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FOOL PLATE SPECIAL
An Investment Opinion by Dale Wettlaufer

Compaq's Quid Pro Quo

Compaq Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %> fell $2 1/2 from its New York close of $27 3/4 on Friday after announcing after the close of trading last week that first quarter results will come in below plan. First quarter revenues are expected to be flat compared with 1997's first quarter revenues of $4.805 billion and down 34% from the seasonally busy 1997 fourth quarter. "Channel stuffing" is the word du jour today as investors figure that sales from past quarters were made at the expense of sales this quarter. Channel stuffing is something of a serious charge against the company, implying nefarious actions on Compaq's part. However, the channel stuffing thesis doesn't quite capture all the dynamics of the present situation.

Compaq has two major dynamics that are conflicting with each other at the moment. The first dynamic is the company's move to push inventory closer to the customer. This is manifesting itself in the company's move to "channel assembly," where it ships PC components to its resellers and other distributors, who then assemble the components into a branded computer. Since that will take some logistical maneuvering on the part of the distributors, Compaq couldn't just force the second dynamic down the throats of its partners. This second dynamic is price protection, a vestige of a distribution strategy that makes little sense these days. Under a price protection regime, the PC manufacturer credits a distributor for a decline in the price of a PC between the time the distributor buys the inventory and the time the end-user buys that inventory. The practice of offering price protection gives no incentive to move inventory quickly and no disincentive for failing to do so.

With price deflation in central processing units (CPUs) accelerating to 2% per week this year and disk drives and memory prices also declining 1-2% per week, Compaq has to credit a distributor $27 for price protection on the CPU and $12 for the memory and disk drive if the distributor hangs onto the inventory for four weeks. Add to that another three weeks that inventory could have spent in Compaq's facilities, and the company has lost nearly $70 per PC just in inventory holding losses. That comes through the income statement in net sales and in cost of goods sold. On a PC with a wholesale price of $1,000, that's a hefty reduction to revenues and addition to cost of goods sold.

With price protection moves and discounting to help distributors deal with the move to channel assembly, the short term was bound to look pretty bad for Compaq. What's in the channel has to move out before the company and its distribution partners can move to channel assembly. That means the second quarter won't look great, either. However, this was a move the company had to make to get inventory flowing through the system as quickly as possible. Dell's direct sales strategy was just killing Compaq with the all-important corporate buyer. In addition, the rise of sub-$1,000 PC has left no margins for Compaq with distributors that have no disincentive to turning inventories slowly. With a heavy slashing of price protection and the move to channel assembly effected by the beginning of the second half of 1998, Compaq's financial picture will be cleaner and ready to go with the Digital Equipment Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DEC)") else Response.Write("(NYSE: DEC)") end if %> merger later this year.

UPS

Alumax Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AMX)") else Response.Write("(NYSE: AMX)") end if %> jumped $10 7/16 to $47 1/8 after agreeing to merge with fellow aluminum producer Aluminum Co. of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AA)") else Response.Write("(NYSE: AA)") end if %> in a deal valued at about $3.8 billion. Under the agreement, Alcoa will launch a cash tender offer for half of the outstanding shares of Alumax at a price of $50 per share. Each remaining Alumax share will be exchanged for 0.6975 of a share of Alcoa stock. Fellow aluminum company Kaiser Aluminum <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KLU)") else Response.Write("(NYSE: KLU)") end if %> also picked up 3/4 to $10.

Long-distance telephone company LCI International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LCI)") else Response.Write("(NYSE: LCI)") end if %> rocketed $3 11/16 to $38 1/16 after multimedia communications firm Qwest Communications International <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QWST)") else Response.Write("(Nasdaq: QWST)") end if %> agreed to buy the company in a $4.4 billion stock swap. Each LCI share will be converted into $42 of Qwest common stock.

CEL-SCI Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HIV)") else Response.Write("(NYSE: HIV)") end if %> moved up $13/16 to $5 7/16 after the immunotherapy developer said animal studies showed that a new version of its HGP-30 AIDS vaccine induces a stronger cellular immune response than the previous vaccine, which could help in fighting the HIV infection.

Canadian forest products company Avenor Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ANR)") else Response.Write("(NYSE: ANR)") end if %> leapt $1 7/8 to $23 13/16 after agreeing to a merger with newsprint producer Bowater Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BOW)") else Response.Write("(NYSE: BOW)") end if %> valued at $2.47 billion, including assumed debt. Under the deal, Bowater will acquire all of the outstanding Avenor shares at $24.67 per share in cash.

