A couple weeks ago, we looked at some of the exciting developments happening in our Content on Demand MegaShift. This is one of the biggest MegaShifts of all, so I want to re-examine the stocks we own in this area today. And we’re going to look at this MegaShift from a different point of view — yours, the consumer, sitting in the digital living room.
As you know, Content on Demand is my shorthand phrase for a world where you get the information, data, entertainment and communications you want, wherever and whenever you want, with a minimum of billing hassles or techie problems. We already know from the accelerating adoption of VVD (Voice, Video and Data) integrated services from providers like Comcast (CMCSA) and Verizon that people want to live in a Content on Demand world. We also know from surveys and foreign examples that this is a huge, global market. So, it is important to get it right.
An October survey showed that 11% of respondents subscribed to VVD services, and by January that was up to 15%. An additional 18% said that they are likely to sign up by the end of April. One-fourth of the current subscribers are with Comcast, which is the market leader with 12.7 million customers. Time Warner Cable and Cox Communications were second and third, showing how well cable is doing versus the telephone companies. Verizon and AT&T were essentially tied for fourth, at about 10% market share each. So, Comcast is bigger than both of them combined.
When looking at the survey results of which provider those current nonsubscribers are likely to use, Comcast had an even higher market share at 27%. But Verizon vaulted into second place at 23%, and AT&T into third with 20%. It is going to be a war between the cable and telephone companies, and I think we own the right cable company. I recently moved CMCSA to a buy under $26 for my $62 target.
The digital living room, also known as the living room computer market, is the key to the consumer part of Content on Demand. Yesterday, Apple shipped the first Apple TV (formerly iTV) media center boxes for the living room. The $299 box acts as a server and router for digital media, so users can wirelessly play iTunes content stored on their PCs or Macs — including movies, TV shows, music, photos and podcasts — on their televisions and home entertainment systems.
One of Apple’s biggest advantages in bridging the computer and entertainment gap is that they understand the consumer better than Dell or Hewlett-Packard. The traditional high-end “personal” computer is labeled as a server, and there are corporate data centers with thousands of server processors working together. In that environment, low power, low heat dissipation and high performance are the keys. While these are all nice features for a living room computer, the real keys for consumers looking for an addition to their home theatre are (1) easy to set up and use, (2) no noisy fan, yet no problem with marginal ventilation, and (3) it looks good enough to be furniture. Steve Jobs has been against loud, distracting fans his whole life, and therefore has strived to make the user experience a huge priority. So, Apple has shown time and again that they understand the human interface much better than other tech companies, and Apple’s TV certainly looks good enough to be placed in a consumer’s living room, with its sleek, compact design.
I think Apple is trying to outflank Microsoft by becoming the dominant living room computer, and they plan to get there with two partners: Cisco and Intel (INTC). Apple’s current operating system and, even more, the forthcoming “Leopard” system due this spring, are media-centric. The Macintosh has always been the computer of choice for graphics, video editing and sound editing, and there is a lot of media management software that already runs on the Mac. That expertise and, in some cases, that same software can be ported to the Apple TV.
But Apple does not have experience in set-top boxes (the standard cable TV connection), home networking or WiFi phones. Since their acquisitions of Linksys and Scientific-Atlanta, Cisco has all three. But Cisco does not have a PC or great human interface experience. Apple does. At the same time, Intel would like to be in every living room computer, and the only major computer manufacturer that exclusively uses Intel chips is Apple. Intel’s VIIV processor has all the multimedia features needed, but it is expensive. Thanks to Moore’s Law, it will get less expensive every year.
So, Apple and Intel already work closely together. Will Apple and Cisco get together? Think of their recent tussle over the iPhone trademark as dating behavior. Cisco clearly owns the trademark. Cisco and Apple were in amicable talks to figure out some way to share it, when Apple casually introduced the product. That’s like a girl you are interested in showing up at your empty house, grabbing your car keys off the rack and driving off in your car. It’s a boundaries issue. So Cisco sued, Apple feigned innocence, and rather quickly the suitor (Cisco) agreed to let Apple use the trademark for no financial consideration. Why? Because Cisco knows they can either use their Scientific-Atlanta set-top box experience to try to compete with Apple, or they can join forces and quickly dominate the living room. Given that Apple is the only PC manufacturer that has its own operating system and its own hardware, it can quickly modify either to fit the needs of Cisco as a partner. And unlike having to partner with a Microsoft-compliant PC manufacturer, Cisco might be able to share in better hardware margins than the cutthroat generic PC business can sustain.
