Thursday, March 4, 1999
DJIA            9467.40  +191.40     (+2.06%)
S&P 500         1246.64   +18.94     (+1.54%)
Nasdaq          2292.89   +27.69     (+1.22%)
Russell 2000     394.02    +2.07     (+0.53%)
30-Year Bond   93 19/32    -2/32  5.70 Yield


Several oil and gas services and contract offshore drilling companies rose today, adding to yesterday's gains following a report that U.S. crude oil and refined product inventories dropped by 8 billion barrels last week due to unusually warm weather. The inventory slide spurred optimism that the ongoing global oil supply glut is subsiding, albeit slowly. In response, the price of the near-month West Texas Intermediate crude futures contract on the New York Mercantile Exchange rose more than 4% to $13.50 per barrel today, its highest price since early January. However, the drillers and suppliers are not out of the woods yet. With the major integrated firms still reducing their E&P spending budgets, cash flows and earnings throughout the sector will likely remain under pressure for the rest of the year. Schlumberger (NYSE: SLB) gained $4 5/8 to $56 3/8, Halliburton (NYSE: HAL) added $1 21/32 to $32 1/16, Smith International (NYSE: SII) advanced $2 1/8 to $28 7/8, Transocean Offshore (NYSE: RIG) rose $1 1/4 to $22 7/16, and Diamond Offshore (NYSE: DO) picked up $1 5/8 to $23 5/8.

Web-hosting services company Verio Inc. (Nasdaq: VRIO) moved up $4 to $36 1/2 after being selected as the exclusive business Web-hosting provider for online services conglomerate America Online (NYSE: AOL). Verio will provide AOL with at least a total of $42.5 million in guaranteed payments in exchange for "significant" promotion of an AOL-Verio co-branded website, which will feature Verio's Web-hosting products targeted at small and medium-sized businesses. The deal provides a source of future hosting revenues for the fast-growing Verio, which has watched its share price rise 41% from its initial public offering price of $23 per share last May as its customer list has grown. America Online's 18 million-member user base offers a fertile feeding ground for Verio's services, as an estimated 3 million to 4 million of AOL's members fit into the small and medium-sized business mold.

QUICK TAKES: Computing products and services giant IBM (NYSE: IBM) gained $4 1/4 to $171 after signing a $16 billion technology agreement with direct PC marketer Dell Computer (Nasdaq: DELL). Under the deal, Dell will be able to integrate IBM's high capacity disk drives, network adapter cards, flat panel displays, and static random access memory (SRAM) chips into its own computer systems... Canadian facilities-based competitive local exchange carrier (CLEC) MetroNet Communications (Nasdaq: METNF) rang up gains of $3 1/8 to $46 1/4 after agreeing to merge with AT&T's (NYSE: T) AT&T Canada subsidiary in a deal valued at about $7 billion... Solid waste disposal company Browning-Ferris Industries (NYSE: BFI) rose $2 5/16 to $33 3/4 on rumors that the company may be a takeover target.

Men's apparel superstore retailer K&G Men's Center (Nasdaq: MENS) picked up $1 to $9 3/8 after agreeing to be acquired by rival Men's Wearhouse (Nasdaq: SUIT) for between 4.1 million and 4.4 million Men's Wearhouse shares, or $110 million and $118 million based on yesterday's prices. Men's Wearhouse fell $1 19/32 to $25 5/32... Electronics retailer Circuit City Stores (NYSE: CC) charged ahead $6 3/16 to $63 1/4 after reporting a 12% increase in same-store sales at its namesake stores during February. Total sales for the month rose 23% from a year ago to $770 million... Discount retailer Dollar General (NYSE: DG) added $2 1/2 to $32 15/16 after reporting a 4% rise in February same-store sales despite a tough comparison from a year ago, when the firm's "comp" figures marched ahead 21.8%.

Arts and crafts retailer Michaels Stores (Nasdaq: MIKE) constructed a $4 3/8 gain to $22 13/16 after reporting fiscal Q4 EPS of $0.99, up from $0.79 last year and ahead of the Zacks mean estimate of $0.93. Additionally, the company said its same-store sales figures for February rose 5% from a year ago... Women's clothing retailer AnnTaylor Stores (NYSE: ANN) rose $2 3/4 to $41 3/4 after reporting a 21.4% increase in February same-store sales compared to the same period a year ago... Collagen implants producer Collagen Aesthetics (Nasdaq: CGEN) swelled $1 5/8 to $15 7/16 after saying it has hired Lehman Brothers to help explore "strategic alternatives," including a possible merger or sale of the company.

