<THE EVENING NEWS>
Monday, June 21, 1999
DJIA 10815.98 -39.58 (-0.36%) S&P 500 1349.00 +6.16 (+0.46%) Nasdaq 2630.28 +66.84 (+2.61%) Russell 2000 449.44 +4.39 (+0.99%) 30-Year Bond 89 12/32 -19/32 6.02 Yield
While considerable investor attention has been paid to corrective laser eye treatment companies like VISX Inc. (Nasdaq: VISX), shares of which have more than tripled in 1999, there's more than one way to cure a cornea. Hoping investors can see this is non-laser vision correction products maker KeraVision Inc. (Nasdaq: KERA). KeraVision stock was down more than 30% this year before today's news that its first product -- Intacs, a non-laser nearsightedness treatment in which two thin half-circles of polymer traditionally used in cataract surgery are inserted into the periphery of the cornea -- appears to be winning market approval. KeraVision stock cleared up $2 7/16 to $11 7/16 as it said it expects to beat analysts' Q2 revenue projections by "at least 50%." The company said surgeon training for Intacs treatments is "well ahead" of schedule, with enrollment in its training schedules booked through August. Since the FDA made Intacs the first approved non-laser myopia treatment in April, 187 surgeons have been trained in the process. The goal was to train 200 by year-end.
Shares of electronic communications products maker Brooktrout Technology (Nasdaq: BRKT) swam up $1 1/2 to $16 5/16 after its high-speed data communications subsidiary Interspeed filed with the SEC for an IPO. Interspeed, formed in 1997, targets Internet service providers and telephone companies with its products, which integrate all of the components required for digital subscriber line (DSL) service into one package as a lower-cost high-speed data access platform. Investors pushing Brooktrout's shares up today might be as optimistic about the prospects of a new offering as relieved to get a good portion of Interspeed off their company's books: the company has lost some $8.8 million since inception, including $3.4 million for the first six months of fiscal 1999 (although those same six months also mark the first period in which the company reported revenues). More losses are expected. The company didn't discuss offer size or price in its filing, although it set an estimated maximum value of $50 million for the purpose of calculating a registration fee for the SEC. The new company is expected to trade on the Nasdaq under the ticker "ISPD."
QUICK TAKES: Mobile data networking technology company Metricom Inc. (Nasdaq: MCOM) added $4 13/16 to $15 7/8 after announcing that MCI WorldCom (Nasdaq: WCOM) and Paul Allen investment vehicle Vulcan Ventures each made $300 million investments in the company to fund the rollout of its Ricochet 128 Kbps mobile data service... Internet platform-enabling software company Phoenix Technologies (Nasdaq: PTEC) rose $4 3/8 to $16 1/16 after it said it will create ebetween, a link between Internet service and content providers. Japan's Softbank will own 20% of ebetween... PC direct seller Dell Computer (Nasdaq: DELL) moved up $2 1/4 to $38 15/16 as Chairman and CEO Michael Dell told this week's Barron's magazine the PC "remains the preferred way to get access to information, and it is going to be at the core of the computing world for years to come."
Boston-based bank holding company UST Corp. (Nasdaq: USTB) grabbed $6 to $30 1/4 after it announced it will be acquired by Citizens Financial Group, a New England-based financial services group owned by the Royal Bank of Scotland, for $1.4 billion, or $32 per share, in cash, a nearly 31% premium to Friday's closing price for UST shares... General Instrument (NYSE: GIC), the nation's largest maker of cable-TV set-top boxes, plugged in $2 3/8 to $43 11/16. The company acquired an 8% stake in Dynamic Digital Depth Inc. for $3 million Canadian... Canadian forest products company MacMillan Bloedel (Nasdaq: MMBL) grew $3 3/8 to $17 13/16 after Weyerhaeuser Co. (NYSE: WY) agreed to buy the company in a stock swap valued at $2.45 billion based on Friday's closing prices. The deal values MacMillan at about $19.53 per share, a 35% premium to last week's final tally.
