The market continues to grind its way higher towards the big test at 1440 on the S&P 500, pausing frequently to dip back to support levels like 1395 to build up energy for the next step up. I still like what I’m seeing and I still think the most likely path leads through 1440 to the old highs at 1555, and then much higher into next April. But we won’t really know until we close solidly over 1440 if this was just a one-year correction in an ongoing bull market or the first wave down in a big bear market. So we’ll watch and wait.

The Fed continues to pour liquidity into the financial system. The $40 billion per month Term Auction Facility program for emergency reserves that started late last year was expanded to $60 billion earlier this year, and then to $100 billion in April. The Fed just bumped that up to $150 billion for May. This is new money created out of thin air and the program now is coordinated with the European Central Bank and the Swiss National Bank. The European Central bank boosted their auctions to $25 billion every two weeks, from the $10 billion to $15 billion level with no set schedule. The Swiss chimed in for $6 billion every two weeks.

The Fed also expanded the kinds of (junk) assets that investment bankers can pledge as collateral. Now that the Fed is loaning to these private businesses for the first time since the Depression, it should be very clear that they are going to keep the fire hose of liquidity on full blast until the credit crisis is over. As usual, a lot of the dollars get parked in financial assets first (stocks, bonds, commodity futures) before working their way into the real economy, accelerating GDP growth. That is a major reason why the stock market is a leading indicator, moving ahead of the consumer economy (a coincident indicator), to be followed by capital spending, consumer confidence, employment, and spending surveys–all lagging indicators.

I’m reading quite a bit of outrage from the bears that all the lagging indicators are getting worse, yet the market is going up. That makes me feel that it’s business as usual, since this is always what happens when the Fed steps in. But, as the poet/philosopher George Santayana said: “Those who cannot remember the past are condemned to repeat it.”

Once the S&P clears 1440 for good, there probably will not be another easy entry point for a while. Those expecting to buy the dip will be disappointed, as the bear trap is sprung. We saw this as recently as the July 2006 bottom, which was another difficult, complex bottom with much thrashing around. But then the S&P marched higher for seven straight months to the February 2007 Shanghai market shock, regrouped and added another five months of advance to the July 2007 top. That one-year advance should be exceeded by the April 2008-April 2009 advance.

I would not be surprised to see a couple of months of consolidation in May and June around the 1440 level, to build up enough energy and bearish sentiment to drive the next leg up.

With the Presidential candidates most likely settled by then, the way will be cleared for a rally like Desert Storm in January 1991, when the S&P gained 20% in only 21 trading days. There is plenty of cash on the sidelines or sitting in put positions and short sales to drive a move like that.

In these big moves, there is a scramble to put money to work in areas that are showing good revenue growth and good earnings, yet stocks are cheap. That pretty much defines technology stocks these days and this week I want to review the outlook for what has to be one of the hottest sectors of all: Video.

On the Edge of a Worldwide Video Revolution

I don’t think “revolution” overstates the situation. Consider these facts:

• Analog television broadcasts end on February 17, 2009
• Digital TV can be broadcast over the air, but also is very appropriate for optical fiber or copper cable transmissions
• Video already accounts for half of the traffic on the Internet
• Video is becoming common on ecommerce websites
• YouTube came out of nowhere to be one of the most popular websites
• Cellphones are moving from including digital cameras to digital camcorders just as the ability to transmit and receive video is improving
• iTunes just announced they will distribute movies digitally the same day they become available on DVD
• The DVD format war is over: Blu-ray won, although digital distribution over the Internet may have passed it by
• Telephone companies are committed to upgrading to fiber optic networks to replace relatively slow DSL over copper lines and be able to cope with video
• Cable companies are committed to rolling out an even faster data transmission standard, DOCSIS 3.0, which will provide a large, rapidly-growing equipment market for many years.

