Fool
Portfolio Report
Thursday, November 13, 1997
by Tom Gardner
([email protected])
ALEXANDRIA, VA (Nov. 13, 1997) -- The Fool Portfolio rose 0.57%, a fine return... except for the fact that the market climbed 1.18%. We were buoyed by AT&T's two-buck climb and KLA-Tencor's four-dollar rise, but held back by America Online and 3Com, which dropped $2 3/16 and $9/16, respectively.
3Com (Nasdaq: COMS) has been in a four-week tailspin, the likes of which you won't often see. On October 12th, 3Com closed bidding $55 1/8. Today, the stock finished just above $30, marking a 45% decline.
With eyes closed, and face in my hands, the following images present themselves -- Minnesota Vikings defensive lineman, Jim "Wrong-Way" Marshall, happily scampering into the New Orleans Saints' endzone, putting points on the board for the wrong team; the Leaning Tower hitting Pisan ground; Fool message-board manager, David Forrest, eating half of my brownie (as he did); the derailing of the Little Engine That Could; and Dick Morris avoiding the subject of those Capitol Hill "exploits" in media appearances during his book tour.
Humiliation and error, accident and loss.
Just what the heck has happened to 3Com? Their merger with US Robotics has proven a burden. The first problem with the merger -- one we overlooked in this column -- was that it took place at a time of enormous upheaval and rapid growth in the networking industry. Typically the worst time to acquire or merge is during periods of extraordinary growth in your industry... when the time-intensive planning for integrating operations distracts a business from blasting ahead.
The second, and more significant problem, is that 3Com joined a company in shaky financial standing. When the merger was approved by shareholders on June 11, US Robotics had recently announced a 14% climb in accounts receivable for the previous three months.
What the heck does that mean?
Well, US Robotics was booking as sales a good amount of cash which they hadn't
yet collected. With an increase in international business, they were receiving
payments later and later. And with their new x2 modem technology on the market,
they were pushing sales at the end of that second quarter -- with less
concentration on collecting the payments.
Fools, there are a lot of good excuses for rising accounts receivable. But in the best of all possible worlds, you can find companies whose business model doesn't create a need for those excuses. In this case, US Robotics brought $718 million in receivables to 3Com's balance sheet and a largely untested new product line. This ISN'T to imply that US Robotics was a loser or is a loser. It is, however, to suggest that buying out a company like USRX, surrounded by question marks, in the middle of a momentum run in networking... is challengable.
Convenient of me to do so after the fact, I know.
At the time, COMS was trading at $50 a share. Through bouts of volatility, we're now sitting on a 40% decline since the merger. This during a period that chief competitor, Cisco Systems (Nasdaq: CSCO), (without engaging in aggressive acquisition) has risen 20%.
Ooops.
Ok, so what to do from here? Analysts have hit 3Com with sharp downgrades over the past ten days. Robertson Stephens took the stock down to "Long-Term Attractive" (whatever that means). Morgan Stanley noted that 15 percent of 3Com's business is being rattled about in Asia, and reduced their 12-month price target to $48. And then Goldman Sachs dropped 1998 estimates by 15 cents, from $2.30 to $2.15. There is, however, a glimmer of hope a bit down the tunnel -- Goldman maintained their $2.70 estimates for 1999.
Most likely, The Fool Portfolio will sit through the bump and rumble and stumble that has been a part of our 3Com investment from the start. My suggestion is that investors study 3Com's balance sheet each quarter, with eyes moving carefully over inventory and receivable levels, while mostly ignoring the earnings performance. Thankfully, Eric Benhamou is still our CEO; he's proven masterful this decade; and we Fools are counting on him to bring order to the madness and singlehandedly rekindle demand for modems across the globe. We may be asking for a little much there -- but if you don't ask, you don't get.
In all seriousness, I believe the latest hit represents a market overreaction. If 3Com can methodically clean up their balance sheet en route to getting within 5% of estimates over the next year, the stock will seem fairly priced around $60. Thus, we plan to hold at $30.
America Online (NYSE: AOL) had an interesting ride today. The stock opened at $71, rapidly fell 10% to $64, then closed the day at $68 1/2. The drop may have been related to AOL's announcement yesterday of the issuance of $350 million in convertible notes. AOL has marked the notes to convert at $104 per share in the year 2002, pinpointing 11% annual growth for the stock. That's conservative -- and perhaps disappointing for investors. But the interest rate on those notes is only 4%, meaning that AOL landed some inexpensive financing yesterday, as well as delaying dilution for four years. Of course, the investing community calculates the dilution today -- assuming, as they are, that the conversion will take place in 2002. (If ya didn't catch all that, please drop by our America Online folder.)
