Thursday, May 20, 1999
DJIA             10866.74   -20.65    (-0.19%)
S&P 500           1338.83    -5.40    (-0.40%) 
Nasdaq            2542.23   -35.17    (-1.36%) 
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30-Year Bond    91  28/32   -11/32   5.83 Yield


With just over a year having passed since Toro Co. (NYSE: TTC) announced a "profit improvement plan" aimed at smoothing out costs, it appears the lawnmower and snowblower maker's yard is looking pretty good. Toro stock bulled its way up $1 5/8 to $34 3/8 today after the company said to expect fiscal Q2 EPS of between $1.81 and $1.83, better than the $1.68 projected by Wall Street's analysts. CEO Kendrick Melrose said the plan is doing what it was supposed to do -- boost gross margins and trim expenses -- and said the company expects to continue making analysts look foolish by beating their current full-year EPS estimates by at least 10%, as sales have been strong in all of its units. Melrose was more cautious in a March prediction in which he was wary of the company's international exposure and its ability to get key components. If all goes as planned, investors are looking at year-over-year earnings growth of well over 200%, which would look pretty nice next to the azaleas.

In the latest wave of Internet mania, online toy retailer eToys (Nasdaq: ETYS) soared $56 9/16, or 283%, to $76 9/16 today after selling 8.2% of the company at $20 a share in its initial public offering (IPO). That gives eToys a market capitalization of $7.78 billion, $2 billion more than rival Toys 'R' Us' market cap of $5.65 billion. Reality check: In the fiscal year ended March 31, eToys had $30 million in sales and losses of around $28.6 million, while Toys 'R' Us in its year ended January 30 had sales of $11.2 billion and earnings of $376 million, before charges (it lost $132 million including one-time charges). To be sure, eToys could be the growth story of the decade. After all, it added 75,000 customers -- or 20.5% -- in the last quarter alone, and the new infusion of cash from the IPO should go a long ways in improving and promoting eToys' website. Still, investors should read the company's prospectus, which clearly says that the company expects operating losses and negative cash flow to continue for the "foreseeable future."

QUICK TAKES: Shares of online health information services firm Healtheon (Nasdaq: HLTH), the company set to merge with WebMD, continued their rapid rise today with a gain of $20 3/8 to $100 5/8. For more on the deal from today's Lunchtime News, click here... PC and computing products distributor Tech Data Corp. (Nasdaq: TECD) improved $4 15/16 to $39 3/8 after the company announced a technology outsourcing deal with General Electric's (NYSE: GE) GE Capital IT Solutions division. The three-year pact is expected to generate about $2 billion in annual incremental revenue for Tech Data when fully implemented... News integrator and provider NewsEdge Corp. (Nasdaq: NEWZ) moved up $7/8 to $9 1/2 on news that it is developing a system to filter news into Microsoft's (Nasdaq: MSFT) Outlook application through the Redmond giant's Exchange server.

U.K. banking group Barclays PLC (NYSE: BCS) rose $3 1/2 to $122 after it announced it will cut 6,000 jobs, 10% of its workforce in the U.K., this year as part of a restructuring program, which it expects will save the company �200 million ($322.12 million) a year starting next year... Consumer and commercial finance company ContiFinancial Corp. (NYSE: CFN) advanced $1 1/4 to $8 7/16 after it said it signed a written indication of acquisition interest from GM's (NYSE: GM) General Motors Acceptance Corp. Terms of the deal should be set within 30 days... Internet banker USABanc.com (Nasdaq: USAB) deposited gains of $1 3/8 to $15 after announcing a 2-for-1 stock split effective June 15.

Fibre channel and network access products maker Emulex Corp. (Nasdaq: EMLX) rose $12 1/4 to $75 1/2 after commencing a secondary offering of 2.1 million shares at $61 each, about a 4% discount to yesterday's closing price... Equity trading services and transaction research company Investment Technology Group (NYSE: ITG) took $6 9/16 to $39 1/8 after forming a partnership with Bloomberg to develop a new trading system... Electronics manufacturer Waters Instruments (Nasdaq: WTRS) accelerated $9/16 to $5 3/16 after inking a contract manufacturing agreement with "potential multimillion dollar" value with Winnebago Industries (NYSE: WGO). Winnebago stock drove ahead $3/4 to $16 7/8 today.

