Tuesday, December 16, 1997
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Switzerland-based orthopedics company Sulzer Medica Ltd. (NYSE: SM) announced this morning that it has signed an agreement to merge with Minneapolis-based medical device maker Spine-Tech (Nasdaq: SPYN), acquiring all of its outstanding stock for $52 per share in cash. Spine-Tech, a supplier of fusion cage devices that are implanted between spinal vertebrae to promote fusion, gained $6 to $51 1/2. The total value of the transaction comes in at a hefty $595 million, which is about 13 times the trailing sales of Spine-Tech. Considering that Spine-Tech has yet to generate a positive return on equity, Sulzer is obviously counting on the expected 70% growth in the market for spinal products (to an expected $185 million next year) to generate its return on investment. Spine-Tech investors have to be smiling, not only due to the stock's annual compound return of 60% since its IPO in mid-1995, but also because up until now it and competitor U.S. Surgical (NYSE: USS) have faced no serious competition. Potential competitor Sofamor Danek Group (NYSE: SDG) recently failed to receive backing for its Novus LC interbody spinal fusion cage from a Food and Drug Administration advisory panel, which delays Sofamor's entry for about a year.

Vishay Intertechnology (NYSE: VSH) gained $3 5/16 to $22 1/8 after the world's largest maker of resistors, capacitors, and other electronic components announced that it will buy the semiconductor segment of Temic Telefunken, a division of Germany's Daimler-Benz AG (NYSE: DAI), for about $500 million. In the U.S., Temic owns 80.4% of the outstanding shares of Siliconix (Nasdaq: SILI), a maker of semiconductor products used for switching, motion control, and power management, which was up $4 to $43 on the news as well. In July Vishay purchased a 65% stake in Lite-On Power Semiconductor Corp., a maker of diodes and silicon wafers, as part of a expansion strategy that continues with the purchase of Temic. Sales for Temic in 1997 are expected to be approximately $850 million, with $915 million projected for 1998, which puts the deal at roughly 0.58 times 1997 sales.

Electronics contract manufacturer Solectron Corp. (NYSE: SLR) jumped $6 to $35 3/4 after reporting Q1 EPS of $0.38, up 32% from the previous year's per-share earnings. Although this quarter's EPS fell below the mean analyst estimate of $0.42, Solectron reportedly issued soothing guidance on its conference call. Additionally, the company's CEO affirmed his confidence in 1998 earnings estimates on CNBC this morning, which drew an upgrade to "strong buy" from "buy" from BT Alex. Brown. Until today's rebound, Solectron's share price had been on a steady decline from $45. Other members of the contract manufacturing sector also moved up smartly today, with Jabil Circuit (Nasdaq: JBIL) gaining $2 1/4 to $37 1/8 in advance of its earnings report this evening, and SCI Systems (NYSE: SCI), Smart Modular Technologies (Nasdaq: SMOD), and AdFlex Solutions (Nasdaq: AFLX) all making strong moves.

QUICK TAKES: Neogen Corp. (Nasdaq: NEOG) gained $1 3/8 to $11 1/4 after announcing that it has released a test to detect Histamine, a chemical contaminant that shows up in seafood when it has been stored improperly... Powerwave Technologies (Nasdaq: PWAV) rose $4 3/32 to $21 1/32 after the manufacturer of radio frequency power amplifiers said sales of its multi-carrier cellular products to customers outside of Korea will more than double this quarter... Following a number of tough sessions that have softened the stock prices of oil and gas drillers and oil services companies, offshore rig builder and shipyard Friede Goldman International (Nasdaq: FGII) gained $2 1/8 to $31 5/16 and offshore driller Global Marine (NYSE: GLM) picked up $2 3/8 to $26 1/8.

Information provider Primark Corp. (NYSE: PMK), which supplies such services as Baseline, I/B/E/S, and Yankee Group market research, gained $4 to $41 5/8 after The New York Post reported that British-based Reuters plc (Nasdaq: RTRSY) will bid $1.5 billion for Primark's business information unit... Cornell Corrections Corp. (NYSE: CRN) rose $1 7/8 to $18 1/2 after announcing an agreement under which the prison operator will own and operate an 812-bed medium security detention facility in Oklahoma... BMC Software (Nasdaq: BMCS) gained $6 1/4 to $62 5/8 after the company was reiterated a "buy" by BancAmerica Robertson Stephens... Multi-user application server products company Citrix Systems (Nasdaq: CTXS) rose $4 5/32 to $68 29/32 after it was upgraded by BT Alex. Brown to "strong buy" from "buy," with a target price of $95.

