HEROES

PRICE ENTERPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PREN)") else Response.Write("(Nasdaq: PREN)") end if %> was marked up $2 3/4 to $22 after the former half of retailer Price/Costco, now known as COSTCO COMPANIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COST)") else Response.Write("(Nasdaq: COST)") end if %>, announced a reorganization designed to further enhance shareholder return. The company, which owns the non-warehouse real estate of Price Club and Costco (totaling 25 million members), has returned over 21% per year since breaking apart from Costco in late 1994 and has a dividend yield of 6.2%. Going into today, the company was also selling below book value because of an abysmal annualized return on invested capital of under 3% this year. In order to take away a tax burden on the real estate, the company will become a REIT and spin off one share of its PriceSmart merchandising business for every four shares of Price Enterprises.

KELLOGG CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: K)") else Response.Write("(NYSE: K)") end if %> ran up $4 to $91 after the cereal and breakfast foods maker benefited from a Merrill Lynch rating upgrade to "long-term buy" from "long-term accumulate." Ironically, Merrill Lynch downgraded the shares of GENERAL MILLS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GIS)") else Response.Write("(NYSE: GIS)") end if %>, possibly before it knew that General Mills was raising cereal prices 2.6%. Some believe that competitors won't take advantage of that move by undercutting General Mills. With price competition so severe over the last few years, the reasoning goes, Kellogg and the Kraft division of PHILLIP MORRIS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MO)") else Response.Write("(NYSE: MO)") end if %> will feel free to raise prices, too. Other analysts believe the price increase is a sign of weakness and that General Mills feels a need to do this. In that case, then maybe competitors smell blood in the water, which may be the reason for Merrill's downgrade of General Mills.

WINSTAR COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCII)") else Response.Write("(Nasdaq: WCII)") end if %> rose $1 7/8 to $16 5/8 after underwriter and long-time backer CS First Boston re-initiated coverage of the competitive local exchange carrier and interexchange carrier company with a "buy" rating. First Boston possibly likes WinStar so much because of the vast amount of investment banking business WinStar sends its way. WinStar uses the cash raised to buy 38-gigahertz wireless licenses and other assets, such as companies owned by WinStar's CEO William J. Rouhana Jr. Some believe that the businesses that WinStar has bought from Rouhana were vastly overvalued and that an emerging telecommunications carrier should just forget about investing in content companies such as WinStar New Media. The other factor driving up the stock price today was the initiation of a shareholder rights plan, which is always a great way to pop up an underperforming stock.

QUICK TAKES: LECTEC CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LECT)") else Response.Write("(Nasdaq: LECT)") end if %> gained $2 1/4 to $8 1/2 after announcing it has won a patent for a "therapeutic method to control long-term human body weight"... "The World's Biggest Bookstore," AMAZON.COM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %>, jumped $3 7/8 to $22 15/16 on no news that the company knows of. Amazon reports earnings on July 24... KRYSTAL CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KRYS)") else Response.Write("(Nasdaq: KRYS)") end if %> exploded $7 1/4 higher to $13 1/2 after a company headed by Phillip Sanford, CFO at COCA-COLA ENTEPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCE)") else Response.Write("(NYSE: CCE)") end if %>, said it will acquire the fast food operator for $14.50 per share in cash... SILICON GAMING <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SGIC)") else Response.Write("(Nasdaq: SGIC)") end if %> hit the jackpot, moving up $1 3/4 to $14 after announcing that its Odyssey computer slot machine "has successfully completed trials with ten Nevada Casinos" and that it has "successfully entered the Tahoe market" in three casinos there... COSTILLA ENERGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COSE)") else Response.Write("(Nasdaq: COSE)") end if %> rose $1 9/16 to $14 1/8 on announcing that it will acquire reserves of six million barrels of oil, 150 square miles of seismic data, and some development property, which it says will be accretive to earnings by 1998... Duty free stores operator DUTY FREE INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DFI)") else Response.Write("(NYSE: DFI)") end if %> rose $3 5/8 to $23 3/4 after agreeing to be acquired by Heathrow and Gatwick airport management company BAA plc for $24 per share in cash... Electronics distributor WYLE ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WYL)") else Response.Write("(NYSE: WYL)") end if %> picked up $6 1/2 to $49 5/16 on agreeing to be acquired by Raab Karcher AG for $50 per share in cash... AMERICAN EXPRESS CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AXP)") else Response.Write("(NYSE: AXP)") end if %> jumped $6 7/8 to $83 on no discernable news outside of the usual CITICORP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCI)") else Response.Write("(NYSE: CCI)") end if %> takeover rumors as well as expectations that its revolving credit card line is doing well... BRITISH TELECOMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BTY)") else Response.Write("(NYSE: BTY)") end if %> climbed $5 9/16 to $81 1/2 as investors were relieved that the company's share of a British "windfall" tax imposed by the Labor government will be lower than expected. MCI <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %>, BT's merger partner, gained $2 3/8 to $42 3/8... First Boston's "buy" rating on CANADIAN OCCIDENTAL PETROLEUM <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: CXY)") else Response.Write("(AMEX: CXY)") end if %> sent the company's shares $1 1/2 higher to $24 5/8.

