<THE EVENING NEWS>
Tuesday, July 28, 1998
MARKET CLOSE
DJIA             8934.78   -93.46      (-1.04%) 
 S&P 500          1130.14   -17.13      (-1.49%) 
 Nasdaq           1895.87   -37.39      (-1.93%) 
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 30-Year Bond   105 12/32   -16/32  5.74% Yield 
 

HEROES

Number one automaker General Motors (NYSE: GM) rose $1 1/8 to $74 1/4 on anticipation that it was close to a settlement with the United Auto Workers to end an eight-week strike at two Michigan auto component stamping plants. In a press conference after the bell, UAW Vice President Richard Shoemaker confirmed that the union had reached a tentative agreement with GM to end the strike, pending ratification by union members in meetings tomorrow. The settlement includes a one-time special payment for striking workers, a "no sale" provision for a key Delphi parts plant through at least late 1999, and the withdrawal of current arbitration proceedings between the two sides. GM also agreed to hold high-level discussions more often with the UAW in an effort to avert labor strife in the future.

Pathologist practice management firm AmeriPath Inc. (Nasdaq: PATH) rose $1 1/4 to $11 1/2 after reporting fiscal Q2 EPS of $0.22 versus $0.08 a year ago, beating estimates of $0.20. Revenues increased 75% to $40.8 million from last year, while operating income climbed 92% to $9.8 million. The company resembles other better-known physician practice management firms in that it provides billing, accounting, and marketing services to its affiliated doctors. But unlike a general company such as PhyCor (Nasdaq: PHYC), AmeriPath deals solely with anatomical pathologists, who make their diagnoses by examining tissue and cell samples. This specialization has failed to protect the firm from the collateral damage inflicted by recent blowups at MedPartners (NYSE: MDM) and FPA Medical Management (Nasdaq: FPAM), though, as its stock has been dragged down 46% since April 1.

Automatic service and support software developer CyberMedia (Nasdaq: CYBR) gained $1 21/32 to $9 7/32 after competitor Network Associates (Nasdaq: NETA) offered to buy the company for $9.50 per share in cash, ending weeks of merger speculation for CyberMedia shareholders. The deal values the Santa Monica, Calif.-based firm at a 26% premium to yesterday's closing price of $7 9/16. CyberMedia brings an array of brand name "self-healing" PC products to the table, such as UnInstaller, First Aid 98, Guard Dog Deluxe, and Oil Change. It also brings some lingering baggage from an inventory gaffe that wrecked the stock earlier the year. However, by adding CyberMedia and the recently acquired Dr. Solomon's Group to its utility software lineup, Network Associates has effectively improved its competitive position vis-a-vis the recent anti-virus linkup between Symantec Corp. (Nasdaq: SYMC) and IBM (NYSE: IBM). Network Associates ended the day down $1 1/16 to $48 7/8.

QUICK TAKES: Automated chip testing equipment maker KLA-Tencor Corp. (Nasdaq: KLAC) advanced $1 11/16 to $28 15/16 after reporting fiscal Q4 EPS of $0.26 (excluding acquisition costs), above the Street's revised estimate of $0.24 and consistent with the company's earnings warning earlier this month... Semiconductor wafer fabrication systems maker Applied Materials (Nasdaq: AMAT) climbed $1 3/4 to $32 13/16 after receiving an order for its Ultima high-density plasma chemical vapor deposition (HDP-CVD) system from chip maker Advanced Micro Devices (NYSE: AMD)... Electronic Arts (Nasdaq: ERTS) gained $3 3/4 to $53 after Credit Suisse First Boston started coverage of the interactive entertainment maker with a "buy" rating.

Consumer services company Cendant Corp. (NYSE: CD) ascended $1 1/4 to $17 after its auditors indicated that Cendant's previously announced $0.22 to $0.28 per share restatement of its fiscal 1997 results is probably on target... Baan Co. (Nasdaq: BAANF) tacked on $1 to $39 11/16 as founder Jan Baan announced he would relinquish his position as chairman of the enterprise software developer's management board... Local area network (LAN) switches and hubs maker MRV Communications (Nasdaq: MRVC) added $2 1/16 to $22 after reporting fiscal Q2 EPS of $0.31, a dime more than a year ago and a penny greater than estimates. Revenues jumped 66% in the period to $65.7 million.

