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THE DAY AHEAD: Balance-sheet hawks make a comeback

COMMENTARY--A funny thing happened on the way to this bear market--balance-sheet watching became popular again. You know balance sheets are cool when analysts spend more time talking about Motorola's cash position than its first-quarter earnings--or lack of them.

The art of balance-sheet analysis--looking at a company's cash position, cash flow, assets and liabilities to put a value on a company--was lost during the Nasdaq's rah-rah days. Operating losses? Who cares? As long as the stock was going up no one asked questions. Getting cash was easy back then--just go back to the stock market and issue more stock.

As we all know, the Nasdaq tanked. Balance-sheet hawks warmed up by analyzing dot-coms' cash burn rates a year ago. Ravi Suria, then a Lehman Brothers bond analyst, followed up last summer with a report questioning Amazon.com's cash position. He became a star and recently joined a hedge fund firm. Suddenly, watching a company's cash flow and debt levels became interesting.

Now for the real pros, balance sheets were standard operating procedure, but now everyone is into the game. Cash concerns--once the domain of never-should-have-gone-public dot-com imposters--are spreading to once invincible companies.

Lucent (NYSE: LU) gets pummeled by bankruptcy rumors. Motorola (NYSE: MOT) will spend much of its conference call today defending its cash position and its debt rating. And Morgan Stanley notes that Palm (Nasdaq: PALM) will burn through half of its $596 million in cash in its upcoming quarter. "No way around it, this is serious," said Gillian Munson, an analyst at Morgan Stanley, referring to Palm's cash position.

It's like everyone is playing the "Let's find the next Xerox" game.

How did this game get started? As noted above, dot-coms brought back the balance-sheet hawks. But the other major factor is the fact that no company--especially in the tech sector--can provide an outlook past the current quarter. That means few investors can value a company based on future earnings. It also means that investors are looking closely at balance sheets to value a company.

The current logic is simple: A company like Microsoft (Nasdaq: MSFT), which has a balance sheet that's a work of art with $27 billion in the bank, should clearly be worth more than Lucent, which may not have the "financial flexibility" to survive. When a company has to spin off and sell assets to pay down debt, it's usually not a good sign.

Motorola, which could see its credit rating cut, is the latest balance-sheet whipping boy.

Because Motorola reported a first-quarter operating loss, investors are rightly worried about the company's prospects in the future. Motorola cut its short-term debt from $6.4 billion at the end of 2000 to $4.9 billion as of March 31. But long-term debt jumped from $4.3 billion to $6.7 billion. Add that debt picture to a fuzzy outlook for 2001, and there's a serious question as to whether Motorola will have the financial horsepower to compete, analysts said.

Motorola countered in its earnings release and added that it has "expanded financing relationships" and "undertaken aggressive cost-cutting measures" to offset any balance-sheet worries. Indeed, Motorola ended the quarter with a little more than $4 billion in cash, up from $3.3 billion for the fourth quarter.

But don't get too excited. Prior to Motorola's earnings report, Merrill Lynch analyst Michael Ching noted the company improved its cash position, but it wasn't through operations. Indeed, Motorola's said "cash flow from businesses, including net proceeds from investments, was positive in the first quarter." Take out the "proceeds from investments," and cash flow wasn't so hot.

Ching said Motorola sold some assets (notably five cellular operating companies) and entered new loan agreements. It's also worth noting that a big chunk of Motorola's investment portfolio--Nextel and Broadcom--has tanked.

Of course, you wouldn't have had those Motorola worries without those ever-persistent Lucent cash concerns. Lucent officials call the chatter about bankruptcy hogwash. Yeah right.

Ching noted that Lucent's recent dealings have improved its debt position. The big question is when Lucent will post a profit. The longer Lucent loses money the worse its debt situation looks. And given Lucent's recent penchant for missing estimates, who is going to bet on its profit prospects?

Like Motorola, Lucent will have to spend a lot of time convincing Wall Street that its balance sheet won't deteriorate while it restructures its business.

As for Palm, its cash position will get worse as it clears out inventory. Morgan Stanley's Munson said she expects Palm to wind up with about $200 million in cash in the next few quarters. The risk is that cash position "leaves dangerously little room for losses and charges/fees for termination of supply," Munson said. In other words, one wrong move from Palm and the balance-sheet hawks will be circling.

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