After the Internet stock bubble burst in 2000, a lot of fuddy-duddies gleefully announced that the New Economy was an illusion, a goofy idea promulgated by Michael Murphy, George Gilder, Esther Dyson and a few others that they thought would never be heard from again. But within a few months, companies were starting up again to build what has become known as the Web 2.0 economy. A few years later, Google, Skype, MySpace and YouTube put the fuddy-duddy case in shambles. Through this whole period, Internet usage skyrocketed, on-line commerce soared, consumers went digital, the VVD revolution (voice, video and data all on one line) accelerated, and wireless mobile communications exploded. Power shifted from producers to consumers, from the U.S. to the globe, and from any company that listened to the fuddy-duddies to companies that accepted and adapted to the New Economy paradigm.
Our first investment in the New World Economy MegaShift, Click Commerce (CKCM), which I planned to hold through 2007, was acquired two months after we purchased it, giving us a 14% gain. I intended our second investment to be Cnet (CNET), although I wanted it closer to $8 than its current price of around $10, and preferably a little further along in bringing their options backdating nightmare to closure. I still think we’ll get a shot at this stock in a month or so. But Cnet has been elbowed out by another company — a recent IPO (initial public offering — remember them?). Furthermore, to use the language of the Internet bubble, this IPO is unprofitable because they are trying to establish a first-mover advantage. The fuddy-duddies must be choking on their croissants.
What’s Going On?
Omniture (OMTR) came public this year on June 27 at $6.50 a share, not much below where it is currently trading. OMTR provides an online service that runs business optimization software for corporate marketing departments that need to manage and integrate online, offline and multi-channel business initiatives. Their SiteCatalyst service collects information on how users interact with their corporate customers’ web sites. This can include how a web user got to the site (Search engine? Pay-per-click? Free publicity?), how they moved around the site, how long they stayed, what they bought, what they almost bought and on and on. All of this can also be related to offline drivers like TV and radio advertising or direct mail, and everything is stored in a data warehouse for easy access by the customer, including the ability to build custom reports.
The customer accesses everything through a web browser — there is no need to buy a huge software package and wait months for it to be installed in-house. This software-as-a-service model, also known as application hosting, is very attractive to me because it provides recurring monthly revenue, instead of the big, lumpy software sales that may come in the last two days of a quarter, or not. I think Wall Street will pay higher price/earnings (P/E) ratios for companies that use this model.
Omniture has a remarkable customer list numbering over 1,000 companies, including Apple, eBay, Expedia, Ford, Gannet, Hewlett-Packard, Microsoft and America Online. AOL and its affiliates are their largest customers at about 12% of sales. These are very technically sophisticated customers, and you might wonder why they would use Omniture instead of just doing this stuff in house. Here’s why.
First, the numbers are enormous. In 2004, the most recent year for which we have solid statistics, companies had $295 billion in online sales and spent $25 billion for online advertising. Since then, the explosion in blogs, RSS feeds and search engine marketing has made it ever more difficult to spend that online advertising budget effectively. And the growth continues — IDC says the number of global online users will go from 820 million in 2004 to over 1.3 billion in 2009. The growth of broadband and mobile networks is likely to increase the amount of time each user spends on the Internet. In 2004, U.S. consumers spent 34% of their available “media time” online, but online advertising accounted for only 6% of total ad spending. In the month of April 2006, just the top 10 Internet properties in the U.S. generated 133 billion page views from 171 million unique users. Tracking ad spending to results is a massive technical challenge. Omniture currently captures over three billion web page views a day and manages over 600 terabytes of data for its customers, with 99.9% uptime — you know how devastating an Internet outage can be to your productivity.
Second, Omniture has established itself as the gold standard for web analytics thanks to the quality of its customers, and it has created a productive cycle of product development. It is rapidly developing new services for its current customer base that have been requested by the clients themselves. At the same time, they are moving down into the middle market of medium-sized, less web-savvy companies, adding new customers easily thanks to their reputation. Sales are currently growing around 100% a year, hitting $41 million in 2005. I am targeting $80 million this year and $130 million in 2007.
