<THE EVENING NEWS>
Monday, April 26, 1999
DJIA 10718.59 +28.92 (+0.27%) S&P 500 1360.04 +3.19 (+0.24%) Nasdaq 2652.05 +61.36 (+2.37%) Russell 2000 434.97 +3.24 (+0.75%) 30-Year Bond 95 11/32 +10/32 5.57 Yield
The British are coming! The British are coming! That was the phrase ringing out in the U.S. networking industry today after high-end asynchronous transfer mode (ATM) and Internet Protocol (IP) switches maker FORE Systems (Nasdaq: FORE) ended months of merger speculation and agreed to be acquired by British industrial conglomerate-cum-networking company General Electric Co. PLC (GEC) for $4.5 billion in cash. FORE was launched $9 1/4 to $33 3/4 by the news. Prior to its acquisition of Cleveland-based local-loop broadband technologies firm RELTEC Corp. earlier this year, GEC only derived about 3% of its $3 billion in annual sales from North America. That will soon change, considering FORE's client list includes such U.S. telecom carrier biggies as MCI WorldCom and GTE. Relying on FORE and its Marconi optical networking unit for future growth, GEC is making a major strategic shift into the enterprise data networking market -- much like chipmaker Intel (Nasdaq: INTC), which just happens to have a year-old enterprise ATM/Ethernet development agreement with FORE.
Yet another independent regional brokerage firm bit the dust today as Chicago-based brokerage firm EVEREN Capital Corp. (NYSE: EVR) agreed to be gobbled up by banking and financial services company First Union (NYSE: FTU) for $1.1 billion in stock, or $30.63 per EVEREN share. EVEREN jumped up $4 5/16 to $28 7/16 on the news, while First Union fell $1 1/4 to $53 3/4. While the pace of the regional brokerage consolidation has abated since the acquisition frenzy of 1997, the local shops' price tags have barely budged. First Union reportedly picked up Richmond-based Wheat First Butcher Singer in 1997 for about 3 times book value, 13 times net income, and just under 1 times revenues. For the larger EVEREN, First Union said it is ponying up 2.5 times book value, 15 times net income, and nearly 1.5 times revenues, based on EVEREN's latest 10-K filing.
QUICK TAKES: British telecommunications services provider Cable & Wireless PLC (Nasdaq: CWP) rose $2 15/16 to $44 5/8 after agreeing to sell its Global Marine undersea cable installation and maintenance company to international carrier Global Crossing (Nasdaq: GBLX) for about $885 million in cash and assumed debt. Global Crossing, which expects the unit to generate up to $100 million in cash flow this year, gained $3 7/16 to $56 5/16... Online auctioneer eBay Inc. (Nasdaq: EBAY) was bid up $8 7/8 to $209 after agreeing to buy auction house Butterfield & Butterfield for about $260 million in stock, strengthening its presence in auctions of fine and decorative arts and higher-priced collectibles. eBay expects the deal to add to its earnings this year... Laser vision correction systems maker VISX (Nasdaq: VISX) eyed a $13 5/16 gain to $131 after McDonald Investments started coverage of the firm with an "aggressive buy" rating.
Airline tickets, home mortgages, hotel rooms, and new cars online purchasing service Priceline.com (Nasdaq: PCLN) climbed $32 3/4 to $120 3/4 after saying more than one million customers have used its services over its first year of operation. Warburg Dillon Read started coverage of the company with a "buy" rating, while Morgan Stanley Dean Witter turned in an initial opinion of "outperform"... Electronics manufacturing services (EMS) provider Jabil Circuit (NYSE: JBL) added $5 1/2 to $47 1/16 after being selected to replace U.S. Filter (NYSE: USF) on the Standard & Poor's MidCap 400 index. U.S. Filter is being acquired by French firm Vivendi S.A... Labor Ready (NYSE: LRW) worked its way $3 higher to $29 3/8 after Credit Suisse First Boston raised its rating on the temporary manual labor company to "strong buy" from "buy."
Brawny paper towels and Dixie paper cups maker Fort James Corp. (NYSE: FJ) stormed $3 3/16 higher to $38 3/16 after saying it will sell its folding cartons and healthcare and microwave products packaging business to ACX Technologies (NYSE: ACX) for $830 million in cash. Fort James also announced plans to repurchase up to $500 million of its outstanding shares over the next 18 months. ACX slipped $1 3/4 to $11 7/8... Manual and computer-operated metal cutting machine tools maker Bridgeport Machines (Nasdaq: BPTM) tacked on $3 7/32 to $9 3/16 after agreeing to be acquired by privately held metal working machinery firm Goldman Industrial Group for $10 per share in cash, or about $56 million.
Cement company Lafarge (NYSE: LAF) rose $1 5/8 to $33 3/8 after posting a Q1 loss of $0.40 per share, which was not quite as bad as the loss of $0.59 per share expected by the two analysts surveyed by Zacks... Enterprise application software developer BMC Software (Nasdaq: BMCS) picked up $2 13/16 to $42 7/16 after saying it is reorganizing its business into five product-specific business units... Broadband communication integrated circuits maker Broadcom Corp. (Nasdaq: BRCM) moved up $5 3/4 to $74 1/2 after announcing over the weekend that it will acquire privately held high-speed home networking semiconductor products maker Epigram Inc. for about $316 million in stock.