Natural gas-fired power plant developer Calpine Corp. (NYSE: CPN) was fueled up $3 1/8 to $57 5/16 after the company said it will break ground on a $275 million natural gas power plant in Arizona tomorrow... High-speed Internet connection company CAIS Internet (Nasdaq: CAIS) jumped $3 1/8 to $22 1/8 in its first day of trading after selling 6 million shares of company stock to the public at $19 each... Maintenance operations and facilities management software company Project Software & Development (Nasdaq: PSDI) got $3 1/4 to $26 7/8 after BancBoston Robertson Stephens raised its rating of the company to "buy" from "long-term attractive" because of its MRO.com business-to-business e-commerce unit.

Earnings Movers

American Eagle Outfitters (Nasdaq: AEOS) up $15/16 to $38 15/16; fiscal Q1 EPS $0.25 vs. $0.12 last year; estimate: $0.21

Circus Circus Enterprises (NYSE: CIR) up $3/8 to $24 3/8; fiscal Q1 EPS $0.43 vs. $0.23 last year; estimate: $0.40

Delco Remy International (NYSE: RMY) up $1 to $10 5/8; fiscal Q3 EPS $0.32 vs. $0.23 last year; estimate: $0.31

PETCO Animal Supplies Inc.
(Nasdaq: PETC) up $1 1/8 to $14; fiscal Q1 EPS $0.17 vs. loss of $0.05 last year; estimate: $0.14


Etec Systems (Nasdaq: ETEC) expanded on the bad news it issued in late March, painting a dreary picture for investors in the semiconductor manufacturing equipment company. The stock gave up $5 5/8 to $30 3/8 after CEO Steve Cooper said to expect a loss in fiscal Q4. Revenues for the quarter are expected to be in the upper $40 million range, well off last year's $88 million. Wall Street was looking for a $0.13 profit. Cooper further said losses could continue into Q1 of fiscal 2000. Fiscal Q3 losses were $0.29 per share, well off the IBES $0.10 profit estimate, and investors have reason to be troubled by a sharp drop-off in gross margins as lower equipment sales meant lower upgrade and accessory revenues. Etec also said installations for several systems took longer than expected, pushing those revenues out of the quarter -- a bad sign, since it suggests internal snafus are compounding the effects of an already difficult market environment. Etec may come to regret the job cuts it announced in March if it can't get work done on time as a result.

Specialty retailer Wet Seal (Nasdaq: WTSLA) flopped down $6 to $35 3/8 after announcing Q1 earnings of $0.34, 36% ahead of last year's results and $0.03 above expectations. Sales at the operator of Contempo Casuals, Wet Seal, and Arden B. increased 17% year-over-year, but same-store sales only moved up 2.9%. Competitors like Pacific Sunwear (Nasdaq: PSUN) and The Buckle (NYSE: BKE) reported higher comp-store sales, in the 7% range. Gross margins expanded to 29.2% from 28.6%, while operating margins in this seasonally weak period jumped to 5.3% from 4.3%. Wet Seal's quarter-end store count soared 17% from year-end as the company jumped into a bunch of shuttered Britches locations.

QUICK CUTS: Nuclear medical imaging systems maker Adac Laboratories (Nasdaq: ADAC) lost $1 3/8 to $8 3/16 after the company said it will delay the filing of its quarterly report; it's working on an evaluation it believes will have a material adverse effect on the company's financial performance... Coronary stent and medical devices maker Guidant (NYSE: GDT) retreated $1 15/16 to $48 1/16 today. Reports said rival Medtronic Inc. (NYSE: MDT) demonstrated its next-generation stent at a Paris conference that some believe could hurt Guidant's market share. Medtronic improved $1 9/16 to $69 1/16... Online retail giant Amazon.com (Nasdaq: AMZN) moved back $8 3/4 to $130 13/16 after filing to sell $2 billion in various types of securities "to gain additional flexibility in accessing the capital markets."

