Investing: Wall Street’s Take on 2000
INSIDE FedEx vs. UPS 34 | Word on the Street 38 | MONEY 30: Coke 42 | Stock to Watch 44
CEO Speaks: Avon’s Andrea Jung 46 | Update: Yacktman and PBHG 50
FEBRUARY 2000 Investing
Wall Street’s Take on 2000
Six pros make their predictions for the year ahead.
AS WE DIP OUR TOES into a new century of investing, investors may be feeling a little wobbly. The past year was both action- and anxiety-packed, a year of Net stocks performing deathdefying aerial tricks, of merger mania rapidly reshaping industries, of watching financial markets scramble to interpret Federal Reserve Chairman Alan Greenspan’s every word. Will the year 2000 give us much to celebrate? In other words — can we relax yet?
To find out what glad or gloomy tidings the year may bring, we caught up with six of Wall Street’s elite: Jeffrey Applegate of Lehman Bros., Gail Dudack of Warburg Dillon Read, William Gross of Pimco, Leila Heckman of Salomon Smith Barney, Edward Kerschner of Paine Webber—all of whom we quizzed in our vear-end 1998 issue (“Wall Street Sizes Up 1999”)—and Steven DeSanctis of Prudential Securities. (He 2000 Outlook has replaced Claudia Mott, another of last year’s experts, as Pru’s director of small-cap research.) Along with getting their views on the year ahead, we’ll look hack at ’99 to see whose predictions panned out — and whose flamed out.
Gross (far left), Dudack, Applegate and Kerschner: a bond guy, a bear and two bulls.
RAGING BULL
Jeffrey Applegate, Lehman Bros.’ chief investment strategist and one of Wall Street’s longest-running bulls, is as gung-ho as ever. Applegate falls into the “new paradigm” camp. He believes that the technology revolution and globalism have rendered old valuation yardsticks useless. He says his model portfolio’s “huge overweight” in equities — 80% — reflects the 15% average gain he expects from stocks. Applegate doesn’t rule out a correction, though, since he expects the Fed to lift interest rates by 50 basis points in the first half of the year.
Looking ahead, Lehman’s guru is betting on tech. It sure worked in ’99: The tech stocks (America Online, Cisco, EMC, IBM, Lucent and Tellabs) he liked last year gained an average 146% from Nov. 13, 1998 to Nov. 30,1999. Even without those high fliers, his nine nontech picks (State Street, Walgreen, Chase Manhattan. Citigroup, US Bancorp. BankBoston (now FleetBoston Financial), Morgan Stanley Dean Witter, Alliance Capital and Franklin Resources) beat the S&P 500’s 23.4% return.
AOL remains an Applegate favorite (“the premier media brand in cyberspace”). Other names: Solectron (“which basically makes all the hardware for a bunch of tech companies — IBM, Cisco, Sun”); Vodafone Air Touch (“a global play on the explosion in wireless and voice data transmission”); and Siebel Systems (for its “supply chain e-commerce software”).
STILL BOOMING
Paine Webber strategist Ed Kerschner remains bullish long term, even if he did turn “relatively cautious” this past July. Inflation can’t go lower, he says, so the only way the market goes up is if earnings go up. “If earnings go up 5% to 8%, a good year is a 12% return and a bad year is flat,” says Kerschner, who expects a 7% earnings gain for the S&P 500 in 2000. At year-end, he expects a Dow’ at 12,500.
Kerschner’s research tries to anticipate the spending patterns of baby boomers. His ’99 picks — AOL, American Express, Compaq, Gap, Wal-Mart and Warner- Lambert — paid off with an average 78.2% gain from Nov. 13, 1998 to Nov. 30, 1999. His only loser: Compaq, down 27.2%. Today, Kerschner cites Carnival. Delta. Home Depot and Bed Bath & Beyond as ways to invest in one important trend, that of affluent Americans spending more money to enrich their home fives and leisure time. To play another major trend, the information revolution, Kerschner likes IBM, Lucent, MCI WorldCom, Gateway and Cisco.
