The Next Blue Chips
BARRONS
Don't fret about finding the bottom, says fund manager; prices are good now
An Interview With Barbara Marcin ~ Taking the helm of a brand new
large-cap value fund in August 1999 might have seemed a tad out of step with
the times. Now, with gains of 11% posted last year and an advance of 8.5%
so far this year in the Gabelli Blue Chip Value Fund , not only is Marcin right
in sync, she's also showing herself to be a seasoned value manager.
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Q: You've owned Compaq for a while. Have you continued to buy?
A: I have. I owned it last year and because the fund has actually seen some
nice growth this year -- it started out the year with $22 million in assets and
now is at $65 million -- I've continued to buy it. Compaq is the largest
position in the portfolio. The other top positions are Cendant and Philip
Morris.
Q: What are you betting on?
A: Compaq gets a valuation as if it were simply a PC company, which it was
just a couple of years ago. But half of its sales now, and it's still a growing
area, are in enterprise sales: servers and storage. The valuation on the
company does not reflect that at all. That's partly because people are just
becoming more aware that the company has faster growing, newer products.
Also, Compaq has gotten a quality discount over the last couple of years
because it did not compete well against Dell . It acquired Digital Equipment
Corp. nearly three years ago and that was somewhat of a disaster in that they
really paid too much. This is typical; when I buy a company it usually has
some sort of quality discount in investors' eyes, and there is something wrong.
But it certainly has been outperforming on a relative basis over the last six
months to a year, even.
Q: Outperforming other PC makers or what?
A: Other PC companies, like Dell, Gateway , or Apple and, more recently,
companies that also make enterprise products like Hewlett Packard or Intel.
Compaq deserves somewhat of a mixed multiple because half its business is
PCs -- commercial and personal -- and half is now enterprise. It has definitely
been an objective of theirs to lessen their dependence on PCs over the last
couple of years.
Q: Isn't everybody moving into servers?
A: But Compaq has become the leading seller of servers with a No. 1 market
share, and storage is a strong part, maybe 15%, of sales, which is a high-
multiple business.
Q: What about its numbers?
A: Low expectations are in the numbers here, and this year I think 85 cents a
share is reasonable to expect. Earnings are such a wild card, but I'm very
comfortable saying that at some point within the next four quarters, earnings
will look more like $1.10-$1.20.
Q: That's normalized?
A: No, normalized might be closer to $1.30. This year is such a slowdown
that from this reduced base the company can grow earnings maybe 15% to
20% the next few years. If I look at it on a discounted-cash-flow model, I feel
that 10% or 11% growth is priced in for the next five years. My target for the
company is 20 times $1.35 a year out, and that's a $27 stock. I think that's
conservative.
Q: What is your average cost of Compaq at this point?
A: My cost is between $15 and $22 a share. I'm comfortable with the values
in here.
Q: What's a newer tech name that you've been buying?
A: I have been buying Lucent since December. And lately I've been buying a
little bit of Nortel Networks , a little bit of Corning , Cisco and EMC .
Q: Why Lucent?
A: Lucent was one of the first to really sell off. The one thing really wrong is
that we are going through a cyclical downturn. But Lucent, of course, has its
own set of problems. It is a true value manager's technology stock, and in my
opinion it is selling at a value that indicates both the cyclical downturn and
quality discount that Lucent probably deserves right now. They missed the
boat on optical networking a couple of years ago and lost that business to
Nortel. They were slow to come out with new products, and when they came
out with the products they were not exactly what the market wanted. The
company missed earnings for four quarters in a row and, obviously, did not
have a very good grasp of its own business. Lucent was strong in vendor
financing and that was accounting for a portion to their sales, and that has hurt
them.
Q: Winstar just filed for bankruptcy and is blaming -- and suing --
Lucent in part for calling a loan.
A: That's part of why the stock is trading so cheaply in a cheap sector. It is
very vulnerable to bankruptcy and liquidity rumors. That's what drove it down
to $5 a share and what keeps it at $7 now.
Q: Have you been adding to your positions as concerns mount?
A: I am adding to it, and it is gut wrenching. With Lucent you have to believe
it has enough cash to pay for its restructuring and its ongoing business in
networking for the next year. It has additional businesses which are up for
sale, and so you have to think its cash position won't be a question 12 months
from now. I believe that. Sales to the large telecom carriers, you know,
particularly the regional Bell operating companies, continue to be strong. It's
gotten some business lately, announcing new contracts with Verizon
Communications and U.S. Cellular . They have good ongoing relationships
and a big base of installed equipment. That's what gives it a year of breathing
room and one reason I'm willing to take this bet. Lucent reminds me of 3Com
a few years ago; 3Com lost out big time to Cisco, but it also had a big base of
installed equipment and continuing good sales to large customers.
Q: What's it worth?
A: I value it on a price-to-sales basis and a discounted-cash-flow basis, and I
come up with $15 a share. I value the Lucent share and the Agere portion
separately. If I value Lucent at 1.5 times sales, excluding Agere , I get about
$12 a share, and if I value the Agere portion at 2.5 times sales, I get $3 a
share. And my sales numbers for both are conservative. There's been no
recent growth and I'm looking at sales from a year and a half ago. On a
discounted-cash-flow basis, I'm assuming normalized earnings for Lucent of
about 80 cents a share.
Q: Why the focus on price-to-sales?
A: Price-to-sales is a valuation metric that works for an industry that is very
cyclical and where you don't think anything is really going to change in the
future so the past has some relevance. Technology is certainly cyclical, as
we're seeing right now. I know I will probably get a lot of grief about
price-to-sales, because there is so much change in technology, but I still think
it is relevant. Lucent at 1.5 times trailing sales is the bottom valuation of the
last five years.
Q: What are you most enthusiastic about at this point in your portfolio?
A: Of my top five or 10, I really like Compaq, Cendant and Philip Morris.
Those are ones I am looking to to add performance to the portfolio over the
next year.
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