<THE EVENING NEWS>
Tuesday, May 18, 1999
MARKET CLOSE
DJIA          10836.95    -16.52    (-0.15%)
S&P 500        1333.32     -6.17    (-0.46%)
Nasdaq         2558.36     -3.48    (-0.14%)
Russell 2000    442.45     +1.10    (+0.25%)
30-Year Bond   91 3/32     +4/32  5.89 Yield

HEROES

Railroad, truck, and trailer equipment maker Varlen Corp. (Nasdaq: VRLN) rolled up $10 to $35 15/16 after privately owned Amsted Industries announced a hostile tender offer to buy the company for $35 per share in cash, about a 35% premium to yesterday's closing price, after Varlen repeatedly denied invitations to friendly talks. Probably the most common reason a company's board would turn away buyout overtures is a desire to get better value (read: a richer offer) from a prospective suitor. With investors paying as much as $36 3/4 for Varlen shares today, it seems many believe the company will be able to coax a better offer out of Amsted despite predictable comments from Amsted's CEO suggesting an unwillingness to raise the bid. Also predictably, Varlen's board said it would take a look at the offer, asking shareholders to wait for word before they make a move; the board's recommendation is due within 10 business days of the offer's opening (it will commence within five).

Hewlett-Packard (NYSE: HWP) improved $6 7/8 to $95 5/8 after it reported fiscal Q2 EPS of $0.88 last night, up from $0.65 last year and beating Wall Street's $0.80 consensus estimate. The good feeling continued as the company guided analysts toward low double-digit revenue growth for the second half of the year. Investors were further turned on by the news that executives are seriously considering a spinoff of some of the company's Internet assets to go along with the planned separation of its medical equipment and measurement operations, announced in March. PC sales were strong and orders were up 10% during the quarter. "Clearly, our challenge is to convert order growth into stronger growth in revenue," said Chairman and CEO Lewis Platt. Meanwhile, shares of PC direct marketer Dell (Nasdaq: DELL) moved up $13/16 to $44 1/16 today in busy trading. After the bell, the company reported EPS of $0.16, flat with Street estimates and a nickel better than a year ago.

QUICK TAKES: Chip manufacturer TriQuint Semiconductor (Nasdaq: TQNT) moved up $4 1/2 to $34 1/2 today as Donaldson Lufkin & Jenrette put the firm on its "top pick" list. For a closer look at TriQuint from the Fool's Alex Schay, click here... Web portal operator Lycos (Nasdaq: LCOS) moved up $4 7/16 to $112 15/16 today. After the bell, the company turned in a fiscal Q3 loss of $0.02 before items, a penny better than expected. The company's board approved a 2-for-1 stock split effective late next month... Broadband Internet access company Redback Networks Inc. (Nasdaq: RBAK) shot up $61 1/8, or 265.8%, to $84 1/8 in the company's first day of trading after the company sold 2.5 million shares to the public at $23 each.

Ultradata Corp.
(Nasdaq: ULTD), which provides information management services to financial institutions, moved up $23/32 to $6 23/32 after CFI ProServices (Nasdaq: PROI) agreed to buy the company for $7.50 per share in cash, a 25% premium to yesterday's closing price... E-banking software and services company Sanchez Computer (Nasdaq: SCAI) deposited $5 5/16 to $72 7/16 after announcing an expanded business pact with IBM (NYSE: IBM) in which Sanchez will help test and develop e-business and other applications in coordination with Big Blue... SFS Bancorp (Nasdaq: SFED), parent of Schenectady Federal Savings Bank in New York, banked $2 to $23 5/8 after Hudson River Bancorp (Nasdaq: HRBT) agreed to buy the company for about $32 million. Hudson's $25.10 per share cash offer is approximately 16% higher than SFS' closing price last night.

Compound wafer fabrication systems manufacturer EMCORE Corp. (Nasdaq: EMKR) advanced $1 9/16 to $19 1/8 after announcing a deal to make indium gallium phosphide epitaxial wafers in connection with Japan's Sumitomo Electric Industries. The wafers are used in digital wireless and cellular applications... Critical Path (Nasdaq: CPTH), which provides e-mail hosting services to Internet service providers, Web portals, and corporations, traveled up $8 3/4 to $69 after agreeing to co-develop a secure e-mail system with secure e-commerce technologies provider VeriSign (Nasdaq: VRSN)... Global telecommunications services firm Teleglobe Inc. (NYSE: TGO) rose $2 5/8 to $31 1/4 after the company reported a 200% increase in Internet capacity sold in Carribbean markets over the past year.

