FOOL PLATE
SPECIAL
An Investment Opinion by Dale
Wettlaufer
Analytical Freedom,
Part 2 --
Putting a Price on Goodwill
Sick of being hassled by the GAAP (Generally Accepted Accounting Principles)
man? As the standard for reporting financials, GAAP builds efficiency into
the equity markets, but there are certain limitations to its usefulness in
assessing the value of an enterprise.
Yesterday, we considered how GAAP hides
the real value of AMERICA ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> by seriously understating
the number of ownership claims (shares) and potential ownership claims on
the company. Today, we take a look at "goodwill amortization," which is a
non-cash, non tax-deductible charge arising from the difference between the
appraised net asset value of a business and the purchase price of that business.
Sound complicated? Not to worry, it means very little when it comes to the
real profitability -- the ability to generate cash --of a business. It does,
however, reduce reported earnings. Happily, it presents an opportunity for
the analytically free investor to look through the amortization to see real
value and comparative value.
Companies that do a lot of cash acquisitions generate goodwill. Instead of
issuing shares to do a pooling of interests (which generates no goodwill
assets and no amortization charges), a cash acquisition when done properly
can be immediately and substantially additive to earnings per share. One
such company, CARLISLE COMPANIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSL)") else Response.Write("(NYSE: CSL)") end if %>, purchases family-controlled
businesses for cash and retains the management teams. It buys wonderfully
boring businesses such as trailer manufacturers and makers of aircraft wire.
A residual effect of its acquisition strategy is quarterly amortization charges
of $1.5 million, or about $0.05 per quarter. Since this is a non-cash charge
and since it doesn't usefully represent the spreading of the costs of that
acquisition over its useful life (the point of goodwill amortization), I
add it right back into earnings. At 15 times earnings, that's another $3
per share in value that is disregarded by the GAAP way of looking at things.
Banking companies are another large generator of goodwill, as the still
fragmented industry continues to consolidate. On the balance sheet of WELLS
FARGO <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WFC)") else Response.Write("(NYSE: WFC)") end if %>, you'll find a ton of goodwill arising from its acquisition
of First Interstate, which makes its way to the income statement in the form
of amortization. Many investors regard the company as being seriously overvalued
at 24 times operating EPS, arguing that it shouldn't carry such a large premium
to a company like BANKAMERICA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %>, which is valued at 17.6
times operating EPS. Wells Fargo has generated $4.09 per share in amortization
over the last twelve months while BankAmerica's income statement is weighed
down by only $0.38 per share in amortization over the same time period. Adding
back these charges and comparing the valuations, we see Wells Fargo trading
at 17.6 times operating EPS and BankAmerica trading at 16.2 times operating
EPS. Taking goodwill and amortization out of a key measure of banking
profitability -- return on equity -- Wells Fargo is 24% more profitable on
an operating basis than BankAmerica, yet carries only an 8.6% valuation premium.
While other bank investors might not look at things in the same way that
I do, and while their accounting adjustments might differ, in the end, we
all should feel free to develop our own valuation tools to plumb profitability
and should not feel constrained by GAAP in all of our analytical perspectives.
UPS
OXFORD INDUSTRIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: OXM)") else Response.Write("(NYSE: OXM)") end if %> was marked up $2 11/16 to $37 5/16
after the apparel marketing and manufacturing company reported record sales
and sharply higher earnings for its first quarter ending August 29, 1997.
Net earnings increased 56% to $5.4 million or $0.61 per share from $0.40
per share the prior year.
Bear Stearns analyst Michele Wolf confirmed today that she raised her rating
on shares of EXCEL COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ECI)") else Response.Write("(NYSE: ECI)") end if %> to "buy" from "attractive"
with a 12-month price target of $36 a share. Excel shares are up $2 1/8 to
$24 15/16 this morning.
Prudential Securities initiated coverage of COMPLETE MANAGEMENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: CMI)") else Response.Write("(AMEX: CMI)") end if %> with a "buy" rating this morning, moving shares of the health care
administrative services company $13/16 to $18 7/8.
VOXWARE INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VOXW)") else Response.Write("(Nasdaq: VOXW)") end if %> gained $3/4 to $5 15/16 after wowing
conventioneers at today's Voice Over the NET conference in Boston, displaying
a technology solution that advances the quality of voice communication over
IP networks.
Electronic hardware distributor QUESTRON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QUST)") else Response.Write("(Nasdaq: QUST)") end if %>
jumped $1 1/16 to $7 11/16 after announcing that it has completed its acquisition
of California Fasteners Inc., a distributor of fasteners and related items.
Satellite-based communications company AMERICAN MOBILE SATELLITE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SKYC)") else Response.Write("(Nasdaq: SKYC)") end if %> launched $1 1/4 higher to $8 7/8 after coverage was initiated by Unterburg
Harris with a "buy" rating.
AURORA BIOSCIENCES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ABSC)") else Response.Write("(Nasdaq: ABSC)") end if %> got a $1 boost to $14 1/2 this
morning after announcing that it has entered into a collaborative research
and licensing agreement with WARNER LAMBERT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WLA)") else Response.Write("(NYSE: WLA)") end if %> with a potential
value to Aurora of over $65 million.
Biometallic chemistry and pharmaceutical company PHARMACYCLICS INC.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PCYC)") else Response.Write("(Nasdaq: PCYC)") end if %> gained $2 to $25 7/8 after Morgan Stanley initiated coverage
with a "buy."
