The Evening News - Thursday, January 02, 1997

GEOTEK COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GOTK)") else Response.Write("(Nasdaq: GOTK)") end if %> gained $1 to $8 after the company placed $50 million in convertible debt with a group of investors including George Soros. While its total valuation, or enterprise value, increases significantly with today's addition of debt, there is also the concept of "fully diluted shares" that an investor has to deal with. When convertible financing instruments are issued by a company, the effect of conversion should be figured into the valuation of the company. For instance, if a company has 50 million shares outstanding and earns $50 million, its earnings per share (EPS) will be $1.00. If it has preferred stock convertible into 7 million shares, 5 million options and 2.5 million warrants "in the money," that EPS would now be $0.78 to $0.85 (at a maximum 10% dividend on the preferred). Plus, the enterprise value would be inflated by the value of the extra 7.5 million shares (the preferred doesn't count in that calculation).

On a day that customer PHILIP MORRIS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MO)") else Response.Write("(NYSE: MO)") end if %> lost ground, SCHWEITZER-MAUDUIT INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SWM)") else Response.Write("(NYSE: SWM)") end if %> gained $1 1/2 to $33 1/8. The company sells fine tobacco papers to cigarette manufacturers and recently extended a supply agreement with Philip Morris. Having exited the reconstituted tobacco leaf business, the company's litigation risk is lower, though it's still not without some of the risk that perpetually hangs over the heads of the tobacco companies. This is why KIMBERLY CLARK <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %> jettisoned the business in 1995. Otherwise, it would have been pretty hard pressed to explain to its shareholders why it would dump a niche business doing operating margins of almost 16% that normally doesn't require expensive capital investments.

QUICK TAKES: BIRMINGHAM STEEL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BIR)") else Response.Write("(NYSE: BIR)") end if %> climbed $2 to $21 after the mini-mill steel company announced a joint venture with Japan's Mitsui on New Year's Eve... Chinese railroad GUANGSHEN RAILWAY CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GSH)") else Response.Write("(NYSE: GSH)") end if %> gained $1 3/4 to $22 3/8 after French bank Credit Lyonnais issued a derivative security involving Guangshen... Titanium foundry COASTCAST CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAR)") else Response.Write("(NYSE: PAR)") end if %> gained $1 1/8 to $15 5/8 as premium golf clubs were a bright spot in the holiday retail picture... COACH USA <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TOUR)") else Response.Write("(Nasdaq: TOUR)") end if %> gained $5 1/4 to $34 1/4 after the tour bus company announced that it will acquire four similar firms, including two Gray Line companies... AMATI COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMTX)") else Response.Write("(Nasdaq: AMTX)") end if %> bounced $1 3/4 to $14 7/8 as an early January-effect baby...

COMPUSA INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPU)") else Response.Write("(NYSE: CPU)") end if %> plunged $4 3/8 to $16 1/8 after reporting that second quarter same-store sales increased 1.5% and total sales increased 22%. The stock has been in retreat since late October as analyst downgrades pummeled it and investors expressed dissatisfaction with the numbers. Today's announcement about sales came without an earnings pre-announcement, so the investor is left without a whole lot of clues as to what the announcement means to the bottom line. With producer price inflation being a double-digit negative number in the PC business almost every year, a single-digit increase in same-store sales doesn't necessarily mean the company can't drive its earnings higher. When expectations are set so high for this company, though, it's likely it just won't be able to meet them every quarter. For the Q3 the company is estimated to earn $0.30 per share, double Q1 EPS.

PC original equipment manufacturer DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> fell $1 7/8 to $51 1/4 as CompUSA's announcement rippled through other parts of the "tech sector." Dell is not in the same boat as CompUSA, though. Dell's revenues have been growing at a greater rate and its margins are far larger than CompUSA's. In addition, CompUSA has to meet the entire spectrum of consumer needs, while Dell's business-to-business sales turn inventories faster and hit the high end of product offerings in the PC industry. While CompUSA might be striving for more business-to-business sales and higher-margin service and teaching sales, they are still vulnerable to the same dynamics that hurt retailers such as BEST BUY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBY)") else Response.Write("(NYSE: BBY)") end if %>. Reading CompUSA's results into the outlook for Dell might be wrong-headed, since they are just not the same type of business.