Omniture will lose a little money this year, around 15 cents a share, and make a little next year, also around 15 cents a share. At this stage of the company’s growth, profits are not the point — a land-grab for customers is. Competitor WebSideStory (WSSI) is trying to show profits and therefore isn’t spending as much money on R&D, marketing and other growth-oriented strategies, and thus will grow slower. So OMTR has already passed them in size. Omniture was profitable for six straight quarters until early 2004 as a private company, and they could turn profitable tomorrow by slashing marketing and R&D. But we don’t want them to do that.
The company had to cut its IPO price from the $7.50 to $9.00 range down to $6.50 because they did the underwriting less than a month after the Vonage IPO mess. The company has a total market capitalization of $345 million at today’s close, less than 3X next year’s sales estimate. It should be selling for double or triple that, given the growth rate. I don’t see OMTR running out of opportunities until it has at least $300 million in sales, though it will probably be closer to $500 million.
Of course, OMTR will have to continue to execute as well as they’ve been doing. This Orem, Utah-based company is run by a group of Brigham Young graduates in their early 30s. The Board of Directors includes Mark Gorenberg from the software venture capital firm Hummer Winblad, and Rory O’Driscoll from BA Ventures (Bank of America) to provide adult supervision.
The company made its first presentation since the IPO at the ThinkEquity Growth Conference on Tuesday; and the stock moved up from the low $7s to the high $7s on light volume. Given my market outlook, I think a tight buy limit is appropriate. Buy OMTR under $8 for a $20 target in 2007. I’m also adding OMTR to the Top Buys, as this overlooked IPO could dominate web analytics.
Avian Flu MegaShift
Crucell (CRXL) signed up two large customers for its STAR technology licensing program this week. UCB, the maker of the allergy drug Zyrtec, signed a five-year deal, and this morning Novartis signed a one-year license. STAR is the process that increases production of antibodies and proteins using human cell lines. These are two big wins for Crucell, and it remains a buy up to $28 for my $50 target as the bird flu spreads south during the fall migration season that is starting now.
Gilead Sciences (GILD) will benefit from a new U.S. government order to Roche for 21.3 million doses of Tamiflu. The stock should react to the new bird flu season, and the LEAP options are timely buys. Buy the January 2008 $50 call LEAP (YGDAJ) on any dips under $16 for my $30 target, and buy the January 2007 $60 LEAP (GDQAL) up to $9 for a $20 target.
Biotech MegaShift
Biogen Idec (BIIB) presented at a Bear Stearns conference on Monday, and said that Tysabri has launched in the U.S. and some European markets, most importantly Germany. It will launch in Canada and Italy in the fourth quarter, and the remaining European markets in the first half of next year. That includes France, which is a large market for multiple sclerosis.
In the U.S., they expect to have 2,500 infusion center practices trained in the new risk monitoring program by the end of the year. It takes several weeks to get a patient onto Tysabri, so the big revenue impact will hit next year.
Biogen management also focused on a couple of areas that they think analysts are not looking at. One is collaborations and in-licensing, where they announced two deals in the second quarter. This morning, they bought the rights to Aviptadil, a blood pressure drug for pulmonary arterial hypertension. They said that they plan to expand beyond their current core businesses in multiple sclerosis and cancer, and even though they have no debt today, they would not hesitate to use debt for a major acquisition.
The other area is their clinical pipeline, where they have a number of programs advancing into Phase III trials. That includes expanding the label for Rituxan in rheumatoid arthritis, multiple sclerosis and lupus. Rituxan has a novel mechanism of action, and may be able to make a big impact on those diseases. BIIB is well-positioned for a strong move upward over the next six months as Tysabri revenues build, and I still think you will make money on the January 2007 $45 LEAP call (IDKAI), which I’m keeping as buy up to $10 for my $21 target. There may not be quite enough time to get all the way to $21 by expiration, but that will depend on how strongly the stock reacts in the market upswing in November and December. The January 2008 $45 contract (YZUAI) is a safer buy up to $12 for a $23 target.
Millennium Pharmaceuticals (MLNM) also presented at the Bear Stearns conference. They focused on Velcade, their approved standard of care for relapsed multiple myeloma. Velcade also has shown significant clinical activity for front-line myeloma, non-Hodgkin’s lymphoma and non-small cell lung cancer. They believe it can become a billion dollar drug.