Standards-based programmable switches maker Summa Four (Nasdaq: SUMA) gained $3 to $16 3/8 after router giant Cisco Systems (Nasdaq: CSCO) agreed to acquire the company for about $116 million in stock. Cisco expects to record a $0.04 to $0.09 charge in the first half of fiscal 1999 related to the deal... Automated blood collection systems maker Haemonetics Corp. (NYSE: HAE) added $15/16 to $16 3/8 after settling a contract dispute from the early 1990s with the American Red Cross... Contract printed circuit board (PCB) manufacturer Jabil Circuit (NYSE: JBL) was lifted $2 1/8 to $33 15/16 by a BT Alex. Brown upgrade to "strong buy" from "buy"... Metal building components maker NCI Building Systems (Nasdaq: BLDG) tacked on $1 11/16 to $25 7/16 after CIBC Oppenheimer started coverage with a "strong buy" rating.

Information technology services and consulting firm Computer Sciences Corp. (NYSE: CSC) moved up $4 to $64 1/2 after reporting fiscal Q1 EPS of $0.40, beating the Street's estimate by a penny... Dental practice management firm CompDent Corp. (Nasdaq: CPDN) rose $3 1/4 to $16 3/4 after agreeing to an $18 per share buyout and recapitalization offer from a private investment group... Input/output (I/O) and high performance computer interface products maker QLogic Corp. (Nasdaq: QLGC) gained $6 1/8 to $62 7/8 after signing an agreement to provide fibre channel adapters to German computer products maker Siemens Nixdorf Informationsysteme AG.

Earnings Movers

Inter-Tel
(Nasdaq: INTL) up $1 to $16; Q2 EPS: $0.18 (before charges) vs. $0.13 last year; Estimate: $0.19

Micro Warehouse (Nasdaq: MWHS) up $1 5/16 to $20 15/16; Q2 EPS: $0.31 (before charges) vs. $0.23 last year; Estimate: $0.24

PC Connection (Nasdaq: PCCC) up $2 1/2 to $21; Q2 EPS: $0.26 vs. $0.16 last year; Estimate: $0.19

Renters Choice (Nasdaq: RCII) up $2 to $25 1/2; Q2 EPS: $0.34 vs. $0.25 last year; Estimate: $0.30

Stratasys Inc. (Nasdaq: SSYS) up $3/4 to $8; Q2 EPS: $0.07 vs. $0.01 loss last year; Estimate: $0.05

GOATS

Local exchange carrier and telecommunications services provider GTE (NYSE: GTE) lost $2 11/16 to $53 1/16 after announcing it has agreed to merge with Bell Atlantic (NYSE: BEL) for $53.36 billion in stock. Based on Bell Atlantic's closing price yesterday, the deal valued GTE at $54.90 per share -- 1.5% below GTE's last close of $55 3/4. This may seem unusual considering GTE's higher revenue growth, but taking into account GTE's high debt -- $14.1 billion as of the end of the first quarter -- the transaction is actually worth $67.46 billion. During the conference call, the companies stressed that the combination will accelerate revenue growth and quickly move the new entity toward increased profitability and becoming a market leader. They expect the transaction will be accretive to EPS in the first year following the deal's completion, and within three years it will produce $2 billion in cost-saving synergies and generate an additional $2 billion in revenue synergies. Explaining that neither "GTE" nor "Bell Atlantic" exemplifies the vision of the new company, the management plans to decide on a new name before the transaction is closed in 12 to 18 months. Bell Atlantic fell $11/16 to $44 5/16 today. For more details, click here. To access the conference call replay, dial (800) 633-8284, access code 4576928.

Manufacturing software and services company Aspen Technology (Nasdaq: AZPN) plummeted $18 3/4, or 38.9%, to $29 1/2 after pre-announcing fiscal Q4 EPS of $0.30 a share (before charges), short of last year's $0.38 and analysts' expectations of $0.45. The company said profitability was hurt by higher costs and slower-than-expected services revenue growth, though it told analysts in a conference call this morning that this was not a revenue problem or a long-term problem. Aspen expects Q4 sales of more than $74 million, up from last year's $53.3 million. The company has been on a acquisition rampage in the past year. It bought Chesapeake Decision Sciences Inc. in April, IISYS Inc. in March, and Special Analysis & Simulation Technologies Ltd. and NeuralWave Inc. last September.

