Monday, July 26, 1999
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Travel plaza and airport food service operator Host Marriott Services (NYSE: HMS) jumped $5 23/32 to $15 15/32 after agreeing to be acquired by Italian catering company Autogrill, which is majority owned by the Benetton family, for $15.75 per share in cash. A formal tender offer is expected to begin on August 2 and close 20 business days later, subject to customary regulatory approvals. As Fool Warren Gump explained in today's Fool Plate Special, one lesson to learn from Host Marriott's takeout is that strategic buyers place quite a bit of value on leading market positions and innovative leadership. Autogrill looked past Host Marriott's one year of sluggish earnings, realizing that it was going to gain a leading presence in the affluent U.S. market. Investors may want to follow Autogrill's example and keep a lookout for other ignored industry leaders that might make for attractive investment opportunities.

Analog chip power management components maker Unitrode Corp. (NYSE: UTR) climbed $8 to $34 3/4 after analog and digital signal processing (DSP) chipmaker Texas Instruments (NYSE: TXN) agreed to acquire the company in a $1.2 billion stock swap, which works out to $38.60 per Unitrode share. Unitrode's three major product areas -- power supply control, "terminator" interfaces, and battery management -- will "fully complement TI's existing analog catalog offering with virtually no overlap," Texas Instruments said. Adding Unitrode will also further cement TI's role as a key supplier of cell phone innards, providing both the chips needed for wireless communications and the technologies that enable phones to stay up and running longer. Besides cell phones, Unitrode's power management products will benefit from future growth in digital cameras, Internet audio players, and other emerging products, according to TI.

QUICK TAKES: Medical instrument systems provider Beckman Coulter (NYSE: BEC) gained $2 11/16 to $49 after saying $40 million in first-half cost savings from the integration of Beckman and Coulter Corp. was largely responsible for Q2 EPS of $0.87, up from last year's $0.32 and a penny ahead of the Zacks mean estimate... Dutch telecommunications services company VersaTel Telecom International's (Nasdaq: VRSA) American depositary receipts picked up another $1 5/8 to $15 3/8 today, adding to the company's 34% gain in its first day of trading on Friday... E-mail and advanced messaging services firm Mail.com (Nasdaq: MAIL) delivered a $1 gain to $21 after saying it has hired Salomon Smith Barney to explore "strategic partnerships" for its collection of 16 geographically related domain name properties, including USA.com, Asia.com, Europe.com, and India.com.

Freight forwarder and logistics management firm Expeditors International of Washington (Nasdaq: EXPD) moved up $1 3/16 to $28 3/8 after U.S. Bancorp Piper Jaffray raised its rating on the company to "strong buy" from "neutral"... Eye care company Bausch & Lomb (NYSE: BOL) eyed a $3 1/16 gain to $73 7/16 after posting Q2 EPS of $0.80 (excluding gains), topping the First Call mean estimate of $0.77. The company also said it has sold its Charles River Laboratories research lab animal business to a unit of DLJ Merchant Banking... Property and casualty insurer Allstate Corp. (NYSE: ALL) tacked on $1 5/16 to $35 5/16 after an analyst made positive comments about the stock in the latest edition of Barron's.

Managed care provider United HealthCare (NYSE: UNH) rose $3 3/4 to $66 after Prudential Securities started coverage of the firm with an "accumulate" rating... Laser vision correction systems developer Summit Technology (Nasdaq: BEAM) jumped $5 3/4 to $26 1/4 after an FDA advisory panel recommended approval of the company's LASIK technique for treating high nearsightedness and high astigmatism... Cancer and autoimmune disease treatment developer IDEC Pharmaceuticals (Nasdaq: IDPH) picked up $2 1/4 to $90 1/2 after Prudential Securities started coverage of the firm with a "strong buy" rating.