BELL ATLANTIC CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BEL)") else Response.Write("(NYSE: BEL)") end if %> gained $2 1/4 to $67 and NYNEX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NYN)") else Response.Write("(NYSE: NYN)") end if %> added $1 3/4 to $49 7/8 as the Baby Bells start to assert themselves -- as seen with today's filing by AMERITECH <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AIT)") else Response.Write("(NYSE: AIT)") end if %> to provide long-distance services in Michigan. MCI <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %> countered with a scorching press release saying that Ameritech continues with non-competitive practices in long-distance by requiring customers to dial a five-digit code to access long-distance carriers. Bell Atlantic/NYNEX moved up on the news because so much long-distance calling is done in its region, which includes Boston, New York City, Philadelphia, and Washington. Should the merger between these two be completed, the combined company would be a force to be reckoned with on all levels of the deregulated telecommunications playing field

QUICK CUTS: Computer products wholesaler INGRAM MICRO <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IM)") else Response.Write("(NYSE: IM)") end if %> lost $1 3/4 to $21 1/4 on PC-market jitters... MAC FRUGAL'S BARGAINS CLOSE-OUTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MFI)") else Response.Write("(NYSE: MFI)") end if %> closed down $2 1/8 at $24 after reporting December same-store sales results of +1.5%... After being cut to "neutral" by brokerage Raymond James, AUTOZONE INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AZO)") else Response.Write("(NYSE: AZO)") end if %> slipped $1 3/4 to $25 3/4... WET SEAL INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WTSLA)") else Response.Write("(Nasdaq: WTSLA)") end if %> dove $3 1/4 to $18 1/8 as retail pre-announcements hurt the shares... CONRAIL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CRR)") else Response.Write("(NYSE: CRR)") end if %> suitor NORFOLK SOUTHERN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NSC)") else Response.Write("(NYSE: NSC)") end if %> lost $2 to $86 as CSX CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSX)") else Response.Write("(NYSE: CSX)") end if %> rebuffed its claim that CSX's merger tactics are coercive... Web software company SPYGLASS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SPYG)") else Response.Write("(Nasdaq: SPYG)") end if %> lost $1 1/4 to $11 1/4 after the company said fourth quarter revenues and earnings will come in light...

How do you know when to purchase a high-flyer that has been shot down like a clay pigeon? Investors looking at shares of COMPUTER ASSOCIATES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CA)") else Response.Write("(NYSE: CA)") end if %> these days have been grappling with this very question. Since the company announced on December 26th that business was not as robust in Europe as previously thought, Wall Street has been falling all over itself to sell the shares, pushing the stock down another $3 1/2 to $46 1/2 today. As hard as it is to believe that barely a week ago Computer Associates was within a hair of its 52-week high of $67 7/8, it is even harder to understand why the same people who were willing to purchase shares of the company at those levels aren't tripping all over themselves to buy now.

Let's try to dissect the announcement that Computer Associates made a week ago in order to ascertain the potential impact on the company's bottom line. Business in Europe was weak. As a result, the company will see fourth quarter revenues increase only 10% from year-ago levels. Management described the product pipeline as "looking good," but deals are simply not closing as fast as anticipated. Rick Sherlund of Goldman Sachs was quoted in the financial press that day saying at least $100 million in revenues need to be taken out of future projections. The specific problems seem to stem from the company's client/server business, while the slow-growth mainframe business appears to remain strong.

Computer Associates is the third-largest independent software concern on the planet, behind MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> and ORACLE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %>. The company is unlike both of these names in that it pays a small dividend and, most importantly, buys other companies in order to continue double-digit growth rates. The most recent deal was the offer to buy out CHEYENNE SOFTWARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CYE)") else Response.Write("(NYSE: CYE)") end if %> for $30.50 per share, a $1.2 billion deal. Although hardly the size of 1995's purchase of LEGENT Software, it does represent the company's commitment to "gobble-to-grow," a policy that has allowed them 45% average annualized profit growth since 1992.

