Friday, February 19, 1999
DJIA 9338.89 +0.26 (+0.43%) S&P 500 1241.99 +4.71 (+0.38%) Nasdaq 2283.14 +22.59 (+1.00%) Russell 2000 392.81 +1.72 (+0.44%) 30-Year Bond 98 11/32 +1/8 5.36 Yield

An Investment Opinion
by Dale Wettlaufer

Big Green Lean and Mean

Mega-regional bank holding company First Union (NYSE: FTU) was flat at mid-morning after opening up just a touch following a meeting with analysts last night. The Charlotte, North Carolina-based company detailed more of the reasons why it advised analysts in late January that it was making some tweaks to its spending and revenue projections for the coming couple of years. The company's surprise shift in guidance a few weeks after its fourth quarter conference call resurrected a credibility problem that it has with analysts, as many of the people who follow the company felt that they should have known in mid-January about the shifting outlook.

Last night, the Big Green Machine said itis going for the lean, mean machine look with the launching of an expense reduction program designed to take $400 million per year out of the company's cost base, or $0.26 per share or so after taxes. According to a Goldman Sachs research note put out this morning by analyst Sally Pope Davis, though, "the expense reduction appears to be a critical element for FTU to achieve 1999 EPS of $4.00+." So First Union watchers get a little bit of a cold shot on that one, as the assumption coming out of the last update for the company was $4.00 per share for the year without these expense reductions. Davis explains the implication of that: "While our $4.00 estimate is unchanged, it would appear to be a de facto increase from the company's late January guidance."

I defended the company's discretionary spending choices at that time, but gosh, come on. At some point you have to have a better idea of your overhead. That's why the stock's not moving this morning. This doesn't really take expenses out this year and give it back to shareholders, it replaces what was not previously assumed by the market. Or perhaps this is one mark on the wall in favor of the market in the never-ending struggle between individuals and the efficient market.

On the positive side, it appears as though these are cutbacks on redundant overhead that is the nearly inevitable result of the pursuit of building a national commercial and branch-based retail bank. Davis says the cuts will translate into a 7-10% headcount reduction, but that the bank has not been specific about where those cuts will take place. There's little doubt in my mind that this will take place within the ranks of low value-added positions. (Sorry to be a capitalist pig about that). Not all of this will be delivered straight back to shareholders, though, as much of the expense savings are going to be invested in expanding revenue-generating initiatives such as building up Capital Markets, capital management, and continuing the company's imaginative advertising campaign.

Ultimately, the expense reduction campaign is meant to increase revenues, as operating expenditures are being diverted from functions that are largely becoming cost centers to areas that are intended to become profit centers. Part of the whole dynamic of shrinking the number of banks serving the country is the cutting of redundant costs and getting the mass needed to offer new services. The short-term accretion/dilution issue that occupies the minds of so many banking analysts misses the issue of what long-term cash flows look like. This is exactly what is going on at First Union. Even when you add back all goodwill that has ever been charged off at the company, and even adding back all unrecorded goodwill that has come about from poolings of interest, this company's return on capital is attractive for the banking world.

Return on capital will be further improved with a step-up in the company's share repurchase program. In the short-term, the company is willing to trade off an increase in asset/equity leverage to take advantage of a low valuation of the company. Adding back goodwill amortization to earnings, the company is trading around 12.6 times 1999 estimated earnings and 11.2 times 2000 estimates. Considering the company's unique geographic coverage and overall quality, and considering interest rates, an earnings yield (the inverse of the P/E) of 7.94% on this year's estimate and 8.93% on next year's estimate is more than fair for this company. If the company executes and meets its goals and can show good reason why earnings for fiscal 2000 can get ahead of current estimates, a $75 share price over the next 12 months is not out of the question.


Telecommunications equipment company Ciena Corp. (Nasdaq: CIEN) gained $1 1/2 to $22 3/8 after surprising Wall Street by reporting fiscal first quarter earnings of $0.02 a share, as new customers jump-started sales. The company had been expected to report a loss of $0.01 a share.

