<THE EVENING NEWS>
Friday, July 2, 1999
DJIA 11139.24 +72.82 (+0.66%) S&P 500 1391.22 +10.26 (+0.74%) Nasdaq 2741.02 +34.84 (+1.29%) Russell 2000 456.51 +2.09 (+0.46%) 30-Year Bond 89 22/32 +3/32 6.00 Yield
Media streaming technologies developer RealNetworks (Nasdaq: RNWK) added another $12 1/16 to $89 15/16 after rising 13% yesterday on news that it will make its latest RealAudio format compatible with Microsoft's (Nasdaq: MSFT) WebTV products. The company also agreed to develop a new RealPlayer G2 for the software company's Windows CE operating system platform for personal digital assistants (PDA) and other devices, including future cable set-top boxes. The deal is having an outsized impact on RealNetworks' market value because it signals a possible detente between the two companies after a falling out last year. While some observers figure the Redmond, Washington software giant is capitulating to RealNetworks roughly 85% market share lead in the streaming media player market, there is some speculation that Microsoft is making an early strategic concession to ward off any future antitrust fears as it focuses its sights on the broadband cable-based Internet delivery area.
Shares of pineapple, resort, and property company Maui Land & Pineapple Co. (AMEX: MLP) were acting fruity today, jumping $4 11/16 to $19 7/8 after the company said Stephen M. Case (yes, THAT Stephen M. Case) has agreed to acquire 41.2% of the company's outstanding shares from the Harry Weinberg Family Foundation and other parties. The company said Case wants to own the shares, which were valued at about $45 million based on yesterday's close, as "a long-term investment." Most folks would say Case has a better-than-average record for making good investments and hanging onto them, judging from his stake in a little company he co-founded and still runs called America Online (NYSE: AOL). Will Pineapple.com replace Apple Computer (Nasdaq: AAPL) on the top rung of orchard success stories? Perhaps. Then again, maybe Case is just a little nostalgic about the island state that served as his birthplace 41 years ago.
QUICK TAKES: Online advertising services firm 24/7 Media (Nasdaq: TFSM) marched up $3 1/16 to $3 1/16 after saying it has booked $13 million in revenues for its 24/7 Direct direct marketing product in the two months since the product's launch, adding customers such as Dell Computer (Nasdaq: DELL), Amazon.com (Nasdaq: AMZN), and Walt Disney (NYSE: DIS)... American Airlines parent AMR Corp. (NYSE: AMR) ascended $2 7/8 to $72 9/16 after reporting that its June systemwide load factor increased 0.1 points to 73.8% compared to last year, even though air traffic controller problems led to delays and cancellations during the month... Online broker National Discount Brokers (NYSE: NDB) traded up $4 5/16 to $59 13/16 after receiving a favorable write-up in the "Heard on the Street" column in today's Wall Street Journal.
Commercial refrigeration and ice-making equipment maker Scotsman Industries (NYSE: SCT) jumped $10 13/16 to $32 5/8 after agreeing to be acquired by British kitchen furniture and cooking equipment company Berisford PLC for $33 per share in cash, or $712 million including $348 million in assumed debt. The price represents a 51% premium to Scotsman's closing price of $21 13/16 per share yesterday... Component and supply management software company Aspect Development (Nasdaq: ASDV) picked up $3 1/2 to $23 1/8 thanks to a Credit Suisse First Boston upgrade to "buy" from "hold"... Wireless communications services provider Western Wireless (Nasdaq: WWCA) rose $2 15/16 to $32 1/2, adding to yesterday's 9.5% gain, on rumors it may be acquired by telecommunications giant AT&T (NYSE: T).
Wireless communications company Digital Microwave (Nasdaq: DMIC) climbed $1 1/2 to $13 3/4 after receiving $10.4 million in orders for its digital microwave radios from China United Telecommunications Corp., which will use the products to expand its global system for mobile communications (GSM) network in China... GoTo.com (Nasdaq: GOTO), whose Web search service connects users with advertisers based on the keywords they search for, moved up $14 to $50 1/2 after signing an agreement to become the leading search provider for America Online's (NYSE: AOL) Netscape NetSearch program... Online credit card issuer NextCard (Nasdaq: NXCD) rose $3 15/16 to $37 after First Union Capital markets started coverage of the company with a "buy" rating and a 12-month price target of $60 per share.
