DQE INC. (NYSE: DQE), parent of the Duquesne Light Co. serving Pittsburgh and western Pennsylvania, gained $1 3/4 to $28 3/8 on agreeing to merge with ALLEGHENY POWER (NYSE: AGY), an electric utility that services Pennsylvania, Ohio, Virginia, West Virginia, and Maryland. DQE is a mostly coal-fired utility, but has a share in three nuclear reactors. The company invests in other non-core energy ventures though its Montauk subsidiary, which accounted for almost 19% of net profit in 1996, according to Value Line. The merger is an excellent move for Allegheny because DQE is a diversified company with lower costs, a much lower dividend payout ratio, has a large customer base compressed into one area, and looks to be very well prepared for the coming competition of deregulation. DQE shareholders will receive 1.12 shares of Allegheny for each DQE share, valuing the company's equity at about $2.6 billion.

ALEX. BROWN (NYSE: AB) was once again a market hero today, gaining $10 to $63 1/8 after announcing its intent to merge with money center bank BANKERS TRUST (NYSE: BT). The deal values each share of Alex. Brown, the fifth largest underwriter of equity issues last year (in dollar terms), at 0.83 Bankers Trust shares -- that's $65.98 as of today's close, meaning there's still some premium left for deal risk, fundamental business risk, and other arbitrage factors. Other brokerages and investment banks also moved today, including diversified underwriter and brokerage DONALDSON, LUFKIN & JENRETTE (NYSE: DLJ), which climbed $2 5/8 to $40 7/8. DLJ offers a potential acquirer a stock at just over ten times earnings as well as one of the largest online brokerages in PC Financial Network. A company with about half of PC Financial Network's membership total, E*TRADE GROUP (Nasdaq: EGRP), is valued at $625 million, or about one-quarter of DLJ's total market cap.

Other mid-cap brokerages and investment bankers also made strong moves today as investors assess the digestibility of all but the largest securities firms trading publicly. HAMBRECHT & QUIST GROUP (NYSE: HMQ), which came public last year, gained $3 to $20 7/8. Its market position is similar to Alex. Brown insofar as H&Q underwrites quite a few "high tech" and healthcare IPOs and has a strong client base in asset management, high net-worth individuals, and corporate relationships. EVEREN SECURITIES (NYSE: EVR) moved up $2 1/8 to $23 3/4 as the employee-owned former Kemper Securities brokerage offers an acquirer a presence in 27 states as well as its investment in Wheat First Butcher Singer, another strong regional broker and investment banker. Practically everything in this sector moved higher on the hopes that future acquisitions will follow the model of a bank trading its stock, with higher valuations, for takeover premia similar to that seen today.

QUICK TAKES: Search software company VERITY INC. (Nasdaq: VRTY) gained $1 7/8 to $8 1/8 after announcing the inclusion of its SEARCH'97 software in Netscape's SuiteSpot server... EPITOPE INC. (Nasdaq: EPTO) gained $1 1/2 to $9 3/8 after the biotech company said it will sue to rescind the acquisition of the unit that sold Hepatitis A-tainted strawberries to school lunch programs last week... Search engine company EXCITE INC. (Nasdaq: XCIT) rose $1 3/4 to $11 1/4 on speculation about a merger between AMERICA ONLINE (NYSE: AOL) and COMPUSERVE (Nasdaq: CSRV), which would greatly expand its captive user base... Storage management software company LEGATO SYSTEMS (Nasdaq: LGTO) gained $2 1/2 to $18 5/8 after the company said its BusinesSuite Module for SAP R/3 is ready to go in Japan... BEST BUY INC. (NYSE: BBY) jumped $1 3/8 to $11 7/8 after Goldman Sachs raised its rating on the retailer to "market outperform" from "market underperform"... Employee leasing company ADMINISTAFF INC. (NYSE: ASF) moved up $1 7/8 to $17 3/8 after announcing the opening of its Orange County, California office... ORGANOGENISIS (AMEX: ORG) gained $3 7/8 to $22 1/8 after the company announced marketing approval for its Apligraf Human Skin Equivalent from the Canadian government... PARKER & PARSLEY PETROLEUM (NYSE: PDP) gained $2 to $31 7/8 after the oil and gas producer announced a merger with MESA INC. (NYSE: MXP).


