It’s been quite an interesting August. Typically, during the dog days of summer the market putters around without much news to drive it in any particular direction, as many institutional investors scurry to the beaches for one last vacation. But this year, as you know, it has been different — the S&P plunged almost 40 points at the start of the month, shot back up seven days later to 1503.89, dropped to a low at 1404.36 mid-month and then darted back up to close at 1462.50 today. That’s as far from puttering as you can get.
So the question that I’m sure is weighing on every investors’ mind is: what can we expect next? So far, the Flash Alert that I sent you on Monday regarding the “Bernanke Put” has been spot-on, as the S&P 500 has moved up 93 points from last Thursday’s intraday low. Now that it has broken through the 1455 level, I would not be surprised to see a few more days of consolidation like today, and even a quick test or two back down. But as long as the S&P doesn’t close under 1452, I think the move back to 1530 is underway. Also, it’s important to note that the VIX Fear & Greed index is coming back down slowly, which suggests that there is enough negative sentiment to complete the run to 1530. In fact, as soon as there is an event that says “the scary, emotional period is over,” look for the Dow Jones Industrial Average to jump 400 to 500 points in a day, with the S&P 500 up at least 40 points.
After that, who knows? My suspicion still is that we will go much, much higher as the Fed prints money and cuts rates to bail Wall Street and the banks out of the sub-prime mess that they created. One clue to watch is the ever-weakening dollar, especially after Labor Day. If the markets are going to succeed in forcing the Fed to cut rates, it will show up early in a rapidly declining dollar. A break below July’s low level of 80 could trigger a minor collapse, sending gold, silver, oil, stocks and even real estate soaring again. In some ways, it would be the simplest path for the Fed to rescue the real estate market.
(Incidentally, if you meant to book a trip to the International Space Station, don’t delay. Earlier this year, Space Adventures was charging $25 million for a seat, but they just raised it to $30 million. They’ve already said it will go to $40 million in 2008. Their reason: The falling value of the dollar.)
Even a break back to 1430 or 1405 would not mean that the bull market is over, but it would be a hard test for many short-term investors to stay bullish. Barring a hurricane or geopolitical event, that much of a test is unlikely at this point. Everyone knows Washington Mutual and National City Bank are in deep trouble, and there will be massive additions to loan loss reserves in the September-quarter reports. But the banking and brokerage stocks with major real estate exposure have already been decimated — that’s what caused a big part of this decline. So, I don’t think any of the credit headlines will have the ability to pull the S&P back down to the low 1400s. We’ll watch and see, though, and continue to base our actions on what the market is telling us to do.
As things quiet down, and earnings reporting season tails off, I want to take this week to update a few stocks that have significant news and answer some subscriber questions. Many of these concerns focus on one company or another, so we’ll cover those stock questions in their respective MegaShifts. Before we get to those, though, I’d like to start with a general question from Irv: “Right now I’m holding a total of 33 stocks you have recommended to buy. Of these stocks only eight are in a positive situation. Some of these down stocks are so far negative that it will take a long upsurge up just to get back even. Are you still standing by your belief we will get these losses back?”
On most of the stocks that you are referring to, the answer is yes. In the market that I see coming through the 2008 elections, we will be selling many of these at a profit. There are some, like QLT (QLTI), UTStarcom (UTSI), Zhone Technologies (ZHNE) and MobilePro (MOBL), where there isn’t enough time to get them profitable before a serious bear market sets in. In those cases, I am tuning my advice to reduce losses. But the vast majority of them has improving fundamentals and will hit their target prices before the macroeconomic outlook forces us to sell.
Biotech MegaShift
Amgen (AMGN) is waiting for the September 11 FDA meeting that will review the use of Aranesp and Epogen for kidney dialysis. We have already seen the impact of the review of their use for cancer, especially in high, off-label doses. I don’t think there will be any change in the use for dialysis, which is an on-label use that has had massive amounts of data and clinical study, both before and after approval. But subscriber Marti wrote: “Unfortunately AMGN goes down and down and there is no end in sight! Now there is a meeting with the FDA on September 11 and I am afraid of the stock’s reaction after that! Are you still sure that AMGN will be at $75 by the end of the year? What happens if there is bad news for AMGN?”
