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MetaCreations (MCRE)

Closing Price 11 15/16  as of November 26, 1997

MetaCreations sells computer software used to create 2D and 3D computer graphics. Over the past year, the company MetaTools acquired three other companies, Fractal Design Corporation, Specular Inc, and Real Time Geometry (RTG). The new conglomerate was named MetaCreations.

Steve's Criteria #1 - Great company with management that has shown that they can sustain the growth of the company successfully.

The performance of MetaCreations stock (and MetaTools stock before that) over the past couple of years is very bad. From November 2, 1995 to October 29, 1997, the stock has underperformed the S&P 500 by 105%, while the software industry as a whole outperformed the S&P 500 by 57%! On top of that, even if MetaCreations meets earnings estimates for 1997, the stock will still command a pretty big P/E ratio of 31. The stock is also extremely volatile, with a 52-week low of 6.50 and a 52-week high of 19.50.  Poor returns and extremely volatile price swings make this stock seem unattractive. Management has done nothing to earn a stamp of excellence.

Despite the stock's poor performance the past few years, there are oodles of good things about MetaCreations and their future business prospects. Here are the reasons I think MetaCreations makes a great investment right now, if you can stomach the volatility:

Andrew Grove, CEO of Intel, recently said that two words define the future of computing: ``connected" and ``visual." Almost every product that MetaCreations creates is a ``visual" creation tool. MetaTools, Fractal Design, and Specular all used to create their own lines of 2D and 3D software, each competing not only with each other, but also with tens of other 2D and 3D software companies. Each line of software was well respected in the graphics industry. Two huge trends will help drive the demand for these 2D and 3D tools: the growth of the World Wide Web (anyone putting up a web site will need tools to create the graphics on their site. MetaCreations tools are great for web graphics), and the growth in accessability to cheap, powerful computing (it takes a lot of computing horsepower to do 2D and especially 3D graphics. The price of this horsepower has dropped precipitously over the past five years). Digital cameras are going to be everywhere soon, and MetaCreations tools work great with images from these cameras.

The consolidation of the four graphics companies to form MetaCreations is a very good thing. The company can take advantage of the previous companies' relative technological and marketing strengths. This is very apparent in MetaCreations' marketing of their lower end, consumer product lines. MetaCreations has developed great channels for moving their sub-$100 products to the masses. After having experienced great success with their $50 Kai's Power Goo and their $50 Kai's Photo Soap, previously MetaTools products, MetaCreations can now use the same channel to move Fractal Design's low end products ($100 Ray Dream 3D and $50 ArtDabbler), and Specular's low end as well ($50 Logomotion). The consolidation also allows MetaCreations to lower SG&A costs, better utilize their sales force, and establish stronger channels in foreign markets.

Breadth of Product Line
MetaCreations has the most awesome breadth of 2D and 3D graphics tools available in the world. There are other companies that have more revenue or great, limited product lines, but MetaCreations has the most number of great 2D and 3D products of any company out there. Many of MetaCreations competitors rely on only one or two products for most of their revenues. Strata and Caligari are two examples. If these companies are late with a product release, or if better products from other companies overshadow their own, then the company is mega-screwed (this has happened to Strata). MetaCreations can be late on single-product rollouts without being mega-screwed, because they now have a broad base of products and revenue streams. Some other companies, such as Macromedia and Corel, have seen sales of their alpha products slow or drop. Without the support of other products, these big companies have been compromised as well. In fact, in Macromedia's case, the supporting products may have contributed to their decline. After poor market acceptance of Extreme 3D and xRes (a 3D tool and 2D tool that would directly compete against MetaCreations' product line), Macromedia has discontinued development of these products.

Low-End to High-End
The breadth of MetaCreations product line is not only defined by sheer number of products, but also by the range of price and power of the products as well. MetaCreations has all types of 2D and 3D graphics tools, from the low-end to the high end. They can penetrate consumer markets as easily as they can penetrate professional markets. The consumer products will help increase awareness of the company, and this increased awareness should help drive sales of MetaCreations products across the board.

Friends and Non-Enemies
Microsoft is an enemy to many software companies, but currently, it is not a big threat  to MetaCreations. They don't focus on the 2D and 3D graphics software market (except on the extreme high-end with Softimage 3D and on the very low-end consumer market). Intel is a friend - they use Kai's Power Goo to demonstrate the power of Pentium II chips. Macromedia used to be an enemy, but with the discontinuation of development of Extreme 3D and xRes, they are no longer a direct competitor in 2D and 3D tools (except for FreeHand), choosing to focus on their bread and butter, interactivity (Director, Authorware and Flash). Adobe is more like a big brother than an enemy. Adobe Ventures has a stake in MetaCreations (and Fractal Design before that), and the general perception is that Adobe has the core 2D desktop, web and video publishing tools, and MetaCreations offers a lot of accessory tools that help enhance the power of the Adobe tools. Corel is more an enemy to Adobe and Macromedia (CorelDraw vs Adobe Illustrator vs Macromedia FreeHand) than it is to MetaCreations. Who are MetaCreations enemies, i.e. their direct competitors, then? Mainly it is the Stratas and the Caligaris, undercapitalized companies with very limited product lines. MetaCreations has the size, development resources, and mind share to kick its enemies butts (or to buy them).

RTG is the Wildcard
RTG is developing some awesome 3D technology for representing 3D and 3D textures, that according to some experts, may have great use on the internet. MetaCreations is in the process of licensing RTG technology to other companies for a range of different hardware and software product lines. One such product would allow a company such as REI to easily generate textured 3D scans of their products and display the 3D images on their web site for their customers to browse. If RTG technology lives up to its hype, it could result in a windfall of revenues and profits for MetaCreations. Even if nothing comes of the RTG technology, MetaCreations should still have a very prosperous future. With RTG success, MetaCreations stock could MetaExplode over the next five years.

Financially Sound
MetaCreations has no long-term debt and $2.30 per share of CASH. On top of that, MetaCreations is profitable. So there should be no fear of MetaCreations going bankrupt any time soon.

Steve's Criteria #2 - Expected earnings growth of 25% or more for the next five years

2 analysts issue a median 5-year growth rate of 34% per year.

Steve's Criteria #3 - Current stock price that allows for 25% or more year-to-year appreciation in the stock.

Using the Lai Fund SMEG-5 Analyzer, and assuming that MetaCreations will experience the predicted earnings growth, the stock should appreciate within the following range over the next five years:

Low Return: 23% annual growth

Middle Return: 35% annual growth

High Return: 44% annual growth



MCRE - 11/27/97

Price: 11 15/16

`97 earn est .39

`98 earn est .69

P/E ratio 31

Market Cap: about 300 million

Expected 5-yr annual growth rate: 34%

% LT Debt to Market Cap: 0%

Cash $2.30 per share

Lai Fund SMEG-5 Return: 35%