Focused Fund
Manager expects a tech rally by yearend
Battle for a Name
At the start of the year, the tiny Dessauer Global Equity Fund drew attention
when its 26% gain landed it in the top spot among all such funds in the first
quarter. Most had managed a mere 3.6%. A healthy portion of large-cap
U.S. names -- about 80% of the portfolio -- powered the $75 million fund to
those lofty heights. The fund remains among the top 15 global funds for the
year, up 8.4%, compared with a loss of about 4.5% for the average global
offering, but the upstart has suffered some comeuppance. In the quarter just
ended, it lost about 11%, with much of the damage coming in the past month,
largely the result of its commitment to the telecommunications sector and to a
concentrated set of stocks. McIntyre, president of $600 million Dessauer &
McIntyre Asset Management, has run the fund since its birth as a closed-end
fund in 1997. It converted to open-end status in April 1999, a month before
founder John Dessauer, best known for his investment newsletter and
appearances on Louis Rukeyser's Wall Street Week, abruptly relinquished his
60% stake in the firm, making McIntyre sole proprietor. The two remain
locked in a legal battle over the use of the Dessauer name. We met with the
Notre Dame grad at the firm's headquarters in South Orleans, Massachusetts,
on the last day of summer to get his impressions on the shifting investment
sands -- and on the Fighting Irish's season so far.
-- Sandra Ward
Barron's: Hard to be as upbeat about the market and corporate
earnings as you were in August. Or is it?
McIntyre: August was a surprisingly good month, something we can barely
remember now. Most people thought the market would either do nothing or
go down. Six weeks ago people were looking for Fed hikes and the game
was trying to predict how many and how often. That seems so silly now.
When it became clear the Fed was going to cease and desist for this year and
probably this cycle, that kicked off the August rally because lower interest
rates, or at least stable interest rates, are good for the financial markets. But
since Labor Day the latest bugaboos are the euro and oil prices. I don't mean
to dismiss either one of them and, because we invest globally, the currency
issue is something we think about. But the euro has gone virtually straight
down. It was probably 86-87 cents five or six weeks ago and now we hit a
new low, but a marginally new low, of 84, and it is as if the world has ended.
It's an issue, but it's an issue that cuts both ways. It wasn't so long ago that we
would wake up every day and hear the dollar had hit a new low. Of course,
at the time we had trade deficits and the dollar was down and people
wondered the same thing:
Should the Fed raise rates to defend the dollar? Luckily, after the experience
in 1987, they did not. And Corporate America went on to become very
efficient, and now we have a strong dollar.
My point is that you can't have a weak euro without having a strong dollar, or
a strong dollar without a weak euro. So you are always talking about the
same thing. If you're an investor, if you're a fixed-income investor, it's more
important because you're focused on principal and interest. But for
stock-market investors, it cuts both ways. A weak euro is stimulative to the
European economies, it's stimulative to exporters. Philips Electronics in
Holland is a beneficiary, just from an accounting-translation point of view, as
are names like Glaxo Wellcome and Elan. But if you're going to own Philips,
you shouldn't own it because you think the euro is going to be strong or weak.
If you are going to own Eastman Kodak -- we don't, by the way -- you
shouldn't do it just because the dollar is going to be strong or weak. That is a
fringe element. Clearly, some people are going to miss numbers and they are
going to blame the euro. Last year, they missed numbers and they blamed
Y2K. It is an acceptable reason, but only at the margin. Managements don't
run companies based upon currency fluctuations, because they can't do
anything about it and because that's not how they're going to reward
shareholders. Clearly we have too strong of a dollar, and if we thought the
Fed had no reason to raise rates in August, we now have a second reason. I
remain optimistic, and with prices down so far in September, there are
opportunities to buy some very good companies, like a Vodafone or Philips,
whose earnings prospects haven't changed that much.
Q: Many investors were looking for more growth out of Europe this
year. What about you?
A: The European Community has been raising rates, too, in an ill-advised
attempt to protect the currency. Where conventional wisdom holds that if
central banks tighten policy and raise rates, capital flows will follow, the
evidence of the past 10 years has been, for the most part, the opposite.
Capital flows go where they are treated best, not to where overnight interest
rates are the highest. Money is flowing into the U.S. at an incredible rate-just
look at the number of European companies buying U.S. companies even with
the euro down as it is -- and the reason is they are buying better business
prospects and better earnings prospects. This is the most dynamic economy.
