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HEROES

ROYCE LABORATORIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RLAB)") else Response.Write("(Nasdaq: RLAB)") end if %> gained $11/16 to $6 7/8 after agreeing to merge with larger generic drug company WATSON PHARMACEUTICALS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WATS)") else Response.Write("(Nasdaq: WATS)") end if %>. Watson has done deal after deal over the last two years and appears to have had success in acquiring defensible niche businesses. It has thus avoided the lingering damage in the generic drug group that was caused by IVAX PHARMACEUTICALS <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: IVX)") else Response.Write("(AMEX: IVX)") end if %> announcing mid-way through the year that price pressures were hurting the business. Using its stock, valued at 19 times 1997 estimates, the deal might appear to be dilutive, but even if the maximum number of shares is issued the whole company would trade at 17 times 1997 estimates without even considering likely cost savings from the merger.

Golf club maker CALLAWAY GOLF <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ELY)") else Response.Write("(NYSE: ELY)") end if %> gained $1 1/2 to $28 1/2 after the company announced earlier this week that U.S. Marshals had conducted a raid on a retailer allegedly selling golf clubs stolen from one of Callaway's suppliers. In the raid, reproductions of the company's Big Bertha woods and irons, as well as its War Bird clubs, were seized. Investors were heartened by the company's continued assertion of its intellectual property rights as "knock offs" eat into sales and margins. Without defending its rights, the company could see erosion of its 28% operating margins and 18-20% net margins (fat margins for almost any industry out there). Fears of brand name erosion and the difficult task of defending copyrights and patents around the world have historically kept the valuation on Callaway below estimated forward growth rates.

PSINET <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PSIX)") else Response.Write("(Nasdaq: PSIX)") end if %> rose $2 1/2 to $13 after announcing that it expects to become cash flow positive in the first half of 1997 for the first time in its corporate history. PSINet attributes the progress to its decision to become a backbone carrier to other Internet Service Providers (ISPs). To that end, the company announced that it has signed agreements more than 20 ISPs for its wholesale services products. The company also benefited from the perception that the FCC is being backed by key members of Congress in the fight between state regulatory authorities and federal authority on pricing interconnect charges for the ISP business. FCC Chairman Reed Hundt is known to be a friend of the ISPs and wants to keep Internet connections tariff-free. Today's filing in Federal court by Congressional members who crafted the telecom deregulation bill cheered investors who believe that access charges would hurt PSINet's customers.

QUICK TAKES: AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> gained $1 3/4 to $43 1/8 as investors take it as a positive that key Congressional members stand behind the case for federal authority in lowering local telephone exchange access charges... ACCELR8 TECHNOLOGY CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ACLY)") else Response.Write("(Nasdaq: ACLY)") end if %> rose $7 7/8 to $20 3/8, a stunning 63%, as Year 2000 stocks had quite a run today... Other Year 2000 companies making moves include ZITEL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ZITL)") else Response.Write("(Nasdaq: ZITL)") end if %>, up $4 13/16 to $52 1/8, and TSR INC. <% if gsSubBrand = "aolsnapshot" then Response.Write(":NASDAQ" & CHR(34) & ">(Nasdaq: TSRI)") else Response.Write("" & CHR(34) & " onClick=" & Chr(34) & "openWindow('http://quote.fool.com/uberdata.asp?symbols=TSRI', 'quotebox', 640, 460); return false;" & CHR(34) & ">(Nasdaq: TSRI)") end if %>, up $6 to $27... Voice processing systems maker MICROLOG CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write(":NASDAQ" & CHR(34) & ">(Nasdaq: MLOG)") else Response.Write("" & CHR(34) & " onClick=" & Chr(34) & "openWindow('http://quote.fool.com/uberdata.asp?symbols=MLOG', 'quotebox', 640, 460); return false;" & CHR(34) & ">(Nasdaq: MLOG)") end if %> gained $1 to $6 1/2 after the company released earnings this morning which appear to have missed estimates after backing out a tax benefit... PHAMIS INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PHAM)") else Response.Write("(Nasdaq: PHAM)") end if %> gained $1 3/8 to $12 7/8 after the healthcare information systems company announced on Christmas Eve that it is making its entry into the European market with a contract in the United Kingdom... Mobile telecommunications products maker ALLEN GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALN)") else Response.Write("(NYSE: ALN)") end if %> added $1 1/2 to $22 3/4 on the strength of an Oppenheimer "buy" rating issued Tuesday... OCEANEERING INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: OII)") else Response.Write("(NYSE: OII)") end if %> gained $1 1/8 to $15 7/8 after the harsh-environment oil services company received a favorable mention on CNBC this morning... Cigar maker CULBRO CORP. (NYSE CBO) gained $4 1/4 to $61 7/8 after the company filed a registration statement to sell certain shares in its General Cigar Holdings investment... CALENERGY CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CE)") else Response.Write("(NYSE: CE)") end if %> rose $2 1/8 to $32 5/8 as the company completed its acquisition of Northern Electric, a U.K. regional electric utility... RALCORP HOLDINGS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RAH)") else Response.Write("(NYSE: RAH)") end if %> gained $1 1/8 to $20 after the FTC approved the sale of its Chex brand cereal to GENERAL MILLS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GIS)") else Response.Write("(NYSE: GIS)") end if %>... Orange County, California-based ELDORADO BANCORP (ASE:ELB) rose $1 7/8 to $22 1/4 after announcing an agreement to be bought by Commerce Security Bancorp for $23 per share.

