Monday, May 10, 1999
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30-Year Bond   92 12/32   +8/32  5.79 Yield


One of the most hotly contested mergers of the year appears to be cooling off, as shares of Web portal operator Lycos Inc. (Nasdaq: LCOS) picked up $15 3/4 to $105 1/4 today following reports that USA Networks (Nasdaq: USAI) will probably give up on its three-month-old bid for the company. USA has reportedly decided it won't be able to get shareholder approval for its deal -- originally announced in early February -- after a highly publicized campaign against it by David Weatherell, chairman of Internet investment firm and 20% Lycos owner CMGI (Nasdaq: CMGI). CMGI sought other bidders for Lycos and even considered buying Lycos itself. CMGI shares grabbed $16 11/16 to $237 15/16 today while USA Networks' stock was essentially flat. With observers skeptical of the deal's ability to win approval through a proxy vote of shareholders --expected in July -- if Lycos is to be moved it is now probably incumbent on either USA or CMGI to produce a better offer. CMGI, meanwhile, likely benefited from majority-owned Internet marketing firm Engage Technologies' plans for a future IPO.

Shareholders responded well to signs of life at embattled PC and enterprise computing firm Compaq (NYSE: CPQ). The shares today climbed $1 1/2 to $26 1/4 after the company announced a new North American distributor alliance program centered around four companies: Inacom (NYSE: ICO), Ingram Micro (NYSE: IM), Merisel (Nasdaq: MSEL), and Tech Data (Nasdaq: TECD). Compaq plans to cut the number of destinations it ships to by 70% so it can "better forecast and manage inventory levels, reduce transportation costs, focus channel resources, and increase customer demand generation activities." Distribution and inventory channel concerns were the main reasons blamed for the company's Q1 difficulties, which eventually led to the dismissal of CEO Eckhard Pfeiffer and the resignation of CFO Earl Mason. This marks the first major action of interim CEO Benjamin Rosen -- who is also chairman and co-founder -- since the upheaval, and investors were heartened by the news.

QUICK TAKES: Online services giant America Online (NYSE: AOL), which announced marketing agreements with five banks -- Bank of America (NYSE: BAC), Bank One (NYSE: ONE), Citigroup's (NYSE: C) Citibank, Union Bank of California, and Wells Fargo (NYSE: WFC) -- in connection with the relaunch of its banking center, deposited $10 1/8 to $128 5/16... Printing and imaging paper distributor Unisource Worldwide (NYSE: UWW) improved $2 3/4 to $11 1/2 after Georgia-Pacific Corp. (NYSE: GP) topped UGI Corp.'s (NYSE: UGI) March buyout offer with a $12 per share unsolicited bid. UGI moved up $2 1/2 to $20 5/16 while Georgia-Pacific gave away $6 9/16 to end at $92... Telecommunications and networking equipment supplier Nortel Networks (NYSE: NT) advanced $4 3/4 to $71 15/16 on news that it won a contract to install an optical backbone network in Europe for telecommunications services company COLT Telecom Group.

Organ transplant-related pharmaceutical developer SangStat (Nasdaq: SANG) gained $2 3/4 to $14 9/16 as the company said revenues rose 582% over year-ago levels and reported a multi-year deal with Abbott Laboratories (NYSE: ABT) to market SangCya cyclosporine capsules, used to prevent graft rejection in transplant operations... Internet business services company Rare Medium Group (Nasdaq: RRRR) added $1 3/16 to $15 15/16 after Apollo Management agreed to boost its investment in the company by $10 million to $85 million... Hearing health care and human communications company ReSound Corp. (Nasdaq: RSND) cleared $1 to $7 9/16 after agreeing to be bought by Denmark's GN Great Nordic for $8.00 per share in cash, about a 22% premium to Friday's closing price.

