DJIA: 7552.59 -28.73 (-0.38%) S&P 500: 921.13 -6.38 (-0.69%) Nasdaq: 1590.72 -11.68 (-0.73%) Disk Drive Index 231.10 -11.58 (-4.77%) 30-Year Bond 99 24/32 +6/32 6.14% Yield
Integrated telecommunications company MCI Communications Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %> gained $4 5/8 to $41 1/2 after agreeing, with the blessing of 20% owner British Telecom <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BTY)") else Response.Write("(NYSE: BTY)") end if %>, to merge with WorldCom Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCOM)") else Response.Write("(Nasdaq: WCOM)") end if %>. WorldCom raised its $41.50 per share stock swap offer to $51 per share, making the agreement the largest merger ever (in nominal dollar terms, not inflation-adjusted) in U.S. corporate history. BT will receive breakup fees worth nearly half a billion dollars as well as a nice gain on the MCI shares it holds. WorldCom, meanwhile, slid $2 3/16 to $30 15/16 on the prospect of issuing nearly one billion shares and taking on $8 billion in additional debt to finance the cash portion of the deal. GTE Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GTE)") else Response.Write("(NYSE: GTE)") end if %> was up $1 1/4 to $44 7/8 on the news, largely as a result of investors heaving a sigh of relief that GTE won't have to add to its debt (current interest payments on debt are 22% of operating earnings).
Medical laser manufacturer Laser Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LASRF)") else Response.Write("(Nasdaq: LASRF)") end if %> rose $3 5/8 to $26 7/8 after inking a deal to merge with laser maker ESC Medical Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ESCMF)") else Response.Write("(Nasdaq: ESCMF)") end if %>. Laser Industries accepted an offer to exchange each of its shares for 0.75 shares of ESC. At a current price of $39 per ESC share (using the end of year '96 share count), the deal is valued at around $240 million, which is about 4 times the 1996 sales of Laser Industries. The transaction combines two firms that are primarily involved in cosmetic and medical laser technology and will create the largest cosmetic laser firm in the world. Tel Aviv-based Laser Industries will provide ESC with two New York locations for cosmetic services. The rapid growth of cosmetic surgery in the U.S. has proven that there is a large market willing to pay high fees for vanity surgery. It is a type of surgery not covered by HMO or insurance providers, so two new points of distribution (4 total with two in Israel) in the U.S. will help ESC going forward.
QUICK TAKES: Mining house WMC Ltd. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMC)") else Response.Write("(NYSE: WMC)") end if %> rose $7/8 to $15 3/8 after it said that it might sell its Nifty copper mining operation in the east Pilbara region of Western Australia... Group 1 Software <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GSOF)") else Response.Write("(Nasdaq: GSOF)") end if %>, a provider of software to the direct marketing industry, gained $4 to $11 after reporting on Friday morning Q2 earnings per share of $0.14 on revenues of $15.4 million... Basin Exploration <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BSNX)") else Response.Write("(Nasdaq: BSNX)") end if %> added $2 1/8 to $21 3/4 after picking up in a bankruptcy sale an estimated 30 billion cubic feet (equivalent) of offshore natural gas reserves at a purchase price under $1 per million cubic feet of gas... Danka Business Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DANKY)") else Response.Write("(Nasdaq: DANKY)") end if %> added $1 3/4 to $37 3/4 after the office imaging equipment distributor signed a strategic alliance with Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %> under which Danka will offer the full HP line, but not yet on a worldwide basis. Danka will show HP its stuff only in the U.S. market while worldwide negotiations take place... Medicus Systems Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MECS)") else Response.Write("(Nasdaq: MECS)") end if %> gained $1 1/2 to $7 after it announced that it was being acquired by Quadramed Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QMDC)") else Response.Write("(Nasdaq: QMDC)") end if %> for $7.50 in cash or 0.3125 Quadramed shares for each Medicus share... BHI Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BHIKF)") else Response.Write("(Nasdaq: BHIKF)") end if %> rose $5 3/8 to $25 5/8 as the bank and financial services company agreed to buy 83% of the CEO's stake in cleaning company Aaxis Ltd. for $73 million.
Read-Rite Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RDRT)") else Response.Write("(Nasdaq: RDRT)") end if %> lost $1 3/4 to $17 1/2 after the manufacturer of disk drive heads and assemblies announced on Friday afternoon that it plans to reduce production of older thin-film inductive heads to speed its transition to magnetoresistive heads, which will result in lower-than-expected earnings and revenues for its first quarter. Competitor Applied Magnetics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> crumpled $3 5/8 to $17 3/4 after being trashed in this weekend's Barron's as well as on perceptions that an acceleration in the competitive environment will hurt the company. Today's announcement by IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> that it will be selling drives with giant magnetoresistive heads also hurt perceptions of Applied. However, Read-Rite has been doing R&D on these so-called "spin valve" heads for a number of quarters, setting it up to be able to license IBM's technology and have a working product quicker than the competition.