Scalable Internet protocol (IP) phone products maker Clarent Corp. (Nasdaq: CLRN) gained another $13 3/16 to $38 11/16 after rising 70% yesterday in its first day of trading following its initial public offering of 4 million shares at a price of $15 per share. Fellow Thursday IPO left-over Ask Jeeves (Nasdaq: ASKJ) advanced another $7 1/16 to $72... Swiss Army Brands (Nasdaq: SABI), which markets Swiss army knives and gear in North America, carved out a $2 5/16 gain to $11 7/16 after Business Week's "Inside Wall Street" column speculated that a U.S. investment group may sell its 24.3% stake in the company to Swiss Army Brands' largest shareholder, Switzerland's Victorinox, at a price as high as $15 per share... Server management and console switching technology company Apex Inc. (Nasdaq: APEX) rose $1 3/4 to $21 7/8 on news it will take Orange and Rockland Utilities' (NYSE: ORU) place in the S&P SmallCap 600 index.
Internet retailer and auctioneer Onsale Inc. (Nasdaq: ONSL) rose $6 5/8 to $25 1/4 on speculation it may be acquired by retailer Amazon.com (Nasdaq: AMZN). An auction site at SellMeDownTheRiver.com would no doubt follow... Contract electronic manufacturing services (EMS) firm Benchmark Electronics (NYSE: BHE) moved up $3 5/16 to $37 5/8 after agreeing to acquire fellow EMS company AVEX Electronics for $255 million in cash and 1 million Benchmark shares... Thin film disk drive lead wire assemblies maker Innovex (Nasdaq: INVX) gained $7/8 to $14 3/8 after agreeing to acquire flexible circuit-based interconnects firm ADFlex Solutions (Nasdaq: AFLX) for $34.1 million or $3.80 per share in cash, an 11% discount to ADFlex's closing price of $4 9/32 per share yesterday.
Premiere gaming company Mirage Resorts (NYSE: MIR) blurred $1 1/2 to $15 1/4 after last night announcing that it expects second-quarter earnings per share to fall between $0.07 and $0.10, well below market estimates of $0.23. According to the company, about $0.06 of the shortfall is attributable to plain old bad luck at the casino, a factor that generally works itself out over time. Most worrisome may be the emergence of two major competitors in the key Las Vegas market. Historically, major casino projects in Las Vegas have been successful. Mirage was the first entry in the mega-resort race, introducing the 3,000-room, $1.8 billion Bellagio last October. But with thousands more new rooms opening or set to open soon -- 6,000 additional rooms have opened up at Mandalay Resort Group's (NYSE: MBG) Mandalay Bay and the Las Vegas Sand's Venetian, and Park Place Entertainment's (NYSE: PPE) 3,000-room Paris is scheduled for completion later this year -- it remains to be seen whether the superclass of Vegas resorts will eventually succeed in the face of competition and, potentially, oversupply. For more on this, head back to today's Fool Plate Special.
Investors were quick to scribble "sell" in their pocket planners today, sending shares of calendar and organizer maker Day Runner Inc. (Nasdaq: DAYR) down $2 5/8 to $10 following last night's warning that it expects to report a fiscal fourth-quarter loss of between $0.14 and $0.18 per share for the period ended June 30. Four analysts surveyed by IBES were looking for a dime's profit. The former Foolish Trouble has for some time lamented a move toward greater manufacturer responsibility for inventory -- which has cut sales to the company's largest domestic accounts, boosted product returns, and cut profits -- and while Day Runner said early back-to-school sales have been encouraging, the inventory tightening has hurt results more than expected. Despite signs of improvement, however, the company is looking at outside options: Day Runner brought in Wasserstein Perella & Co., which it hired for last fall's purchase of England's Filofax Group, to examine possibilities ranging from the solicitation of new investors to an outright sale.
QUICK CUTS: Software components and tools maker Rogue Wave Software (Nasdaq: RWAV) dropped $1 7/8 to $7 3/8 after last night reporting preliminary fiscal Q3 EPS of $0.04, well off IBES' two-analyst consensus estimate of $0.13... Yearbooks, class rings, and school photography company Jostens Inc. (NYSE: JOS) dulled $1 9/16 to $20 7/16 after saying full-year 1999 EPS may fall below analysts' current expectations of $1.60 to $1.67 and come in between $1.55 and $1.65 a share... Promotional products distributor and telemarketing services company HA-LO Industries (NYSE: HMK) shed $3 13/16 to $6 1/16 after saying it expects Q2 EPS of $0.02, missing Wall Street's $0.17 consensus estimate.
Floral importer and wholesale distributor U.S.A. Floral Products (Nasdaq: ROSI) wilted $1 to $6 9/16 after saying it expects to miss First Call's $0.26 consensus earnings projection for Q2 with EPS of between $0.10 and $0.15. The company attributed the expected shortfall to pricing pressure caused by global oversupply... Finnish paper industry equipment marker Valmet-Rauma Corp. (NYSE: MX) dumped $10 3/4 to $12 3/4 following reports in a Helsinki newspaper that the company was considering a cost-cutting measure that could mean the cutting of 2,000 jobs... 3D graphics hardware and software developer Evans & Sutherland Computer (Nasdaq: ESCC) gave up $1 5/8 to $12 3/8 following news that it expects to report a Q2 loss of between $0.35 and $0.40 per share.