QUICK CUTS: Several phone companies declined in the shadow of the GTE-Bell Atlantic merger announcement. WorldCom (Nasdaq: WCOM) fell $2 13/16 to $52 1/4, while merger partner MCI Communications (Nasdaq: MCIC) was down $3 1/8 to $63 13/16. AT&T (NYSE: T) slipped $15/16 to $59 1/16; BellSouth (NSYE: BLS) dipped $2 13/16 to $69 3/8; Ameritech (NYSE: AIT) shed $2 3/8 to $49 1/4; Qwest Communications (Nasdaq: QWST) tumbled $2 7/8 to $40 3/4; Tel-Save Holdings (Nasdaq: TALK) was cut $1 1/4 to $13 11/16; and Nextel Communications (Nasdaq: NXTL) lost $1 1/8 to $25 1/4... Warner-Lambert (NYSE: WLA) fell $3 1/4 to $79 3/8 after the Food and Drug Administration said that 14 people have died from liver failure while using the drug company's new diabetes drug Rezulin, but the FDA added that the drug was worth keeping on the market.

General Electric (NYSE: GE) slipped $1 3/16 to $90 13/16 as it announced that one of its units has formed a new pipeline development company with an affiliate of the Bechtel Group... Walt Disney Co. (NYSE: DIS) was held back $1 to $35 5/8 after The Wall Street Journal reported that the entertainment company's foray into the cruise business may be getting off to a slow start, with travel agents reporting less-than-expected demand for the first season... Telecommunications equipment company Lucent Technologies (NYSE: LU) shed $2 1/8 to $92 1/4 after announcing it has acquired privately held MassMedia Communications Inc., a developer of next-generation network interoperability software, for an undisclosed sum... French telecommunications equipment maker Alcatel SA (NYSE: ALA) slid $2 1/8 to $40 7/8 after saying its sales growth in the first half of the year slowed to 2.4% while orders rose 3.6% thanks to weak demand in Asia. Analysts had expected double-digit growth in orders.

Telebras (NYSE: TBR) fell $3 11/16 to $113 1/16 after a Brazilian judge issued an injunction suspending the privatization of the telephone company scheduled for tomorrow... Shipping specialist Airborne Freight Corp. (NYSE: ABF), better known as Airborne Express, nose-dived $6 3/16 to $24 5/8 after reporting Q2 EPS of $0.66, up from $0.59 in the year-earlier period but short of the $0.68 expected by analysts... Industrial graphite and calcium carbide products manufacturer Carbide/Graphite Group (Nasdaq: CGGI) tanked today, falling $6 5/8 to $21 1/4 after warning that fiscal Q4 EPS will be around $0.50 to $0.55 mainly due to lower-than-expected needle coke sales. Analysts had predicted EPS of $0.67. The company anticipates that the weakness in demand will last through the next several quarters.

Drug maker Mylan Laboratories (NYSE: MYL) shed $2 3/16 to $27 13/16 after announcing fiscal Q1 EPS of $0.28, double the same year-ago period. Analysts were expecting $0.27 per share... Mexico City-based media company Grupo Televisa S.A. (NYSE: TV) dropped $7 1/16 to $33 15/16 after reporting a 9.3% decline in operating earnings to 358.4 million pesos ($40.5 million). Analysts had expected operating income of 487 million pesos, according to Bloomberg... Oilfield services company BJ Services (NYSE: BJS) lost $1 3/8 to $22 1/16 after reporting fiscal Q3 EPS of $0.41 compared with $0.34 in the year-ago period and the analysts' mean estimate of $0.43. The company blamed the shortfall on prolonged weak oil prices... Lyondell Petrochemical (NYSE: LYO) sank $2 3/16 to $25 13/16 after reporting Q2 EPS of $0.38, down from $1.17 in the prior-year quarter and analysts' expectations of $0.47.

