DJIA 10712.19 +57.52 (+0.54%) S&P 500 1314.26 +7.61 (+0.58%) Nasdaq 2452.38 -1.28 (-0.05%) Russell 2000 440.26 -0.13 (-0.03%) 30-Year Bond 92 17/32 -5/16 5.78 Yield
FOOL PLATE SPECIAL
An Investment Opinion
by Dale Wettlaufer
Banking Downside
Financial services massif First Union <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FTU)") else Response.Write("(NYSE: FTU)") end if %> lost $5 3/16 to $44 3/4 this morning after revising once AGAIN its 1999 earnings guidance. Upon hearing the news early this morning on TV, I thought, "Alright, these guys can't be trusted. They've pre-announced three times already this year." Since I had already stuck my neck out on previous occasions this year when they've done this, I also thought, "Great, I'm wrong and I look like an ass." Getting past those natural human reactions and looking at the primary materials rather than getting hung up on a headline I heard on TV, I found much more reason to be optimistic about the situation and I believe that First Union's management is doing the right thing strategically here.
First, let's just come out and deal with the fact that the former CoreStates is a bigger turnaround project than anticipated. Mellon Bank was totally in the right to turn down the economically obstinate demands of CoreState's Chairman at the time Mellon tried to force the issue on the merger. First Union came along and paid the higher price. Thus, the CoreStates Chairman got to look like the good guy and the excess employees got to hold their jobs a little longer. The CoreStates shareholders, meanwhile, have seen the premium they received evaporate because it ultimately came out of First Union's stock price. So the thesis there is that an intra-market merger would have been better for Mellon and CoreStates, but I guess what's done is done.
First Union is taking the right approach here. If the current economics of that territory are that planned revenue growth isn't materializing and that additional money needs to be spent to create a sales and service-oriented culture, then that's what the deal is. It's ultimately a bad decision to try to put off until next year what needs to be done today, 1999 earnings be damned. Not to lay this all on the CoreStates territory -- this looks like spending and revenue initiatives across regions. I've talked to First Union's customers from all of its regions and it's obvious that the company needs to improve service. I would hope that Future Bank is not just about improving the sales-driven nature of the bank but also the service features of the business. I jumped off the train on the Charlotte banks a couple of months ago because I was not convinced they were competing effectively in satisfying retail customers. When that changes, I'll get back on board.
This piece from the press release is encouraging: "Further development of First Union's distribution channels includes an accelerated Internet expansion strategy. The company expects to double the number of Internet customers from 700,000 currently to more than 1-1/2 million by year-end 1999. The company's goal is to grow that number to 5 million by 2001." With annual non-interest expenses of around $8 billion, the company has more than enough room in the budget to outspend and outmarket any Internet-only bank out there. No company like this should cede the Internet channel to an Internet-only bank with no ATM network of its own and nowhere near the array of services that First Union has to offer. As Dick Kovacevich at Wells Fargo has said, they're channel agnostic. Whatever gets the customer and keeps the customer is what needs to be done here. The earnings hit in the meantime is a rounding error. I would love to see a big bank like this get really aggressive with its Internet strategy. If that's what's happening here, then I'll go out and be a missionary for the Big Green Machine.
Meanwhile, one has to consider that some of the softer revenues across the board and higher-than-expected loan loss provisions at First Union are not just First Union-specific. Charge-offs and provisions have been incredibly favorable at the big banks over the last year. If you're not dialing the possibility of less favorable credit losses into your risk/reward equation on large commercial banks right now, you're not thinking right, in my opinion. Check out the Fed's National Information Center banking database if you want to look at this data. Part of the "sell" call Michael Mayo of CS First Boston put out yesterday on some banks was based on his view of credit cost activity. Tier 1 leverage has been increasing, loans and lease allowances have been trending down, and non-accrual loans, leases, and other real estate acquired has been trending up. True, loan loss experience has been trending down and earnings coverage of net losses has increased, but what happens if the rosy scenario doesn't keep on going?
