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HEROES

California savings bank holding company Life Financial Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LFCO)") else Response.Write("(Nasdaq: LFCO)") end if %> rose $1 1/4 to $12 5/16 on reporting Q4 EPS of $0.73, up 74% year-over-year. Does 4.2 times annualized EPS look a little cheap? One might not want to dive headfirst into this aboveground pool without looking at the cash flow statement. Net gains from mortgage financing operations represented 80% of revenues. That sounds pretty innocuous unless you mention the dreaded phrase: "gain-on-sale accounting." Life Financial is no ordinary bank, but looks very much like a finance company. Taking out gains on securitizations of loans, and capitalizing half of the company's noninterest expenses (to match revenues from excess loan servicing in the future), net cash-based income looks closer to $0.23 to $0.30 per share for the year, which puts Life Financial closer to 41 to 50 times earnings rather than the 4.94 times earnings according to Generally Accepted Accounting Principles at which the bank now sells.

California bank City National Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CYN)") else Response.Write("(NYSE: CYN)") end if %> rose $2 1/16 to $36 1/8 after Goldman Sachs started coverage of the company by including the shares on its "recommended list." City National closed its merger with Orange County-based Harbor Bancorp late last month. That acquisition gathers in excellent market geography in Long Beach and Orange County, California, and should add to the company's non-interest revenue lines of business such as trust and investment services. In addition, the company's provision for loan losses now stands at 122 months of gross charge-offs and 444% of nonaccrual loans and "other owned real estate," or OREO. These figures do not include the Harbor combination. With negative charge-offs (loan recoveries and loans taken off non-accrual status are higher than charge-offs), the company's credit condition looks to be improving, leading Goldman's analyst to indicate a $40 per share six-month price target.

Feeder airline Mesa Air Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MESA)") else Response.Write("(Nasdaq: MESA)") end if %> gained $1 7/16 to $8 1/8 after a shareholders group led by Jonathan G. Ornstein and a limited partnership that he runs filed an amended 13D statement of ownership. The group of shareholders registered their dissatisfaction with Mesa's handing of its relationship with United Airlines' <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UAM)") else Response.Write("(NYSE: UAM)") end if %> United Express airline, saying it "believe[s] the Board of Directors should develop alternatives with respect to the United Express assets to preserve or enhance shareholder value. Such alternatives include, without limitation, the possible spin-off of such assets or sale of such assets, possibly through an employee stock ownership plan or otherwise."

Larger financial institutions turned around today, with the specialty banks among the money center institutions leading the way. J.P. Morgan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JPM)") else Response.Write("(NYSE: JPM)") end if %> gained $3 15/16 to $108 7/8 and Bankers Trust <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BT)") else Response.Write("(NYSE: BT)") end if %> traded up $3 7/8 to $110 7/8. Chase Manhattan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CMB)") else Response.Write("(NYSE: CMB)") end if %> also gained $3 1/16 to $114 1/4, and BankBoston <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKB)") else Response.Write("(NYSE: BKB)") end if %>, with exposure to both Latin America and the thriving Boston economy, gained $3 5/8 to $95 1/4. Some investors think that regional U.S. banks offer a safe haven alternative to these sorts of companies. That ignores the fact that the money center banks are probably not going to retain much of the risk they underwrite in re-floating South Korean banks. Rather, they will securitize the syndicated loans and send their salespeople out into the countryside. The portfolio investment officer at a smaller regional bank might want to juice up his or her bank's yield and take down a bunch of this Korean paper. If the banks default, it would mean a hit to these companies, but it could also ruin the "safe" domestic bank.

QUICK TAKES: RMI Titanium Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RTI)") else Response.Write("(NYSE: RTI)") end if %> rose $2 9/16 to $22 13/16 after the titanium foundry announced a number of long-term contracts with aerospace companies Boeing <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BA)") else Response.Write("(NYSE: BA)") end if %>, Northrop Grumman <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOC)") else Response.Write("(NYSE: NOC)") end if %>, and Aerospatiale... Appliance manufacturer Whirlpool <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WHR)") else Response.Write("(NYSE: WHR)") end if %> added $2 1/16 to $60 1/4 on reporting Q4 EPS of $0.86 (before one-time items), up 46% year-over-year. Net sales for the quarter gained 18% over last year's Q4... General Scanning Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GSCN)") else Response.Write("(Nasdaq: GSCN)") end if %> gained $2 5/8 to $18 after the manufacturer of lasers for metrology and machine vision equipment reported a 34% increase in Q4 revenues and a 76% increase in operating earnings (before a merger-related charge). EPS of $0.33 (excluding the charge) climbed 83% from last year's Q4 EPS of $0.18.