Q: But oil prices are a real issue and pertinent to corporate profits.
A: Oil is an issue. And people remember very vividly waiting in gas lines. But
there are no gas lines. People began consuming more gas during a time when
there was little investment in refining because prices were so low. Now oil
prices are acting, as you might imagine, as a big tax. After spending more
money at the gas station, people have less money to stay in hotels, to go to
Las Vegas or whatever else they might do. So we are caught betwixt and
between. We are going through a market cycle, but we are going to get
through it.
Q: What does this mean for your portfolio?
A: For the most part, we invest in global franchises with the exception of a
couple of special situations. But the essential candidates are here in the U.S.
We try not to react to macro problems and we try to go where the bargains
are. When the Fed was tightening earlier this year we were buying financial
stocks. Countrywide Credit and Citigroup were two names we picked up. In
technology and telecom stocks, which we are getting hurt on, the market isn't
differentiating. That presents tremendous entry points. A company with a
business plan like LSI Logic sees its stock corrected from 90 a share to 27.
Its bookings are at all-time records. National Semiconductor, Texas
Instruments, Cypress Semiconductor all have excellent forecasts. Earnings are
up, in many cases, very, very strongly. I think all of this sets us up for a
tremendous rally, whether before or after the election I don't know.
Q: But sometime before the end of the year?
A: I think so. I don't know if it is coincidence or what, but October 1997 was
a tremendous bottom. October of 1998 was a tremendous bottom, October
of 1999 was a tremendous bottom. I thought this year might be a little
different because in all three of the last three years, of course, the market
started out really strong in the first six months before flopping down in
October. This year we never did break out of the gate strong.
Q: So, what's the mix in your portfolio?
A: The U.S. stock portion has grown tremendously. Three years ago, we
started out with a mix of 60% U.S. and 40% the rest of the globe. Now it's
more like 70% U.S., because of market appreciation, and 30%, mostly in
European stocks. Lately-in the past three months -- we've been doing some
realigning to take advantage of opportunities in Europe. We own three
life-science companies in Europe and have started to build our positions in
European telecoms.
Q: What names do you have there?
A: Vodafone, Cable & Wireless and KPN Qwest, a stepchild to Qwest
Communications, another name in our fund, which is how we got to to know
it.
Q: What's your approach to picking stocks?
A: We are focused, we have only about 20-25 positions. When we get a
winner, we want it to count. Scientific-Atlanta is 15%-16% of the portfolio
and we have trimmed some. The stock has corrected from 90 to under 60
and at 90 there was probably a bit of puff there. So at times like this the fund
can go down disproportionately, too. But the key thing is to focus on trends,
global trends. We want to own the global powerhouses involved in the
communications revolution. The technology, telecommunications,
entertainment, financial-services and Internet-infrastructure companies that
should benefit from all the advances.
Q: What portion of the portfolio is devoted to communications and
telecom?
A: About 40%-45%, which is bit of an overweighting, but the S&P 500 is
heading there quickly. Certainly what is happening in the economy is slowly
but surely being reflected in these indexes.
Q: What's your next-biggest sector position?
A: Financial services. We've had some big winners there, including
Countrywide Credit Industries and SEI Investments and Citigroup. But we
are always trying to be opportunistic. We are not out buying things when they
are popular. We bought WorldCom when it was doing the MCI deal and
Vodafone in this year's rout. We try and keep in mind the long-term trend of
the businesses these companies are in.
Q: WorldCom is still not very popular. Do you still own it?
A: When things like that go against us, we do a lot of venting, but as long as
we like the fundamentals we stick with a name and add to it. We are taking
our lumps on WorldCom. Luckily, though, two of our three telecom positions
have done well this year: Qwest Communications and Cable & Wireless.
Q: But when the tide keeps going against you,
as it has with WorldCom, don't you have to
look at it with extra scrutiny to determine if there's been a fundamental
change?