Metrology products maker Brown & Sharpe Manufacturing (NYSE: BNS) lost $1 to $4 1/4 on news that it expects Q2 EPS to be "substantially less" than the year-ago $0.22 mark. One analyst had already given IBES a $0.14 estimate. The company also said a restructuring will put it in default under its loan covenants... Specialty inorganic chemical company TETRA Technologies (NYSE: TTI), which directed investors toward a loss for the quarter -- two analysts told IBES they were looking for a $0.14 profit -- gave away $3/4 to $8 1/2. The company also sold its waste and potable water treatment business for about $39 million... Medical testing, information, and services company Quest Diagnostics Inc. (NYSE: DGX), which said its acquisition of pharmaceutical company SmithKline Beecham's (NYSE: SBH) clinical laboratory operations has been delayed, lost $3 3/16 to $24.
Banking and equipment lending company Eldorado Bancshares Inc. (Nasdaq: ELBI) lost $7/8 to $10 1/8 on news that residential mortgage volumes since April are approximately 50% below plan, forcing cost-cutting initiatives. Mortgage division head William Rast resigned, to be replaced by mortgage banking consultant Dennis Meroney... Pharmaceutical marketing services provider Access Worldwide Communications (Nasdaq: AWWC) spilled $1 3/16 to $4 3/8 after saying it expects a "modest loss" for the quarter. Two analysts surveyed by First Call were expecting an $0.11 per share profit... Secure online transactions technologies developer and marketer Internet Commerce Corp. (Nasdaq: ICCSA), which named former Philips (NYSE; PHG) information technology CEO Dr. Geoffrey Scott Carroll as its president and CEO, moved down $1 1/8 to $11 1/2.
Enterprise software firm Computer Associates (NYSE: CA) slumped $1 1/8 to $53 after the company revealed in an SEC filing that it replaced Ernst & Young as its principal accountant. The company did not report any disagreements with Ernst & Young... Satellite communications earth station products company Vertex Communications (NYSE: VTX) descended $1 3/4 to $12 after Chairman and CEO Rex Vardeman said Vertex "continues to experience difficulty in achieving this fiscal year's targets for revenue and earnings. We expect a continued deterioration of orders and earnings in the second half"... Scented candle maker Yankee Candle Co. (NYSE: YCC), which wafted up $6 1/8 yesterday in its first day of trading after selling 12.5 million shares at $18 apiece, returned $2 5/16 to $21 13/16 today.
Books-A-Million (Nasdaq: BAMM) returned $2 1 /8 to $11 3/4 after snaring $6 11/32 yesterday on news of a partnership with mega-retailer Wal-Mart (NYSE: WMT) whereby the bookseller will become the exclusive provider of books and related products to Wal-Mart's Internet customers... Manufactured homes maker and marketer Cavalier Homes (NYSE: CAV) retreated $1 7/16 to $6 7/8 after Southwest Securities downgraded the stock to "neutral" from "buy"... Doors, windows, and millwork distributor Crane Co. (NYSE: CR) was lowered $2 7/16 to $29 1/8 after Donaldson, Lufkin & Jenrette downgraded the stock to "market perform" from "buy"... The brokerage made the same change to the stock of Intermet Corp. (Nasdaq: INMT), which makes iron and aluminum cast components for automotive and industrial equipment manufacturers, and the shares lost $1 11/16 to end at $13 1/16.
On Investor Expectations
Shareholders in Starbucks (Nasdaq: SBUX) probably still have a headache from yesterday's burn. As you are probably aware, the company announced its long-awaited Internet portal strategy along with the shocking news that earnings estimates for the upcoming two quarters were going to fall 17% below expectations. Was that an overreaction? Is Starbucks now the buy of the month? That depends on your expectations about the future of the company.
I'm not going to be talking that much about the company's strategy. You can get perspectives on that from our message boards or last night's Fool on the Hill column. Instead, I'm going to attempt to provide a financial framework trying to explain part of reason the stock fell so substantially.
Some people reading this article might be wondering, "What? Where did you pull out that 17% number? Didn't Starbucks only reduce earnings expectations by 10% to $0.54 from $0.60?" That's true for the year. But Starbucks' year ends in September. They have already announced results for the first two quarters of that period. The warning only applied to the third and fourth quarter. Prior to the warning, estimates for that period were $0.36. Now, the company is estimating $0.30, a 17% drop. Be sure not to let the "company spin," a 10% drop in estimates for the year, overshadow the reality, a 17% drop in estimates over two quarters.