Dekalb Genetics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DKB)") else Response.Write("(NYSE: DKB)") end if %> added $3 13/16 to $32 3/16 after the company prevailed in an intellectual property dispute brought to court by Mycogen Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MYCO)") else Response.Write("(Nasdaq: MYCO)") end if %>... Casino operator Aztar Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AZR)") else Response.Write("(NYSE: AZR)") end if %> moved $1 higher to $9 after signing an 18-month option to purchase for $120 million the portion of the Las Vegas Tropicana it doesn't already own... Investors bid up the shares of Harvey's Casino Resorts <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HVY)") else Response.Write("(NYSE: HVY)") end if %> $2 3/16 to $29 3/16 after a buyout group and members of the management team agreed yesterday to acquire the company at a roughly 20% discount to the rest of the casino market (on a price/EBITDA basis). Those buying the shares today might have been thinking the largest shareholders could be convinced to accept a sweeter offer from another bidding group.

Compaq <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %> rose $2 9/16 to $33 after yesterday cutting prices on its DeskPro line of PCs... Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> tacked on another $3 1/4 to $86 5/16 in a run that has been virtually in force since it reported Q4 earnings... Heavy equipment manufacturer Terex Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TEX)") else Response.Write("(NYSE: TEX)") end if %> plowed ahead $1 5/8 to $22 3/4 after announcing its intention to call in debt, which will save the company $5-6 million in yearly interest expenses... DRAM and PC manufacturer Micron Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %> rose $2 9/16 to $37 13/16 as CEO Steve Appleton went to Capitol Hill today to give his opinion that International Monetary Fund help for South Korea should be based on certain conditions. Micron, a small DRAM maker in comparison to other global competitors, doesn't like the subsidies South Korean manufacturers receive from the South Korean government... Programmable logic device manufacturer Altera Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ALTR)") else Response.Write("(Nasdaq: ALTR)") end if %> jumped $2 1/16 to $38 1/2 after Prudential Securities started coverage of the company with a "buy" rating.

GOATS

The New York County Medical Society, representing roughly 5,000 Manhattan doctors, announced today that they are filing arbitration proceedings against HMO Oxford Health Plans <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: OXHP)") else Response.Write("(Nasdaq: OXHP)") end if %> in order to recover an estimated $140 million in payments that they claim Oxford owes them. Although Oxford disputed the amount of the claim and reported that it was "disappointed" by the group's action, the company's stock fell $1 3/16 to $16 9/16 on the news. This latest round of wrangling comes on top of a subpoena issued to Oxford by the New York State Attorney General's office related to the status of the company's reported $145 million backlog of overdue payments to doctors and hospitals statewide. In a deal hammered out last July, Oxford agreed to make quarterly reports on its progress in working down the backlog (this was before the Q3 earnings debacle), as well as pay interest on the outstanding claims. A spokesman for the Attorney General's office stated that regulators are still waiting for the first report. Oxford Health blew up late last October after blaming a computer conversion for overestimating its membership rolls and underestimating its claims, a gaff that also rendered Oxford unable to bill customers and make payments to doctors and hospitals.

Canadian broadband datacom products company Newbridge Networks <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NN)") else Response.Write("(NYSE: NN)") end if %> was cut $5 1/2 to $20 after pre-announcing a significant earnings shortfall for its fiscal third quarter. Newbridge stated that before cumulative one-time charges and gains, it expects to report Q3 EPS of $0.07 (after currency translation based on the average exchange rate of 0.7006 for the quarter) versus expectations for $0.24. The company attributed the looming Q3 drop to a "significant sequential decline" in revenue for time division multiplexer (TDM) systems, an "older" platform technology employed by phone companies to transmit large amounts of data across networks (the company has roughly 40% of the $15 billion TDM market). TDM sales fell to $91 million compared with Q2 sales of $133 million. With more and more companies moving to packet-based wide area network products (like ATM and frame relay) and roughly 50% of the company's revenues coming from ATM, investors would be wise to assess Newbridge's future in terms of its ATM Portfolio.