Construction management services firm URS Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: URS)") else Response.Write("(NYSE: URS)") end if %> tacked on $11/16 to $14 13/16 after reporting fiscal Q1 EPS of $0.27 versus $0.22 a year ago, which beat the First Call mean estimate by three cents.

Seismic data acquisition services firm 3-D Geophysical <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TDGO)") else Response.Write("(Nasdaq: TDGO)") end if %> climbed $17/32 to $9 13/32 after agreeing to be acquired by oilfield services company Western Atlas <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WAI)") else Response.Write("(NYSE: WAI)") end if %> in a cash tender offer for $9.65 per share. The purchase price is a 9% premium over the $8 7/8 closing price of 3-D Geophysical's shares on Friday.

Multimedia projection display systems provider Proxima Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PRXM)") else Response.Write("(Nasdaq: PRXM)") end if %> soared $2 1/4 to $10 9/16 after agreeing to be acquired by Norway's ASK for about $84 million in cash, or $11 per share. The purchase price represents a 32% premium over Proxima's closing price of $8 5/16 on Friday.

Internet-based audio and video communication software developer VocalTec Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VOCLF)") else Response.Write("(Nasdaq: VOCLF)") end if %> gained $1 9/16 to $23 1/8 after signing an agreement with Fujitsu Business Systems to distribute VocalTec's telephony network products to corporate clients worldwide, starting in Japan.

Internet connectivity solutions and software provider Netopia Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NTPA)") else Response.Write("(Nasdaq: NTPA)") end if %> added $1 to $6 1/8 after Internet services provider EarthLink Network <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ELNK)") else Response.Write("(Nasdaq: ELNK)") end if %> agreed to license Netopia's Virtual Office software on EarthLink's "Internet Room" personalized website.

Enterprise data storage management firm MTI Technology Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MTIC)") else Response.Write("(Nasdaq: MTIC)") end if %> advanced $13/16 to $14 1/4 after introducing fibre channel support for its Gladiator ESS storage system. Fibre channel will increase transfer rates up to 100 Mbit/second and increase cable distances to over six miles, the company said.

Video-game maker Acclaim Entertainment <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AKLM)") else Response.Write("(Nasdaq: AKLM)") end if %> gained $25/32 to $6 3/8 after closing its coin-operated game divison on Friday and shifting the unit's resources to its Acclaim Studios home entertainment products business.

Internet stocks gained as the latest investment thesis posits that the sector will be isolated from the Asian financial problems causing the latest "tech armageddon." Search engine company Yahoo! Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: YHOO)") else Response.Write("(Nasdaq: YHOO)") end if %> added $4 7/16 to $85, fellow search engine Infoseek <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SEEK)") else Response.Write("(Nasdaq: SEEK)") end if %> advanced $2 15/16 to $21 5/16, and Excite Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: XCIT)") else Response.Write("(Nasdaq: XCIT)") end if %> ascended $4 5/16 to $52 3/4. Online bookseller Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> was up $6 5/8 to $83 3/8 and cyber-auctioneer ONSALE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ONSL)") else Response.Write("(Nasdaq: ONSL)") end if %> rose $2 7/16 to $31 1/8.

Welding products company Lincoln Electric Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LECO)") else Response.Write("(Nasdaq: LECO)") end if %> shot up $4 3/8 to $47 5/8 after announcing a two-for-one stock split last Thursday.

Drugmaker ICN Pharmaceuticals <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ICN)") else Response.Write("(NYSE: ICN)") end if %> gained $3 15/16 to $63 1/8 after Goldman Sachs put the stock on its "recommended list" on the belief that the firm's new hepatitis C treatment is close to being approved by the Food and Drug Administration.

Portable computer repair and multimedia services firm Enhanced Services Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ESVS)") else Response.Write("(Nasdaq: ESVS)") end if %> surged $1 1/8 to $5 3/4 on news that it will invest $50 million in interactive advertising sales and marketing company ZULU-tek Inc.

DOWNS

Aerospace and defense giant Northrop Grumman <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOC)") else Response.Write("(NYSE: NOC)") end if %> skidded $15 to $122 5/8 on news that the Department of Justice is fundamentally opposed to the proposed $12 billion merger between Northrop and rival Lockheed Martin <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LMT)") else Response.Write("(NYSE: LMT)") end if %>, which dipped $2 5/16 to $112 7/8. The two companies said they will "vigorously oppose" any attempt to block their merger, which would create a $37 billion behemoth.