Applegate remains one of Wall Street’s raging bulls. He sees tech stocks leading the market to another fat year.
GRIN AND BEAR IT
Warburg Dillon Read chief equity strategist Gail Dudack represents an endangered species: the Wall Street bear. In late 1998, Dudack was calling for a Dow of 8500, tops, by year-end, though she raised her estimate during 1999. “I was too worried about Latin America and the impact of a devaluation on the U.S.,” she says. “Instead of those negatives, we had pretty good global economic activity.” .As you’d expect, Dudack’s ’99 picks, which were defensive plays, had a tough year. Among the losers: First Union (-36%), American Electric Power (-36.9%), Manor Care (-39.5) and Philip Morris (-51.4%). The average return: -9.3%. Her one true winner: IBM, up 30.9%,
Dudack maintains that the Net stock rally is a bubble. She notes that while market indexes had an up year in ’99, a handful of stocks accounted for much of the advance, while a stealth bear market was unfolding for many issues. For 2000, she predicts an S&P 500 earnings gain of 9% and two more interest-rate hikes.
Stocks that can weather any market environment relatively well and absorb Fed-induced rate hikes are Dudack’s focus now. She also wants to avoid “accounting landmines.” Her picks: IBM (“solid accounting standards, exposure to the Net through website consulting”); Bell Atlantic (“I expect it to get approval to offer long distance service in New York State and gain 25% market share within five years”); Johnson & Johnson (“core products are well established with reliable revenue streams”); and Exxon Mobil (“I see five-year earnings growth averaging 14%”).
THINKING SMALL
If Dudack feels out of vogue, well, she has company in Steven DeSanctis. Someday — yes, someday — small-caps will enjoy a prolonged advance. They’re rallying now, but after so many head fakes, no one wants to bet that this is the big one. DeSanctis cites a sign of hope: strong cash inflows into smallcap growth mutual funds. Then there are the typically rosy forecasts rounded up by IBES and others predicting profit increases of 30%-plus for small-caps.
De Sanctis worries, however, about the deluge of initial public offerings. “When deals per month increase,” he says, “performance tails off because people put money into the hotter IPOs rather than existing small-caps.”
The Prudential small-cap picks we featured last year delivered mixed results. There’s staffing firm Select Appointments (recently bought by a Dutch firm), up 59.2% from Nov. 13, 1998 to Nov. 30,1999, and biotech firm Gilead Sciences, which had a 67% gain. Linens ’n Things rose 12.5%. Then there’s Consolidated Graphics, which fell 58.4% and Orthodontic Centers of America, which slid 38.3%. Average gain: 8.4%, about half the Russell 2000’s 16.6% advance.
Small-caps that Pru analysts think will do better than that this year include $638 million (market cap) Digital River, an e-commerce outsourcer that went public this past August. “They signed up their first top 10 desktop-software pubfisher, which tells me that they’re gaining momentum,” says Internet retailing analyst Mark J. Rowen. Another Pru pick is Gentex, which designs and manufactures a type of self-dimming mirror for cars and trucks. Other ideas: Station Casinos, which operates casinos targeting Las Vegas residents, and graphics-technology leader Nvidia.
BONDS: THAT OTHER ASSET CLASS
Stocks, stocks, stocks. It’s easy to forget that there’s a whole other asset class out there — bonds. And when it comes to bonds, a lot of investors rely on the index-beating expertise of Bill Gross, manager of the $30 billion Pimco Total Return fund. What does Gross foresee in 2000? For starters, an acceleration in the core rate of inflation to 3%, because of a pickup in the global economy and low levels of unemployment. The yield on the 30-year Treasury bond shouldn’t go above 6.5%, he says (it’s now around 6.4%).
When yields reach 6.5%, Gross will begin buying longer-term bonds.
For investors in high-tax states like New York and California, Gross likes municipal bonds, which offer yields that can top 6%, rivaling those on long-term Treasuries. He also likes mortgage bonds like Ginnie Maes.