QUICK CUTS: Waste services company Browning-Ferris Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BFI)") else Response.Write("(NYSE: BFI)") end if %> was dumped for a $2 1/4 loss to $31 after reporting Q1 EPS of $0.45 versus estimates for $0.47... Funeral services provider Service Corp. International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SRV)") else Response.Write("(NYSE: SRV)") end if %> dropped $1 3/4 to $27 1/4 over concerns surrounding cumulative insider sales of 2.35 million shares since November of last year. The company was also the subject of negative comments in Sunday's edition of 60 Minutes... Worthington Foods <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WFDS)") else Response.Write("(Nasdaq: WFDS)") end if %> spoiled for a $2 9/16 loss to $10 13/16 after the meatless foods processor reported Q4 EPS of $0.11, which included a tax benefit. Taxing net income at its average rate for past quarter, Q3 operating EPS came in at approximately $0.06. In either case, the company missed the First Call mean estimate of $0.21.

Telecom services reseller CTC Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CPTL)") else Response.Write("(Nasdaq: CPTL)") end if %> was disconnected for $1 31/32 to $6 9/32 after a U.S. District Court issued a temporary injunction prohibiting the company from offering intra-LATA (local access and transport area) services in Bell Atlantic's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BEL)") else Response.Write("(NYSE: BEL)") end if %> phone territory. CTC says it has won the first round in a mutual dispute because the court also denied Bell Atlantic's request for arbitration, which brings the case before a jury... Consolidated Cigar Holdings <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CIG)") else Response.Write("(NYSE: CIG)") end if %> fell $3 1/16 to $21 7/8 after reporting a slowing in revenue growth in the fourth quarter. Although fiscal fourth quarter (which includes the holidays) revenue growth of 32% was strong, that was down from the 41% growth rate seen through nine months of the year. Q4 diluted EPS of $0.49 was below the First Call EPS estimate of $0.52.

Surgical sealant manufacturer Focal Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FOCL)") else Response.Write("(Nasdaq: FOCL)") end if %> dropped $13/16 to $14 3/16 after announcing that it expects "net losses to increase substantially in 1998" after reporting a Q4 loss of $0.08 per share... R.P. Scherer Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SHR)") else Response.Write("(NYSE: SHR)") end if %> a maker of drug delivery systems, sank $4 1/2 to $58 5/8 after reporting Q3 EPS of $0.52 (excluding a change in tax status), compared with prior period EPS of $0.61.

Diversified telecom company Cincinnati Bell <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSN)") else Response.Write("(NYSE: CSN)") end if %> slid $2 1/4 to $33 9/16 after announcing an agreement to acquire for $100 million an 80% interest in a regional PCS (personal communication services) network, teaming up with AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %>. Cincinnati Bell says start-up costs will bring down 1998 EPS by $0.15... Scan-Optics Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SOCR)") else Response.Write("(Nasdaq: SOCR)") end if %> fell $1 1/8 to $8 11/16 after the character recognition and image processing system company reported Q4 EPS of $0.33 versus $0.31 in the prior year period... Autoliv Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALV)") else Response.Write("(NYSE: ALV)") end if %>, a maker of automotive safety systems, dropped $2 5/16 to $31 1/8 after posting Q2 EPS of $0.45, missing estimates for $0.49.

FOOL ON THE HILL
An Investment Opinion
by Michael Dowd

Paired-Share Shenanigans

A major tax break that helped drive two hotel real estate investment trusts (REITs) shares through the roof last year will be cancelled if a Department of Treasury proposal announced yesterday becomes law. REITs are supposed to be fairly passive real estate owners, and only four publicly traded REITs have the special grandfathered structure called "paired-shares." That structure lets a REIT operate its own hotels, golf courses, or other real estate that is leased short-term.

