We live in interesting times, or at least the S&P 500 does. That ancient Chinese curse certainly applies to the last few months of trading. The San Francisco Money Show is only a couple of weeks away, and if you look at the daily chart of the S&P 500, in the two months since the Las Vegas Money Show, through yesterday we had netted no gain after four runs up and four runs down. The weekly chart, though, shows an almost complete consolidation of the huge run up that started a year ago. It often takes many months to consolidate a move like that, but this time it happened in about eight weeks.
That’s one big reason that I am keeping the parabolic upturn on the table as an option. After today’s move, I’m pretty sure that we are about to blast through the old high at 1552 and break 1600 on the S&P 500. Whether we then get the parabolic move to 1800 I don’t know, but looking at the weekly chart, I sure would not rule it out.
The root cause of all this nominal strength is the ever-weakening dollar, which is down to a new low against the euro this week. I expect the dollar to fall a little against the Chinese yuan and a lot against the Japanese yen over the rest of the year. After five years of a falling dollar, at some point it is has to hit bottom. But while Wall Street is watching interest rates — the price of money — for a clue, I am watching the quantity. The Street thinks that if the Fed has to cut rates to save the economy from a real-estate-led recession, the dollar will keep falling. If not, the buck can strengthen. But as long as the Bernanke Fed is growing the M3 money supply at a 13% clip, I think the supply of new dollars will continue to depress the value of the greenback and push up stock prices.
There are some other interesting indicators that lead me to believe that the market will continue to head up. Hedge funds are shorting S&P 500 futures at the highest rate in three years. It will require $45 billion to cover the shorts, although, undoubtedly, some of that is already hedged. But at the same time, according to the new Commitments of Traders report, the smart money commercial hedgers, who have generally held net short positions in equity index futures contracts for the past seven years, have swung to their biggest net long position in 20 years. They now have a $14 billion bet that the bull market will resume. It is stunning that they are holding a new record long position at this time. The last time that they were anywhere near these levels was October 1999, and before that in May 1994. Both times, these hedgers got in at the lows for the S&P over the next several months. So, it is very unusual that they would be net long at all when the indices are currently flirting with new highs. That’s why I think that these levels are going to be a drop in the bucket compared with the record-setting highs that we’re going to see later in the year.
In this environment, the right thing to do is to be fully invested, although you should still be willing to trade one position for another to upgrade your portfolio with the best companies for profits right now. I am recommending some sales and carefully looking for new buy ideas for you in each of our MegaShifts, especially those that are depressed, with improving fundamental outlooks, where the stock seems to have bottomed and already started moving up. That describes this week’s recommendation in the Content on Demand MegaShift.
Be QUIK!
As you know, Content on Demand is a huge MegaShift that is affecting a wide swath of companies, as the demand for more user-friendly, sometimes handheld, devices with capabilities to provide media content to consumers any hour of the day, anywhere in the world, continues to grow. The new Apple iPhone is a great example of this, as it contains your cell phone, Internet browser, text messaging, digital camera, email and MP3 player. And while Apple would seem like a very logical investment in the Content on Demand MegaShift since they are taking the right steps, you know that I like to delve a little deeper into the technology and find the companies that are really making it all happen.
A lot of times these companies are supplying the materials to create the hot new products hitting the shelves at your local electronics store. A great example of this is Harmonic (HLIT), as it provides the best video encoders and other equipment that allows cable, satellite and telephone companies to deliver video directly to the consumer. We have a number of these types of companies already in our portfolio, but today I’d like to add another one. This new recommendation is also an arms merchant — supplying the semiconductors in many of the portable devices on the market.
Right now, you’re probably thinking that we’ve already got a great semiconductor investment with our Intel (INTC) LEAPs position, and what makes this new company so special? The answer is that they own a unique technology that is perfectly suited for battery-powered, high-volume consumer electronics — just the sort of device that gets content on demand to the user.