There's another side to risk and reward, and when everyone and his brother goes on CNBC and refutes Mayo's opinion, focuses on just the Y2K issue, and writes off all these other issues, it's a little discouraging. Now's not the time to load up on these things. I think First Union's experience here shows some of the flaws in the earnings profile of the entire large commercial and retail banking sector. I'm sure lots of companies will be announcing new rounds of bogus "one-time charges" when they run through their current restructuring reserves. Your actual mileage may vary, but consider that a deep average cost curve cuts into earnings when revenues slide back a bit. In other words, at peak revenue levels, sure, these banks make a ton of money. But what happens when credit costs go up, revenues come down a bit, and your high-cost big platform results in higher average costs on a smaller revenue base?
So there are two issues here. A First Union-specific thing accounts for much of it. I think they're absolutely doing the right thing here strategically. I'll also cop to the fact that I underestimated the softness of their revenues. But I think there's a sector-wide downside in the big banks that the market tried to price in yesterday and I also think a lot of people that rushed to defend the banks yesterday are dialing in a single-point assumption on how things are going in banking. Michael Mayo didn't give a single reason for the "sells" yesterday -- he was looking at a spread of probabilities that end up in a composite risk/reward outlook that is unattractive in his opinion. He gave a bunch of little reasons that add up to a good case as to why there's downside. I agree fully.
Related article:
The Evening News 08/14/98: Big Banking Bargains
Internet portal company Lycos Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LCOS)") else Response.Write("(Nasdaq: LCOS)") end if %> advanced $5 1/2 to $103 1/4 on news that it will join the ranks of the Nasdaq-100 Index beginning Friday, replacing communications-equipment maker Fore Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FORE)") else Response.Write("(Nasdaq: FORE)") end if %>, which is being acquired by the U.K.'s General Electric Co. PLC.
Website developer Navidec Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NVDC)") else Response.Write("(Nasdaq: NVDC)") end if %> advanced $7/8 to $10 1/16 on news that it is consolidating its 14 existing car-buying sites and forming a wholly owned Internet subsidiary, DriveOff.com, which will sell new cars and compete against the likes of CarsDirect.com and Autobytel.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ABTL)") else Response.Write("(Nasdaq: ABTL)") end if %>. DriveOff.com will work exclusively with a national alliance of auto dealers now being organized. The dealers will pay DriveOff.com a setup and monthly marketing fee.
Bandwidth management technologies company Adaptec <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ADPT)") else Response.Write("(Nasdaq: ADPT)") end if %> rose $1 15/16 to $29 3/16 on news that it will expand its stock buyback program by $200 million with the shares to be repurchased on the open market. According to Reuters, CEO Robert Stephens told reporters in Singapore the company expects revenue growth of at least 20% for fiscal 2000.
Rechargeable lithium battery researcher Valence Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VLNC)") else Response.Write("(Nasdaq: VLNC)") end if %> powered up $11/16 to $7 7/8 after the company reported its first shipment of lithium polymer battery components to its joint venture partner in Korea. The order marks the first shipment from a new Valence plant in Northern Ireland.
Clean power resources and pesticides company Thermo Ecotek Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: TCK)") else Response.Write("(AMEX: TCK)") end if %> moved up $2 7/16 to $10 7/8 after it agreed to be merged into its parent company, Thermo Electron Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TMO)") else Response.Write("(NYSE: TMO)") end if %>, in a stock swap, terms of which were not reported. The company also said it will take restructuring and other charges of about $125 million, most of which will be recorded in fiscal Q3.
Sun Energy Partners <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLP)") else Response.Write("(NYSE: SLP)") end if %> lost $9/16 to $5 3/8 after energy and chemical company Kerr-McGee Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMG)") else Response.Write("(NYSE: KMG)") end if %> raised its offering price for Sun to $5.75 a share from $4.52 and settled three class action lawsuits relating to the previously announced roll-up of Sun. The initial $4.52 will be payable upon completion of the merger, while the additional $1.23 will be payable, with interest, upon final court approval of the settlement.