Airline catalog retailer SkyMall (Nasdaq: SKYM) soared $3 1/8, or 26.5%, to $14 15/16 on news that the nation's fourth-largest airline, Northwest Airlines (Nasdaq: NWAC), will carry the company's in-flight catalog on all domestic flights. The 3 1/2-year agreement raises SkyMall's share of the domestic airline market to 78% from 70%.

America West Holdings (NYSE: AWA) took off this morning, gaining $2 13/16 to $22 13/16, after The Wall Street Journal reported that UAL Corp. (NYSE: UAL) has made a conditional cash bid for the Phoenix-based airline. According to the Journal, the offer could end up sparking a bidding war between UAL and Continental Airlines (NYSE: CAI.A), which holds an 8% stake in America West and the right of first refusal to buy a controlling stake in the company in the event of an acquisition bid. For more details, see today's Breakfast With the Fool.

Amazon.com (Nasdaq: AMZN) tacked on $4 13/16 to $94 5/16 and Yahoo! (Nasdaq: YHOO) picked up $2 3/4 to $131 5/8 after CIBC Oppenheimer analyst Henry Blodget reportedly said it's time to buy shares of Internet stocks such as the online book and music retailer and the leading Web portal. Excite (Nasdaq: XCIT) rose $2 13/16 to $93 3/4, Infoseek (Nasdaq: SEEK) added $1 1/8 to $60 3/4, and Lycos (Nasdaq: LCOS) traded up $3 3/16 to $87 7/16.

Morgan Stanley Dean Witter raised its ratings on chemical companies Union Carbide (NYSE: UK), Dow Chemical Co. (NYSE: DOW) and Millennium Chemicals (NYSE: MCH) to "outperform" from "neutral." Union Carbide moved up $7/8 to $39 7/8 and Dow Chemical gained $1 3/4 to $95 1/2, while Millennium Chemical climbed $7/8 to $18 7/16.

Nuclear aircraft carrier and submarine builder and refueler Newport News Shipbuilding (NYSE: NNS) cruised ahead $4 1/16 to $32 1/2 after announcing it has received an unsolicited $1.35 billion offer from General Dynamics (NYSE: GD) to acquire all of its outstanding shares for $38.50 a share in cash. On January 19, Newport News announced it would merge with Avondale Industries (Nasdaq: AVDL) in a stock swap valuing Avondale at $470 million. Because regulators may block General Dynamics' proposed bid, Newport News said that until General Dynamics can satisfy its board's concerns as to the reasonable certainty of the deal's closing, it remains "fully committed" to the deal with Avondale. Still, Avondale dropped $2 13/16 to $29 7/8 this morning.

Prison operator Wackenhut Corrections Corp. (NYSE: WHC) gained $1 7/16 to $20 1/16 after saying that the fourth quarter results it released yesterday understated revenues and operating expenses. Revenues were actually $88.696 million, not $87.784 million, while operating expenses were really $76.2 million, not $75.3 million. The company also announced plans to buy back an additional 500,000 shares.

ResMed Inc. (Nasdaq: RESM), which makes medical equipment for treating sleep disordered breathing, rose $3 1/8 to $33 after saying it has no explanation for the recent drop in its share price and that it is "comfortable" with analysts' estimates for the remainder of its fiscal 1999. The company added that its recent entry into the hospital and sub-acute marketplace is "producing promising results" and that it will be announcing "positive clinical results" on a major new autosetting device at an American Thoracic Society meeting in April.

Bank of Commerce (Nasdaq: BCOM) jumped $1 11/16 to $18 3/4 on news that it will be acquired by U.S. Bancorp (NYSE: USB) for about $314 million in stock, or $19.75 a share, a 16% premium over Bank of Commerce's closing price yesterday of $17 1/16 ($17.0625). U.S. Bancorp added $3/4 to $33 11/16.