QuickLogic (QUIK) and I go way back. The company was funded in 1988 by my old friends at Morgenthaler Ventures, and almost 20 years later, QUIK’s founding CEO Tom Hart is still running the show. QUIK is a semiconductor company that began as a competitor to Xilinx and Altera in programmable logic semiconductors — these chips can be inserted into a hardware programmer that alters them to do different functions based on what the customer wants. For example, if the customer wants to sell a portable device that plays audio and another model that plays both audio and video, the same QuickLogic chip can be programmed for both of these uses.
The demand for programmable logic semiconductors is growing, and many customers, like Dell and Apple, are turning to companies like Xilinx, Altera and QuickLogic for their chips. The reason for this transition is that it is very expensive to make full-custom chips to do each of the desired tasks.
QuickLogic is “fabless,” which means all of their chips are manufactured by companies like Taiwan Semiconductor. So, what QUIK does is provide the basic chip design and then someone like Taiwan Semiconductor creates it. Then QUIK orders these chips in huge volumes to get the lowest cost that they can. Finally, they sell design software, programming hardware and a low number of chips to a new customer for their engineers to create a design. There may be many functions on the final chip that the customer does not use right away or ever, but the overhead cost of this waste space is still much less than doing a full custom design.
Once the design is validated and the product introduced, QUIK has built-in revenue growth. As that product grows, QUIK’s sales of the chips inside grows. If the product turns into a very high-volume winner, it is possible that the customer could replace the QUIK chip with a custom part that can be manufactured for less money. But in real life, many of QUIK’s chips go into mobile products like cell phones, which are sold to consumers. So, QUIK’s customers must constantly upgrade, add features and respond quickly to their competitors, and it is both very easy to modify a QUIK design and very hard to modify an all-custom design. In practice, once QUIK gets the design win, they are rarely displaced.
While QuickLogic now has good retention rates with its customers and a better technology that creates smaller and, therefore, less expensive chips than its competitors, back in the early ’90s when its chips were just hitting the market, they ran into a few snares. Trouble was, engineers were completely familiar with the design tools provided by Xilinx and Altera, and it wasn’t easy to convince them to learn a whole new way to design the chips. So in order to draw in more customers, QuickLogic targeted power-sensitive applications, where it has the biggest technological advantage. This is when it also created its standard product designs that can easily be modified by the customer to become Customer Specific Standard Products. That reduced design time and time-to-market, while still giving the customer enough room for customization to create a competitive advantage.
Product lines coming into this year included the Eclipse II and QuickPCI II, which provide low power solutions for applications requiring medium to small amounts of programmable logic, and the PolarPro architecture to provide very low power consumption. Using QUIK’s chip designs, their customers are able to produce a wide range of products: Medical electronics, aircraft navigation and flight controls, semiconductor test equipment, cellular base stations, telecom switching equipment, 3G data cards for laptop computers, video compression, flat panel display controllers and many others.
For the past year, QUIK has been going through a radical transition to focus almost exclusively on top tier manufactures of high-end, battery-powered, usually handheld, consumer electronics. For example, they have a low-power secure digital input/output controller that they optimized for high-capacity applications, like the memory cards used in digital cameras, MP3 players and cell phones. Using QUIK’s design tools, customers can keep up with the rapid increase in storage size that has been enabled by the collapse in flash memory prices, while lowering the battery drain thanks to QUIK’s lower power requirements.
As the company was going through this transition period, they were also upgrading and changing their sales force, and introducing an important new product. All of that has been disruptive to their business, and they missed guidance last year, which drove the stock to a low of $2.61 last September and $2.45 in March.
Then on April 25, QuickLogic introduced the new product that I’ve been waiting for — the ArcticLink. It is based on the PolarPro, but in addition to low power consumption, it adds important functions like USB 2.0 and Bluetooth support. These added capabilities are going to drive sales for ArcticLink, as USB and Bluetooth markets are expanding at a rapid clip. The market research firm iSupply projects that by 2010 there will be 750 million handheld units shipped that include USB. The second most popular connection will be Bluetooth, which iSupply projects will be included in 680 million handheld units by 2010.
