Monday, July 27, 1998
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An Investment Opinion
by Dale Wettlaufer

Telecom Time

Does the state of the ruble have you down? Feeling jittery about PC demand? Buck up, little trader, there's enough going on in the telecom sector to keep you busy. AT&T (NYSE: T) and British Telecom (NYSE: BTY) announced yesterday that they will invest in a global joint venture expected to have revenues of $10 billion per year in its first year of operations, generate operating profit of 10% of revenues, grow at a rate of 15% to 20% per year, and is "expected to contribute positively to the earnings of both parents from day one." The majority of the revenues and earnings aren't incremental, however, as much of these revenues and earnings will be generated from existing capital assets and will just be moved below the operating income line. The synergies that the two companies should realize probably won't be dinky, but it's not as if this deal looks like it's adding a ton of value to either of these companies, either.

The companies made sure to emphasize all the right concepts in today's press release: Facilities-based, seamless global services, TCP-IP, and electronic commerce are all phrases that subtly spiced today's announcement. When it gets down to it, the companies are taking advantage of size to create a competitive advantage in price, service, and ability to handle the capital expenditures necessary to lay down transoceanic cables, build out fiber networks in lesser-developed or heretofore overregulated markets. The non-merger mergers in industries such as airlines provide an interesting model for thinking about this transaction. Rather than merging or making an investment in each other, cash and assets will go directly into the joint venture.

With the sheer size and growth of the global economy, certain companies almost need to increase at an exponential rate the scale of their investment and operating cash flows if they want to outpace yearly global output growth. In capital-intensive industries, it's almost too much to ask one corporation to try to capture significant market share all on its own. Whether the payoff will be there is anyone's guess, especially as it would be quite a bummer to sink $20 billion in a new European fiberoptic network only to see that technology preempted in 10 years. But hey, there's no accounting for those who see these low return on capital businesses as cheap at 20 times earnings and see Coca-Cola as ridiculously expensive at 55 times earnings. Never mind that Coke could finance internally exponential growth here and on Mars. It's technology, baby! It's exciting, it's here, it's TCP/IP!

In other telecom news, The Wall Street Journal reported today that Bell Atlantic (NYSE: BEL) is thinking of hooking up with GTE (NYSE: GTE). Let's take a wild guess here. Somehow the European Commission will find a way to meddle in a Bell Atlantic deal if it happens. Meanwhile, BT and AT&T can tie up a significant portion of undersea fiberoptics and that'll be just dandy with European regulators. The Journal says the rumored $55 billion deal would give Bell Atlantic a "springboard for entering coveted long-distance markets." Coveted? With companies such as Qwest Communications (Nasdaq: QWST), IXC Communications (Nasdaq: IIXC), and Level Three Communications (Nasdaq: LVLT) pouring billions of dollars into advanced communications backbones that will allow them to cut the dime lady's rates to half pennies, long-distance is about as coveted as the Edsel or General Pickett's position on July 3, 1863. Bell Atlantic covets long-distance in its current areas. That's where it can build serious value.

With good commercial lines of business and a very good local exchange traffic business, GTE offers some attractive attributes to Bell Atlantic. It is these attributes, rather than long-distance, that would draw Bell Atlantic to GTE. The initial market reactions to all of these huge telecom deals are more valid than one might think. Assuming the market is a fairly efficient mechanism, market reactions can indicate very quickly investors' assessments as to who stands a chance of building value and who stands a chance of destroying it. So far, AT&T and Bell Atlantic have struck out on the deal front this year (insofar as share price is concerned). Today's reaction will be telling. As of midday, AT&T traded up $1/16 at $60, British Telecom gained $8 1/4 to $146, GTE slipped $1 to $56 15/16, and Bell Atlantic rose $1/4 to $45 7/16.


Philip Morris (NYSE: MO) rose $1/2 to $41 15/16 after a judge dismissed a lawsuit seeking Medicaid reimbursement brought by the state of Indiana against the tobacco industry. Meanwhile, Credit Suisse First Boston added the tobacco and food products company to its "focus list" and rated the stock a "buy."

Drug wholesaler AmeriSource Health Corp. (NYSE: AAS) surged $10 1/16 to $77 9/16 and Bergen Brunswig Corp. (NYSE: BBC) soared $2 7/8 to $54 3/4 as Bloomberg reported that U.S. District Judge Stanley Sporkin sent his strongest signal yet that he's likely to rule in favor of proposed acquisitions of Bergen Brunswig by Cardinal Health (NYSE: CAH) and AmeriSource by McKesson Corp. (NYSE: MCK). Sporkin said he didn't share the Federal Trade Commission's fears that the companies would raise prices and hinder competitors from entering the $94 billion drug distribution market. Cardinal picked up $1 1/2 to $96 1/8, while McKesson slid $1 to $78 5/16.

Life and administrative reinsurance company Life Re Corp. (NYSE: LRE) picked up $2 11/16 to $91 11/16 after announcing it has agreed to be acquired by Swiss Reinsurance Co. for $95 per share, or about $1.8 billion in cash. The deal is expected to be accretive to earnings by 2000.