Corrections Corp. of America (NYSE: CCA) was cut $2 1/8 to $19 3/8 as the governor of Ohio called for a shutdown of one of its prisons after six inmates escaped over the weekend. CCA Prison Realty Trust (NYSE: PZN), which has proposed buying the company, fell $3 1/4 to $23... Carpenter Technology (NYSE: CRS) dropped $3 11/16 to $43 1/4 after Bear Stearns lowered its rating on the company to "attractive" from "buy." Yesterday the specialty steel maker issued an earnings warning for its fiscal Q1... Swimwear and fitness apparel company Authentic Fitness Corp. (NYSE: ASM) dipped $3/4 to $13 13/16 on news of a securities fraud class action lawsuit against the company and certain of its officers and directors... Equipment rental company United Rentals (NYSE: URI) slid $2 15/16 to $38 13/16 after reporting Q2 EPS of $0.14 versus analysts' expectations of $0.12.

Earnings Movers

BWAY Corp. (NYSE: BY) down $1 1/4 to $20; Q3 EPS: $0.30 (before charges) vs. $0.44 last year; Estimate: $0.35

ICG Communications (Nasdaq: ICGX) down $4 1/4 to $28 5/8; Q2 EPS: loss of $2.25 vs. loss of $2.06 last year; Estimate: loss of $2.07

Information Analysis (Nasdaq: IAIC) down $2 13/16 to $9; Q2 EPS: $0.04 vs. loss of $0.02 last year; Estimate: $0.06 (single analyst)

Meridian Diagnostics (Nasdaq: KITS) down $2 1/16 to $8 3/4; Q3 EPS: $0.10 vs. $0.12 last year; Estimate: $0.14

NBTY Inc. (Nasdaq: NBTY) down $1 7/8 to $16 3/4; Q3 EPS: $0.14 (before special items) vs. $0.11 last year; Estimate: $0.14

Oryx Energy (NYSE: ORX) down $3/8 to $17 11/16; Q2 EPS: $0.15 vs. $0.22 last year; Estimate: $0.03

Redwood Trust (NYSE: RWT) down $1 1/16 to $14 15/16; Q2 EPS: loss of $0.03 vs. profit of $0.52 last year; Estimate: profit of $0.08

FOOL ON THE HILL
An Investment Opinion
by Dale Wettlaufer

Starbucks Brew-Ha-Ha

As has become the norm with the writers of the Fool on the Hill column and the Fool Plate Special (in the Lunchtime News), today we will take a quick look at a Fool Portfolio holding. People who don't work at the Fool often don't realize that there is a lot of room for dissent in what we publish versus what others in the company have to say about particular companies. When we happen to agree on something, such as in the case of Amazon.com (Nasdaq: AMZN), the conspiracy theorists come out of the woodwork alleging all sorts of nefarious plots, but that's just not the way it works. I am not sure if I'm alone in this, but I personally think the 3Dfx (Nasdaq: TDFX) is an investment that holds little chance of outperforming the market, given that the history of graphics chips companies holds no examples of companies that have built sustainable competitive advantages. I've written as much and I've also detailed how the company's earnings are inflated by the lack of an income tax provision (due to net operating loss carryforwards).

Seeing as that is the case, I don't think David Gardner and Jeff Fischer will have a problem with my analysis of Starbucks (Nasdaq: SBUX). I won't get a raise from the Fool and I won't get a lifetime supply of Starbucks coffee if I write something positive, and I also won't be fired if I write something negative about the company. And contrary to the claims of those who were unintelligent enough to have shorted Amazon.com over the last couple months, I don't write anything with the intent of pumping up a Fool Port stock. We're trying to get at assessing intrinsic value, for which it can take years to see if the assessment was correct, not days. With that having been said, let's take a look at Starbucks.

Right away, one has to recognize the brand ubiquity of Starbucks. At times, it seems omnipresent -- as you can walk out of some stores and come within sight of another within moments. And some people think McDonald's (NYSE: MCD) is overbuilt. However, Starbucks believes that it can "cluster" its locations in high-traffic areas, so it's not as if you're going to walk into a cornfield with your cup of Starbucks and emerge on the other side of the field at the steps of another store. This concentration is in dense urban areas where a number of high-rise buildings supplies customers to one Starbucks and another set serves the store down the street.