And that’s not all this product does. QuickLogic says that ArcticLink provides a highly flexible platform that enables designers to integrate a broad spectrum of interfaces without compromising their power budget and to still keep pace with consumer demands. ArcticLink can connect to and control wireless devices, mobile TV, flash memory cards, micro hard disk drives and optical drives in mobile products. Target markets include smartphones, portable media players, portable navigation devices, flash memory cards and numerous portable industrial products. It is a relatively small chip and has instant-on capability. EETimes polls its design engineer readers for the best new products, and they just named ArcticLink a Top 10 new product in the processors and memories category. As you can see, ArcticLink is going to be a huge product for QuickLogic.
QuickLogic got a clean bill of health from the SEC in March on their options accounting. The company currently has $22.6 million in cash, which is plenty to get over the hump with ArcticLink and to get profitable. I expect QuickLogic to show revenue acceleration for the rest of 2007 based on sales of Eclipse II and PolarPro, with design wins for ArcticLink this year and serious volume hitting in 2008. There is a bit of risk that the June quarter will be softer than I expect as the older products wind down, but Wall Street expectations are already low. The Street is looking for $7.5 million in sales in the June quarter, followed by $8 million in September. I think that the company will report closer to $8 million — the top end of their guidance range — in their conference call around July 25, and then guide for $8.5 million to $9 million in September. The consensus earnings estimates for a nine-cent loss in June and an eight-cent loss in September are probably correct, as QUIK absorbs the introductory expenses associated with ArcticLink. But the stock will move up on a positive revenue surprise. In fact, it has already started moving up a little this month. The company also hired the former VP of Worldwide Sales at Broadcom, with the incentive of a boatload of out-of-the-money stock options. This guy has a great reputation, and I expect him to get the company in front of customers that they have not been able to crack before.
I want you to buy a one-half position in QUIK under $3.50, with an $8 target this time next year. If the company disappoints on the July conference call, you will be able to buy the second half around $2.75. If they hit my numbers, you will probably pay $4. Either way, you will be well-positioned for the acceleration in revenues that should start in earnest in the second half of this year.
Content on Demand MegaShift
Confirming my write-up on QUIK, this morning Wal-Mart said that their strongest sales category is entertainment merchandise — including flat panel televisions, MP3 players, video game hardware and accessories, laptops and desktop computers — which had “significant” year-over-year gains.
Intel (INTC) hit a 52-week high today after the Banc of America Securities analyst raised his June-quarter estimate a penny to 21 cents and his yearend target $1 to $29. Our LEAP purchase is looking very timely. I am taking it off my Top Buy list because it has been trading over my buy limit, but if you get another chance in this volatile market, do not hesitate to buy the January 2009 LEAP calls with a $22.50 strike price (VNLAX) if they trade back under $5. The target price remains $12.50 at expiration, a 250% return from the buy limit.
If you missed this trade but want to get in on the next big LEAP mover, I think it will be Motorola.
Motorola (MOT) stock could have been killed today after last night’s announcement that they will report a second-quarter loss on lower-than-expected revenue, due to poor mobile-phone sales in Europe and Asia. The company will report sales of $8.6 billion to $8.7 billion, well below both its prior $9.4 billion target and the $9.25 billion Wall Street consensus. They also said that the mobile-handset business won’t be profitable for the entire fiscal year. In an effort to improve things, they named a new EVP of mobile devices. But he has been running supply chain operations, and I’m not sure about his marketing chops.
So, this is bad news for the company. But for the stock? Up 13 cents at the close! To me, this indicates that:
- The stock is sold out, because when bad news like this hits, it can’t move the shares down.
- Shareholders who voted 55% to 45% against Carl Icahn in the recent proxy fight for a board seat are probably mighty sorry.
- MOT just moved way up on the list of takeover targets.
Stocks that act surprisingly well in the face of bad news are virtually always strong buys. It means that there aren’t any sellers left, and it won’t take much buying or even rumors of a takeover to send the stock up. I am moving the Motorola January 2009 $17.50 LEAP calls (VMAAW) to a Top Buy up to $4 for a $10.50 target (based on a $28 target for the stock minus the $17.50 strike price) in January 2009.