So the satellite, fiberoptic cable or WiMAX wireless signal comes to your home, where it is grabbed by a Cisco (Scientific-Atlanta) set-top box. In the box is a little Cisco router and a Cisco (Linksys) Wi-Fi module that handles Wi-Fi voice phones and Wi-Fi data connections from anywhere in your home. The router sends the video signal to an Apple TV, controlled by an iPod-like device with a click wheel. Music or video from iTunes or the VVD supplier would reside on a hard disk, providing all the functionality of a TiVO personal video recorder. The Apple TV introduced yesterday has a 40-gigabyte hard disk, and it is not a TiVO replacement — yet.
The potential market is huge. Market researchers estimate that between 2005 and yearend 2006, the number of North American homes with networked digital video recorders more than quadrupled, from 400,000 to 1.7 million. They predict that shipments of products with integrated wired home networking, like the Apple TV, will rise by more than ten times to hit 223.8 million units in 2010.
But there are still issues with the rapid spread of the digital living room. It is a complex integration problem to make sure all the possible sources of high-definition video streams work through several different brands of set-top boxes, media players and HDTV sets without dropping a frame — with multiple video streams going to several TVs and PCs at the same time. Today’s home networking systems are too hard to set up and too hard to use. I expect everyone to standardize on the single-wire HDMI standard that is the core product at Silicon Image (SIMG). However, there are other standards like DisplayPort and the Unified Display Interface vying to displace HDMI and become the standard for a secure digital link in consumer systems and computers. I watch the development of these potentially competitive standards closely. Since its weak guidance for March quarter results, Silicon Image stock has traded down to a 52-week low. But consumer electronics are always weak in the March quarter, and I think this is a major opportunity to buy a key player in the digital living room at fire sale prices. SIMG remains a Top Buy up to $13 for my $20 target — more than a double from today’s close.
The industry also has not agreed on a Quality of Service standard, which makes it very difficult to interoperate equipment. Everyone seems to want to control their Quality of Service as a competitive advantage, or at least so that they can provide better technical support. The Universal Plug and Play Forum is tackling this issue from a high-level software perspective, while the 802.1 Audio/Video Bridging Task Group is trying to make changes in silicon for Quality of Service. Two other groups need to agree to a standard: The Home Gateway Initiative representing telephone companies and their suppliers, and Cable Labs, which does R&D for the cable TV industry.
There also are too many different home network standards, seemingly one for each type of network. Wi-Fi is a standard for wireless networks (technically, 802.11n broadband), but there is the Multimedia over Coax Alliance for coaxial cable, the Home Phoneline Networking Alliance promoting existing phone lines, the Broadband-over-Power Line-based HomePlug 2.0 group, and several versions of the newer ultrawideband and Bluetooth wireless standards. Either the industry has to agree on one standard to run over all these physical networks, or one has to “win” by establishing a dominant market share, or engineers have to figure out how to let one connect to another easily.
No matter how it comes out, Telkonet (TKO) will be able to adapt its iWire system to any new home networking standard and continue to dominate the in-building Broadband-Over-Power Line market. TKO remains a Top Buy up to $5 for my $15 target.
Then there’s always the whole issue of digital rights management (DRM). It is unsettled but vital, because the home networks are designed to carry both personal and paid-for content, like songs and movies. So far, there’s no standard way to protect the so-called premium content from being copied and freely distributed. Microsoft’s Windows Media DRM is gaining momentum as a de facto standard because of its widespread use in PCs, but almost every other type of hardware maker doesn’t like it. But there’s no way the industry can ask consumers to live in a digital home with one DRM on their PC, another on their iPod and a third on TV content — none of which talk to another. Intel is promoting Digital Transmission Content Protection over IP as a core standard for this area.