Marti, I think AMGN put in a bottom at $48 a few days ago, but, of course, it has to go back there and test it before we will know for sure. I feel your pain on this one, but as I said above, I don’t think anything bad will come out of the September 11 meeting — and that alone could drive a $10 relief rally. If I’m wrong about that, the stock will get hit hard.
But if I’m right, in a good market I still think that we’ll see $75 by the end of this year. However, that is not the right time period to look at. We are buying January 2009 LEAPs because we want the extra cushion of another year to let Amgen right their ship. They have already announced dramatic cost reductions to protect their earnings, and they can accelerate clinical programs to get new drugs on the market faster than Wall Street currently expects. So my eye is still on $95 by mid-January 2009, which would make the $70 LEAPs worth $25. Continue to buy the Amgen January 2009 $70 LEAP call (VAM AN) up to $12.50, with a $25 target price. I think you want to own these before the September 11 meeting, and if you are nervous about that, buy out-of-the-money September 2007 puts to hedge your position.
Dendreon (DNDN) jumped this week for a silly reason — they reported Phase I trial results for Neuvenge for breast cancer in the August 20 issue of the Journal of Oncology. Neuvenge was “safe and well-tolerated” and “stimulated significant immune responses” in the18 patients in the trial. The study included patients with aggressive metastatic breast cancer who had failed to respond to chemotherapy. According to the article, four of the patients (22%) had evidence of anti-cancer activity, including three whose illnesses did not deteriorate for more than a year
Surprise. Neuvenge is Provenge by another name, and I’m not sure why Wall Street thought this was worth gapping the stock up 7% on Monday. About half the gain has stuck, probably because so many shares are sold short. The shortsellers can be counted on to keep you in a state of panic until the interim results for Provenge come out next year or the company signs a European marketing agreement. Those are the only two things that really matter right now.
The stock drew a couple of recent questions, the first from John: “I recently read that DNDN will sell a 4.75% convertible note, yielding 10 million shares. How will this dilution affect us? Negatives surround DNDN and growing, not value?”
Biotech companies have to raise money until they get their product on the market, and selling the convertible note was pretty cheap financing. Dendreon raised $85 million. The extra potential shares will not matter for the next few years, because when a company is running at a loss, extra shares reduce the loss per share, so companies are not allowed to calculate the per share loss using the extra shares. In my opinion, the $85 million will let the company build shareholder value quicker by funding some small Phase II trials for Neuvenge. And even though the positives are growing, not the negatives, the shorts will try to keep you blind to that fact.
Which brings me to Steven’s question: “What is the true value of DNDN? I’ve received recommendations to buy puts on this stock with the notation that it is worth $2 to $4.”
Dendreon will be worth $40 a share when Provenge is approved. If the interim peek does not show statistical significance next year, the stock may well go to $2 or $4 for a while. Then, after the Provenge trial wraps up in 2010, the stock will go to $40. So don’t chase it on meaningless news that it did well in a Phase I trial. Instead, buy DNDN on dips under $7 for my $40 target.
Isolagen (ILE) was the subject of a question from Fred: “I blindly jumped into ILE and that seemed to be the kiss of death as it has moved from $4.50 to under $2.00. Is this just another chance to double up?”
Isolagen dropped after they put an important clinical program on hold, and although they have not restarted it, they are about to. Here is the full story: Isolagen has two major strategic programs, Aesthetics and Therapeutics. We are primarily interested in the Aesthetics program, which means cosmetic medicine for baby boomers. The Therapeutics program is important as an additional way to create value from their technology, but it will take longer.
In Aesthetics, they have two clinical programs: Wrinkles/Nasolabial Folds for the lines that run from the nose to the corners of the mouth, and Full Face Rejuvenation for finer lines and wrinkles anywhere on the face. It was the Nasolabial program that had a problem.