Brokerage and investment bank Merrill Lynch (NYSE: MER) was helped up $6 11/16 to $84 3/8 after fellow broker Salomon Smith Barney raised the firm's Q1 earnings estimate to $1.20 per share from $1.05 per share, citing strong underwriting and retail brokerage activities... Sears, Roebuck & Co. (NYSE: S) gained $3 1/8 to $43 3/4 after hiring former Safeway (NYSE: SWY) CFO Julian Day as its new CFO. The retailer also reported a 0.8% year-on-year rise in February same-store sales... Specialty integrated circuits maker VLSI Technology (Nasdaq: VLSI) added $15/16 to $18 5/16 after the Netherlands' Philips Electronics (NYSE: PHG) said it will start a cash tender offer for all of VLSI's shares tomorrow at a price of $17 per share, following up on its initial offer to buy the company last week.

Biotechnology firm Genzyme (Nasdaq: GENZ) tacked on $2 3/4 to $48 3/16 after reportedly guiding analysts to expect fiscal 1999 EPS between $1.75 and $1.85, higher than the previous estimated range of $1.70 to $1.75... Desktop publishing software developer Adobe Systems (Nasdaq: ADBE) gained $5 7/16 to $45 5/8 after Merrill Lynch raised its near-term rating to "accumulate" from "neutral"... Supply chain management software developer i2 Technologies (Nasdaq: ITWO) moved ahead $3 5/8 to $27 1/4 courtesy of a Prudential Securities upgrade to "accumulate" from "hold."

Perfume maker French Fragrances (Nasdaq: FRAG) added $1 to $7 1/16 after posting Q4 EPS of $0.21, beating the Zacks mean estimate of $0.17... Biopharmaceutical developer Gilead Sciences (Nasdaq: GILD) gained $6 5/16 to $48 1/4, adding to yesterday's 4% rise after saying preliminary results from Phase III trials for a lower dosing regimen of its Preveon reverse transcriptase inhibitor HIV treatment are positive and an application will be submitted for FDA approval in Q2. Recent Gilead acquisition target NeXstar Pharmaceuticals (Nasdaq: NXTR) rose $2 3/16 to $18... Payroll specialist Paychex (Nasdaq: PAYX) cashed in for a $4 5/16 gain to $42 7/8 following an upgrade to "buy" from "outperform" from Salomon Smith Barney.


Gaming products and software developer International Game Technology (NYSE: IGT) paid out $3 5/8 to $14 11/16 after it said it may not meet analysts' estimates for fiscal 1999 because of slower replacement machine sales -- domestic shipments are expected to be about flat with last year's levels -- and uncertainty about the timing of new casino openings. Also looming is a bill that may be proposed in the Nevada legislature limiting or prohibiting gaming machine makers from receiving a percentage of floor profits from MegaJackpot games in the state, a common lease arrangement. Major casino operators don't want to share the take from "participation games" -- which spread a growing slot jackpot through several casinos -- with the equipment makers. Some casinos want to establish their own "progressive games," but believe the multi-casino games are too powerful. If such a law goes through, other states may pick it up as well, further endangering International Game's profits. It hasn't been proposed in Nevada yet, it should be noted, but the session lasts through May, and some reports have a proposal hitting the floor tomorrow.

The challenge for small-town pharmacy company Horizon Pharmacies (AMEX: HZP) has always been pretty predictable: Could it keep up its busy acquisition pace, rapidly buying mom-and-pop pharmacies and tying them into its distribution network? That hasn't been much of a problem since the company's July 1997 IPO, with the chain more than doubling in size. The shares were rocked today on news of something else entirely. Horizon dropped $2 9/16, or 31%, to $5 11/16 after it said complications with its prescription pricing communications technology -- its system wasn't updating prices properly, meaning prescription prices rose daily and gross margins were penalized -- are likely to result in a loss in Q4, full-year 1998, and Q1 1999. Wall Street was calling for profits in all three reporting periods. Horizon said it has fixed the problems by changing to a new information system and is trying to recoup its losses (figured at between $1.0 and $2.5 million) and obtain rebates from its suppliers.

QUICK CUTS: Local area network (LAN) switching and wide area network (WAN) access systems maker Level One Communications (Nasdaq: LEVL), downgraded to "accumulate" from "strong buy" by Adams, Harkness & Hill, shed $5 1/4 to $27 1/8. After the bell, Intel (NYSE: INTC) said it will buy Level One in a $2.2 billion stock deal... Midway Airlines (Nasdaq: MDWY) descended $11/16 to $12 1/16 after discount airline Southwest Airlines (NYSE: LUV) announced plans to begin flying to North Carolina's Raleigh-Durham airport (RDU). Such plans would give Southwest its first city between Baltimore and Florida and allow the company to move in on Midway's turf; Midway is currently the biggest carrier at RDU.

