Friday, February 26, 1999
DJIA 9295.44 -70.90 (-0.76%) S&P 500 1232.70 -12.32 (-0.99%) Nasdaq 2289.52 -37.30 (-1.60%) Russell 2000 391.76 -0.93 (-0.24%) 30-Year Bond 95 23/32 -1 8/32 5.54 Yield

An Investment Opinion
by Dale Wettlaufer

The Rogue Elephant

Alright, dammit, who broke the PC stocks? It's Compaq (NYSE: CPQ), isn't it? It is kind of like the guy that always broke something at your parents' house when you had a party, getting you busted and wrecking it for everyone. Well, maybe I shouldn't pin it all on Compaq, but all the PC companies are down this morning with the proximate cause being a couple of Compaq downgrades and the contributing factor being the assumption of a slower growth rate for the PC market. Compaq was slammed for a $4 5/8 loss to $36 3/8, Dell Computer (Nasdaq: DELL) was off $2 1/2 to $79 1/4, Gateway (NYSE: GTW) was off $6 1/8 at $74, IBM (NYSE: IBM) was blown over $5 to $168 5/8, and Micron Electronics (Nasdaq: MUEI) fell $7/8 to $13 11/16.

According to Bloomberg, Merrill Lynch analyst Steven Milunovich dropped his first quarter revenue estimate for Compaq from $10.1 billion to $9.8 billion and decreased his EPS estimate 14%, to $0.30 from $0.35. Quoting from Bloomberg, "Milunovich said the company said sales to small and medium sized businesses, which represent 40% of its revenue, were weak in January and the beginning of February." Great, that tells us so much about Compaq, which includes Digital Equipment Corp., don't forget. Digital is huge in software sales and re-sales, service, and non-PC computer sales. You've also got Tandem in there, which doesn't just sell to huge corporations. Here's the problem. A lot of people are correlating Dell's quarterly report with this and getting freaked out about PC market growth. The worrywart season is now beginning, almost on schedule, but now that Dell has "stumbled," the secular growth worry about PCs that's a seasonal event now seems to have some validity.

Dell's quarterly growth was not highly problematic. The company's cash flow for the quarter was the same as it would have been had it shown lower margins on higher sales, netting out a few working capital adjustments. Instead, Dell was a little more disciplined with pricing and it gets smacked because all of a sudden one cell on a spreadsheet ripples through a discounted cash flow model. Couple that with the Compaq news today and uh-oh!

To the individual investor, the information that comes out of Compaq is just about as noisy as it can get. One quarter it says look at sales, another quarter it's sell-out from the channel. Next quarter it's going to be hits on AltaVista.com, and next quarter it'll be sell-in to the channel. From all the recent info I've seen, the re-sellers again have too much inventory. And that's not just today; last quarter they were discounting to clear out inventories. With Compaq protecting its price less and Web re-sellers increasing unit sales, the traditional channel players aren't happy. Compaq has even obliged them with a 90-day moratorium of sales to Web-based PC re-sellers starting in mid-February.

In a nutshell, Compaq's cash flow is awful even before taking into account the cash outflow for prior restructuring costs. Cash flow for the year was down over $3 billion to $644 million. Through nine months, cash flow was down $2.1 billion to $700 million. Is this the rogue capacity that's going to wreck the entire industry? It's definitely not helpful to be standing near an elephant bull when it goes rogue. Let's be serious -- Dell's quarterly revenue and unit growth were strong, but a little less strong than expected. It might have been too careful on pricing (as if that's a bad thing), but there was nothing wrong with its cash flows. Compaq, on the other hand, has signs of dysfunctionality. Confusing its problems with the state of the rest of the industry is a mistake unless the thesis includes Compaq's screwing up things with pricing. It's not the industry that is slowing down, it's Compaq and its entire distribution chain that is stumbling that is causing these problems. Can the direct PC companies deal? I think so.


Truck and bus manufacturer Navistar International Corp. (NYSE: NAV) motored ahead $4 1/8 to $43 9/16 after a report in a Swedish newspaper reignited speculation that heavy duty trucks maker Volvo (Nasdaq: VOLVY) will make a bid for the company. Volvo, which reportedly is staying mum, fell $1/2 to $25 3/4.

Specialty integrated circuits maker VLSI Technology (Nasdaq: VLSI) jumped $4 1/2 to $15 1/4 after the Netherlands' Philips Electronics (NYSE: PHG) offered to buy the company for $17 per share in cash, or about $777 million. Instead of making mobile phones through its joint venture with Lucent Technologies (NYSE: LU), which ended last year, Philips will focus instead on making the wiring inside the phones with VLSI, whose number one customer in fiscal 1997 was Ericsson (Nasdaq: ERICY). For more on the news, so this morning's Breakfast With the Fool.

