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Analyst reports: Safeguard shares hurt by mixed reviews

Wall Street's mounting skepticism of Internet infrastructure companies stings Safeguard Scientifics, a day after the company announced third-quarter earnings.

Wall Street's mounting skepticism of Internet infrastructure companies stung Safeguard Scientifics on Friday, a day after the company announced third-quarter earnings.

The Wayne, Penn.-based business incubator, which directly controls 50 infrastructure companies and has holdings in about 300 others, reported a net loss of $25.2 million, or 22 cents per diluted share.

For the nine months ended Sept. 30, Safeguard reported net income of $6.6 million, or 6 cents per diluted share. Safeguard also reported aggregate pro forma unaudited revenue for 350 partner companies in the third quarter of $1.34 billion, up from $1.24 billion in the same period a year ago.

Although analysts did not provide a consensus number as a benchmark for financial performance, Safeguard CEO Warren V. "Pete" Musser acknowledged the third quarter was "turbulent."

"We at Safeguard have, of course, seen other challenging times during our 40-year history, and have had success in operating in both strong and challenging market conditions," Musser said in a statement. "We have never departed from our core strategy of identifying and acquiring leading technology companies and managing and accelerating their growth by leveraging our vast network."

The stock dropped 8.3 percent in midday trading on Friday, hovering at $14.50. The stock has fallen 24.18 percent since the beginning of the week, and it's 85.35 percent lower than its 52-week high of $99.

Safeguard also announced Thursday the purchase of Palarco, an e-business services company specializing in information technology consulting and applications development.

One Safeguard holding, Nextron Communications, has already filed an initial registration statement with the Securities and Exchange Commission for an initial public offering of its common stock. Safeguard owns 54 percent of Nextron, which provides software applications for Web content management. The number of shares to be sold in the offering and the number of shares to be offered to Safeguard shareholders has not yet been determined.

Other Safeguard holdings that could be ready for an IPO are Atlas Commerce, Mi8, Persona, Redleaf, Vitts, WirelessOnline and ThinAirApps.

Although the IPOs could generate revenue, many analysts worry that flagging enthusiasm for the IPO market and troubles for infrastructure companies will pinch Safeguard and force it to dig into cash reserves. As of Sept. 30, Safeguard had liquidity resources totaling about $540.1 million--including cash reserves of $240.1 million and a $300 million untapped credit line.

On Friday, Merrill Lynch analyst Henry Blodget lowered his long-term rating on Safeguard from "buy" to "accumulate," mainly because of the anemic outlook for IPOs in upcoming months. Although Blodget hedged his bet by saying his pessimism "may prove too Draconian," he still thinks the company will dip into its cash reserves next year.

"Given the current state of the equity markets, next year's venture capital cash distributions may not be as large or dependable as this year's (we've estimated $100 million vs. a $240 million estimate in 2000)," Blodget wrote in a research note issued Thursday afternoon. "How fast the company's cash flow generating businesses will ramp is tough to judge. However, even in a bullish case, we don't believe these cash flows will be enough to offset cash needs."

Robert Baird Securities downgraded Safeguard to "market outperform," while First Union Securities downgraded it from "buy" to "market perform."

But not all analysts were so bearish. First Albany reiterated its "strong buy," while Janney Montgomery and Credit Suisse First Boston reaffirmed "buy" ratings.

Analysts Michael Whitney and Joseph Craigen of Tucker Anthony Capital Markets emphasized their "buy" rating in a research note issued Thursday afternoon. The investment bank managed or co-managed a public offering of securities for one or more Safeguard partner companies in the past three years.

"The financial position of Safeguard looks strong in our opinion," the analysts wrote. "The return on these funds has been solid--the weighted average...nearly twice the industry average."