NIKE CORP. (NYSE: NKE) fell $4 1/4 to $54 7/8 on a rating downgrade from Smith Barney, whose analyst said the company had cut its production forecast by 20% in Indonesia and China. Taking the cue from one of the largest sales forces in the retail brokerage world, investors turned the "neutral" rating into a "sell." Nike called CNBC late in the day to refute the assertion that production changes are predicting weakness in the business. For a company that has built its financial results not only on its brand equity but also on its tight handling of production and distribution, a 20% variance would be quite unusual. Some analysts would probably think twice before downgrading Nike coming off the NCAA basketball showcase and going into The Masters golf tournament, where Tiger Woods will be giving the company heavy exposure. The only advertisers on the telecast are Cadillac and Travelers, giving the Swoosh an even more noticeable presence, especially if Woods plays on the weekend.

Software development tools company RATIONAL SOFTWARE (Nasdaq: RATL) was sullied for a $9 3/4 loss to $13 5/8 on announcing an agreement to acquire software development automation company PURE ATRIA SOFTWARE (Nasdaq: PASW), which was down $7 3/4 to $10. The deal was worth a lot more this morning, around $900 million. As of the close, though, the value of the acquisition had fallen to the mid-$500 million range. Hambrecht & Quist wasn't a large fan of the deal, saying business predictability would be reduced until the company closes the deal later in the year. The real downer for the merger partners was Pure Atria's pre-announcement of Q1 EPS of $0.02 to $0.04, well below estimates of $0.12. Without that pre-announcement, Rational software holders might have reacted differently, as the acquisition would have been nicely accretive to Rational's 1997 EPS estimate of $0.47.

QUICK CUTS: HEI INC. (Nasdaq: HEII) crumbled $3 5/16 to $4 1/2 after the disk drive micro components company said a disk drive industry customer cut off the company as a supplier to move production offshore... BIOS software company PHOENIX TECHNOLOGIES (Nasdaq: PTEC) burned down $2 3/4 to $12 7/8 after pre-announcing Q2 earnings per share (EPS) of $0.11 to $0.14, down from Q2 1996 EPS of $0.15... METATOOLS INC. (Nasdaq: MTLS) lost $1 3/16 to $6 15/16 after the graphics software company pre-announced Q1 revenues of $6.1 to $6.2 million, down from $8.9 million recorded last quarter... Database software company SYBASE INC. (Nasdaq: SYBS) lost $2 to $13 3/4 despite loosing a barrage of press releases on investors, including an announcement of a partnership with HEWLETT-PACKARD (NYSE: HWP)... ULTRAK INC. (Nasdaq: ULTK) fell another $1 1/2 to $10 3/8 on the lingering damage from its failed merger deal with CHECKPOINT SYSTEMS (NYSE: CKP)... Laminates, composites, and coatings company MATERIAL SCIENCES CORP. (NYSE: MSC) fell $2 7/8 to $14 1/2 after the company said a rogue plant comptroller had falsified financial reports, which will force the company to restate results for a number of accounting periods... Contract oil and gas driller ROWAN COMPANIES (NYSE: RDC) slid $1 1/8 to $21 1/4 after announcing on Friday the termination of a contract with Penzoil after failing to reach contract depth, which will take $20 million off Q1 1997 earnings.

An Investment Opinion by MF Templar

AOL Merger Rumor Dissected

AMERICA ONLINE (NYSE: AOL) fell $4 1/8 to $44 1/2 after the Wall Street Journal Interactive confirmed rumors that surfaced last week that the company was in talks to purchase one of its largest rivals, COMPUSERVE (Nasdaq: CSRV). Most media is focusing on the subscriber numbers that would result from this combination, which would give America Online more than 10 million users in the U.S. and 12 million worldwide -- if you accept CompuServe's subscriber numbers at face value. More importantly for some, America Online would gain CompuServe's underutilized network assets, potentially offsetting the need to rent 50,000 modems from another service provider.