Even the engineers working on ways to make things interoperable have more than one effort underway: The Digital Living Network Alliance, the Universal Plug and Play Forum and Intel’s Networked Media Product Requirements. Although Intel’s approach may get to market first, eventually I think the Digital Living Network Alliance will set the standard — and a lot of it will look like Intel’s.
If all this works out, between increasing market share and a future VIIV-based Apple/CiscoTV, Intel will see a meaningful revenue bump as early as 2008. That’s one of the reasons that I recommended the Intel LEAP calls.
But why not recommend Apple if they’re going to be at the heart of the digital living room experience? First, the success of the Intel-based Macs and the Apple TV is already priced into Apple’s stock, but not into Intel’s stock. Second, I still think Steve Jobs will be indicted for backdating stock options at both Pixar and Apple, and profiting from the backdating at Apple to the tune of tens of millions of dollars. Even though Disney said this week that their internal investigation cleared “all current members of management” of wrongdoing (Jobs is a Disney board member) and Al Gore’s investigation cleared Jobs at Apple, I doubt the SEC is impressed.
So, why not recommend Cisco? Well, to be frank, I missed it. When the stock was under $20 last summer I was worried about the effects of the predicted bad hurricane season on oil prices and the market. By the time that threat was gone, the stock was nearing the mid-$20s and now trades above $25. I would want to buy two-year LEAP calls on Cisco, but at current levels, I just don’t see an easy double or better, as I do with Intel. Maybe we will get another chance, or maybe not. I’ll keep you updated if the opportunity arises. Meanwhile, though, the Intel January 2009 $22.50 LEAP call (VNLAX) is a Top Buy up to $3.50 for my $12.50 target, and it is especially cheap right now.
Who else wins from the digital living room? I get asked lots of questions about Advanced Micro Devices (AMD) at the Money Shows. At January’s Consumer Electronics Show in Las Vegas, AMD introduced reference designs for a home cinema device and home media server under a new AMD Live! Banner, which runs Microsoft’s new Windows Vista Home Server operating system. These are direct competitors for Apple TV, bridging the gap between the PC and the TV in a good-looking form factor.
The home cinema device and home media server are meant to show consumer electronics companies how to get into this market using AMD microprocessors, and I’m sure they will find some customers, particularly in Asia. But it is a long way from a processor to a winning consumer product, as Sony and others have shown. I also think the advantages that AMD had over Intel for the last couple of years in both architecture (multiple processors on one chip) and performance per watt are gone — Intel is fighting back, and some server customers that moved to AMD are now moving back to Intel. That is the primary reason why AMD’s December quarter was so disappointing.
And, although they are not in the digital living room, someone has to win from delivering video to the living room. That someone is Harmonic (HLIT), where I recently raised the buy limit because I wanted to make sure that no one missed getting on board. Buy HLIT under $10 for my $16 target.
Avian Flu MegaShift
Gilead Sciences (GILD) presented at the Lehman Brothers Global Healthcare Conference on Monday, where they noted that Truvada is the leading HIV medication in the top five European Union countries with a 25% market share. But the biggest problem with HIV patients is that many are walking around ignorant of their infection. The global healthcare system is looking to automate HIV checks as routine processes. Because healthcare is not centralized it will take some time, but the more people know about their illness, the larger the market will grow as more turn to these drugs. Doctors are advocating beginning medication earlier than people are taking it now, which is another factor that will increase drug usage.
The stock jumped Tuesday after the presentation, as Merrill-Lynch upgraded GILD from neutral to buy with a $91 target. The Gilead January 2008 $50 LEAP call (YGDAJ) remains a hold, well on its way to my $30 target (equivalent to $80 on the stock).
Biotech MegaShift
Dendreon (DNDN) has a March 29 date with the FDA’s Cell, Tissue and Gene Therapy Advisory Committee to review Provenge. CTGT is a more hospitable panel for Dendreon than the Cancer Advisory Committee, which is known to be real sticklers, but CTGT is not a pushover. And while the new FDA Commissioner is a prostate cancer survivor, and the odds for Provenge to be approved are good, the company and I know anything can happen before an Advisory Committee. So, Dendreon filed a $146.8 million shelf registration for equity and debt that will give them more flexibility to do whatever is necessary, no matter what the committee decides. (They already have about $1 a share in cash.)