A "paired-share" REIT that can manage its own hotels can effectively recapture the profits otherwise made by the management company and the franchiser. That means it gets something like 20% more yield on every dollar it invests in a hotel. The four who can play that game are Starwood <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HOT)") else Response.Write("(NYSE: HOT)") end if %>, Patriot American <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAH)") else Response.Write("(NYSE: PAH)") end if %>, Meditrust <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MT)") else Response.Write("(NYSE: MT)") end if %> and First Union Real Estate Investments <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FUR)") else Response.Write("(NYSE: FUR)") end if %>. (To learn more about paired-share REITs, read this related article.)

Once there were more paired-share REITs, but the Treasury has picked them off one at a time over the years and they have been pretty much forgotten. They suddenly came back into favor when a nearly defunct paired-share hotel REIT was taken over by an aggressive young CEO named Barry Sternlicht. The REIT, re-named Starwood, became a real performer, zooming from under $11 per share to north of $55 in less than 36 months.

Starwood's closest hotel REIT competitor, Patriot American, became a paired-share company after acquiring a small paired-share REIT last year, and the race to acquire more hotels and management companies has been pretty intense ever since. Now the Treasury, in a "revenue saving" measure, has announced that it will ask Congress to amend the "paired-share" rules. The proposal in President Clinton's fiscal 1999 budget would freeze the tax status of paired-share real estate investment companies such as Starwood.

It appears this would not affect the Starwood acquisition of ITT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ITT)") else Response.Write("(NYSE: ITT)") end if %>, unless Starwood's price drops too low. The final board vote is expected on February 12th. The Treasury has agreed that Starwood is grandfathered and confirmed that proposed rules regarding paired-share REITs won't apply to properties acquired before a Congress acts on the proposal. Transactions currently in process could proceed to closing before that date without being hurt by any new legislation.

The future of all paired-share REITs is in some jeopardy, though, and the ones most likely to get hurt are Meditrust and First Union, the two that have not yet acquired very many properties that they can manage. There is some question how hard the Treasury will fight for this change. Their estimates say it will only save about $100 million in revenues for the government. That's barely enough for one nice fighter plane or 2 1/2 special prosecutors. It may become a bargaining chip in the final budget to be traded off for something, and Starwood has employed former Senators George Mitchell and Robert Dole to see what they can do.

On rumors the Treasury would do something, the market had already whacked both Patriot and Starwood hard this year. Patriot was down 9.5% last week and Starwood has lost nearly 9% this year. Patriot American picked up $1 1/8 to $26 1/2 today after taking a bit of a beating going into the weekend, and Starwood regained $7/8 to $52 7/8 after being punished yesterday.

The total impact on these companies has been enormous. Since the rumors of the Treasury moving against paired-share REITs started in late November, the total market capitalization of these four stocks is down by some $2.3 billion. The decision to trash the paired-share REITs will have an interesting effect on the Treasury as well. The eventual potential loss to the Treasury in capital gains taxes is something approaching $580 million. In return for that, the government expects to save $100 million over five years. (A good call by someone.)

All of that Sturm und Drang leaves Patriot American selling at about 13 times Cash Available for Distribution (CAD), and Starwood at about 14.8 times CAD. (CAD is analogous to "free cash flow" in the corporate world). At those multiples, Patriot American would appear to be selling pretty close to the value of its underlying assets (including its Wyndham hotel brand name), and it seems reasonable to think the market has over-reacted. Starwood is still selling at a healthy premium, especially if its deal flow dries up as a result of all this, but if Congress does not pass this law, the irrepressible Mr. Sternlicht may well surprise the pants off Starwood's doubters. It would be a very risky short position to take.

Monday's trading ended with the paired-shares REITs a little worse for the wear. Starwood sold off on volume of 2.51 million shares, well above its 30-day average daily volume (722,000). 2.5 million is a big chunk of Starwood's 51,325,000 total shares outstanding. A few major funds like Cohen & Steers and Fidelity have been such large holders they will have a hard time bailing out in any hurry. If Sternlicht can persuade them that he is likely to win a significant part of the legislative battle, the bottom may not be too much further down.

[Michael Dowd is a real estate investment banker and a longtime Fool writing under the screenname TMF Yorick. Yorick and the crowd in the real estate industry folder invite you to join their beta test of a daily and weekly spreadsheet containing the latest REIT pricing and valuation data. If you would like to join the gang, send Michael a note at [email protected].]

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