Monday, April 5, 1999
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Online discount brokers got a boost today after Credit Suisse First Boston analyst Bill Burnham said in a report that online transactions grew by 30% to 35% in the first quarter. That's stronger growth than Burnham had initially expected, prompting him to forecast higher Q1 revenues and earnings for the sector across the board. Charles Schwab (NYSE: SCH) rose $9 1/8 to $103 3/8, recent Daily Double National Discount Brokers (NYSE: NDB) gained $4 9/16 to $32, E*Trade Group (Nasdaq: EGRP) added $11 3/4 to $72 5/8, Siebert Financial (Nasdaq: SIEB) climbed $4 11/16 to $28 1/8, JB Oxford Holdings (Nasdaq: JBOH) traded up $1 1/4 to $8 5/16, and Ameritrade (Nasdaq: AMTD) advanced $29 1/16 to $91 5/8. Track Data (Nasdaq: TRAC), which is set to join the online trading services fray next week, soared $14 to $27 in anticipation.

Atlanta-based online bank Net.B@nk (Nasdaq: NTBK) surged $25 11/16 to $101 11/16 after saying it opened 8,000 new accounts in Q1, putting the company in position to beat its goal of attracting an average of 2,000 new accounts every month this year. The bank currently has just over a total of 24,000 accounts, a figure that will double by the end of this year if the new-account creation rate from the first quarter can be sustained over the coming three quarters. The company attributed the rise in accounts to a new advertising program that promotes the bank's low fees and high yields for its core FDIC-insured checking and money market products, which represent about 66% of total accounts. Since reporting its first profitable quarter last July, Net.B@nk's shares are up 238% -- a high yield by any measure.

QUICK TAKES: Australian media and publishing powerhouse News Corp. (NYSE: NWS) rose $3 5/16 to $33 7/8 on various reports that the company will buy Liberty Media's (NYSE: LMG.A) 50% ownership interest in the Fox/Sports Networks cable TV channel partnership to consolidate its sports interests in the U.S., perhaps as soon as this week... Elsewhere, Liberty Media agreed to buy 10 million shares of set-top box maker General Instrument Corp. (NYSE: GIC) from private investment firm Forstmann Little for $280 million, sending that company's shares up $1 3/16 to $32 5/8. Liberty will become the largest shareholder in General Instrument, owning 18% of its outstanding shares. Forstmann Little also agreed to sell 5.3 million General Instrument shares back to the company for $148.4 million.

Online services conglomerate America Online (NYSE: AOL) climbed $16 15/16 to $166 15/16 after an article in the online version of the San Jose Mercury News speculated that the company may be thinking about a possible merger with TV network CBS Corp. (NYSE: CBS). CBS rose $1 3/4 to $41 7/8... Network processors maker MMC Networks (Nasdaq: MMCN) popped up $4 1/4 to $21 after naming former 3Com (Nasdaq: COMS) executive Douglas Spreng as its new president and CEO... Semiconductors and mobile communications equipment supplier Motorola (NYSE: MOT) added $2 7/8 to $76 7/8 after winning a three-year $219 million mobile communications contract from the Defense Department late last week. Motorola will be providing equipment which will be used in conjunction with the low earth-orbit satellite network operated by Iridium (Nasdaq: IRID), which rose $1 5/8 to $17 1/8.

Paging company SkyTel Communications (Nasdaq: SKYT) jumped $3 29/32 to $19 1/32 after Business Week's "Inside Wall Street" column speculated that telecommunications giant MCI WorldCom (Nasdaq: WCOM) may be interested in acquiring the company... Customer service support software provider Mosaix (Nasdaq: MOSX) moved up $2 3/8 to $10 3/4 after telecommunications equipment maker Lucent Technologies (NYSE: LU) agreed to acquire the company for about $145 million in stock, or $10.77 per Mosaix share. Lucent rose $3 1/16 to $58 15/16... Web portal Yahoo! (Nasdaq: YHOO) picked up $39 3/8 today to $219 1/8 on lingering positive sentiment following its announcement last week that it will acquire streaming media company broadcast.com (Nasdaq: BCST) for $5.7 billion in stock. Broadcast.com rose $27 to $157.