Messaging and directory software provider ISOCOR <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ICOR)") else Response.Write("(Nasdaq: ICOR)") end if %> took $7/16 to $7 3/4 after making its N-PLEX Internet messaging software available to users of IBM's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> RS/6000 server.
Online job listings provider CareerBuilder <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CBDR)") else Response.Write("(Nasdaq: CBDR)") end if %> rose $2 1/4 to $14 7/8 on top of yesterday's $1 3/16 gain powered by news that software giant Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> will pay $17.8 million for a minority stake in the company. Along with the investment, CareerBuilder said it will develop a private-label career center for Microsoft's MSN online offerings.
Federated Department Stores <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FD)") else Response.Write("(NYSE: FD)") end if %> put down $1 to $54 9/16 this morning. The company announced a pact to develop an integrated in-store and online bridal registry with privately held Wedding Channel, operator of WeddingChannel.com. Federated will become a significant -- reportedly about 20% -- owner of Wedding Channel. The service will integrate the inventories and registries of Federated's line of stores, which includes Bloomingdale's, Lazarus, and Macy's.
Shoe retailer Just for Feet <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FEET)") else Response.Write("(Nasdaq: FEET)") end if %>, a March Foolish Trouble, was trampled for a loss of $1 11/16 to $8 7/8 after reporting fiscal Q1 EPS of $0.15, down from last year's $0.19 and $0.02 below estimates. "The operating results of our specialty store division were below plan with lower-than-anticipated gross margins and higher store operating expenses as newer specialty stores have not achieved initial projections," said CEO Harold Ruttenberg.
Online health and medical information provider adam.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ADAM)") else Response.Write("(Nasdaq: ADAM)") end if %> gave up $1 to $19 after reporting a fiscal Q4 loss of $0.34, well off last year's penny profit. The company has spent heavily -- expanding senior management, hiring new staff, leasing office space and developing its website -- and adam.com hopes it is now positioned to collect revenues from advertising, partnerships, and other avenues.
Vision care products retailer Cole National Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CNJ)") else Response.Write("(NYSE: CNJ)") end if %> blurred $1 5/16 to $10 7/8 after the company said it's unlikely to post a year-over-year increase in EPS from last year's figures because of a promotional sales environment. Cole said fiscal Q1 EPS was $0.20, half last year's mark and below IBES' three-analyst $0.27 consensus.
Healthcare information and pharmaceutical distributor McKesson HBOC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MCK)") else Response.Write("(NYSE: MCK)") end if %> lost $3 5/16 to $34 7/8 on news that further restatements to its fiscal 1999 financial results are needed. The stock already took a heavy hit last month when the company first said improper revenue recognition was rearing its ugly head, and it appears now that the picture is even worse than first thought.
Equine-branded apparel designer Polo Ralph Lauren <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RL)") else Response.Write("(NYSE: RL)") end if %> bucked off $1 1/4 to $22 5/8 after announcing fiscal Q4 EPS of $0.27 before charges, $0.02 off last year's tally and flat with estimates. "Although we established new records in revenues, operating income and earnings per share before restructuring charges in fiscal 1999, our performance did not measure up to the standards we have set for ourselves," said CEO Ralph himself.
Drug delivery products maker Fuisz Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FUSE)") else Response.Write("(Nasdaq: FUSE)") end if %> spilled $1 5/8 to $4 7/8 after the company said it expects a loss for Q2. Fuisz also said CEO Kenneth McVey and director Fredrik Schreuder were resigning. The company plans to hire a management consulting firm to help with streamlining efforts.
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Contributing Writers Brian Graney (TMF Panic), a Fool David Marino-Nachison (TMF Braden), a new Fool
Editing |