Data network company Equant (NYSE: ENT), which will be added to the bellwether CAC-40 market index on the Paris Stock Exchange July 19, closed up $6 1/2 to $95... Marketing software developer Exchange Applications (Nasdaq: EXAP) bagged $4 to $27 after consulting company Ernst & Young chose its VALEX product as its recommended campaign management application... Online brokerage E*Trade (Nasdaq: EGRP) earned $5 11/16 to $40 11/16 after announcing a deal with AT&T (NYSE: T) that will give people who open a new account with E*Trade six free months of "Yahoo! (Nasdaq: YHOO) Online Powered By AT&T WorldNet Service," which combines content with Internet access... Internet software provider Vignette Corp. (Nasdaq: VIGN) loaded up $8 3/8 to $56 3/4 after announcing software integrator and leading enterprise software provider debis Systemhaus will offer Vignette products to its customers in Europe.
Canadian newsprint and value-added papers manufacturer Abitibi-Consolidated Inc. (NYSE: ABY) rolled up $1 to $11 7/8. The company said it closed its West Tacoma, Wash., plant because of "market conditions"... Red chip minibus manufacturer Brilliance China Automotive Holdings (NYSE: CBA) shone today, adding $7/8 to $15 3/8 on news that it approved a 3-for-2 stock split effective July 12... Print and digital information management firm World Color Press (NYSE: WRC) brightened $2 1/16 to $26 5/8 after the company said it closed the purchase of privately held Metroweb Corp... Free e-mail and paid Internet access provider Juno Online Services (Nasdaq: JWEB) advanced $3 1/16 to $14 1/8 after PaineWebber started coverage of the stock with a "buy" rating.
Recycled plastic lumber company U.S. Plastic Lumber (Nasdaq: USPL) improved $1 3/8 to $8 15/16. The company told Investor's Business Daily it is looking for an acquisition to add raw materials... Online brokerage DLJ Direct (NYSE: DIR) grabbed $2 11/16 to $31 1/4 after Merrill Lynch started coverage of the company with near-term and long-term "accumulate" ratings... Brokerage Lehman Brothers (NYSE: LEH) deposited $4 1/4 to $60 5/16 in advance of the company's second-quarter earnings report. First Call's consensus estimate is $1.68... Online financial brokerage company Internet Financial Services (Nasdaq: IFSX) ran ahead $2 to $14 1/8 after naming Nikko Securities CFO Joseph Ramos its CFO... Semiconductor technologies licensor MIPS Technologies (Nasdaq: MIPS) sped up $5 1/2 to $38 1/2 after Chartered Semiconductor Manufacturing signed on to give system-on-a-chip makers access to MIPS' processor cores.
Voice, video, and data hardware and software systems provider ADC Telecommunications (Nasdaq: ADCT) slumped $3 to $47 1/8 after agreeing to buy Irish telecom billing and customer service software provider Saville Systems PLC (Nasdaq: SAVLY) for about $700 million in stock, or $17.94 per share. The purchase price represents a 15% premium to Saville's closing price of $15 5/8 per share on Friday, but the company fell $1/2 anyway to $15 1/8. ADC is picking up Saville for about 4.2 times fiscal 1998 revenues and 26 times 1998 earnings -- a fair shake for a company that has grown revenues at a 46% compounded annual rate and earnings at a 33% compounded rate over the past three years. However, Saville also comes with the baggage of a poor Q1, when it lost $0.08 per share. Saville shareholders, on the other hand, may have had their fingers crossed for a higher profile telecom partner than ADC, considering customer care and billing leader Kenan Systems was gobbled up by Lucent (NYSE: LU) earlier this year.
Natural gas pipeline company KN Energy (NYSE: KNE) leaked $5 5/16 to $12 13/16 after agreeing to call off its proposed acquisition by gas and electric company Sempra Energy (NYSE: SRE) after the firms realized that they would not be able to achieve "the business objectives that they originally anticipated" by combining. Perhaps not totally unrelated to the break-up was KN's simultaneous announcement that warm weather will lead to a Q2 loss between $0.20 and $0.25 per share, missing the First Call mean earnings estimate of $0.16 per share. For the year, the firm is forecasting breakeven or possibly EPS of $0.10, well below expectations of $1.07. While Sempra said it will look for other possible strategic alliances, KN may attract other buyers as the gas transmission business consolidates. Looking past the earnings problems, KN still has significant pipeline assets in the Central and Western U.S. Also enticing is its share price, which is now 33% below where it was when the Sempra deal was announced in February.