LOOKING ABROAD
Leila Heckman, Salomon Smith Barney’s head of global asset allocation, gathers data such as forecast earnings growth and price momentum for stocks in a slew of countries. She then treats countries as stocks and ranks their relative appeal. Lately, she likes what she sees: “I’m pretty bullish about everyplace around the world.”
In emerging Asia, she expects the best performances from South Korea and Singapore, citing high growth and falling interest rates. Her ranking also favors Brazil (“cheap”) and Mexico. It’s not that Heckman dislikes developed markets. It’s just that, relatively speaking, they don’t offer as much opportunity. Sounds good to us. Emphasizing die best ideas is, after all, what investing is all about.
Showdown
UPS vs. FedEx
Which will deliver on the e-conomy’s promise?
UNITED PARCEL SERVICE is the current darling among investors who are looking for a safe way to play the growth of e-commerce. The hot stock made its debut in November at $50, jumped as high as $77 and is now trading in the high $60s. Just eight months ago, Federal Express was the way to play Internet package delivery. Now the stock of parent FDX is down 35% from its high and trading at 18 times earnings, compared with UPS’ P/E of 29.
What gives? At first glance, the two companies’ fortunes look similarly rosy. UPS dominates ground shipping, as FedEx does air delivery, and both are certainly benefiting from the stunning growth of e-commerce. They are both expected to increase earnings over the long run at 12% to 14% a year. And UPS chairman James Kelly and FDX’s Frederick Smith are each working to turn their companies into corporate logistics experts, not mere shippers. UPS was recently hired by Lucent Technologies to oversee its supply chain in Asia; FedEx will soon be coordinating all of Cisco’s shipping. Finally, both companies are benefiting from the upturn in the global economy. About 23% of FedEx’s revenue now comes from overseas vs. 13% for UPS. “I would argue that international markets will improve more than domestic markets over the next 18 to 20 months,” says Merrill Lynch analyst Jeff Kauffman.
Federal Express is the leader in express delivery, but UPS has begun picking up market share.
Unravel all this wrapping, however, and UPS looks far more attractive. It’s got $2 billion in cash on its balance sheet and a triple-A credit rating. And it’s in the right business at the right time. Ground deliveries, which account for more than 65% of UPS’ revenue, are picking up, with volume growing 3.5% in 1999 vs. a typical 2%, courtesy of the likes of Amazon and eBay. For the Christmas ’98 season, about 55% of all online purchases were delivered through UPS.
FedEx, meanwhile, has started looking at least as much like an Internet casualty as an e-commerce beneficiary. Now that documents can be zipped around the world nearly instantly, demand for 24- to 48-hour deliveries, which provide more than 75% of FDX’s earnings, has hit a plateau. Domestic express delivery volume grew 10% to 12% a year over the past five years, according to Bear Stearns analyst Edward Wolfe, but that number has now slowed to 4%. Another issue: more competitors in a maturing market. FedEx recently acknowledged that it has lost overnight share to UPS. Meanwhile, its RPS ground-based division, which it acquired two years ago, hasn’t been growing as fast as planned. Add in 50% higher fuel costs — jet fuel sucks up more revenue than gas for brown trucks does — and FDX is expected to report 1999 profit growth of just 3%. At UPS, profits are expected to increase by 14% for the year.
So UPS is in better shape, but is it the better buy right now? Its stock is riding high on IPO and Internet euphoria, made worse by the holiday shopping season. “People are forgetting that UPS is a cyclical company with high fixed costs and demand that is extremely sensitive to the economy,” argues Jean- Marc Berteaux, an analyst for John Hancock funds. Kurt Kuehn, UPS’ vice president of investor relations, responds that in a downturn, manufacturers and retailers would prefer to ship goods as needed rather than keep large inventories. Perhaps, but that doesn’t mean UPS won’t suffer in a slowdown.
“I understand why UPS would be a more attractive investment than FDX — at the same price,” says Merrill’s Kauffman. “But with UPS trading where it is, the decision isn’t as clear-cut.”
