Beleaguered earnings growth at Gillette, Coke, and Wrigley has caused clearance sale prices for these three wonderful businesses. Their heavy dependence on garnering incremental growth from foreign markets is the primary cause, and the cure is a recovery of these markets. Recoveries are coming along, albeit slowly. Personal contacts in Asia Pacific say GDP growth has "recovered" to 1%, a rate the US would consider rather depressing. However, the growth drivers are in place, and Asia Pacific will build momentum. The price decline of these three has created a store of value that should add incremental performance over the next five years. Proprietary product franchises are a rarity in this productive and competitive world, and these companies own three of the best!

Averaging the imputed value row gives a prospective stock price for Searle alone over $40.00, more than the price of all of Monsanto. Therefore, Monsanto can be viewed as ownership of Searle, one of the fastest growing American pharmaceutical companies, accompanied by a perpetual, free call option on cutting-edge agricultural technology.

The depressions in some Asian and South American countries broke the 20 year string of 1.7% annual compounded demand growth for basic foodstuffs at the same time that Monsanto’s seed technology increased productivity as much as 15% for farmers planting its insect resistant and Roundup resistant seeds. In 1996, scary articles about perennial food shortages appeared in prominent business magazines. "How would the world’s population be fed when the only additional arable land is occupied by rain forests?" reasoned the articles. In a 180° about-face, today’s articles express the view that food supplies will exceed demand for years to come. These articles, like the ones in 1996, are worth the paper they are written on. Did you notice the story the other day about the birth of the world’s 6 billionth person?

Someday the world will again worry about how to feed its compounding billions. When that day comes, the dominant owner of intellectual property rights for farm productivity will have great value. In view of the fact that food price inflation is an historical enemy of high p/e ratios, such a company may be an important long-term hedge for portfolios.

We believe that the shareholder value of Monsanto would best be enhanced by the spin-off of Searle. Then, what might the rest of Monsanto be worth? First, Monsanto has announced its intention to sell its food additive businesses. These should bring $3 billion. Monsanto, ex-Searle, could earn net operating profits after tax of $500 million. Total capital would be about $9 billion, consisting about evenly of debt and equity. A rough guess of market value would be in the high teens per share. As the company that owns both Roundup and a proprietary seed technology franchise, the market price will fluctuate dramatically in correlation with grain prices. Please note the above information includes a lot of assumptions that could be incorrect, because Monsanto discloses a minimum of financial information for its segments.

There are two dangers in Monsanto.

1. If the oversupply of grain continues for years to come, an environment would be provided in which GMO concerns could multiply rather than recede. This would negatively impact earnings and growth in the agricultural business. (As soon as grain supplies get tight again, the world will worry about how to feed itself, forsaking GMO concerns.)
2. Management, which is under a lot of pressure, could act with desperation to increase shareholder value by trading all or part of Monsanto for the stock of a big, over-capitalized, over-diluted entity, like DuPont.

The handset division is projected to produce about $1.5 billion of revenue in fiscal 1999, and is approaching production capacity of approximately 1 million phones per month. A sale would result in the loss of these revenues, but operating profit margins should nearly double. Basically, all the phone profit is in the chipsets and royalties. If one projects that Qualcomm will sell chipsets to the buyer of the handset division and also collect royalties on each phone, Qualcomm actually ends up making more money. Phone manufacturing is capital-intensive, requiring state-of-the-art plants and equipment to compete. Add to that the necessity of financing large accounts receivable and inventory balances, and phone manufacturing ties up a lot of cash. In contrast, collecting royalties and designing chips requires only sufficient infrastructure to support a lot of brainy, imaginative engineers. Intel and IBM physically manufacture Qualcomm’s chips. Thus, selling the division will bring a capital infusion and increase earnings at the same time!

Qualcomm is no longer cheap. At the same time, their control of the principle technology that enables wireless data transmission is expected to drive very healthy long-term growth.

Upcoming visits include Enron.

Steven L. Re´, CFA

October 12, 1999

The above is for information purposes only and is not to be construed as a recommendation to purchase or sell securities. The above information is from sources deemed reliable but is not guaranteed. It should not be assumed that investments in any of the above mentioned securities will be profitable, and past performance is not a guarantee of future results. Earnings projections often miss, and markets don’t always go up. The employees and families of Quality Growth Management, Inc. may own the above mentioned securities in their own accounts, and may trade them at any time without notice.