Friday, December 19, 1997
MARKET CLOSE
DJIA:            7756.29   -90.21       (-1.15%)
S&P 500:          946.78    -8.52        (-.89%)
Nasdaq:          1524.74    +1.55        (+.10%)
Japan's Nikkei  15314.89  -846.75       (-5.24%)
30-Year Bond   102 28/32    +8/32   5.91% Yield

HEROES

Showboat (NYSE: SBO) floated $8 7/16 higher to $29 9/16 after Harrah's Entertainment (NYSE: HET) made a $1.2 billion bid (after assumption of debt) for the company. Showboat shareholders will get $30.75 per share in cash when the deal is consummated, a great leap from the $18 7/16 at which the stock traded at the start of the week. Rumors had been floating around for weeks that Showboat was on the block, especially after some of the company's top brass pulled out from a speaking engagement at a gaming industry conference sponsored by Bear Stearns and trade rag Casino Journal. Most in the industry had thought that Hilton (NYSE: HLT) would be the most likely acquirer, so the Harrah's bid comes as somewhat of a surprise. Showboat's stock spiked up on the Hilton rumor earlier in the week. This deal would make Harrah's the largest gaming company in the country with combined revenues of $2.5 billion.

Nike Inc. (NYSE: NKE) added $1/8 to $40 1/8 after being off as much as $2 1/4 intra-day. Last night the manufacturer of athletic shoes and apparel reported disappointing second quarter EPS of $0.48, well below estimates of $0.56. The warning last week from competitor Reebok International (NYSE: RBK) clued many investors into the fact that athletic shoe sales are still in the dumper, but enough people were scared into selling today to drive the stock to a new 52-week low. Thankfully Nike is one of the few problems that is not being blamed on economic turmoil in Asia. While the comparisons with last year's strong post-Olympics sales are not helping Nike at all, a powerful secular downturn in demand has served to remind brand-conscious investors that any company whose products are faddish tends to see its business follow patterns that many would describe as "cyclical." Although Nike is far from bankruptcy, the company still trades at 20 times annualized earnings per share (the 48 cents it just reported times four quarters), a level that can hardly be described as a bargain. Other athletic shoe-related companies were off today, with Reebok down $1 3/16 to $28 5/8, Footstar (NYSE: FTS) off $5/8 to $26 5/16, Just For Feet (Nasdaq: FEET) losing $3/4 to $12 13/16, and Woolworth (NYSE: Z) tumbling $9/16 to $19 13/16.

Tel-Save Holdings (Nasdaq: TALK) attempted another acquisition today, offering $15 per share in cash for the 95% of Symetrics (Nasdaq: SYMT) it does not already own. Symetrics shares gained $4 9/16 to $14 9/16. The $24 million cash deal represents Tel-Save's fourth attempt to acquire another company in the past year. The other three attempts met with failure as other buyers stepped in and topped Tel-Save's offers for those companies. Symetrics is a Melbourne, Florida-based electronics contract manufacturer. Tel-Save's $3 1/2 rise to $21 today was also helped by the news that Tel-Save had successfully acquired 27,000 new customers in a 24-hour ad blitz on America Online (where its annoying pop-up ads for $0.09 a minute long-distance appear every time a user logs on). Tel-Save's next move might be to reduce the access fees it pays to other carriers to complete its international calls by acquiring such a provider, which would also take advantage of AOL's international membership.

First Plus Financial Group (Nasdaq: FPFG) gained $4 9/16 to $33 5/8 after the home equity lender announcing that non-cash gain-on-sale revenues would be "substantially eliminated" from total revenues in its December quarter and in calendar 1998 and 1999. Investors were relieved that the company would not have to take a charge or restate earnings, a problem that shattered Green Tree Financial (NYSE: GNT). As a result of the company's more conservative discount rate assumptions it will use in its securitization valuations, EPS for calendar 1998 and 1999 will be much lower, but they will more closely approximate the cash flows of the business. The company is projecting EPS of $2.50 to $3.00 for calendar 1998 and $4.50 to $5.00 for calendar 1999. Analysts had projected EPS of $6.38 for fiscal 1999 ending in September 1999. This move may pressure other firms that record earnings on the sale of bonds backed by mortgage or home equity loans to change their accounting as well. Those candidates include Aames Financial (NYSE: AAM) and The Money Store (NYSE: MON). The conference call replay discussing the company's outlook will be available at (888) 888-9547.

