Tuesday, December 22, 1998
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An Investment Opinion
by Alex Schay

More Value in Oil

After the bell on Monday, Standard & Poor's announced that the leading U.S. motor oil maker, Pennzoil Co. (NYSE: PZL), will be booted from the S&P 500 after the close on December 30th, to be replaced by contract electronics manufacturer Solectron Corp. (NYSE: SLR). The announcement sent shares of an already battered Pennzoil even lower, dropping $2 5/8 to $30 7/8. However, once the firm completes its planned separation into two entities, an Upstream Exploration & Production (E&P) unit, which will be called PennzEnergy, and a Downstream/Car Care Products company, named Pennzoil-Quaker State -- reflecting the completion of its merger with Quaker State Corp. (NYSE: KSF) -- the combined Pennzoil-Quaker State unit will be back in the S&P MidCap 400 Index.

Financial restructurings like the classic "spin-off," where the same group of assets simply gets shuffled around, often seem like financial legerdemain. After all, offering shareholders a new smaller piece of pie, cut from the slice that they already own, wouldn't seem to do much on the intrinsic value front. However, the simple fact remains that in many circumstances restructurings do fundamentally change the way corporations are run (hence, their value), and Pennzoil seems to fit in this category. There are a lot of justifiable reasons for Pennzoil to be trading near its 52-week low: a firm highly leveraged to commodity prices (which are at historic lows), sequential financial declines, the uncertainty surrounding management's ability to restructure successfully and generate the planned cost savings, as well as general pain in its industry.

Despite this, the primary reason for Pennzoil's sequential earnings decline in its most recent third quarter was a $66 million increase in pre-tax exploration expense (roughly $47 million of the exploration expense was related to the write-off of two of the company's overseas prospects). Trading at 3 times trailing cash flow from operations, Pennzoil's two businesses look to be valued at well beneath even grim expectations for 1999. Assuming the E&P segment can make a mere $3.00 per share in cash earnings next year, at 7 times this figure the number one motor oil brand in the U.S. can be had for under $10 per share. Acknowledging that these metrics are necessarily simplistic and are awarded in the marketplace based on financial performance rather than on paper, it's still a decent starting point. Interested investors should take a closer look at what the two businesses can do in 1999, and find out just how cheap they are.


Online discount broker Ameritrade Holding Corp. (Nasdaq: AMTD) traded up $7 1/4 to $28 1/4 after pre-announcing fiscal Q1 EPS between $0.09 and $0.11, which is above the company's previous guidance of EPS of $0.06 or $0.07 for the quarter. The company expects to post more than 32,000 trades per day and net revenues greater than $50 million for the quarter, or three times the trades and twice the revenues of a year ago. Fellow online broker E*Trade Group (Nasdaq: EGRP) picked up $3 1/16 to $35 3/16 as well, following an upgrade to "strong buy" from "buy" by Piper Jaffray.

BA Merchant Services (NYSE: BPI) added $2 5/16 to $19 7/8 after BankAmerica (NYSE: BAC) agreed to buy the remaining 33.4% economic stake in the payment processing firm it does not already own for $20.50 per share in cash. BankAmerica expects the deal will close by the end of the first quarter of fiscal 1999.

Canadian enterprise software developer Cognos Inc. (Nasdaq: COGNF) gained $4 1/4 to $21 7/8 after reporting fiscal Q3 EPS of $0.36 versus $0.27 (before charges) last year, beating the Zacks mean estimate by a penny. Revenues increased 23% to $76.3 million in the quarter, led by a 32% increase in sales of the company's business intelligence tools. Merrill Lynch and BT Alex. Brown both raised their ratings on the company.

E-commerce business services firm iMALL Inc. (Nasdaq: IMAL) advanced $5 3/16 to $17 5/16 after announcing an agreement with telecommunications giant AT&T (NYSE: T) allowing users of AT&T's WorldNet service to receive up to $20 in annual discounts from iMALL's new shopping portal site, Stuff.com.

Microelectronics capital equipment maker FSI International (Nasdaq: FSII) moved up $1 3/4 to $8 5/8 despite reporting a fiscal Q1 loss of $0.31 per share compared with earnings of $0.08 per share a year ago, which was worse than the Zacks mean estimate of loss of $0.20 per share. However, the company said bookings were up sequentially in the quarter, producing a book-to-bill ratio "considerably above" 1.0. Both NationsBanc Montgomery Securities and Needham & Co. raised their ratings this morning.

Coronary stent maker Boston Scientific Corp. (NYSE: BSX) tacked on $2 1/16 to $24 15/16 after reportedly telling analysts that it is comfortable with the current First Call mean earnings estimate for 1999 of $1.05 per share. Revenues are expected to rise to $3 billion next year from this year's expected $2.2 billion figure. The company also believes an improved version of its troubled NIR ON Ranger with SOX stent, which was recalled in October, will be approved by the FDA early next year and reintroduced around midyear.

Contract electronics manufacturer Solectron Corp. (NYSE: SLR) climbed $3 15/16 to $80 15/16 on news it will be added to the Standard & Poor's 500 Index to replace oil lubricants marketer Pennzoil (NYSE: PZL), which is spinning off and then merging its Pennzoil Products unit with Quaker State Corp. (NYSE: KSF).

Internet services provider PSINet (Nasdaq: PSIX) rose $15/16 to $17 15/16 after agreeing to buy dark fiber capacity around the San Francisco area from Metromedia Fiber Network (Nasdaq: MFNX) for undisclosed terms. The company also announced it has acquired three Hong Kong-based Internet companies, boosting its presence in the Asia-Pacific region.

