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THI Report March 2000: Can we sell yet?



Title:

A long report this month (even longer than my annual report last September) but I hope you have time to read it.  I'm advocating that we sell this stock -- something we've never done before.

Name:               Thermo Instrument Systems
Stock Symbol:       THI
Shares Held:        46
Date Purchased:     8/25/97
Purchase Price:     $31.403 (Adjusted for split)
Currently Trading:  $20 5/16 @ close on 3/24/00
Percentage Gain:    -41.02%
Annualized Gain:    -21.09%

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Broker Recommendations
   Strong Buy     0
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   Buy            1
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   Hold           1
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   Sell           0
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   Strong Sell    0
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   Consensus   2.50  (1=Strong Buy, 5=Strong Sell)
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Thermo Instrument Systems (THI) has had a nice run-up in the last few months, mostly due to the huge speculation in subsidiary Spectra Physics (SPLI).  Spectra has made a couple big deals in dense wavelength division mulitplexing (DWDM), an optical fiber technology, and that industry sector has been hit by takeover fever.  SPLI has gone from single digits last fall to a high of 98 1/2, and closed at 70 on Friday. 

THI is in the process of "spinning in" or selling off its other publicly traded subsidiaries, and will itself be reabsorbed by parent company Thermo Electron Corp. (TMO).  The stock market has been reacting favorably to this reorganization, but we should realize that this is a very different company than what we bought three years ago.  This may be a good opportunity to sell.

Annual Reports

Both THI and TMO have released annual reports and SEC 10-K filings in the last month, but only the TMO 10-K is available online.  Press releases state that THI's EPS was .67 for 1999, down 15% from 1998.  However, by excluding the third annual round of "one-time" restructuring costs, Earl R. Lewis, THI President and CEO, claims that profits are up.  Revenues were $2.09 billion, up 25%, primarily due to the acquisition of Spectra-Physics AB.

If we include the ongoing restructuring costs, parent TMO had a substantial loss in 1999.  I've uploaded a revised Stock Analyzer file for TMO, but the numbers are a mix of official 10-K results and Value Line's estimates.  This was necessary because TMO has "restated for discontinued operations" its 1997 and 1998 filings, so none of the sales and earnings numbers match anything they previously reported, and they did not provide enough information to adjust prior years' results.  I'm filing this under "smoke and mirrors" accounting (see http://www.woodland.org/hpd/archive/1999/msg00178.html and http://www.woodland.org/hpd/archive/1998/msg00111.html).

Stock Analyzer still rates TMO a buy, with a forecast high of almost 134.  Personally, I don't believe it.

Spin-Ins and Sell-Offs

TMO currently holds 88% of THI stock, and has set an exchange ratio of 0.85 shares of TMO per share of THI for the remaining shares.  The market seems to think THI is worth more like 0.93 shares of TMO, based on current prices.  THI's is unlikely to insist on a higher ratio, since their board is controlled by TMO.  We would end up with 39 shares of TMO after the merger, which is expected to close in Q2.

THI is making cash offers for its subsidiaries, rather than a stock swap.  They've proposed $28.00 per share of Thermo BioAnalysis, and $9 per share of Onix Systems.  In all of the spin-in transactions, the parent company is seeking to acquire 90% of the subsidiary through a tender offer.  Once this is accomplished, the transaction can be completed as a "short-form" merger at the same price as the tender offer, without the approval of the subsidiary's board or shareholders.

THI's spin-in of Onix has hit a snag, as Advance Capital Partners LP has refused THI's tender offer for its 12% stake, calling the offer of $9 per share "inadequate and unfair."  Onix's sole board member who isn't affiliated with THI or TMO has formed a "special committee," which stated that he/it was "neutral" on the $9 offer.

On Friday, THI sold Nicolet Imaging Systems and Sierra Research and Technology, Inc. to GenRad, Inc. for $40 million.  Nicolet Imaging Systems and SRT make imaging systems used in assembling complex printed circuit boards and in airbag manufacturing.

Spectra Physics (SPLI) will apparently remain a public company, majority owned by TMO.  It is now 79% owned by THI, and has a market cap $1.1 billion.  Compared with THI's market cap of $2.4 billion, it's a substantial asset at current prices, and many investors don't think TMO is giving THI shareholders enough value for SPLI in its tender offer.

Moving forward

We bought this stock on the basis of the Thermo companies' management by John Hastopoulos, and his business strategies, which I'd call financial engineering.  Thermo would buy companies to acquire their market share, while at the same time spinning off publicly traded subsidiaries in which Thermo would retaining controlling interests of around 80%.  For a while, this seemed to increase shareholder value.  But in the three years we've held THI, the market has soared while the Thermo companies have tanked.  Since the parent company has such a controlling interest, minority investors (like us) have often felt screwed by the various restructuring deals, which generally benefitted the parent company.  (See SPLI, above.)

Hatsopoulous was removed from power last year, and his consulting agreement was terminated this year with a pay-off of $2 million to go away forever.  Richard Syron, TMO's current chairman, president, and CEO has reversed Hatsopoulous's strategy, bringing subsidiaries back into the parent company, and getting rid of companies outside of Thermo's core business.  This may be a good thing, and certainly Wall Street has liked it.  It's not what we signed up for in 1997, however.