MLNM’s pipeline includes eight new molecules in cancer and inflammation, and their goal is to put one or two new candidates into the clinic every year. In the last two years, they have moved five molecules from discovery to development. At the same time, they are determined to show pro forma profitability for this year, as they did in the first half, in spite of the heavy R&D budget. There could be another buyout bid for the company at any time, and MLNM remains an excellent buy while it is under $11 for my $23 target.
Metabolic Pharmaceuticals (MBLPF) still has a wide-open field to be the winner in obesity drugs. Xenical causes rectal leakage, and Reductil has been linked to heart problems, mental issues and even suicide. GlaxoSmithKline’s Alli is just a weaker version of Xenical, and Sanofi-Aventis’s Acomplia is an appetite-suppressing drug, not something that causes the body to release stored fat. Metabolic’s AOD9604 has the right technology. They fully enrolled their Phase IIb study earlier this year, getting 536 subjects in April. Results are expected in March 2007. This drug also appears to be useful against osteoporosis, and a Phase II trial will start in 2007.
Metabolic’s pain drug, ACV1, successfully completed a Phase I safety trial, and the Phase IIa trial is being planned now. This is a buy-it-and-put-it-away stock to make 100-to-1 on your money if it works. Buy MBLPF up to 56 cents a share in the U.S., or buy MBP on the Australian Exchange up to 75 Australian cents. I’m still looking for at least a $4 stock over the next few years, but obviously it has the potential to go much higher on the back of a successful obesity program.
QLT (QLTI) completed their Dutch auction at the high end of the range, buying 13 million shares for $8 each. That’s 14.7% of the outstanding stock, and now the fun begins.
First, there were small presentations on Visudyne combination therapy at the American Society of Retinal Specialists meeting in Cannes this week, and there will be important data at the American Academy of Ophthalmology meeting in November.
Second, I expect a takeover bid from Rodney O’Conner, the major shareholder who founded Atrix Laboratories and sold it to QLT. He said that he may make a hostile tender offer after the buyback process ended, and of course the buyback simply increased his current percentage holding. I expect an offer from him in the $13 area, but others may bid, including Genentech. Now is the time to buy or average down in QLTI under $8, with a potential buyout at my $20 target price.
China MegaShift
Huaneng Power (HNP) received state approval to build two 1,000 megawatt power plants at a total cost of $1.16 billion. They will put up 25% of the cost and borrow the rest. Even in a worldwide economic slowdown, China’s demand for power will keep growing. The recent decline in oil prices cuts Huaneng’s costs, and I expect to see some decent earnings numbers for the rest of the year. Buy HNP under $30 for my $45 target, and collect a 4.6% yield while you wait.
Content on Demand MegaShift
Comcast (CMCSA) expanded their ON DEMAND video on-demand service to include 100 hours of high definition movies, including 20 movies a month from Starz. Customers who see high definition never want to go back, so I expect Comcast to use this as a wedge to dramatically expand HD availability. The company continues to do a great job of leveraging the new technologies to keep its cable cash flows growing. At a Merrill Lynch conference, management not only said that they are “very convinced” of double-digit cash-flow growth this year, but added they expect that to continue for “several years ahead.” CMCSA is a strong hold for my $62 target.
Harmonic (HLIT) announced two new contracts, one with a Norwegian satellite operator and the other with a Hungarian telecom bringing broadband to apartment buildings.
Nokia and Motorola agreed to make their implementations of the new Digital Video Broadcasting-Handheld standard (DVB-H) interoperable. This is an open standard, and Harmonic has been investing R&D for both the head-end broadcasting equipment and the mobile video side. The company is well-positioned for the rapid spread of video to mobile devices. Buy HLIT on dips under $6 for my $12 target. If the stock doesn’t drop that far in the next market decline, I will raise the buy limit a bit.
Silicon Image (SIMG) was a stop on the WR Hambrecht Silicon Valley bus tour yesterday. Management emphasized that Silicon Image is about Secure Digital Content Delivery in consumer electronics, storage and the personal computer. They said that they expect the 36% growth rate of the first half of 2006 to continue, as consumers, electronics manufacturers and content suppliers insist on easy connectivity in the home. SIMG now thinks about that as the Personal Domain Environment. The HDMI standard is the key to delivering easy set-up plus protection that, say, an HD movie bought for $19 won’t disappear off the hard disk.
