Top Dog or Mutt?

by Jeff Fischer(TMFJeff@aol.com)
and Ron (RonNTup@aol.com)

ALEXANDRIA, VA (Oct. 5, 1998) -- The stock market continued to be incredibly volatile, with Cisco Systems leading the Nasdaq to a roller-coaster drop. Cisco's earnings estimates were lowered by one analyst, but perhaps a primary driver behind the decline was news of the government opening an antitrust investigation of Cisco for unfair business practices. The stock of Lucent Technologies (NYSE: LU) declined with Cisco on the possibility that the two companies (along with Canada's Northern Telecom) worked together to segment networking markets among themselves.

Rather than paint the Fool column in "rumor red," let's paint it in red -- period. The Nasdaq smeared a bright red loss of nearly 5% across the day, while the S&P fell a comparatively slight 1.4%. The Fool did well to lose only 2.6% considering its exposure to technology and Nasdaq holdings. 3Dfx rose, Starbucks was flat, and other Nasdaq stocks that we own were generally down less than the market, including KLA-Tencor (Nasdaq: KLAC).

Two weeks ago we promised insight from a KLA employee on KLA-Tencor, the stock being a fraction above its 52-week low. Today is part one of a two-part column on KLA. Without further ado, I welcome and thank Ron from KLA-Tencor.

KLA-Tencor, by Ron (RonNTup@aol.com)

In a recent Fool Port Recap, Jeff asked the following: "When have we knowingly written about KLA-Tencor?" Since I am both a Fool and an engineer at KLA-Tencor (Nasdaq: KLAC), I volunteered to grab the pigskin and make a run of it.

From the Fool Port's perspective, and seemingly from the start, KLAC has been on a steep decline. These are the types of purchases we all dread. You have done your research, you have pored over the prospectus, and maybe you have even met the CEO for lunch (hopefully he footed the bill). You conclude the company is building a better mouse trap, has a terrific balance sheet, and looks poised for greatness (and at this point, you really love management). Certain your judgment is sound -- you plunk down a small fortune and lay claim a piece of, in this case, the KLA-Tencor pie. A few months later, the stock has begun its downward spiral.

Sound familiar? It should. This is precisely how the addition of KLAC to the Fool Port (excluding the CEO luncheon) has transpired.

By all appearances, this stock has certainly been a drag on the Fool Port. Certainly, there are some that would label it a "Dog." But is it really? And if we conclude it is a dog, do we own the Top Dog (that has just been dealt its fair share of bad days) or is it truly a mutt?

In 1996, the semiconductor market began to soften. Prior to the fall, the semiconductor market (1994 - 1995) was riding high on the Windows 95 and Pentium processor wave. Two symbiotic products came to market at precisely the right time. Everyone wanted Windows 95, and in order to run it, they needed Pentium processing power. Accordingly, PC sales began to rise and the semiconductor market began to fire on all cylinders.

The increased demand for PCs resulted in a need for increased semiconductor manufacturing capacity. Everyone involved in supplying the PC market was riding high as orders were coming in faster than they could be filled. Accordingly, component makers began to open new facilities and began filling those facilities with all the right equipment. The likes of KLA-Tencor enjoyed the ride and things were just peachy. During this peak, the Fool made its infamous purchase of KLAC. (It also purchased Applied Materials (Nasdaq: AMAT) at the same time, but subsequently took the loss on that stock.)

At about the same time these new facilities began to come online, the PC market began to soften. Everyone who wanted the Windows 95/Pentium combination had it. Additionally, with all these new facilities online, the market was flooded with excess capacity. As a result of this double whammy, we began the downturn of 1996.

Fast-forward to 1998. We are in the midst of another terrible downturn and are faced with the same double whammy that created the 1996 downturn. Add the spreading Asian contagion, and things look very dire indeed. Semiconductor companies in Asia have lost their ability to turn a profit, and even if they were profitable, the devaluation of their currencies makes our equipment all that more expensive. Couple these events with the current banking situation in Japan (where almost all Asian loans originate, since Japan has tremendously low interest rates), and even if those companies wanted to make equipment purchases, banks simply do not have ability to lend.