As a result of the confluence of these forces and events, video is one of the hottest areas in all of tech-land. Comcast, for example, said on their conference call that they are reducing capital spending from 20% of revenues last year to 18% this year. Since revenues will grow 10%, capital spending dollars will be about flat. But they are tilting their spending towards high-speed Internet connectivity, in large part to handle video. Cable modem users share the cable coming into their houses, and if everyone is downloading lots of video, service can be slow. Comcast is rolling out a new, faster standard called DOCSIS 3.0, intending to upgrade about 20% of its user base this year and continue the program for several years. On one of their slides, they said they would focus their capital spending on:

1. Reclaiming bandwidth by completing the conversion from analog to digital video across its network. In order to do this, they need to deploy many more digital encoders, as supplied by Harmonic (HLIT).
2. Beginning the switched digital video rollout, which simply means instead of sending 500 channels to every subscriber’s house and letting them switch among them, they only send one or two channels and let the switch happen at the Comcast facility (known as the head-end). This is a much more efficient use of the existing bandwidth, and easily supports video on demand that always has to be switched at the head-end.. Harmonic makes a device called an EDGE QAM that supports DOCSIS 3.0 for cable modem Internet access, switched digital video and video on demand.
3. Video on demand is another growing area that helps maintain customers, lowering the churn rate, and signing up new subscribers who want unlimited access to the Comcast library. Harmonic acquired Rhozet, a company that had transcoding technology to insert targeted ads into video. HLIT also acquired Entone, a maker of video servers. Comcast is not a customer for these two companies today, but Harmonic could win a share of the much larger future orders for this sort of equipment.
4. The DOCSIS 3.0 rollout will dramatically increase data speeds, especially when combined with reclaiming analog bandwidth. Comcast has historically bought this type of equipment from Arris (ARRS), but now Harmonic is sharing the business. On the Arris conference call, they said it will take several years for all the cable companies to complete their roll-outs, which matches my expectation that we are looking at strong growth for many years in this area.
5. Business services are a huge opportunity for Comcast and other cable companies. Historically, their cables have bypassed office complexes to get television to the residential areas. Now that they offer high-speed Internet access and telephone service, they can go back and sell to all those offices, with very little extra equipment required. The specific equipment is Coarse Wave Division Multiplexing, which Comcast buys from Harmonic.
6. Comcast sees interactive advertising, which combines the ability to target ads to particular users, as a revenue opportunity with Google-like attributes. Harmonic offers real time ad insertion via its Rhozet products, and recently introduced a new Gator user interface to manage this process.

When Harmonic announced its results, they gave conservative guidance in part because they did not know what Comcast would say about its capital spending plans. Comcast was a $50 million customer for HLIT in 2007. What Comcast does, the rest of the cable industry will do, and what the cable industry does, the telephone companies must respond to.

Comcast added almost half a million new broadband subscribers in the March quarter, with over two-thirds of them coming from competitors selling DSL over copper wires. Comcast and the other cable companies know that the telephone companies will move as fast as they can to upgrade to fiber, and therefore the cable companies have to up the ante. DOCSIS 3.0 allows broadband speeds up to 100 megabits per second, about 150X as fast as most DSL and over 3X faster than the fastest FIOS package advertised on Verizon’s website.

So why did Harmonic’s stock go down after they reported their excellent quarter? I think there are two reasons and neither one should bother us. The first is the company’s guidance, which after the Comcast call they now admit was conservative.

One of our subscribers, Elie, asked about the second issue:

Q. “I was wondering if you could comment on why Harmonic has not really taken off. Harmonic has outperformed analysts’ expectations from all aspects. You once mentioned, and I have read, that analysts may be keeping the stock down because Harmonic’s tax rate could go up significantly in 2009 to 38% versus its current cash tax rate of only 5% to 7%. Should we be concerned about this tax rate change (i.e. will the tax rate change really take a chunk out of HLIT’s profit?)”

Elie, the Board has decided the company is likely to maintain and grow its profitability, so later this year they will take an extraordinary gain for their tax asset as required by accounting conventions, and then report fully taxed numbers in 2009. Although it does not affect the company’s cash flow since they will net future stated taxes against past realized net operating losses, there may be some confusion in the reported numbers. I expect Harmonic to provide apples-to-apples comparisons adjusted for the tax rate for 2009 quarters, but the news readers on CNBC may report the unadjusted numbers and scare some investors with a negative comparison. I think the reported tax rate will be around 30%.

As I titled this section, I believe we are on the edge of a worldwide video revolution. Since Motorola (MOT) bought General Instrument, Cisco bought Scientific-Atlanta, and Ericsson bought Tandberg, Harmonic is one of the few major independents left. HLIT’s future is very bright and the stock is at a ridiculously low price, less than 12X this year’s earnings estimate. HLIT is a Top Buy up to $12 for my $18 target.

