First, my apologies for the curtailed Radar Report last week. A truck hit a power pole — actually, the power pole — that feeds electricity to my whole valley early Thursday morning, and it was 14 hours before we had power again. I haven’t moved my backup propane generator to the new house yet, so the whole Radar Report was trapped on my very quiet hard disk. Maybe this was the Money Show gods telling me that I should have been in Orlando last week. OK, I surrender; I’ll be at the Las Vegas Money Show, May 12 to 15.
Now the big news this week is President Bush signing the economic stimulus package, but it isn’t because of the tax rebate checks going in the mail in May. People are so worried that a lot of these checks will be saved or used to pay down credit cards. And the money that is actually spent will clear out some inventories that may or may not be replaced, given that businesses are just as worried about the economy as consumers and know this is a one-shot stimulus.
The important part of the bill is the sharp increase in the dollar limit for what qualifies as a conventional mortgage that can be sold to or guaranteed by a government entity, versus what gets labeled a jumbo mortgage that no one wants to offer right now. The $417,000 conventional limit on an 80% mortgage covered a $521,000 house. In many parts of California, the Chicago area, Connecticut, New York City and elsewhere, that doesn’t buy you much. The new limit of $729,750 in high-cost areas will cover a $912,000 house with 20% down, so the whole $500,000 to $1 million bracket is about to “unlock.” Combined with the number of foreign buyers able to buy at a 20% to 30% perceived discount due to the weak dollar, the response should be immediate.
I suspect this is coming too late to save the AAA credit ratings of mortgage insurance companies like Ambac and MBIA by itself, yet the Fed cannot allow them to be downgraded. If a mortgage insurance company loses its Triple A rating, then all the paper that it insured also gets downgraded. All of a sudden, the banks holding this stuff are required to put up a lot more equity to cover the lower-rated assets — equity they don’t have, especially after writing off a large portion of their sub-prime loans.
I read a wonderful “the-sky-is-falling” comment on this situation: “This could be the bank crisis that rivals the 1920′s, that led to the Glass Steagall Act, that started the FDIC and the government’s insuring of bank deposits. If Ambac and MBIA are allowed to lose AAA status, many commercial banks will be faced with capital risk concerns, which will stifle lending, and partially shut down the credit function in the United States…The ramifications could be the onslaught of an economic depression, not recession.”
As if the Fed is not about to step in with some sort of pooled plan to guarantee Ambac and MBIA, thus letting Moody’s and S&P maintain the fiction that these are AAA credits. They used public money to save the Savings & Loans in the late ’80s, and they’ll do it again to save the bond insurers. The Fed is owned by the banks, for heaven’s sake — who do you think they look out for? The unwritten rule in America is: Privatize your gains, socialize your losses. They have already let banks borrow at the special Term Auction Facility (TAF) window to meet their reserve requirements. Another $30 billion went out through the TAF this week, and you’ll see a second $30 billion go before February is over.
The government will prompt outside money like the Middle East soverign (government) funds to come in, too. Also note that Warren Buffet is lining up with the Fed to reinsure municipal bonds held by Ambac and MBIA. Anyone who thinks Treasury Secretary Paulson (ex-Goldman Sachs) and Fed Chairman Bernanke aren’t aware of the problem and don’t have plans to avoid “the onslaught of an economic depression” is welcome to bet against the Fed. But don’t you get suckered into taking that wager.
There’s little difference between a shallow recession and no recession, so it amazes me how many people are eager to say that we are in a recession already, when they have so little evidence of that yet. The December-quarter GDP growth rate is likely to be revised up from the 0.6% preliminary estimate due to inventory accumulation. And this week’s news that retail sales rose 0.3% in January instead of dropping 0.2% as the consensus forecast should give the recesison bears a pause — but it probably won’t.
The best forecaster of recessions is the S&P 500, and as I said in Tuesday’s Flash Alert, it may be about to give a definite signal that the recession everyone fears is not going to happen. Yesterday’s close virtually right at the key 1368 level needs to be followed by a push over 1380 soon. Remember that last Tuesday the Index dropped from 1380 to 1336 in one day, seting up the test of support at 1326. This consolidation and testing process has built up more than enough energy to make a big move up. Tomorrow is options expiration day, and not much is likely to happen. But if the upturn gets underway early next week, there is a very large short interest and once the S&P goes over 1395, shorts will cover and the Index will woosh up to — surprise — 1440. The consolidation around 1440 will tell us if the S&P is headed for 1495 right away, to be followed by a record close over 1555, or if there will be more backing and filling until the March 22 turn date. After that, I think new highs are a lock. I’ll continue to keep you posted on the situation in Radar Reports and Flash Alerts when necessary.
