Drip Portfolio Report
Tuesday, October 21, 1997
by Randy Befumo (TMF Templr@aol.com)

ALEXANDRIA, VA (Oct. 21, 1997) -- PORTFOLIO NEWS. Jeff and I have decided that we're sending $300 to invest in Intel next month. Intel is our only current holding and we view the current price as attractive. We will send this money out in the next few days. The final deadline for investments is November 1st, but Harris Trust needs to have the money five business days before this. If you want to invest more in Intel, the check needs to be received by Harris Trust by October 27th. Tomorrow, we will analyze Intel's latest quarter and try to explain why we are still so excited about the company even though the stock is down $8 from where we first bought it.

STOCK ANALYSIS. For all of you who wrote to me over the past 24 hours pointing out my mathematics blunder, all I can say is thanks and I blew it. For those who did not catch it yesterday, let's recap. Over the past two weeks I have been working very hard at valuing the parts of KANSAS CITY SOUTHERN (NYSE: KSU) to determine whether the company is an attractive Drip Portfolio candidate at this juncture. I put a price on Kansas City Southern's Financial Asset Management (KCS-FAM), Kansas City Southern Railroad (KCSR) and the Miscellaneous (Misc.) operations.

KCS-FAM                 -- $1.1 billion to $2.7 billion
KCSR                    -- $753 million to $1.5 billion
Misc.                   -- $1.0 billion
Total Value             -- $2.9 billion to $5.2 billion

Unfortunately, I also included the following example of poor addition:

Current Stock Value     -- $3.6 billion
Current Long-Term Debt  -- $0.9 billion
Current Value           -- $5.4 billion

As dozens of you have mentioned, in most countries $3.6 billion plus $0.9 billion equals $4.5 billion, not $5.4 billion. My conclusion that Kansas City Southern was not attractive at this point was actually, in retrospect, not quite correct. With the highest possible reasonable price at $5.2 billion, Kansas City Southern could be undervalued by about 15%. Of course, $4.5 billion is 56% more than our lowest reasonable valuation. Given the 15% undervaluation versus the 56% potential overvaluation, the risk-reward of the investment does not seem terribly attractive.

Had we looked at Kansas City Southern when I first mentioned it on July 30th when the stock was at $24 7/16, it would have been a different story. At $24 7/16, Kansas City Southern's stock would have been worth $2.6 billion, making the whole thing worth $3.5 billion (yes, I double-checked that one). At our hypothetical $3.5 billion, Kansas City Southern would have been, at worst, 20% overvalued and, at best, 33% undervaluated. Although not a grand slam by any stretch, it is clear that the potential reward far outweighed the possible risks.

While I am copping to basic math errors, I also wanted to point out one other thing that I sorta blew when I first looked at it that, in retrospect, could affect the valuation. When we looked at the operating earnings of KCS-FAM, I was struck at the time by how much higher the operating margins at KCS-FAM were than other asset management companies. Operating margins, which are operating earnings divided by revenues, were 43.1% at KCS-FAM versus 30.2% for Franklin Resources and 36.1% for T. Rowe Price. However, because KCS-FAM owns 41% of DST Systems, under equity accounting rules it can count the portion of DST's operating earnings it controls as its own. This means that 41% of DST Systems operating earnings are double-counted by KCS-FAM.

       AUM   Op. Earnings   Revs   Shares    Cash    Debt

BEN   $208.8b  $572.9m $1,896.1m  126.1m  $323.3m $521.5m
EV     $21.0b   $60.6m   $197.2m   19.3m  $130.5m  $53.1m
KSU    $71.3b  $142.3m   $330.1m       X        X       X
L      $36.2b  $170.5m $1,156.2m   29.4m   $13.3m      $0
TROW  $116.9b  $234.2m   $647.2m   58.1m  $134.3m      $0

So, why is this a problem? Because we counted the operating earnings when we valued KCS-FAM and we counted the full value of the current equity in DST when we looked at the miscellaneous assets. Although one could argue that it is okay to do this for a host of reasons, this is far from the conservative to moderate valuation range that I was trying to construct. So, in conclusion, even though my math was wrong and I made a bad assumption on the KCS-FAM valuation, the conclusion is correct -- Kansas City Southern does not seem terribly attractive at the moment. We will re-evaluate when the actual spin-off or split-off occurs in the fourth quarter. We will also exhibit much better math skills in the upcoming weeks.


              Stock   Close     Change
              Intel   $85 1/8  +1 1/16

            Day   Month Year  History
        Drip:    +0.00%   0.00%  0.00% 0.00%
        S&P:     +0.00%   0.00%  0.00% 0.00%
        NASDAQ:  +0.00%   0.00%  0.00% 0.00%

        Rec'd   #    Security         In At      
       9/8/97   1      Intel         $94.69      

                        Base: $800.00
                    Expenses: $ 55.50 (Moneypaper)
                   Purchases: See above
                        Cash: $649.10
                 Total Value: $735.00 apprx.

The portfolio began with $500 on July 28, 1997, adds $100 on the 15th of every month, and the goal is to have $150,000 by August of the year 2017.