Even though I was looking for a big drop in the market before we really blast off on the two-year tech bull market that lies just ahead, last week was nerve-wracking. For now, the market seems to have stabilized. What that really means is the energy is balanced between buyers and sellers, and so far there is little indication of which short-term direction we will go next. But the range is pretty tight: Any substantial weakness in the S&P 500 under 1395 or strength over 1405 should tell the tale. So far, the bounce has been unimpressive if the bulls really are ready to reclaim all the ground that was lost from the highs. If I had to guess, I would say that we will break to the downside, but I don’t have to guess — we can just watch and wait.

If the S&P does drop under 1395, the next stops are 1325 and then 1295. I don’t think it will get worse than that. On the other hand, if it breaks 1405, we should be back up at the 1450 highs fairly quickly, with new all-time highs above 1550 in sight before the end of the year. As I’ve said many times, technology should lead the next big rally up, and I think our MegaShifts will lead technology.

So, while the stock market marks time, deciding what to do next, I wanted to update you on the Content on Demand MegaShift, where there were some interesting moves and rumors this week.

First, Qualcomm announced that they have a major new customer for their MediaFlo video-to-cell phone transmission service. Verizon, which already offers a video service called Vcast, said that they are launching a MediaFlo-based service, initially in 20 cities. They will send eight channels of full-length television shows to a cell phone for $15 a month. The picture is about twice as clear as Vcast, which means that it will be of similar quality to current TV. That’s definitely good news, since picture quality has been a problem with the current round of video-to-phone services — it’s the main reason why there are just over seven million customers today, or a measly 3% of all the cell phone users in the U.S.

Qualcomm’s next customer will be AT&T, which is launching a similar service later this year.

While you may not want to watch video on your current cell phone, there are plenty of media and technology junkies that are chomping at the bit for these advancements. And this, of course, will drive upgrades to phones with bigger screens and all the latest features, such as a digital camera or camcorder, personal digital assistant and maybe GPS. Also remember that AT&T (Cingular) is the exclusive distributor of the forthcoming Apple iPhone. Verizon and the other providers need to catch up, and there will be a full-scale price war in this area to drive the cost to consumers even lower. A little over 5% of current worldwide cell phone users already have a high-end smart phone that can get video, and those 50 million phones will turn into 500 million phones over the next four years.

Video on demand is an important revenue driver for the fiber-to-the-premises programs at Verizon and AT&T, as well as the network upgrades underway at the cable companies. Verizon already has over 100,000 subscribers and AT&T is just starting its installations. Those numbers aren’t big enough to scare Comcast (CMCSA) today, which has millions of subscribers to its digital cable and On Demand video service.

In addition to the fiber upgrades, the new mobile services using MediaFlo will be joined by more fixed and mobile WiMAX services starting later this year.

• Craig McCaw’s nationwide WiMAX service, Clearwire, went public this morning at $25 a share, valuing the whole company at $600 million. It starts its network rollout early next year, as does Sprint.
• Intel should ship Centrino processors with built-in WiMAX and Wi-Fi capability towards the end of this year — providing another route for video into the home. Then the PC-to-TV connection is an easy one-wire job, using Silicon Image (SIMG) HDMI chips.

By the time the 2007 holiday season is over, there will be over 100 million high-definition, flat-screen TVs installed around the world. By the end of 2008, that number could double as we approach the February 15, 2009 deadline when the analog signal goes dark. Sure, you’ll be able to buy a digital-to-analog converter to keep your old CRT set in use — but will you bother?

The growth in the demand for high-definition TVs is definitely going to benefit Silicon Image. Not only are their HDMI connections built into every new TV, but all the gear that has to connect together in the consumer’s living room — radios, DVDs, TiVOs, media centers, PCs — also needs an HDMI connection. Consumers are not going to buy this stuff if they have to plug in 24 RCA jacks to make everything work. One wire carrying voice, video and data from device to device with no loss of quality is the solution, and that describes HDMI. Over 500 consumer electronics companies have signed on to the standard, and the volumes are huge. SIMG is a great Top Buy at today’s close of $8.89, and all the way up to $13 for my $20 target.

