Dear New World Investor:

What an amazing week! And I am not talking just about the stock market, where I think we have picked our way through the minefield just about as well as anyone could. I came right to brink of recommending put protection if positive energy did not release into the S&P 500 at what effectively was its last opportunity to avoid a drop to 520. But I did not have to pull that trigger, as cash came off the sidelines at the critical moment and the “look, look, I’m bearish!” crowd covered their shorts in a panic.

Some commentators have claimed the sparks to start the rally were the pending reinstatement of the uptick rule by the SEC and the Financial Accounting Standards Board’s commitment to rewrite its Mark To Market rule. I ran short-only funds and a shorts-only newsletter for years, and I can promise you that the uptick rule made zero difference then, and even less difference now that we live in a world of one cent bid/ask spreads instead of eighths. If it made any sense to “stop shortsellers from ganging up on a stock and driving it down” by having a rule that you can only sell short on an uptick (a price equal to or higher than the last trade), then why not have a downtick rule to “stop manipulators and daytraders from piling on to a moving stock and driving it up?” If they could only buy stock on a downtick (a price equal to or lower than the last trade), wouldn’t that make our stock market much more efficient?

No. And imposing an uptick rule won’t do any good, except giving the SEC something cosmetic to talk about to Congress, who collectively believe that all ticks are bad, especially the ones that get on their Maltese.

The FASB may need to write a better mark to market rule, but the talking heads are acting as if the Board is going to effectively do away with mark to market. After all, wouldn’t we all be better off if we didn’t know how bad things are? Shouldn’t Ken Lewis be able to value Merrill Lynch’s derivatives at what he thinks they’re worth, instead of the stupid market?

No and no. It reminds me of Humpty Dumpty in Through the Looking Glass: “When I use a word, it means just what I choose it to mean – neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master – that’s all.”

Exactly. Do we trust the market to tell us what something is worth, or do we trust Ken Lewis to be the Master? (Not to pick on Mr. Lewis; you can substitute John Thain, Jamie Dimon, Jimmie Cayne, Bernie Madoff or any of the other tarnished and fallen financial “heroes” of the first seven years of the 21st century.)

I think it is far more likely that the market went up not because an impotent policy is about to be reimposed by the SEC, or because investors think biased management guesses are worth more than open market price discovery in valuing assets, but because stocks have been beaten to a pulp and there’s no new bad news. Combine that with a rapid plunge to key long-term energy levels like 750 and 664, and the contrarians were able to turn things back up. Probably for longer than people think. I am working on a Big Picture Alert on how all this fits in with a mid-April turn date, and I can tell you the bottom-line: The character of the market is likely to change in mid-April, as fears of depression give way to fears of hyperinflation. In real terms – that is, adjusted for inflation – stocks may be flat to down for several years. But at the same time, in nominal terms – reflecting inflation and then hyperinflation – the S&P 500 can go from 750 to 7500 to 75,000 as the insane Obama-Bernanke-Geithner stimulus plans play out.

So What’s Next?

This has been a remarkable rally, even stronger than I expected. Or wanted. It is healthier to see markets retrace and successfully test support at key energy levels, and I would like to see the S&P make a quick dip to 750 to build up energy for a bigger leg up. It could be the market will break out over 820 and just keep going, squeezing the shorts, panicking the cash-laden and bankrupting the put buyers. But that is not the way to bet.

More likely, we will see a consolidation over the next several days, either via a dip back towards 750 or an extended noodling around just under 800, where we closed today. Another possibility is an immediate run to 820 followed by a scary, fast 10% dip back to 740. Either way, in the absence of truly new bad news, after consolidations markets usually resume the underlying trend, which in this case means a resumption of the recovery rally to what still looks like a top at 1060 or, God willin’ and the creeks don’t rise, 1250. To get beyond that will require a new energy source, such as hyperinflation.

The Fed Comes Out Of The Closet

The amazing week I referred to in the opening sentence includes the Fed deciding to buy about a trillion dollars of long-term treasury bonds in the open market. That’s how you print $1 trillion and hyperinflate the economy without sending interest rates soaring.

The Fed said: “To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.”