QUICK TAKES: Computer retailer CompUSA (NYSE: CPU) gained $1 5/8 to $28 after Lehman Brothers reiterated its "buy" rating on the firm... PC seller Gateway 2000 (NYSE: GTW) shot $2 7/8 higher to $33 after rumors circulated that the company might be acquired by Compaq Computer (NYSE: CPQ)... Portable hard drive company Iomega Corp. (NYSE: IOM) gained $1 7/16 to $ 25 7/16 after the company was raised to a "strong buy" from "buy" at H.D. Brous & Co... A merger approval had shares of Healthdyne Technologies (Nasdaq: HDTC) up $1 3/8 to $20 1/16. Respironics (Nasdaq: RESP) got the okay to acquire the medical products manufacturer after the Hart-Scott-Rodino waiting period had elapsed... Software Artistry (Nasdaq: SWRT) rose $6 1/2 to $24 1/4 after IBM's (NYSE: IBM) Tivoli Systems unit made a $24.50 per share cash offer for all of the outstanding shares of the company. The deal will cost IBM around $200 million for Software Artistry's customer support and relationship management line of software products.

Emeritus Corp. (AMEX: ESC) announced that its wholly owned subsidiary EMAC Corp. has begun a hostile cash tender offer of $17.50 per share for all outstanding shares of ARV Assisted Living (AMEX: SRS), which rose $1 5/16 to $15 9/19 on the news... Adobe Systems (Nasdaq: ADBE) gained $2 1/4 to $36 7/8 after the software developer posted Q4 EPS of $0.56 versus estimates for $0.55... A giant merger in the single-family homebuilding industry had shares of Continental Homes (NYSE: CON) up $4 5/8 to $39 11/16. D.R. Horton (NYSE: DHI) is paying $44.50 per share for Continental, making it the fourth-largest homebuilder in the country with operations in 21 states. D.R. Horton shares were down $2 5/16 to $16 15/16... Meridian Resource Corp. (AMEX: TMR) got a $15/16 boost to $9 5/16 after announcing that Shell is merging its Louisiana assets with Meridian's and giving the company $23.7 million to boot. In return, Shell will get 15.2 million shares of Meridian's common stock and 8.5 million shares of convertible preferred stock.

The approval of a merger had Energy Group PLC (NYSE: TEG) up $1 5/16 to $44 1/2 and PacifiCorp (NYSE: PPW) up $1 1/8 to $25 7/16. PacifiCorp bid for the U.K.-based utility back in June and the bid had to be approved by U.K. anti-trust officials. Although the original bid has lapsed under U.K. law, PacifiCorp is free to make another bid and has expressed on numerous occasions that it is interested in doing just that... Premisys Communications (Nasdaq: PRMS) rose $2 13/16 to $25 after Goldman Sachs analyst Mary Henry upgraded the stock to "trading buy" with a 12-month price target of $29... Accounting software developer Great Plains Software (Nasdaq: GPSI) gained $1 5/8 to $22 1/4 after the company reported Q2 earnings of $0.15 per share, $0.02 better than the $0.13 per share expectations.

A potential beneficiary from all the Korean turmoil is chip maker Texas Instruments (NYSE: TXN), which gained $2 1/16 to $45 7/16 after investors assessed the possibility that Korean DRAM makers might plan to cut capital investments down the road... Lehman Brothers whipped out the upgrades on some semiconductor capital equipment companies, including Applied Materials (Nasdaq: AMAT), which gained $1 7/8 to $30 on a "buy" reiteration, and KLA-Tencor Corp. (Nasdaq: KLAC), which rose $3 9/16 to $37 13/16 after it was raised to "buy" from "outperform"... McDermott International (NYSE: MDR) gained $2 to $32 1/2 and J. Ray McDermott (NYSE: JRM) rose $3 15/16 to $38 1/2 after the companies sold their 50% interest in Hereema Offshore Construction Group for $318.5 million in cash.

Integrated circuit maker Micrel Inc. (Nasdaq: MCRL) added $4 3/8 to $27 3/8 after the company was raised to "strong buy" from "buy" at Hambrecht & Quist... NCR Corp. (NYSE: NCR) rose $1 9/16 to $29 after the automated teller machine maker cum transaction procesor announced that it has agreed to sell some of its manufacturing assets to Solectron (NYSE: SLR) for roughly $100 million... Pre-Paid Legal Services (NYSE: PPD) shot $5 3/16 to $32 3/8 after the provider of legal expense plans announced a marketing agreement with Primerica Financial Services where 100,000 of Primerica's personal financial analysts will market Pre-Paid Legal plans.

GOATS

Reptron Electronics (Nasdaq: REPT) was crunched for $1 to $10 5/8 after the company said that fourth quarter results would be disappointing. The electronics distributor and contract manufacturer will only make $0.06 to $0.10 per share in the quarter, well below the $0.29 that was expected. Reptron complained of price competition in its distribution business. To blunt the impact of the disappointment, the company's board approved the repurchase of up to 1 million shares, or about 12% of the outstanding shares. With the $49.3 million in cash on the balance sheet and a small loan, the company could actually take itself private if it wanted to, given that it only has 6.3 million shares outstanding worth all of $64.8 million. The company is flush with cash because it sold $100 million in bonds convertible into stock at $28 1/2. Reptron currently has $130.5 million in long-term debt that, at this point, looks unlikely to convert into stock anytime soon. Reptron is one of the many electronics distributors that has decided to spice up its product offerings by becoming a contract manufacturing solution as well. It originally planned to use the extra cash from the offering to acquire other distributors or contract manufacturers.