Enterprise IT company Softworks (Nasdaq: SWRX) was crushed for a loss of $4 3/32, or 43.7%, to $5 9/32 today on news that the company expects to post a Q2 loss of $0.02 to $0.03 per share when it reports earnings later this week. Three analysts surveyed by First Call were looking for a $0.04 per share profit. "The... shortfall was not due to competitive reasons," insisted CEO Judy Carter. "Certain sales that did not close in the second quarter have closed or are expected to close during the third quarter." If that's the case, it would follow that Q3 results are poised for an upside boost, and today's disappointment may provide investors with the opportunity to do some bargain shopping. Softworks, after all, hadn't missed market estimates in three consecutive quarters and has been busily expanding its reach into Asian and European markets. Some of today's move, however, might be connected to IBM's (NYSE: IBM) unveiling of a new line of enterprise storage servers, as Softworks recently announced a partnership to develop enterprise storage products with Storage Technology Corp. (NYSE: STK) -- for years an IBM supplier that now stands to lose business. For more on that story, revisit this morning's Breakfast With the Fool.

Shares of cosmetics company Revlon (NYSE: REV) may be headed south again, as the stock took a hit today following reports in the Financial Times that Coty, a subsidiary of Dutch consumer products company Benckiser NV, is backing away from making a bid for the company as a whole. News that Coty may still be interested in snapping up some of Revlon's better-known brands -- its interest in Revlon, though widely reported, is unconfirmed -- couldn't stop the stock from losing $4 3/4 to $21 1/2 today. That a company might want to pluck away some of Revlon's sweeter fruits, Revlon, ColorStay, Almay, and Flex among them, isn't surprising, but to sell them off might leave the company without much going for it besides heavy amounts of debt. Still, if Revlon becomes willing to sell itself in bits and pieces, other bidders may emerge to help ease majority Revlon owner Ron Perelman's pain. News of talks between the two companies were Foolishly reported in a Breakfast News article about two months ago.

QUICK CUTS: Online services company America Online (NYSE: AOL) dropped $7 13/16 to $100 1/8. Executives including Chairman Stephen Case and President Robert Pittman reportedly sold 4 million shares of company stock today... Online garage sale eBay (Nasdaq: EBAY) closed down $3 7/16 to $104 3/8 in advance of the company's second-quarter earnings report. After the bell, the company turned in pre-charge EPS of $0.04, beating Wall Street's projections by a penny... Internet portal operator Lycos (Nasdaq: LCOS), which split its stock 2-for-1 after the market's close today, lost $6 3/4 to $88 3/16.

Millimeter wave digital radio systems maker P-Com Inc. (Nasdaq: PCMS) shed $1 to $4 9/16 after the company said it delayed the release of its Q2 results, originally scheduled for today. Wall Street is currently expecting an $0.11 per share loss... Internet address registrar Network Solutions (Nasdaq: NSOL) slipped $2 3/8 to $70 7/8. The company reportedly plans to launch a new online business directory today. The "dot com directory" will include the 1.8 million businesses that have an Internet address registered with Network Solutions. The company plans to make money by selling advertising... Healthcare technology provider Allscripts Inc. (Nasdaq: MDRX) slowed $2 7/8 to $16 7/8 in the stock's second day of trading. The company sold $7 million shares to the public for $16 each on Friday.

Timeshare operator Silverleaf Resorts (NYSE: SVR) dulled $15/16 to $7 15/16 after the company said "the ongoing ramifications of technology issues in our call centers and related staffing complications... will continue to contribute to the higher than anticipated sales and marketing expenses for the remainder of 1999." Q2 EPS missed First Call's four-analyst estimate of $0.46 by $0.04... U.K. drug company Shire Pharmaceuticals Group (Nasdaq: SHPGY) moved back $1 1/8 to $25 7/8 on news that it will acquire Eatontown, N.J.-based Roberts Pharmaceutical Corp. (AMEX: RPC) in a deal valued at around $1 billion, or $30.71 a share. That represents a 23% premium over Roberts' closing price Friday. Roberts' stock moved up $1 1/2 to $26 1/2.

