online is inevitable. The issue was more one of timing than one of whether or not it made sense to offer such a fee structure. Speculation about where America Online's pricing is going has been a live issue since the company told analysts after the close of the fourth quarter to expect gross margins to trend down, sales and marketing to head up, and revenue per subscriber to come in at $16.50 a head -- below the prevailing historical trend. The lower gross margin and lower revenues per subscriber hinted that more pricing announcements were forthcoming, pending analysis of what they might do to the business model.
America Online is always testing various pricing models. According to the Investor Relations department a few weeks ago, the firm currently has seven different pricing plans under "testing." A few weeks ago, attention in the Fool's message board turned to one of these options, a $20 flat fee, after one customer who was offered the deal when he tried to cancel his account posted the information online. In the space of a few hours, cagey cybernauts had parsed out which of the hundreds of customer service representatives America Online employs were authorized to offer this package and had begun besieging them with cancellation notices, in hopes of getting the same deal. Some have argued that much of the current state of America Online shares is governed by fear of what any kind of flat-fee pricing will do to its overall business model. A boilerplate comment in the 10-K filing a few weeks ago caused America Online to drop more than 10% when it seemed to intimate that the company might face strong competition from flat-fee providers of Internet service.
Despite the fact that the financial community seems to be scared to death of any pricing change that could cause forward estimates to be revised downward, there has not been a lot of analysis on how the economics of a shift like this would work. For months, the skeptical financial press has focused on the fact that a disproportionate share of America Online's revenue from usage come from a small group subtitled "heavy users." These customers who gobble up more than twenty hours a month have bills that average $50 or $60. Journalists are quick to conclude that should America Online introduce a flat fee, these people will see their bills fall to $20 a head, and America Online will see its revenues crash. We don't often see the opposite side of the argument, though, where overwhelming consumer demand for flat-fee pricing drives the $9.95-per-month users to switch up to a $20 or so flat fee, doubling their monthly bill.
The company's investors are now confronted by the intellectual project of figuring out what would happen if America Online were to go to some sort of flat-fee or hybrid flat-fee program. America Online has a number of options in front of it, including offering Internet-only flat-fee deals, offering overall flat-fee deals, offering plans for a fixed number of hours with fees lower than the current offerings, or decreasing the cost of using additional hours from the current $2.95 level. Company historians will recollect that it was America Online's fee-cutting exercise in 1994 that drove it to overcome chief rival COMPUSERVE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CSRV)") else Response.Write("(NASDAQ: CSRV)") end if %> and propelled it into online dominance. This is a company with a good sense of the elasticity of demand and one that has actually used pricing as a way to control the strain on its network. With the media and the public harping on flat-fee access, the ill will generated by this method of controlling network usage is becoming sizable, resulting in churn. Remembering its past experience with expanding demand following price cuts, it would not at all be out of character to see some sort of decrease in the cost to customers announced tomorrow.
The exercise that would shed the most light on the potential investment consequences is to take the extreme case scenario and see where America Online ends up after that. What is the most draconian cut in prices that America Online could offer? A $20 flat-fee for unlimited access to both America Online and the Internet. Currently many households have multiple America Online accounts to take advantage of pricing plans that reward this behavior. If the company were to go to a flat fee, there is some potential for lost accounts due to consolidation resulting from this. Obviously, not all households would have the accounts consolidate, as only one person could be on the account at the same time, limiting the ability for people with separate phone lines to access America Online simultaneously. With 5.8 million domestic subscribers as of the end of the fiscal year, we have to figure out how many accounts could be lost through account consolidation. We have to make an assumption about this number in order to get a sense of what revenues from usage would look like.
The other important variable component we have to make an assumption about before we can figure out what would the company's revenues would look like under the absolute extreme case scenario would be how many would convert to the $20 flat fee. As America Online will keep its five hour, $9.95 deal, we have to determine how many will trade up and how many will stick with the lower-price plan. Below, I have built a table that takes into account the two variables in order to come up with what revenues from American usage alone would be. This excludes any positive effect from overseas revenues, as it is difficult to predict what pricing would be for any of the localized international offerings, given that they are not under the same pressure to go to a flat-fee situation as the domestic service. It also removes the high margin "other revenues" component, simply analyzing what would happen to the revenues from usage. The percentages in the left column are the assumptions about what percentage of customers AOL will lose from account consolidation and the percentages across the top are the portion of the customer base that moves to a $19.95 flat fee, with the assumption being that the rest remain at $9.95.
Subs 50% 66% 75% 90% 0% 5.80 $260.13 $287.97 $303.63 $329.73 10% 5.22 $234.12 $259.17 $273.27 $296.76 15% 4.44 $199.00 $220.30 $232.28 $252.24
Knowing that revenues from usage (including the 400,000 international subscribers) was around $300 million last quarter, you can see that even if America Online were to lose a net 10% of its subscribers, as long as about two-thirds go to the $19.95 plan, it will only take a 14% hit on revenues. As long as a large number of people go to the flat fee, which I believe will be the case given the sense out among consumers that the flat fee is best, even if the initial sticker price is higher than the alternative $9.95 value plan, America Online can actually lose accounts from consolidation of household accounts and not take a significant hit to the revenue line. Knowing that the forward guidance called for an average of $16.50 in revenue per subscriber, America Online could actually have higher-than-expected revenues if the majority of people move to a high-priced flat fee. Build in last quarter's "other revenues" of about $31 million at a decent rate of growth and $6 to $8 million from AOL International increasing as well, and the future revenue picture should the company go to a flat fee is not all that negative at all. The prevailing opinion that it could cause a significant revenue hit could be extremely overexaggerated, particularly if this move causes a surge in demand.
FOOLISH FEATURES
The Lunchtime News featured a look at Primark's recent price slide, building up the context for the softness.
Earnings Central is a great place to look for new stock ideas. Among the recently added calls are Medicis, CheckFree, and Wackenhut Corrections.
Dale Wettlaufer (MF Raleigh),
a Fool
Heroes & Goats