QUICK CUTS: Drug distributor and healthcare information technology systems provider McKesson HBOC (NYSE: MCK) fell $2 5/16 to $33 3/4 after it dismissed chairman Charles McCall and accepted the resignations of president and CEO Mark Pulido and CFO Richard Hawkins. All three former executives will be replaced by current managers promoted from within the organization. The company also said it is "unlikely" that it will file its 10-K annual report with the SEC by June 30... Several aluminum producers dropped today after Bloomberg News reported that an Alcan executive said he does not see aluminum prices increasing at all over the next two years. Alcan (NYSE: AL) dropped $2 1/16 to $31 1/2, Alcoa (NYSE: AA) slid $4 3/16 to $63 3/8, and Reynolds Metals (NYSE: RLM) sank $3 3/8 to $57 3/8.
Pegasus Communications Corp. (Nasdaq: PGTV), which markets digital broadcast satellite (DBS) systems in rural areas, dropped $3 7/16 to $43 13/16 after Barron's took a shot at the company, rehashing fears about its near-term prospects that intensified two weeks ago when the National Rural Telecommunications Cooperative sued DirecTV owner Hughes Electronics (NYSE: GMH)... Specialty packaging and tissue company Chesapeake Corp. (NYSE: CSK) was knocked down $3 to $34 after saying a "short-term margin squeeze" in its North American packaging business will lead to Q2 earnings 10% to 20% below the $0.51 per share the company said analysts had been expecting... GoTo.com (Nasdaq: GOTO), whose Web search service connects users with advertisers based on the keywords they search for, gave back $1 to $21 3/8 after jumping 49% on its first day of trading Friday.
Carbonated beverage giant Coca-Cola (NYSE: KO) went flat and fell $1 7/8 to $61 9/16 after Goldman Sachs cut the firm's Q2 earnings estimate by a penny to $0.40 per share due to a week-long Coke products health scare in Europe. The fiscal 1999 estimate was also lowered to $1.39 per share from $1.40 per share... Midway Airlines (Nasdaq: MDWY) descended $1/2 to $9 13/16 after Morgan Stanley Dean Witter cut its rating on the regional air carrier to "neutral" from "outperform"... Industrial products direct marketer MSC Industrial Direct Co. (NYSE: MSM) lost another $1 1/16 to $10 1/16 after dropping 32% on a fiscal Q3 profit warning Friday.
Atlanta-based bank and thrift holding company Premier Bancshares (NYSE: PMB) dropped $2 1/2 to $17 3/8 after warning that higher expenses and lower commercial and mortgage banking profitability will result in Q2 EPS between $0.14 and $0.16, missing the First Call mean estimate of $0.26... OmniQuip International (Nasdaq: OMQP) was handed a $3/8 loss to $8 1/8 after saying lower sales at its Snorkel aerial work platform unit will result in lower-than-expected fiscal Q3 sales and EPS between $0.12 and $0.15, short of the Zacks mean estimate of $0.44. Snorkel's president has resigned and about 25% of the unit's workforce will be eliminated, the company said.
Thinking about ROA
Ask the average investor how Return on Assets (ROA) is calculated and he or she will probably give you the following equation:
Net Income ROA = ------------- Total Assets
While the above equation is absolutely correct, there is another way of arriving at ROA that is very insightful to both investors and managers. It involves using two seemingly dissimilar efficiency metrics that often get overlooked. The alternative route to ROA is the following:
Return on Assets = Asset Turnover X Net Margins
Break the two halves of the above equation down mathematically a bit further and we see why this works. Asset turnover is defined as trailing sales divided by total assets, and net margin is defined as net income divided by sales. The "sales" cancel each other out from the two fractions and we are left with our original equation of ROA equaling income divided by assets.
ROA = Sales Net Income ---------- X ------------- Total Assets Sales
What's the point here? Stick with me, this is more than just a boring math exercise. The point is that many investors seem to have it ingrained in their heads that "low margin businesses are bad." The common thought is that the higher margins a company can achieve, the better. However, looking at margins in solitude without looking at how efficiently a company uses its assets is practically useless.
The above equations should tell you that a low-margin business turning its assets over very frequently can be just as successful as a high margin business that lumbers with its assets. It's a bimodal equation, and having a company efficiently using its assets is equally as important as achieving high margins. Having high margins doesn't do you much good if you can't get sufficient sales volume. Likewise, having high revenue doesn't mean a whole lot if the profit margin is not there.