New media company CNET (Nasdaq: CNET) zoomed ahead $22 7/16 to $136 3/16 after announcing a deal to produce a twice-weekly television show about technology and the Internet for General Electric's (NYSE: GE) CNBC that will air beginning in October. CNET also paired with online direct marketing company Xoom.com (Nasdaq: XMCM), a recent Foolish Double, and NBC to form NBCi, with the little "i" standing for, of course, "interactive." News of the new broadcast/portal/e-commerce partnership sent shares of Xoom up $6 3/4 to $81 7/8... Desktop publishing software developer Adobe Systems (Nasdaq: ADBE) ascended $4 1/2 to $72 7/16 after reporting the availability of version 6.5 plus of its PageMaker software and a new promotional campaign for version 8.0 of Illustrator.

PC direct marketer Dell (Nasdaq: DELL) got $2 1/16 to $42 1/4 on news of an upgrade to "buy" from "market perform" at BT Alex. Brown, which set a $50 per share 12-month price target... In other high-tech kudos, online auctioneer eBay (Nasdaq: EBAY) was bid up $16 11/16 to $193 3/8 as noted tech investor Rajiv Chaudhri told Barron's he favored the company, while e-brokerage E*Trade (Nasdaq: EGRP) headed upward $9 7/16 to $119 13/16 following a reiterated "buy" rating from Volpe, Brown, Whelan & Co... Predictive software firm HNC Software (Nasdaq: HNCS), which launched its eFalcon Internet fraud detection service for online merchants, flew up $4 to $25 today... Norwegian oil company Saga Petroleum's (NYSE: SPM) American depositary receipts fueled up $3 1/8 to $14 1/4 after compatriot Norsk Hydro (NYSE: NHY) offered a one-for-three stock swap to Saga's shareholders, a 35% premium on Friday's closing price.

California sporting goods superstore company Sport Chalet Inc. (Nasdaq: SPCH) jumped up $1 1/4 to $6 3/8 after announcing the launch of its online store. The company's e-commerce activities will be run by Global Sports Interactive (Nasdaq: GSPT)... Network connectivity products maker Osicom Technologies (Nasdaq: FIBR) plugged in $3 3/16 to $11 after reporting Q1 revenues from its core U.S. operations of $19 million, 28% above last year's $14.8 million mark... Confectioner Rocky Mountain Chocolate Factory (Nasdaq: RMCF) sweetened $2 3/16 to $5 11/16 after Whitman's Candies offered to buy the company for $5.75 per share, a 64% premium to yesterday's closing price... Locomotive parts and services company MotivePower Industries (NYSE: MPO) rumbled up $1 13/16 to $20 1/8 after a joint venture including its Boise Locomotive subsidiary earned the right to negotiate a five-year contract, worth up to $175 million, to provide maintenance for Boston's commuter rail line.

Meridian Medical Technologies (Nasdaq: MTEC) got $1 7/16 to $6 7/16 after the drug delivery company won FDA approval for an injectable drug to treat heart disease... Industrial parts washing products company Mansur Industries (Nasdaq: MANS) cleared up $1/4 to $7 3/4 after the company said it raised $5 million through a private sale of convertible stock... Antibody humanization technologies developer Protein Design Labs (Nasdaq: PDLI), upgraded to "buy" from "attractive" at PaineWebber today, was propelled up $2 1/4 to $19... Specialty metal alloy auto parts maker Autocam Corp. (Nasdaq: ACAM), which today turned in fiscal Q3 EPS of $0.32 -- First Call's three-analyst consensus was $0.22 -- drove up $1 9/16 to $11 3/4... Online health and medical information provider adam.com (Nasdaq: ADAM) rose $1 3/4 to $15 1/2 after the company debuted its new consumer health information website and reported the acquisition of pediatric website Dr. Greene's HouseCalls.


Shares of pharmaceutical developer Zonagen (Nasdaq: ZONA) lost about half their value today on news that the company expects the Food and Drug Administration (FDA) to issue a non-approvable letter for its erectile dysfunction drug Vasomax. The stock fell $9 1/8 to $10 11/16. Hopes were high that the drug would be approved and launched in the U.S. this year, but CEO Joseph Podolski said in an interview with Bloomberg News that he didn't expect that to occur until 2000 at the earliest. According to a company press release, Zonagen and marketing partner Schering-Plough (NYSE: SGP) decided to forego a June FDA Review Panel of Vasomax because they want to wait and submit additional information from recent clinical trials. While that may sound like a smart idea, neophyte biotech investors may want to look for a more stable way to take advantage of the drug sector, as suggested in today's Fool Plate Special.