Biotech MegaShift

BioCryst Pharmaceuticals (BCRX) reported earnings this morning, and fell very short of the consensus. They lost 34 cents a share compared to the 18-cent loss estimate, on $10.8 million in revenues compared to the expected $19.8 million. Revenues, however, were up 17.4% from last year. They have $81.2 million in cash and expect to burn $25 million to $50 million in 2008, depending on the timing of reimbursements from the Department of Health and Human Services.

I am most interested in the intravenous (I.V.) version of peramivir for patients hospitalized with the flu, especially avian flu. Management said later this summer they are expecting an update from a trial run by their partner, Shionogi. For Biocryst’s own trial in hospitalized patients, they will provide an update by the end of the year. I still expect this to work and be better than Gilead/Roche’s Tamiflu.

BCRX stock is certainly down in the dumps, but good news from Shionogi followed by good news from their own trial will make for a very different picture by the end of the year. Although my buy limit and target price are far above the current stock price, those are still the right numbers if I.V. peramivir works as I expect. Buy BCRX up to $8 for my $30 target after permavir is approved for purchase for government antiviral stockpiles.

eResearch (ERES) reported a really excellent quarter, as their rapidly-growing order flow from last year turns into a rapidly-growing revenue flow this year. They did $33.7 million in sales, an all-time record and up 59.7% from last year. Earnings hit 11 cents a share, up 175% from last year’s four cents. The gross profit margin increased to 52.5% from 47.6% in the December quarter.

Best of all, they did $50.1 million in new orders, and all-time record that tells us growth will continue at a blistering pace for at least another 12 to 18 months. The backlog of signed contracts increased to a record $151.4 million, up $11.2 million in three months. To top it off, they increased their June quarter guidance to revenues of $34 million to $36 million and 10 cents to 12 cents a share. They increased 2008 guidance to revenues between $133 million and $140 million with 44 cents to 49 cents a share, up about $3 million in revenues and two to three cents a share.

The stock moved up about $2.50 on heavy volume, but ERES remains a Top Buy while it is (barely) under my $16 buy limit, and I am even more confident about the $30 target price.

New Energy Technology MegaShift

Energy Conversion Devices (ENER) reported this morning and rose over 40% to $14.44 a share today in a spectacular burst of short covering. My advice to give the new management a chance to perform was solid, as the company reported 25 cents a share in pro forma profits versus the consensus expectation for a six cent loss. Sales rose 155.5% from last year to $70 million, well above the $66.7 million consensus. The company gave above-consensus guidance for the June fourth quarter, looking for $73 million to $78 million in sales, compared to the $73.1 million consensus.

Business at United Solar is so good that the company has been able to get take-or-pay contracts with its customers. They will expand and add 120 megawatts of additional capacity to their Greenville facilities, funding the expansion from cash flow. This will get them to approximately 300 megawatts of capacity by the end of fiscal year 2010.

They said they are pursuing a sale of Cobasys and I think the buyer most likely will be Toyota.

One of my subscribers, Dana, asked a good question:

Q. “What is the business model of the relationship with Intel on phase-change memory? Please give us detail on income model basis on just how much revenue and income is to be expected from various assumptions of market success of phase change memories.”

The phase change technology is in a separate company, Ovonyx, which is a joint venture between ENER and Intel. So we won’t see the revenues and earnings on ENER’s income statement, which is one of the company’s goals–they are trying to insulate themselves from erratic quarters. However, the value will build in the company as phase change moves into the marketplace and then anything could happen from Intel buying the whole company to an IPO to a sale to another company. Ovonyx is the icing on the United Solar cake, and solar is where I am focused.

Another subscriber, Eugene, asked a question about solar stocks.

Q. “How do you rate solar stocks such as STP and SPWR?”

We are not in these stocks right now for two reasons. First, their sales depend on government subsidies, and it is always possible that the government will come to its senses and put the money into coal-to-liquids or wave power, that make economic sense today. It’s not a likely scenario, I know, but it is possible.