Small business Internet services firm Netopia (Nasdaq: NTPA) picked up $1 5/16 to $11 7/8 after agreeing to create and manage a digital subscriber line (DSL) education center for GeoCities (Nasdaq: GCTY). Netopia will also be the exclusive small business DSL partner for GeoCities' "Pages that Pay" e-commerce affiliate program. GeoCities gained $26 7/16 to $143 9/16... Electronics manufacturing services (EMS) provider Jabil Circuit (NYSE: JBL) climbed $3 3/4 to $44 7/16 after Morgan Stanley Dean Witter started coverage of the company with an "outperform" rating and a 12-month price target of $50 per share... Office-furniture maker Steelcase (NYSE: SCS) forged a $1 7/8 gain to $16 5/8 after receiving a positive write-up in the latest edition of Barron's. Computer printer maker Lexmark International (NYSE: LXK), which was also cast in a favorable light by the magazine, moved up $6 7/8 to $116.

Equipment rental company Rental Service Corp. (NYSE: RSV) jumped $5 to $22 1/4 after rival United Rentals (NYSE: URI) announced it has launched an unsolicited $22.75-a-share cash tender offer for the company in an attempt to break up a pending acquisition of Rental Service by NationsRent Inc. (NYSE: NRI)... Networking products and switch designer FORE Systems (Nasdaq: FORE) picked up $1 1/8 to $21 5/8 on continuing speculation that the company is a takeover target and will soon be acquired by a bigger fish in the networking sea... Natural foods retailer Whole Foods Market (Nasdaq: WFMI) tacked on $5 1/2 to $42 3/8 following an upgrade to "strong buy" from "accumulate" from Adams, Harkness & Hill.

Wireless communications technologies firm Qualcomm (Nasdaq: QCOM) gained $11 7/8 to $148 7/8 after First Albany raised its rating on the company to "accumulate" from "neutral" with a 12-month price target of $170 per share... Financial services transaction management systems developer BancTec (NYSE: BTC) gained $2 1/2 to $15 1/2 after agreeing to be acquired by private investment firm Welsh, Carson, Anderson & Stowe for $525 million in cash and assumed debt... Consumer products marketer and distributor Sel-Lab Marketing (Nasdaq: SELB) soared $6 3/8 to $11 1/8 after posting fiscal 1998 EPS of $0.14, up from $0.03 last year. The company also said it will launch a website selling cosmetics over the Internet this summer.


Component and supply management software company Aspect Development (Nasdaq: ASDV) dropped $14 15/32, or 64.6%, to $7 15/16 today following Friday afternoon's announcement that it expects first-quarter earnings "significantly below" Wall Street's $0.12 per share estimate. Net income is seen between breakeven and $1 million after a $3 million one-time gain from a joint venture transaction is figured in; last year's figure was about $2.8 million. Aspect's explanation is that clients are making increasingly large orders from Aspect, requiring more than the usual amount of internal approvals; as such, the company said, several large prospective contracts slipped out of Q1. It's important to note, however, that those contracts won't all slip neatly into Q2. "Aspect is taking a more cautious view of its near-term growth," read a company statement that said revenues will grow more slowly than anticipated; Aspect expects to be profitable in the final three quarters of the year. It is also retooling its sales force to better pursue both large and smaller contracts. Unhappy with the new projection, at least six brokerages downgraded Aspect today.

Business computer security services firm Axent Technologies (Nasdaq: AXNT) dumped $11 15/16 to $8 1/16, a 59.7% loss, after announcing a preliminary Q1 loss of between $0.05 and $0.10 per share before merger-related charges. Axent joins the hit parade of software companies -- Aspect, at least, took some of the heat itself -- that have blamed delayed orders and Year 2000 spending among its clients for disappointing results. The First Call mean EPS estimate is $0.18. Axent has beaten earnings projections consistently in recent years, but not this time, it appears. The outlook isn't great for the rest of the year, either, as the company said to expect breakeven results for the rest of the year, well off Wall Street's $1.05 consensus. The charges Axent mentioned but didn't itemize were for last week's $50 million purchase of UK-based password and sign-on technology company PassGo Technologies and January's purchase of Internet Tools Inc., a computer security company, for shares valued at the time at about $28 million. Q1 results are expected April 29.

QUICK CUTS: Enterprise systems software company Software AG Systems (NYSE: AGS) dropped $2 3/16 to $5 3/16 after it said it expects Q1 EPS of between $0.16 and $0.18 per share, missing Wall Street's $0.21 consensus estimate.... Consumer products giant Gillette (NYSE: G), subject of a recent Foolish Duel, was shaved for a $1 1/2 loss to $57 3/4 on news that buyout firm Kohlberg Kravis Roberts & Co. plans to sell up to 29.5 million shares in the company in a proposed secondary offering to provide liquidity for other investments... EarthWeb (Nasdaq: EWBX), which provides online information and services to computer programmers, developers, and technicians, gave up $7 1/8 to $64 3/4 today. The company announced a partnership with Internet search and retrieval software provider Verity Inc. (Nasdaq: VRTY) today; Verity shares rose $2 3/4 to $30 3/16.