"Unimaginable," "unthinkable," and "surprising" were some of the words used by the mainstream press last week to describe the fate of Comps.com Inc. (Nasdaq: CDOT), the provider of online and offline commercial real estate sales information that will forever be saddled by the ignominious distinction of being the first company with ".com" in its name to fall flat on its face on the day of its initial public offering. The weak performance by the company, whose shares fell 5% on their first day of trading Wednesday and shed another $3 11/16 to $10 1/16 today, has prompted some observers to speculate that the heyday of Internet-related IPOs has come and gone, even though it is estimated that less than a third of all U.S. residents are currently connected to the Web. That theory will receive a major test this week, which is scheduled to include IPOs from Careerbuilder Inc., Alloy Online Inc., and TheStreet.com Inc.

QUICK CUTS: Bank holding company Republic New York Corp. (NYSE: RNB), the parent company of Republic National Bank of New York, fell $1 15/16 to $68 1/16 after Britain's HSBC Holdings agreed to acquire the company and its sister company, Safra Republic Holdings SA, for a total of $10.3 billion, or $72 a share, in cash. Republic's shares rose 14% on Friday on speculation that it would be acquired... Honeywell Inc. (NYSE: HON) slid $2 9/16 to $101 7/16 after an analyst at Robert W. Baird lowered his rating on the building, aerospace, and industrial control systems designer to "market perform" from "market outperform"... Private label casual apparel contract manufacturer Tarrant Apparel Group (Nasdaq: TAGS) was marked down $2 13/16 to $42 3/16 despite reporting Q1 EPS of $0.30 versus $0.20 a year ago, beating the Zacks mean estimate by a penny.

Marketing software developer Exchange Applications (Nasdaq: EXAP) fell $4 5/8 to $23 3/8 after filing a 3-million-share secondary offering with the Securities and Exchange Commission, which includes 2 million shares being sold by existing shareholders... Information technology services company Computer Task Group (NYSE: TSK) skidded $1 7/16 to $17 11/16 following a Janney Montgomery Scott downgrade to "accumulate" to "buy"... Voice and data conferencing technologies company Latitude Communications (Nasdaq: LATD) gave back $1 11/16 to $12 1/8 after rising 15% on Friday following its initial public offering of 3 million shares at a price of $12 per share.

Railroad operator Union Pacific Corp. (NYSE: UNP) sank $1 to $66 after PaineWebber cut its rating on the company to "neutral" from "attractive"... Shares of gold producers continued to fall today after dropping Friday on word that the Bank of England plans to slowly sell nearly 60% of its gold reserves in a move to rebalance its portfolio and increase its foreign currency holdings. Newmont Mining (NYSE: NEM) lost $2 5/16 to $20 7/16, Barrick Gold (NYSE: ABX) fell $1 5/8 to $18 7/8, Homestake Mining Co. (NYSE: HM) slid $11/16 to $8 3/4, and Anglogold Ltd. (NYSE: AU) gave up $1 3/4 to $21 3/16... Mine Safety Appliances (Nasdaq: MNES), which develops products for the protection of mine workers, fell $3 to $64 after posting Q1 EPS of $0.59, down from $1.23 (including a gain) a year ago.

An Investment Opinion
by Alex Schay

A Graham of Sense

The following Fool on the Hill was originally published on December 7, 1998 -- a date that will live in infamy. While checking out The Motley Fool's coverage of the 1999 Berkshire Hathaway Annual Meeting, take some time to peruse our past columns on Benjamin Graham, "the father of value."

As previously mentioned in this space, despite what a company's management might claim, restructuring charges and asset write-downs are invariably an admission that a firm has misallocated capital. Some of the common justifications for the move to restructure or write down assets are overcapacity in the industry (making certain existing facilities unprofitable) and the emergence of low cost competition.