GOATS

IXC COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IIXC)") else Response.Write("(Nasdaq: IIXC)") end if %> slumped $4 1/8 to $20 1/4 after the fiber optic telecommunications backbone provider said that revenues and cash flow margins in its switched long-distance business have fallen short of plans. Although the company once again emphasized its low-cost structure and said it believes that 1998 EBITDA (earnings before interest, taxes, depreciation and amortization) will grow 525%, its cash flow outlook has been hampered by an unfavorable business mix of long-distance voice traffic generated by customers in high-cost regions, as well as "uneven traffic patterns [which created] high network overflow costs."

RANKIN AUTOMOTIVE GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RAVE)") else Response.Write("(Nasdaq: RAVE)") end if %> declined $1 1/4 to $7 3/4, continuing a sharp slide from its high of $24 1/2 set in mid-May. Dow Jones said "sluggish sales" are possibly a factor, while others believe Rankin was simply overvalued. The company runs operating margins of 2.1% and generates return on invested capital (after-tax operating earnings divided by total assets minus cash and non-interest bearing current liabilities) of 4.95%. Even backing out the goodwill on the balance sheet, the company generated return on tangible invested capital of 5.3%. Neither of these is good enough to even cover the costs of the capital invested in the business, which made people wonder earlier this year why a commodity retailer of auto parts was trading at 47.5 times FY98 EPS estimates, 450 times FY97 EPS, and 103 times operating earnings. If a company can't cover the costs of capital invested in the business, a cash crunch often follows.

QUICK CUTS: INSO CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INSO)") else Response.Write("(Nasdaq: INSO)") end if %> was almost cut in half today, losing $9 11/16 to $11 1/16, after the maker of the American Heritage Dictionary software and spell-checking and proofreading software announced a restructuring because of lower-than-expected revenues and expected EPS of $0.10, below estimates of $0.36... Regional railroad WISCONSIN CENTRAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCLX)") else Response.Write("(Nasdaq: WCLX)") end if %> lost $2 7/8 to $38 3/8 after Donaldson, Lufkin & Jenrette lowered its rating on the company to "market perform" from "buy"... Regional brokerage and investment bank INTERSTATE/JOHNSON LANE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IJL)") else Response.Write("(NYSE: IJL)") end if %> fell $2 5/8 to $19 7/8 on thin volume of 14,400 shares... Diagnostic kit maker SELFCARE INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: SLF)") else Response.Write("(AMEX: SLF)") end if %> shed $1 1/16 to $11 3/8 on a Lehman Brothers rating downgrade to "outperform" from "buy."

FOOL ON THE HILL
An Investment Opinion by Randy Befumo

Dilution in Defense

NORTHROP GRUMMAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOC)") else Response.Write("(NYSE: NOC)") end if %> rocketed $21 1/8 to $110 today after LOCKHEED MARTIN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LMT)") else Response.Write("(NYSE: LMT)") end if %> announced a massive acquisition that will create one of the largest defense companies on the planet. Lockheed Martin will swap 1.1923 shares of its own stock for each share of Northrop Grumman in a "pooling of interests" acquisition. The deal is the latest in a series of major mergers between aerospace and defense companies since the collapse of the Berlin Wall, a trend that continues to shrink the number of major players in the aerospace and defense electronics business. Looking at a large deal like this that involves billions of dollars in equity and debt gives us an interesting opportunity to explore how to quickly analyze a merger to determine whether or not it will be "dilutive."

The first step in determining whether a deal will be dilutive is figuring out what prices are being paid. Valuing this merger involves a bit of digging, given that Northrop Grumman has another pending merger with defense electronics developer LOGICON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LGN)") else Response.Write("(NYSE: LGN)") end if %> that has not been completed. Should the Logicon merger close at the current 0.6919 share exchange ratio, Northrop Grumman will have 67.9 million shares outstanding. This means that Lockheed Martin will need to issue $8.0 billion in total stock at the current market price for the equity (or stock). The equity is only part of the purchase price, however. Since Northrop has $2.9 billion in long-term debt from its acquisition of Westinghouse's defense electronics business last year, Lockheed Martin will have to assume this debt as well. The equity and the debt added together put the acquisition value at roughly $10.9 billion.

