<THE EVENING NEWS>
Tuesday, July 20, 1999
DJIA 10996.13 -191.55 (-1.71%) S&P 500 1377.10 -30.55 (-2.17%) Nasdaq 2732.18 -98.11 (-3.47%) Russell 2000 453.55 -7.82 (-1.69%) 30-Year Bond 91 5/32 +6/32 5.88 Yield
Eager to break up the humdrum trading days of midsummer somewhat, Wall Street treated itself to an initial public offering fiesta today. Traders celebrated the 3.5-million share IPO of storage area networks (SAN) hubs and switches maker Gadzoox Networks (Nasdaq: ZOOX) like children diving for candy from a broken pi�ata, driving the company's share price up $53 13/16 to $74 13/16 per share from an initial price of $21 per share. Also getting in on the action was online ad targeting software maker Engage Technologies (Nasdaq: ENGA), which jumped $26 to $41 in after lunch-hour trading. Elsewhere, data and voice network services firm Convergent Communications (Nasdaq: CONV) danced up $6 1/2 to $21 1/2, online communities designer Talk City (Nasdaq: TCTY) jabbered up $1 11/16 to $13 11/16, and digital media operating system firm Be Inc. (Nasdaq: BEOS) boogied for a $2 1/16 gain to $8 1/16.
Online health information services firm Healtheon (Nasdaq: HLTH) advanced $4 1/16 to $63 1/8 after agreeing to develop an online prescription services pilot program for physicians with a high concentration of patients served by Merck's (NYSE: MRK) Merck-Medco pharmacy benefit management (PBM) unit. Under the deal, Healtheon will provide the software to physicians while Merck-Medco will provide the prescription application and physician sponsorships, allowing doctors to look at a patient's prescription history and drug coverage before writing a script (electronically, of course). The undisclosed payout Healtheon will eventually receive from the deal brightens the business outlook for the young firm, which is all of three years old. On the other hand, investors may also want to keep their eyes open for future online moves by Merck, which appears intent on making sure Merck-Medco will be top dog in the online-oriented PBM business of the future.
QUICK TAKES: Oil and natural gas exploration and production firm Enron Oil & Gas Co. (NYSE: EOG) moved up $11/16 to $20 7/16 after major shareholder Enron (NYSE: ENE) said it will exchange 62.27 million of its 82.27 million EOG shares for EOG's China and India operations and $600 million in cash. EOG expects the transaction will add to its cash flow per share "immediately"... Freight transportation company CNF Transportation (NYSE: CNF) rolled $2 1/2 higher to $41 3/4 after a Morgan Stanley Dean Witter upgrade to "strong buy" from "outperform"... Security software maker Check Point Software (Nasdaq: CHKP) locked up a $3 7/8 gain to $60 1/8 after posting Q2 EPS of $0.52, beating the First Call mean estimate of $0.50. BancBoston Robertson Stephens raised its rating on the firm to "buy" from "long-term attractive."
Online job recruiting services firm Webhire Inc. (Nasdaq: HIRE) gained $1 1/32 to $7 21/32 after Japanese Internet investment company SOFTBANK agreed to take a 40% stake in the company through a $20 million direct investment and the purchase of 1.67 million Webhire shares currently held by online retailer Amazon.com (Nasdaq: AMZN)... Enterprise application development management products firm Merant (Nasdaq: MRNT) rose $2 3/4 to $23 1/8 after agreeing to buy privately held Internet services firm The Marathon Group for $15 million in cash... Industrial pulsed power technologies firm Maxwell Technologies (Nasdaq: MXWL) gained $5 9/16 to $30 11/16 after saying independent tests paid for by a subsidiary indicated that the company's PureBright pulsed light system inactivates HIV and other viruses in medical and pharmaceutical applications.