On the other hand, FDX has serious problems to overcome before investors will value its stock with anything near the kind of multiple they give UPS. But optimists, such as Morgan Stanley transportation analyst Kevan Murphy, believe that UPS’ newly public status will be a catalyst for improvement at FDX, which for years has had investor interest pretty much to itself. When FDX announced quarterly results in December that were 6% lower than a year ago, it also outlined cost-cutting measures and said it plans to more closely tie the Federal Express and RPS brands. Unfortunately, FDX won’t be able to deliver on these changes overnight.
The bottom line: UPS is an A-list company, but the chance of a near-term correction is high. If you’re interested, nibble at the stock via dollar-cost averaging. Investing a little each month will lower your overall cost basis. FDX, on the other hand, is strictly for contrarians.
-SARAH ROSE
Word on the Street
What’s up with John Neff, small-caps and more. Plus: Everyone’s a VC!
One value investor who won’t say uncle
When we profiled famed stock picker John Neff in August, he had been shorting the Nasdaq 100 since early in the year. Since our piece, the tech-stock-heavy index is up 64%, and a stunning 102% for 1999.
Neff, the retired manager of Vanguard’s Windsor fund, may be down, but he’s not out. He remains convinced that the index, which can be bought and sold like a stock, is headed for a fall of 40% to 50%. He’s still shorting. “Stocks that were kind of overvalued to start with are now even more overvalued,” he says. “And the whole Nasdaq Internet part is just crazy. I’m afraid it’s going to come to a bad end sooner rather than later.” Neff won’t disclose how much his opinion has cost him.
Neff ran Windsor for 31 years, regularly beating the S&P 500’s return with his low-P/E approach to investing. Now he picks stocks for Case Western Reserve University and his own portfolio.
(He’s shorting only in the latter.) What is Neff buying? Housing and building-materials companies, REITs and banks. One of his picks mentioned in our profile, Owens- Corning, is down to $15 from $37 as of Dec. 15. “It has an asbestos cloud that hangs over it, but they’ve settled about 95% of the claims,” Neff says. “It’ll become less of a cloud this year and the year after that.” — NATASHA RAFI
Now you can be a venture capitalist
Speaking of Internet stocks, the next phase of Net-IPO fever is coming — venture capital for the masses. Is this a bug that you’ll want to catch?
This spring, Silicon Valley VC firm Draper Fisher Jurvetson plans to launch a mutual fund so that small investors can buy into companies before they go public. Why try to scramble for shares at the offering price when you can get them for pennies apiece the way the smart money does? The meVC fund follows similar recent or planned efforts by Offroad Capital, Charles Schwab and Hambrecht & Quist. Draper Fisher, which funded e-mail service Hotmail and online investment bank Wit Capital, has put $4.5 million into meVC. It plans to raise about $500 million, most of which will be invested in companies also held by the firm’s private funds. Those funds are open to institutions or millionaires who put up a minimum of $100,000.
“To allow the individual investor to participate in venture capital helps the entrepreneur to have more investors,” says Draper Fisher managing partner Tim Draper, ‘‘and it allows investors to participate in the new economy’s formation.”
MeVC investors must have at least $50,000 in the bank and $50,000 in annual income. The minimum investment is $5,000. MeVC will charge a hefty 2.5% management fee and take 20% of profits. Because it’s a closed-end fund, shares will trade like a stock, so the managers can’t be forced to sell illiquid investments to meet redemptions.
Before you jump in, remember that most VC- backed businesses fail. Draper says that his firm’s elite status allows it to get in on the best deals. But Mike Howard, a private money manager in Silicon Valley, worries that investors could get hurt by these kinds of funds when Net- mania cools. “I see this,” he says, “as one of the largest investment debacles for the smalt investor since the limited partnerships of the 1970s and ’80s.” – JEANNE LEE
Is small-cap indexing for losers?