Drugstore giant Walgreen Co. (NYSE: WAG) lost $1 1/2 to $26 7/16 despite reporting a 15.6% boost in same-store sales for March, with total sales up 21% to 1.6 billion for the month... Elderly long-term care provider Centennial HealthCare (Nasdaq: CTEN) gave up $4 3/16, or 49%, to $4 5/16 after 23% owner Welsh, Carson, Anderson & Stowe cancelled plans to buy the rest of Centennial, citing a pending investigation of Centennial by the Department of Health & Human Services... Design tools and verification systems maker Synopsys (Nasdaq: SNPS) stumbled $7 1/16 to $46 today after trading about at nine times normal daily volume. The company said in a statement that it expects to report Q2 EPS "in the range" of expectations following bearish comments from one analyst... Internet website co-location services and direct access provider AboveNet Communications (Nasdaq: ABOV), which established the third of its European Internet service exchanges in London, gave back $7 to $118.

Aspen Technology (Nasdaq: AZPN), a maker of simulation and automation software, lost $3 5/16 to $9 15/16 after it said it expects a "significant" operating loss in fiscal Q3, missing First Call's $0.18 profit projection... Dallas-based home-equity lender Amresco (Nasdaq: AMMB) gave away $1 1/8 to $6 5/8 today. Amresco's board met last week to discuss several proposals for "significant transactions," deciding not to move forward with any of them... Healthcare information technology firm QuadraMed (Nasdaq: QMDC) fell $2 3/4 to $4 1/4 today after at least two brokerages lowered their ratings on the stock... Blood pressure monitoring devices maker Medwave Inc. (Nasdaq: MDWV) shed $3 5/8 to $10 1/2 after the company said a six-month "standstill" during which an unnamed interested party had exclusive rights to review the company's hand-held blood pressure monitor expired without any further agreement.

Hardee's and Carl's Jr. quick-serve restaurants operator CKE Restaurants (NYSE: CKR) spilled $1 7/8 to $17 7/8 after BancBoston Robertston Stephens downgraded the stock to "buy" from "strong buy"... Landry's Seafood Restaurants (Nasdaq: LDRY), operator of Joe's Crab Shack, Landry's Seafood House, and Crab House restaurants, gave back $7/8 to $6 3/4 after stating that it was not currently in negotiations to be sold. More on this in today's Lunchtime News... Nuclear aircraft carrier and submarine builder and refueler Newport News Shipbuilding (NYSE: NNS) lost $3/4 to $30 1/2 after thousands of steelworkers -- about half the company's workforce -- went on strike early this morning. Head back to this morning's Breakfast With the Fool for more information... Fertilizer producer and distributor IMC Global (NYSE: IGL) lost $1 1/16 to $19 after J.P. Morgan lowered its rating on the stock to "long-term buy" from "buy."

Applications software company Mapics (Nasdaq: MAPX) moved back $2 3/4 to $4 9/16 after it said fiscal Q2 EPS is seen missing the year-ago $0.16 EPS mark, itself short of First Call's $0.18 estimate, because of slowing revenue growth... Cruiser motorcycle maker Excelsior-Henderson Motorcycle Manufacturing (Nasdaq: BIGX) slowed $1 3/4 to $5 15/16 after it said it expects full-year 1999 losses to "significantly exceed" Wall Street's $0.43 estimate... Biopharmaceutical company Sugen Inc. (Nasdaq: SUGN) coughed up $3 15/16 to $18 1/2 today, reportedly because a Sunday broadcast of 60 Minutes said early testing of its cancer drug has been positive but not as positive as expected.

Enron Corp. (NYSE: ENE) leaked $1 5/16 to $63 1/8 after it disclosed in an SEC filing that its board recommended rejecting an offer to buy its 53.5% stake in oil and natural gas exploration and production company Enron Oil & Gas (NYSE: EOG)... Human resources outsourcing company NovaCare Employee Services (Nasdaq: NCES), which said it is working with advisers to explore alternatives, possibly including a sale, fell $1 to $5 5/8. The company said to expect Q4 EPS below analysts' expectations...Pediatrix Medical Group (NYSE: PDX), which provides physician management services to neonatal intensive care units (NICU) in hospitals, lost $9 1/2 to $17 1/8 after it said government officials in Arizona and Colorado are seeking billing-related information from the company.