The company’s troubles came from two identical pivotal Phase III trials that the FDA approved in October 2006 under a Special Protocol Assessment, which means if they hit statistical significance, they get approval. Each trial includes 200 patients, and all the patients were enrolled and injections started in early 2007. But then ILE ran into a manufacturing problem that messed up the schedule, so they had to go back to the FDA and file an amendment to the study protocol and their manufacturing and control submission. So, of course, the stock took a hit. But the FDA approved that amendment on July 11, and injections will begin again shortly and be completed in October. We should get results early in 2008.
The Full Face Rejuvenation trial is a Phase II open label study (no placebo) in 50 patients, spread across five investigators. About 45 of them have been enrolled, and they will be followed for six months following their last injection. We should hear the results on this around mid-2008, and it could move the stock sharply due to the headline-grabbing impact of “look 20 years younger.”
In Therapeutics, Isolagen has four clinical programs targeting acne scars, restrictive burn scars, acute burn scars and dental papillary recession. The acne scars program is about to enter a Phase III trial, pending FDA approval of the program Isolagen filed in July. I am expecting approval after Labor Day, and this trial will begin shortly thereafter.
The restrictive burn scars trial is a Phase II program. The company filed for approval to go forward in February, and it is about to start a 20-patient demonstration trial with two investigators. Isolagen thinks that they can reduce or eliminate restrictive burn scars, which cause a permanent tightening of the skin that can affect the underlying muscles and tendons to limit mobility and possibly damage nerves.
The acute burn scars prevention program will be entering a Phase II trial, but the company has only had preliminary discussions with the FDA so far, and there is no approved trial design yet. Isolagen wants to use their therapy about six weeks after the burn event — which is just about when scar formation begins — to prevent the formation of both restrictive burn scars and hypertrophic (red, thick, raised) scars. We will know this program is progressing when Isolagen files a formal IND for the Phase II trial.
The dental study targets the problem of receding gums, as measured by the gap at the lower part of each tooth. In the second quarter of 2005, they completed a Phase II trial and found that both investigators and patients saw improvements that were statistically significant four months after treatment. But that was on a visual scale, so then they took actual measurements and the results were not statistically significant. So in 2006, they started an open-label Phase II study in 11 patients who will be followed for a longer period of time, with the trial completed and data evaluated in the first half of 2008. If the trial results are good, they will probably do another, larger Phase II study before proceeding to Phase III, so the payoff from this program is a ways away.
Clearly, the key to the stock in the near-term is the Phase III Nasolabial program, which was a successful treatment in Phase II trials, and I don’t see any reason that won’t follow through to Phase III. We should hear the results in the next six to eight months, and a successful outcome will guarantee approval under the Special Protocol Assessment. The company had proposed raising $50 million in new stock and convertible debt, in part to pay off some old convertibles. But they withdrew that filing and this morning completed a registered private placement, raising $13.8 million to get them through this period.
A successful Nasolabial product will have a huge market, and the total market capitalization of ILE has fallen under $80 million. The manufacturing issues were a management stumble (the Chief Medical Officer was replaced in February and the CFO promoted to COO in June), but that is behind them now that the FDA has greenlighted resuming the study. And I think they were wise to raise a smaller amount of money with the stock so low. So, Fred, this long-winded answer to your question is: Yes, double up now or buy ILE under $4.50 for my $9 first target, on the way to $25. And isn’t it nice that it seems to have bottomed and is back up near $2.50?
Rochester Medical (ROCM) got some stunningly good news. Medicare established new rules last week to withhold additional payments to hospitals for treating preventable medical errors and hospital-acquired infections. The rules go into effect after October 1, 2008, and payments will be withheld from hospitals for treating catheter-associated urinary tract infections and other problems, like bed sores. Catheter-associated urinary tract infections account for 38% of hospital-acquired infections, or 561,000 cases last year. The easiest way to prevent them is with Rochester’s Release-NF silicone catheter incorporating nitrofurazone.