Compaq Computer Corp. (NYSE: CPQ) rose $3 to $57 1/2 after it announced that it had taken over the No. 1 position in the industry in terms of units shipped and revenue for workstations based on Intel processors and Windows NT... Software designer Compuware (Nasdaq: CPWR) gained $2 9/16 to $31 3/4 after the company was reiterated a "buy" at BancAmerica Robertson Stephens... Computer services firm Electronic Data Systems (NYSE: EDS) gained $3 13/16 to $43 3/8 after it was raised from "hold" to "buy" at UBS Securities with a 12-month target price between $45 and $50... Safeguard Scientifics (NYSE: SFE) rose $1 7/8 to $32 7/8 after receiving an initial rating of "buy" in new coverage from Prudential Securities... Whole Foods Market (Nasdaq: WFMI) was energized $4 3/8 to $47 7/16 today after the Department of Agriculture unveiled its official certification standards for organic foods, allowing Whole Foods products to distance themselves from companies that make false claims.

Party supply retailer Party City Corp. (Nasdaq: PCTY) whooped it up $1 3/4 to $28 1/2 after being upgraded by Morgan Keegan to "aggressive buy" from "buy"... Telecommunications equipment company Lucent Technologies (NYSE: LU) dialed $2 9/16 higher to $75 1/2 after being upgraded from "neutral" to "buy" at SBC Warburg Dillon Read... Lason Inc. (Nasdaq: LSON), a provider of outsourcing services for record management, gained $2 9/16 to $28 13/16 after a favorable write-up in today's Investor's Business Daily... Networking products company International Network Services (Nasdaq: INSS) rose $1 15/16 to $18 7/8 after the company was raised to "buy" from "outperform" at Lehman Brothers with a 12-month price target of $30... Gilead Sciences (Nasdaq GILD) gained $3 3/16 to $37 after it and Hoffmann LaRoche Inc. said they are starting international Phase II and Phase III testing of a drug to treat and prevent influenza.

FFVA Financial Corp. (Nasdaq: FFFC) shot $4 higher to $39 1/8 after the company agreed to be bought for $42.98 a share by One Valley Bancorp (NYSE: OV)... Takeover speculation fueled the rise in a number of brokerages today, including A.G. Edwards (NYSE: AGE), which gained $2 3/8 to $37 15/16; Everen Capital Corp (NYSE: EVR) rose $3 1/8 to $44 1/8; and Morgan Keegan (NYSE: MOR) shot $2 1/4 higher to $25 7/8... Network Computing Devices (Nasdaq: NCDI) added $1 11/16 to $7 15/16 after it announced today that Douglas H. Klein has been appointed to the Board of Directors of the thin client network computing hardware and software company, and after investors were advised that it bears the same name as a recently maligned division of Oracle Corp. (Nasdaq: ORCL).


Ready-to-assemble furniture manufacturer O'Sullivan Industries (NYSE: OSU) slid $1 1/4 to $11 1/8 after advising investors that it expects to report Q2 EPS of approximately $0.19 to $0.22, below estimates of $0.28, due to lower-than-expected sales to the company's largest customers and a lower-margin sales mix during the quarter. O'Sullivan also said that retooling of its production line and software upgrades on its lines will impact third and fourth quarter results, keeping year-over-year sales gains in the low single-digit range and attenuating profits to a level slightly below last year's second half results. The company is selling at around 13 times projected earnings for fiscal 1998 going into a year when its quick turnaround inventory system will be augmented by the company's process enhancement efforts now being put into place. While the valuation picture got worse with estimated 1998 EPS going down 20% and the stock price only moving down 11% today, the company's moves to increase productivity and margins may hold promise outside of this fiscal year or possibly within the year if things move along more quickly than expected.

Christiana Companies (NYSE: CST) dropped $3 3/4 to $37 3/8 after the freight logistics and warehousing company agreed to merge with oilfield equipment manufacturer EVI Inc. (NYSE: EVI). Christiana shareholders will receive 0.72 shares of EVI for each Christiana share, plus approximately $5 per share in cash and a contingent right to receive $1.85 per share in cash in five years. The total package valued Christiana at $35.80 per share (discounting the variable rights at 11% per year) as of last night's close --13% below its closing price. What's great for EVI is that there won't be a net issuance of shares in the transaction, since Christiana already owns 3.9 million shares of EVI, which equals the number of shares it proposes to issue in the merger. Christiana will also sell its principal operating subsidiary, Total Logistic Control, to a newly formed corporation in which its shareholders may buy shares. EVI will retain a one-third interest in that company, meaning that it is buying back shares worth $161 million for only $140 million and getting a chunk of this logistics unit for what is basically a cost basis of negative $21 million.

