Monday, January 26, 1998 Barron's Roundtable -- Part Three of FourQ:
There have been some big consolidations in insurance. Are any of these
companies you've mentioned possible targets? MacAllaster: The
consolidation is continuing. They certainly could be. ReliaStar has
about $20 billion in assets, yet it sells for not much more than $1.2
billion in the marketplace. Certainly it's of a size that it could be
taken over. It would surprise me, though. They do very well themselves.
They are more apt to be buyers. Finally, I have two speculations here.Q:
They all sound like speculations.MacAllaster: No, the ones I've
mentioned so far are not low-priced. These are. First, EntreMed, which
is in the business of trying to find something to fight cancer. EntreMed
has a connection with a children's hospital up in Boston. It has been
financed by Bristol-Myers Squibb. It was formed in '91, went public
about two years ago at $15. Sells for 11 now. It has 12 million to 13
million shares outstanding. They are working on a substance that shrinks
blood vessels around a tumor and starves it. They have had some success
in animals. It has about $40 million in cash, or $3.50-$4 a share. The
range in the stock, every year, has been like 6 to 17. You could
probably make a case, on a short-term basis, to buy this thing. And my
guess is that if you shorted it at some point during the year, you could
also probably make a buck on a short-term basis. But I also think that,
long-term, it's got a good chance. Your risk is the $11 you pay for it
here. If they are successful, you get a high multiple of that. They're
high-grade people. It's well-financed. But it is just a speculation.
Perkins: How far along is their product?MacAllaster: They've only tested
it in animals. There were some articles a month or two ago about their
studies that ran the stock from about 7 1/2 to 16 in two days. Then it
came back down to 11. They had some success in mice. Reduced the tumors.
Another speculation: a bank down in Atlanta called Net.B@nk, which was
underwritten this last July at 12. The stock is at 11 1/2 . There are
six million shares. They basically take in all of their deposits over
the Internet. They do no other business on the theory that their cost to
attract deposits will be a lot lower than most banks'. They have capital
of over $30 million. Total assets are now up to about $100 million.
They've been in the red. Had a loss last year, will probably have a loss
in the first quarter. In the second quarter, they should swing into the
black and probably break even for the six months. It would make 20-30
cents for the year, all in the second six months.Perkins: If they have
$30 million to earn interest on, and a low-cost business over the
Internet, why no profits?MacAllaster: They just raised the $30 million
and they've been paying people. Their hope is that by the end of '99,
they'll have about $400 million of total assets, and earnings in the
neighborhood of maybe $10-$12 million, or close to $1 a share. Neff: Art
would be willing to pay 25 times earnings.Samberg: Speak for yourself.
MacAllaster: It is an Internet stock. Of course, there is no barrier for
anybody to get into the Internet business. In fact, Wells Fargo is large
on the 'Net already. But Net.B@nk has managed to set one up. They have
experienced banking officials running it. And they seem to be drawing a
lot of deposits.Ziegler: Is it doing any lending?MacAllaster: They
actually make mortgage loans.Rogers: I looked at this bank and thought
about buying it. But I figured that any bank that wants to can do the
Internet.Neff: Citicorp is pushing very hard. They've not only advanced
the state of the art, but reduced the price to the consumer.Rogers: I
agree with the theory one million percent. I just can't figure out why
this one would work and others not.MacAllaster: Net.B@nk has a chance.
And it's only trading at two times book. That is it.Black: "Sometimes
there are opportunities in oil." Q: Thanks, Archie. Felix, what are you
up to?Zulauf: I am going to be quite brief. As I said this morning about
the macro picture -- the developments in Asia will put downward pressure
on economic growth and inflation rates in the U.S. as well as in Europe
-- and those equity markets are still quite high. There will be earnings
disappointments and revisions to the downside. Therefore, U.S. and
European markets are vulnerable. I see cyclical bear-market declines.
But it will be a strange bear market because you'll have both interest
rates and equity prices declining. Something we haven't seen in any bear
market in the last several decades. The U.S market is the most vulerable
because its valuation is the highest of all. The U.S. market,
structurally, has the highest ownership by institutions and households
-- as high as they've been since the late 'Sixties, at the secular peak.
I think S&P earnings will be slightly negative this year. Expectations
are unrealistic. So a 20%-30% decline from the top is possible -- in a
very volatile way. In fact, I think this is going to be a volatile year,
but downwardly biased. So I'm short the S&P futures. And I won't
recommend the individual stocks.Q: You're so up, Felix.Zulauf: European
stock markets will also come down. The market with one of the highest
valuations is the most cyclical -- Germany. It's trading at over 20
times earnings. The German market index has a very high weighting in
capital goods, cars, chemicals -- also banks. And the German banks have
as much exposure to Asia as the Japanese banks, so they are in it deep.