Troubled fashion purveyor Bernard Chaus (NYSE: CHS) apparently closed down $5 7/16 to $3 1/16 today, but only after the company's rights began to trade separately. After the company's recent reverse split to bring the shares from the realm of the absurd back to a reasonable price, the company also gave each shareholder the right to purchase about 5.5 shares for $1.43 apiece. With Chaus at $3 1/16, that means each rights offering is worth about $9 at current prices (the current price less the rights price times 5.5). When a company has a rights offering, a spin-off, or any other kind of dividend or distribution, its stock price is adjusted before the market opens to reflect this payout. If you get a capital gains distribution of $1.00 from your mutual fund, for instance, the next morning the fund will be worth a dollar less and you will have a dollar more in your account. Even when a company pays a dividend the price is adjusted, which means when a company has a big payout (like Chaus), it often looks like the stock has dropped quite a bit. At year-end many mutual funds pay distributions, causing a lot of confusion for shareholders.

QUICK CUTS: AMR Corp. (NYSE: AMR) was dumped for $2 15/16 to $124 7/8 after getting cut to "neutral" by Ed Starkman of SBC Warburg Dillon Read. Starkman set the 12-month price target at $130... Japanese economic worries hurt shares of Amway Japan (NYSE: AJL), off $5/8 to $9 3/16 today... Baan Co. (Nasdaq: BAANF) slid $1 9/16 to $31 9/16 after Adams, Harkness and Hill analyst Ben Rose initiated coverage with a "market perform"... Manugistics (Nasdaq: MANU) tumbled $3 1/4 to $40 1/8 on concerns that sales through its third party licensing partner Oracle (Nasdaq: ORCL) would slow further after being down sequentially in the third quarter just reported... ConAgra (NYSE: CAG) dropped $2 5/16 to $35 5/16 after reporting second quarter earnings of $0.46 per share, in line with estimates... Smart & Final (NYSE: SMF) fell $15/16 to $16 15/16 after the company reported that it would not make fourth quarter earnings estimates...

Briggs & Stratton (NYSE: BGG) was mowed over for $3 3/16 to $49 1/16 as the manufacturer of small engines reported that it would earn less in the second quarter than it did last year, completely blowing earnings estimates of $0.67 per share... Cablevision (NYSE: CVC) was docked for $3 7/16 to $88 after News Corp. (NYSE: NWS) and Tele-Communications Inc. (Nasdaq: TCOMA) finalized their purchase of 40% of the company's sports assets... Chrysler (NYSE: C) was whacked for $1 1/16 to $34 9/16 after announcing a 1.325 million truck recall, while Ford (NYSE: F) was also off $1 1/2 to $45 7/8 in tune with the market on no particularly interesting news... DepoTech Corp. (Nasdaq: DEPO) was pounded for $8 7/8 to $4 1/8 after a Food & Drug Administration advisory panel recommended against approval of the company's neoplastic meningitis drug...

British engineering consultants Doncasters Plc (NYSE: DCS) slid $1 13/16 to $22 15/16 after making a bid for automotive and power engineering firm Triplex Lloyd Plc, apparently on concern that the offer was too much. Doncasters was recently spun-off from Inco Ltd. (NYSE: N)... The perception that KN Energy (NYSE: KNE) may have overpaid for $4 billion in Occidental Petroleum natural gas pipeline assets that it bought today had shares of the company down $7/8 to $47 5/8... Economic and financial consultant LECG Inc. (NYSE: XPT) dropped $7/8 to $8 1/8, falling below the $9 price at which it came public yesterday. Originally priced at $11 to $13, LECG has already undergone the humiliation of being priced below the estimated range -- now it has broken the offering price on the second day of trading...

Microsoft (Nasdaq: MSFT) was down $2 5/16 to $128 9/16 in sympathy with the perception that PC sales were slowing and general weakness among PC-related stocks, although a lot of ink was spilled linking it to the current Department of Justice brouhaha over the company's Internet Explorer browser... Storage Technology (NYSE: STK) fell $2 11/16 to $56 after the company's marketing agreement with IBM (NYSE: IBM) for mainframe disk drives was revised to avoid being to taken federal court on antitrust grounds... TulTex Corp. (NYSE: TTX) dropped $1/2 to $4 after the maker of athletic clothing said crappy sales on Turkey-Day weekend put fiscal 1997 earnings between break-even and $0.10 per share, well below the $0.34 analysts were expecting... Universal Forest Products (Nasdaq: UFPI) was axed for $ 2 1/32 to $12 29/32 after the lumber products company said results for the fiscal fourth quarter would be break-even because of competitive lumber pricing, particularly in products related to manufactured homes.