Office equipment distributor Danka Business Systems (Nasdaq: DANKY) was pounded for a $17 15/16 loss to $13 1/16 after warning investors that it will report Q3 EPS of $0.21 to $0.24, below the mean analyst estimate of $0.43, because revenues will fall up to 6% short of company expectations. The company said its global integration project is not progressing as well as planned. When reporting record second quarter earnings, Danka commented, "Overall, the company is pleased with the progress it is making with the integration and the benefits it will yield, yet there remains some uncertainty surrounding the time at which the benefits will arise." Not this quarter, apparently. In an imaginative move, Salomon Smith Barney lowered its rating on Danka to "hold" from "buy."

Dallas-based home equity lender FIRSTPLUS Financial Group (Nasdaq: FPFG) lost $1 15/16 to $33 3/16 after announcing the arrangement of a $1.6 billion credit line with an American unit of Deutsche Bank. However, some investors are looking at the deal as a positive, since the interest rate on the credit line is one-half of one percent lower than its old credit line. That's sort of like worrying about getting more speed out of the HMS Hood and the HMS Invincible, since it is credit quality and accounting that the market is worrying about with the company and not a 50 basis point reduction in funding costs. Though the company reported that it is considering switching its accounting methods away from "gain on sale" accounting, investors are still worried that the company is not building real shareholder value, with gross cash flow before changes in operating assets and liabilities of negative $185 .5 million in fiscal 1997.

QUICK CUTS: Extended stay hotel operator Suburban Lodges (Nasdaq: SLAM) was slammed for a $6 5/32 loss to $13 on reporting that it expects to report Q4 EPS of $0.12, well short of the mean analyst estimate of $0.18. The company said hotel pre-opening costs are putting a drag on earnings... American Frei ghtways (Nasdaq: AFWY) hit a speed bump this morning, falling $4 9/16 to $10 1/16 after the trucking company said heavy operating expenses and less-than-expected revenue growth will bring fourth quarter EPS down to the $0.05 level, short of the $0.19 a share analysts had been projecting... Alternative fuel products manufacturer IMPCO Technologies (Nasdaq: IMCO) lost $1 3/4 to $9 1/4 on announcing an agreement to purchase a bankrupt manufacturer of alternative fuel tanks... Research Inc. (Nasdaq: RESR) lost $1 15/32 to $8 29/32 after the manufacturer of heat control products announced that it expects year-over-year sales to be flat and Q1 earnings to fall below last year's loss of $59,000 due to an order delay from a Korean customer.

Lifecore Biomedical (Nasdaq: LCBM) lost $3 5/32 to $21 27/32 on reporting that European data from trials of its INTERGEL adhesion prevention solution will not be combined with data gathered from U.S. trials... Telecom products and services company XETA Corp. (Nasdaq: XETA) descended $2 5/8 to $19 1/8 on reporting Q4 EPS of $0.27, up 50% over last year and better than the single analyst estimate published by First Call... Women's clothing designer and manufacturer Liz Claiborne Inc. (NYSE: LIZ) fell $4 to $44 5/16, Jones Apparel Group (NYSE: JNY) slid $3 11/16 to $43 7/8, and Consolidated Stores Corp. (NYSE: CNS) dropped $4 15/16 to $42 1/2 as investors fear sales of women's apparel in December haven't been as robust as expected... Famous Dave's of America (Nasdaq: DAVE) lost $7 7/16 to $9 5/8 after the roadhouse-style barbecue restaurant operator said its estimates of revenue growth for the fourth quarter were too optimistic because newer units didn't develop as well as expected. The company expects to report a loss of approximately $0.23 per share (before charges), below the two-analyst estimate of $0.16 a share listed by First Call.

Computer systems integrator Pomeroy Computer Resources (Nasdaq: PMRY) was bounced for a $1 5/8 loss to $16 3/4 after the company said that it will not supply computer products to the headquarters operation of hospital company Columbia/HCA (NYSE: COL) in 1998. Pomeroy added that it will supply hospitals in the Columbia chain, though... Wide area networking products company Digital Link (Nasdaq: DLNK) fell $2 1/4 to $13 1/4 on a rating downgrade to "outperform" from "buy" from SBC Warburg Dillon Read... Network test equipment maker Giga-tronics Inc. (Nasdaq: GIGA) got a 10% haircut today, losing $1 to $8 1/2 after announcing that it expects to report minimal third quarter earnings due to lower-than-expected revenues and higher R&D costs.

An Investment Opinion by Jim Surowiecki

What's Next for Microsoft?

One of the benefits of being a bellwether stock is that your shares tend to benefit from the sudden eras of good feeling that occasionally seize the market. This seems to be the case today with Microsoft (Nasdaq: MSFT), which was up $2 15/16 to $139 1/16 on very little news. Of course, underlying the recent volatility in Microsoft shares -- the stock was as high as 146 last week before falling nearly ten points -- is investor uncertainty about the implications of last Thursday's court decision ordering Microsoft to stop requiring personal-computer makers that license Windows 95 to also accept Internet Explorer, Microsoft's Web browser.