Digital subscriber line (DSL) services provider Covad Communications (Nasdaq: COVD) shed $6 7/16 to $56 1/2 on news that it filed to sell 7.5 million shares of company stock to the public. The company held its IPO in late January... Long-distance telecommunications company Viatel Inc. (Nasdaq: VYTL) shed $3 5/8 to $48 1/2 as it said it will sell 4.7 million shares of company stock to the public, a 20% boost to the current outstanding... Waste Management (NYSE: WMI) dumped $1 15/16 to $54 7/16. The company said it is selling $1.5 billion in senior notes in a debt offering to pay down other debts. CEO John Drury said that though his health prevents him from keeping a regular work schedule, he remains "in close contact with... senior executive officers."

Timeshare operator Silverleaf Resorts (NYSE: SVR) dulled $5/8 to $6 7/8 after announcing that full-year 1999 EPS is expected to be $1.60, well off First Call's $1.83 consensus estimate, as sales and marketing expenses move to around 49% instead of the approximately 46% analysts expect... Liberty Media (NYSE: LMG.A) subsidiary TCI Music (Nasdaq: TUNE) quieted down $2 1/16 to $46 15/16. TCI, which will be renamed Liberty Digital, announced an agreement to take a 10% stake in MTV's online music ventures. MTV is a division of Viacom Inc. (NYSE: VIA)... Web-based business and financial information provider OneSource Information Services (Nasdaq: ONES) lost $2 1/4 to $12 in its second day of trading. The company sold 3.6 million shares to the public yesterday at $12 each.

Personnel services firm ASI Solutions (Nasdaq: ASIS) gave up $3/4 to $8 3/4 after reporting fiscal Q4 EPS of $0.14, flat with the IBES estimate and a penny better than last year... Singapore-based Internet services provider Pacific Internet Ltd. (Nasdaq: PCNTF) lost $5 5/8 to $51 1/2 on news that it agreed to buy Australian Internet service provider Mira Networking. No terms were reported... Radio station operator and outdoor advertiser Chancellor Media Corp. (Nasdaq: AMFM) gave away $2 7/16 to $54 1/4 today. The company said it's changing its name to AMFM Inc. and will launch three Internet business units... Altera Corp. (Nasdaq: ALTR), a maker of programmable logic devices and associated computer aided engineering (CAE) logic development tools, lost $1 15/16 to $38 3/16 today. The stock split 2-for-1 after the market's close yesterday.

Earnings Movers

Photronics (Nasdaq: PLAB) down $1 3/8 to $24 1/8; fiscal Q2 EPS: $0.09 vs. $0.22 last year; estimate: $0.11

Stage Stores (NYSE: SGE) down $1 1/8 to $5 13/16; fiscal Q1 EPS loss of $0.08 vs. $0.32 gain last year; estimate: loss of $0.08

Venator Group (NYSE: Z) down $3/16 to $11 5/16; fiscal Q1 EPS loss of $0.08 vs. loss of $0.04 last year; estimate: loss of $0.09

An Investment Opinion
by Dale Wettlaufer

A View to a Sell

Talk about weird. Yesterday, I announced in the Boring Portfolio that we had decided to sell Cisco Systems (Nasdaq: CSCO) because I don't really understand the company as well as I would like. The emotional outpouring has been amazing to watch and it truly scares me. I haven't worried about the market in years, because thinking about the market as a whole isn't what I do with most of my time. Most of my time is spent on looking at individual companies and on figuring out what they're worth. To do that, you have to possess some quantitative faculty and know something about a company and an industry. The lack of specific knowledge about the industry and company that my detractors have exhibited is really beyond belief and I think it's probably a reflection of the level of knowledge of many people investing in these sorts of companies.

One of the biggest problems in securities analysis comes from anchoring on incorrect or irrelevant data and conclusions. For instance, a lot of people in the media have recently anchored on the belief that AOL is threatened because they don't own cable properties. That's anchoring on a somewhat irrelevant issue. AOL can run on top of any TCP/IP connection. AOL doesn't need to own the cable plant to get you into the community and charges you 55% less per month if you do not use the service as an access provider. The dynamics of a customer leaving or staying as a result of having cable access are not as simple as the headlines will have you believe.

Regarding Cisco, the dynamics of maintaining its competitive position are a lot more complex than just looking at its huge margins today and projecting that 15 years down the line. Most people don't even know what Cisco's margins are, anyway, since everyone looks through the writeoff of in-process R&D charges. It's totally unclear what the cost of maintaining the franchise is unless you engage in extensive revisions of the financial statements and have a good knowledge of the costs and benefits gained through the company's acquisitions. You don't get that from the outside.