Looking at Computer Associates' historical results, it seems clear that the company has a lot of fixed costs but not a tremendous amount of variable costs in their business model. What I mean by this is that it costs them a fixed amount to run their business, but above this almost everything else is profit. This is why their last four quarters of profits show a large degree of variability, running $0.60, $0.70, $0.32 and $0.59 earnings per share (EPS) -- while revenues are much less volatile, clocking in at $1004.4 million, $1110.4 million, $792.1 million and $990.1 million. This is why the company is able to grow earnings faster than revenues, and why it may be able to hit earnings estimates in spite of the fact that a bunch of business failed to materialize.

The most interesting thing to emerge out of the conference call was the fact that management believes it can still hit its $0.75 EPS estimates for the quarter, in spite of the business shortfall and the cost of sending all kinds of technical employees to Europe. If the company can do this, it would represent 25% growth over the $0.60 per share that it earned a year ago. Even if it misses by a few pennies, 20% profit growth seems possible on revenue growth of around 10%. If Computer Associates makes the estimates, the company would have $2.36 EPS in trailing earnings and $3.992 billion in trailing revenues. Given the current share count of 364.8 million shares, $740 million in long-term debt and $201 million in cash, we can run some valuations on the stock.

At $46 1/2:

Price/Earnings Ratio -- 19.7
Price/Sales Ratio -- 4.25 
Enterprise Value -- $17,502 million
Enterprise Value/Sales -- 4.38
Profit Margins -- 21.7% last quarter, 21.4% last year

What kind of growth can the investor in Computer Associates expect to see over the next few years on average? Consensus estimates before the recent debacle called for 22% growth, not bad for a company with profit margins above 20% and trailing revenues of roughly $4 billion. What would a fair multiple on the current earnings be? Given the perceived risk of a profit shortfall this quarter, the institutions are saying that 20 times trailing earnings is a fair price to pay. These are the same guys who said two weeks ago that 22 times forward earnings estimates of $3.09 EPS was a fair price to pay, thus the $66 price tag.

The last factor investors should throw into the mix here is the fact that the company is buying back its stock. During July, when the share price touched the high $30s during the "technology" sell-off, Computer Associates called the current share price "completely irrational" and promised to aggressively buy back stock. The company's Board of Directors extended the 1992 share repurchase to 75 million shares, an addition of 18.75 million. Although Computer Associates does not file with EDGAR yet, I would assume it is buying back about 2% to 4% of its shares over the next year, which should juice up its EPS results.

In a piece written in early December called Discount, we analyzing the notion that the current price of a share of stock is the value of the sum of the estimated cash-flows the company can generate discounted for the degree of risk associated with generating these cash-flows. Computer Associates has gone from 22 times forward earnings to 20 times trailing earnings largely because the risk has increased, not because the numbers have changed. Although this is far from a traditional value stock, the risk-to-reward is pretty plain. If this is a major problem that will cause the growth rate to slow to 15%, the stock will probably be around $40 in a year. If this is just a short-term problem and the company can maintain 20% growth, $60 is not out of the question. Despite the high multiple, the risk-reward looking a year (and not a quarter) out is fairly good.

Presstek, Iomega, Iraqi Oil Sales, a stock market crash, Disney's two Michaels... Some of these might show up in the Rogue's "The Good, the Bad, and the Hyped." Join Jim Surowiecki and Randy Befumo as they stroll down the primrose path of 1996 happenings, observing the Foolish and the not-so-Foolish.

Learn to value stocks painlessly! In the Industry Decathlon primer, MF Bogey takes readers by the hand and walks them through five stock valuation methods and ten financial ratios, demonstrating how to compare a bunch of companies in your industry of choice and find the most promising one. This is very useful stuff, folks! Check it out at keyword: FoolMart on America Online or at our website (). You might also be interested in his weekly Industry Decathlon report, delivered by e-mail or fax. In it, Bogey examines a different industry each week and runs its top players through his decathlon to discover which one company looks the most attractive.

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