Biotech MegaShift
Dendreon (DNDN) said that it was notified on July 9 that the SEC has started an informal probe of the timing of insider sales in relation to the clinical trials for Provenge, its market application for the drug and the FDA’s subsequent review of that application. I suspect that this is in response to a shortseller’s unsupported allegations that since three officers sold stock after the advisory panel recommended approval, they must have known that the FDA was going to turn it down. The news stories quoted unnamed analysts, which is a dead giveaway that the shortsellers called the reporters to be sure they saw Dendreon’s announcement. Pay no attention to this issue and continue to buy DNDN anytime it dips under $7 for my $40 target.
Geron (GERN) recently started Phase I/II clinical trials of its telomerase inhibitor drug, in combination with standard chemotherapy, for leukemia and non-small cell lung cancer. This is their first combination trial with chemotherapy, and I doubt that it will work. Officially, the test is for safety and maximum dosage, and I’m sure that part will be fine. But chemotherapy is so destructive to the body that it will probably mask any beneficial contribution from inhibiting telomerase, so the combination is unlikely to achieve statistical significance. Depending on how the stock acts, we may want to get out before results are reported in about a year. I’ll let you know if this is the case.
I’ve always thought it interesting that polls of oncologists typically show that 75% to 85% of them would not recommend or undergo chemotherapy if they or a family member had cancer, yet they often recommend it to patients because it is the standard of care. Between peer review and reimbursement guidelines, oncologists would be taking career risks to discourage chemotherapy, even though they would never do it themselves. That’s one of the saddest commentaries that you will ever see that shows how messed up the U.S. health care system is. For now, GERN should be bought while it is under $9 for my $18 target.
China MegaShift
Huaneng Power (HNP) said that they increased power generation by 13.9% year-over-year in the first half of 2007. The stock has been a stellar performer and closed over my $48 target price again today. Sell HNP and take your 63% gain in 21 months. I am still very interested in their pebble bed nuclear reactor technology, and we will be back to HNP on any meaningful weakness.
New Energy Technology MegaShift
A minor refinery outage in Coffeyville, Kansas, of all places, sent oil over $73 a barrel today — well, that plus the usual terrorism fears. The Kansas refinery handles 250,000 barrels a day, and it should be back on line this weekend. But this speaks volumes about the fragile balance between supply and demand right now, as we head into hurricane season. Maybe we will have a second record-low number of hurricanes after the benign 2006 season, but that is not the way to bet. All of our energy technology positions will do extremely well if it is even a normal season, and the forecasters are calling for a relatively high number of storms. Of course, they were completely wrong last year, so there are no guarantees. I think it is safe to say that if we do see a spike in oil and gas prices related to hurricanes, Infinity Energy Resources (IFNY) and Gasco Energy (GSX) will have the most upside leverage. IFNY remains a Top Buy up to $5 for a $10 target.
Gasco said that they had record quarterly production from their Riverbend Project in Utah. They estimate 1,135 million cubic feet equivalent (MMcfe) in the June quarter, up 7.9% from the March quarter and 32% from last year’s June quarter. They posted this production increase even though they deliberately delayed completion of some recent wells due to the low gas prices in the Rockies. They also curtailed production from existing wells, as they see no sense in giving the gas away at these levels. Part of the problem is a lack of takeaway capacity, which will be relieved in January 2008 when Phase I of the Rockies Express pipeline goes into service.
The company will present at the A.G. Edwards Exploration & Production Conference in New York on July 17 at 3 p.m. ET. Buy GSX up to $4.50 for my $9 target.
Energy Conversion Devices (ENER), as you know, supplies the batteries for Toyota’s hybrid cars — the Prius, Camry and Highlander. The president of Toyota Motor North America predicted this week that hybrids will dominate U.S. roads as gasoline prices move ever-higher. In fact, he said: “Eventually, everything will be a hybrid.”