HEWLETT-PACKARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %> and FOREFRONT GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FFGI)") else Response.Write("(Nasdaq: FFGI)") end if %>
today announced that HP had acquired ForeFront's Internet-printing technology
for net cash proceeds of approximately $2.3 million. Forefront gained $13/16
to $7 3/4.
Fixing debt at attractive rates spurred numerous deals on Monday, among them
ADELPHIA COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ADLAC)") else Response.Write("(Nasdaq: ADLAC)") end if %> more than doubled the size
of its offering of senior notes to $325 million from $150 million, which
boosted its equity shares $1 13/16 to $11 5/8 this morning.
DOWNS
Producer of dynamic random access memory chips MICRON TECHNOLOGY
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %> got crunched $3 9/16 to $36 15/16 after announcing that it earned
$0.33 a share in the fourth quarter, falling below the Wall Street consensus
forecast of $0.50 per share.
Citing lower giftware sales and a charge to downsize operations, STANHOME
INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: STH)") else Response.Write("(NYSE: STH)") end if %> was demolished for a $2 7/8 loss to $30 7/8 on saying
after the bell on Monday that it expects to report a net loss for the third
quarter.
In other earnings guidance, LAN and WAN doctors WANDEL & GOLTERMANN
TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WGTI)") else Response.Write("(Nasdaq: WGTI)") end if %> dropped $2 to $9 3/4 after saying that it
expects to report lower-than-expected revenues and earnings for its fourth
fiscal quarter ending September 30, 1997.
Manufacturer of aluminum electrolytic capacitors AEROVOX INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ARVX)") else Response.Write("(Nasdaq: ARVX)") end if %> lost $1 1/8 to $5 1/4 after the company lowered its sales and earnings
forecast for the third quarter because of "sharply lower'' bookings in its
AC film capacitor lines. It now expects to post a loss in the third quarter
because of deeper-than-anticipated production cutbacks among North American
air conditioning manufacturers.
High-performance vehicle parts maker EDELBROCK CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: EDEL)") else Response.Write("(Nasdaq: EDEL)") end if %>
hit the brakes $1 3/4 to $18 1/8 after reporting that it expects strong operating
results for the first fiscal quarter ending Sept. 25, 1997, but that its
net results may be influenced by the announced reorganization of one of its
largest customers, Super Shops Inc.
Marine support and transportation services company HVIDE MARINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HMAR)") else Response.Write("(Nasdaq: HMAR)") end if %> sank $2 5/8 to $33 1/2 this morning after announcing that it expects
earnings in the third quarter ending September 30 to be below analysts'
expectations but higher than in the previous quarter, and well above the
year-ago period.
The earnings woes continue as thin-film and integrated passive electronic
circuit maker CALIFORNIA MICRO DEVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CAMD)") else Response.Write("(Nasdaq: CAMD)") end if %> lost $9/16 to
$7 3/8 after saying late Monday that it expects to post flat sales in the
second quarter, leading to profits that will be "somewhat below" the last
quarter.
DELTA AIR LINES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DAL)") else Response.Write("(NYSE: DAL)") end if %> descended $6 3/16 to $100 1/2 after Credit Suisse First Boston and Lehman Brothers lowered their first-quarter earnings estimates on the company after it issued a warning that it would fall short of the previous consensus projection.
CONFERENCE CALLS
HEILIG-MEYERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HMY)") else Response.Write("(NYSE: HMY)") end if %>
(804) 254-3939 -- replay
MICRON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %>
(402) 220-1002 -- replay through 9/23
CABLETRON SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CS)") else Response.Write("(NYSE: CS)") end if %>
(402) 220-4881 -- replay through 9/29
09/23/97 (Tuesday)
MICRON ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MUEI)") else Response.Write("(Nasdaq: MUEI)") end if %>
(800) 846-0416 -- replay through 9/24
09/24/97 (Wednesday)
COREL CORPORATION <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COSFF)") else Response.Write("(Nasdaq: COSFF)") end if %>
(416) 626-4100 (code: 633413) -- replay
THIS WEEK'S CONFERENCE CALL SYNOPSES
ORACLE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %>
Call
EASTMAN KODAK <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EK)") else Response.Write("(NYSE: EK)") end if %>
Call
FOOL PORTFOLIO BORING PORTFOLIO AMZN down $7/8 at $53 1/8 ATLS down $1/4 at $26 1/8 AOL up $1/2 at $75 7/8 BGP down $1/4 at $27 7/8 ATCT up $3/16 at $5 11/16 CSCO up $1 7/16 at $76 5/8 CHV up $7/32 at $85 3/8 CSL down $5/8 at $46 1/4 COMS up $15/16 at $51 5/16 GNT down $1/16 at $47 9/16 DJT down $13/16 at $11 5/16 ORCL up $21/32 at $37 13/16 GM down $27/32 at $66 3/4 OXHP down $1/16 at $77 3/4 INVX down $1/4 at $32 1/2 PMSI down $1/8 at $14 3/8 IOM up $3/8 at $27 5/16 TDW down $7/8 at $57 7/8 KLAC up $2 7/32 at $72 11/32 LU up $1 1/4 at $83 3/4 MMM up $13/16 at $87 3/4 T down $1 1/8 at $44 13/16WE DELIVER - Get The Lunchtime News delivered
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Randy Befumo (TMF Templr), a Fool
Alex Schay (TMF Nexus6), Fool Two
Dale Wettlaufer (TMF Ralegh), Fool Three
Contributing WritersBrian Bauer (TMF Hoops), another Fool
Editing