Newsletter Q2 2000
April 1, 2000
Technology
Fluff vs. Cash
During
the last year, many internet and related technology companies had initial
public offerings that appreciated substantially in price shortly thereafter.
There has been much speculative interest and the price of some stocks
appeared to be based upon the number of press releases with key buzz words
such as "B2B," rather than fundamental considerations such as
revenues or earnings. In recent
weeks, the valuation disparity between "new economy" and "old
economy" stocks has become too obvious to ignore.
Speculators have realized that since they pay their bills with dollars,
it might be a good idea to buy companies that generate cash.
The
March 20 issue of Barron's had an article entitled "Burning Fast"
which listed 207 internet and related technology companies that were losing
money. Many of the companies had
multi-billion dollar valuations even though they would have to improve profit
margins significantly or obtain additional financing through secondary
offerings to remain in business. Some
of the companies have sold additional stock or convertible bonds through
secondary offerings and others are currently in the process of doing so.
In
addition to the supply of shares from secondary offerings, a significant
number of shares are likely to be sold by corporate insiders as lockup
agreements expire on restricted stock. Lockup
agreements are contractual agreements between the underwriters and major
shareholders that prevent the sale of shares within six months or a year of
the IPO. In many IPOs, the number
of shares sold may represent only 10 to 20% of the shares outstanding.
The remaining shares are retained by insiders.
Since many of the companies that have gone public in the last year are
losing money and have high valuations, corporate insiders will probably be
eager to sell significant portions of their holdings when their lockups
expire.
The
recent declines of the NASDAQ Composite Index are likely to continue as
investors become more attuned to business fundamentals.
Price declines of 80% or more will not be uncommon for some of the
technology fluff stocks. Businesses that generate cash, however, will continue to gain
investor attention. Value
investing will be back in favor before the year is over.
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Updates
General
Motors (GM) announced in February its offer to shareholders to repurchase GM
common stock in exchange for approximately $8 billion of GM Class H (Hughes
Electronics or GMH) common stock. An
additional $7 billion of GMH stock will be contributed to finance pension
benefit related liabilities. The
combination of the reduction in the number of GM shares outstanding and lower
pension expense should increase earnings per share by approximately $2.50.
Consensus earnings estimates for 2000 and 2001 are now $9.64 and $11.15
per share, respectively.
Meditrust
Companies (MT) announced a reorganization plan at the end of January that
included an orderly disposition of healthcare assets, suspension of the
dividend, and substantial reduction in debt.
The Companies have $210 million in debt that matures in 2000 and $1.4
billion that matures in 2001. As
of December 31, 1999, Meditrust's healthcare portfolio which is subject to
disposition had a book value of approximately $2.2 billion.
Many investors have overreacted to the reorganization.
MT had funds from operations of $2.00 per share in 1999 and tangible
book value of $14.56 per share. As
of the end of March, MT is selling for 1X funds from operations and 13% of
tangible book value. Absent any
unusual surprises, MT has significant recovery potential.
American
Real Estate Partners (ACP) announced that the partnership would not redeem the
preferred units on the March 31 payment date.
Holders of the preferred units will instead receive a 5% pay-in-kind
dividend. I had been expecting a
redemption of the preferred units and will be reducing the position over time.
AMR
Corp. (AMR) completed the spin-off of Sabre Holdings Corp. (TSG) in mid-March.
Sabre provides information technology solutions for the travel and
transportation industry and links over 130,000 travel agency terminals.
Sabre also owns 70% of Travelocity.com, which recently merged with
Preview Travel to become the third largest e-commerce site.
Sabre currently sells for 17.6X estimated earnings.
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Additions
Equity
Inns (ENN) is a real estate investment trust focused on the upscale extended
stay, all-suite and midscale limited service segments of the hotel industry.
ENN owns 102 hotels that are leased for a percentage of revenue to
various operators. Major brand
names of the hotels are Hampton Inns, Residence Inn, and AmeriSuites.
ENN currently sells for 4.3X 1999 funds from operations of $1.59 per
share and has a dividend yield of 18.5%.
Interstate
Bakeries Corp. (IBC) is the largest wholesale baker and distributor of bread
and snack cakes in the United States. IBC
products are marketed under many brand names including Wonder, Hostess, Home
Pride, Dolly Madison, Millbrook, Holsum, Roman Meal, and Marie Callender's.
The Teamsters Union recently ended a strike that had shut down
production at several plants. Northeasterners
were relieved to hear that Twinkies would once again be on their grocers'
shelves. IBC is currently selling
for 8.6X estimated earnings.
ITLA
Capital Corp. (ITLA) is the holding company for Imperial Thrift and Loan
Association, which has over $1.1 billion in assets and is primarily engaged in
originating real estate loans secured by income producing properties.
The company has a strong balance sheet with an 11.1% equity/assets
ratio and is currently selling for 5.3X estimated earnings.
RGS
Energy Group (RGS) is a holding company for Rochester Gas and Electric, which
produces and distributes electricity and gas around Rochester, New York.
RGS has a dividend yield of 8.5% and currently sells for 8.7X earnings.
UnumProvident
Corp. (UNM) provides group and individual disability, life, and other
insurance products through its subsidiaries in the United States, Canada, and
the United Kingdom. UNM had some
nonrecurring charges in the second and third quarter of 1999 for reserve
adjustments, merger-related expenses, and early retirement for some employees.
UNM's stock price had dropped about 80% from its high last year and is
currently selling for 6.3X estimated earnings.
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Deletions
Autodesk
(ADSK) met my price objective and profits were taken.
Qualcomm
(QCOM) was sold in most accounts early in the quarter.
The company has done a great job of bringing their technology to the
marketplace. The valuation,
however, left modest upside potential for the stock price.
Geltex
Pharmaceuticals (GELX) was sold for a small profit. Revenue projections
and earnings estimates by research analysts had been reduced substantially
since the company was purchased. As a result, GELX was used as a source
of cash.
If
you have any questions regarding your accounts, please do not hesitate to call
me.
Sincerely,
Robert G. Kahl,
CFA,
CPA, MBA
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Sabino
Investment Management, L.L.C.