Nitrofurazone is a broad-spectrum antibacterial agent, and I had a great question at the San Francisco Money Show from a doctor subscriber who challenged my statement that it is not an antibiotic. You may recall that one of Rochester Medical’s allegations in the lawsuit against C.R. Bard, Tyco, Premiere and Novation was that those companies told hospitals that Rochester used an antibiotic that might lead to antibiotic resistance. The doctor subscriber said that as far as she was concerned, nitrofurazone may not technically be an antibiotic, but it was just as bad.
I really like feedback like that, and I take it very seriously. I spent several hours researching nitrofurazone and discovered that even researchers throw around the phrase “antibiotic” very casually. I read several scientific papers that called nitrofurazone an antibiotic.
But I also learned the difference between an antibacterial and an antibiotic. Medicinal chemists call antibiotics any drugs that kill bacteria and come from natural sources like molds. So penicillin G is an antibiotic, because it is produced by fermentation of Penicillium chrysogenum. Completely synthetic organic compounds that have structures very similar to natural antibacterials are also designated as antibiotics. So even though Ceftriaxone is made synthetically, it is also called an antibiotic, because Cephalosporium molds produce compounds with the same fundamental structure.
But not all antibacterials are antibiotics. Synthetic antibacterials that are not similar to natural antibiotics are not classified as antibiotics, and there are a lot of these, including the quinolones, oxazolidinones and sulfa drugs.
Furthermore, some antibacterials, whether classified as antibiotics or not, may be called antimicrobials, because they are also effective against viruses, funguses or parasitic microorganisms. That’s why penicillin G is the drug of first choice for syphilis, which is caused by a spirochete, not a bacterium. And tetracyclines are preferred against the rickettsia that cause typhus.
So, I called Jim Conway, the CEO of Rochester Medical, to confirm all this and get his perspective. He pointed out that because the nitrofurazone is in the silicone and slowly comes out into the urethra, it never enters the bloodstream and therefore it is unlikely to create resistant bacteria. Also, nitrofurazone appears to have two mechanisms of action against bacteria, and it is very difficult to have a mutation that protects against both mechanisms of action at the same time. Finally, the drug was used for years in chicken and cattle feed without developing any resistant bacteria. (It was banned because traces of it were found in the animals after slaughter.)
My conclusion is that it is technically correct to say that nitrofurazone is not an antibiotic and, even more important, it is very unlikely to cause bacteria to mutate to a resistant strain.
With the upcoming change in Medicare rules, Rochester’s future is made. Tyco spun out its healthcare subsidiary as Covidien, and I expect a settlement of the remaining antitrust lawsuit against Covidien and Novation any day. This is a stock that you have to own at current levels. This company has a lot of great things going for it, and I expect the stock price to continue to move up, so I recommend that you get onboard now. ROCM remains a Top Buy up to $23 for my $40 target.
ViroPharma (VPHM) was clobbered when Wyeth stopped dosing hepatitis C patients in the Phase II study. ViroPharma’s drug, HCV-796, is partnered with Wyeth, which stopped the trial because 8% of the patients taking the drug were experiencing higher liver enzyme levels, compared to only 1% of the patients in the standard of care arm of the trial. Higher liver enzyme levels are an early indicator of liver-related disorders for any drug, and they are a bigger problem than usual here because hepatitis C affects the liver to begin with. The FDA says that elevated liver enzyme levels are the #1 cause of all drug adverse events and, worse, of all new drug application rejections.
The only positive from all this is that the truncated study results showed good activity in eliminating hepatitis C for certain patients who previously failed treatment with the standard of care. Fully 23% of those patients had undetectable levels of the virus in their bodies after only 12 weeks of treatment, and there are no other good treatment options for these non-responder patients. But that would be a much smaller market than VPHM, Wyeth or Wall Street was looking for, so the stock was hit. I got numerous emails on this, and David asked for the bottom line: “What do you feel should be done with VPHM after this steep drop.”
First, this caught me by surprise, as it has not been an issue in previous trials. Of all the hepatitis C polymerase inhibitors, HCV-796 was the furthest along in clinical trials and could have been a big win. I have taken it out of my model completely, although it may get approved for patients who have failed everything else.