In the face of all this, KLA-Tencor management has battened down the hatches. We are very fortunate that K.T. management had such foresight and began cost-cutting measures soon after the news of the pending Asian implosion broke in October of 1997. Soon after the news broke, the CEO of Applied Materials appeared on CNBC and opined that the Asian crisis would amount to a mere road bump in its business plan. Clearly, it is much, much greater than that. As a result of his mistake, Applied Materials has had to cut 30% of its workforce (and has indicated it may cut more).

This is tremendously important, because during the next upturn, Applied will have to replace these individuals in order to meet renewed demand. The unfortunate thing is that these people have to be trained, and training someone to work on complex semiconductor processing equipment usually takes more than six months. This lends to a very long "training curve" for Applied Materials, and as such, it will not be able to respond to the coming upturn as quickly as it would like.

This is not the case at KLA-Tencor, however. Our management recognizes this paradox of cutting jobs to save money and has made every attempt necessary to keep everyone on board. To date, we have had minor "restructuring" job cuts, but they are nowhere near the magnitude seen at Applied Materials. I believe we have seen about 150 (or so) jobs lost due to restructuring. Accounting for the fact that we have more than 4,000+ employees, this is only about 4% of our work force. KLA-Tencor is continually positioning itself for the inevitable upturn, and this is another method in which this is being carried out. Oh� and let me add: this makes for a fiercely loyal workforce.

For certain, however, we are still in for hard times, as Japan has not sorted out its banking mess. It is widely believed that "where goes Japan, so too goes Asia." I believe that once that mess is straightened out, the region will begin to recover. Only then will we see equipment purchases rebound and K.T. return to its days of glory.

Tomorrow, part two. Where the future could take us and the industry.



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10/05/98 Close

Stock Change Bid ---------------- AMZN -4 1/4 106.00 AOL -4 1/8 103.00 T -1 1/16 57.56 DJT - 5/16 3.06 DD - 5/8 54.50 XON +1 7/8 74.88 INVX - 7/8 10.75 IP + 1/2 45.81 IOM - 1/8 3.50 KLAC - 15/16 21.69 LU -4 1/2 58.81 SBUX --- 36.50 COMS -1 5/8 28.50 TDFX + 9/16 11.38
Day Month Year History Annualized FOOL: -2.56% -4.63% 36.01% 356.46% 43.96% S&P: -1.40% -2.80% 1.87% 115.65% 20.25% NASDAQ: -4.85% -9.28% -2.14% 113.38% 19.95% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 103.00 2732.44% 9/9/97 580 Amazon.com 19.11 106.00 454.66% 5/17/95 1960 Iomega Cor 1.28 3.50 173.35% 10/1/96 84 LucentTech 23.81 58.81 147.03% 4/30/97 -1170*Trump* 8.47 3.06 63.84% 8/12/96 130 AT&T 39.58 57.56 45.44% 2/20/98 200 Exxon 64.09 74.88 16.83% 2/20/98 270 Int'l Pape 47.69 45.81 -3.94% 2/20/98 215 DuPont 59.83 54.50 -8.91% 7/2/98 235 Starbucks 55.91 36.50 -34.72% 8/13/96 250 3Com Corp. 46.86 28.50 -39.19% 8/24/95 130 KLA-Tencor 44.71 21.69 -51.49% 1/8/98 425 3Dfx 25.67 11.38 -55.68% 6/26/97 325 Innovex 27.71 10.75 -61.20% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 73130.00 $70548.13 9/9/97 580 Amazon.com 11084.24 61480.00 $50395.76 4/30/97 -1170*Trump* -9908.50 -3583.13 $6325.38 5/17/95 1960 Iomega Cor 2509.60 6860.00 $4350.40 10/1/96 84 LucentTech 1999.88 4940.25 $2940.37 8/12/96 130 AT&T 5145.11 7483.13 $2338.02 2/20/98 200 Exxon 12818.00 14975.00 $2157.00 2/20/98 270 Int'l Pape 12876.75 12369.38 -$507.38 2/20/98 215 DuPont 12864.25 11717.50 -$1146.75 8/24/95 130 KLA-Tencor 5812.49 2819.38 -$2993.12 7/2/98 235 Starbucks 13138.63 8577.50 -$4561.13 8/13/96 250 3Com Corp. 11715.99 7125.00 -$4590.99 6/26/97 325 Innovex 9005.62 3493.75 -$5511.87 1/8/98 425 3Dfx 10908.63 4834.38 -$6074.25 CASH $12005.75 TOTAL $228227.88

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