But now, let’s take a look at what’s been happening with our MegaShift holdings. We’ve had a lot of companies report earnings, as well as a lot of subscriber quesitons this week and more from last week that I couldn’t get to. So let’s address some real news instead of worrying that the U.S. financial system is about to fall into a deep depression because Paulson and Bernanke haven’t noticed that there’s something wrong.
Avian Flu MegaShift
Crucell (CRXL) reported their preannounced December quarter, with decent results that fell short of their original guidance, but then made a surprise announcement that they are ending their West Nile virus program. There’s nothing wrong with the vaccine, but the U.S. market has fallen from 10,000 infections in 2003 to only 3,000 today. This was a major program, even if only a small part of the potential future value of the company. But the stock was not hurt after the announcement Tuesday morning.
Total revenue grew 51.2% for the year to $311.5 million, and operating cash flow hit $75.3 million in the December quarter, bringing the year into the black at $32.4 million. In 2006 Crucell had negative operating cash flow of $78.9 million, so this was a significant turnaround. Management said that they would get cash flow positive, they just didn’t hit the even higher numbers that they were targeting. For 2008, they said to look for 20% growth in both revenues and operating income.
The biggest driver of the upturn was the successful launch of Quinvaxem, a 5-in-1 vaccine for children. I am very much opposed to vaccines like this, which put children’s lives at risk just to save the cost of administering the vaccines separately. The shots also are typically given before a child has much of an immune system, which I think both increases the risks of serious side effects, including death, and weakens their immune systems in the long run. But others do not agree with me, and as long as the Gates Foundation is pouring money into less developed countries to vaccinate their children, Crucell will do well even if the children don’t.
In regards to ending the West Nile virus program, this was a big negative surprise. Given the numbers, management probably made the right decision, although one can hope that a smaller firm or nonprofit picks up the program just to eventually provide relief for patients who become infected. Wall Street seemed happy enough with the company’s guidance, though, to overlook the termination of the West Nile virus program.
Crucell looks awfully cheap to me. So I’m trimming the buy limit on CRXL to $17 to reflect the current market, but leaving the $35 target unchanged.
Biotech MegaShift
Amgen (AMGN) was supposed to do a business update call yesterday, according to CallStreet, but the reporting service had it wrong. The next major event is the March 13 FDA panel meeting, and I expect the company to come out of this last hurdle unscathed. Continue to buy the Amgen January 2009 $70 LEAP calls (VAMAN) up to $12.50 for a $25 target.
eResearch (ERES) drew a question from an anonymous subscriber: “You referenced in particular Blum Capital’s support — were you aware he sold over 1 million shares as of December 31?”
Blum Capital did file a Form 4 regarding the disposal of two blocks of stock, one for 676,743 shares and the other for 449,400 shares. However, they did not sell these. They distributed them to a limited partner on December 31. Usually, this means the limited partner left the fund for some reason, often an estate situation. The money manager lets the limited partner take shares rather than cash, in part to avoid the transaction costs of selling stock, and in part to avoid sending a message that they no longer like a large position. Furthermore, we don’t know if the limited partner got to pick and choose (not uncommon) or if Blum Capital decided to use ERES stock to fund the withdrawal. So there really is no way to draw an accurate message out of it.
ERES will report earnings on February 26, and I think that they will beat the Street consensus for $28.6 million in sales and eight cents a share. ERES remains a Top Buy before the earnings report up to $16 for my $30 target.
China MegaShift
The Capitalist Miracle took a hit last week as the Chinese government reverted to its pre-market reform era and froze electricity prices after earlier capping coal prices. The recent freak snowstorms in China, where one inch of snow brought many cities to their knees, also caught the utility companies with low coal stocks, in part because mines shut down rather than continue to sell coal at regulated prices. The idea that Beijing can regulate prices in major sectors of the economy and not cause shortages is absurd, but they seem determined to try in order to hold down inflation. I have a better suggestion for holding down inflation: Stop printing money at 18% per year! I understand why they want to weaken the yuan as fast as Bernanke is weakening the dollar, but it isn’t going to work. Their inflation spike is mostly in food and utilities, which affects the poor most severely, so they’ll freeze food prices and shift the pain to farmers, who will then cut output or switch to freely-traded crops. Ah, the command economy…such a hard idea to keep under the rock where it belongs.