Sub-prime home equity lender Southern Pacific Funding Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SFC)") else Response.Write("(NYSE: SFC)") end if %> lost $1 to $16 7/16 after Moody's cut the company's senior debt rating to B3 from B2 and its subordinated debt ratings to Caa1 from B3. Moody's said the change in ratings reflect the company's negative operating cash flow and limited financial flexibility over the near term.

Tennessee-based ShoLodge Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LODG)") else Response.Write("(Nasdaq: LODG)") end if %>, franchisor of Shoney's Inns and owner of Sumner Suites, plunged $2 1/2 to $9 3/4 after announcing that it expects to report fourth quarter earnings in the range of $0.08 to $0.11 per share, but that includes roughly $0.11 per share in income tax benefits and $0.24 per share in income from sales of property and other assets, as well as a loss of $0.02 per share from early extinguishment of debt. The projected Q4 earnings fall short of the First Call mean estimate of $0.15.

Computerized balancing equipment maker Schmitt Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SMIT)") else Response.Write("(Nasdaq: SMIT)") end if %> slid $1 11/16 to $6 1/8 after announcing after the bell Friday that it anticipates lower-than-expected earnings for the third and fourth quarters. Because the growth outlook for the company's precision measurement instruments subsidiary is linked to the semiconductor and data storage industries, which already have pre-announced sales and earnings shortfalls, Schmitt has had to delay shipments from the third and fourth quarters to next year.

Bionx Implants <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BINX)") else Response.Write("(Nasdaq: BINX)") end if %>, a developer of self-reinforced, resorbable polymer implants for use in orthopaedic and craniofacial surgery, was cut $3 1/4 to $20 after announcing that new competition and deep discounts in the meniscus repair market will impact sales and earnings in the first two quarters of 1998. The company anticipates lost sales will total $1-$2 million.

Template Software <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TMPL)") else Response.Write("(Nasdaq: TMPL)") end if %> fell $1 to $11 1/2 after announcing that it expects to report a first quarter loss of about $0.05 per share compared with earnings of $0.08 in the prior-year period. The software solutions company anticipates first quarter sales will fall below analysts' estimates. Piper Jaffray downgraded its rating on the company to "neutral" from "strong buy."

Network Computing Devices <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NCDI)") else Response.Write("(Nasdaq: NCDI)") end if %> dropped $1 3/4 to $11 3/4 after the computer hardware and software company announced that it anticipates lower revenues and "modest" losses in the first half of 1998, and that it expects the ramp-up of orders for "thin client" systems to begin by the third quarter.

Biotechnology company ZymeTx Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ZMTX)") else Response.Write("(Nasdaq: ZMTX)") end if %> lost $1 to $5 after announcing it will not realize significant sales of its ZStatFlu influenza diagnostic tests in 1998 because of the unexpected short influenza season in North America and because doctors prefer to have a "test drive" period before making a purchase decision.

Berg Electronics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BEI)") else Response.Write("(NYSE: BEI)") end if %> slipped $2 1/4 to $25 7/8 after Merrill Lynch lowered its near-term rating on the electronic connectors maker to "neutral" from "accumulate" while keeping its "long-term buy" rating.

British publisher Reed International Plc <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RUK)") else Response.Write("(NYSE: RUK)") end if %> fell $3 5/8 to $41 1/4 after announcing it has scuttled plans to merge with the Netherlands' Wolters Kluwer NV. Reed International and Dutch partner Elsevier NV <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ENL)") else Response.Write("(NYSE: ENL)") end if %> said they abandoned their planned $9 billion takeover of their Dutch rival because conditions expected by regulators would have diminished the advantages of the merger.

Solectron Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLR)") else Response.Write("(NYSE: SLR)") end if %> slipped $2 5/16 to $41 5/16 after Merrill Lynch cut its rating on the contract manufacturer to "near-term accumulate" from "near-term buy" while keeping its "long-term buy" rating.

Network computing systems maker Sun Microsystems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SUNW)") else Response.Write("(Nasdaq: SUNW)") end if %> dipped $1 11/16 to $41 1/16 after The Wall Street Journal Europe reported that an ongoing investigation by the U.S. Department of Commerce is delaying the company's plans to market Russian-made encryption software.

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Dale Wettlaufer (TMF Ralegh), Fool
Alex Schay (TMF Nexus6), Fool
Yi-Hsin Chang (TMF Puck), Fool
Brian Graney (TMF Panic), Fool
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