But remember that this was a Phase II trial, and ViroPharma has the antiviral Camvia in two Phase III studies now enrolling — one to protect stem cell transplant patients from infection with cytomegalovirus, and the other to protect liver transplant patients from the same infection. Data from the stem call Phase III is due in the second half of 2008.
Of course, ViroPharma is still fighting the generic Vancocin war (and winning, it appears to me), so getting replacement products into and through the pipeline is vital to winning buy recommendations from Wall Street. At this point, with the stock bouncing back about 25% in the last week, the company has a market capitalization just under $700 million. It will have operating income of at least $100 million this year, and it had over $260 million in net cash at the end of the June quarter. June-quarter earnings easily beat Wall Street estimates and the company raised 2007 sales guidance for Vancocin.
I think that they will take their cash hoard and the remaining cash flow from Vancocin before generic competition hits in 2009 or 2010, and make a strategic acquisition of an approved or near-approved product to replace the Vancocin revenues. That has been the strategy all along — we bought the stock knowing Vancocin would go away in 2009 or 2010. This is a really superb management team, and while the clinical failure of HCV-796 is a big negative, the reaction in the market has been way overdone. I am lowering my buy limit on VPHM by $1 to $12 to reflect the HCV-796 failure, and lowering the target price by $3 to $25. That means the stock is an excellent buy at today’s prices.
China MegaShift
UTStarcom’s (UTSI) dip to the $3 area has depressed many, including Barry, who asked: “UTSI down another 12% today, and off 90% since the buy recommendation. Where do we go from here? Or do we wait for the stock to disappear from the Board?”
UTSI needs to change its CEO and show continued orders in Internet Protocol Television and broadband data access to get Wall Street liking it again. I’m not too worried about the orders, but when UTSI will change the CEO is a lot less certain. The stock is very cheap relative to sales, and that alone may spark a takeover offer. Given the recent firing of the heir apparent, my numbers are too high, so I am reducing the buy limit on UTSI to $4 and the target price to $10. But I still think it can be bought, as it seems completely sold out at these levels.
Content on Demand MegaShift
Intel (INTC) may have a capacity problem supplying enough computer motherboards in the second half of the year, according to rumors. If so, this is testimony to the acceleration of the Vista upgrade. It’s going to be a good year for PCs, and I don’t think you have much longer to buy the Intel January 2009 $22.50 LEAP calls (VNLAX) under $5. My target price is $12.50 at expiration, based on INTC hitting $35 over the next 17 months.
Motorola (MOT) should see some action shortly, as Carl Icahn bought 45.9 million more shares, more than quintupling his stake to 55.3 million shares, or 2.4% of the company. Shareholders are probably sorry that they didn’t vote him on to the Board in the recent proxy fight. I am expecting CEO Ed Zander to either resign or find a white knight to acquire the company, possibly taking it private. Icahn’s moves will accelerate that timetable. The Motorola January 2009 $17.50 LEAP calls (VMAAW) remain a buy up to $4 for a $10.50 target ($28 on MOT minus the $17.50 strike price) in January 2009.
Silicon Image (SIMG) drew several subscriber questions, ranging from Michael K’s: “What on earth is going on with SIMG?” to Michael C’s: “A few months back you addressed a question from a subscriber (me) regarding potential competition to SIMG’s HDMI technology. At the time you said you were going to continue to research the issue and provide an update in the near future. I haven’t seen the update yet and was wondering if a) you had completed your research and are ready to share your findings with us and b) if the recent huge slide in SIMG represents a good opportunity to double down on our investment. Please advise and thanks.”
Seward also asked: “Would you please discuss Silicon Image’s business prospects in greater detail? I bought the stock last year at $8.85, enjoyed the move up to $14.50, but now am seemingly going down with the ship. I understand that the selling in the stock is probably exacerbated by the market’s overall weakness, but your analysis seems off. Analyst estimates for revenues and earnings have been trimmed repeatedly this year and the company is guiding down. Since hitting a 52-week high of $14.68 in October of last year, the stock has lost 67% of its value. It appears as though the market thinks that SIMG’s supposed technological advantage is either shrinking or has disappeared. I thought that this was a bottleneck technology but now believe that I was wrong. Your price target seems hopeless at this point.”
