Bally May Have Room to Gain; JDS Overpriced or the Next Cisco?

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

Bally Total Fitness (BFT)

Mike: Boy, would I love to be in Bally Total Fitness’ market; that business has to be nirvana.

Jim: Why am I afraid to ask you why?

Mike: Think of it. Here you offer a service that’s capital-intensive, what with all that equipment.....

Jim: And the buildings to place it in.

Mike: ... and you charge people up front because they think they want the service. And then they never use it! Think of how little wear and tear there is on your assets.

Jim: Which you’re depreciating the whole time on your income statement.

Mike: Right! So you’ve got 4 million customers, and they never come around. I mean, everyone signs up in January after the holidays, they go for a week, and by November and December you haven’t seen them for 10 months.

Jim: Then they sign up again!

Mike: You got it. What a business!

Jim: And Bally--which was spun off from the Bally Entertainment gaming empire in 1996--is the biggest in its industry and a well-run operation. But its stock is another matter. It was red-hot in ‘96-’97, but then last year it turned sharply lower.

Mike: Yeah, it looked like it caught in the treadmill.

Jim: The consensus was that Bally’s stock, as they say on Wall Street, simply got ahead of itself. In other words, investors bid the stock up even higher than Bally’s improving performance warranted. So when the momentum stopped, everyone bailed.

Mike: And this year?

Jim: The same thing. Up nicely for much of the year, then it pulled back again after the summer. Recently it has turned up again and now trades in the high-$20s, for a rather cheap 18 times its expected ’99 earnings per share.

Mike: Sort of climbing the Stairmaster, if you will.

Jim: Ugh. Anyway, we should remember that overall this has been a good stock in recent years, Mike. Since ‘96, it has more than quadrupled in price, which is twice the gain of the broader market.

Mike: So the question is, how long before the little red light comes on, telling us that the stock’s latest rally is over and it’s time to rest?

Jim: Will you stop? Point is, Bally posted solid third-quarter results, which helped the stock. The company also has invested heavily in new equipment and in sprucing up many of its facilities.

Mike: It has also been buying up lots of clubs.

Jim: Correct, and that plays into a strategic shift it’s made in terms of its memberships. The fitness business is notorious for offering people dirt-cheap sign-up costs, and then charging them by the month.

Mike: Which leads to lots of turnover, with people jumping from one club to another.

Jim: Yep. And to counter that, Bally is working hard to sign people to one-year memberships that allow customers to use any of Bally’s clubs, not just the one closest to their house. And those memberships aren’t exactly cheap, at about $1,000.

Mike: Per year.

Jim: Right, but Bally also provides financing for that cost, charging 16% to 18% interest. So in a lot of ways Bally looks like a leasing company.

Mike: True, though anyone with brains should know that’s too high a price to pay. But enough people are paying it.

Jim: And it keeps Bally’s membership rolls from turning over so fast. There’s one problem here, though. All of this financing has made Bally very debt-heavy. And that’s one reason I would not buy the stock.

Mike: I’d buy it, even though I have a more fundamental problem with Bally. What happens when the economy turns south? What’s the first thing people are going to cut back on?

Jim: Their fitness clubs.

Mike: Right.

Jim: They’ll just have to run around their backyards.

Mike: Or revert to the mean, which is being 30 pounds overweight.

Jim: So why buy the stock?

Mike: Despite all of that, Bally’s stock is nicely priced right now, and therefore has a nice gain ahead of it, at least for another year or so.

Jim: I agree it’s cheap. But I don’t see a major step-up in Bally’s growth prospects, and the stock’s inconsistency in recent quarters also tells me that Wall Street isn’t sure whether the stock is worth owning, either.

Mike: Don’t forget, Bally also is determined to squeeze every ancillary dollar out of its members. Its clubs sell juice, nutritional items and fitness wear. Exercisers are like golfers--they’ll buy any damn thing that goes with their sport.

Jim: Still not enough to convince me to buy the stock. And I’ll blame part of my bias on you, because I think you’re absolutely right that if the economy softens, look out below for Bally.

Mike: Sorry, I’m still pumped up about the stock. Right now, people want to look and feel better, and they’ve got the cash to spend at Bally instead of settling for Ben & Jerry’s.

JDS Uniphase (JDSU)

Jim: Several of our readers have asked us to look at this company.

Mike: And one of them used the magic words--and I don’t mean “pretty please.”

Jim: What were they?

Mike: They wondered if JDS Uniphase is the next Cisco Systems of the world. And if that’s possible, at what price are you willing to buy it? To put it another way, are you paying for the next Cisco or the next Planet Hollywood?

Jim: Well, the answer is it might be the next Cisco, but right now its price is way too high--even relative to its rosy outlook--and that’s the main reason I would not buy it.

Mike: I like this stock. But first tell us what JDS does.

Jim: Basically it makes so-called fiber-optic components that enhance the capabilities of all sorts of communications networks, whether for telecommunications, cable TV, etc.

Mike: It makes electronics stuff.

Jim: Stuff, right. And it’s very good at what it does, and there’s no question its products are in hot demand right now. In its fiscal year ended in June, sales totaled just under $300 million. They’re likely to at least double this fiscal year.

Mike: Now, JDS has no shortage of competitors, depending on what market we’re talking about, whether it be cable TV or long-distance telecommunications or what have you. Folks such as Lucent Technologies, Nortel Networks and, oh yes, Cisco.

Jim: Even so, you can’t argue with JDS’ success.

Mike: That’s right. One reason: JDS has aggressively bought other companies that have technologies it wants to get on the market quickly.

Jim: A la Cisco’s technique.

Mike: Exactly.

Jim: But what about JDS’ stock?

Mike: I hate to say this, but I’m throwing in the towel.

Jim: Huh?

Mike: Look I’ve been so burned by splitting hairs over whether some of these fast-growing tech companies are just overpriced, not overpriced much or ludicrously overpriced. Either way, they keep going up.

Jim: I can’t believe you’re capitulating like this. Must have something to do with us passing on Broadcom a year ago--before it quadrupled in price.

Mike: Let’s not go there. Look, JDS has a strong future with real technology that is in high demand, and I think investors are going to keep bidding the stock up based on those fundamentals.

Jim: I don’t blame you for being gunshy, given your track record, Mike. But not me. In the last two years, JDS’ stock has skyrocketed elevenfold to around $235 a share, and it’s now selling for 180 times fiscal 2000 earnings per share.

Mike: Is that all?

Jim: And I don’t care if it’s the next Cisco and Microsoft combined some day, I wouldn’t pay that kind of premium right now, and this stock is also extremely volatile. However, as I say this, I know JDS has a 2-for-1 stock split set for Dec. 29, so the shares are likely to get at least one more bump higher before that occurs.

Mike: Well, we’ve looked at some companies whose business development--and stock prices--were very similar to JDS’ and we were wrong to pass on them. So I’m going to average up here by recommending JDS. Or am I averaging down?

Jim: Several readers have asked whether we’ll be reviewing some of our past picks, Mike, to see how we’ve fared. We’ve done so before, and we’ll do it again toward the end of the year. I’m looking forward to it this time.

Mike: And I’m hoping to be sick that day.

Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the book, “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age.” Either can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.

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You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).

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Bally Total Fitness (BFT), Monday: $28.31

JDS Uniphase (JDU), Monday: $234.06