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April 9, 1999

Fools in Newsprint

Fool Take Samples

An Upside of Downsizing
Originally ran 12/18/98

Financial services giant Citigroup announced recently that it will take a pre-tax charge of roughly $1.38 billion for a restructuring, reducing its reported after-tax earnings by about $900 million. This is its second major restructuring in the last five fiscal quarters. In 1997, the Citicorp unit took an $889 million pre-tax charge to earnings, principally in its global consumer and global corporate banking divisions. Restructurings are typically considered one-time events for companies, but we like to take a longer-term view.

The Citigroup charge will pay for downsizing about 10,400 employees, 6% of the company's global workforce. (Many positions were duplicated when Citicorp merged with Travelers Group.) A simple way of looking at this is to consider the per-employee expense. With a pretax cost of $1.38 billion, that's roughly $133,000 per employee. It's not all for severance compensation and retraining, though. Part of it will cover closing facilities, canceling contracts, and other usual restructuring initiatives.

The company says this will save about $975 million in yearly operating expenses by the year 2000. Comparing pretax savings to the pretax expense of the restructuring, that's a 71% yearly return on investment, if revenues do not take a hit from the reduction in resources. The process of looking at return on restructurings and where cost savings will be invested is more complicated than that, but this is a useful way for Fools to begin considering restructuring charges.

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Accretion
Originally ran 12/4/98

Coronary device maker Arterial Vascular Engineering recently ballooned some 50% per share after medical device manufacturer Medtronic agreed to acquire it. The deal is expected to be "accretive" to Medtronic's earnings, increasing them through the external addition of the acquiree's earnings. Accretion is an important concept for investors to understand.

Imagine a company with 50 million shares outstanding, projected to earn $50 million next year ($1 per share). If it's selling at $50 per share, it's priced at 50 times next year's earnings. Let's say it acquires a company projected to earn $25 million next year. The acquired firm has 25 million shares outstanding and trades at $25 per share.

If the acquirer issues half of one of its shares for each share of the acquired company, it creates 12.5 million new shares. Next year's projected earnings for the new, combined company: $75 million.

Whereas earnings per share (EPS) was expected to be $1.00 for the acquiring company before the deal, it will now be $75 million divided by 62.5 million shares, or $1.20. Just by acquisition, the company has increased next year's EPS by 20%. That's accretion. If the firm keeps its pre-deal 50-times-EPS multiple, the shares will now be worth $60, up 20% from the pre-deal share price of $50. Switching from the hypothetical to the practical, EPS accretion is part of Medtronic's plan to build shareholder value in this deal.

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Margins vs. Unit Growth
Originally ran 11/20/98

Dell Computer reported another quarter of solid results last week, but its share price fainted. Investors and the media are fretting over Piper Jaffray analyst Ashok Kumar's projection of slowing sales growth in desktop PCs at the number-one direct-to-customer seller of personal computers, servers, and workstations. Things don't look so bad to us Fools, though, as Dell is about more than just desktop computers.

The company reported a 51% year-over-year increase in third quarter revenues of $4.82 billion and a 65% increase in earnings per share of $0.28. Sequential sales growth (this quarter over the second quarter) in higher-priced products was excellent. While sequential unit growth in $1,800 desktop units was only 11%, Dell reported 16% sequential growth in higher-priced laptop units and 29% sequential growth in servers and workstations ("enterprise sales") costing upwards of $5,000.

Dell can hardly be faulted on its desktop unit performance when you look at the success of its overall product mix. In addition, its average selling price stayed relatively steady, despite a shortage of Intel's Xeon chips that held back enterprise growth during the quarter. Kumar's thesis of slowing desktop sales growth is correct, but that's not the most important part of the Dell story. While unit growth in lower-priced PCs has slowed, growth in high-end products is quite robust. Fools should not overlook this.

Next: My Dumbest/Smartest Investment

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