Drip Portfolio Report
Wednesday, August 27, 1997
Randy Befumo (TMF Templr@aol.com)

ALEXANDRIA, VA (Aug. 27, 1997) -- Fear not, gentle readers. I am back to save you again from the soothing, dulcet tones of Jeff Fischer and to bore you yet again with more talk of Owens Corning as a potential investment. First, however, an update for investors who are mirroring the Drip Portfolio's recent purchase of Intel. In an effort to serve all Fool customers, the folks at Moneypaper have moved the deadline back to September 5th for getting your Intel purchase in. Apparently, they have received a tremendous response from Fools across the country and want to try to make them happy.

As for myself, I am quite flattered that so many investors have considered the arguments Jeff and I have posited and decided to invest in Intel as well. Although the stock is certainly not even close to the low, hopefully this recent pullback will give us time to start accumulating a position in a quality business that we can be happy owning well into the next century. Keep in mind that Jeff and I are about as flawed as two human beings can be and not be in jail (although I think Jeff has spent some time in the slammer for undisclosed offenses). You should always double-check our ramblings before investing your savings.

[Editor's note: Jeff has never seen the walls of a jail, of course. Well, from the outside, yes.]

About two weeks ago, I identified five key issues that need to be examined before we could consider OWENS CORNING (NYSE: OWC) as an investment. The first, the potential asbestos litigation cost, was dealt with the next day. The next issue, the company's debt level, is what I wanted to tackle today. On August 12, I wrote: "Recently, Owens Corning has added a ton of debt after slowly whittling down its debt since 1994... [is] management making the right move using debt instead of stock to make acquisitions?" Today I want to look at the role debt plays in financing a corporation, using Owens Corning as the example. Let's take a look at the liabilities portion of the balance sheet from the most recent quarterly earnings press release.

                        June 30,   Dec. 31,   June 30,
                        1997        1996       1996
LIABILITIES             (In millions of dollars)      
   Accounts payable     $591        $705       $534
   Reserve               300         300        275
   Short-term debt       156          96        152
   Long-term debt --
        current portion   23          20         18

    Total current      1,070       1,121        979

LONG-TERM DEBT         1,181         818        972

According to this, Owens Corning has $1.2 billion in long-term debt, rounding up. It is the last number given in the liabilities portion of the balance sheet after all of the current liabilities are disclosed. Long-term debt has risen $363 million over the past year as the company has made a number of acquisitions, including vinyl siding maker Fibreboard. If you think about it, $1.2 billion is a lot of debt. You could purchase 236 homes valued at $5 million with the debt Owens Corning currently sports. You could buy 4.7 billion sodas from Fool HQ's refrigerator with that debt, quenching the thirst of 1.9% of all Americans.

Debt gets a real bad rap in investment circles. Many investors routinely discard any company that carries substantial debt as a matter of course. Ironically, this very act occasionally creates an interesting opportunity -- if everyone is not looking at a company, odds are that it could be mispriced. The problem here is that debt has such a bad PR department. Debt, overall, is a neutral quality. The question is never whether or not a company has debt, but whether or not they can manage that debt and what they have assumed that debt to accomplish.

Most of the debt on Owens Corning's balance sheet has a very specific purpose -- the company needed to add it to stay independent. When Wickes Co. was attempting to take over Owens Corning against management's wishes in 1986, the company took on debt in order to scare Wickes away. By adding debt to their balance sheet, Owens Corning made it so Wickes could not borrow as much to finance the acquisition. Certainly the debt was a good thing for shareholders who believed the $75 per share offer from Wickes was too low.

The rest of the debt has come as the company has made acquisitions in the global building supplies business, using debt instead of stock to buy other companies because of management's belief that their own shares are undervalued. This makes sense as well -- if the stock is truly undervalued, it certainly wouldn't make sense to give it away. In fact, keeping the balance sheet highly leveraged and clear of cash helps to pump up the return on equity (ROE), which is why some companies routinely run with this corporate structure. Although it is more risky, it results in better returns if you do it right -- kinda like all of the fancy options garbage that people love to explore when they first get interested in investing, thinking it is a giant slot machine.

While I certainly am not a champion of a "leveraged" balance sheet -- meaning one with a lot of debt -- if the debt is manageable and there for a good reason, it is not ipso facto a bad thing. Tomorrow, I will look at how specifically to determine how much debt is acceptable by examining a few handy ratios. Stay tuned and don't turn that channel! Even if you don't like Owens Corning, hopefully you'll learn a few handy analytical tools that will help you analyze businesses in the future.

--Randy Befumo