Bookseller Books-A-Million (Nasdaq: BAMM) packaged gains of $1 29/32 to $10 5/8 after its online division trumped Borders (NYSE: BGP), Amazon.com (Nasdaq: AMZN), and Barnes & Noble's (NYSE: BKS) Web operation, cutting prices on New York Times bestsellers by 55% for special members... Compound semiconductors maker Cree Research (Nasdaq: CREE) advanced $8 1/2 to $57 1/2 after announcing new high-performance light emitting diode products... Personal care products maker Helen of Troy (Nasdaq: HELE) ascended $15/16 to $14 15/16 after Donaldson, Lufkin & Jenrette started the company on its "top pick" list with a 12-month share price target of $21.

Canadian wireless communications technology company Research In Motion (Nasdaq: RIMM) moved up $2 1/4 to $13 3/16 after Merrill Lynch started coverage of the company with near-term "accumulate" and long-term "buy" ratings, setting a 12-to-18 month price target of $16 per share... Graphic arts and printing company Workflow Management (Nasdaq: WORK) achieved gains of $1 1/4 to $12 9/16 as Prudential Securities opened coverage of the company with a "strong buy" rating and a 12-month share price target of $20... Electronic component devices maker Methode Electronics (Nasdaq: METHA) powered ahead $2 3/8 to $18 1/2 after Merrill Lynch boosted its near-term rating on the stock to "buy" from "neutral," keeping its long-term rating at "buy."

Motorcoach and airport shuttle services provider Coach USA (NYSE: CUI) motored ahead $1 1/16 to $26 7/8 on the strength of a new "buy" rating from Friedman, Billings, Ramsey & Co., which set a 12-month price target of $38 per share... Wireless communications company Digital Microwave (Nasdaq: DMIC) heated up $2 1/8 to $15 1/8 after BT Alex. Brown upgraded the stock to "strong buy" from "buy"... Online business-to-business printed information provider RoweCom (Nasdaq: ROWE) moved up $3 7/16 to $25 after signing on to become a "preferred supplier" to users of Commerce One's BuySite and MarketSite e-commerce operations... Computer systems and equipment maker Data General (NYSE: DGN) took on $15/16 to $12 15/16 after announcing that its storage business unit will offer fiber channel-based storage area network technology.

Earnings Movers


Donaldson Co. (NYSE: DCI) up $1 1/16 to $23; fiscal Q3 EPS $0.37 vs. $0.32 last year; estimate: $0.33

Hot Topic Inc. (Nasdaq: HOTT) up $2 5/16 to $23 3/8; Q1 EPS $0.13 vs. $0.01 last year; estimate: $0.05

Kasper A.S.L. Ltd. (Nasdaq: KASP) up $1 3/4 to $6; fiscal Q1 EPS $0.76 vs. $0.59 last year; no estimate

Razorfish Inc. (Nasdaq: RAZF) up $1 5/8 to $40; Q1 EPS $0.03 vs. breakeven last year; no estimate

U.S.-China Industrial Exchange (Nasdaq: CHDX) up $3 3/4 to $10 7/8; Q1 EPS $0.39 vs. loss of $1.78 last year; no estimate

Zale Corp. (NYSE: ZLC) up $1 7/16 to $39 1/4; fiscal Q3 EPS $0.17 vs. $0.04 last year; estimate: $0.12

GOATS

Satellite operator PanAmSat Corp. (Nasdaq: SPOT) tumbled $3 5/8 to $30 5/8 after saying manufacturing delays have caused it to readjust its launch schedule for this year, which is expected to result in full-year revenues "comparable" to the $767 million reported a year ago and net income down "modestly" from last year's $0.83 per share. The First Call mean estimate had called for earnings of $1.17 per share this year. Satellite builder Hughes Electronics (NYSE: GMH), which holds an 81% stake in PanAmSat, also fell $1 15/16 to $57 1/2. Since touching $58 3/16 last June, PanAmSat's trajectory has been a long, steady descent toward Mother Earth. While the company maintained today that the long-term outlook for the business remains "very strong," management miscues and a smattering of old fashioned bad luck over the past year have investors crying, "Out, damned SPOT! Out, I say!" as they dump the company from their portfolios.