The market may also still be struggling with AOL's advertising sales for the most recent quarter.
As always here in the Hall of Portfolios, we're engaged in trying to locate organizations that are adding value in excess of cost for their customers, that are innovative, and that have sales forces which believe in the product line. Tracking down those quality organizations, in my estimation, is far more important than trying to divine a fair value for their shares in the short-term. The best (and the extreme) example is Coca-Cola, which may have seemed overvalued dozens of times in the past 70 years, but which has most substantially rewarded those who just bought and held, and added more.
Segue coming...!
Our search for those sorts of organizations has most recently extended to the non-profit world, where we are proposing investments in Share Our Strength, which David wrote eloquently of in last night's report (11/12/97: The Fool's Newest Partnership). It's the only investment recommendation you'll find in this column!
In the days ahead, we'll be presenting you more information about the organization. We'll be breaking out more formally how their charity works. And, I expect we'll be showing some photographs of existing kitchens. For many reasons, we're extremely excited about this and want you to know that when the opportunity to contribute begins on Monday, November 17th... no contribution is too small. Size doesn't measure up to meaning.
We have received some extraordinary emails in the past 24 hours. The potential for good (even great) acts by hundreds of thousands of Fools across the globe (yep, a joyful note from Holland arrived last night) is a wonder to behold.
--Tom Gardner, Fool
A Missed Beat: Yesterday's Fool recap contained an error. The text stated, "Ninety-four years ago, on November 12, 1903, Enrico Caruso recorded the aria "On with the Motley" from Verdi's opera I Pagliacci; it became the first million-seller in recording history and hit #1 for four weeks."
It was actually Leoncavallo, Ruggero -- not Verdi -- who wrote I Pagliacci. The Fool apologizes for the error. We happily received email corrections from several Fools, including the editor of La Scena Musicale, and another witty reader who sent the correction with the Foolish headline, "What aria talking about?"
Fool on...
Today's FoolWatch: all the latest in Fooldom.
TODAY'S
NUMBERS
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Day Month Year History FOOL +0.57% -5.09% 17.77% 214.31% S&P: +1.18% 0.22% 23.75% 99.97% NASDAQ: +1.04% -2.25% 20.66% 116.30% Rec'd # Security In At Now Change 5/17/95 980 Iomega Cor 2.52 28.94 1048.31% 8/5/94 355 AmOnline 7.27 68.50 841.86% 10/1/96 42 LucentTech 47.62 78.75 65.38% 8/11/95 125 Chevron 50.28 82.00 63.07% 8/12/96 110 Minn M&M 65.68 95.06 44.74% 8/12/96 130 AT&T 39.58 48.75 23.18% 9/9/97 290 Amazon.com 38.22 46.25 21.01% 8/12/96 280 Gen'l Moto 51.97 62.25 19.77% 4/30/97 -1170 *Trump* 8.47 8.63 -1.84% 8/24/95 130 KLA-Tencor 44.71 41.50 -7.18% 6/26/97 325 Innovex 27.71 24.50 -11.58% 8/13/96 250 3Com Corp. 46.86 30.31 -35.31% Rec'd # Security In At Value Change 5/17/95 980 Iomega Cor 2509.60 28358.75 $25849.15 8/5/94 355 AmOnline 2581.87 24317.50 $21735.63 8/11/95 125 Chevron 6285.61 10250.00 $3964.39 8/12/96 110 Minn M&M 7224.44 10456.88 $3232.44 8/12/96 280 Gen'l Moto 14552.49 17430.00 $2877.51 9/9/97 290 Amazon.com 11084.24 13412.50 $2328.26 10/1/96 42 LucentTech 1999.88 3307.50 $1307.62 8/12/96 130 AT&T 5145.11 6337.50 $1192.39 4/30/97 -1170*Trump* -9908.50 -10091.25 -$182.75 8/24/95 130 KLA-Tencor 5812.49 5395.00 -$417.49 6/26/97 325 Innovex 9005.62 7962.50 -$1043.12 8/13/96 250 3Com Corp. 11714.99 7578.13 -$4136.87 CASH $32438.81 TOTAL $157153.81