As any indexing fan will tell you, in recent years (save 1999) fewer than 20% of active large-fund managers have beaten their benchmark, the S&P 500. But does indexing make sense for small-cap stocks? A fund family made up mainly of, surprise, actively managed small-cap funds argues that it doesn’t.
Dallas-based Undiscovered Managers recently released a report claiming that over a five-year period, 70% of all small-cap managers beat the Russell 2000, the best-known small-cap index. The report’s explanation for the outperformance is reasonable enough. The Russell is made up of the bottom two-thirds of the 3,000 largest capitalized stocks. When the index is adjusted once a year, its best-performing stocks tend to grow their way out of the index. This “reverse survivorship bias,” argues Undiscovered Managers, dooms small-cap index investors to poor relative returns because active managers can ride their top stocks, while index managers inevitably lose theirs.
Makes sense, but there’s more to the story. First, Undiscovered Managers’ study uses a time period, June 1993 to June 1998, when small-cap performance was at its worst relative to large-cap stocks.
Second, the authors don’t calculate the effect of taxes on returns. Index funds are tax efficient; actively managed funds can hit their shareholders every year with sizable, and taxable, capital-gains distributions.
Finally, there’s the issue of asset allocation. You may not be getting the diversification you want in your equity portfolio if your small-cap fund manager never lets go of big winners that become mid- and large-caps. If you’re an index believer, this study shouldn’t be enough to dissuade you.
— BRIAN P. MURPHY
Why Coke Still Isn’t It
Coke’s great returns in the ’90s were based on the notion that it could keep increasing earnings at 20% or more per year. It can’t.
BACK IN October 1998 I wrote a column that singled out Coca-Cola (KO) as the classic example of an overvalued blue chip. Coke’s potential earnings growth, I maintained, was not high enough to support its P/E of 42. Coke’s stock was then at $65, more than $5 above today’s price. The S&P is up more than 30% over the same period.
Coke’s spectacular underperformance climaxed in December when chairman and CEO M. Douglas Ivester, 52, decided to retire unexpectedly, after just over two years at the helm. The stock dropped but soon rebounded as analysts and investors approved Coke’s promotion of Douglas N. Daft, 56, to president. But in my view, Ivester’s retirement doesn’t change anything; the outlook for Coke as an investment remains poor.
Coke’s problem isn’t its management but what I call the consumer-products growth fallacy: the belief that topflight multinationals can sustain high double-digit earnings growth and are worthy of the multiples that tech stocks get.
In the case of companies like Coke, Gillette and McDonald’s, the rapid globalization of the 1980s and early ’90s created stunning earnings records. But once you’ve got restaurants in every country and all the men in Poland own twin-blade razors, growth rates begin to drop toward levels that are the norm for these kinds of companies. That’s moderately above average, say around 14%.
The MONEY 30, an index of blue-chip growth stocks representing the new economy, gained 11.2% from Nov. 30 through Dec. 31, to 4010 (January 1996=1000). The group is up 47% from a year ago, with five members more than doubling in value. Leading the way: Oracle, which caught fire and rose 290% in 1999 after convincing investors of its e-commerce potential. Mattel was the worst laggard, dropping 43% last year after continued earnings shortfalls. Notes: ‘As of Dec. 31. 2Split 3 for 2 on Dec. 31. 3Splft 2 for 1 on Dec. 7. Source: Baseline.
In Coke’s case, analysts think the company might reach 15%—but that’s still not the 30%-plus earnings growth of a Nokia. And Coke’s growth isn’t as good as it looks. The company’s complex accounting separates the results for the core syrup business from those of some of its major bottling plants. There’s nothing improper about this, but it makes Coke’s reported earnings look better than they otherwise would.
So, what should you pay for a company with reported 15% earnings growth that isn’t even growing quite that fast? A P/E of 30, tops. Optimistic estimates for 2000 call for earnings of $1.60 a share. At a multiple of 30, that’s a price of $48 compared with today’s $58.