Prison owner Prison Realty Trust (NYSE: PZN) was slammed for a $1 9/16 loss to $13 3/8 today, continuing a rapid 42% erosion in the company's share price over the past five trading days. Yesterday, Legg Mason cut its rating on the firm to "market perform" from "buy" after a conference call with the company prompted doubts about management's forthrightness. While the company reportedly admitted to raising the fees it will pay to its privately held affiliate and prison management company Corrections Corp. of America to $4,000 a bed from the previous $845 a bed, it raised eyebrows by brushing off concerns that the move would not affect Prison Realty Trust's future funds from operations (FFO). Legg Mason isn't buying that line, and apparently neither are the four other brokerage firms that also downgraded the stock yesterday. Meanwhile, investors are left wondering if the conflict of interest fears that accompanied last year's complicated stock swap between Prison Realty Trust and CCA are becoming a less-than-legit reality.

QUICK CUTS: Electronic accessories, car audio, and loudspeakers company Recoton Corp. (Nasdaq: RCOT) was knocked down $2 23/32 to $13 1/32 after reporting a Q1 loss of $0.06 per share (excluding charges) compared to earnings of $0.30 per share last year, falling short of the Zacks mean estimate of earnings of $0.23 per share. The company also said that Vice President Arnie Kezsbom will replace Stuart Mont as CFO... Cable modem supplier Com21 Inc. (Nasdaq: CMTO) slipped $5 7/16 to $24 13/16 after saying chief technical officer Mark Laubach has resigned to pursue other interests. Current Com21 executive John Pickens will replace Laubach... Online fax-to-email services firm eFax.com (Nasdaq: EFAX) slid $1 5/16 to $17 3/4 after saying its president and COO, Rob Pollock, has resigned.

Delphi Information Systems (Nasdaq: DLPH), which provides software to the property and casualty insurance industry, lost $15/16 to $8 3/4 after reporting a Q1 loss of $0.28 per share compared to earnings of $0.04 per share a year ago due to lower legacy software services revenues, higher operating expenses, and expansion costs... Cleveland-based thrift holding company Charter One Financial (Nasdaq: COFI) shed $1 11/16 to $29 1/8 after agreeing to acquire Chicago-based thrift St. Paul Bancorp (Nasdaq: SPBC) for about $1.2 billion in stock. St. Paul rose $1 11/16 to $26 3/8 on the news... Ready-to-assemble furniture maker O'Sullivan Industries Holding (NYSE: OSU) lost $3/4 to $16 5/8 after accepting a $350 million cash and stock buyout offer submitted by a management-led group of investors in March.

Greeting cards maker American Greetings (NYSE: AM) was shredded $1 13/16 to $26 5/16 after saying lower order shipments will result in EPS between $0.10 and $0.15 in fiscal Q1 and breakeven results in Q2. The Zacks mean estimate had called for EPS of $0.35 in Q1 and $0.03 in Q2... Telecommunications company US WEST (NYSE: USW) lost $3 15/16 to $54 5/16 following a Legg Mason downgrade to "market perform" from "buy" a day after the company agreed to merge with international telecom carrier Global Crossing (Nasdaq: GBLX)... Agricultural machinery maker Deere & Co. (NYSE: DE) skidded $2 5/16 to $38 1/2 after saying it will further scale back production by shutting down its manufacturing facilities for 25% of the working days in Q2 as it tries to cope with slowing worldwide demand for agricultural products.

FOOL ON THE HILL
An Investment Opinion
by Warren Gump

Will J.C. Penney Moves Make Dollars?

J.C. Penney (NYSE: JCP), the mid-scale department store and drugstore operator, announced this morning that it was going to implement a couple of initiatives in an attempt to enhance shareholder value. First, the company plans to sell off a 20% interest in its Eckerd drugstore unit via a tracking stock IPO sometime in Q4 1999. The remaining 80% of Eckerd's tracking stock is expected to be spun off to shareholders in a tax-free transaction sometime in the year 2000. In addition, J.C. Penney plans to sell off its credit card receivables and outsource its credit card operations to a third party. Investors seemed to think the news was better than a dose of Prozac, running the stock up $4 7/16 (or 9.7%) to $50 1/8.

The logic behind the Eckerd spinoff is quite simple. The stock market values department stores and drug stores very differently. This valuation discrepancy results primarily from department stores being a fairly mature business that is highly dependent on economic cycles, whereas drugstores are considered to be a recession-resistant growth industry (thanks to aging baby boomers). Looking perfunctorily at the average Price/Earnings (P/E) ratio for the four largest drugstores and major department stores on Bloomberg, drugstores are trading at 28x current year earnings expectations, while department stores are trading at 19x estimates. If J.C. Penney were able to maintain its own multiple and attract a closer-to-market multiple on its Eckerd earnings, value would obviously be created.

