Friday, February 19, 1999
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The recent rush of consolidation in the airline industry appears to be continuing, as The Wall Street Journal reported that United Airlines operator UAL Corp. (NYSE: UAL) made a conditional cash bid for America West Holdings (NYSE: AWA). America West took off today, gaining $2 3/4 to $22 3/4, as the Journal said the company may find itself the subject of a bidding war between UAL and Continental Airlines (NYSE: CAI.A). Continental owns an 8% stake in America West and the right of first refusal to buy a controlling stake in the event of an acquisition bid, which it's likely to exercise. The move comes after recent news of another big-dollar airline merger: Delta Air Lines (NYSE: DAL) agreed on Tuesday to buy Atlantic Southeast Airlines parent company ASA Holdings (Nasdaq: ASAI) for about $700 million. To avoid the sticky "sick-out" wicket that grounded AMR's (NYSE: AMR) American Airlines flights recently, UAL has said that its offer is contingent upon labor integration issues being worked out before the deal closes.

Electronics components and computer products distributor Arrow Electronics (NYSE: ARW) shot ahead $1 1/8 to $16 3/16 after Morgan Stanley got on board with a rating upgrade from "neutral" to "outperform" from "neutral." The company's shares have been battered over the last year, rising off the mat in the fourth quarter only to fall once again after the company guided Q4 quarter estimates downward. Weaker-than-expected European sales and gross margin pressure led the company to forecast fourth quarter EPS of $0.30-$0.35 -- so at its low, the company traded at 11.2 times annualized earnings. "Is this a classic value trap?" some investors might ask. In other words, the question "Is this dangerously cheap?" is germane here. A company whose business is about to go off a cliff usually looks pretty cheap before actually making the plunge. With companies such as soon-to-be-public pcOrder.com possibly threatening the competitive advantage of such a company, the value investor interested here should do some snooping around and ask not just company-centric questions but also bigger-picture questions.

QUICK TAKES: Telecommunications equipment company Ciena Corp. (Nasdaq: CIEN) gained $1 9/16 to $22 7/16 after surprising Wall Street by reporting fiscal first quarter earnings of $0.02 a share, as new customers jump-started sales. The company had been expected to report a loss of $0.01 a share... Two website software developers rose after their IPOs today. Vignette (Nasdaq: VIGN) added $23 11/16 to $42 11/16 after selling 4 million shares at $19 each, while WebTrends (Nasdaq: WEBT) moved up $14 1/16 to $27 1/16 after selling 3.5 million shares for $13 apiece... Airline catalog retailer SkyMall (Nasdaq: SKYM) soared $2 15/16, or 24.9%, to $14 3/4 on news that the nation's fourth-largest airline, Northwest Airlines (Nasdaq: NWAC), will carry the company's in-flight catalog on all domestic flights. The 3 1/2-year agreement raises SkyMall's share of the domestic airline market to 78% from 70%.

Telecommunications services company CoreComm Ltd. (Nasdaq: COMMF) rang up $7 1/16 to $33 1/4 after it agreed to buy most of USN Communications' (Nasdaq: USNC) local exchange telecommunications resale business for about $27 million in cash plus other considerations... DRAM chip enhancement technologies developer Rambus Inc. (Nasdaq: RMBS) gained $9 3/4 to $71 following reports that Intel (NYSE: INTC) is expected to "reaffirm" support for the company at its upcoming developers' conference... Enterprise software maker Brio Technology (Nasdaq: BRYO) rose $3 to $20 1/4 after it said IBM (NYSE: IBM) will resell its Brio Enterprise software package bundled with IBM's DecisionEdge hardware, software and service suite.

Amazon.com (Nasdaq: AMZN) tacked on $12 3/8 to $101 7/8 and Yahoo! (Nasdaq: YHOO) picked up $6 7/16 to $135 5/16 after CIBC Oppenheimer analyst Henry Blodget reportedly said it's time to buy shares of Internet stocks such as the online book and music retailer and the leading Web portal. Excite (Nasdaq: XCIT) rose $4 1/16 to $95, Infoseek (Nasdaq: SEEK) added $1 15/16 to $61 9/16, and Lycos (Nasdaq: LCOS) traded up $3 1/4 to $87 1/2... Prison operator Wackenhut Corrections Corp. (NYSE: WHC) gained $1 3/8 to $20 after saying the fourth quarter results it released yesterday understated revenues and operating expenses. The company also announced plans to buy back an additional 500,000 shares.