The decision, handed down by U.S. District Judge Thomas Jackson, was a preliminary injunction, which means that Microsoft had to obey it immediately, and was intended to keep Microsoft from expanding its growing share of the browser market while the Justice Department's antitrust case against the software giant continues. In other words, Thursday's decision does not close the book on the Justice Department's antitrust allegations. It simply freezes things as they are today.

"Freezes," of course, is something of an overstatement. In the first place, Microsoft appealed Jackson's decision almost immediately. In the second place, although Microsoft is complying with the injunction, it is doing so in a manner that could be called less than willing. The company insists that as Windows 95 has gone through successive versions, the code for the operating system and the Web browser have become increasingly intertwined, so that stripping out Internet Explorer leaves you with an operating system that won't operate.

As a result, Microsoft is offering three versions of Windows to PC makers: the one that's probably running on your computer right now; that same version with Explorer stripped out; and a two-year-old original version of Windows 95 sans Explorer and sans other code as well. The problem is this: the second option, which is the one that Judge Jackson wanted Microsoft to make available, doesn't work. That means PC makers are unlikely to choose it. It also means that the fully integrated version is the one that will continue to go on almost all Wintel PCs.

The whole affair does have something of a tempest-in-a-teapot flavor to it, particularly when you consider that almost all the major PC manufacturers -- Compaq (NYSE: CPQ), Dell (Nasdaq: DELL), and Hewlett-Packard (NYSE: HWP) -- have said they prefer the integrated version. But, as the market's reaction on Friday and Monday suggests, and as Microsoft's own delaying tactics imply, Jackson's decision does have potentially wide-scale ramifications. Jackson did not, of course, impose the $1 million a day fine that the Justice Department asked for. But by calling into question the degree to which Microsoft can legally integrate its browser with its operating system, Jackson cast a cloud over Windows 98, which will feature an "active desktop" fully integrating the Web and all other activities. Originally, it was believed that the fuller integration of Explorer into Windows 98 would circumvent legal concerns, since it would be impossible to argue that you could sell Windows 98 without the browser. But Jackson's injunction raises the possibility that any system that forces PC makers to install Internet Explorer would violate antitrust law.

On the one hand, it seems odd that Microsoft should be prevented from offering whatever product it wants to offer. If the bundling of Windows 95 with Explorer is so awful, then PC makers can just not buy it. On the other hand, it's safe to say that in a world in which 90% of new personal computers use Windows, an individual PC maker doesn't really have a choice. And that's what monopoly power means.

Microsoft has not won many minds with its rather implausible argument that Explorer is an integral part of Windows 95. In reality, the browser you use is no more essential to the operating system than is the word processing program. And a Windows 95 without Explorer would be a Windows 95 into which Explorer or Netscape's Navigator could be installed. You can buy Explorer in a computer store or download it from the Web. It exists as a standalone product. Why, then, has Microsoft argued that it isn't?

There seem to be two reasons: first, the company was laying the groundwork for a defense of Windows 98, where the integration will be much tighter. At the same time, the company is demonstrating how important the Web has become to its future plans. Dominating the browser market seems to be now as important to Microsoft as dominating the operating system was in the early 1990s. And if you remember what happened to OS/2, betting on the survival of Netscape (Nasdaq: NSCP) may not be the wisest move.

The curious thing about all this, though, is that, as important as the Web is to Microsoft, it's not clear that bundling Explorer is the best decision from a consumer-happiness point of view. Everyone I know who has used the "active-desktop" format with Explorer 4.0 -- a format that incorporates push technology -- has quickly removed it, and it's far from clear that what people want from an operating system is perpetual access to the Web. Perhaps we will become the networked beings that George Gilder envisions. But for now, when I turn on my PC, I'd rather not have to wade through a host of website symbols to get to my word-processing program. It would be a lucky side effect of this legal battle if it got Microsoft to reconsider its decision to create a fully integrated Windows 98.

The fundamental problem for Microsoft, of course, is how to keep revenues and profits growing at a time when every new product is only incrementally -- and not qualitatively -- better than the last. Windows 98 will likely be a hit, but it will be a much smaller hit than Windows 95 precisely because it is simply an upgraded version, rather than a dramatically improved version. There's no reason at all to worry about Microsoft's continued domination of the operating system market, nor really about its eventual control of a majority of the browser market. But at a P/E of 52, all the good news has been priced in. Where do we go from here? is a question to which there is no obvious answer.


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