The China Video Industry Association recently announced that they will promote and support HDMI in consumer electronics — and they make 50% of the world’s TVs. Sony’s coming PlayStation3 supports HDMI, as does the Xbox360, and Silicon Image expects to be the first company to release an HDMI video processor for the PlayStation console. The Apple iTV media center that Steve Jobs previewed on Tuesday had an HDMI connection on the back.
There were 5.0 million HDMI devices sold in 2004 and 17.4 million in 2005. The market research firm In-Stat expects 59.8 million chips sold this year, followed by 123.6 million in 2007, 200.7 million in 2008 and 278.8 million in 2009. That excludes the mobile market, where the new mini-HDMI plug will be adopted in the hundreds of millions.
A lot of these chips will be low-feature “jellybeans” made in China or Taiwan, and that is one of the fears surrounding SIMG’s stock. But the high-end equipment — PCs, LCD TVs, Apple’s media center, high definition displays — will use the richly-featured chips that SIMG makes. At the coming Consumer Electronics Show, SIMG expects to show a home network solution that can display content from any device on any other device with a screen (with an automobile and a mobile interface), provide secure storage and be self-installing.
The company expects to grow 20% to 30% a year in the long term, and get 60% gross margins. Buy SIMG on dips under $10 for my $18 target, and I will raise the buy limit after we see where the stock bottoms on the next market dip.
Zhone Technologies (ZHNE) presented at the Think Equity Growth Conference on Tuesday. Zhone is #1 in the broadband loop carrier market, tying all types of broadband access together for use by the customer. They expect the single line, multilevel service market to grow 30% to 40% a year. Their goal is to increase their gross profit margins from the low 30% area to the 38% to 40% area by outsourcing their manufacturing, a process that is underway. Finally, except for sales commissions, they expect to hold quarterly overhead expenses flat in the $22.5 million to $24.5 million range, so the incremental gross profits can mostly fall to the bottom line.
I know this one is taking a long time to get off the ground, but they have an excellent market position for the worldwide broadband explosion, serving both the cable and telco industries. Zhone has plenty of cash and is paying down debt. The operating leverage in their business model has the potential to make them profitable in the December quarter, and then every quarter next year. That’s what it will take to make this stock fly. Buy ZHNE up to $3.50 for my $7 target, although we may not see that until the first half of next year.
New Energy Technology MegaShift
Holly Corp. (HOC) dropped sharply with the price of oil, giving us an excellent opportunity to buy the stock. As one of the few refineries that can handle heavy, sour crude, it will not be affected by Exxon’s new deepwater discovery in the Gulf of Mexico or a decline in oil prices from $75 to even $55. A lot of the world’s incremental oil capacity, including Saudi Arabia and the Canadian tar sands, is heavy or sour crude. Nobody is building any more of these refineries. Regardless of the price of oil, the world, including China and India, will use more and more of it, and that incremental sour barrel of oil has to be refined somewhere. Buy HOC under $46 for my $60 target.
Nanotech and Materials MegaShift
Integral Technology (ITKG) completed a license with Jasper Rubber Products to have the rights to use ITKG’s ElectriPlast technology. The two companies will wok together on developing new products. This is another in a string of development contracts that eventually will drive a large royalty stream to ITKG.
I had a question from Chet: “Mike, what is your take on ITKG? It’s gone past your recommendation and is still climbing. Are you expecting a major pull back?”
ITKG sailed past my $3 target for this year, but as it says on the web site, this is a multiyear holding. I couldn’t argue with someone taking some of their profits off the table, but I find it difficult to trade in and out of small stocks like this. These stocks are always volatile, and if we see the sharp drop in the market that I am still expecting, ITKG could retreat to under $3 in just a few days. Of course, in the subsequent bull market, it’s likely to go over $5 in 2007. So, I am raising the target price to $4, which it already hit at the end of August, but leaving the buy limit at $2.50 for now. Once we get past the high-risk period for the market, I will adjust the buy limit to try to pick it off when it is in the lower end of its trading range, whatever that is at the time.
Security MegaShift
@Road (ARDI) won two important contracts, and it now looks like they will beat their guidance for new subscribers this year. BellSouth picked an @Road solution for their 17,000 field technicians, and E.ON chose them for 1,300 field engineers. That means the company has booked 61,000 new subscribers so far this year, and they previously guided for 70,000 for the whole year. So, they should report a penny or two profit per share in the September quarter, and guide up for December, where the Street currently is at four cents a share on $26.9 million in sales. ARDI is just under my $5.50 buy limit, and can be bought for the $8 target.