In the last few months, THI has been as low as 8 1/8.  It closed today at 20 5/16.  It's now trading at 93% of TMO value, when the tender offer will only give us 85% of TMO shares -- a decent premium.  I'd like to cut our losses now, and invest the $1,000 in something else.  (We may also need the cash to pay out to Mike Hughes, whose stake is over $5,000.  More on this in the Treasurer's Report.)

The Company's View

From THI's annual report press release:

``In light of Thermo Electron's proposed reorganization to become a single, publicly traded company focused on instrumentation, we have already begun to manage our company for the future,'' Mr. Lewis continued. ``We have aligned Thermo Instrument into three sectors: life sciences, photonics, and measurement and control. Colin Maddix, who has considerable experience in the life sciences and has done an excellent job growing Thermo BioAnalysis, will lead our life sciences sector. Barry Howe, who has done an excellent job managing and growing Thermo Optek, will head the photonics sector. Leading the measurement and control sector will be Denis Helm, who has consistently managed our core monitoring businesses extremely well. I look forward to working with all three and all our employees to build the 'new' Thermo Electron, with the goal of becoming the preeminent instrument company in the world.''

    Consolidated Statement of Income
    (In thousands except per share amounts)

                           Three Months Ended         Twelve Months Ended
                       Jan. 1, 2000  Jan. 2, 1999 Jan. 1, 2000   Jan. 2, 1999

    Revenues              $571,114      $449,636   $2,093,537    $1,659,981

    Costs and Operating Expenses:
      Cost of revenues     312,137       240,457    1,136,675       889,575
      Selling, general,
       and administrative
       expenses            151,834       123,284      580,432       447,860
      Research and
       development
       expenses             41,967        29,568      157,255       113,917
      Restructuring and
       other nonrecurring
       costs, net            (332)          (85)        1,211        23,209
                           505,606       393,224    1,875,573     1,474,561

    Operating Income        65,508        56,412      217,964       185,420
    Interest Income          4,525         7,271       22,124        33,509
    Interest Expense      (11,624)      (10,723)     (50,988)      (45,458)
    Equity in Earnings
     (Losses) of
     Unconsolidated
     Subsidiaries            2,343            --      (7,886)            --
    Gain on Sale of
     Investments                43            --        1,159           713
    Gain on Issuance of
     Stock by Subsidiaries      --            --           --        18,582
    Other Income (Expense)     696         1,150      (2,690)         1,150

    Income Before Provision
     for Income Taxes,
     Minority Interest, and
     Extraordinary Item     61,491        54,110      179,683       193,916
    Provision for Income
     Taxes                  23,425        23,726       75,437        74,674
    Minority Interest
     Expense                 5,371         5,152       16,447        15,677

    Income Before
     Extraordinary Item     32,695        25,232       87,799       103,565
    Extraordinary Item, Net
     of Provision for Income
     Taxes and Minority
     Interest of $248 and
     $391*                      --           324           --           519

    Net Income            $ 32,695      $ 25,556      $87,799     $ 104,084

    Earnings per Share:
      Basic                   $.28          $.21         $.74          $.86

      Diluted                 $.25          $.20         $.67          $.79

    Weighted Average Shares:
      Basic                118,829       119,259      119,305       120,975

      Diluted              141,401       130,709      130,518       133,103


Represents gain on early extinguishment of debt, which increased diluted earnings per share by $.01 in the three-month period ended January 2, 1999.

Restructuring Forever!

A summary of the endless restructuring, from TMO's annual report:

Continuing Operations

                                                                 Abandonment
                                                                   of Excess
(In thousands)                                      Severance     Facilities          Other         Total
----------------------------------------------- -------------- -------------- -------------- -------------

1997 Restructuring Plans
 Costs incurred in 1997 (a)                         $     953      $       -      $       -      $     953
 1997 usage                                              (709)             -              -           (709)
 Currency translation                                       -              -              -              -
                                                    ---------      ---------      ---------      ---------

 Balance at January 3, 1998 (b)                           244              -              -            244
 1998 usage                                              (244)             -              -           (244)
 Currency translation                                       -              -              -              -
                                                    ---------      ---------      ---------      ---------

 Balance at January 2, 1999, and                    $       -      $       -      $       -      $       -
   January 1, 2000                                  =========      =========      =========      =========

1998 Restructuring Plans
 Costs incurred in 1998 (c)                         $  15,700      $   1,656      $   1,420      $  18,776
 1998 usage                                            (6,630)          (418)          (670)        (7,718)
 Currency translation                                     211             25             26            262
                                                    ---------      ---------      ---------      ---------

 Balance at January 2, 1999 (d)                         9,281          1,263            776         11,320
 Costs incurred in 1999 (e)                             1,486          1,280            652          3,418
 1999 usage                                            (7,205)        (2,046)          (838)       (10,089)
 Reversal of reserves (f)                              (2,101)          (217)             -         (2,318)
 Currency translation                                    (568)           (55)           (26)          (649)
                                                    ---------      ---------      ---------      ---------

 Balance at January 1, 2000                         $     893      $     225      $     564      $   1,682
                                                    =========      =========      =========      =========

1999 Restructuring Plans
 Costs incurred in 1999 (g)                         $   4,127      $     324      $   7,853      $  12,304
 1999 Usage                                              (287)             -         (2,115)        (2,402)
                                                    ---------      ---------      ---------      ---------

 Balance at January 1, 2000 (h)                     $   3,840      $     324      $   5,738      $   9,902
                                                    =========      =========      =========      =========