– Michael Sivy
The MONEY 30, an index of blue-chip growth stocks representing the new economy, gained 11.2% from Nov. 30 through Dec. 31, to 4010 (January 1996=1000). The group is up 47% from a year ago, with five members more than doubling in value. Leading the way: Oracle, which caught fire and rose 290% in 1999 after convincing investors of its e-commerce potential. Mattel was the worst laggard, dropping 43% last year after continued earnings shortfalls.
Notes: As of Dec. 31. 2SpIlt 3 for 2 on Dec. 31. ‘Split 2 for ion Dec. Z source: Baseline.
Stock to Watch
Return to Cendant
Damaged by cooked books, it may now be an honest buy.
WALL STREET’S love affair with high-flying Cendant and its high-profile CEO, Henry Silverman, ended on April 15,1998, when the consumer-services giant confessed that a recently acquired subsidiary had been cooking the books for years. In one horrific trading session, angry investors slashed $14 billion off Cendant’s market cap.
A disgraced Silverman, owner of 28 million shares, had to face the long, hard work of salvaging Cendant, franchisor of hotels (Days Inn and Ramada), rental cars (Avis) and real estate (Century 21 and Coldwell Banter). ‘We could either wring our hands and cry, ‘Woe is me,’ ” he recalls, “or we could do something.”
Out went top executives; in came new I accountants to help restate more than three years’ worth of tangled financials. The company “dumped 18 separate businesses for $4.5 billion and bought back 160 million shares of stock, roughly 20% of its float. As the big franchising names continued raking in cash, the result was rising earnings—and seven straight quarters of beating analyst estimates.
Yet Wall Street barely noticed. “It was,” Silverman grumbles, “like a tree falling in the forest.”
Investors finally heard the timber tumbling in December. First, the company said it had reached a $2.8 billion settlement of a class-action shareholder lawsuit accusing it of fraud—the largest such agreement in history. A week later, Cendant made a far more surprising announcement: Cable mogul John Malone is investing $400 million in Cendant through Liberty Media— and taking a seat on the board.
The Malone deal (steered by mutual fund giant Capital Research, which is both Cendant’s largest shareholder and the biggest outside owner of Liberty Media) will let Cendant market to cable subscribers and put Liberty’s cable services in Cendant’s hotels. The news sent Cendant shares soaring 40% in one day, to $23. All of a sudden, Cendant was hot stuff. “It is now politically correct to talk about Cendant in polite company,” says value investor Tom McIntyre of money manager Dessauer McIntyre, which has bought 1.4 million shares since Cendant unraveled in 1998.
Of course, some scorched shareholders won’t trust Cendant—or Silverman—again. And securities regulators and federal prosecutors continue to investigate the past accounting trickery.
But Cendant clearly has moved beyond pariah status. For the latest 12 months, it earned $1 billion on revenues of $5.6 billion, giving it net profit margins of 17%. Annual cash flow: nearly $2 billion. Cash on hand: more than $1.5 billion. “Cendant doesn’t have a balance-sheet problem,” argues McIntyre. “It has a perception problem.”
With perceptions changing—the stock, at a recent $24, is up 78% from its 52-week low—Silverman is now talking expansion. Hoping to get in on the market’s dotcom action, he wants to turn Cendant’s online shopping division into an IPO and to issue a tracking stock for its online real estate operations. And for the first time ■ since the scandal broke, the quintes- sential dealmaking CEO is eyeing ” acquisitions.
“The decks are clear now to see t what our next strategic course is,” Silverman says. “We were very successful acquirers before.” Many investors no doubt hope he’s learned his due-diligence lessons.
—AMY FELDMAN
CEO Speaks
Remaking the Avon Lady
Andrea Jung must show U.S. women that her brand hasn’t gone out of style.
WHEN Andrea Jung left a fast-track job at upscale retailer Neiman Marcus in 1994 to join mass-market cosmetic maker Avon, she set out to update the company’s merchandise and change its dowdy image. By the time Jung was named second in command to new CEO Charles Perrin in July 1998, investors had bought in: The stock climbed 48% that year.