Portable PC card maker Xircom Inc. (Nasdaq: XIRC) gained $2 9/16 to $35 3/8 after reporting fiscal Q3 EPS of $0.48, a nickel better than the First Call mean estimate. First Albany raised its opinion on the firm to "accumulate" from "neutral"... Internet audio appliances and video accelerators maker Diamond Multimedia Systems (Nasdaq: DIMD) advanced $19/32 to $5 25/32 after signing an exclusive multi-year agreement to deliver digitally downloaded audio content to Viacom's (NYSE: VIA) MTV Networks Online... Wireless communications company Qualcomm (Nasdaq: QCOM) tacked on $4 1/4 to $162 15/16 after posting fiscal Q3 EPS of $0.75 (excluding charges), thumping the $0.56 to $0.68 range expected by analysts surveyed by First Call. Credit Suisse First Boston raised its fiscal 1999 EPS estimate to $2.44 per share from $1.75.
Analytical Surveys (Nasdaq: ANLT) up $1 11/16 to $25 9/16; fiscal Q3 EPS: $0.42 vs. $0.28 last year; estimate: $0.39
DLJdirect (NYSE: DIR) up $1 7/8 to $26 3/4; pro forma Q2 EPS: $0.05 vs. $0.01 last year; estimate: $0.05
Entrust Technologies (Nasdaq: ENTU) up $2 7/8 to $31 5/8; Q2 EPS: $0.02 vs. loss of $0.04 last year; estimate: $0.01
Inter-Tel Inc. (Nasdaq: INTL) up $2 1/4 to $23 1/4; Q2 EPS: $0.27 vs. $0.18 (excluding charges) last year; estimate: $0.22
MYR Group (NYSE: MYR) up $1 1/8 to $19 13/16; Q2 EPS: $0.51 vs. $0.31 last year; estimate: $0.50
OneSource Information Services (Nasdaq: ONES) up $1 7/16 to $9 15/16; Q2 EPS: loss of $0.13 vs. loss of $0.20 last year; estimate: loss of $0.22
PolyMedica Corp. (Nasdaq: PLMD) up $1 13/16 to $14; fiscal Q1 EPS: $0.25 vs. $0.13 last year; estimate: $0.21
Theragenics Corp. (NYSE: TGX) up $1 3/16 to $9 1/4; Q2 EPS: $0.14 vs. $0.11 last year; estimate: $0.12
Transaction Network Services (NYSE: TNI) up $1 5/8 to $30 1/2; Q2 EPS: $0.27 (excluding charges) vs. $0.17 last year; estimate: $0.25
What looked on its face like a successful second-quarter earnings report for network security detection software maker ISS Group (Nasdaq: ISSX) didn't translate into a boost for the company's shares today, as an analyst's downgrade sent the stock down $11 3/4 to $26 9/16. ISS reported fully taxed EPS of $0.03, flat with market estimates and reversing last year's $0.03 per share loss. Besides turning a profit for the second straight quarter after years at or below the water level, ISS showed improvement in several areas: service revenues were about 10% of revenues, up from less than 4% a year ago, and total revenues more than doubled. While exactly what was behind the downgrade to "market perform" from "recommended list" by Goldman, Sachs & Co analyst Rakesh Sood wasn't clear, it may have had to do with some slight gross margin erosion. Investors may also be disappointed with the earnings, perhaps remembering the fallout from a March Barron's article suggesting that much of the stock's prior run-up was due more to enthusiasm than execution.
Cracker Barrel chain parent CBRL Group (Nasdaq: CBRL) continued to lose ground today, crumbling $2 to $16 after saying it expects earnings for fiscal Q4, ending July 30, to be between $0.21 and $0.25 per share. That's significantly short of both last year's EPS of $0.56 and Wall Street's $0.37 mean estimate. The company had directed investors to scale back their expectations for the year in mid-February, and scale back they did as share prices fell. Today's further disappointment probably doesn't sit too well in their stomachs. Same-store sales have not met expectations, margins have come under fire, and expenses have risen as the company increased store management staffing levels. Still -- as mentioned in various Foolish columns from the pen of Warren Gump -- the company added staff with improved service in mind. It is still integrating its Logan's Roadhouse acquisition, and a new, lower-priced menu was introduced this spring. Customer traffic has improved, and management is cautiously optimistic. "We believe we have not yet seen the full effect of our actions," said Chairman and CEO Dan Evins.