Let’s start with Michael C’s question on the potential competition from IBM’s DisplayPort standard, which is free of royalties. That is attractive to some low-end personal computer manufacturers. But it has no other advantages over HDMI — they both have the same 10 gigabit bandwidth, and thus the same resolution, and they both transmit audio, video and data on the same cable. The difference is that HDMI is in hundreds and hundreds of consumer products already, and it is not likely to be displaced.
So, will DisplayPort take over personal computers? On the one hand, companies like Advanced Micro Devices have said that they will supply DisplayPort-compatible graphics cards in 2008 to any PC manufacturer that wants them. But in my book, most PCs are consumer electronics and will need to deal with peripherals like HD-DVD and Blu-ray disk players. DisplayPort cannot deal with digital rights management software, and HDMI can. To me, it makes more sense for an LCD panel manufacturer to stick with HDMI, which can be used as a TV or computer display, than to go to DisplayPort for their computer displays. It also makes more sense for the consumer to buy the more flexible display, considering the very low price differential.
So, moving on to one of Seward’s questions, I think HDMI is still a bottleneck technology. SIMG stock came down 30% in two days after the company beat the upper end of its revenue guidance by nearly a million dollars, beat the upper end of its gross margin guidance by 0.7 points, and guided for double-digit growth with less price pressure and better margins in the second half of the year. Here’s what CEO Steve Tirado said:
“We expect to see another quarter of double-digit growth in our unit demand. … We also expect to see average selling price pressures begin to moderate given our expected product mix with a focus on product margin improvements in the second half of 2007. We believe that our second-half 2007 product gross margin will experience a modest improvement relative to our second-quarter 2007 product gross margin.”
The stock was hit because their positive outlook was not positive enough — it was below Wall Street expectations. So on Monday, Steve Tirado bought 20,000 shares on the open market, increasing his position to 140,000 shares. For those of you who hate to see insider selling, the CEO buying that much stock should give you confidence. SIMG bounced 9% on Tuesday, and with the holiday season for consumer electronics just around the corner, the stock has probably bottomed. I still think that they deliberately guided low, and SIMG is a buy up to $13 — more than a double from today’s close –for a move to $20.
Telkonet (TKO) dropped a bit after naming their new Chief Operating Officer, prompting Jim to ask: “Recent ‘good news’ from TKO apparently has hurt the stock rather than help it, down 15 cents today. WAS this good news or should we take this reaction as a sell sign?”
Jim, this was really good news. No one may care until he is moved up to CEO, and I think that could happen in the next 60 days and will happen by the end of the year. The stock dropped 15 cents after they reported June-quarter results, with $3.7 million in sales and a loss of $4.6 million, or seven cents a share. Revenues were at the high end of their guidance and up substantially from the first quarter’s $1.25 million and last year’s $1.2 million, as several large programs got underway towards the end of the quarter. The loss was down from $7.6 million or 16 cents a share last year. Their energy management and Federal systems businesses will drive further revenue acceleration in the September and December quarters. They are targeting profitability in December.
So what did Wall Street not like? Eric Kainer of Thinkequity Partners, who has been negative on TKO since he was at Needham, came out and reiterated his “sell” recommendation. He has been right for the last year, and I have been wrong. But I think the accelerating revenues and the imminent change of leadership at the top make a big difference. With Google and DirecTV now blessing Broadband-over-Power Lines via investments in and deals with Current Group (private), TKO’s moment has come. Buy TKO up to $5 for my $15 target.
New Energy Technology MegaShift
Natural gas prices plunged more than 10% on Monday after Hurricane Dean turned away from the U.S., the biggest one-day drop in four years. Tuesday, prices fell another 3.2% after Dean weakened to a Category II storm, and September contracts hit $5.85. But prices came right back on Wednesday to climb back above $5.85, which held today. This sets up a good-sized rebound move at least to the $6.50 breakdown point.