(It should be noted, in the spirit of full disclosure, that analysts reduced their estimates for the first two quarters of fiscal 2000 by 10%, reducing overall estimates over the next 12 months by 13% to $0.60 from $0.69. History shows, however, that management teams and analysts are often too optimistic about the impact of a performance slowdown on future quarters. Management expects to address problems with a "quick-fix," when the underlying problems are usually more serious. This is the reason that one piece of bad news is often followed by more in future quarters -- consider Gillette (NYSE: G) a textbook example.)
While the drop in earnings estimates for the current year is important, more important is the expectation about future growth. On Wednesday, analysts were expecting the company to post a long-term growth rate of 30%. Today, that estimate has been lowered just a tad to 27%. A seemingly small difference to be sure, but one that ripples through expectations about future profits, as you will see below.
(Estimates for 2004 and 2009 calculated using estimated long-term growth rates.)
Earnings Per Share Estimates Wednesday Today Difference 1999 $0.60 $0.54 -10% 2000 $0.79 $0.70 -11% 2001 $1.02 $0.85 -17% 2004 $2.24 $1.74 -22% 2009 $8.32 $5.75 -31%
The reduction in profit estimates, on a percentage basis, increases over time as the compounding of growth takes its toll. As all investors should know, compounding is an extremely powerful force. Using modest growth rates of 10% (below the long-term historical average for stocks), compounding helps turn $10,000 into $453,000 over 40 years. On the downside, compounding has an equally powerful, but negative impact when future growth rates are reduced. This downside is clearly demonstrated in that a 10% cut in current year earnings projections and a 3 percentage point reduction in growth rate expectations yields 31% shrinkage in a projected 10-year earnings estimate. In that light, the 28% decline in the stock price yesterday doesn't really seem out of whack.
Of course, analysts estimates about earnings and future growth rates are just that -- estimates. What really happens will depend on management moves, the market environment, and the overall economy. Predicting what will happen next year can be tough enough for most people, much less what will happen five, ten, and twenty years from now. The challenges with prognostication create the need for investors to closely evaluate a company's historical performance and management's ability to deliver promised results when considering future growth rates.
Prior to Wednesday, many investors had a high level of confidence that Starbucks would achieve 30% earnings growth. Because of those expectations, they were willing to pay much more for a dollar of Starbucks earnings than for the market at large. In fact, at Wednesday's close, Starbucks was trading at 37x estimates for 2001, which compared to a 28x multiple on 1999 estimates for the Standard & Poors 500 index. Even taking expectations out two years because of its stellar track record, Starbucks' projected earnings were valued more highly than current earnings from the average S&P 500 company.
Using today's closing price, the stock market is indicating a less rosy view towards Starbucks' future. The company is now only trading at 32x the reduced estimates for 2001. That's still well above the multiple of the average S&P 500 company, but noticeably less than the number two days ago. This data reinforces what common sense would suggest: people still believe Starbucks will grow faster than the overall market, but not nearly as much as previously anticipated.
A former boss told me that the biggest rewards an investor earns come from correct, non-consensus views. In other words, your greatest profits will come when you make an investment decision based on a correct evaluation you make that other people in the market don't anticipate. One of the best examples that pops into my mind to demonstrate the validity of this statement is David Gardner's decision to buy America Online (NYSE: AOL) for the Rule Breaker portfolio in 1994, when others thought the Internet was a fad that would quickly pass. That holding is now up over 12,000% in less than five years.
Do you believe Starbucks will be able to post 30%+ earnings growth over the upcoming years? If so, it would seem like the stock might be attractive now that market expectations are lower than that. If you think earnings growth will slow down below 20%-25%, you probably don't want to get close to the stock. Starbucks' stock appears to be trading in a reasonable range if you expect the company to post growth somewhere between those figures. Your decision to invest in this case should rest primarily on how much you believe and want to invest in Howard Schultz's vision for the future.
The news from Starbucks this week did provide a healthy warning to investors. It was a not-so-subtle reminder of the value in keeping abreast of your expectations for a company relative to what the market overall expects. If you bought Starbucks expecting 20%-25% growth, maybe it would have been worthwhile to take some money off the table when expectations started to exceed 30%. While it is preferable to buy and hold a stock forever, you might want to consider taking some of your money off the table if market expectations rise to levels you deem unachievable. From the opposite perspective, you need to be aware when market expectations fall below your own. Those situations may present excellent opportunities for investment.
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