To cope with the electricity shortages, thousands of trainloads of coal were rushed to utility power stations. Hundreds of mines were told to continue operating even through the Lunar New Year holiday. But the price of coal is expected to as much as double in 2008, and the government hasn’t said how the power companies are expected to cope. Huaneng Power (HNP) is down $14 or 28% from where we sold it in July 2007, yet I have no desire to lead you back into this stock in the current environment.
I assume that in a strong U.S. stock rally, Chinese stocks will participate. But I am glad that we are out of harm’s way for now, as they grapple with their inflation and political problems, while still keeping a good face on everything at least through the Summer Olympics. The government keeps gasoline and diesel prices low, and consequently fuel consumption is growing at 20% a year, and they import almost all of it. As crude oil prices went up, refineries were squeezed and stopped expanding capacity. Result: A diesel shortage in October that had truckers lined up at filling stations like a Mad Max movie, and a 10% price increase in November.
I would not be surprised if the government’s intervention and energy price caps cause power shortages and general disruption that ultimately increase inflation. Can political crackdowns be far behind?
Content on Demand MegaShift
Akamai Networks (AKAM) reported a great quarter last week, hitting $183.2 million in sales, up 14% from last year and well ahead of expectations for $174.6 million. Net income was up 47% from the September quarter, and they did 41 cents a share pro forma versus 21 cents last year. They now have 2,645 long-term contract customers, up 13% from last year. Their average customer now spends more than $275,000 per year with Akamai, and they have over 100 customers who spend more than $1 million a year. All the concerns about slowing growth and price competition were just blown away.
On the conference call, management attributed the strength in the quarter to “rich media” (in other words, video) “performing beyond expectations” and named the iTunes movie store as a major customer. They said that high-definition video is not yet a major factor, but in three to five years it would be a huge revenue generator. The video gaming market showed very strong growth. In response to a question about the rumor that Akamai would get into the ad-serving business, they gave a flat “no” and added that they do not compete with their customers.
In a really refreshing response to a question, management said that the company is unlikely to be hurt by an economic slowdown and may be positively affected as companies try to cut costs by moving more operations to the Internet. The stock moved into the $30s on this news, and AKAM is an excellent buy up to my $36 limit for the $60 target.
Harmonic (HLIT) has been weak, and I know only one possible reason why. Business is great in content on demand, as the Akamai results suggest, and Harmonic is better managed now than ever. But the company will probably move from untaxed to fully taxed reporting next year, and maybe Wall Street is worried about the reported numbers being flattish for a year. Note that this does not affect cash — Harmonic will continue to use tax-loss carryforwards to offset nominal taxes due. Normally, Wall Street understands this transition and does not penalize a stock for it. After all, it means that the accountants and board have decided that the company is likely to remain continuously profitable in the future, and therefore needs to start reporting taxed results.
During this transition, the key to the stock will be revenue growth. Right now, the consensus revenue estimates are for a 13% growth rate in 2009. That is laughably low — 26% is closer to reality. As long as HLIT can keep clobbering the revenue estimates, I don’t think that the stock will be hurt by the change in tax rate. I expect management to make this point every quarter, and they will probably give a comparably-taxed earnings growth rate just to make sure Wall Street gets it. Buy HLIT up to $12 for my $18 target.
Intel (INTC) unveiled their new phase change memory technology at the International Solid State Circuits Conference in San Francisco. This is the Ovonic Memory technology that is owned in part by Energy Conversion Devices (ENER). Intel has figured out a way to double the capacity of the memory. Phase change will replace NOR flash memory in cell phones and computers, and it may eventually replace NAND flash memory for digital cameras and MP3 players. But I won’t hold my breath on the NAND flash market, as I’ve been through too many of these “fabulous new memory” technologies that never could catch up to the existing technologies as they marched down the cost curve following Moore’s Law. I do think that Intel will make phase change a success, and the market currently values it at zero for ENER (or maybe a little less, since it uses some cash).
And the Service Pack 1 release for Windows Vista should drive personal computer sales for the rest of the year. Intel is very attractive at current levels, so continue to buy the January 2009 LEAP calls with a $22.50 strike price (VNLAX) under $6. The target price is $12.50 at expiration, over 500% on your money.