The FDA will release their briefing documents — its staff review of the Provenge data and questions for the advisory panel — next Tuesday, March 27. Expect the fireworks to start then. I will send you a Flash Alert immediately if anything changes, but it looks to me like Provenge will be recommended for approval. The stock is worth $25 to $30 a share if the FDA grants approval and if Provenge eventually does $1 billion in annual sales, as I expect. It really hasn’t started to move yet, and DNDN remains a Top Buy all the way up to $7 for my $14 target.
Geron (GERN) reported a December fourth-quarter loss of $13.1 million, and still has $214 million in cash on the balance sheet. On the conference call, management said that the money from the $3-billion California stem cell initiative has started to flow. They also pointed to extensive clinical progress in 2006, with numerous data publications, and they projected that the pace will continue for 2007. As I’ve said many times, if anyone has the silver bullet for cancer, it is Geron. Their stem cell work also will be easier under any Democratic initiatives from the current Congress that can get past a Presidential veto. Buy GERN under $9 for my $18 target.
Content on Demand MegaShift
Comcast (CMCSA) may say goodbye to Google, as the company has — for the first time — opened up bidding for its search provider. Under its existing contract, which ends this year, Google pays Comcast around $70 million annually for the use of its website, but Comcast is said to be looking for around $100 million from the successful bidder. Currently, about 70% of Comcast’s 12.7 million high speed Internet subscribers visit the site on a monthly basis, and the company plans to more than double its subscriptions in the next few years. Comcast is also requesting bids to manage its own website advertising, which could generate several hundred million dollars over the next three years. It’s this ability to leverage infrastructure and content that makes Comcast a media juggernaut.
Comcast is keeping an eye on its customer service mandate and announced that it is opening a new support center in Denver specifically dedicated to providing service to businesses that use Comcast Workplace High-Speed Internet and Workplace TV services, as well as Workplace Digital Voice. The center will have 200 technical support reps by the end of 2007. As I said above, CMCSA is a buy under $26 for my $62 target.
Telkonet (TKO) completed a shopping spree with its acquisition of EthoStream for $11.7 million in cash and stock. EthoStream will provide centralized remote monitoring and management platforms extending over high speed Internet access, digital video surveillance and energy management, all running on TKO’s Broadband-Over-Power Line system. That lets Telkonet provide a broader range of services and a higher return on the customer’s investment. The ability to offer a complete range of applications and service will allow Telkonet to market iWires as an in-building infrastructure backbone, which demonstrates true technology convergence. TKO is a Top Buy up to $5 for my $15 target.
New Energy Technology MegaShift
Silicon Valley CEOs, venture capitalists and technologists hit Washington this week to buttonhole politicians on the need to double funding for clean energy, “green tech” research. Their thesis is that the political climate has shifted, and clean energy will be an important issue in the 2008 presidential campaign.
One recommendation is to follow the model of medical research, now organized in the National Institutes of Health, and consolidate all energy research in one entity — a National Institute of Energy — that would fund public-private partnerships to support energy efficiency initiatives. They also asked for minimums for alternative energy use by government agencies, given that the Federal government is the largest consumer of energy in the country. Any of this would be great news for our New Energy Technology stocks.
Energy Conversion Devices’ (ENER) Cobasys joint venture with Chevron will supply its NiMHax nickel metal hydride battery systems for the Lotus Engineering EVE (efficient, viable and environmental) vehicle. This is the company’s first win in the UK. Buy ENER on dips under $32 for my $55 target.
Fuel Cell Energy (FCEL) and Air Products announced that they have commenced construction on an advanced hydrogen energy demonstration station funded in part by the Department of Energy. The joint project is to demonstrate a tri-generating (hydrogen, electricity and heat) process that can produce energy from material such as anaerobic digester gas from industrial or municipal wastewater treatment facilities, as well as readily available fuels, including natural gas and propane, at a significant cost reduction.