New media marketing company CKS Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CKSG)") else Response.Write("(Nasdaq: CKSG)") end if %> was flattened for a $22 7/8 loss to $13 3/8 after announcing that it expects to report Q4 revenues and EPS well below analysts' estimates. Because of seasonal declines in customer marketing budgets and lower-than-expected development of new business, CKS expects to report Q4 EPS of $0.06 to $0.10, at least 58% below the mean estimate of $0.24. With about one-third of its sales in new media and the rest in traditional marketing, today's shortfall in the growth outlook points out that it's not all straight-line growth just because the company is involved in burgeoning markets like the "Internet." CKS saw its shares downgraded by each of the five analysts covering the company, with BT Alex. Brown and Goldman Sachs going from the equivalent of a "buy" rating to "market perform" ratings.
Medical imaging center management company Medical Resources Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MRII)") else Response.Write("(Nasdaq: MRII)") end if %> fell $3 1/8 to $8 7/8 after pre-announcing Q3 revenues of approximately $60 million, representing sequential growth of about 15%. EPS of $0.16 to $0.19 would be flat to down from last quarter's EPS of $0.19 and below the mean analyst estimate of $0.21. The company's COO and General Counsel also resigned today. For some reason, some amazingly prescient market forces dropped MRI by 34% on no news last Friday. Last week, though, the company appointed an interim CEO, the entrance of whom may have hastened the departure of the company's COO. The pre-announced numbers don't really look horrible enough for executives to quit en masse. Culturally, the new CEO probably just wanted his own people running things.
QUICK CUTS: Centocor Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CNTO)") else Response.Write("(Nasdaq: CNTO)") end if %> fell $9 to $43 1/8 even though one analyst said that investors may be misinterpreting results of a study of its Avakine anti-arthritis drug, which had shown that some patients had experienced serious side effects. That analyst says that the incidence of lymphoma among study participants was no higher than control group lymphoma indicence... Web scratch-and-dent and overstocked inventory retailer OnSale Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ONSL)") else Response.Write("(Nasdaq: ONSL)") end if %> fell $3 1/8 to $22 7/8 as mutual fund managers rendered their negative opinion on the company in this weekend's Barron's. Amazon.Com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> also fell $3 1/4 to $50 1/2 on a similar verdict... E*Trade Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: EGRP)") else Response.Write("(Nasdaq: EGRP)") end if %> lost $3 1/2 to $29 1/4 as some investors argue that price cuts won't dent the company's franchise while other investors argue that its valuation leaves no room for error on any front.
Northwestern retailer Fred Meyer Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FMY)") else Response.Write("(NYSE: FMY)") end if %> fell $2 7/8 to $29 5/16 after announcing on Friday two large acquisitions of supermarkets in Southern California and Washington State. The company said the deals would be dilutive to 1998 EPS and accretive in the years thereafter... Telecom Argentina <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TEO)") else Response.Write("(NYSE: TEO)") end if %> lost $1 11/16 to $24 as an Argentine court delayed its decision on extending the exclusive franchise of Argentina's dominant phone companies... Hampton Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: HAI)") else Response.Write("(AMEX: HAI)") end if %> slid $1 3/16 to $8 13/16 after reporting a 30% year-over-year decline in third quarter EPS of $0.41... Apple Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> descended $1 to $18 3/4 after investors apparently weren't impressed with the company's announcements of going direct with its selling model and its "Think Different" concepts.
FOOL ON THE HILL
An Investment Opinion by Randy Befumo
Drive Makers Tumble
Disk drive investors who thought they might catch a break today were disappointed. A profit warning from Read-Rite <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RDRT)") else Response.Write("(Nasdaq: RDRT)") end if %>, an all-out mashing of Read-Rite competitor Applied Magnetics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> in Barron's, a product transition at IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %>, and a whole mess of downgrades from analysts on Western Digital <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %> and Seagate <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %> gave investors an overall down day for the entire cluster of drive and drive-component makers. Investors struggled to digest the sudden overflow of information, rooting through all of the contradictory information spewing out of the business media.
Investors involved in the industry have gotten a sudden, nasty lesson about deflationary economics. Understanding a business where prices for components and end products are supposed to fall rapidly -- and not always in tandem -- is a challenge. Assessing the available public information and developing a working model for how the future might play out given the past and similar situations in related industries is what investors should focus on right now. For those who slacked on their homework on the way in, it is time to break out the textbooks and pull an all-nighter.
Back in early October, Western Digital blamed lower-than-expected first quarter results on the fact that Seagate was dumping excess drives at cut-rate prices. Although both Western Digital and Seagate reduced production plans to account for the oversupply, Fujitsu has apparently jointed the price-cutting party. Potentially as a result of the recent monetary crisis in Southeast Asia, potentially as a part of its plan to increase worldwide market share to 7.6% from 5.2% in calendar 1996, Fujitsu is flooding the "grey" market with drives priced at levels Western Digital Chairman Chuck Haggarty said looked close to cost.
