August 21, 2000
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Barron's Cover
Early Bird
An MFS fund tries to hop on rising stocks ahead of
the momentum gang
By DAVID FRANECKI
Mark Regan looks for fast-growing companies whose stock is on the
rise, but don't dare use the "m" word -- momentum -- to describe him.
He says he's not a momentum player.
Regan, who runs the MFS Mid-Cap Growth fund,
doesn't think highly of momentum investors. The
44-year-old portfolio chief asserts that it doesn't take
much thought to be a member of their tribe, to watch
stock charts for fast-climbing issues, hop on and hope
the ascent continues. Instead, he tries to locate
winners before they've surged. To Regan, being
early isn't a mistake; it's a modus operandi.
He doesn't like companies with too many
competitors. Instead, Regan looks for outfits whose rivals have been
weeded out to about two or three and industries in which it's clear
who the leader is. If he finds a company attractive, he'll buy it and
jump off when the stock hits his target price. The former engineer and
McKinsey consultant looks for companies that are growing 25%
annually and that don't seem overpriced -- a factor that separates him
from the momentum pack.
While more than half of the stocks in MFS Mid-Cap Growth are
traditional growth issues, Regan is also willing to give some fallen
darlings a second chance. About a quarter of the stocks that have
dropped by 60%-70% melted down because of short-term problems,
which masks the fact that they are still great businesses, he figures.
Consider Network Solutions (now owned by VeriSign). The stock
went from $72 last March to about $30 in May amid fears that it
would be stripped of its government-sanctioned monopoly on issuing
Internet domain names -- the .com, .net, .edu and .org at the end of
Web addresses. Regan says MFS's analysts realized before the
market did that an agreement the government had negotiated with
Network Solutions couldn't be ended without an act of Congress.
Thus, a change was unlikely and, if one were to occur, it would take
years to implement.
What Regan saw was a company growing 100% annually, with a
monopoly on what it calls "building permits for the Internet." You
can't open a Website without doing business with Network Solutions
because you need a domain name for every site, making the
company neatly positioned to profit from the Internet boom. Regan
made the stock his top holding, and it went from $29 in March to
$244 in September -- one of the best investments he's ever bought.
Because Regan avoids momentum investing, MFS Mid-Cap growth
won't shoot the lights out when the market is roaring, but Regan's
steady approach has paid off over the long term. The fund has
returned 39.34% annually for the past three years, and is up over
21% this year. That record puts it in the top 20% of its peers, in both
periods.
One of Regan's favorite stocks falls into the second-chance category.
VISX makes equipment for laser eye surgery, the increasingly
popular procedure used to correct vision. Not only do the machines
needed for this fetch as much as $500,000, but most of VISX's
revenues come from royalties doctors pay when they perform surgery
with the equipment.
For much of 1999, the company
was humming along, with a 70%
annual growth rate and a
commanding market share. Its
stock hit $103 last July, but was
rocked in December after a
court ruled that Nidek, a
Japanese competitor that doesn't
charge doctors a per-procedure
fee, could sell equipment in the
U.S. VISX shares slid further in
January, when it was learned
that fourth-quarter demand for the surgery had sagged; this later was
shown to be just a seasonal slowdown, as people put off undergoing
procedures until after the holidays. And the stock was smacked again
in February when VISX announced that it would slash the royalty
doctors must pay, to $100 from $250 per procedure. Analysts cut their
earnings estimate to 85 cents a share this year, about half of what
previously had been expected. By February, the stock had tumbled
80%, to around $16.
VISX last month adopted a poison-pill plan to deter corporate raider
Carl Icahn, who announced his intention to buy $15 million of its
stock -- about 11% of the outstanding shares -- at the then-current
price. Regan thinks the interest of Icahn, normally a deep-value
buyer, is evidence that VISX is undervalued by Wall Street.
Regan believes a rebound is ahead for the company, which still has
70% of a fast-growing market. He figures that the royalty reduction,
which has let doctors dramatically cut their own fees, will boost
demand substantially. Whereas last year the operation cost about
$2,100 per eye, now about half of the doctors doing the surgeries are
charging that amount for both eyes. Only a few million procedures
have been done so far, and there are about 85 million eyes out there
that could be corrected with laser surgery, meaning the market is
barely penetrated. It also helps that several high-profile athletes --
most notably champion golfer Tiger Woods -- have raved about the
procedure.
Table: Top 10 Holdings
Regan says the key for VISX will be to maintain its market share and
keep the procedure growing at a 70% clip. Although some analysts
believe VISX will lose share, Regan disagrees, pointing out that the
company controls the market for doctors who perform the highest
volume of eye surgeries and that VISX machines have a superior
record of reliability, compared with competitors'. He expects the
company to earn 85 cents a share this year, $1.35 in 2001 and $2.10
in 2002. With a 65%-70% annual growth rate, the stock, he contends,
could easily crack $100 again by 2002. It recently was around 24.
One thing that's helped MFS Mid-Cap Growth beat its peers this year
is that it owns fewer tech stocks than most of them. However, Regan
isn't afraid to buy technology, if he finds an enticing issue.
One of his favorites is Emulex, which makes adapters crucial to data
storage. Many fund managers have jumped on the storage
bandwagon, snapping up better-known names like EMC, but Regan
thinks Emulex will grow as fast or faster than EMC and is cheaper.
Emulex trades at 80 times expected 2000 earnings; EMC, at 123
times. "It's hard to find a storage area that's reasonably valued,"
Regan says. In March, the stock got as high as $218, then backed
down into the 40s. Lately, it's been in the low 70s.
Every storage device must hook up to what techies call a "bus,"
which is essentially a pipe. In order to make this connection, they
need adapters, formally known as "host bus adapters," which is what
Emulex makes. Only two or three companies produce these devices.
And Regan likes companies that have few direct rivals. The fund
manager expects Emulex to make around $1.30 a share in fiscal
2001, which would mean growth of about 60%. Regan thinks that
will push the stock up to $90-$100 in the next six months. |