Biotechnology firm COR Therapeutics (Nasdaq: CORR) tacked on $1 3/8 to $11 1/2 after BancBoston Robertson Stephens raised its rating on the company to "strong buy" from "buy" based on improving fundamentals and higher-than-expected Q1 sales of its Integrilin unstable angina drug... Biopharmaceutical company Abgenix (Nasdaq: ABGX) rose $1 1/2 to $14 7/8 after signing a research collaboration and licensing agreement with biotech Amgen (Nasdaq: AMGN) concerning its XenoMouse human antibody generation technology... Commercial IP telephony systems developer VocalTec Communications (Nasdaq: VOCL) advanced $2 1/2 to $12 11/16 after China Telecom chose the company's software for a nationwide IP telephony trial network.
Cruise line operator Carnival Corp. (NYSE: CCL) ran aground for a $3 7/16 loss to $43 3/4 today after saying the current military conflict in Kosovo has slowed bookings of its Mediterranean cruises and will lower fiscal 1999 earnings by $0.06 to $0.08 per share, split between Q3 and Q4. However, COO Howard Frank maintained that he expects "strong earnings growth" for the company this year. The uncertainty also sank rival Royal Caribbean Cruises (NYSE: RCL), which dropped $1 9/16 to $36 9/16. However, Royal Caribbean's CFO told Reuters that there was nothing to fear, as the firm's bookings to the Med are "sluggish" but will not damage future earnings. While Carnival said the Med accounts for about 7.5% of its total second-half bookings, Royal Caribbean appears even more insulated from the area with only three of its 17 ships listing Europe as a primary area of operation.
Ascent Entertainment Group (Nasdaq: GOAL) descended $1 1/4 to $11 1/8 after agreeing to sell the Denver Nuggets NBA franchise, the Colorado Avalanche NHL franchise, and the under-construction Pepsi Center where the two teams will eventually play to a group led by former college basketball player William Laurie and his wife, Wal-Mart (NYSE: WMT) heir Nancy Walton Laurie, for $400 million in cash and debt. Current Ascent CEO Charlie Lyons will become President of the new ownership group. If the deal is approved by the respective sports leagues, Ascent will be left with its interest in On Command Corp., a hotel pay-per-view TV business, and its TV satellite service and maintenance business for General Electric's (NYSE: GE) NBC unit. Those businesses represented 76% of the company's $343.6 million in fiscal 1998 revenues, up from 72% the year before.
QUICK CUTS: Financial services holding company Equitex (Nasdaq: EQTX) dropped $13/16 to $17 after an article in Barron's shed light on the past of the company's management, citing especially an SEC securities violation settlement involving president Henry Fong in 1994... Contract oil and gas driller Noble Drilling Corp. (NYSE: NE) sank $1 3/4 to $16 5/8 following a Donaldson, Lufkin & Jenrette downgrade to "market perform" from "buy"... Drug developer Warner-Lambert (NYSE: WLA) fell $1 to $66 7/8 despite reporting Q1 EPS of $0.45, beating the First Call mean estimate by a penny. For a closer look at the company's results, see today's Fool Plate Special... Chocolate and candy maker Hershey Foods (NYSE: HSY) soured for a $2 5/16 loss to $52 5/16 after Credit Suisse First Boston cut its rating on the firm to "hold" from "buy."
Chemical giant Union Carbide (NYSE: UK) spilled $3 1/2 to $48 1/4 after reporting Q1 EPS of $0.52 (before accounting changes), down from last year's $1.01 but ahead of the First Call mean estimate of $0.45. The company said it expects licensing income will be lower in Q2 than in Q1 based on an operating environment in which it is "difficult to get a clear picture" of performance in the quarter... Commonwealth Telephone (Nasdaq: CTCO), which operates an Incumbent Local Exchange Carrier (ILEC) and a Competitive Local Exchange Carrier (CLEC) business under the same roof, dropped $2 1/4 to $43 following a downgrade to "hold" from "buy" from ING Baring Furman Selz... Electronic motion control systems maker Kollmorgan Corp. (NYSE: KOL) slumped $1 1/16 to $12 after reporting Q1 operating EPS of $0.16, down from last year's $0.19.
Restaurant operator Outback Steakhouse (Nasdaq: OSSI) was seared $2 3/8 to $36 after Morgan Stanley Dean Witter downgraded the firm to "neutral" from "outperform." Dain Rauscher Wessels also cut its rating to "buy" from "strong buy"... Cable TV provider Comcast (Nasdaq: CMCSA) slid $1 9/16 to $64 1/4 on reports that AT&T (NYSE: T) is working on a confidentiality agreement as part of its MediaOne Group (NYSE: UMG) takeover bid, which topped an earlier bid from Comcast. Meanwhile, CNBC reported that Comcast may be working on a higher bid for MediaOne that includes the participation of online services giant America Online (NYSE: AOL)... Copper mining firm and magnet wire maker Phelps Dodge Corp. (NYSE: PD) was shafted for a $2 1/8 loss to $59 15/16 following a Goldman, Sachs downgrade to "market outperform" from "trading buy."