FOOL ON THE HILL
An Investment Opinion by Randy Befumo

Networkers Hit Hard Times

3Com (Nasdaq: COMS) shareholders caught a breather late today when shares only closed down $1/2 to $32 5/8 after being down as much $2 1/16 this morning. A downpour of earnings estimate revisions followed by the company's somewhat somber guidance in last night's post-earnings conference call dragged on the shares. 3Com's plight has tracked almost exactly that of the industry, as company after company has been laid low by a lumpy demand, executive error, and management hubris. The Computer-Local Networks Industry currently ranks 146 out of 197 industries in Investor's Business Daily after sitting at number 16 only three months ago.

Many investors find it hard to remember a time when companies involved in the fast-growing networking industry were not doing well, with the exception of last April. Now it is hard to find a company in the industry that is doing well. Where small networking companies were once viewed as an engine of innovation and growth, many of these companies now have been left behind for dead as the Cisco-led "end-to-end" systems solutions have come to dominate the industry. The conventional wisdom holds that if you are not among the top five players, forget about it. As much as a Fool would like to dispute this conclusion, for the most part except for companies with expertise in a single product line the big guys are not involved in, it usually holds true.

While the small companies have been getting smaller, the big have not been doing all that well either. With the single exception of Cisco Systems (Nasdaq: CSCO), each of the big five has either warned, made discouraging comments, or issued questionable and confusing statements to analysts that some interpreted as negative. In the past month, 3Com has cleaned out its inventory channel, Cabletron (NYSE: CS) has laid off 600 workers, Bay Networks (NYSE: BAY) issued statements at an analyst meeting interpreted by some attending as negative, and Ascend Communications (Nasdaq: ASND) has only poked its head up when pretty outlandish rumors of a Lucent (NYSE: LU) buy-out circulated for the umpteenth time.

The problem that many investors have with these companies is that based on deteriorating financial results, they are not getting cheaper. The valuations are declining just enough to keep up with the earnings shortfalls and revenue shortcomings. Take 3Com for instance. In the quarter it just completed, sales dropped 14% year-over-year and 24% sequentially to $1.22 billion. The lion's share of this drop came from the client access business (modems and NICs), which saw revenues tumble 24% year-over-year and 32% sequentially. However, even the systems business dropped 2% year-over-year and 13% sequentially to $621.5 million. The company reported that it still had inventory to clear in the systems business next quarter, and that for half a dozen reasons gross margins might fall further -- indicating that financial results may not recover substantially until fiscal 1999.

With $621.5 in systems sales, consisting of switches, routers, hubs, and remote access, 3Com is the second-largest company in the networking business. In fact, the company may not even be the number two company for the current quarter. Number three Bay Networks did $601 million in revenues last quarter and sees sales going up sequentially, although there are significant questions about whether or not the company's router business (22% of sales last quarter) will further erode. A sequential sales gain of more than 3% will put the company on par with 3Com for the first time since the Wellfleet-Synoptics merger that created the company, an interesting turn of events indeed.

Although both companies have their individual issues, things get even worse further down the networking food chain. Two weeks ago number four in the industry, Cabletron, said it would do $330 to $340 million in sales in its upcoming quarter, not counting the $70 to $80 million in revenues from the Digital Equipment Networking business it recently bought. Put another way, sales could drop more than 9% for Cabletron's core business without clearing out an inventory channel that some analysts believe is equally as bloated as 3Com's. The fact that the company has laid off 600 workers in an attempt to realign its cost structure is even more troubling that anything 3Com or Bay can offer up, as it suggests that the problems Cabletron has encountered may still be here next year. Number five Ascend is even more of a wild card, with sales already down by more than 12% last quarter and potentially slipping even more as pricing in remote access is destroyed by Cisco.

Despite this sustained downtrend in the industry, all of these companies still are valued at more than two times trailing sales -- even though profit margins at all but Cisco have gone below 15% -- with most seeing profits below 10%. While certainly networking is not going to become a thing of the past, as the industry continues to consolidate and demand gets lumpier, these companies will command less generous valuations. Even if 3Com, Bay Networks, Cabletron, or Ascend manage to right their businesses, what new valuation paradigm will exist remains unknown. With industry growth for the next two years estimated to be well below that seen in the first part of the decade, investors involved in any of these stocks should be careful that they do not just use historical multiples as their guide but instead focus on what the underlying profitability of these companies will be and what sort of value companies with similar profitability get. The bloom may not be off the rose, but the halo has certainly been removed from quite a few corporate heads.

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Randy Befumo (TMF Templr), a Fool One

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