American Science & Engineering (ASEI) moved up nicely after a potentially whopping contract win from the Department of Homeland Security for a new cargo inspection system. The development part of the contract was awarded as a $28.8 million, two-year program. But the follow-on procurement phase is capped at $450 million — big numbers! This next-generation inspection system is targeted at shielded nuclear threats hidden in containers passing through the country’s ports.
Even more important in the short run, ASEI got a contract for 36 Z Backscatter vans, which is worth $42.4 million. This probably means that they will ship more vans this quarter than the 52 they sold in last year’s September period, and that is much more than Wall Street is expecting. In addition, the profitability on this program is substantially higher than it was. The Street estimate for September is 62 cents a share, with a high estimate of 72 cents. If ASEI can ship most of this order by the end of the quarter, they could easily report 90 cents a share. While that would still be down from last year’s extraordinary $1.18, it would more than double the June quarter’s very disappointing 41 cents and should move the stock up sharply. So, ASEI is a very timely buy now, and can be bought up to $59 for my $93 target — which now seems a lot more likely.
Gemalto (GEMP) said it would miss its forecast for 2006 due to economic developments and the costs of integrating the merger between Gemplus and Axalto. I don’t buy it. The economy in their area of expertise is still strong, and they have said all along that they had a handle on the merger acquisition costs. So, until they get themselves straightened out, I recommend that you sell GEMP, and we will revisit the situation later — assuming there is a U.S.-traded stock to buy.
Packeteer (PKTR) should benefit in the short run from an amended IPO filing by Riverbed Technology, a competitor to Packeteer’s Tacit product. The valuation on Riverbed will be very high, and may generate a positive spill-over for PKTR. Longer term, it will mean another well-financed competitor (along with Cisco), but over the next several months I think it will help Packeteer’s stock. Buy PKTR under $10 for my $17 target.
Video iPod MegaShift
Microvision (MVIS) won a $6 million contract from General Dynamics for full-color, helmet-mounted displays for the Army. But they did not get the contract we needed to see to keep holding the stock, as Apple did not introduce a higher-end video iPod on Tuesday. What Apple did introduce was a video iPod with a somewhat brighter screen, although still only 2.5″, with a bigger hard drive and better battery life. They also announced the availability of 75 feature films on iTunes, with many more to come. Apple cannot let customers download these without violating the Burst.com (BRST) patents. It seems to me that Apple must be about to either settle the BRST lawsuit or buy the company. Otherwise, Burst can go for an injunction to stop the video service, which would throw Apple’s market into complete confusion.
I will not know for a while if PortalPlayer (PLAY) won the chip design for this iPod, although I have a call into the company to ask them. By early next week, I should have the bill of materials. Microsoft showed their Zume player today, and it also does not have a Microvision display. It is being built by Toshiba, so the odds are it does not have a PortalPlayer chip, either. But I should know for sure next week.
So, here’s what to do now. Sell Microvision and we will come back to it when Apple finally introduces the high-end video iPod. I’m raising the buy limit on BRST to $1.15, while maintaining my $2 target. Keep buying PLAY up to $12 for my $20 target because even if they did not win this iPod contract, they may well be the processor in the Zume music player.
Google Short Sale
We were stopped out of the Google (GOOG) short sale by my $388 stop loss on Wednesday. When I’ve taken two small losses in a row like this, stopped out both times because the stock moved through meaningful resistance levels, I think it is wise to watch and wait for a while. The stock could easily test back down to $392 or even $388, and still resume its uptrend. But if it can move on up from here, we will be able to move our entry point up to just over $400, and wait for the stock to fall through that before we re-establish the position.
Market Outlook
The last three autumn market drops began from tops set in the September triple witching week, the once-a quarter event when options, options on futures and futures all expire on the same day. In 2003, the decline started on Friday, September 19. In 2004, it began on Monday, September 13. Last year, it started on Monday, September 12.
Each of these tops was followed by a drop of 550- to 700-points in the Dow Jones Industrial Average, in less than a month. Tomorrow is the September triple witching expiration for 2006. Yesterday might have marked the high for this grinding rally, even with a mild hurricane season and sharply falling oil prices. Stay tuned.
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