The sudden, unexpected fall in drive prices has forced Western Digital to transition faster than expected to magnetoresistive (MR) heads from thin-film inductive heads. This means Western Digital's main supplier of drive heads, Read-Rite, has to do the same. Although in hindsight many are accusing both companies of being behind the technology curve, it is really this sudden price drop that upset the apple cart. If a PC manufacturer could get the same or better price performance out of a thin-film inductive head because of higher yields and precision production, there was no real advantage to one over the other. With prices rapidly falling, thin-film inductive has lost any cost-efficiency almost overnight.
Unfortunately for Western Digital, Quantum <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QNTM)") else Response.Write("(Nasdaq: QNTM)") end if %> has already bought a good deal of the existing worldwide capacity for MR heads from TDK and Yamaha. With Read-Rite having difficulties in the transition and Applied Magnetics even farther behind, Western Digital's reliance on outside suppliers as opposed to the vertically-integrated, make-it-yourself models used by Seagate and IBM is now unfortunately going against it. As prices drop and make thin-film inductive less appealing on a cost-basis, without a firm supply Western Digital has become the odd man out in the drive industry.
All this bad news prompted a number of analyst downgrades on Western Digital. Needham & Co., Hambrecht & Quist, and Salomon Brothers all downgraded Western Digital's stock to "hold" from "buy," and Robertson Stephens cut its rating to "market perform" from long-term "attractive." All cited the renewed risk in the MR ramp-up due to the recent price declines as a major factor, cutting '98 earnings estimates to anywhere between $1.75 to $2.20 EPS. Read-Rite also got nailed as analysts assumed Western Digital would clamp down on the company's pricing. The accelerated move to MR also had Applied Magnetics downgraded by Salomon analyst John Dean.
The reason Quantum has not dropped as much as Western Digital and Seagate is because some believe the company could gain market share as a result of the turmoil. With an MR head supply firmed up, it has a temporary competitive advantage. Others point to the product mix, saying Quantum gets a larger percentage of its profits from the tape business. However, profits may not be the best way to look at this, because if Quantum takes a dive on its currently profitless business on the high-end, it could eat away profits from other product categories. With Western Digital forecasting a unit volume between 7.3 million to 7.5 million for the quarter, if it makes it target it should be able to retain its number two position.
Proving that any temporary turmoil brings the marginal opinions out of the woodwork, ex-Gruntal analyst Roxanne Googin took today as an opportunity to make a name for herself, doing an interview on the new CBS MarketWatch website. Dropped from Gruntal after sustained bearishness on basically everything she covered, Googin alleged all of Western Digital's woes could be traced back to the popularity of the sub-$1000 personal computer. "So what's happening really is that the PC does not have enough new innovations on it to support continued price performance in the components," Googin quipped, suggesting that the 2.1 gigabytes on low-end platters is sufficient for this emerging class of PCs. Googin neglected to explain why smaller drives on the desktop would not translate into larger storage capacity on the server-end, or how this view of the world fit with her May bearishness on high-end drives while she was still at Gruntal.
Further confusing today's story was IBM's launch of its giant MR technology, under development for the last three years. Giant MR (GMR) heads will go into drives that can store between 3.2 to 16.8 gigabytes of information. The "giant" is not because the heads are bigger, but because their areal densities are much higher. According to Dow Jones, these drives will have a list price of 5.3 cents per megabyte. This compares well with the existing price per megabyte, although the total price will obviously be more than double what users are paying right now. Although people are nervous about a new jump in head technology given that the last one has gone so poorly, IBM will certainly cross-license its patents to Read-Rite and Applied Magnetics. Ironically, if there were a jump to GMR it would actually give Western Digital a chance to jump ahead of Quantum and Seagate, as both are already pretty committed to MR.
In summation, the real question here is how fast head and media prices will fall on the desktop. Both drive prices and drive component prices fall at a pretty fast rate. Right now we have a situation where drive prices have fallen faster than component prices, putting pressure on gross margins at the drive makers. However, Komag <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KMAG)") else Response.Write("(Nasdaq: KMAG)") end if %> has too much capacity on the media side and Read-Rite and Applied are under pressure from their customers. Odds are, component prices will quickly follow drive prices after a lag, allowing all of the outsourcing oriented drive manufacturers like Western Digital and Quantum to regain equilibrium. As for the risk from Net PCs, any share lost on the desktop will probably come right back on the enterprise side. Rather than panicking over falling prices, investors need to understand which operating models capture the benefits of falling prices most quickly. The prices falling are inevitable -- it is just a matter of figuring out who is best prepared.
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Randy Befumo (TMF Templr), a Fool One
Dale Wettlaufer (TMF Ralegh), Fool Two
Alex Schay (TMF Nexus6), Fool Three
Contributing Writers
Brian Bauer (TMF Hoops), Fool Four
Editor