The move in gas matches a corrective pattern in crude oil that started at the end of July and has brought prices down from $78 a barrel to just under $70. This is the same consolidation range that we saw in mid-June, before the breakout to $78, and I expect it to end the same way. These full tests down to the last breakout level shake out as many bulls as possible, before the trend resumes. In this case, summer driving season is coming to a close and there haven’t been any serious hurricanes, yet oil prices are still near $70 as we enter the heavy industrial use period in the fall. With China growing well above that government’s 10% target and world production flat to falling, it isn’t hard to see why we keep getting higher lows and higher highs in oil prices.
Infinity Energy Resources (IFNY) dropped after what I thought was a good conference call, drawing questions from Susan, Gabriel, Doyce and others. Doyce’s questions were representative: “Within the last month you were predicting Infinity would double by the end of summer. I assumed that you were talking about the summer of 2007 — is this correct? If so, what happened, since it is now worth only about 50 % as much as it was a few months ago. Did the quarterly report issued about a week ago have any good news in it? I didn’t see any and from the market response of the last week, it doesn’t appear to have impressed any buyers. If your recommendations are still favorable on this stock when can we expect a turnaround? I am an admirer of your logical presentation of financial advice, but the action on this stock make me wonder if you missed the boat here. I would appreciate an updated analyses based on the most recent quarterly results.”
I think the main problem with the stock has been the dramatic weakness in natural gas prices, which probably bottomed yesterday. I commented on the June-quarter results in last week’s Radar Report and, unlike Doyce, I saw lots of good news in it. Deals are in motion and will be announced, the management team is being upgraded, and they are about to start proving up their massive Nicaraguan oil lease concession. I think you will see the stock move when deals are actually announced, and those announcements are imminent. IFNY remains a Top Buy all the way up to $5 for my $10 target, based on their huge potential in Nicaragua.
Lighting Science Group (LSGP) drew a good question from Michael K.: “You recently recommended LSGP as a buy, and mentioned Iroquois Capital taking a significant stake. Is their arrangement like that of Cornell and MobilePro? Cornell and the naked shorts ran MobilePro into the ground, and it appears that LSGP cannot shake the naked shorts either. Is this because of LSGP’s financing arrangement with Iroquois Capital?”
Michael, I don’t think that these arrangements are the same at all. I work from a long checklist developed over the years from things that went wrong, and need to be checked. Before I recommended LSGP, I checked Iroquois’ status with the SEC and their reputation in the industry. They are one of the largest investors in private equity transactions for public companies, doing over 100 transactions a year. They seem to have a good reputation and don’t make money by running companies into the ground.
LSGP did make quarterly payments on its convertible bond in stock in 2006, but a big chunk was converted into common stock this year. They will continue to pay in stock to conserve cash, around one million shares for this year. That is not the kind of spiraling dilution that got MobilePro in trouble.
I don’t think this stock will be under 50 cents a share for long, so if this kind of very small company is your cup of tea, buy LSGP under 50 cents a share for a move to $1 in 2008, $2 in 2009, $3 in 2010, $4 in 2011 and $5 in 2012, when the California incandescent light conversion deadline hits.
U.S. Geothermal (UGTH) took a nice 40-cent jump on Monday and has been trading higher ever since. I don’t think you are going to get a chance to buy the rest of a position any cheaper, so I am raising the buy limit on UGTH to $3 and the target price to $6.
Robotics MegaShift
iRobot (IRBT) jumped over my $19 buy limit last week after The Associated Press broke a story that: “The Pentagon plans to purchase up to 3,000 additional robots to be used by U.S. soldiers in Iraq and Afghanistan to detect explosive devices and roadside bombs.” It’s a little more complicated than that, but this would be a big contract for the company, worth around $180 million based on iRobot’s selling price of $60,000 per PackBot. That’s almost as much as the company’s entire revenues in 2006. One thousand PackBots will be ordered this year, with 2,000 more to follow over the next five years. (Did you know that the Department of Defense is planning to be in Iraq and Afghanistan until 2012?)