ResMed Inc. (Nasdaq: RESM), which makes medical equipment for treating sleep disordered breathing, rose $3 5/8 to $33 1/2 after saying it has no explanation for the recent drop in its share price and that it is "comfortable" with analysts' estimates for the remainder of its fiscal 1999... Bank of Commerce (Nasdaq: BCOM) jumped $1 9/16 to $18 5/8 on news that it will be acquired by U.S. Bancorp (NYSE: USB) for about $314 million in stock, or $19.75 a share, a 16% premium over Bank of Commerce's closing price yesterday... Investment bank and brokerage Eastbrokers International (Nasdaq: EAST) jumped $15/32 to $7 after announcing plans to develop an online business services subsidiary with Cyber Realm, an Internet access and content provider... Georgia bank holding company Colony Bankcorp (Nasdaq: CBAN) deposited $2 1/4 to $25 1/4 after announcing plans to split its stock 2-for-1 effective March 31.

Camera maker Polaroid (NYSE: PRD) clicked up $3 1/4 to $22 1/4 following quotes from an analyst in Business Week's "Heard on the Street" column saying there are "rumblings" hinting at a merger deal... Mining company Arch Coal (NYSE: ACI) picked up $3/8 to $10 1/4 after Merrill Lynch raised its long-term rating on the stock to "buy" from "accumulate" and its near-term rating to "buy" from "neutral," citing "attractive valuation" and "strong cash flow"... Highway civil contractor Granite Construction (NYSE: GVA), pummeled yesterday for a loss of $7 3/4 after disappointing earnings news, recovered $1 5/8 to $23 15/16 today as at least three brokerages upgraded the stock... Circus Circus Enterprises (NYSE: CIR) benefited from similar treatment, gaining $1 1/2 to $17 3/16 as at least three brokerage houses upgraded the casino owner and operator today. Merrill Lynch believes the shares could reach the "low $20s" over the next 12 to 18 months.

Bicycle maker Cannondale (Nasdaq: BIKE) rolled up $2 1/4 to $11 1/4 after Hambrecht & Quist upgraded the shares to "buy" from "hold"... High-performance metals company Special Metals (Nasdaq: SMCX) was burnished $1 3/8 to $7 after United Steelworkers of America Local 40 reached a tentative agreement last night to end the strike at the company's West Virginia facility... Vitamin maker and retailer NBTY Inc. (Nasdaq: NBTY) popped up $1 3/32 to $6 11/32 after it said its Body Fortress sports nutrition products will be sold in Wal-Mart (NYSE: WMT) stores... Internet service provider Frontline Communications (Nasdaq: FCCN) took $2 to $13 after naming Vasan Thatham its CFO.


Avondale Industries (Nasdaq: AVDL), which makes amphibious ships for the U.S. Navy and double hull oil tankers for commercial clients, leaked $2 15/16 to $29 3/4 today as nuclear aircraft carrier and submarine builder Newport News Shipbuilding (NYSE: NNS) reported an unsolicited $1.35 billion offer from General Dynamics (NYSE: GD) to acquire all of its outstanding shares for $38.50 per share in cash, a 35% premium over yesterday's closing price. Avondale shareholders fear that the General Dynamics offer might cause Newport News to end a planned merger with the company. While Newport News said it remains "fully committed" to the Avondale deal, if General Dynamics can satisfy its concerns as to the certainty of the new deal's closing, that situation may change. Newport News tied on $3 1/2 to $31 15/16 today. Some observers believe the General Dynamics proposal -- which would leave only one maker of nuclear submarines for the U.S. government -- could come under fire from federal regulators and politicians.

Electronics manufacturing services (EMS) company Celestica Inc. (NYSE: CLS) shed $2 1/16 to $28 after it said last night that it will sell 8 million shares for $28.65 each -- about a 5% discount to yesterday's closing price -- to fund expansion. Celestica is not the only EMS company to take advantage of firmness in the valuation of EMS companies. Contract manufacturer Jabil Circuit (NYSE: JBL) recently registered to sell 10.5 million shares with a 1.6 million share "greenshoe"; in late January Solectron (NYSE: SLR) issued $700 million of convertible senior notes (and recently called for redemption $230 million of convertible subordinated notes); and Flextronics (Nasdaq: FLEX) issued 3.7 million shares in early December. With the industry growing at a 25% annual rate due to organic growth in electronics markets and in the transfer of facilities from original equipment manufacturers (OEMS) to EMS companies, any addition to capital that can earn more than its cost of capital is going to be a value-adding move. That explains the excellent share price performance at Flextronics, which has been the most aggressive acquirer in the industry in recent years.