Department store retailer Saks Inc. (NYSE: SKS), which said February same-store sales were flat with last year's levels, lost $2 to $34. Revenues rose 7% to 403.9 million for the month. Click here for more same-store sales numbers... PC retailer CompUSA Inc. (NYSE: CPU), which said last night it expects a "high single digit" decrease in same-store sales in fiscal Q3, retreated $1 7/16 to $8 1/8 today... Satellite-based mobile telecommunications services firm Iridium World Communications (Nasdaq: IRID) lost another $7/8 to $19 1/2 as several analysts, fearing the company's troubles acquiring products and distribution for its global service, cut their estimates... Drug developer Synaptic Pharmaceutical Corp. (Nasdaq: SNAP) snapped off $3 5/8 to $11 7/8 after Eli Lilly & Co. (NYSE: LLY) decided to delay Phase III clinical trials of a migraine compound the companies are co-developing following discussions with the FDA.

Applied Micro Circuits
(Nasdaq: AMCC), which makes semiconductors used in communications networks, gave up $1 1/2 to $36 after it agreed to buy privately held Cimaron Communications Corp. for around $115 million in stock to expand its high-speed digital communications business... Discount apparel and accessories e-tailer Bluefly (Nasdaq: BFLY), which announced a marketing agreement with Web portal Excite (Nasdaq: XCIT), shooed away $3 1/16 to $12 9/16 today. Bluefly was the topic of a recent Foolish column... Biopharmaceutical firm Abgenix (Nasdaq: ABGX) trailed off $9/16 to $15 after announcing the sale of 3 million shares of company stock for $15 each, a slight discount to yesterday's $15 9/16 closing price. Proceeds from the offering are slated for research and development.

Auto components supplier Hayes Lemmerz International (NYSE: HAZ) was hazy today, dropping $2 7/16 to $22 after it reported Q4 EPS of $0.31, badly missing First Call's six-analyst estimate of $0.56... Satellite systems designer Orbital Sciences Corp. (NYSE: ORB) lost $2 3/16 to $24 1/2 today as company veteran Alan Parker stepped down as president of global development at its ORBCOMM subsidiary... Aviation petroleum products, cargo services, and support systems provider Mercury Air Group (AMEX: MAX) descended $1 1/8 to $6 7/8 after ending talks with an unnamed company that expressed acquisition interest last month.

Howmet International (NYSE: HWM) gave away $1/4 to $14 7/8 after the aerospace components manufacturer revealed testing and specification problems at its aluminum casting operations and said the U.S. Air Force may debar the company from future government contracts and subcontracts... Seafood restaurant operator Landry's Seafood Restaurants (Nasdaq: LDRY), in trouble last summer, found more today after Sanders Morris Mundy downgraded the stock to "hold" from "buy" in the wake of the company's acquisition of Consolidated Restaurants. The shares lost $7/8 to $5 1/8 today... Equipment rental company United Rentals (NYSE: URI) returned $1 5/16 to $30 3/8 after it reportedly priced an offering of 8 million common shares at $30 apiece, about a 5% discount to yesterday's closing price.

Cable TV operator Cablevision Systems (AMEX: CVC), reportedly trying to buy the New York Mets after November's bid for Roger Clemens' Yankees went bust, tuned out $1 7/16 to $63 9/16... Electronic payment and collections systems maker CheckFree Corp. (Nasdaq: CKFR) lost another $4 to $31 1/2 after retreating $3 3/8 yesterday when personal finance software developer Intuit (Nasdaq: INTU) sued the company for breach of contract. In a statement released this morning, CheckFree said it is "confident that we have been correct in all actions that we have taken." Intuit added $3 1/8 to $91 1/8... CD and software distributor Navarre Corp. (Nasdaq: NAVR) dropped $1 11/16 to $13 7/16, reversing yesterday's small advance powered by news that the company filed with the SEC for a $37.4 million IPO of its NetRadio operation, which broadcasts audio over the Internet.

An Investment Opinion
by Dale Wettlaufer

PCs Are Not TVs

On our message boards recently, we've been having a pretty fast and furious discussion about the sustainability of the PC industry and the inherent dangers of a discontinuous technological innovation hurting the industry. To frame the issue, some people believe that the PC will go the way of the television. The thought goes that the growth rate of PC spending will slow and the excess returns will disappear in a highly, if not perfectly, competitive business.