Rumors of a buyout materialized on Tuesday of last week, initially promoted by an investment research firm called Wall Street Strategies. CompuServe confirmed the rumors on Wednesday in a terse statement that it was "currently engaged in external discussions regarding a possible business combination involving CompuServe." At the time, America Online declined comment on the situation, stating that it does not comment on market rumors. However, the Washington Post quoted an "industry source" on its front page as believing America Online was "exploring the purchase of CompuServe."

The Wall Street Journal Interactive stated that negotiations held this weekend put the purchase price at somewhere between $11 to $14 per share in America Online stock. This prices CompuServe at $1.02 billion to $1.30 billion, with $176.1 million in cash and investments in the bank as of last quarter. At the current price, America Online would need to issue roughly 22.7 to 28.9 million shares for CompuServe, depending on what CompuServe's outstanding share count is on a fully diluted basis. With America Online having about 95.8 million shares outstanding last quarter, this would represent a pretty substantial increase, apparently prompting today's price decline.

Interestingly, CompuServe was off $1 5/8 to $12, as investors there apparently had the contradictory idea that they could get more than $14 per share. This notion is not completely irrational given that the company did come public less than a year ago at $30 a share, but with the company spending $235 million last quarter to gain $211 million in revenues, the current operating model is not what one would describe as robust. CompuServe suffers from decelerating revenues, with last quarter coming in at $211 million. Annualize this and America Online is proposing to pay 1.2 to 1.5 times sales for a company that is making absolutely no more money than America Online is currently making, although it would not be dilutive on a price/sales basis. What are the potential benefits of this deal?

CompuServe currently has 3.2 million direct subscribers worldwide with 2.1 million people subscribing to NiftyServe, a distinct online service owned and managed by CompuServe's Japanese licensee. The combined company would have 10.2 million subscribers, less any overlap or cancellations, on both a consumer-oriented and business-oriented service. The combined companies would have more than 1.5 million subscribers in Europe, and America Online's start-up service in Japan could replace NiftyServe. SPRYNET, which currently has 270,000 subscribers for unlimited Internet access service, would probably be folded into America Online much like GNN was a few months ago, putting the combined companies at 10.5 million subscribers before the inevitable cancellations due to double accounts and the like.

This number of subscribers would be more than five times its closest competitor (MSN) and roughly half of the available consumer online subscribers in the U.S. (backing out CompuServe's one million European subscribers). CompuServe, which could easily be renamed America Online Business, could remain a premium-priced service targeted specifically at enterprises, while the America Online brand could focus specifically on consumers. The companies do complement each other decently, with America Online having a usable interface geared toward consumers but only starting AOL Enterprise about a year ago, while CompuServe has a clunky interface and robust business content. In fact, this deal could stop "Red Dog," CompuServe's plan to move its basic service to the Web, and instead just publish it in America Online's proprietary language.

America Online's ANS subsidiary would gain the crown jewel of CompuServe -- its network services business. This business did $65.2 million in revenues last quarter and has been growing at a rate of 25% year-over-year with 25% operating margins, according to the company. The combination of ANS and CompuServe's network services business could enhance ANS's customer list substantially. Additionally, CompuServe's 80,000 modems could be added to America Online's current 320,000 modems, enhancing its ability to provide network services at a critical time. With 9.5 million subscribers in the U.S., lowering America Online's ports per user to 23.75 from its current 25, a nominal improvement.

Some are skeptical of the merger, citing the fact that the two companies have hated each other for so long. Cowan & Co. analyst Scott Reamer stated, "An AOL-CompuServe deal is highly unlikely.... [a]nyone who suggests it will should check their sources." The other companies that CompuServe could theoretically be in talks with include AT&T, Microsoft, MCI Communications/British Telecommunications, Sprint or any of the remaining five Baby Bells. The financials of the potential merger also have a few flaws. As bad as CompuServe looks, it would look worse under America Online accounting conventions. Under America Online's current "gold standard" accounting for subscriber acquisition costs, CompuServe would actually show larger operating losses than it currently does, as it is still amortizing recognition of subscriber acquisition costs.


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