Foolish Special
[ Friday, December 17, 1999]
A Foolish Year -- The Motley Fool looks back at 1999
By Christopher Spink (TMF Eagle)
1999's Conquerors
Some shareholders will certainly be celebrating a very merry Christmas indeed. At the time of writing in mid-December, a staggering 42 companies in the FTSE 350 have seen their share prices more than double during 1999. That represents exactly 12% of the stocks in this premier index.
If you have held only a couple of these companies over the past year in your portfolio then no doubt you will be cracking open a celebratory bottle of champagne on Christmas Day, unless of course you are teetotal. However, whether some of these gains are sustainable throughout the first year of the next Millennium is more open to debate. Will the bubbly go flat after the corks have popped?
For much of the year the market was relatively quiet, though. Retailers got crucified. Only Matalan (LSE: MTN), which specialises in cut-price clothing, managed to survive the storm amongst store operators. The group's shares soared 320% over the year, leaving them on a pretty flighty rating of 39 times next year's prospective earnings.
The company reports figures for the year to the end of February. That means this festive season will be crucial for Matalan. Seasonal sales will have to be impressive if such a roaring valuation is to be maintained. All will be revealed before next Easter.
Many other normally strong sectors were wiped out as well. Engineers and textile companies continued to find the going particularly tough. In fact any company which seemed to be offering a commodity rather than a sought-after product or service struggled. Thus old style brewery-cum-pub companies and food manufacturers were also marked down mercilessly.
What really got investors going was the ballistic re-rating of technology stocks towards the end of the year. Any group with the merest link to the Internet or else offering a technologically based product or service suddenly shot up in the last quarter.
Look at Imagination Technologies (LSE: IMG), for example. Over the past year the company, which designs the chip inside Sega's Dreamcast computer games console amongst other gadgets, has seen its shares rise over 720%. However, most of this jump came in the final quarter of the year when the stock shot up nearly 375%!
Of the 42 stocks which have doubled in the FTSE 350 over the year, more than seven did so in the last quarter of the year alone! These lucky few are: chip developer and licensor ARM Holdings (LSE: ARM); set top box provider Pace Micro Technology (LSE: PIC); hand held electronic gadget maker Psion (LSE: PON); Sage (LSE: SGE), the accountancy software and IT services group; fibre telecom network operator Colt Telecom (LSE: CTM); Filtronic (LSE: FTC), microwave technology provider to the military; and technology licensor BTG (LSE: BGC).
What is going on? Well consider that every single one of these stocks happens to be in the highly fashionable IT services, telecom, technology development or media sectors. These few areas have dominated the market to such an extent that investors involved in other shares are simply left standing, admiring the astonishing gains with their gaping mouths wide open. Why has their been such a sudden demand for these stocks?
Individual investors are realising that the technological revolution is not going away. Consequently a desperate scramble appears to be taking place. At the moment people, including 'professional' Wise institutions, are piling in regardless of any normal methods of valuation in the hope that over the long term some of these ventures will succeed handsomely.
The prices of various shares have gone up meteorically, seemingly in defiance of gravity, simply because there are few shares freely available in such companies. Many directors or venture capitalists retain significant stakes in these enterprises, which they are reluctant to reduce. This style of investment resembles more that of an early stage venture capitalist rather than somebody involved in the steady valuation of companies at a later stage of the business cycle.
Strip out these tech-style stocks, though, and the handful of doubled shares which remain then really have done magnificently well. For example who would have thought that established South African based miner Billiton (LSE: BLT) would have improved 195% this year? Remember though that 1998 was, in the words of Her Majesty the Queen, a real "annus horribilis" for commodities. Prices were low and many miners considered abandoning some of their operations. Consequently Billiton was heavily marked down and has recovered this year. Look at the share price over two years and the stock has only gone up by a third.
Some tech stocks have improved their fundamental figures as well. Here I have tried to point out these beasts, which might still look undervalued even after this year's wonderful re-ratings.
Eyeing up Eidos
The last year of the second millennium was the year when computer games developer and publisher Eidos (LSE: EID) really took off. For the moment I won't mention what the share price did, since that's the last thing we should be admiring as Fools. Instead let me take you on a brief tour through the company's corporate history.
Founded in 1990 as a developer of innovative 'video compression' software, the company floated only in October 1995 when it also moved into the entertainment software market. To you or me that's computer games. Its first product was the hugely successful Championship Manager.
A year later Eidos launched Tomb Raider, which involved the adventures of Lara Croft. This bestseller, with 17 million units sold so far, created the first cyber celebrity and showed the company's real talent for inventing seriously compelling characters and games ideas.
Since then the company has developed many other games and attracted or else bought in top designers to work on this strategy. To date, over 30 games have been released. So far most have been published by Eidos along traditional lines, on compact discs like other software producers.
What has partly changed over the past year is the distribution of these products beyond the UK and through other media. Now Eidos has secured stakes in other software houses and done other publishing deals throughout the world, including some with players in the lucrative Japanese and US markets.