Investment bank and brokerage Eastbrokers International (Nasdaq: EAST) surged $1 15/32 to $8 after announcing plans to develop an online business services subsidiary with Cyber Realm, an Internet access and content provider.


The maker of razors and batteries, Gillette Co. (NYSE: G), was trimmed by $7/16 to $55 1/4 after announcing that Chairman and CEO Alfred Zeien will retire April 15 after an 8-year tenure and 31 years of working for the company. He will be succeeded by Gillette President and COO Michael Hawley, a 36-year veteran of the company.

Pharmaceutical promotions consultant Boron, LePore & Associates (Nasdaq: BLPG) lost $1 3/8 to $10 7/8 after saying it expects Q1 EPS of between $0.09 and $0.11, missing the $0.16 consensus estimate four analysts gave First Call. The company blamed the loss of revenue from Glaxo Wellcome (NYSE: GLX) -- which decided in October not to continue using Boron for various training and panel services -- and uncertainty about the "magnitude and timing of revenue from new and existing clients" for the shortfall.

Trash removal and recycling firm Waste Industries (Nasdaq: WWIN) dumped $2 to $14 after pre-announcing Q4 EPS of $0.18 or $0.19, missing the First Call mean estimate of $0.22. The company also announced the acquisition of a 340-acre landfill in Tennessee and two waste services companies, as well as two governmental contracts in Georgia and North Carolina.

Dairy products processor and distributor Dean Foods Co. (NYSE: DF) curdled $2 to $33 7/16 after it said fiscal Q3 EPS is seen coming in below the market's $0.44 consensus estimate. Dean attributed the shortfall to high raw milk costs and declining butterfat prices, as well as integration costs and lower margins at recently acquired dairies. The company expects EPS of $0.20 before an $8 million charge for the close of its Michigan pickle operation.

Drug maker Pfizer Inc. (NYSE: PFE), downgraded to an intermediate-term "accumulate" from "buy" by Merrill Lynch, lost $1 5/8 to $129 1/2 today. The brokerage, which maintains a long-term "buy" rating on the stock, believes the company's price to earnings ratio is "at or near a peak."

Men's footwear maker Florsheim Group (Nasdaq: FLSC) dropped $13/16 to $5 15/16 after it announced the hiring of Bear, Stearns & Co. as its financial adviser "to evaluate and recommend financial and strategic alternatives," including "merger opportunities, recapitalization, strategic alliances and other financial structures." The company said it is looking for new capital to help accelerate growth. Q4's loss was $0.08 per share, down from an $0.08 per share profit a year ago and half of what two analysts polled by First Call expected.

Chip performance accelerator technology developer NeoMagic Corp. (Nasdaq: NMGC) faded $7/8 to $13 1/4 after it announced Q4 EPS of $0.34, $0.02 above last year's number but flat with market projections. The company also announced the purchase of Mitel Semiconductor's optical drive development group and ACL, an Israeli array processing company. Terms for the deals weren't reported.

Computer and communications design and manufacturing services firm Celestica Inc. (NYSE: CLS) shed $2 1/16 to $28 after it said last night it will sell 8 million shares for $28.65 each -- about a 5% discount to yesterday's closing price -- to fund expansion.

Earnings Movers

DAOU Systems (Nasdaq: DAOU) down $7/8 to $5 1/8; Q4 EPS: $0.17 vs. $0.05 last year; estimate: breakeven

Sepracor Inc. (Nasdaq: SEPR) down $7 1/2 to $129 3/4; Q4 EPS: loss of $1.10 vs. $0.51 loss last year; estimate: loss of $1.11

St. Mary Land & Exploration Co. (Nasdaq: MARY) down $1 3/8 to $16 1/8; Q4 EPS: loss of $0.44 vs. $0.12 profit last year; estimate: $0.03 profit


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