The second factor that hit this week was yesterday’s announcement by Norway’s Tandberg Television. It recommended that shareholders accept LM Ericsson’s $17-per-share takeover bid for the company. Ericsson outbid U.S.-based Arris Group by more than 10%. Ericsson wants to be a leader in Internet Protocol Television, or IPTV, to homes, laptops, cell phones or whatever. Tandberg was the leader in MPEG-4 equipment for high-definition TV, until the market got real and Harmonic (HLIT) introduced better products.

Now, here’s where it gets interesting. Arris now has $1 billion in acquisition credit lines and no head-end (broadcaster, cable office, or telephone company office) equipment, and the same is true of at least five other companies that need to be in this product area. So, that means there are six potential buyout customers and only one independent head-end equipment company of any real size: Harmonic. At the same valuation as Tandberg, in a buyout situation Harmonic stock would go for $15.13 to $16.34. That’s an easy target, because Harmonic is worth more based on its newer products and because it would be the last chance anyone got to buy an IPTV and high-definition head-end equipment company with significant market share. Hmmm. This could get interesting. I am raising the HLIT buy limit again to $10 to help new subscribers get into this stock. The target price remains $16 for this year, and I expect it to go much higher in future years if it isn’t bought out.

Telkonet (TKO) drew several anguished emails when the stock slipped to $2.50 on Monday, and I feel your pain. David said: “I have held this stock for some time, and yet it hardly shows signs of real movement. What’s the deal or do I sell?”

William added: “Do you think it is going to hit your $15 a share anytime soon?”

The stock certainly has moved, but in the wrong direction. Yet, the company continues to make substantial progress, and recently said that they will be cash flow positive this year. I believe they can do it. Just take a look at what they have done so far in 2007:

• They signed a deal with the Department of Commerce to provide engineering and security services, a wedge into later selling them on Broadband over Power Lines.
• They’ve started shipping on the EDS/Army contract and the first system is up and running.They did a private placement of four million shares to get some breathing space until they turn cash flow positive. They won and are doing a 50-site rollout of BPL systems for all the WorldMark byWyndham timeshare properties in the U.S. and Canada.
• They signed an exclusive deal with General Electric’s GE Energy to co-develop an innovative BPL product that enables remote monitoring and management of utility substation equipment. GE Energy has already started test site installations.
• They introduced an energy management product, Telkonet SmartEnergy, and last Friday they announced that they will buy Smart Systems International for $7 million in cash and stock. Smart Systems has installed over 60,000 of its patented intelligent thermostat, air conditioner controller and wireless sensors for individual room control in various commercial applications. By eliminating unnecessary heating and cooling of unoccupied rooms, they cut energy consumption by up to 30%. Telkonet will modify Smart Systems products to run over BPL. Then they’ll go back to all the existing customers and sell them energy management as an upgrade.

And it isn’t even the middle of March yet!

TKO said that they will do about $25 million in sales this year, including $8.5 million from the various government contracts and $1.5 million from the initial GE Energy placements. In the last year, they’ve installed BPL systems in U.S. military sites; the Wyndham by WorldMark timeshare resorts; Accor Hotels in Denmark; the Royal Oak and Samlesbury Hall in the UK; Trump Tower, Trump Palace, Trump Park, Trump Park East and The Octagon in New York; the Queen Mary in California; and apartment complexes in Washington, D.C.

In the last year, the stock has gone from around $3.90 to today’s close of $2.75. Why? I don’t know. The company keeps winning contracts, installing systems and doing deals, as evidenced above. But the skeptics seem to be focusing on fiber or wireless winning virtually all the broadband communications business, and therefore treating TKO like a minor niche company. With the building conversion business TKO has already won, and the EDS contract to deploy BPL on virtually every Army and Marine base around the world, I don’t see how Wall Street can treat it as a niche company for long.

