Run Over to Staples, but Steer Clear of Silicon Graphics

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

Before We Start ...

Jim: Apparently the folks at Motorola read last week’s column, Mike, in which we praised General Instrument.

Mike: That’s right. As our colleague Sallie Hofmeister reported Monday, Motorola may be set to make a takeover offer for the company. Well, OK, maybe Motorola came up with the idea on its own, but clearly it sees the same potential in General Instrument that we do.

Staples (SPLS)

Jim: This is a busy time of year for this big chain of office-supply superstores, Mike, because it’s a central location for back-to-school supplies. But actually Staples relies mostly on small-business customers.

Mike: And it would be even more of a central location today were it not for our crack Federal Trade Commission, which said “not so fast” two years ago when Staples tried to buy its chief rival, Office Depot.

Jim: The FTC nixed that deal on antitrust grounds.

Mike: Despite all the promises from these companies that the merger would not lead to higher prices, for some strange reason the FTC didn’t believe them. But Staples’ business just kept flourishing anyway.

Jim: Staples last year had $7 billion in sales. It’s carved out the role of being one of the major “big box” retailers in its market, like Home Depot or Wal-Mart Stores in theirs.

Mike: Fair enough.

Jim: Staples’ stock was a favorite for much of the ‘90s because the chain kept spitting out 20%- to 30%-plus sales and earnings growth year after year. This stock has split six times in the last six years. But suddenly this spring, everyone started getting skittish about Staples’ outlook--so the stock has tumbled 37% since March 31, to around $20 a share now.

Mike: Care to account for that? Was it office-supply fatigue?

Jim: In a manner of speaking, yes. As interest rates started heading higher, people began fretting that Staples’ stupendous sales growth might ease because small businesses might cut back their spending. With all the competition Staples faces from Office Depot and the rest, the worries deepened.

Mike: This is what happens when you post 24.7% sales growth instead of the 25.6% growth everyone expected. Horrors!

Jim: Your sarcasm is dead on, but that’s the price a company pays when it’s got a reputation for constantly exceeding everyone’s forecasts. If there’s just a whiff in the marketplace that you might come up a tad short, look out below.

Look at what happened last week, when Staples’ stock lost 10% in a day because its CEO said, in effect, that things would be great but not necessarily absolutely fabulous.

Mike: And let’s be honest, Jim, it’s a fair question to ask whether there are enough shopping centers left where Staples can put new stores to keep expanding. Particularly when Staples talks about having a new strategy of opening even larger stores.

Even so, the perceived wisdom on Wall Street is that, of the big three chains--Staples, Office Depot and OfficeMax--Staples is the best at execution.

Jim: I certainly think it is.

Mike: So you’d buy this stock? Are you bottom-fishing?

Jim: Yep. The drop in Staples’ price makes a great entry point to own this stock. Staples remains a proven, well-entrenched competitor, and I’ve noticed that its profit margins have been inching steadily higher in the last three to four years.

Mike: Hmmm, that suggests that Staples’ improved margins are coming out of the hide of the companies that make the supplies Staples sells.

Jim: Maybe, maybe not. You know, you can still boost your earnings per dollar of sales--and not demand cheaper prices from your suppliers--if you control your inventories well and tighten other costs. And Staples does that.

Anyway, I also like Staples because it’s planning to offer more services to small firms, and because it’s focusing on selling lots of “consumables,” which is the nickname for all that stuff you put in computers, fax machines and printers that gets used up--like printer cartridges. There’s big money in all that. And I think all the fears about an easing of Staples’ growth have been badly overblown.

Mike: There’s a lot I like about this company, too, and I’d also buy the stock. But investors have to realize that its expansion opportunities are not infinite.

Jim: Nor is its high sales growth rate necessarily sustainable.

Mike: But it’s fair to say that some of the tougher expansion is already behind Staples. After all, they’re already in most of the markets where you find their two big rivals.

Jim: And where Staples has prospered, nonetheless.

Mike: Right. Staples’ financial structure is also very healthy and its margins are growing, as you said. Also, its move toward more services will mean not only offering copying machines for customers, but computers and other electronic services.

Jim: Plus, Staples’ Internet site is being tailored to help feed those services, and its supplies, to customers to complement its store traffic.