A: WorldCom's come down on concern about long distance and because
they didn't do the deal with Sprint, although after hearing the latest news from
Sprint, maybe we should be rejoicing. But I am disappointed with its deal
witrh Digex Intermedia. Anytime you do a deal for $3 billion and it costs your
market capitalization a multiple of that, you should probably think about what
you're doing. And the market was hoping for other announcements, like a
plan to separate themselves from their long-distance business. But if you look
at a lot of our winners, they were once where WorldCom is today. Enron
couldn't shoot straight in 1997. They disappointed people for years. Time
Warner throughout the 'Nineties has been very frustrating. Scientific Atlanta,
our biggest position, went up tenfold in less than two years, but take a look at
what people were saying about it in October 1998.
Q: At what point do you sell a stock?
A: I have the perfect example. We moved into Lucent Technologies about a
year or so ago when their valuation was less excessive than Cisco's and they'd
had 15 straight quarters of earnings growth. Then they hit the Street with an
earnings warning. They missed the product cycle in optics. I'm not going to
run the first time. They had two more quarters where they hit their numbers
and said everything was in line. They announced a spinoff and appeared to be
taking steps to create value.
Then in July they warned not only for the September quarter but for the
December quarter, as well. There was a window where the stock didn't
collapse. At 55 we figured we could get out with our shirt on and take the
next six or seven months to watch the news flow and see if we wanted to get
back in. We also had other options. This is a stock market with plenty of
good names out there. We wanted to buy into Vodafone. Motorola is also a
new addition in the past three months. We bought Motorola as we moved out
of Lucent. It collapsed in April with the overall tech massacre and concerns
about handset margins. The stock split 3-for-1 and came down from about
60 to under 30 now. They reported a good June quarter and gave good
guidance for several quarters and for next year. They are not only in handsets
but in wireless infrastructure and in semiconductors, so they're enjoying some
pretty good up cycles.
Q: What are the estimates on Motorola?
A: Estimates are $1.03 a share for this year and $1.42 a share for next. It's
trading at about 21 times next year's earnings, and its growth rate is closer to
30%. It's a stock that everybody loves to hate because it has been frustrating
for the last several years. If you traded it, you probably made some money,
but as an investment it's been frustrating. First it was the semiconductor
business being in the tank for two to three years, then the Iridium debacle, and
now concerns about handset margins. But the company insists handset
margins will be 10% for the fourth quarter. There's a funny thing, too. When
Ericsson issues a profit warning, Motorola's stock goes down, Ericsson's
doesn't. Nokia issued a profit warning in August, and Motorola went down.
Motorola, though, keeps issuing solid guidance. And they are selling at a
multiple that's half of their competitors'. Their semiconductor business is going
to do well in the next several quarters. They also bought General Instrument a
year ago, and that's something we know a little bit about because they're the
biggest rival to Scientific Atlanta and the No. 1 set-top-box user. They are
also one of the biggest foreign investors in China.
Q: At what price did you buy it?
A: Right around 35-36.
Q: Any other names that are newish to the portfolio?
A: Tyco International. We started buying in February-March. The stock
plunged because of questions about their accounting, but their 10K got a very
aggressive once-over by the accountants and no changes were required. Then
they announced an IPO for their undersea fiberoptic-cable company. They
started buying their own shares. They came out with good numbers and a
good forecast. And the SEC not too long ago signed off on their accounting.
We were buying in the low 40s. I wish we had been as aggressive last fall
when it was in the 20s. Their core businesses are strong. They are making
acquisitions. They are back on track. They are expected to earn $2.17 a
share this year and $2.70 a share next.
Q: What about Vodafone?
A: The biggest reason we own Vodafone is
they are the biggest global player in the wireless
business. Their acquisition of Mannesmann is
forcing them to divest companies which they're
getting high prices for. That pays for the
new-generation licenses they've been buying at
high prices. So net-net, it's a wash. At the end
of the day, they are going to have the
balance-sheet strength to carry forward their
business plan while others won't. I'm not as
interested in cash flow this year as I am two or
three years down the road. You are buying
management, you are buying a theme and you are buying a balance sheet.
Q: How do you determine a good entry point?
A: At 60, everybody loved it. At 45, I thought it was a good entry point. It
has proven not to be the best. The stock is now at 37 or so. The big worry is
whether they can get a good return on their investment in the licenses. But
wireless will be a powerful force going forward. They also have a 45% stake
in Verizon Wireless, which will be worth a lot of money in an IPO.
Q: Any others?
A: LSI Logic. A chipmaker. About 60% of its business is communications.
