Markets & Finance

S&P Says Sell Level 3


Level 3 Communications (LVLT): Reiterates 1 STAR (sell)

Analyst: Todd Rosenbluth, Ari Bensinger

Three institutional investors, most notably Berkshire Hathaway, converted all of their outstanding 9% junior convertible notes due 2012 into shares of common stock. While the conversion reduces Level 3's long-term debt by $457 million and generates cash interest savings of $41 million annually, it also dilutes the existing shareholder base by about 25%. Fundamentally, S&P continues to see weak demand for Level 3's data transport and software services. At an enterprise value to EBITDA well above peers, S&P views Level 3 as unattractive.

Lehman Brothers (LEH): Reiterates 5 STARS (buy)

Analyst: Robert McMillan

The investment bank posted May-quarter earnings per share of $1.67, vs. $1.08 -- well above S&P's expectations. Strong fixed-income capital markets activity helped offset lower commissions, interest and dividend income, and investment banking results. S&P expects Lehman shares, trading at 17 times S&P's fiscal 2003 (Nov.) earnings per share of $4.26, which S&P is reviewing, and at a discount to the S&P 500, to significantly outperform the market on continued robust fixed-income results and improving commissions and investment banking results, reflecting encouraging strength in the stock market and an uptick in M&A activity.

Freddie Mac (FRE): Maintains 2 STARS (avoid)

Analyst: Erik Eisenstein

An article in Thursday's Wall Street Journal cites sources to the effect that the pending restatement will boost prior earnings by anywhere from about $1 billion to $3 billion over the short term. Given previously reported GAAP income of $4.1 billion in 2001 and $5.8 billion in 2002, the range of possible change is both wide and meaningful. Freddie Mac has said that any such boost would be offset in future periods. While S&P views the article as speculative, it does highlight, in S&P's opinion, the lack of meaningful guidance to the market on Freddie Mac's part as well as the magnitude of uncertainty regarding the prospects for this mortgage-finance giant.

Micron Technology (MU): Upgrades to 3 STARS (hold) from 2 STARS (avoid)

Analyst: Thomas Smith

Micron Technology reported a third-quarter fiscal 2003 (Aug.) loss per share of 36 cents, vs. a loss of 4 cents; the loss is 9 cents narrower than S&P's estimate. Revenue was down 5% year-over-year, and 7% quarter-over-quarter. Memory production in megabits rose 20%, but was offset by a 15% decrease in average selling prices. S&P thinks lackluster personal computer sales in fiscal 2003 will improve in fiscal 2004. DRAM industry capacity remains ample, despite tariff rulings against rival Hynix. S&P is raising its fiscal 2003 estimate to a loss per share of $1.85 (before charges), and is keeping the loss per share estimate of 35 cents for fiscal 2004. Cost controls are improving the outlook.

Jabil Circuit (JBL): Maintains 4 STARS (accumulate)

Analyst: Richard Stice

Jabil posted May-quarter earnings per share before charges and amortization of intangibles at 19 cents, vs. 12 cents (GAAP was 2 cents, vs. 10 cents), in line with S&P's estimate. Revenue increased 6% from the February quarter, and was boosted by strength in the instrumentation/medical segment. Gross margin of 9.2% was above S&P's 9% forecast, aided by a production shift to low-cost geographies. S&P is keeping its fiscal 2003 (Aug.) earnings per share estimate at 71 cents, and sees fiscal 2004 at $1.01. Given S&P's view of Jabil's favorable industry position, and with shares trading at a discount to the S&P 500 on a p-e-to-growth basis, S&P thinks Jabil shares remain attractive.

Expedia (EXPE) and Hotels.com (ROOM): Maintains 5 STARS (buy)

Analyst: Scott Kessler

On Wednesday Expedia and Hotels.com competitor Travelweb re-launched its website. Travelweb is a hotel-distribution network owned by Hilton, Hyatt, Marriott, Six Continents, Starwood Hotels, Pegasus Solutions, and Priceline.com. Although Travelweb's backers have notable experience in the hotel business, its operating model is largely unproven, in S&P's view. S&P thinks Expedia and Hotels.com have the customers, relationships, technology, and experience to more than hold their own against Travelweb, whose CEO resigned in May and has not yet been replaced.


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