An Investment Opinion
by Alex Schay

Selling the Buyout

No, it wasn't an April Fool's gag. At the behest of buyout firm Kohlberg, Kravis, & Roberts (KKR), consumer products giant Gillette (NYSE: G) filed an S-3 on the first of April. The contents of the registration statement revealed that KKR planned to sell slightly more than half of its 51.3 million share stake in Gillette -- assuming the exercise of the underwriters' over-allotment option (which would put the offering at 29.5 million shares, or roughly $1.79 billion). Gillette dipped slightly today, falling $1 1/2 to $57 3/4 after reaffirming that first quarter results will not meet expectations.

KKR's 4.6% interest in Gillette reflects the queer lineage of equity ownership in America, and is also the only tangible link remaining to KKR's buyout of Duracell more than a decade ago. Perhaps the most interesting feature of the liquidity driven sale, however, is that it highlights KKR's status as a principal investor and not just a fee-collecting financial intermediary -- a focus that necessitates a long-term approach to investment.

Financial history of the 1980s is imbued with myth and lore, and having been dubbed "the decade of greed" by the popular press, the most common characterizations of the period invoke words like "junk," "predators ball," "bailout" and "raider," rather than language reflecting the august stewardship of assets (and rightly so). Often, the portrait of KKR in those years is painted with the same broad brush strokes that popularly define the decade -- but to put a finer point on the work, KKR really needs to be painted with a finer brush.

Jerome Kohlberg, one of the K's in KKR, is commonly credited with establishing the buyout as a specialized financial practice during his years with Bear Stearns. In a June 19, 1987 interview with the New York Times, Kohlberg noted that he "refined" the traditional bootstrap deal "by adding the role for management as owners." On top of this development, and perhaps what has become the most overlooked element of the KKR management buyout, was the fact that KKR in its role as financier simultaneously became a principal investor in the business. The vaunted "dealmakers" would end up committing themselves to a long-term engagement, where the success of the entire undertaking was predicated on working closely with management following the buyout. As one partner put it, "When the deal is closed the work begins." KKR's role involved less financial legerdemain and more operational blocking and tackling.

Of course, debt made it all possible. As George Roberts (of odd consonant fame) commented when asked why he was willing to part with conventional wisdom and use lots of the stuff, "because we couldn't afford them [the target firms] any other way." The logic was clear, KKR would invest in cash-rich firms that showed signs of "undermanagement." Executive managers would invest a substantial amount of their own net worth in the remaining equity. KKR would have a "governance function" and look to be an investor for five to seven years (while paying down debt), and then sell the shares for a capital gain.

For those having trouble with the basic buyout business model, here's an example provided by George Baker and George Smith in their book, The New Financial Capitalists:

"To see how this works in general terms, imagine an all equity company that is bought for $100 million. Before the acquisition, this company generates $10 million in cash flows, just enough to give shareholders a 10 percent return. The acquisition is financed with $90 million in debt and $10 million in equity. The company is then able, through improved operations, superior asset utilization, and careful capital investment, to increase cash flows from $10 to $20 million per year, without either increasing or decreasing the value of the assets. By paying no dividends, and by using this $20 million in cash flow strictly for debt service, this company can pay down the $90 million of debt (at an interest rate of 10 percent) in about 6 years. At the end of that period the company would still be worth $100 million, but it would now be all equity. In other words the original $10 million equity investment had been transformed into one worth $100 million, for a 47 percent compound annual rate of return."

Duracell turned out to be a classic example of this strategy. Acquired from processed food giant Kraft in 1988, Duracell's cash from operations soared by a compound rate of 17% from 1989 to 1995, thanks to strong technology investments and an unshackled Duracel management that was allowed to pursue an aggressive five-year plan (as well as one of the earliest high-profile EVA implementations). Duracell was sold to Gillette in 1996 in a swap that awarded 0.904 shares of Gillette for each Duracell share. After almost eight and a half years, KKR managed to realize a 39% compound annual return on its original equity investment. Adjusted for splits as well as the acquisition, the remaining Gillette shares now carry a cost basis of around $2.77 apiece for KKR.

Duracell turned out to be one of KKR's most profitable buyouts, and in its relatively short history controversy has swirled about a number of its other investments. For those investors interested in taking a look at the numbers on all of its deals, as well as a history of the firm, an excellent resource is the previously mentioned work, The New Financial Capitalists.


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