This would suggest that the company can spread overhead over a larger revenue base, build brand equity through ubiquity, and afford a large marketing budget due to the absolute size of its cash flows before marketing expenses. This brand equity can fuel revenue growth through the introduction of new products such as its highly successful Frappucino, which it markets through a joint venture with PepsiCo (NYSE: PEP). The company is also already turning a profit on its ice cream joint venture with Dreyer's Grand Ice Cream. Though not addressed directly, there is enough evidence available in the company's dealings with analysts that Starbucks is modeling revenue growth of 20% per year over the next 10 years, which makes the goal $10 billion in revenues by the year 2008. That's a pretty audacious goal. What shakes out on a present value basis from that goal?

Taking it at a simple level, let's say the company does a 8% to 9% net margin in the year 2008. That's a bottom line of $800 million to $900 million. How generous can we be with that? Let's say the stingy end of the valuation range is at 14 times earnings and the generous end is 22 times earnings. That's a future value of $11.9 billion to $18.7 billion on a share base of 111.5 million shares, or $106.73 to $167.71 per share. Big bucks, right? On a yearly basis, the shares would have to appreciate only 8.7% to 13.7% per year to get to those values. Can Starbucks revenues grow at a 23% yearly clip? Sure, why not. One doesn't have to make the argument that its stuff is not successful and can't be successful the world over. It has proven itself to be a great company so far and there isn't a reason to believe it can't achieve that growth. However, at the present share price, there isn't a lot of room for error on two things: the execution of the strategic plan and the valuation the company will carry in the year 2008.

Looking at the company based on free cash flow and economic value added (EVA) -- which yield the same present value -- one has to be pretty generous with the assumptions to project a world-class investment. First, one has to assume yearly capital growth starting at 25% and slowly scaling down to 15% year-over-year in 10 years. This implies that the company will have to take on debt or sell more equity, which is no surprise. We net that out of the final valuation. The performance necessary to suggest that the stock will outperform the market over the next decade also reaches outside of quick-serve restaurant performance.

On an invested capital base of $3.7 billion in year 10, the company would have to generate a return on invested capital of 17%, run a cost of capital of 11%, and carry a valuation of 20 times net operating profit after taxes and 6 times invested capital to get to $177.96 in per-share value. In that cash flow model, we assume stellar performance in most years but with a glitch in two years, just to reflect either a recession or missed execution on its goals. The other parts of the model suggest flawless and sparking performance for eight years. With that as the requirement, the stock would appreciate 14.4% per year. In the most optimistic performance scenario I can come up with, the company's stock would appreciate 16.7% per year, to $215.98 in year 10. That assumes no flaws in performance, a huge ramp-up in capital, extraordinary capital efficiency, great capital management, and great margins in year 10.

For the EVA model, the very optimistic model currently puts the present fair value of the stock between $43.98 to $64.54 per share, using 13% as the required rate of return. The less optimistic model puts the present fair value of the stock anywhere from $24.46 to $52.42 per share.

Can the company achieve these goals? As someone who doesn't follow restaurants, brews his own coffee, likes Coke better as a soft drink, and can't imagine willfully going to a Starbucks for a Spanish coffee after dinner or just as a playful thing to do after the sun goes down, I can't imagine how the company can grow revenues 23% per year. Nor can I imagine that the company can really be as efficient on a capital management basis as it needs to be for the current price of the stock to be in the undervalued range. The company needs to be able to handle the price of coffee, stave off companies like Coke (who want you to imbibe 64 ounces of Coca-Cola product per day), grow revenues and invested capital at a prodigious rate, and achieve McDonald's like profitability once it gets to year 10 to really trounce the market. You may have some better ideas on this than I do, but I personally wouldn't think about the stock again until it gets down to the mid to low $30 range.

CONFERENCE CALLS

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Contributing Writers
Yi-Hsin Chang (TMF Puck), a Fool
Brian Graney (TMF Panic), Fool Two
Alex Schay (TMF Nexus6), Fool, too
Dale Wettlaufer (TMF Ralegh), Final Fool

Editing
Brian Bauer (TMF Hoops), another Fool
Bob Bobala (TMF Bobala), a Fool's Fool
Jennifer Silber (TMF Amused), Fool at last

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