GOATS

No hair-raising tales of financial ruin, woe, and misery to tell today. Traders and investors appear to have come to the market in much too jovial a mood to supply us with any such stories.

And now on to some very Quick Cuts:

QUICK CUTS: GAME FINANCIAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GFIN)") else Response.Write("(Nasdaq: GFIN)") end if %> fell $1 to $7 3/4 even though the company announced this week that it has signed a contract to increase its number of outlets... As Tuesday's deal rumors died down, AMERICAN EXPRESS CO. (NYSE AXP) shed $2 3/4 to $56 7/8.

CONFERENCE CALLS

12/27/96 (Friday)
COMPUTER ASSOCIATES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CA)") else Response.Write("(NYSE: CA)") end if %>
To Discuss Q3 Sales and Earnings
(888) 243-0816 (Code: 4321) Toll Free
10 AM EST 12/27 through 10 AM 12/28

FOOL ON THE HILL
An Investment Opinion by MF Templar

MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> is one of the many personal computer-related companies to enjoy a nice rally in the last few weeks, even after climbing straight up for virtually the entire year. The software concern is most famous for holding the Windows operating system semi-monopoly, as well as dominating the applications market for word processors and spreadsheets. The Redmond, Washington-based giant has been the continued focus of attention from both fans and critics as it has moved to plow its massive free-cash flow into other businesses besides the mature operating systems and applications units, most notably the Internet and traditional broadcast media (MSNBC).

Calendar 1996 has been a tremendous year for Microsoft. Ever since the shares took a precipitous slide in August of 1995 after initial sales of Windows 95 disappointed extremely high expectations, the company has managed to press forward with earnings and revenue growth normally reserved for much smaller firms. Revenues have grown sequentially each of the past four quarters with earnings staying strong. The company has expanded gross margins as it has continued to ship more products on CD-ROM or direct via the Internet as opposed to old packaged software. As the company has begun to defer the recognition of some revenues from its core operating system and applications business, cash flow has actually improved faster than the rate of earnings growth would suggest.

With $8.95 billion in trailing revenues, Microsoft ranks as the largest independent software company in the world, second only to IBM's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> captive software unit in scale. The company had $7.1 billion in cash when it last reported earnings on September 30th, prior to the company's plan to float $1 billion worth of convertible debt with a meager 2.75% yield. At the current quote of $85 1/2, Microsoft trades at 47.2 times trailing earnings and 34.5 times forward earnings -- numbers that inspire many to use phrases like "Tulipmania" and "South Seas Bubble" to describe the current market price. Weighing the risks and rewards to ascertain the net present value of Microsoft shares is an Olympian task, made difficult by the number of moving parts in the corporate financials.

Microsoft had net profit margins of 26.8% in its fiscal first quarter, far and away in the top tier of corporate America. The company has maintained these net profit margins in the face of continually decreasing the price point paid by businesses and consumers for its products and services -- behavior rarely seen from monopolies. In spite of the continued price decreases, talk of network computers and "thin clients" from Larry Ellison of ORACLE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %> and Scott McNealy of SUN MICROSYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SUNW)") else Response.Write("(Nasdaq: SUNW)") end if %> have struck a cord with some in the media at least, prophesying the eventual downfall of the Microsoft monopoly when everyone stores their bad poetry on huge Big Brother-like networks. Looking at this possibility, many have wondered at the current price that is being paid for Microsoft shares.

The company's cash flow makes one pause before concluding that the shares are ridiculously priced, though. Because of the revenue deferral, cash flow is actually stronger -- but more volatile -- than reported earnings. In the first quarter, earnings before interest, taxes, depreciation and amortization (EBITDA) were $1.064 billion, giving the company a cash flow multiple of about 24.0 (if we multiply the $1.064 by four to get a full year result), compared to the S&P 500 trading at about 20.0 times cash flow. Microsoft can grow at 25% annually and increase margins over the next five years. The S&P 500 can grow at about 8% annually and will probably have flat margins over the next five years. If you had to buy Microsoft or the S&P 500, where would you anticipate getting an excess return on your capital? Keep in mind, Microsoft has this cash flow even while it sinks half a billion dollars into MSN, MSNBC and other broadcast and online ventures -- god forbid they turn profitable. As always, it would appear the question of valuation for Microsoft is more complicated than many would lead you to believe, although the ultimate answer will show up in portfolio performance.

ANOTHER FOOLISH THING

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Randy Befumo (MF Templar), a Fool
Fool On the Hill

Dale Wettlaufer (MF Raleigh), another Fool
Heroes & Goats

Brian Bauer (MF Hoops), one more Fool
Editing

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