Discount brokerage TD Waterhouse Group (NYSE: TWE) slipped $2 13/16 to $18 1/4 after it said COO Frank Petrilli resigned. Keith Gray, who has been providing strategic expansion and acquisition advice to TD Waterhouse, will step in. Petrilli went to E*Trade (Nasdaq: EGRP), where he was named president of E*Trade Securities Inc. Shares of the online brokerage were off $1 3/4 to $30 1/4... Business Internet services provider (ISP) PSINet (Nasdaq: PSIX) was unplugged for a loss of $3 1/4 to $54 7/8. The company announced the purchase of two Spanish ISPs. PSINet also said its Q2 earnings conference call, scheduled for tomorrow morning, will be open to the public. Click here for information on how to tune in.

Electronics retailer Good Guys! (Nasdaq: GGUY) fell $1 3/16 to $7 on news that fiscal Q3 losses were $0.54 per share, well off the $0.24 loss estimate one analyst gave First Call. The company said it will remove computers and home office products from its product mix by the end of Q4, expanding its wireless phone and Internet-related divisions... Website developer Navidec Inc. (Nasdaq: NVDC) gave up $1 5/8 to $12 1/4 after Wells Fargo (NYSE: WFC) agreed to buy a $25 million stake in the company and its DriveOff.com subsidiary. Wells Fargo shares slipped $13/16 to $40 7/8... Internet-based messaging and communications services company JFAX.com (Nasdaq: JFAX) moved down $1 1/4 to $8 1/4 in the stock's second trading session. The company sold 8.5 million shares on Friday for $9.50 each.

Earnings Movers

Ducommun Inc. (NYSE: DCO) down $15/16 to $13 1/16; Q2 EPS: $0.32 vs. $0.43 last year; estimate: $0.32

Pioneer-Standard Electronics (Nasdaq: PIOS) down $1 7/16 to $12 15/16; fiscal Q1 EPS: $0.26 vs. $0.20 last year; estimate: $0.27

Power-One Inc. (Nasdaq: PWER) down $1 9/16 to $27; Q2 EPS: $0.11 vs. $0.18 last year; estimate: $0.09

RSL Communications Ltd. (Nasdaq: RSLC) down $1 13/16 to $20 11/16; Q2 EPS: loss of $1.36 vs. loss of $1.47 last year; estimate: loss of $1.32

Seacor Smit (NYSE: CKH) down $5 1/4 to $48 1/2; Q2 EPS: $0.51 vs. $1.58 last year; estimate: $0.85

StarTek Inc. (NYSE: SRT) down $2 11/16 to $26 7/8; Q2 EPS: $0.18 vs. $0.10 last year; estimate: $0.13 (one analyst)

Texaco (NYSE: TX) down $1 1/2 to $60 7/8; Q2 EPS: $0.52 (before items) vs. $0.60 last year; estimate: $0.49

An Investment Opinion
by Dale Wettlaufer

Gateway's Solid Q2

PC company Gateway Inc. (NYSE: GTW) blasted ahead on Friday after reporting its Q2 results Thursday evening. Once again, the company demonstrated excellent progress in a number of areas, not the least of which was the income statement. Revenues grew 18% year-over-year and net income grew 47%. The quality of earnings was excellent as well -- a 143 basis point increase, year-over-year, in gross margin contributed to a 46.4% increase in operating income even as sales, general and administrative expenses as a percentage of revenues expanded by 18 basis points.

Working capital management was once again excellent, as Gateway has been a solid performer in this area for more than four quarters running. This is almost expected of the company at this point. The average cash conversion cycle was negative 7.6 days and ending days in inventory were 7.4. Invested capital expanded at a 47% annual rate sequentially while return on invested capital (ROIC) was approximately 43%. In general, a company is going to increase in value when it can expand invested capital at such rates and show returns on capital so far in excess of its cost of capital.

On a trailing basis, return on capital has been closer to 50%, but a lower ROIC in percentage terms is not unfavorable given that it's being generated on a higher capital base. In terms of economic value added (EVA) analysis, EVA has increased and thus market value added should expand.