QUICK CUTS: Drug company Sepracor Inc. (Nasdaq: SEPR) lost $21 1/4 to $116 after reporting a Q4 loss of $1.10 per share, down from last year's $0.51 loss but a penny better than Wall Street's projection. Gruntal & Co. downgraded the stock to "buy" from "strong buy" today... Global satellite and paging company Iridium World Communications (Nasdaq: IRIDF) fell $3 to $27 5/16 today. The company said it approved Kyocera Corp.'s hand-held phones for use with its network -- the launch of the Kyocera handsets was postponed from Nov. 1 because of software issues... Wireless telecommunications systems developer InterDigital Communications (Amex: IDC) moved down $11/16 to $4 15/16 after it said Germany's Siemens AG will end an agreement it has to use InterDigital's broadband code division multiple access.

Gillette Co. (NYSE: G) was trimmed by $3/8 to $55 5/16 after announcing that Chairman and CEO Alfred Zeien will retire April 15 after an 8-year tenure and 31 years of working for the company. He will be succeeded by Gillette President and COO Michael Hawley, a 36-year veteran of the company... Pharmaceutical promotions consultant Boron, LePore & Associates (Nasdaq: BLPG) lost $1 3/8 to $10 7/8 after saying it expects Q1 EPS of between $0.09 and $0.11, missing the $0.16 consensus estimate four analysts gave First Call... Trash removal and recycling firm Waste Industries (Nasdaq: WWIN) was dumped $2 1/16 to $13 15/16 after pre-announcing Q4 EPS of $0.18 or $0.19, missing the First Call mean estimate of $0.22. The company also announced the acquisition of a 340-acre landfill in Tennessee, two waste services companies, and government contracts in Georgia and North Carolina.

Dairy products processor and distributor Dean Foods Co. (NYSE: DF) curdled $1 7/16 to $34 after it said fiscal Q3 EPS is seen coming in below the market's $0.44 consensus estimate. The company expects EPS of $0.20 before an $8 million charge for the close of its Michigan pickle operation... Men's footwear maker Florsheim Group (Nasdaq: FLSC) dropped $7/8 to $5 7/8 after it announced the hiring of Bear, Stearns & Co. as its financial adviser "to evaluate and recommend financial and strategic alternatives." Q4's loss was $0.08 per share, down from an $0.08 per share profit a year ago and half of what the two analysts polled by First Call expected... Drug maker Pfizer Inc. (NYSE: PFE), downgraded to an intermediate-term "accumulate" from "buy" by Merrill Lynch, lost $2 3/4 to $128 3/8 today. The brokerage, which maintains a long-term "buy" rating on the stock, believes the company's price-to-earnings ratio is "at or near a peak."

Chip performance accelerator technology developer NeoMagic Corp. (Nasdaq: NMGC) faded $1 1/2 to $12 5/8 after it announced Q4 EPS of $0.34, $0.02 above last year's number but flat with market projections. The company also announced the purchase of Mitel Semiconductor's optical drive development group and ACL, an Israeli array processing company. Terms for the deals weren't reported... Healthcare information technology firm QuadraMed (Nasdaq: QMDC) put away another $1 1/4 to $16 7/8 after losing $4 15/16 yesterday on news of Q4 EPS of $0.29 (before one-time items) versus $0.15 last year. Analysts expected EPS of $0.28.

Dental and medical digital radiographic imaging systems developer Schick Technologies (Nasdaq: SCHK) slid $1 1/4 to $4 after it said it expects to report a "substantial" net loss for its fiscal third quarter... Electronic enclosure, thermal management, and industrial tool products firm Applied Power (NYSE: APW), upgraded to "strong buy" from "buy" at Credit Suisse First Boston, nevertheless lost $3 9/16 to $26 1/4... Paging company SkyTel Communications (Nasdaq: SKYT) slumped $1 1/16 to $19 after Lehman Brothers reportedly cut its rating on the stock to "outperform" from "buy"... St. Mary Land & Exploration Co. (Nasdaq: MARY) dropped $1 3/8 to $16 1/8 after reporting a Q4 loss of $0.44 per share vs. $0.12 per share profit last year and an estimate of $0.03 profit.

An Investment Opinion
by Warren Gump

Investors Warming Up to Lady Luck

Casino stocks such as Mirage Resorts (NYSE: MIR), MGM Grand (NYSE: MGG), Harrah's Entertainment (NYSE: HET) have been out of favor with investors for quite a while. After hitting highs in June 1996, these shares have been big losers, and investors who stayed away have probably been pleased with their decision. While the Standard and Poor's 500 Index has been racking up 20%+ annual returns, these stocks have lost as much as half their value. Since the end of January, however, a rebound of 20% or more has hit these stocks.