On top of this the company has managed to gain licenses to make computer games for several top global franchises. These apply in the sporting world to the Olympics, UEFA Champions League and Formula One Motor Racing, amongst others.
In the more general entertainment arena the group has recently signed a three-game deal with top animation film producer and entertainment giant Disney. One of these will help promote the sequel to the 101 Dalmatians called, surprisingly, the 102 Dalmatians!
In addition many of the group's games can now be played over the rival Sega Dreamcast, Gameboy and Playstation consoles. And the PC-based versions can be sold over the net and then downloaded directly from the group's impressive website. This is very interesting.
The group has just bought a 20% stake for £34m in Maximum Holdings, a US company which owns GameCave.com, a portal site concentrating on computer games. Maximum attracts an impressive 3.5 million unique visitors per month at present.
All of Eidos's games will naturally be available through this very popular site, developing even further the group's fan base, or as us webby types like to call it the community. Eidos, with its valuable content, is thus becoming a veritable Waddingtons of the web. (For those unaware of Waddingtons, the company is the leading off-line traditional board games manufacturer!)
All this activity allowed Eidos to report a 130% rise in pre-tax profits to £37.9m on sales up 65% to £226m in the year to the end of March 1999. The profits are calculated before significant write-offs of goodwill accumulated from all the various acquisitions. This concrete proof of Eidos's financial performance sent the group's shares through the roof this year, leaping an astounding 575% to 6000p.
Profits next year will be lower as the company is increasing its spending on marketing its games aggressively and expanding onto other outlets via the Maximum Internet deal for instance. However, sales should continue to grow as the company marks its stamp on this sector and benefits from leveraging its addictive games on to the Internet and selling this content through its various websites.
If this happens then in ten years time Fools might look back and laugh at the time at the end of the last millennium, when people became worried that Eidos looked overvalued at just 40 times historic earnings and 3.5 times sales.
Soaring Psion
The other stock which deserves a particular mention is Psion (LSE: PON). The maker of hand-held electronic gadgets has started to stand out from the crowd this year through an innovative joint venture project called Symbian.
This brings together many leading technology companies, including Ericsson, Nokia and Motorola, with the aim of developing the next generation of mobile Internet technology. Psion will provide the software to achieve this vision of allowing Internet access via wireless telephony.
This 'next generation', as it has been dubbed, of handheld devices has dominated the thoughts of investors in Psion lately. The prospect of lucrative revenues from this Symbian venture has sent the group's shares up over 300% to nearly 2500p.
Much of this rise has come in the past quarter as investors have latched onto the idea that Psion's model for the Symbian stake is rather like that of ARM Holdings (LSE: ARM), the microchip developer mentioned in the licensing technology section of the Christmas review. Neither Symbian nor Arm will manufacture their products but instead license out this right to third parties to make the end product.
Psion shares currently trade on nearly 300 times historic earnings. That is almost unbelievable, considering the company actually made a £23.3m pre-tax profit last year and 8.3p of earnings per share. The whole group is worth nearly 12 times last year's sales.
However, Symbian is an entirely different concept for Psion, inaugurating an entirely different way of making money. This could prove more efficient as well once the new products are developed. A Chinese proverb states: 'may you live in interesting times'. Psion shareholders certainly are.
Fantastic Floats
Finally two companies which have performed spectacularly well only joined the market this summer. Future Network (LSE: FNET), a publisher of computer and internet related magazines and websites, has jumped 110% to 874p since launching on the stock exchange this June. And Kingston Communications (LSE: KCOM), the local telecom stock serving the Hull area which also has a very interesting business arm called Torch, has shot up 150% to 720p since coming to the market in June.
Both are involved in some of the exciting areas of the market: media and telecoms. Unlike many of their smaller brethren though who have floated recently, both are also quite established companies with substantial revenues. Future Network, originally the subject of a management buy out from Pearson (LSE: PSON), dominates computer magazine publishing in the UK. It publishes over 100 titles. These are being transferred to the web. The company is thus creating addictive passion centres for interested readers across several different media forms.
Kingston Communications on the other hand was previously owned by the corporation of Hull. Sales at the Torch subsidiary, which specialises in providing businesses with ultra-fast telecom connections, jumped 96% to £32.9m at the half way stage, after customer numbers rose 37% to 928. One new client is Egg, the Prudential's (LSE: PRU) Internet bank. Egg has well over half a million individual customers, most of whom need to telephone the help desk at some stage. Torch seems to be the flame which will lead Kingston forward into the new millennium.
The Year In Review
Introduction
1. TMFEagle looks at the gold medallists of 1999.
2. TMFMayn visits the kennel: who were the dogs of the past year?
3. TMFEssex ruminates on a sector by sector basis.
4. TMFNigel thumbs through the year on the World Wide Web.
5. TMFTiger reviews the rise of intellectual property companies.