QUICK CUTS: Drug giant American Home Products (NYSE: AHP) lost $1 15/16 to $50 15/16 on news of Q2 EPS of $0.34, flat with estimates. Worldwide sales fell 1% primarily because of lower U.S. agricultural products and animal health products sales offset only in part by higher sales of pharmaceuticals and consumer health care products... Web portal giant Yahoo! (Nasdaq: YHOO) calmed down $7 3/8 to $142 1/8 as it closed the purchase of streaming media company broadcast.com. The company expects to take a one-time $22 million charge in Q3... Online financial services firm Net.B@nk (Nasdaq: NTBK) deposited Q2 EPS of $0.03, which beat last year's mark by $0.02 but missed estimates by a penny. The shares fell $3 11/16 to $27 1/16 today.
Software giant Microsoft (Nasdaq: MSFT) fell $5 1/16 to $93 5/16. The company posted a 39% gain in fiscal fourth-quarter revenues from the year before, but warned that it expects revenue growth rates to fall in fiscal 2000. For more on the news, head back to this morning's Breakfast With the Fool... Customer relationship management (CRM) software company Firstwave Technologies (Nasdaq: FSTW) gave back $2 5/8 to $6 after rocketing up $6 3/4, or 360%, yesterday on news that Microsoft chose its Netgain Sales Web-based CRM system for its embedded systems group... Glass products maker Apogee Enterprises (Nasdaq: APOG) was shattered for a loss of $1 7/8 to $12 1/8 after announcing that it expects to turn in Q2 EPS of between $0.18 and $0.20, down from last year's $0.33 and well off First Call's three-analyst mean estimate of $0.38.
Computer-aided design and manufacturing software developer Parametric Technology (Nasdaq: PMTC) fell $1 11/16 to $14 1/8 on news of Q3 EPS of $0.16 before charges, flat with last year's mark and a penny ahead of estimates. "Our transition to a more strategic, solutions-oriented selling approach has taken longer than expected to reach full productivity," said Chairman and CEO Steven Walske... Storage management software developer Veritas Software Corp. (Nasdaq: VRTS) gave away $5 1/4 to $57 1/2 following the announcement that president and COO Terry Cunningham resigned... Online services giant America Online (NYSE: AOL) gave back $5 13/16 to $113 3/16 today. AOL Europe CEO Andreas Schmidt said in a Reuters interview that the competition in Germany's market will be cutthroat.
Retailing Rule Maker Gap Inc. (NYSE: GPS) frayed $2 11/16 to $47 after Prudential downgraded the stock to "accumulate" from "strong buy," setting a 12-month price target of $55 per share... Contract offshore drilling company R&B Falcon (NYSE: FLC), an April Foolish Trouble, slid $5/8 to $9 5/8 following reports that a company deepwater drill ship was seized in South Africa because of some $35 million in debt allegedly owed to a Portuguese shipyard. The company said it will protest the seizure.
Personal care products network marketer Nu Skin Enterprises (NYSE: NUS) shed $4 1/2 to $14 3/4 after reporting Q2 EPS of $0.25, flat with last year's results and $0.06 below the First Call estimate. The company also closed its $37 million purchase of privately held e-commerce technologies firm Big Planet... Seismic data acquisition and oilfield services company Petroleum Geo-Services (NYSE: PGO) leaked $1 1/2 to $19 13/16 on news that the company plans to sell 10 million American depositary shares and $200 million in senior notes... Semiconductor fabrication equipment company PRI Automation (Nasdaq: PRIA), which reported a fiscal Q3 loss in line with estimates at $0.17 per share, retreated $6 1/4 to $31 7/8. Merrill Lynch cut its near-term rating on the stock to "neutral" from "accumulate."