And over the past couple of days, these stocks have actually moved up quite a bit. Both Mirage and MGM Grand moved up 9% yesterday and 6% today. Harrah's followed suit, moving up a total of 18% over the past two days. Volume has also been extremely heavy. Mirage's volume of 4.6 million shares today is more than three times average volume over the past 50 days. Volume in the other two stocks was similarly high.

Fueling this boom is news that visitor volume in Las Vegas jumped 6.7% in December, helped by the October opening of Mirage's 3,005 room Bellagio Resort, the most expensive hotel ever built, costing roughly $1.8 billion. Bringing new visitors to Las Vegas is extremely important because the gambling mecca is expected to add roughly 21,000 rooms over the three-year period starting with the opening of Bellagio. During 1999, three new mega-resorts with about 3,000 rooms each (Mandalay Bay, the Venetian, and Paris) are scheduled to open. A lot of new visitors will be needed to keep those rooms filled and the cash flowing at the gaming companies.

Historically speaking, casino openings in Las Vegas have led to increased visitorship to keep the rooms and casinos full. Analysts and investors have been concerned, however, that the magnitude of new rooms planned has been so great that visitorship would not rise sufficiently to keep occupancy rates up. If that were to happen, the lower occupancy and the resulting increase in competition would reduce profitability.

This first bit of news that Bellagio has increased visitorship has been extremely welcome. Of course, one month's data does not make a trend. This increase in visitorship will need to continue (and grow) over the next year as the new properties open. Even more important than an immediate surge in visitorship will be the sustained levels that these resorts experience after their first year of operation. (Most casinos have extraordinarily strong results during their first year as gamblers check the place out.)

Even if all of these casinos are successful in attracting new visitors, investors will need to scrutinize the returns that the casinos earn on their recent investments. As the cost of new projects has skyrocketed, the returns are expected to be lower. While Las Vegas casinos have traditionally been looking for cash-on-cash returns of 20% or more, most of these new projects are likely going to be somewhere in the mid-teens. One securities analyst estimated that Bellagio will only yield a cash-on-cash return of 13.2% in its first year because of its high cost.

Although Mirage's properties are more glamorous and exciting, I find Harrah's to be the most interesting of the gaming companies. (Our resident gaming aficionado, Paul Larson, also selected this company as a gaming company to watch in Industry Focus 1999.) What I like about Harrah's is its diversity of operations, as well as its very successful loyalty program, Total Gold. I believe that Harrah's attempt to create a nationwide brand will allow it to continue to grow its business in the years ahead. In the meantime, the company can still be picked up for about 13 times earnings estimates for the year ahead.

Harrah's operates casinos across the country where gaming is legalized. In addition to properties in the major Nevada markets and Atlantic City, the company has riverboats in Illinois, Louisiana, Mississippi, and Missouri. Harrah's has leveraged off of this broad distribution by creating Total Gold, where gamblers earn points that can be redeemed for prizes at other properties. This means, for example, that a gambler in Joliet, Illinois, can win rewards to stay in one of Harrah's Las Vegas properties. Total Gold has proven successful at increasing play across Harrah's facilities in different markets.

Harrah's diversity means that it isn't fully exposed to the Las Vegas market. While the company has three major properties there (including the recently acquired Rio), a significant portion of revenues and earnings comes from other venues. Increasing competition in Las Vegas would hinder results, but would not be as devastating as at other companies with more exposure there.

Consolidation is still occurring in the gaming business, and Harrah's has shown a keen interest in acquiring the companies that want to sell. Last year's announced purchases of Showboat and Rio enhanced the company's position in both the Las Vegas and Atlantic City markets. As more smaller players decide they would benefit from the resources of a larger player, Harrah's could pick up some additional assets.

Creating a company-wide loyalty program has given Harrah's an advantage over its rivals when looking at acquisition prospects. Beyond the normal synergy such as corporate overhead reduction and lower financing costs, the company has an opportunity to enhance revenue growth by branding the property. If the company can successfully boost revenue where competitors cannot, Harrah's will have a significant advantage when seeking acquisitions.

The gaming business is not for every investor. While cash flow tends to be high, the companies also have commensurately high levels of debts. More debt lowers the overall cost of capital but increases the risk to equity holders if unexpectedly poor results occur. In addition, the companies are subject to all kinds of regulatory and legal risk.

This summer, a Congressionally appointed panel will report on the effects of gambling. Currently, the panel is expected to propose that Congress ban Internet gambling and put curbs on Indian gaming, two positives for existing casino companies. If Congress doesn't follow these recommendations or decides to impose stricter regulations, gaming companies could be adversely impacted.

If, despite the risks of the industry, you are interested in taking the plunge in a gaming stock, Harrah's would be my choice for a long-term investor. You won't get the excitement of a new mega resort, but you might get better performance.

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