But while Jung improved Avon’s products and packaging, women in the U.S. still seemed to associate the company with bubble bath and tacky lipstick. In the third quarter of 1999 it became clear that U.S. sales, which account for 30% of Avon’s business, weren’t growing. Investors hammered the stock down 35%. Perrin resigned in November, and Jung took over the corner office, becoming the first female CEO in the company’s 114-year history.
Jung, 41, says she will continue with Avon’s push to upgrade its image and find new ways to reach consumers without alienating its 3 million sales reps — the Avon ladies. What’s different, Jung says, is the “urgency” with which she’ll make those changes.
THE BASICS
Avon Ticker: AVP
Price: $32
52-week range: $23 to $60 ’00
P/E: 17.4
12-month revenue: $5.3 billion
Market cap: $8.4 billion
Note: Data as of Dec. 16. 1999. Source: Baseline.
She has good cause to move quickly. Avon’s stock price won’t go anywhere it an’ t get U.S. sales rolling again. To do that, Avon is doubling the U.S. ad budget to $40 million (still half of what Estee Lauder spends).
The company is also looking at expanding its retail presence and will invest $60 million in its website, which will be relaunched in June. This, while trying to reassure all those sales reps that their lunch won’t be eaten.
It’s a tall order for an executive who, while praised as a great marketer, has limited operating experience.
Investors at this point are cautious but encouraged. “Their strategy makes sense,” says Robert Hagstrom, manager of Legg Mason Focus fund, which has 3% of its assets in the stock. Avon’s sales force, he says, “gets the products out at a level that competitors can’t, particularly in a global market.”
MONEY’S Sarah Rose sat down with Jung one month after she was named CEO.
Q.Your new initiatives appeal to a different kind of buyer than rd imagined the Avon customer to be.
A. True, all of our strategies, which include our new advertising campaign, our current Internet strategy, as well as the product and image enhancements, have really not been targeted toward our core customers. We’re trying to capture new customers.
Q. So do you risk alienating your core group by talking to a more upscale audience?
A. No. We have a brand that is priced at mass, and we are committed to that. We are not trying to be Clinique or Estee Lauder. We are not trying to sell $15 lipsticks. We are selling $3.15 lipsticks. And beautiful packaging, great formulas and great-looking models never alienate any beauty customer.
Q. What are you doing to improve Avon’s weakest link—U.S. sales?
A. Certainly the great thing about Avon is the global portfolio. Still, U.S. sales are a third of the business, and we’re in a CEO Speaks continued highly competitive market. But we’re doubling advertising spending in the U.S., almost doubling the samples we distribute, and we are really radically improving the sales brochures. Were also increasing our new product offerings by 30%, and these initiatives will back that effort. Also, the Internet is very U.S. based.
Q. Can I order an unlimited amount of products from your ‘website, or do I need to go through a representative ?
A. You can buy an unlimited amount on the site, and we hope you do!
Q. Can I buy directly in your retail outlets as well?
A. We’ve got 50 beauty kiosks in malls across the U.S. where you can buy directly from Avon.
Q. What plans do you have to expand the kiosks?
A.We have to evaluate a couple of things first. We are going to test franchising some of them, as we’ve done overseas, and we are considering partnering with a large retailer, probably one that is in the malls. This wouldn’t be a Saks Fifth Avenue, though. We still don’t want to go upscale.
“The Internet is direct selling, and that is what we invented 114 years ago.”
Q. But about 98% of your sales come from your representatives. Won’t the Internet and retail be the death of the Avon lady?
A. If you think about it, the Internet is direct selling, and that is what we invented 114 years ago. This technology can completely transform a representative’s experience, even with her existing customers. Now the representative can submit purchase orders directly with one click to Avon. Any information about products, availability, anything that she would have called her client on the phone about, she can communicate around the clock via email. If I am a representative, do I feel this is a conflict? No. I am giving you a standing ovation, Avon, because you’ve just given me an opportunity to have a much better business proposition.