Second, there is a major quality issue in this industry in that some manufacturers’ solar panels, like Sharp and Kyocera, last a long time, while others’ panels do not. In a subsidized world that doesn’t matter, but the solar installers know about the differences and eventually I think prices will match quality. I don’t have good comparisons right now and they are difficult to get, but in my view this is a major question to be answered before we should invest. I do know that ENER’s United Solar products have a terrific reputation and a big form factor advantage for replacement and new roofs on industrial buildings, and that’s why I’m happy to participate in solar through ENER right now.

Today’s stock price jump put ENER well over my $30 buy limit, so I am moving it to a Hold for my $55 target.

Gasco Energy (GSX) reported a four cent loss after losing five cents a share on a derivatives hedge, but they also had record oil and gas sales as the Rocky Mountain pipeline situation opened up, and record cash flow from operations. They are producing at record daily rates. The futures markets for natural gas suggest a $1 to $1.50 increase in the near term to around $8.50 per million BTU. By early next year, natural gas should be around $11, and a winter natural gas crunch is looking more likely due to very low imports of liquid natural gas (LNG). A recent Goldman Sachs report said we are already two months into the summer refill season when producers normally stock up on cheap gas to sell in the winter, yet the storage facilities are empty as they take advantage of high prices now.

In New Jersey, an energy auction in February resulted in power prices based on natural gas costs of about $8.50 per million BTU, said Ralph Izzo, chief executive of utility company Public Service Enterprise Group Inc. But natural gas prices projected for early next year are about 30% higher, or roughly $11 a unit, showing more increases could lie ahead. This bodes very well for Gasco, and you should buy GSX up to $4.50 for my $9 target next winter.

Plug Power (PLUG) posted a 42% increase in March quarter revenues to $3.7 million, but lost 24 cents a share compared to 13 cents last year. Three cents of the loss came from a write-down of auction rate securities, which means their CFO made a major mistake. Another five to eight cents came from their new operations in Canada. GenDrive, their fuel cell forklift truck, is in deployment at Wal-Mart and got follow-on orders from Bridgestone Firestone, plus initial deployments at SYSCO Foods and Ace Hardware.

The company shipped 61 backup power systems in the March quarter, received 54 new orders, and has a 298 unit backlog. PLUG remains a buy up to $5 for my $10 target.

WiMAX MegaShift

Craig McCaw’s Clearwire will combine with Sprint’s wireless broadband unit to form a new $14.5 billion mobile WiMAX service company. About 22% of the company will be owned by Intel ($1 billion), Google ($500 million), Comcast ($1.05 billion), Time Warner Cable ($550 million) and Bright House Networks, a regional cable provider ($100 million). Sprint Nextel will own 51% and current Clearwire shareholders about 27%, but the company will adopt the Clearwire name, service the existing 400,000 Clearwire subscribers and be managed mostly by Clearwire. The new company expects to cover 120 million to 140 million people in the United States by the end of 2010.

This partnership is targeting both consumer “last mile” technology to compete with DSL, cable modem and satellite data services, and fourth generation (4G) cellphones and smartphones that will connect to the Internet. Where Wi-Fi has a range of 100 to 300 feed and can transfer data at about one megabyte per second, WiMAX has an effective range of four to six miles and transmits at up to five megabytes. For comparison, current 3G cellular broadband transmits at up to 1.4 megabytes. The cable companies need to offer wireless connectivity as part of their VVD (voice, video, data) packages, and this lets them offer a technically superior product years before their telephone company competitors can respond.

This is mobile WiMAX and the immediate impacts on our portfolio are on Alvarion (ALVR) and Airspan (AIRN) as potential equipment suppliers, which clearly is good news. There also is an indirect impact on Towerstream (TWER) for WiMAX service, and again it is good news. Towerstream wants to move from fixed WiMAX equipment to mobile even though their business service is targeted at fixed locations. Mobile WiMAX equipment will be cheaper due to the high volumes of production, and also can be installed by the user without a truck roll from a professional installer. Equipment and installation costs are a big chunk of Towerstream’s up-front costs to bring on a new customer, so these savings matter.

At the same time, the new Clearwire is not going to target the business market using wireline T1 connections, which is what Towerstream targets. Winning in that business requires getting the right rooftops for Towerstream’s antennas and they have done a superb job of locking up these locations in the major cities. Clearwire, like any consumer DSL or cable company, sells a “best efforts” product to consumers. Towerstream sells a service level agreement, specifying speed and uptimes, to businesses. It is a different market and a different sales call.