A recent study, Clean Energy Trends 2007, forecasts that the fuel cell sector is expected to leap from $1.4 billion in revenue last year to $15.6 billion in 10 years. And FCEL is definitely going to get a piece of this pie. Buy FCEL under $11 for my $22 target.
Plug Power (PLUG) announced its third acquisition since 2000 by acquiring Cellex Power Products Inc (Canadian) for $45 million, which gives PLUG an entry into the forklift truck market. That’s a $2.8 billion market growing 5% a year, with more than 700,000 electric lift trucks in operation. Importantly, Cellex has key clients and collaborators that Plug sees as vital to entering this market, including a recently completed field trial with Wal-Mart that Plug Power CEO Roger Saillant called “hugely important.” PLUG is a buy up to $5 for my $10 target.
Holly Corp. (HOC) went over my $60 target this week, with oil prices rallying. Crude oil for May delivery was up more than 3% today to $61.43 a barrel because U.S. refiners are expected to increase operating rates to prepare for the crucial summer driving season. Most of the incremental crude in the world is sour or heavy oil, which is what Holly and very few others can refine. So, I don’t want you to sell yet. I am moving HOC to a hold and raising the target price to $65.
WiMAX MegaShift
Alvarion (ALVR) won two orders, the first from Telecom Namibia for a country-wide BreezeMAX installation. The second is from Enforta, the biggest telecom provider in Russia. They will install WiMAX systems into six Russian cities covering 4.5 million people. ALVR is a Top Buy under $9 for an $18 target.
Market Outlook
Yesterday’s explosive upswing after the benign Fed statement demonstrated that the consolidation period since the late-February decline to the 1377 area is over. The S&P 500 blew right through obvious energy levels in the 1420s, and after a few days of consolidation, the 1510 target is back on the table. I expect that to be another congestion and testing area, followed (finally) by a breakthrough to record highs above 1550.
It would not be surprising at all to see a test back down to 1420 or even 1410, although that is as far as it should go if we are in fact launched on the two-year tech bull market. But if the market is really strong, it will just go sideways for a few days and then break higher. If you are not already fully invested, now is the time, and any pullback should be regarded as a gift.
It is no accident that yesterday Chinese stocks completed a full recovery from the one-day, 10% drop on February 27, which started the decline in our markets. The Shanghai Composite Index hit a marginal new high yesterday, which calmed global investors and brought money back into stocks worldwide.
It is also no accident that the U.S. dollar is again declining on world markets, which moved gold up sharply yesterday to reclaim the critical $660 level. Gold goes up when the dollar goes down. The Australian and New Zealand dollars hit multiyear highs against the dollar, while the British pound and the Canadian dollar surged against the U.S. currency. Now as soon as the euro takes off — as it will, because euroland growth is stronger than the U.S. and the EU central bank is about to raise rates — the dollar will be in freefall again.
Meanwhile, the Fed essentially took a rate increase off the table yesterday. I don’t think Chairman Bernanke is dumb enough to cut rates in an effort to save the economy from the imploding subprime mortgage market, simply because that small sector of our economy is not important enough to cause widespread financial stress. Probably half a million subprime borrowers will default on their mortgages over the next couple of years — bad news for them and bad news for whomever holds the mortgage, but it is really just a drop in the ocean compared to the rest of the economy. Or even to the housing sector. Of course, if Bernanke did cut the Fed funds rate, the dollar would go to new lows rather quickly.
You will still see commentators saying that new lows for the dollar would be bad for U.S. equities and bonds, and they are half-right. It would be bad news for bonds in the medium to long term. In the short term, though, even more inflation premium would come out of long rates, and bonds would probably rally for a while.
But for stocks, a falling dollar has been great news for the last five or six years, as well as for real estate, oil and commodities, and especially the metals. (That may be one reason that the Canadian dollar is so strong: metals prices are headed back up again.)
While, we don’t need a falling dollar to make a lot of money in our MegaShift stocks, it provides a nice tailwind for the whole market. I still expect our stocks to lead the market up for the next couple of years, as the real growth in the economy is happening in new technology-based products.
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