Bank One (NYSE: ONE) down $1 1/16 to $59 3/8; Q2 EPS: $0.93 (before charges) vs. $0.86 last year; estimate: $0.93
Citrix Systems (Nasdaq: CTXS) down $7 3/4 to $54 5/8; Q2 EPS: $0.32 vs. $0.19 last year; estimate: $0.31
Cognizant Technology Solutions (Nasdaq: CTSH) down $1 13/16 to $27 5/8; Q2 EPS: $0.27 vs. $0.15 last year; estimate: $0.25
Corning (NYSE: GLW) down $15/16 to $70 11/16; Q2 EPS: $0.49 (before items) vs. $0.39 last year; estimate: $0.46
Cypress Semiconductor Corp. (NYSE: CY) down $3/4 to $19 3/8; Q2 EPS: $0.08 vs. loss of $0.07 last year; estimate: $0.12
DoubleClick (Nasdaq: DCLK) down $7 3/16 to $87 5/8; Q2 EPS: $0.13 loss (before charges) vs. $0.14 loss last year; estimate: $0.13 loss
IBM (NYSE: IBM) down $6 1/4 to $128 3/8; Q2 EPS: $0.91 (before gain) vs. $0.75 last year; estimate: $0.88
Immunex Corp. (Nasdaq: IMNX) down $11 9/16 to $109 1/2; Q2 EPS: $0.08 vs. breakeven last year; estimate: $0.08
Informix Corp. (Nasdaq: IFMX) down $1 1/16 to $8 5/16; Q2 EPS: $0.09 vs. $0.07 last year; estimate: $0.07
ISS Group (Nasdaq: ISSX) down $11 3/4 to $26 9/16; Q2 EPS: $0.03 vs. loss of $0.03 last year; estimate: $0.03
Lucent Technologies (NYSE: LU) down $6 5/8 to $70 3/16; fiscal Q3 EPS: $0.26 (before charges) vs. $0.17 last year; estimate: $0.23
Osteotech (Nasdaq: OSTE) down $1 to $24 1/4; Q2 EPS: $0.23 vs. $0.17 last year; estimate: $0.23
Reliability Inc. (Nasdaq: REAL) down $1 5/16 to $4 15/16; Q2 EPS: $0.03 vs. $0.30 last year; no estimate
Southwest Airlines (NYSE: LUV) down $1 9/16 to $20 3/8; Q2 EPS: $0.29 (split-adjusted) vs. $0.25 last year; estimate: $0.30
Tellabs (Nasdaq: TLAB) down $5 3/16 to $64 9/16; Q2 EPS: $0.32 vs. $0.23 last year; estimate: $0.30
Texas Instruments (NYSE: TXN) down $8 15/16 to $141; Q2 EPS: $0.92 vs. $0.35 last year; estimate: $0.86
Genentech's Stock Beating Again
Biotech giant Genentech (NYSE: DNA) came public (again) today, jumping $30 from its $97 offering price to close at $127. For those of you who not familiar with the story, the Genentech stock traded over the past several years was not normal common stock. Instead, it was a "special common stock" with unusual rights. Genentech's parent company, Roche Holdings (OTC: ROHHY), had the right to buy all of these shares for an escalating price that reached $82.50 on June 30, 1999. If Roche didn't exercise its right by that date, holders of the special common stock could force Genentech to buy back their shares for $60 apiece. These odd conditions basically put a collar on the old Genentech's stock price.
Last month, Roche announced that it was going to exercise its option and increase its Genentech ownership to 100%. Recognizing the value of having a publicly traded security that can be used for acquisitions and option compensation, however, Roche announced that it would reissue normal common shares representing about 16% of Genentech. Those are the shares that hit the market today. For the first time in quite a while, investors can invest in Genentech with full ownership rights (although with an 84% stake, Roche controls the show).
So what is Genentech and why am I devoting time to it? The company is now the second-largest biotech firm based on market capitalization. Although none of the company's drugs have reached blockbuster status -- more than $1 billion in annual sales -- it does have five notable products on the market, giving it the broadest major product line of any biotech firm. In addition, Genentech is also considered to have one of the best research and development (R&D) programs in the business.
Looking at the company's top line, 1998's product sales growth of 23% has accelerated further, thanks to surging revenue from two drugs. In the first six months of the year, product sales increased at a 48% clip to $503 million. Herceptin, introduced late last year for breast cancer, had sales of $86 million in the first half of the year (compared to zilch last year). In addition, non-Hodgkin's Lymphoma treatment Rituxan had an 81% increase in sales to $131.5 million. Combined revenues for other products, which include growth hormones Protropin and Nutropin, as well as heart attack drug Activase and cystic fibrosis treatment Pulmozyme increased 7% to $284 million. The company had royalty and contract revenue of $149 million in 1999's first six months, flat with the prior year.