Secondly, if you're listing the strengths of Cisco, you want to look at its unbelievable reputation for service. People at Cisco are given heavy incentives to make the customers happy. That's something I've found out through talking to the company's customers and that's a basic business attribute that you want to see in a company, whether it's a something like Frito-Lay, Home Depot, or a technology-intensive business. But what's totally blown me away is that less than one in ten people who have tried to tell me what an ass I am for selling the company have enumerated this among their reasons for how clueless I am on the company. That just blows me away. You don't get it if you don't understand this aspect of Cisco and name it as one of the top three reasons the company succeeds.

Third, if you're paying attention to what Cisco is talking about these days, they're talking about "the New World of integrated data, voice, and video communications." The company is not a gorilla in voice. The current access path for voice is through a Lucent switch. Combine Lucent's position there with Ascend's data access concentrator strengths, Lucent's obvious willingness to go out and use its equity to acquire other companies, and one of the most prolific research laboratories in the world, and you've got a pretty formidable contender to deal with. The reason why I would sell is very much due to this confrontation. The gorilla game doesn't reward second place very well. In a technology lock-down market, you either win or you come in a distant second place.

None of this is to say that Cisco won't win. This is just to say that I don't have a very clear picture of whether it will or not. I don't have much confidence in the hypothesis I've examined. Some people will tell you that's wrapped up by the company's Internet Operating System (IOS). Maybe so, but that points to the danger of entering into a new tornado and crossing a new chasm, to use the vocabulary of The Gorilla Game. What happens if the standards on the other side of the tornado aren't owned by Cisco? I believe I have zero confidence in my ability to answer that question and I also believe that most of the people that have taken time out of their busy days to flame me for my decision don't know any better than I.

If someone else wins the fight in the competition for owning the enabling technologies in the New World, and that's a necessarily technical question that is not answered by the fact that Cisco is a gorilla today, then the downside is unattractive in my calculation of the risk and reward of the situation. What are the probabilities of the situation? Let's say they are these:

Probability (first column) of 5-year return (second column):

5%... 1,050%
25%... 271%
25%... 76%
20%... 0%
20%... -25%
5%... -60%

Running the calculation using those numbers, the expected annual return over a five-year holding period is 12.7%. If we change the distribution to reflect higher probabilities of Cisco succeeding:

15%... 1050%
25%... 271%
40%... 76%
10%... 0%
5%... -25%
5%... -40%

Then the expected return is 26% per year. In the above scenario, there's a 15% chance the company will have a $1.8 trillion market cap in five years and a 40% chance it will have a market cap of nearly $600 billion and only a 20% chance it will be the same or smaller five years down the line.

What if we weight the possibility of the company losing the next gorilla game?

5%... 1050%
15%... 271%
25%... 76%
5%... 0%
25%... -25%
25%... -40%

The expected return falls to 6.3% per year.

You either have a clear thesis there or you don't. The middle of the road is kind of treacherous. Let's put it in these terms, though. For 16 years, I've been an owner of a company that manufactures printing blankets that go into the process of transferring images onto polyethylene containers. I could show you around the plant and teach you how the things are manufactured and converted, introduce you to some customers, and show you how the printing process works. Even if you took some time to read about the industry and I took an hour every 90 days to tell you what happened during the quarter, you still would not understand the business anywhere near as well as I or others in the industry do. And that's a slow-changing industry. If the pace of change in the industry were accelerated to Cisco's level, you would have little hope of ever gaining an understanding equal to mine, especially if I held back in discussions of what is going on in the industry and the company.

That's what I mean when I say I don't understand Cisco. I understand its current position fine. I don't have faith in my ability to forecast whether the company will dominate in the New World. Certainly, the rewards on the upside are great. But the rewards on the downside are unattractive. If you feel comfortable projecting Cisco's competitive position across the tornado and through the chasm, knock yourself out. But the decision to sell is a personal one that I don't think can be remedied by reading trade journals and knowing the exact growth rates of Cisco's target markets that are expected over the coming five years. With 38% of the portfolio invested in the company, I would be putting my eggs in a basket I know I can't watch all that well.


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