Multiple Compression

By: Chad Hudson | Wed, Aug 8, 2001
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A couple more telecom companies went bankrupt today. Metricom, the provider of Ricochet wireless Internet service, and Covad Communications, one of the many DSL providers that is has experienced the same fate. Covad is trying to convert $1.4 billion of debt into one up-front payment of $283.3 million and 33 million shares worth just under $15 million. This agreement would eliminate the payment of $2.4 billion over the next ten years. Quite a deal! This seems to be the newest trend in corporate finance. XO Communication is reported to be spending $250 million to retire $800 million worth of debt and Level 3 has expressed interest in similar plans. The only problem with these plans is that the companies are not fully funded. XO and Level 3 will have to raise capital at some point in the future. Looks like a big gamble betting the financing window will open back up before they run out of money or one last-ditch effort to cut costs enough to get Wall Street interested again.

Everyone still is expecting the economy to bottom within the next couple quarters. The most common reason is because the Federal Reserve has cut interest rates six times for 275 basis points, and there will be another 25 in a couple weeks. This has to stimulate the economy and since the lag is usually six to twelve months, it just has to start turning up soon. Please! Not only are bullish pundits calling for a bottom to be forming now or within the next couple quarters, they are forecasting growth to accelerate to bubble growth rates, with estimates calling for S&P 500 earnings to leap 20% in 2002.

Last night during Cisco's earnings conference call John Chambers, CEO of Cisco, said that 1999 and 2000 were the exception and not the rule. Chambers also noted that Cisco's long-term outlook has been revised. Chambers also said, "No one really knows when the economic and capital spending will bottom out and turn back up." Cisco experienced revenue growth of 43% and 55% in 1999 and 2000, respectively. This occurred when everything was going Cisco's way. Internet users were growing, PC sales were growing, Internet start-ups were growing. Now PC sales and Internet users are declining and Internet companies are selling their equipment on eBay. Currently there are more than 2000 Cisco items up for sale and just yesterday, there were 391 Cisco items sold for almost $342,000. While several items were for memory chips and parts, 87 items were sold for over $1,000. In light of even Chambers telling analysts that the 1999 and 2000 will not be repeated, Needham introduces its fiscal year 2003 revenue estimate of $25.5 billion, 38% higher than its 2002 forecast.

Dow Jones carried a story today with comments from Kent Engelke of Anderson & Strudwick about Cisco's valuation, "If its average P/E ratio was 63 during a growth period where its five-year annual growth was 54%, how do we justify 2002's 74 multiple in today's environment?" That is the crux of the situation. While stock prices have been falling they have not been falling as fast as expected earnings and expected growth rates. Since earnings multiples are commonly aligned with growth rates, it is only a matter of time until the market begins compressing valuation multiples. Lower multiples on lower earnings, does not bode well for stock prices. Today, Nortel filed its 10-Q. Inside Nortel indicated that "meaningful growth in spending isn't expected to occur before the second half of 2002 after economic concerns subside and anticipated rationalization of the telecom industry is well underway." It is only a matter of time until investors began to listen to companies and realize that there will not be a strong recovery.

The big surprise for the week was the decline in consumer credit. Considering June same store sales were up 1.6%, it was surprising to see the consumer hinting at retrenching. While credit card debt grew $2.8 billion or 5% annualized, non-revolving credit actually fell $3.8 billion or at a 5% annualized rate, which is surprising since vehicle sales increased in July. It is still quite possible that consumers were shifting how they carry their debt load. The high number of refinancings lends support to that theory. With July auto sales falling to the lowest level since December there are indications that the consumer is starting to retrench. July retail sales data is released tomorrow and should shed further light on the ability and willingness for the consumer to keep shouldering the burden. Today's release of the Federal Reserve Beige gave an indication on what can be expected. The report noted "Retail sales generally were sluggish and frequently below expectations, despite substantial discounting on a wide range of consumer goods."

By looking at the few retailers that have reported sales, it appears sales could come in weak. Radio Shack reported that total sales declined 5% and same store sales fell 6% in July, which is the worst showing since at least before 1998. Since Radio Shack is a large retailer of wireless phones, it provides a glimpse of how well handset sales are going. Radio Shack indicated that handset sales were flat with last year, and that was the best part of its business, besides its parts and batteries business, which was up 2%. Computers had the worse showing, down 40%.

The advertising market continues to exhibit weakness. After the close today, billboard company Lamar Advertising reported earnings for the second quarter and guided down for the rest of the year because of "July's top line performance (down 3%) coupled with the increasingly difficult ad environment". Guidance for the third quarter now forecasts revenue to decline 7% and EBITA 18%. The outlook does not look too good for Lamar. Despite the big boom over the past couple years in advertising, Lamar has not had a profitable quarter since the third quarter of 1998. Oh yeah, I'm supposed to look at EBITDA, interest expense and maintenance as discretionary expenses.

It is doubtful the employment situation will be getting better anytime soon. Challenger, Gray and Christmas announced the largest monthly total of job-cuts since it began tracking the announcements in 1993. John Challenger said, "Companies are looking at their staffing needs for the balance of 2001 and the numbers do not present a very positive picture. If companies were anticipating a 2001 turnaround…we would not be witnessing the extraordinary number of job cuts." As job cuts start taking hold consumers will start to tighten the purse strings. This will provide one large experiment on Keynes' paradox of thrift.

Oh yeah, the poll results. Last week I asked what your plans were for the tax rebate checks. It looks like our readers do not fit the national demographics, what a surprise.

Save / Invest 24%

Buy a bear fund 8%

Buy gold / silver coins 14%

Buy foreign bonds 4%

Pay debt 12%

Buy an item 14%

Expenses 14%

Pay other taxes 6%

Give away 4%

I'll keep it open one more week for anyone else that wants to respond. Just email me at the address below, Thanks for all the comments.


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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