The economic recovery has been weaker in Germany than in the rest of
Europe. Schafer: Are the earnings German companies report comparable to
U.S. ones now? They used to be understated.Zulauf: More and more so. Not
all of the companies, but the larger multinationals have all adjusted to
the U.S. standards.Schafer: So 20 times earnings is an apples-to-apples
comparison?Zulauf: Absolutely. Earnings growth expectations in Germany
are on the order of 18%-20% for '98, which are way too high -- and will
come down. Of course, the dollar/D-mark exchange rate is an important
factor for Germany. I see the dollar coming under some pressure in the
second half, because the U.S. will cooperate with the Asians much more
than the Europeans -- and that should hurt them. Another important
development is that Germany will have a parliamentary election in
September. The poor economic environment will, I believe, lead to a
victory by the Social Democrats. [Chancellor Helmut] Kohl will not be
re-elected.Q: What do the polls show?Zulauf: The opposition parties are
ahead by a margin of 10%-15%. However, in previous elections, that has
always been the case-then the opposition's lead in the polls has eroded
into the election. This time I think Kohl will lose, because he has
managed the economy very poorly. He has managed the German reunification
very poorly. He is forcing the country into the EMU [European Monetary
Union], which the majority of the people don't want to participate in.
And his loss has yet to be priced into the market.Q: When do you see the
German market starting to worry about that?Zulauf: Well, right now it is
worrying about other things -- and will go down with all the other
markets. But sometime beginning in the spring, it will begin to discount
that.Q: And the prospect of a Kohl loss will be a significant market
depressant?Zulauf: I think so, because the two strongest partners in
this EMU are France and Germany. Right now, the Socialists are in power
in France, but counterbalanced by the Conservatives in Germany. If that
tips over and the Social Democrats come to power in Germany, along with
the Greens, who they'll need to form a coalition, the financial markets
won't like it much. But that should be discounted before the election;
afterwards, the market could start up again.Biggs: Will that call into
question the whole progression of EMU?Zulauf: I don't think so, because
the Social Democrats are in favor of EMU. Except, their probable
candidate is not personally in favor of EMU -- even though his party is.
Which makes the whole issue very complicated. It's almost guaranteed to
be a political mess.Schafer: Didn't they also just raise the VAT by 17%
or so?Zulauf: They raised taxes. They'll go up this spring and then
again next spring.Biggs: Isn't that what Japan did?Zulauf: Exactly. They
are overestimating the momentum of the recovery, which basically has
been all export-driven. The domestic economy has not done -- Biggs: The
latest numbers on the Germany economy are negative, anyway.Zulauf: Now,
the export sector is rolling over and the domestic economy never really
recovered. So you have potential for negative surprises in the real
economy.Q: What happens to German short-term rates in front of EMU?
Zulauf: The Bundesbank has stated publicly now that short rates will
converge under EMU at the core countries' level -- Germany's and
France's -- which is about 3 1/2%. I believe it'll be even lower,
because the economic dynamics will roll over. So in the second half,
German short-term rates will come down, but not by as much as the
U.S.'s, because they're quite low now.Rogers: So, how do you play it?
Zulauf: I'd be short the DAX futures. But I don't want to mention any
individual companies. This is a market call. I also want to sell the
French market, the CAC futures. That index is also trading at 20 times
earnings.Q: Felix, will the big-caps and small-caps get hit equally in
Europe?Zulauf: The big-caps will probably decline more at the very
beginning. But over the bear cycle, the small-caps will decline more.
That's because the big-caps are multinationals that can optimize their
tax situations, their manufacturing bases, etc. They can squeeze
subcontractors. Then, too, there is another important thing going on in
Europe. As we go to EMU, European institutional investors who are
liability-driven, like pension funds or insurance companies, will be
able for the first time to invest outside their own national boundaries
without a currency risk. In the past, they've done very little of that,
precisely because of the currency risk. Under EMU, there will be new
pan-European EMU-type stock indexes created, including, for instance,
the 100 biggest stocks. Then, because most people underperform the
indexes over time, everybody will move into those big-cap stocks. The
smallercaps will be sold. You will see that over the next few years. So
a European small-cap theme is still way too early. Schafer: Felix,
there's been a lot of talk about the Year 2000 problem in computers. For
example, I hear that some Japanese banks are in a state of denial-as if
it is never going to happen.Rogers: They won't be around in 2000.
Schafer: Can European companies handle both the switch to EMU and the
Year 2000?Zulauf: The big ones are equipped for EMU, no question. But
whether they're ready for the Year 2000 is something I can't answer.
Samberg: There is a huge Y2K problem in Europe. It's well behind the
U.S. They all have to be brought up to snuff by 2000. The governments
there are in denial, just like our government is. Big companies, in
general, have addressed it, but beyond that, it's a real mess.Zulauf:
Maybe the French will stop the clock for a year or two.Samberg: Or
maybe a century or two.Rogers: But you're convinced, Felix, that there
will be a euro?Zulauf: The euro will start. I don't believe it will work
for 20 years. But it will, for a couple of years. The real test will
come once the euro is in force and we have a big recession in part of
Europe. Then people will realize that the currency-depreciation tool
isn't available in the individual countries anymore -- and that will be
a big problem. We are about to lose an important tool for managing the
economy. In fact, a recession in one part of Europe could lead to what
the EMU was supposed to avoid, namely, the rise of nationalism.
MacAllaster: Why can't they just depreciate the euro? Zulauf: They can,
but who decides?Schafer: They can't do it on a country-by-country basis. |