Another important factor to the tracking stock is the consolidation of the drugstore industry. Over the past few years, drugstores have been gobbling each other up. Many of these transactions have involved the acquiring company paying the acquired in stock. The higher your earnings multiple, the fewer number of shares you will need to issue in such acquisitions. With a competitor like CVS Corp. (NYSE: CVS) having a multiple of 31x estimates for 1999, J.C. Penney is at a distinct disadvantage as an acquirer if it uses a stock trading at 17x current year estimates (today's multiple). If the company could use an Eckerd tracking stock trading at, say, 25x-30x estimates, the playing field would be closer to being level.

As to sale of credit card receivables and the outsourcing of credit card functions, J.C. Penney is raising cash and trying to improve its product offerings. At the time a sale is expected to be completed (sometime during Q4), the company should have about $4 billion in receivables. The proceeds will be used to reduce J.C. Penney's debt outstanding, reducing leverage on the balance sheet. In addition, ongoing working capital needs will be reduced since receivables won't need to be funded. The cost of these moves, which is not insubstantial, will be the loss of profitability associated with the credit card business. From a product standpoint, a third-party manager should be able to provide more comprehensive and customized offerings since they will likely have a much more sophisticated technological infrastructure.

Beyond these strategic initiatives, J.C. Penney also announced earnings for its first quarter. While earnings per share (EPS) of $0.60 (excluding a one-time gain of $0.01) were well ahead of the $0.53 estimate, they were still below the $0.64 earned last year. Total revenue increased 7.3% to $7.5 billion, while net income fell 4% to $167 million.

Sales at the department and catalog stores were basically flat overall, but comparable department store sales declined 0.5%. Even worse, margins were hampered as the company tried to clear out merchandise that wasn't selling well. Operating profits for the division fell 29% to $167 million from $234 million.

J.C. Penney department stores have been suffering as consumers go elsewhere for their clothes. Consumers have generally been favoring specialty stores over department stores of late. In particular, competition from quickly expanding concepts like Old Navy and Kohl's (NYSE: KSS) have hurt Penney's. To combat this threat, J.C. Penney management is trying to emphasize its proprietary brands like Stafford, Hunt Club, and St. John's Bay by setting up "specialty shops" within the department stores. J.C. Penney Chairman James Oesterreicher reportedly said that sales for these brands increased 10%-16% in April.

An important thing to remember when investing in J.C. Penney is that the department stores and catalog operation account for a majority of profitability at the company. Despite a 26% fall in operating profit for the division last year, department stores and catalog still accounted for two-thirds of J.C. Penney's overall operating profit. This business is key to the company's overall health. While results later this year will likely show an improvement when compared to last year's disastrously weak numbers, expectations for this year are still below the levels achieved two years ago. Penney's will have to make some drastic changes to achieve positive long-term growth in this business.

Eckerd's results were much stronger than J.C. Penney's department store business. Overall revenue grew 19% and comparable store sales increased 12.3%. This increase was driven by a 17.7% increase in same-store pharmacy sales and a 4.5% improvement of "front-end," or nonprescription, merchandise. Although sales were increasing nicely, operating profit only increased 8.4% to $129 million as margins were squeezed by an increasing percentage of lower-margin managed care pharmaceutical sales.

To put those results in perspective, CVS reported an 18% increase in revenue and a 23% increase in operating profit in its first quarter. Walgreen (NYSE: WAG), generally considered the preeminent retail drug chain, saw a 15% increase in sales and 17% jump in operating profit in its most recent quarter. Given the nature of Eckerd's business, it will obviously be accorded a higher earnings multiple than J.C. Penney's namesake stores. For it to achieve a comparable multiple to its peers, though, it will need to achieve reasonably comparable results. Right now, that doesn't appear to be happening.

Today's announcement of J.C. Penney's strategic initiatives indicate that management is trying to address the problems plaguing the company. From an investment standpoint, however, potential investors need to ask how confident they are that these changes will ultimately revive performance in company stores. While Eckerd's results simply need some spiffing up, the department stores -- the major contributor to earnings -- need a full makeover. If you believe management will turn around operations, the stock could be appealing right now. If you aren't sure how the ship will be turned around, holding off for clearer signs of rejuvenation may be more prudent.

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