Towerstream reported March quarter results yesterday and there was both good news and surprising news. The good news was that year-over-year sales growth continues to accelerate, with the March quarter up 31.7% to $2.1 million. Guidance for the current June quarter is up 47% and it looks like the March 2009 quarter will be the peak growth, up 70%. The company lost 10 cents a share, a bit worse than the consensus for an eight cent loss. The churn rate dropped back to 1.35%, as management predicted. The average sale per trained salesperson also dropped as I expected. Towerstream has been in a rapid sales-force expansion phase, and it is to be expected that average sales will fall until their average experience grows. The stock was murdered last quarter by this factor, but it didn’t hurt today. Perhaps Wall Street is finally understanding what is going on.

During the quarter the company opened their ninth market, Dallas/Ft. Worth. The surprising good news is that management looked at the stock price and competitive situation and decided to slow down their expansion to increase profitability. If the stock was where it belongs – between $5 and $10 – I doubt they would do this. But there isn’t any other company close to them so they can slow their sales-force expansion, stick with their current nine markets for a while and drive up revenues until they are profitable. Then they can turn the expansion back on because during this time they can continue to lease rooftops in new cities and hold onto them until they are needed.

They expect to be EBITDA positive by the end of the March 2009 quarter by holding the sales team to the current 110 to 120 people. This “pause” (while revenue growth accelerates from 31.7% to 70%) will give them time to tighten operations and improve productivity. Even if the business economy continues to slow, TWER sells a solution that is faster and cheaper than the telephone company competitors and should benefit from corporate cost-cutting.

Here’s a YouTube video that is pretty elementary due to the interviewer’s confusion over what business TWER is in, but still worth watching. And for laughs, don’t miss this one kidding Nextel. TWER is a Top Buy up to $6 for my $16 target.

Airspan (AIRN) reported another quarter marred by a sharp decline in their legacy business, while their mobile WiMAX products made progress. Overall, revenues fell 35.6% to $17.2 million and the company lost 17 cents a share. WiMAX is up to 78% of their revenues and I expect one more quarter of the decline in legacy products will mark the end of that dynamic. They guided for $21 million in sales in the current June quarter.

The company burned $2.7 million in cash in the quarter and still has $34.0 million on their balance sheet. They are reducing expenses another 15% by the September quarter. There’s no question that they have good, competitive mobile WiMAX products–they had 20 new customers during the quarter and 90 total WiMAX customers. They have the cash to survive. But there is a question about how fast carriers will deploy mobile WiMAX. At today’s close, the whole company had a market capitalization of only $50 million plus $9.2 million in debt. If we subtract the cash, the market is valuing their product portfolio and business at about $25 million–less than four months’ revenue. That doesn’t make any sense. AIRN remains a buy all the way up to $3 for an $8 target after they turn profitable.

Death of the Dollar

I saw an interesting forecast that if the dollar continues to lose purchasing power at its current clip, within about 10 years China and India will be buying all the food in the world and Americans will have to grow gardens to eat. It sounds like wild speculation, except Sam’s Club is now limiting the amount of rice customers are allowed to buy. India and Vietnam have banned rice exports to try to avoid the food riots that have now hit around 12 countries with another 30 or so on the edge. Of course, this government meddling will cause lower rice prices, followed by lower planting, less supply, and higher prices anyway.

The United States is still sending too many dollars all over the world, and Helicopter Ben is accelerating the printing presses. Our dollars cause inflation in other countries, rising food prices, and…riots. Converting corn to ethanol – a dumb idea that benefits only Archer-Daniels-Midland, Monsanto and fertilizer producers like Rentech – is already driving up tortilla prices in Mexico. With the dollar slumping to record lows, steel prices are at record highs even though construction and automobiles are in major slumps. With metals prices high, plastics prices rising due to the cost of petroleum feed-stocks, and oil for transportation at record levels, the absolutely inevitable destructive inflationary results of Bernanke’s policies are bubbling up. I expect the April 2009 turn date will be driven by some event precipitated by a renewed decline in the dollar and the whole 2010-2011 deep recession to mark the end of the dollar as the world’s reserve currency. But for the next year or so, the dollar should stabilize around current levels, giving the stock market a chance to catch up with commodity and precious metals prices.

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