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From: Cyrus Mashhoodi
Jul 26 1996 8:26PM EST
Reply #448 of 448
dppl, Jim and all the Gang:
Here is an article which justifies thinking of this thread.
Hope everyone will read, and learn so we may prevent people from
investing
foolishly in high hopes.
Fallen Stock Market Angels
Yesterday I talked about some of the dynamics that I believe are
behind the massive drops we have seen in some of the
once-popular "momentum" stocks, namely AMERICA ONLINE
(NASDAQ: AMER), C-CUBE MICROSYSTEMS
(NASDAQ: CUBE), IOMEGA (NASDAQ: IOMG) and US
ROBOTICS (NASDAQ: USRX). All of these stocks have
suffered humiliating corrections that have left many investors entirely
bereft of profits. As the sequential,
quarter-over-quarter momentum for these companies began to
decay, the shares violated many quantitative and technical
criteria and were consequently sold without regard to fundamental
value.
The obvious next question is where the fundamental value lies? If the
quantitative guys don't like how the companies are
doing relative to last quarter or sell-side analyst consensus estimates,
and the technical guys are looking for support (e.g.
signs that other people are buying the stock,) who is actually going to
be purchasing shares of these companies and at
what level will they start to get interested?
Among the many and varied approaches to investing, the so-called
"growth" school would seem at first to be the one that
is going to get interested in the stocks first when they hit the right
price. "Growth" investors look for cash-rich
companies at a price that is low relative to their rate of earnings and
revenues growth. This is the classic approach that
has been used at fund management companies like Fidelity and T.
Rowe Price for decades. However, there is a problem
with the thesis that growth investors will catch these falling stocks.
With the slowing sequential growth, many of these
companies will need to prove for two to three quarters that their
overall growth stories remain intact before these
investors will feel comfortable enough to risk their client's capital.
This would leave an eclectic band of special situations investors and
the absolute value gangs to be the first to step in and
start buying. With names like these, this leaves a significant distance
between where the momentum players had pushed
them to and where they start to look cheap on an absolute basis,
making for a heck of a lot of volatility. In order to
discern where many of these value investors might start to get
involved, looking at the quarterly run-rates for these
companies could be quite helpful. For the purpose of ease of
illustration, I will focus on C-Cube and US Robotics,
which product electronic components or peripherals and have simply
reported that sequential growth will slow, saving
similar analysis of America Online and Iomega for future columns.
C-Cube Microsystems just reported revenues of $72.958 million last
quarter and earnings of $0.39 EPS. Even with
sequential revenue growth slowing, year-over-year growth remains
strong and C-Cube should continue to produce
above average growth. But where is a fair price? If you take the last
quarter and multiply it times four, I think you come
out with a pretty low-ball estimate for what this company and its
ex-momentum brethren can do over the next twelve
months. With C-Cube, this would give you $291.83 million in
revenues and $1.56 EPS. At the current price of $25, this
puts the company at 16 times earnings on a per share basis.
With 35.697 million shares outstanding, C-Cube has a market
capitalization of $892 million. With $142 million in cash
and short-term investments on the balance sheet and $87.8 million in
long-term obligations, the company has an
enterprise value of $837.8, or about 15 times last quarter's net income
multiplied by four. C-Cube still has an enterprise
value/sales ratio of 2.87, well above most of its peers in the proprietary
semiconductor industry and something that is
probably going to keep value investors away for a while. Trading at 18
times trailing earnings and 3.7 trailing sales, the
company still continues to trade a premium to its peer group and its
long-term sustainable growth rate. The most
successful proprietary chip manufacturer in the world, Intel, has
growth earnings in the 20% to 25% range over the past
five years, implying that C-Cube still sells at only a slight discount to
its long-term sustainable growth rate. Before the
shares interest value investors, it will have to go lower.
US Robotics did $546.8 million and $0.66 EPS last quarter, giving it a
revenue run-rate of $2.19 billion and $2.64 EPS.
At $53 a share and 96.6 million shares you have a market
capitalization of $5.12 billion. With $114 million in cash and
$53.4 million in long term debt, the enterprise value is $5.18 billion, or
2.4 times run-rate sales and 3.12 times trailing
sales. Shares trade at 20 times the run-rate and 26 times trailing sales,
as netting out the cash for US Robotics is
negligible. As a pure-play on hardware for consumer access to online
services, sustainable long-term growth over the
next five years shoud fall between 30% to 50%. Consistent
misperception of the company as a commodity modem
manufacturer should make many value players want to buy it at a
larger discount, suggesting that 15 times the run rate or
a enterprise value/run-rate sales ratio of 1.5 or so is when the might
start to get really interested.
Quantifying the downside risk in both companies is a matter of
figuring out when it would present a compelling buying
opportunity for a class of investors that has as of yet not been
interested in these companies. The daisy chain of
momentum to value to growth to momentum again is clearly
illustrated in the semiconductor and semiconductor
equipment industries over the past two years. I think 15 times the EPS
run-rate for either company would be a
fundamental point where value investors would start to support the
shares, which would be ~$22 for C-Cube and ~$40
for US Robotics. The enterprise value to sales ratio would definitely
have to be below 2.0, but would not necessarily
need to fall below 1.0 to get these guys interested again. Using 1.5 you
have $12 on the downside for C-Cube or $34 on
the downside for US Robotics. Splitting the difference again, $17
would be a low for C-Cube and $36 would be a low
for US Robotics in a sustained correction as the companies pump out
solid quarters to rekindle the fires of the
longingly-amorous growth investors. |
