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Sickly McKesson HBOC No Bargain; Donna Karan Slowly Unraveling

Stock Exchange lets readers listen in as Times staff writers James Peltz and Michael Hiltzik debate merits of individual stocks.

August 29, 2000|JAMES PELTZ and MICHAEL HILTZIK

McKesson HBOC (MCK)

Jim: Don't buy

Mike: Don't buy

Jim: This outfit is known on Wall Street for all the wrong reasons, because lots of McKesson HBOC stockholders got bloodied after too many people ignored too many red flags about this company.

Mike: That's right. But first explain to our readers what this company does.

Jim: McKesson HBOC is mainly a wholesaler of drugs and other medical supplies. It also used to own Sparkletts, but sold that business this year.

Mike: Too bad; that's the one business most people can easily comprehend.

Jim: But McKesson also bought a company in early 1999 called HBO & Co., which is in the health-care software field.

Mike: No relation to Home Box Office.

Jim: Correct. Now, HBOC had been a highflier, but only a few months after McKesson bought it, guess what? It dropped a bombshell that more than $44 million in revenue that HBOC had recorded was, uh, not really there. So all hell broke lose. McKesson's stock got routed. A torrent of lawsuits alleging accounting abuses were filed. The chairman and four other executives got fired.

Mike: And since then, its new management has engaged in all sorts of overhauls to save this ship, which are costing McKesson plenty. Yet that mess still hangs over this company.

Jim: So what do we have here now, Mike?

Mike: A health-care supply and software house that isn't doing very well, accounting scandal or not. The supply business is very competitive, with lots of new entrants, and HBOC's software business is struggling. So we have another company here with its work cut out.

Jim: In the last two months McKesson's stock has moved up--it was in the midteens and now trades around $25, which is why some of our readers asked us to take a look at it. But I think this upswing is a head-fake. I don't see any major improvement in McKesson's core businesses any time soon, the accounting hassle is one more liability and I'd simply avoid the stock.

Mike: Agreed. There isn't much smooth sailing ahead. Now, McKesson is trying very hard to migrate a lot of its business to the Web. But once it gets there, it's going to discover that there are a lot of companies already there doing what it does.

Jim: And McKesson's performance in the meantime isn't good. In its fiscal year that ended in March--if you throw out all the special charges--their earnings from their basic business dropped 23% from the prior year. Then in its fiscal first quarter that ended June 30, they dropped an additional 20%.

Mike: Look, there's probably no business in the world that needs better management and efficiency than the health-care industry. In addition, a lot of health-care clients--that is, McKesson's clients--are less and less in a position to pay a lot of money for these services because they're strapped themselves.

Jim: Your point being that McKesson has little room to screw up.

Mike: Yes.

Jim: In fact, I've seen some analysts who are predicting that McKesson won't be able to exceed its 1997 earnings until 2003 at the earliest. And there's another thing that bugs me about this stock: Despite the hammering it took, it's still selling for 24 times its expected per-share earnings for this fiscal year. That's hardly a bargain.

Mike: I noticed that myself. Any company that has this much work ahead to get its business in shape shouldn't be valued that high.

Jim: Absolutely. I wouldn't buy this stock if it was selling for a price-to-earnings multiple of 12, never mind 24.

Donna Karan International (DK)

Jim: Don't buy

Mike: Don't buy

Mike: Now here's a company that carries a pretty glamorous name.

Jim: Too bad its stock is so unglamorous.

Mike: Ummm-huh. As we speak, I'm eyeballing a recent report from a Merrill Lynch analyst whose ranking on Donna Karan International stock is "accumulate." Now in Wall Street terms, rating a stock "accumulate" is akin to calling your girlfriend's new hairdo "interesting." Because this is the closest most Wall Street analysts ever come to saying "sell."

Jim: Donna Karan, of course, is the New York apparel designer. Her company went public in mid-1996 at $24 a share, and it's been coming apart at the seams ever since. This outfit is another example of how the reputation and hype attached to a name often have no bearing on how a company or its stock will perform, and this is especially true in the rag trade.

Mike: They still apparently love Donna on the runway.

Jim: But not on the Street. Right after Donna Karan went public, the company's earnings started sagging and the stock started dropping. It's been rough sledding ever since.

Mike: That's all true, Jim, but I want to put my finger on the albatross that is really dragging down this company.

Jim: What would that be?

Mike: It's something called Gabrielle Studio, and it's such a remarkable factor in this company's condition that I want to get to it right now.

Jim: I don't blame you. Enlighten us.

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