I think management can hit their goals this year: $25 million in sales and cash flow breakeven, which means no more cheap stock private placements. If they can do that, there’s no reason why TKO can’t power on up to $15 or higher. At that level, it would still be a small-cap stock with an $850 million market cap. I think sales growth will accelerate for a few years, so TKO remains a Top Buy up to $5 for my $15 target.

New Energy Technology

Fuel Cell Energy (FCEL) reported their January quarter after the close yesterday, and although it was a good quarter, it was short of the consensus revenue estimate. They did $6.8 million in revenues, up 15.3% from last year, but well under the $9.1 million consensus estimate. Product sales grew 63% to $4.9 million, but R&D was $1 million lower than last year. I am more interested in product sales, as that is what will make FCEL a big company. The R&D contracts are a way for them to get their development expenses funded, but they typically carry low profit margins.

FCEL reported a 38-cent per share loss, a bit larger than last year’s 34-cent loss but exactly on the consensus. How could they have such a large revenue shortfall, but still make their bottom-line number? Because the shifting revenue mix towards products and away from R&D contracts helped their profitability. They would have done even better if they had not written down some inventory of long lead time components. They have been building inventory in anticipation of several large multi-megawatt orders, and if those components are reduced in price, FCEL has to apply the reduction to their inventory.

The product backlog was up nicely to $36.7 million from $24.5 million last year, due to orders for megawatt-class products. The R&D backlog was also up sharply to $29.1 million from $12.9 million last year, mostly due to two recent contracts:

• A Department of Energy award to develop large scale stationary coal-based solid oxide fuel cells.
• A Department of Defense award to develop an electrochemical hydrogen-separation system that will generate electricity, thermal energy and hydrogen, which can be used as a fuel for hydrogen-powered trucks, busses and cars.

FCEL’s new 10-year manufacturing and distribution strategic alliance with South Korea-based POSCO Power to penetrate the Asian market is already starting to pay off, with an order for two 1.2 megawatt systems that will be combined into the largest fuel cell power plant in the world, capable of supporting 2,000 homes. South Korea has substantial subsidies for fuel cell installations, with initial subsidies of 23 cents to 28 cents a kilowatt hour. The power has to be exported to the utility grid to get the subsidy, so most installations will be multi-megawatt systems like those FCEL makes.

POSCO bought $29 million of FCEL stock at $7.63 a share after the quarter closed. The company used $22.3 million in the quarter, including a $6.8 million inventory increase in anticipation of some major orders. They have $104.6 million left on the balance sheet, including the POSCO investment.

Goals for 2007 include taking another 20% out of cost of goods sold, similar to 2006, which will get them to a positive gross margin. They’ll also increase power output by another 15%, and expect to book many multi-megawatt orders. In addition to South Korea and Europe, two other important markets this year will be California and Connecticut.

California passed the Global Warming Solutions Act of 2006 in December, which strictly limits carbon dioxide and other greenhouse gas emissions. Combined with our high electricity costs, the FCEL power plant is a great alternative for many applications. There’s no combustion, so the plants meet all emission standards and are very fuel efficient. FCEL has sold over 11 megawatts of systems in California, and recently booked another one-megawatt order from the city of Riverside. It will power a 30-million-gallons–a-day wastewater treatment facility and — get this — is powered by anaerobic digester gas (methane) created in the treatment process.

At the end of March, Connecticut’s Project 100, which I discussed last year, will announce the winning projects for major fuel cell installations. FCEL and its developer partners submitted bids for a whopping 98.6 megawatts of power, in projects ranging from 2.4 megawatts to 28 megawatts. This is the type of event that can really move a stock. I expect FCEL to win many of these, and therefore I am upgrading the stock to a Top Buy under $11 for my $22 target.