Motorola (MOT) is thinking of selling its cell phone operations, or maybe even breaking up into three companies. At the same time, Carl Icahn is going to start another proxy fight. With Ed Zander out, I think it is likely that there will be a big transaction or two at substantially higher prices. The stock jumped 10% on the news, but then backed off.
This is the process that we have been waiting for, and we are entering the payoff zone. Motorola and Nortel Networks are rumored to be in talks to merge their wireless infrastructure businesses, while Samsung has said that they are not interested in buying Motorola’s mobile phone operations. It will take six months to a year to get everything cashed out, and there will be lots of rumors and volatility along the way. Our LEAP calls are selling for peanuts, but I still think that the value of the company is in the $28 area in a breakup, so use this weakness to average down in the Motorola January 2009 $17.50 LEAP calls (VMAAW), looking for a final buyout price in the $28 area and making the calls worth my $10.50 target in January 2009.
Silicon Image (SIMG) reported a weak quarter, showing $85.3 million in sales compared with $86.3 million in the September period, and $87 million last year. But real results were even weaker than that, because the company used to defer sales in the last month of each quarter as the distribution channel couldn’t tell SIMG what their sell-through was. This quarter, they fixed that problem and added $6.7 million in December revenues, making them not comparable with prior periods. For the whole year, consumer electronics sales grew 24% and SIMG has a 57% gross profit margin — not too shabby.
But they guided below estimates for the first quarter, forecasting $61 million to $63 million in sales compared with the consensus for $69.2 million. They said that the year would come in at $270 million to $290 million, versus the consensus for $308.6 million. Management said that this is a “transitional” year as they complete and introduce a five-pin chip to connect mobile devices to high-definition TVs. That product will sell in volume in 2009.
The company has a ton of cash and no debt. They accelerated their current stock repurchase program, which is $62 million remaining on the original $100-million authorization, and said that the Board has authorized a second $100-million program.
Besides that, the story sounds like dead money, except yesterday when Artisan Partners disclosed a 5.2% stake. Artisan is an “activist” fund, and SIMG jumped over 11% on a whopping 10 million shares. I am cutting the buy limit to $8 and the target price to $16, because that is what the real value of the company is, whether in a takeover or on its own.
New World Economy MegaShift
CNET Networks (CNET) also reported a better-than-expected quarter last week, with $125.5 million in sales, up 11% year-over-year, and ahead of the $122.6 million estimate. Operating earnings hit 15 cents a share versus 12 cents last year. The reported number actually was $1.33 a share due to a huge tax benefit, and on that basis, analysts were looking for $1.29.
CNET guided for 8% to 13% growth this year, to between $440 million and $460 million, with pro forma profits in the 12- to 14-cent-per-share range. The consensus was looking for $447 million and 14 cents.
But for the March quarter CNET expects a pro forma loss of two or three cents a share on $91 million to $95 million in sales. That was a bit below analyst forecasts for a penny loss on $98.7 million in sales. But the stock did well anyway, in part because of a rumor that Google will buy them (I doubt it) and in part because hedge fund Jana Partners is leading a group of dissident shareholders to get control of the Board.
I think CNET is on the right track, and I hope that they stay independent. I don’t see much risk in the stock, and whether they earn their way out of the doldrums, get bought by Google (or Microsoft) or get split up by Jana Partners, CNET is a low-risk buy up to $9 for my $17 target.
Next Week’s Radar Report
I’ll cover the reports from Energy Conversion Devices, Rentech (RTK), iRobot (IRBT), American Science & Engineering (ASEI), Alvarion (ALVR) and numerous others next week. I also hope to get back on track answering your recent questions, but earnings season is always a big crunch time. Thank you for your patience as I listen to conference calls and analyze the results.
Death of the Dollar
Currency traders are betting that the Fed rate cuts will goose the U.S. economy as Europe slows, so they’re going long the dollar. It’s interesting that while the stock market worries about recession and the larger bond market shows no worries about inflation, the largest-of-all currency markets are betting on a stronger economy. The consensus forecast of 31 currency analysts surveyed by Bloomberg is that the dollar will gain 5.4% against the euro by the end of 2008 and another 6% in 2009. For perspective, the dollar fell 11.4% in 2006 against the euro, and 10.6% in 2007 for a cumulative drop of 19.9%.