Mike: It’s a nice package, simple as that. This is a robust company. It has room to grow and its stock is a buy.

Silicon Graphics (SGI)

Mike: Here is a case study in the life cycle of a high-tech company, Jim, from cradle to college to--well, to grave ...

Jim: Grave?

Mike: Yes, the question is: How much longer will Silicon Graphics be with us?

Jim: The short answer: Not much.

Mike: I’m afraid you’re right. This is a company in deep, deep disarray.

Jim: Silicon Graphics makes very-high-performance computers that specialize in elaborate graphics; in fact, its gear was used in making the movie “Jurassic Park.”

Mike: And it’s also a company with a sterling Silicon Valley pedigree. Its founder was Jim Clark, whom most people might know better as the founder of Netscape. He started Silicon Graphics to market a graphics chip he developed at my favorite lab, Xerox PARC, and the computers running on it.

Jim: Silicon Graphics also, until recently, sold those incredible number-crunching machines called supercomputers.

Mike: We’ll get to that in a moment, when we talk about great moves that should never have been made.

Jim: Fine. Keep going.

Mike: What’s notable about this company is that it illustrates what happens when you have great technology but you don’t move beyond it. Silicon Graphics’ fabulous technology became a niche business. Ultimately, the company’s competitors passed it by and Silicon Graphics had no other means to keep growing.

Jim: Right, it began getting pummeled by the likes of Sun Microsystems.

Mike: Beyond that, Silicon Graphics has had severe management problems. In fact, it has virtually been run into the ground, as far as I’m concerned.

Jim: And the stock says it all. The shares were loved by Wall Street until 1995--when they topped out at $45 and change--but they’ve been on an agonizing descent ever since.

Mike: It now trades for about 13 bucks.

Jim: Things really got bad this summer. The company lost $115 million in its fiscal year ended June 30, excluding a one-time gain, on sales of $2.7 billion. Last month the chief executive, Rick Belluzzo, abruptly quit.

Mike: To go to Microsoft.

Jim: On top of that, the company last month said it planned to lay off between 1,000 and 1,500 of its 9,000 employees. So you can imagine how hard it would be now for Silicon Graphics to gain the trust of potential new customers.

Mike: Customers? How about new employees? What’s distressing here is that Silicon Graphics needs to move in new directions with new technologies, which means it must tap into the pool of talent available in and around Silicon Valley. But how is it supposed to do that now?

Jim: Nor can it buy that talent with an acquisition because it doesn’t have the cash or the attractive stock needed to do a deal.

Mike: So SGI doesn’t have the credibility to hire the best people. It doesn’t seem to have enough of a future to give new recruits any incentive. And it doesn’t have a stock worth a damn with which it can buy new technology.

Jim: I’d say you got the picture. Now, to get back to your earlier point, Silicon Graphics now plans to shed its Cray supercomputer business to help stop the bleeding.

Mike: Right, the company’s purchase of Cray in 1996 was widely ridiculed, and for good reason. Cray’s sales growth was slow and there was no excuse for it being with Silicon Graphics.

Jim: Now, the only case that can be made for this stock is that Silicon Graphics itself is a sitting duck for a takeover. But that scenario is pretty iffy, because the consensus on Wall Street is that the list of companies that might even be interested is pretty short.

Mike: Not only that, but if you want to invest in potential buyout targets, you should be looking for companies that are on an upward curve--and that will get a premium price from buyers. We don’t have that here.

Jim: We have a distress sale.

Mike: This company has something in the area of $8 a share in net asset value, after subtracting liabilities. But its real assets are things with feet. And there’s no guarantee that whatever talent Silicon Graphics still has will stick around if the company gets bought.

Jim: You’re right. That’s no way to invest, and I’d avoid this stock entirely.

Mike: This was a great company for a while. It had marvelous technology and made a lot of difference in a lot of people’s lives. I mean, Silicon Graphics was the dream of a lot of those Silicon Valley people who want to change the world.

Jim: And it did.

Mike: But then the world changed around it.

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Write or e-mail with a stock you would like to see discussed in this column. James Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Michael Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the new 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.

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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Staples (SPLS)

Monday: $20.88

Silicon Graphics (SGI)

Monday: $13.00