Semiconductor voice record and playback solutions provider Information Storage Devices (Nasdaq: ISDI) spiked up $2 3/16 to $7 3/8 after announcing late Friday that Winbond International Corp. has offered to acquire the company for $8.25 a share in cash -- a 59% premium over the company's last closing price. Winbond is an existing shareholder of the company.

Music and software distributor Navarre Corp. (Nasdaq: NAVR) gained $15/32 to $7 1/4 after announcing that its subsidiary NetRadio Corp. plans to register to make an initial public offering of common stock. NetRadio is an Internet radio network featuring 150 channels of originally programmed audio content and sells CDs and computer software online.

Healthcare marketing and communications services company Healthworld Corp. (Nasdaq: HWLD) jumped $1 to $16 after announcing the acquisition of Colwood House Medical Publications, a leading U.K. medical education company, for an initial purchase price of around $6.6 million paid in cash at closing. Healthworld will pay an additional $5.6 million in cash in two installments, in April 2000 and August 2001, if Colwood's operating earnings exceed set targets.

Tallahassee, Fla.-based financial services company Capital City Bank Group (Nasdaq: CCBG) climbed $1 19/32 to $32 3/32 after reporting on Friday Q2 EPS of $0.39, a penny more than a year earlier.


Wireless communications products maker Ericsson (Nasdaq: ERICY) was cut $5 5/8 to $28 1/16 after reporting a 21% increase in fiscal Q2 earnings from a year ago. However, sales of mobile phones rose only a scant 1%, while rival Nokia (NYSE: NOK.A) last week reported a 50% gain in cell phone sales in the same quarter. Sales in China jumped 62% in the period. Without China, though, Ericsson's sales in Asia slid 27%.

Telecommunications services provider MCI Communications (Nasdaq: MCIC) dropped $2 13/16 to $65 1/16 as British Telecom (NYSE: BTY) announced an alliance with AT&T (NYSE: T) following the failure of a similar arrangement with MCI. In sympathy, MCI merger partner WorldCom (Nasdaq: WCOM) fell $2 9/16 to $53 5/16.

Do-it-yourself home improvement retailer Home Depot (NYSE: HD) lost $2 1/16 to $43 3/16. The Wall Street Journal reported on the company's pilot program to provide home remodeling services. Already, the company offers vinyl siding, roofing, and replacement window installation services through a pilot program at 100 of its 676 stores.

Call center management products developer Genesys Telecommunications Laboratories (Nasdaq: GCTI) fell $3 1/16 to $23 7/8 after president and CEO Gregory Shenkman resigned late Friday. Current COO Michael McCloskey will replace Shenkman as president.

Online remote access systems designer Shiva Corp. (Nasdaq: SHVA) was clipped $13/16 to $7 3/16 after saying late Friday that its total fiscal 1998 restructuring-related charges will actually be higher than the $10 million to $12 million reported in its Q2 earnings release last week. The release did not include a $1.6 million charge from Q1, which will raise the total amount of charges for the year to between $12 million and $14 million.

Internet-related companies moved lower this morning, continuing Friday's sector downtrend that coincided with Infoseek's (Nasdaq: SEEK) Q2 earnings (or non-earnings) release. Infoseek fell $1 15/16 to $27 1/16, America Online (NYSE: AOL) slid $7 1/4 to $111 15/16, Netscape (Nasdaq: NSCP) slipped $2 1/8 to $29 7/8, Egghead.com (Nasdaq: EGGS) dropped $1 5/8 to $18 11/16, Amazon.com (Nasdaq: AMZN) sank $7 3/8 to $116 7/8, and Excite (Nasdaq: XCIT) slumped $3 5/8 to $41.

Disk drive maker Western Digital Corp. (NYSE: WDC) was spun for a $7/8 loss to $10 9/16 after reporting a fiscal Q4 loss of $1.84 per share compared to earnings of $0.95 per share a year ago. The Street had been expecting a $1.30 per share loss. The results included about $22 million in costs related to a new licensing agreement with IBM (NYSE: IBM). Further, the company said the supply of disk drives in the distribution channel is still "too high." Rival Seagate Technology (NYSE: SEG) fell $1 1/8 to $22 1/8 and Quantum Corp. (Nasdaq: QNTM) slipped $1 1/32 to $18 1/32.

Chemicals giant Union Carbide Corp. (NYSE: UK) slid $1 1/16 to $49 15/16 after reporting fiscal Q2 EPS of $0.85, a penny ahead of the Street's estimate but down 19% sequentially and 51% year-over-year. The results were held back by the Asian financial crisis and weak prices for some key products, according to the company.

Ratings Movers

Sylvan Learning Systems (Nasdaq: SLVN) dropped $1 5/8 to $32 3/8 after Bear Stearns downgraded the provider of higher education services to "neutral" from "attractive."

Cleveland-Cliffs (NYSE: CLF) sank $3 9/16 to $49 15/16 after PaineWebber lowered its rating for the mine operator and iron ore marketer to "neutral" from "buy."

Information technology consultant AnswerThink Consulting Group (Nasdaq: ANSR) slumped $3 1/4 to $24 3/4 after Donaldson, Lufkin & Jenrette downgraded the company to "market perform" from "buy."


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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

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