I think that the forecasters are wrong and also focused on the wrong thing. It is true that the European Central Bank (ECB) is lending huge amounts of money to their banks to maintain liquidity, making our Fed look like Scrooge in comparison. The ECB has already pumped $623 billion into the banks, and they are letting the banks post collateral that includes about $500 billion in asset-backed paper, including sub-prime mortgage loan paper at face value. That means the banks have a few hundred billion in write-offs to take, but the ECB will let them spread it over many years.
The banks themselves don’t want to lend to each other, because no one knows who is in big trouble until they ‘fess up to some write downs. I believe that the rumors are true that one of the largest European banks is legally busted, with a negative book value if they wrote off their bad mortgage paper, as the U.S. banks have started to do. But, like Citigroup and Wells Fargo in the late ’80s, the regulators will paper over it, and there will be no day of reckoning.
The papering-over process tends to create a strong economy as liquidity is pumped into the system and interest rates are held low. The main reason that I think the euro will remain strong against the dollar is that the Europeans started with a budget closer to balanced, and they rely more on monetary policy than fiscal policy to save their banks while avoiding a serious recession.
In contrast, the record $3.1 trillion budget just proposed by President Bush will produce record deficits, and that’s before adjusting for his proposed spending cuts on Medicare and proposed elimination of dozens of popular domestic programs that will never happen. He proposed killing or sharply cutting about 150 programs to save $18 billion in 2009, including eliminating community services grants to nonprofit groups that help the poor, a food program for low-income seniors, the $283-million program to help people make their homes more energy efficient, grants to states to keep illegal immigrants convicted of felonies in jail, clean water grants, funding for local law enforcement, and homeland security grants to states and local governments. Funding for the food program for low-income pregnant women and their children would be frozen in spite of skyrocketing food costs, as would funding for health research by the National Institutes of Health. Many of those cuts have been proposed and rejected by Congress before, so this is all show. He would increase spending for a few programs, such as abstinence education.
He proposes spending only $70 billion on the wars in Iraq and Afghanistan, down from $189 billion in the September 2008 fiscal year, with no visible intention to cut troops. Through this sleight-of-hand, defense spending in 2009 is supposed to fall to $588 billion from $670 billion this year.
The longer-term projections are equally ludicrous. After 2009, there is nothing in the budget for either Iraq or Afghanistan. Spending on veterans’ medical benefits is going up slightly in 2009, but the Bush budget proposes cutting it each year for the following four years. The projected deficits before any adjustments for reality are $410 billion in 2008 and $407 billion in 2009, right around the record $413 billion deficit that he ran four years ago. That’s assuming Rosy Scenario is back, with 2.7% growth in 2008 — about double the consensus forecast. He forecasts a $48 billion surplus by 2012, assuming the Alternative Minimum Tax stays in place to sock the middle class.
When this “conservative” president took office, the projections were for $5.6 trillion in surpluses over 10 years. Those estimates were off-base, but there’s no question that he’s leaving the budget in much worse fiscal shape than he inherited. When he took office the total federal debt held by the public was $3.3 trillion. It will hit $5.4 trillion this year and $5.9 trillion in 2009, according to the President’s budget. About $2.3 trillion of that is held by foreigners, so we no longer “owe it to ourselves.”
The good result of a weak dollar is an improving trade balance, and this morning we learned that after five straight years of setting records, the U.S. trade deficit fell in 2007, in spite of higher oil prices and another record deficit with China. The improvement came from an increase in exports, thanks to the weak dollar. The annual deficit fell 6.2% to $711.6 billion, and if that dollar improvement continued, we’d hit the balance point in 2022. Cold comfort.
But perhaps the real story is not whether the dollar or the euro wins the race to the bottom. Perhaps I should change the title of this section to “Death of Paper Currencies.” The dollar, euro and yuan are all going to go down versus commodities — agricultural, metals, mined products, forest products, you name it. In other words, worldwide inflation is a much more real and serious problem than a shallow, possibly imaginary recession or a shortseller’s fantasy depression. In this context, I expect gold to hit $1,000 an ounce soon, but then enter a multi-month consolidation similar to what the stock market had been through over the last year. When the consolidation ends, there will be another great leap upward in gold, just like the one we are about to see in stocks, as people try to get out of paper currencies. Stay nimble and keep your cash in yen.
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