It's a leader with Qualcomm in CDMA phone technology and is a play on the
communications buildout. It's involved with Play-Station 2. It has little
exposure to the PC market. Its stock has fallen from 90 to the current level of
27 or so after a revenue disappointment in June. But it's expected to earn $2
a share next year, and it's trading at about 14 times next year's earnings. It has
raised its guidance for revenue growth to 10%-12% sequentially for the third
and fourth quarter.
Q: On the financials, what's the case for Countrywide?. It's been up for
sale but so far nothing's occurred.
A: It hasn't been formally announced, but there have been reports that they've
hired Goldman Sachs to look for a buyer. Countrywide is run by Angelo
Mazzillo, a very savvy fellow, who may have determined that while the
company has been very successful at growing earnings and growing market
share and becoming technologically efficient, making them the low-cost
producer of mortgages and provider of mortgage servicing, the market isn't
rewarding them. They have a good brand name. But the company isn't a
depositary like a bank, and so it faces a cost-of-capital issue. There have
been a number of consumer-finance deals lately, including Citigroup buying
Associates First for about 16 times earnings. I think Coun-trywide has a
better outlook going forward, a more stable one. Earnings for the year ending
February are estimated at $3.50 a share. If you put a multiple of 16 on that,
you get about 56 a share. Which would be a new high for the stock. The
stock has moved up, and here in the high 30s it's probably fairly valued in the
near term. But I think a deal is coming. One of the reasons we've owned it for
so long is that it always remains too cheap to sell.
Q: And your special situations?
A: Park Place Entertainment began as a special situation. Before it was Park
Place it was Bally Manufacturing. That was 10 years ago. Arthur Goldberg
came in, an outsider who had never run a gaming company before. The
company had a good business but way too much debt and was in default on
its bonds for several years. Goldberg and his team rebuilt the company. He
rebuilt the balance sheet. Then he sold out to Hilton in December 1996. Two
years later, he saw many more opportunities for a separate gaming company,
given the consolidation that was going on. Park Place was spun out from
Hilton in January 1999, when gaming stocks were completely out of favor and
the conventional wisdom of the time was to stick with the hotel chain and
forget the crummy casinos. Asia was down. Everyone was overbuilding in Las
Vegas. We held on to our Hilton but we loaded up on Park Place. It spun out
at about $6 a share and is now at 14-15. In the intervening months, Goldberg
and his team completed the deal for Caesars Palace and the Grand Casinos in
Mississippi. Now it is the premier, the largest and the most profitable gaming
company anywhere. It's investment grade, so he has access to low-cost
capital. He has tremendous free cash flow he can use to buy in stock or pay
down debt. The chief financial officer, Scott LaPorta, said they will generate
enough free excess cash flow in the next five years to take themselves private.
That's pretty powerful. Park Place is a core holding for us in entertainment.
Q: Is there another special situation?
A: Also in 1996, Bally Manufacturing under Goldberg spun out a health-club
company, Bally Total Fitness. We owned a bit because it was spun out to us.
I never sold it, but I never bought more because it's in health clubs and had a
checkered past. But things changed when Arthur Goldberg named Lee
Hillman, the former CFO at Bally Manufacturing, chief executive about three
years ago. Goldberg owns 20% of the company through warrants. Insiders
own 25%. They fixed the balance sheet, began to grow same-store sales, so
to speak, and added different activities to fill the clubs. The fixed costs are
incredible at a company like this. So the business plan is to get more people
coming, more often, for different reasons instead of having it sit empty.
Revenues are growing. Earnings are growing. The stock, spun off at $4 a
share, is now at 25. It is projected to earn more than $3 a share next year.
That's a bit puffed up because it contains some tax-loss carryforwards, but
the reality is the company is selling at about eight times next year's earnings. I
think it's potentially worth twice what it's selling for today.
Q: When did you start buying actively?
A: When Hillman showed up in the summer of 1997. We continue to buy it
on dips. In the last year, the stock has done nothing, but earnings have
continued to come in on plan. But Arthur Goldberg and Lee Hillman are
dedicated to creating value for themselves and the shareholder. It doesn't fit
with the rest of our global themes, but we own it.
Q: One last note. Any predictions on the Fighting Irish?
A: The presumption was that if we got off to a real bad start, it would be the
end of Bob Davie. I think he's dodged a bullet. He made it past this earnings
call, so to speak.
Q: Thanks, Tom. |