Probability Theory and the Market
Virtually every day, we make decisions in the face of uncertainty. Considering that we do so on such a necessarily consistent basis, its hard to fathom that our decision-making structures do not adhere to some form of accessible logic. If not a logic of the formalized, probabilistic variety, then perhaps one imbued with a more evolutionary imperative. One that works.
In short, it's hard to completely embrace the notion that we are fundamentally irrational -- as it has been "traditionally" defined. However, when the question of rationality is examined in light of the evidence provided by probability experiments, we have a pretty dismal record. That is, the non-statisticians among us do very poorly when asked to measure the likelihood that an event will happen in the future given certain data.
Many have been embarrassed by the "false positive" puzzle -- in random testing you score positive for a disease that yields false positives 5% of the time in a population where one in every thousand people have the disease. By the way, there is a 2% chance that you have the disease, not a 95% chance -- which is undoubtedly the product of a conspiracy by probability theorists to make people feel like idiots. There's an even better popular example though, which is quite a bit more confounding, alternately called "The Prize" or the "Monty Hall Puzzle."
Given three boxes, you are asked to choose one. In two of the boxes there is nothing, in the third there is a prize. After you have chosen, but before your box is opened, another box is opened to reveal no prize, just air. You are then given the option to change your mind and choose the other unopened box. Does the decision really matter? After all, you've just been shown a box with no prize, and there are only two boxes left. One will have the prize and one won't, so there's a fifty-fifty chance you'll get the prize, right? Sorry, you can actually double your chances of winning the prize by switching to the other box.
I came across this probability brain teaser in its "Monty Hall" incarnation in a recent issue of The Economist (the Feb. 20th - 26th, 1999 issue: "Getting the Goat") where it was noted that violence often ensues after reasonable discussions about the puzzle have been exhausted.
Famed psychologists Daniel Kahneman and Amos Tversky have pursued numerous experiments confirming that we are typically "not rational" when the defining element of reason is action in accordance with the laws of probability. Despite this, they have found that our cognitive models do adhere to a readily definable logic. In one study, Kahneman and Tversky found that a majority of subjects will judge a deadly flood (causing a thousand deaths) triggered by a California earthquake to be more likely than a fatal flood (causing a thousand deaths) occurring somewhere else in North America on its own. Again, probability theory rears its ugly head. The majority of the respondents in the study were wrong, because probability theory asserts that the likelihood of any event (A) is always greater than or equal to any event (A), conjoined with event (B).
Commenting on the Kahneman-Tversky results in their recent book, Philosophy in the Flesh, George Lakoff and Mark Johnson note:
"Presumably, most of their subjects had a mental model in which earthquakes occur with reasonably high probability in California, a model in which earthquakes cause tidal waves, and a model in which sudden tidal waves cause a large number of deaths. When these cognitive models are evoked by the question and linked together, they imply that the probability of a California earthquake triggering the highly fatal flood is higher than other well known scenario for such a highly fatal flood, most of which have many fewer than a thousand fatalities because of excellent warning systems for most large floods."
For most of their book Lakoff and Johnson explore the manner in which we employ our cognitive models to contextualize and make sense of situations and information. We reason and understand using metaphors, frames, and prototypes. And while this may be "contextually inappropriate" at times, it has nevertheless been our most basic and successful tool for survival. While the book really poses a challenge to a Western philosophical tradition that has largely ignored input from cognitive science over the last thirty years, it's also an extremely interesting commentary on the theory of rational action in general, and I would wholeheartedly recommend it to anyone.
Understandably, if we are so ill equipped to reason about basic probability questions, then more profound issues regarding how the stock market works should really be daunting. Perhaps the most pedestrian view is that prices are merely set by the sum total of the actions taken in the market. Our intuition tells us that prices move up and down in a concrete process dictated by money flows, where "ending" prices are a function of the sum of all the inputs. However, as with probability theory our intuition is not a helpful guide when presented with the vast, complex entity called the market. In fact its just downright contextually inappropriate.
In a decentralized market view there are no "leaders" that set prices on the margin, but rather it is through the teeming interaction of countless players that a "meta system" emerges. That is, the market carries properties and characteristics "distinct from the agents that comprise it" (see "The Invisible Lead Steer" at CAP@Colmubia). The aggregate becomes more than the sum of its parts, or put another way, the market is "smarter" than any one of its participants.
Yes, the stock market reflects all available information and incorporates what is believed about the present value of the future, but this is not to say that prices are "correct." Correct is a determination that can only be made in the future. The implication here is that the most fruitful endeavor for the investor is to take a harder look at existing prices to determine what is built into the equity. It is only from this vantage point that disjunctions with possible future results can be assessed.
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