One thousand robots, or $60 million, is still a big order, but iRobot may have to split it. Foster Miller, a subsidiary of Britain’s QinetiQ Group, makes the Talon bomb disposal robot with similar capabilities at about the same price. There’s even a chance Exponent’s MARCbot could get some of the business, even though it is not as advanced as the PackBot, as it is cheaper. Still, even sharing the contract will generate a nice chunk of change.
One company that is not likely to get a share of this contract is Robotic FX, formed by an ex-iRobot employee. They make a tactical surveillance robot called Negotiator that looks like the PackBot, but they claim will sell for only $20,000. iRobot has sued them in Federal and state court for patent infringement and misuse of confidential information.
Another threat to iRobot that I am watching is the new armed robot from QinetiQ’s Foster Miller. Only three of these bad boys have been deployed so far, but they are designed to wheel into combat or door-to-door searches and shoot people. According to National Defense magazine, the U.S. Army started putting Foster Miller’s SWORD armed robots into combat a couple of months ago, and it can get rid of roadside bombs in addition to (or possibly at the same time as) shooting people.
iRobot does not make an armed robot, and they’ve never talked about a development program. The Army says that reaction by soldiers has been so positive that they want 20 more SWORD robots immediately, part of an 80-unit purchase authorization. According to the Pentagon, robots will be 33% of our combat forces by 2015, as part of the $127 billion Future Combat System Program. I suspect this is a direction that iRobot has to go in order to keep up with competition.
With the holiday season coming, sales of Roomba and Scooba home vacuums should pick up. IRBT remains a buy on dips back under $19 for my $30 target.
Security MegaShift
SiRF Technologies (SIRF) drew a question from Sherry: “What is going on with SIRF? Is it still a buy?”
The second part of your question is easy to answer: Just go to the website anytime, 24 hours a day, and you will see my up-to-date recommendation. Any changes to my buy advice will be noted there, as well as in a Flash Alert or Radar Report. As for the first part, since I recommended the stock three weeks ago on the day that it broke to close at $20.09, it hasn’t done much but consolidate just below $20. SIRF has presented at a couple of technology conferences since then, and I think it is clear that Wall Street is waiting for the September-quarter results to decide if the next five points on the stock are up or down. I think they will be up, because so many consumer electronics products that will be gift items this year include GPS. So, SIRF remains a buy while it is under $22 for my $40 target.
WiMAX MegaShift
MobilePro (MOBL) said that the sale of Kite Networks to Gobility fell through after Gobility was unable to raise the required $3 million in capital by August 15. MOBL has the option to re-acquire Kite immediately, and the company is in discussions with other possible buyers. They also might sue Gobility for breach of contract, but good luck on that. If Gobility has no money, why sue them?
MOBL pointed out in their 8-K filing that if they can’t sell Kite, MobilePro will be on the hook to make substantial back payments to Kite’s equipment lessors. They also have sold their payphone and Internet service provider business to United Systems Access. These sales need regulatory approval before they can close, and United Systems Access is acting as the owner in the meantime, including paying some of the Cornell Capital interest. Assuming this deal closes, Cornell Capital will be paid off. However, if it doesn’t close, MOBL will not be able to continue as a going concern without restructuring the Cornell Capital debt. But I think the deal will close.
However, Kite Networks’ municipal Wi-Fi systems have run into the same problems as everyone else: Lower usage than forecast. These systems take time to get installed, due in part to regulatory and permit requirements, and they are expensive to build. Weak subscriber growth brings the whole business model into question.
I think we should give the company until the end of the year to close a deal to sell Kite, close the various sales to United Systems Access and get Cornell Capital paid off. We can then see what we have and decide whether the stock is worth more as a tax write-off or for a recovery. I am really sorry I got us into this one — I should have realized that Cornell Capital’s SEC problems meant that we should never have had anything to do with a company that they are involved in. Don’t ever wrestle with pigs — you both get dirty, and the pig enjoys it. For now, hold MOBL until their restructuring plays out.
Thanks for all your great questions. I have no doubt from reading what you ask and meeting so many of you at Money Shows that you are the smartest group of subscribers any investment newsletter writer could have, or wish for. Keep those questions coming!
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