This $10.9 billion price tag values B-2 bomber contractor Northrop Grumman's debt and equity at 1.3 times the company's current revenue run-rate of $8.4 billion, including Logicon's pro forma revenues. A run-rate is the last quarter's results multiplied by four to get an annualized result. In this case, since Northrop had about $1.9 billion and Logicon had $155 million in sales last quarter, the run-rate comes out to about $8.4 billion after rounding. The reason why we want to look at the run-rate is because the acquisitions Northrop has made in the past year may not be fully reflected in the historical financials for the last four quarters. Looking at the company's current run-rate is much more indicative of its actual sales potential than looking at the trailing revenues. The only trick when using run-rates is to make sure that you use them consistently to ensure you are making apples-to-apples comparisons.

With 216.4 fully diluted shares outstanding, Lockheed Martin's equity is currently valued at $21.5 billion with $9.9 billion in debt outstanding. The company booked $6.7 billion in revenues during its last reported quarter, giving it a revenue run-rate of roughly $26.6 billion. This values Lockheed's debt and equity at 0.85 times sales. Because Lockheed is paying a higher multiple to sales for the debt and equity of Northrop (including Logicon), this implies that the deal may be "dilutive." The concept of dilution is pretty straightforward -- if one company acquires another company at a higher valuation than it currently warrants, earnings per share will probably be "diluted" as a result, and will be lower than it otherwise would have been.

While we know that the sales per share will be dilutive, we have to go another step to determine whether or not this deal will be dilutive to earnings. The simplest way to do this is to look at the relative profit margins for both companies. For Northrop, we need to add Logicon's results in order to reflect the whole package that Lockheed Martin is buying. Because of the acquisitions over the last year, we will look at the quarterly profit margins instead of the profit margins over the last year. Northrop and Logicon earned $84.3 million on $2.1 billion in revenues, giving it net profit margin of roughly 4.0%. Lockheed Martin earned $290 million on $6.7 billion in sales, giving them net profit margin of 4.3%.

Now that we know Lockheed earns slightly more on each dollar of sales than Northrop, we can make a preliminary conclusion about how this merger at the current valuation will affect Lockheed's near-term earnings. Lower margins and a higher valuation for Northrop mean that Lockheed will suffer near-term dilution in earnings per share. Although net earnings will increase, the number of shares outstanding due to this acquisition will increase faster, canceling out the effect of the increased earnings. This is why in spite of the size and scale of this $42 billion merger, Lockheed Martin fell $4 7/8 to $99 1/8 on the day. Being able to determine quickly whether or not a merger will be potentially dilutive to earnings can help explain why a company's stock price moved down in spite of positive merger news.

CONFERENCE CALLS

PAYCHEX INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PAYX)") else Response.Write("(Nasdaq: PAYX)") end if %>
(402) 220-5186
Replay available through 7/4

GENZYME CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GENZ)") else Response.Write("(Nasdaq: GENZ)") end if %>
(Re: Genzyme Tissue Repair shares and Carticel performa
(402) 220-6028 -- replay available through 7/8 @ 5:00 p.m. EDT

VISUAL EDGE SYSTEMS INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: EDGE)") else Response.Write("(Nasdaq: EDGE)") end if %>
(800) 247-9979 -- replay for 24 hours

07/08/97 (Tuesday)
HELEN OF TROY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HELE)") else Response.Write("(Nasdaq: HELE)") end if %>
(800) 275-2442 -- replay for 24 hours

07/08/97 (Tuesday)
CANANDAIGUA WINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WINEA)") else Response.Write("(Nasdaq: WINEA)") end if %>
(800) 839-1153 (password: 1234) -- through 12:30 p.m. EDT on 7/10

07/09/97 (Wednesday)
MOTOROLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MOT)") else Response.Write("(NYSE: MOT)") end if %>
(402) 220-4831 -- replay available through 7/10

THIS WEEK'S CONFERENCE CALL SYNOPSES

MOTOROLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MOT)") else Response.Write("(NYSE: MOT)") end if %> DRAM Call
APOLLO GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APOL)") else Response.Write("(Nasdaq: APOL)") end if %> Q3 Call

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