A couple of problems arise from this sort of thought. First, when Zenith and the American-made television died off, it's not like all manufacturers of televisions stopped generating economic returns on investments in the television business. It's just that Zenith couldn't compete with manufacturers that were better equipped to deal with a mature industry and who could suck out the excess returns that were still left in the industry.

Second, from a utility viewpoint, the TV stopped evolving around that time. Incremental advances in picture tube technology and other advances didn't really add new dimensions of usefulness; they just added to an already substantial utility value found in the device.

Third, TV manufacturers that just focused on TVs were probably doomed to fail anyway. But a company that saw itself as a consumer electronics manufacturer willing to invest its cash flow into new market segments could keep generating shareholder value. Sony didn't just say, "Well, the TV game is up, so we had better lie down and die." They reinvested cash in VCRs, Walkmans, CD players, stereo equipment, PlayStations, etc.

I've always argued that PC companies are less like "technology companies" than they are precision manufacturers. Much of their economics come from being manufacturing services. Look at the economics of companies like Jabil Circuit (NYSE: JBL) or Solectron (NYSE: SLR) to check this. Same low margin/high turns model of doing business. The computing and communications device of tomorrow may not even be the box you're reading this on right now. It could be a thin tablet with a CPU and other electronics stuffed in there. It could be something different. But the PC manufacturers do think about this sort of thing. If something becomes the high volume consumer electronics device of its day, there's some value in the option that current PC original equipment manufacturers (OEMs) morph into that sort of business.

Look at Dell's (Nasdaq: DELL) announcement with IBM (NYSE: IBM) today. Part of the Dell story that is still intact is the expansion of the products the company manufactures. The richening of the company's product mix to include things other than PCs -- servers, workstations, and what now looks like even higher-level enterprise computing systems such as storage systems -- has accounted for its increasing returns to shareholders and its avoidance of some of the negative price inflation in plain vanilla PCs. So when you look at Dell or Gateway (NYSE: GTW) or Micron Electronics (Nasdaq: MUEI), the direct PC manufacturers, there are the economics of being a precision manufacturer as well as the option to get into other product categories.

Another part of the economics of direct PC companies come from being the distribution and retailing channel. Compaq (NYSE: CPQ) might be a manufacturer, but it deals extensively with indirect distribution, acting as its own retailer/distributor for a tiny fraction of sales. Part of the value that the distributors and retailers have captured for themselves is captured in the economics of the direct PC companies. Gateway has enhanced its value by going after the bricks-and-mortar retailing model with its Gateway Country stores. With 75% of the PC market still buying computers that way, that's a pretty fat target. So this is where the company is seeing some attractive incremental returns, and this is where it's investing. Both Dell and Gateway are also going after the Web-based retail market for things other than PCs -- software, peripherals, accessories, and services. These are not trivial opportunities -- they are moves intended to capture market share from less efficient and less well-financed competitors.

For Dell, some of the excess returns come from being a service company in addition to being just a plain vanilla manufacturer. You might ascribe that to its "brand value," but its superb logistics support and delivery of customized boxes (taking the value from value-added resellers, or VARs) is what differentiates it and creates extra return. So when you look at a company like a Dell, it is part electronics manufacturer, part retailer, part distributor, and part value-added reseller. Micron wants to get there too. The more service it can put into its business, the more its business can look like Dell's. Then there's also the option to get into other market segments and richen the product mix and increase operating dollars on a capital base that is not expanding as rapidly.

Finally, because there are so many services being developed that are complementary to the PC, the PC product cycle won't just die off. High bandwidth programming, IP-based telephony, and new applications to present information and interact in dimensions that don't look anything like what happens on today's PCs are all attracting tons of financial and human capital to develop them. You're not going to run these things on a 1998 PC, let alone the huge installed base of 386 Wintel machines that are out there.

In all, sure, the PC market is subject to discontinuous technology innovations and eventual maturity, but it's also run by people who are thinking about these things. The odds are that the PC industry is not going to die tomorrow or next year. Even if that were the case, the forward-thinking PC companies are going to reinvest their free cash flow to deal with it and go off in another direction. Depending on the company's cash flow, management, the date on which the competitive advantage period for the industry and certain companies ends, and the potential value of new market opportunities, there's value to the options available to today's PC companies. To what extent the market realizes this and values it appropriately is your call.


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