On the retail side, about 95% of those sales are incremental—the customers shopping in the mall are not currently our customers. And representatives say they feel good about Avon in the kiosks, because they feel it enhances the brand’s image.
Q. Much of your effort since joining Avon has been focused oil improving the brand. Is it easier to control your brand when sales reps are on the Internet?
A. Yes. When we roll out the new Internet site, we will provide representatives with a template to create their own sites. About 90% of each site will be standard, while the rest can be customized with, for example, special offers from a representative.
Q. I take it, then, that you plan on preserving the directselling model?
A. Direct selling means making products available to women when they want them. I want to add other ways for people to get the products, but I’m not doing away with our representatives, by any means. I don’t think customers are really going to be just direct-selling customers, or just Internet customers or just mall customers. They are going to want to be all three.
Update
Yacktman Goes from Bad to Worse
And PBHG makes a surprising comeback.
April ’99
Don Yacktman’s Lonely Crusade’
Morningstar.com’s message board for the Yacktman Fund is an awfully quiet place these days. “How long does one wait,” asks a lone investor, “while performance…continues to lag other similar funds by a wide margin?”
How long, indeed. When we profiled manager Don Yacktman this past spring — after a board room brawl over control of his value-oriented mutual funds — his flagship was up just 0.6% for 1998 and its assets bad plunged to S280 million, a shadow of the y ‘ SI.2 billion it managed in 1997. Things only got worse. By December, the year-to-date return was a gruesome -21% and the fund’s assets had shrunk to $113 million.
“It’s a disaster,” says ousted board member Stanislaw Maliszewski, who had fought Yacktman’s shift to smaller companies and value plays amid a market romp by larger growth companies. “Subsequent events have underscored our concerns.”
Yacktman insists he’ll win. “When we show that our method of investing gets good results,” he says, “1 think you’ll see a dramatic turnaround in the attitudes toward the fund.”
But the Yacktman Fund has become increasingly concentrated as investors have yanked their money. In fact, more than half of it is in only five stocks. Unfortunately, his two biggest bets — longtime holding Philip Morris and a ceramic-figurine maker called Department 56—are down about 50% and 45%, respectively. “These are incredibly profitable businesses,” Yacktman says. “I believe in what I’m doing.” He’d better: Yacktman says he has “seven digits invested” in his namesake fund.
May ’99
“The Rise and Fall of PBHG”
The PBHG message board was buzzing in December, as longterm investors cheered a comeback—and a few of the hastier ones lamented their exits during bad times. Earlier this year the company was performing so poorly that when parent United Asset Management put it on the block, it found no takers. MONEY’S story chronicled management discord last spring when the flagship PBHG Growth was down 5% for the year and the company’s fund assets had dropped to $12 billion, from nearly $20 billion in 1996. But seven months later, the FOR SALE sign is off—and PBHG Growth is up 71%, thanks to such technology picks as Gemstar International and Applied Micro Circuits.
For those who stuck by the fund, it all adds up to an annualized return of 25% for the past five years. Other PBHG offerings, such as Emerging Growth and Select Equity, also have seen double-digit returns, and the company’s total fund assets have risen to $16 billion. Gary Pilgrim, veteran manager of the growth fund, knew his time would come again. “We are,” he explains, “very specialized aggressive growth managers. It is not a style for all seasons.”
Nor is it a style for the squeamish. Morningstar, for instance, recently decided to remove PBHG Growth from its own 401(k) plan. “This fund had volatility than employees wanted in a retirement plan,” says CEO Don Phillips. “Personally, I’ve kept my money in it, and my intention is to stay with the fund.”
Investors looking up 1999 performance results are likely to pile in, but the funds’ net redemptions through October were $2.4 billion, and it may be a while before PBHG sees a lot more money coming in than going out. “People have a propensity to sell when they break even, so there’s likely to be a nearterm runoff,” explains industry consultant Geoff Bobroff. “One great quarter or six months alone are not enough. They’ll have to prove themselves longer in the market.”
—NATASHA RAFI