Plotting both asset turnover and net margin on a simple four-quadrant chart, the desirability and efficiency in regard to ROA might look something like this:
Asset Turnover High Low M A High Best Good R (Dell) (Microsoft) G I Low Good Poor N (Wal-Mart) (Bethlehem Steel)
In picking out high-profile companies that fit the above model, Dell (Nasdaq: DELL) was the best "best" I could come up with. Dell has net margins of 8.0% (versus about 5.4% for the rest of the market) and asset turnover of 3.3 times (versus 0.5 times for the average public company). The company is in the "best" category, but more accurately plotted it would probably be somewhere in the middle between Microsoft and Wal-Mart.
Microsoft (Nasdaq: MSFT) has margins to die for, 40.3% net, but it only managed to turn its assets over 0.6 times in the last twelve months. Back before Microsoft had more cash than what it knew what to do with, it was well into the "Best" category of ROA heaven. This was obviously a boon to the company's shareholders and among the factors that made Bill Gates as insanely wealthy as he is. For reference sake, Microsoft now has $21.5 billion in cash on the asset side of its balance sheet. This means roughly 65% of the company's assets are tied up in cash, which is a major drag on the company's ROA and why it has shifted right on the above chart. (Yo, Bill! Think about buying some more shares back!)
And then there's Wal-Mart (NYSE: WMT) sitting there in the lower left quadrant of the above chart. The company has margins of a mere 3.3% but turned its assets over 2.9 times in the last year. Best Buy (NYSE: BBY) has also gotten on the efficiency bandwagon and turned its assets 4.4 times even while margins were a comparatively thin 2.4%. Just like there is more than one way to skin a cat, it should hopefully be apparent that there is more than one way companies can get a return on their investment.
In other words, it's not really prudent to dismiss companies with low margins without first seeing how they use their assets, too. This is especially relevant for those interested in the emerging e-commerce explosion. Many companies operating solely on the Internet may be operating with relatively low gross and net margins, yet they are not hobbled with billions worth of assets tied up in bricks, mortar, and inventory. Amazon (Nasdaq: AMZN) instantly comes to mind as do numerous other e-commerce companies as examples of firms that are taking the low-margin, high-turnover approach to, hopefully, eventual profitability. (For more on this thought, check this out.)
Thinking about ROA in this different way may also help explain why eBay (Nasdaq: EBAY) has been bid to nosebleed levels. EBay already has extremely high margins for such a young company, 84.9% gross and 17.4% net in the most recent quarter. Plus, the company has an extreme amount of leverage at its disposal to increase its top line, technical embarrassments aside. Without adding a dime to its nonexistent inventory and investing minimal amounts in its physical operations, the company has the ability to exponentially grow sales. Over the past year eBay has managed to grow its sales at triple the rate that its property, plant, and equipment has grown. Smell those asset turns kicking into turbo?
Rewind ten years and try to think about a company that had the types of massive operating leverage eBay and many other "new era" companies enjoy today. Can't think of one? Me neither. (Except for maybe Microsoft, maybe.)
It's also worth noting that one can substitute "invested capital" in the above figures and equations to calculate a more meaningful and important ratio than ROA, Return on Invested Capital (ROIC). While an extremely important number for companies and investors alike, figuring out exactly how much "invested capital" a company has is not so cut and dried. Some assets, such as goodwill, are obviously accounting relics and not invested capital, but exactly how to back out other numbers such as "excess cash" is not so clear. Get ten analysts in a room, ask them to calculate a given company's invested capital, and you are likely to get ten different answers with none of them being incorrect.
Regardless, the above equations work equally well when thinking about ROA and ROIC, even if ROIC varies a bit from one person's analysis to the other. The point of this whole exercise in math is to help both investors and business managers think better about what strategies different businesses may use to generate shareholder value.
If there's one take-home message in this whole column it is the following: Margins are important, but to get the true efficiency of a company margins must be taken in the context of how often a company can turn its capital. It's not one metric or the other that matters, but both.
-- How to Value Stocks (Fool's School)
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David Marino-Nachison (TMF Braden), a new Fool