One huge thing that didn't get much play in the press accounts I noticed (I have no idea why) is the company's deal with GE Capital Information Technology Solutions. This unit of General Electric (NYSE: GE) is one of the largest information technology companies in the world. In essence, this is a huge distribution and service arm for Gateway. From the company's conference call last week:

"Today we made a major announcement of an alliance with GE Capital Information Technology Solutions. [Gateway will partner] with them as they go into the global 2000 marketplace. This is a market we've not actually been strong in." Gateway doesn't have a lot of the "services capabilities that are required to compete in that market. GE does have those capabilities and now what we're doing is marrying our world-class build-to-order capabilities with their capabilities. Our relationship with them is unlike most relationships in the channel. And that is that we basically will build to order based on client needs, we'll ship directly to the client, we'll use our custom-integrated services capabilities to customize for the client, and then GE will take it from there. It's really a very unique relationship. We're not shipping inventory to GE. They're not sticking things on shelves, we're not negotiating price protection agreements. All the things that are so damaging in existing channel relationships do not exist in this relationship and we are looking forward to this being a very, very significant relationship as we go forward."

This is a big step forward for Gateway in the corporate arena. All of a sudden it has the market reach capabilities of a giant IT services company. This works for both companies in the deal. GE gets a build-to-order PC manufacturing partner, and Gateway leverages its strengths as a precision manufacturer. If the relationship works well, it can allow Gateway to further refine its supply chain efficiencies and get it to scale in servers, which in turn richens product mix and gives the company the possibility of an increased offense against average selling price declines. Not to overstate things, but that sounds like Dell Computer (Nasdaq: DELL) circa 1996-1997.

Granted, the company will probably cede some margins on these products by wholesaling to GE, but who cares? The idea isn't to generate pretty margins or even maximize ROIC. The goal is to maximize economic value added, or the difference between return on invested capital and weighted average cost of capital, both expressed as percentages, times invested capital. Plus, if it gives Gateway scale in the server and workstation business, it equips the company to compete much more effectively against Compaq (NYSE: CPQ) in corporate sales. After all, I think at this point Compaq is still the wounded old lion and the direct PC companies are the hyenas. Hyenas work in pack fashion on crippled competition and won't turn on each other until that competitor is dead.

In the consumer segment, Gateway is hitting on all cylinders -- 46% unit growth in consumer PCs resulted from the company's strong product offerings and price points that make sense to customers, the bundling of ISP access, financing packages, and good overall word of mouth. On Thursday President Jeff Weitzen commented on Gateway's consumer strategy for the quarter in one of the more telling comments in the conference call, indicating that the management team of Gateway is very much on the ball: "The strategy there was to go fishing when the fish were biting. That means the company would scale back marketing and competitive pricing in April and May, when consumers are less active and returns on operating expenditures are lower, and focus more on margins and profit dollars during those periods. In June, when the fish are biting, the company was aggressive on pricing and really focused on maximizing units. The company had a 'tremendous June' almost on equal in results with December, which is usually the best month of the year for Gateway. The net of all this was consumer unit growth of 46%."

As far as I'm concerned, the growing evidence that Gateway will not acquire an Internet service provider is big news, as well. Rather than paying a big premium for an ISP in hopes that the synergies generated will cover the company's required rate of return on such an acquisition, many investors would prefer to see the company remain technology-agnostic and strategically flexible. Synergies are nice, but the company had better know what it's doing if it wants to get into the infrastructure business, where hundreds of billions of dollars worth of incumbent capital and scrappy new companies are going to be working against it.

In sum, I believe the market was pleased by the financial and operational results for the quarter, overwhelmed at the huge positive in the GE Capital IT Solutions announcement, and relieved that Gateway probably won't be acquiring an ISP. Once again, there's nothing not to like here and a heck of a lot to like on the strategic front. At $71, the company is still a fine value -- I believe it will outperform the market over the next five years.


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