While the sale or liquidation of an unprofitable activity is not in itself grounds for going on hyper-alert, the prospect of a "big bath" and the fact that the activity might actually be continued (despite announcements to the contrary), with the inventory and PP&E written down resulting in lower expenses, should be cause for concern. As Ben Graham offers in Security Analysis, "Once it is decided to take a major write-down, there is little additional embarrassment in charging off every possible doubtful asset, thereby preparing the way for accounting prosperity."

Much of Graham's early valuation work was balance-sheet intensive, so he definitely had a masterful understanding of the accounting regime and the nuances of accounting treatments that could "artificially" pump up earnings. In 1936 (yes, that date is correct), he wrote what has been billed as "A Satire on Accounting Shenanigans" entitled, "U.S. Steel Announces Sweeping Modernization Scheme." Of course, the "modernization" strategies that he writes about in such a Voltaire-like fashion have little to do with the substantive changes that drive real business development, but instead entail the manipulation of financial accounts. As Graham writes at the outset, "Contrary to expectations, no changes will be made in the company's manufacturing or selling policies. Instead, the bookkeeping system is to be entirely revamped."

Citing comprehensive survey results from a fictitious outside consulting firm Price, Bacon, Guthrie & Colpitts (undoubtedly hired to explore the company's "strategic alternatives"), Graham forcefully argues that U.S. Steel should immediately adopt the following strategies:

1. Writing down of Plant Account to minus $1,000,000,000.
2. Par Value of Common Stock to be reduced to $0.01.
3. Payment of all wages and salaries in option warrants.
4. Inventories to be carried at $1.00.
5. Preferred stock to be replaced by non-interest bearing bonds redeemable at 50% discount.
6. A $1,000,000,000 Contingency Reserve to be established.

What follows is a hilarious and insightful look at the details concerning the implementation of the above strategies -- and all the while Graham pokes fun at firms that shuffle accounts and preach the gospel of modern accounting (thereby avoiding capital allocation decisions that might actually create enduring value).

"In setting up this arrangement, the Board of Directors must confess regretfully that they have been unable to improve upon the devices already employed by important corporations in transferring large sums between Capital, Capital Surplus, Contingency Reserves and other Balance Sheet Accounts. In fact it must be admitted that our entries will be somewhat too simple, and will lack the element of extreme mystification that characterizes the most advanced procedure in this field."

Taking a look at number one and number four on Graham's modernization list -- since they relate to our opening discussion of asset write-downs -- serves as a neat lesson in logical extremes. Since some companies write down the value of their PP&E to "relieve" their income accounts of depreciation, why not write down the value to a negative number? In that way, instead of taking a depreciation charge, a company can, in fact, take an "appreciation credit" as the plant wears out, because as Graham sarcastically observes, "It is now a well recognized fact that many plants are in reality a liability rather than an asset, entailing not only depreciation charges, but taxes, maintenance, and other expenditures."

Also, Graham notes that some companies -- especially in the metal and cotton textile industries -- have suffered serious losses during the depression due to the fact that they need to adjust the value of their inventories to reflect market conditions. How about a more "progressive" policy? In order to eliminate the possibility of further inventory depreciation as well as boost earnings, inventories should be carried at a dollar -- and the write-down can be affected by dipping into the newly established Contingency Reserve (which in turn is replenished by funds transferred from the Capital Surplus account, which itself grows through the exercise of Stock Option Warrants). It's really a brilliant model for the "modern" company to follow.

Kind of eerie, these words from the past, huh? Investors shouldn't merely draw a "nothing new under the sun" conclusion from this discussion though, but rather, the more important point that financial reality is not necessarily the sum of the accounting parts.

(A copy of the full text of Graham's satire can be found on pp. 159-165 of The Essays of Warren Buffett: Lessons for Corporate America courtesy of The Cardozo Law Review for $25 -- edited by Lawrence Cunningham.)


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