Wireline and wireless network synchronizing products maker Datum Inc. (Nasdaq: DATM) gained $1 9/16 to $8 5/16 after reporting Q4 EPS of $0.01, flat with last year's results but ahead of the First Call mean estimate of a loss of $0.07 per share. Despite returning to profitability ahead of expectations, the company said it sees "continued softness" in the wireless market.

Embedded integrated circuits development tools provider Wind River Systems (Nasdaq: WIND) sailed ahead $2 3/16 to $22 15/16 after posting Q4 EPS of $0.20 (excluding charges), up from $0.15 a year ago and ahead of the First Call mean estimate of $0.19. President and CEO Ron Abelmann said the company's 40% revenue growth in fiscal 1998 "underscores our continued and substantial gain in market share."

Valassis Communications (NYSE: VCI), a printer of newspaper advertising inserts, tacked on $2 to $49 after Merrill Lynch raised its near-term rating to "buy" from "accumulate."

Internet telephony technologies firm NetSpeak Corp. (Nasdaq: NSPK) added $2 1/4 to $14 5/8 after Business Week's dubious "Inside Wall Street" column speculated that Motorola (NYSE: MOT) may expand its 32% stake in the company or just buy the whole shebang outright.

Broadcast tower services provider WesTower Corp. (AMEX: WTW) picked up $1 1/8 to $26 3/4 after BancBoston Robertson Stephens started coverage of the company with a "buy" rating, saying the company is well positioned to achieve its stated goal of adding more than 1,000 towers annually to its installed base over the next five years.

Credit card lender Capital One Financial (NYSE: COF) charged ahead $5 1/2 to $129 3/8 after Piper Jaffray started coverage of the firm with a "strong buy" rating and a 12-month price target of $157 per share.


Networking products and switch designer FORE Systems (Nasdaq: FORE) gave back $2 3/16 to $15 1/8 this morning. The company last night said it bought Dublin, Ireland's Euristix, a telecommunications software developer, for about $81 million in stock and options. FORE expects to take a pre-tax charge of $30 million to $35 million in its fiscal fourth quarter, ending March 31.

Biotechnology firm Emisphere Technologies (Nasdaq: EMIS) moved back $2 3/8 to $12 7/8. The company said the FDA asked for additional information about the development of oral heparin, meant to help prevent deep vein thrombosis following hip replacement surgery. The request is expected to delay the start of the third and final phase of clinical testing.

Securities market maker Knight/Trimark Group (Nasdaq: NITE) darkened $1 1/2 to $33 7/8 after it announced the secondary offering of 9 million shares at $35 per share. The stock closed at $35 3/8 last night.

Entertainment and consumer products retailer and direct marketer K-tel International (Nasdaq: KTEL), which launched a German e-commerce site targeting the central European market, lost $2 1/8 to $10 1/2 today.

Signal processor chip maker Analog Devices (NYSE: ADI) dropped $1 3/8 to $25 11/16. Yesterday afternoon the company announced the purchase of Scotland's Edinburgh Portable Compilers, a privately held company that develops high performance C/C++ and Fortran language compilers.

Boston-based equity investment firm Affiliated Managers Group (NYSE: AMG) dumped $7/8 to $26 1/4 after it priced an offering of about 5.5 million shares of company stock at $27 1/8 per share, yesterday's closing price. The company intends to use proceeds from the sale to pay down debt.

Database software company Oracle Corp. (Nasdaq: ORCL) slid $2 to $56 this morning. The stock will split 3-for-2 after the market closes today. Same story for software and information technology services provider Compuware Corp. (Nasdaq: CPWR), which lost $3 to $57 7/8.

Enterprise resource planning software developer Platinum Software Corp. (Nasdaq: PSQL), which Donaldson, Lufkin & Jenrette downgraded to "market perform" from "buy" today, fell $1 1/2 to $7 1/16. First Albany also lowered its rating on the stock to "accumulate" from "buy," setting a $17 per share 12-month price target.

Chip maker Micron Technology (NYSE: MU) shed $7 13/16 to $59 after Goldman, Sachs & Co. downgraded the company to "market outperform" from its "recommended list."

International long-distance phone service provider Star Telecommunications (Nasdaq: STRX) moved down $1 to $13 after ING Baring Furman Selz downgraded the stock to "buy" from "strong buy," lowering its 1999 EPS forecast to $0.38 from $0.48.

Earnings Movers

Lycos (Nasdaq: LCOS) down $2 1/4 to $90 3/4; fiscal Q2 EPS: loss of $0.03 (before charges) vs. profit of $0.01 last year; estimate: loss of $0.04

Novell Inc. (Nasdaq: NOVL) down $1 to $19 7/8; fiscal Q1 EPS: $0.08 vs. $0.04 last year; estimate: $0.08

W.R. Berkley Corp. (Nasdaq: BKLY) down $9/16 to $26 3/4; Q4 EPS: loss of $0.43 (before one-time items) vs. profit of $0.72 last year; estimate: profit of $0.53


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