Hybrid sales will be up 60% this year, but the 12 available hybrid models only account for 2.3% of all sales. Toyota expects to sell 175,000 Prius hybrids this year, up from 109,000 last year. Toyota sells three out of every five hybrids in the U.S. Honda just killed their Accord hybrid due to slow sales. When I decided to trade in my 2003 Honda Civic hybrid, I test drove the Accord hybrid and then the Camry. It was no contest, and with 19,000 miles now on the Camry, I am sure that I made the right decision.
With Toyota hybrid sales up more than 60% this year, ENER is a strong buy while it is under $35 for my $55 target.
Royal Dutch Shell (RDS.A) was downgraded by the UBS analyst from buy to neutral just because the stock is up 30% since mid-March. They raised their target price 10% at the same time. This follows a Goldman Sachs downgrade to sell.
I have no doubt that Royal Dutch will move higher if there is a bad hurricane season, but it is now about $10 over my target price. Mindful of the old Street saying that bulls make money, bears make money and pigs get slaughtered, I think it is time to sell RDS.A for a 35% gain in just over 12 months. We got a nice 3.3% dividend, too.
Robotics MegaShift
iRobot (IRBT) got a $17.5 million order for 74 robots from the Department of Defense’s Robotic Joint Project and, oddly enough, the Naval Sea Systems Command. These robots are used to identify bombs in Iraq and Afghanistan. IRBT remains a buy on dips under $18 for my $30 target.
Security MegaShift
Packeteer (PKTR) said that it will hold its earnings call on July 19, and they did not make a negative preannouncement. The recent Wall Street fears that the company will disappoint again appear to be wrong. If you are worried, July put options expire the day after the earnings release and provide protection at low cost. The $10 contract (XOUSB) is the only one that makes any sense, but, frankly, I think it will be a waste of money.
I found it interesting that Elliot Associates, which has asked the board to solicit bids for the company, increased its stake in PKTR from 6.3% to 8.6% in spite of the proposed IRS action. He seems to think the IRS allegation is as meaningless as I do. PKTR is a buy up to $12 for my $22 target.
WiMAX MegaShift
Airspan Networks (AIRN) won a $4.5 million contract with Guyana Telephone & Telegraph, Guyana’s largest telecommunications carrier, to install a WiMAX network in the licensed 3.5Ghz frequency band. The network will eventually cover the whole country. This really is the Year of WiMAX, and I expect a flood of orders like this for all of our WiMAX companies in the second half of the year. AIRN is a buy up to $5 for my $10 target.
MobilePro (MOBL) is selling its telephone and ISP subsidiaries to a private company, USA Telephone, for $21.9 million in cash and $8.1 million in convertible preferred stock. This was the best offer that they received from a dozen companies that responded to MobilePro’s asset sale. When the deal closes in 90 to 120 days, they will entirely pay off Cornell Capital.
In addition, they sold their mobile broadband business to another private company, Gobility, for $2 million in convertible bonds. Gobility has to raise $3 million in cash by August 15 for the deal to go through.
Assuming both deals close, Cornell Capital will be out of the picture and the company will be left with the municipal WiFi business that interested me in the first place. The president resigned the same day that the Gobility deal was announced, as CEO Jay Wright trims back expenses. There will be an ungodly number of shares outstanding due to the Cornell Capital fiasco, but the base will be there to build something of major value. As I’ve been saying in the portfolio comments on the website, with a pure play on the municipal Wi-Fi business unencumbered by Cornell Capital, we have a good chance of seeing the stock recover. For now, MOBL remains a hold.
Rich asked: “I just saw a notice on Bloomberg regarding an audit concern regarding MobilePro. They have serious doubts that MOBL can remain a going concern. Any thoughts?”
It is standard procedure for accountants to put in “going concern” language for small companies that are losing money, and, of course, those comments were made before these resent asset sales. The real issue going forward is whether Jay Wright can make his options good by building the municipal WiFi business with minimal additional dilution, and take advantage of the new mesh network and WiMAX technologies to create a meaningful business. This is an investment in a technology and a person, and I still think he is the right guy to pull it off.
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