Rising sales are extremely important to a biotech company, because it indicates that additional resources will be available to invest in R&D and support marketing efforts, not to mention boost the bottom line. Drug and biotech companies have some of the highest gross margins you'll find in any business. In the case of Genentech, that number hovers in the 80% range. For every dollar of product sales, the company only spends 20 cents on the cost of product sold, leaving quite a bit for other expenses.
Of course, those other costs are substantial. Selling, general, and administrative expenses eat up 33 cents of each dollar in revenue. This amount has increased a bit over the past year as the company incurred the costs of promoting its two new products. The other major expense for a drug company is R&D, which has claimed 28% of total revenue thus far in 1999. With more products hitting the market and sales moving higher, Genentech is trying to lower its R&D spending as a percentage of sales. Thanks to surging sales and a slight decline in the absolute level of expenses, this year's figure is down from 39% in 1998. While it would be disconcerting to see the company neglect the development of new products, Genentech's 28% R&D level is comparable to that of its peers.
Analysts seem to think that Genentech has some great things in its product pipeline. As someone with a financial background rather than a medical one, I can't provide too much analysis, but I assume it to be true given the company's terrific track record. Genentech is currently preparing regulatory filings for two drugs, Nutropin Depot for growth hormone deficiency in children and TNK for acute myocardial infarction. In addition, the company has four Phase III trials underway: two to extend use of Pulmozyme and Rituxan, and two for new drugs to help with asthma and acute coronary syndrome. The company also has several compounds in Phase II trials. To get some more details, you can check out the company's Web site.
From a balance sheet perspective, Genentech is rock solid. As of June 30th it had $1.7 billion in cash and marketable securities, the biggest hoard in the business. This should serve the company well should interesting acquisition or collaboration agreements emerge. In addition, it ensures the ability to continue investing in attractive research efforts regardless of short-term sales. Partially offsetting this cash is nominal long-term debt of $150 million.
As with any stock, there are several risks borne by Genentech stockholders. One of the biggest is potential adverse developments in the R&D pipeline. Since new medical territory is being explored, disappointments can pop up at any time. When that happens, the stock of the company invariably plunges as traders abandon ship. Genentech also faces some legal challenges. The most serious involves the University of California, which claims that Genentech infringed on U.S, patents in the development of Protropin and Nutropin. Earlier this year, a jury deadlocked 8-1 against Genentech. A new trial is now set to start on January 3, 2000. The potential stakes are quite high: UC is seeking $400 million in lost royalties and interest, a figure that could be tripled under federal patent law. On another front, competition from new drugs by other companies is also an ever-present threat in the business. At this point, however, it appears that Genentech is well positioned.
The last piece of the Genentech equation is earnings and earnings growth. The closest we can get to expectations for the company are those released prior to the Roche takeover. Analysts were looking for the company to make $1.74 per share this year, with long-term growth estimates of 25%. Due to some adjustments to agreements with Roche, this number could change when new estimates are released in the next month, but it should approximate new expectations. These figures exclude some recurring goodwill amortization created by the elimination of the special common stock, but most analysts will likely do that when they reinitiate coverage. Sticklers about value should note that about 21% of Genentech's earnings per share so far this year is attributable to interest income, which is generally less valuable to investors than operating earnings.
Genentech is a definite power to be reckoned with in the biotech industry. The growth of Rituxan and Herceptin are the engines of near-term earnings growth, while longer-term prospects are dependent on the company's well funded R&D pipeline (and the way it uses its cash stash). If valuation didn't matter, investing into Genentech would be a no-brainer to me. As someone who cares about the price I pay for companies in which I invest, I have to admit being a little reluctant. Wouldn't it be better to wait until something causes the stock to dip down? Perhaps, but then the stock might go much higher as sales continue soaring or new products make it through the pipeline.
As I make that statement, I envision the stock chart of America Online (NYSE: AOL). About three years ago, I passed on that company, hoping to pick some up at a more reasonable valuation. As you probably well know, that pullback never occurred. Holding the beliefs that biotechnology firms are poised to make dramatic breakthroughs and Genentech is one of the absolute leaders, I'll probably overlook my valuation concerns and consider taking a small stake when I can find the cash.
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