Online software delivery technologies company Digital River (Nasdaq: DRIV) streamed $5 1/8 higher to $39 1/8 after announcing it will be the exclusive provider of downloadable software products for retailer Kmart's (NYSE: KM) website. Kmart's online store plans to offer all of Digital River's more than 131,000 software titles, some of which will be sold using special discounts.

Higher education services provider Sylvan Learning Systems (Nasdaq: SLVN) advanced $2 3/16 to $27 5/8 after The Wall Street Journal's "Heard on the Street" column reported on the recent hubbub about Sylvan's supposed "aggressive accounting" practices, citing one analyst who believes the accounting methods used by the firm do not change the "character of the company's earnings."

Auction house Sotheby's Holdings (NYSE: BID) was bid $3 higher to $31 this morning after Merrill Lynch raised its intermediate-term rating to "accumulate" from "neutral," commenting that the company may be revalued by the market once it announces its online auction strategy, which Merrill expects "in coming months."


Information technology consulting firm Atlantic Data Services (Nasdaq: ADSC) sank $5 7/16 to $7 9/16 after it said a major customer -- which accounted for about 21.7% of the company's revenues for the six months ended Sept. 30 -- will end its contract at year's end. The company is "very comfortable" with Wall Street's $0.17 EPS estimate for fiscal Q3, but it believes the cancellation could hurt results in future quarters.

PC direct marketer Micron Electronics (Nasdaq: MUEI) lost $3 1/16 to $18 5/16 after it said fiscal Q1 EPS was $0.12, a penny above Street estimates and also well ahead of last year's $0.01 profit mark. The company expects a $3.2 million one-time charge stemming from the consolidation of its Japan operations.

Dental practice management company Monarch Dental Corp. (Nasdaq: MDDS) rotted $4 11/16, or 54.4%, to $3 15/16, after it forecasted Q4 EPS of $0.06 to $0.12 (before charges), below analysts' mean estimate of $0.18. The company cited a variety of difficulties across several of its markets, including weaker-than-expected results in three new markets: Austin, Texas; Dayton, Ohio; and New Mexico.

Case Corp.
(NYSE: CSE) lost $15/16 to $19 1/2 on news that the company expects a nearly 60% drop in 1998 earnings per share, before charges, and even lower numbers for 1999. The farm equipment maker will cut about 3,400 jobs by the end of next year and take a fourth quarter charge of $130 million to $135 million.

Circuit maker Cypress Semiconductor (NYSE: CY) wilted $1 1/4 to $8 9/16 as the company is forecasting a Q4 loss of around $0.04 a share, compared with analysts' mean estimate of earnings of $0.04 a share. The company blamed a manufacturing problem in its Philippines assembly and test plant that has since been corrected. Morgan Stanley Dean Witter downgraded the company to "neutral" from "outperform."

Semiconductor equipment maker Align-Rite International (Nasdaq: MASK) lost $1 3/4 to $11 1/8 after saying it anticipates fiscal Q3 EPS of $0.15 to $0.18, roughly half of analysts' expectations of $0.32. Chairman James MacDonald said an industry-wide slowdown in new design activity in the semiconductor industry was to blame.

Juice maker Northland Cranberries (Nasdaq: CBRYA) fell $3 to $8 1/8 after it said it expects lower-than-expected revenue and earnings for its fiscal Q1 (ended Nov. 30) and full-year fiscal 1999 (ending Aug. 31). The company expects Q1 EPS to be flat with last year's $0.01, compared with analysts' projections of $0.06.

Calendar and organizer company Day Runner Inc. (Nasdaq: DAYR) slowed $4 7/16 to $13 9/16 following its announcement of expected fiscal Q2 EPS of $0.30 to $0.35, short of analysts' mean estimate of $0.55.

Specialty chemicals maker Hercules Inc. (NYSE: HPC) weakened $3 to $25 5/8 following reports that it expects Q4 EPS of $0.28 to $0.33 (excluding charges) compared with analysts' forecasts of $0.47. The company will cut 700 jobs as it merges with Betzdearborn (NYSE: BTL). Longer-than-expected customer shutdowns and construction slowdowns in Europe were among the culprits for the earnings trouble.

Silicon Valley Bancshares (Nasdaq: SIVB), which makes loans to tech firms and life-sciences companies, lost $5 1/2 to $19 after it said it anticipates Q4 EPS of $0.20 to $0.25, below analysts' expectations of $0.42.

Auto repair chain Monro Muffler Brake (Nasdaq: MNRO) stalled for a loss of $1 1/2 to $6 1/4 after it said slow progress in improving same-store sales at its recently acquired Speedy U.S.A. locations is expected to cause Q3 net losses of between $0.10 and $0.11 per share. Two analysts polled by First Call currently expect a profit of a dime a share.

Networking products maker Cabletron Systems (NYSE: CS) dropped $15/16 to $8 following its announcement of fiscal Q3 net losses of $0.12 per share, about $0.02 below the company's pre-announced forecast from earlier this month. "We have some work to do on our operating basis but I am enthused by the growth in our key driving sectors including the SmartSwitch Router," CEO Craig Benson said in a statement.

Grocery warehouse retailer Smart & Final (NYSE: SMF) fell $13/16 to $8 13/16 as lagging operating results from its foodservice distribution units and the impact of interest expense and other costs from its recent restructuring of debt facilities are expected to pull Q4 earnings "significantly" below analysts' expectations, which were $0.17 a share.

Generic drugmaker Mylan Laboratories (NYSE: MYL) lost $1 1/2 to $25 1/4 after dropping $3 5/16 yesterday, when the Federal Trade Commission formally sued the company on antitrust grounds alleging "restraint of trade."


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