In short, the Fed is monetizing the debt by creating money out of thin air and exchanging it for Treasury securities. Gold soared, oil soared and the dollar tanked. There is little doubt remaining that the decision has been made to sacrifice the dollar. The greenback may not do badly against the euro and yen, simply because the EU and Japan have even bigger problems than we do. The Chinese will keep the yuan pegged to the dollar in order to protect their export industries, while their huge holding of Treasury securities loses most or all of its purchasing power. But the Swiss franc will soar, as will commodities, as will the currencies of commodity-exporting countries like Canada and Australia. If Russia wasn’t run by Mafia thugs, even the ruble could become a strong currency in the hyperinflation that is coming. The ProShares UltraShort 20+ Year Treasury Bond (TBT) exchange-traded trust was clobbered on the news that T-bond yields will be falling, so I am glad to have been patient before we activate that position. We are getting very close to the buy point, and I will email you a Flash Alert when we get there.

But Wait, There’s More….

Cisco made a major announcement this week that they would start supplying computer servers, in competition with Hewlett-Packard and Dell, as part of their Integrated Data Center vision. That also puts them squarely in opposition to IBM and Sun Microsystems, so it is no surprise that those two companies are talking about a merger. I’ve covered the basics below (we already own most of the winners), and will expand my thoughts shortly in a Backgrounder or next week’s Radar Report. But in this issue I really wanted to flesh out the QuickLogic story that I sent you in the first of two Flash Alerts yesterday. Incidentally, both QUIK and Arena Pharmaceuticals (ARNA – the subject of a second Flash Alert yesterday) shot up right after I posted the writeups and sent out the emails. Try to stick to the buy limits, as one of our goals is to take as many shares as possible away from the market makers before they start jacking up the price. In the short run, the “New World Investor effect” may pop prices for a day or three, but then they will come back down and you can get a position at a more attractive price. QUIK dropped back 30 cents today to $1.29.

And More on QUIK…

As I said in the Flash Alert, the excitement at QuickLogic is over both of their major products. The VEE (Visual Enhancement Engine) meets the developing need for brighter “always-on” smartphone displays with a low battery drain. Their CSSP (Customer-Specific Standard Product) programmable logic lets their customer introduce a full line of products instead of a single middle-of-the-road product.

I also made a controversial prediction in yesterday’s Flash Alert that the Next Big Thing will be smartphones loaded with handy little applications to make your life easier. Since Apple opened the iPhone App Store just eight months ago, an amazing 25,000 applications – most of them free – have been written by 50,000 registered developers, leading to 800 million downloads. Now we’re seeing unauthorized iPhone application websites for the programs Apple rejects. What do these programs do? In addition to all the games, including chess, there are programs to control your computer from your iPhone, connect to friends via Twitter or AOL Instant Messaging, or read a book using Amazon’s Kindle for iPhone. You can record brief messages to your iPhone for future reference, or track your time for billing purposes.

You can listen to hundreds of genres of streaming music via Pandora. You can paint or sketch and save or email the results. Kids can use Doodle Kids that lets iPhone users draw with their fingers by touching the iPhone’s touch-screen and then clear the screen by shaking the phone. That application was written by nine-year old Lim Ding Wen from Singapore for his younger sisters, aged three and five. It’s been downloaded more than 4,000 times.

One application turns the iPhone into a bright little flashlight. Others let you play an electronic piano, guitar, drums or flute. Here’s a one-minute video of an iPhone flute ensemble playing Stairway to Heaven:

http://www.youtube.com/watch?v=kfrONZjakRY

Yesterday, Apple previewed version 3.0 of the iPhone operating system, which increases the functionality of the hardware and therefore will lead to even more sophisticated applications. Of course, Palm, Research in Motion (Blackberry) and Nokia are racing to open their own application stores for their respective smartphones.

All of this leads to a higher percentage of smartphones in the hands of customers, larger displays that burn more power per minute, and more hours of usage, tilted heavily towards the always-on applications. This market is one of the few still growing rapidly, as over 11% of all consumers expect to buy a smart phone in the next 90 days – a remarkably high number in the middle of a depression.

QuickLogic is a crucial arms supplier in the smartphone wars. Big, bright displays and long battery life are two sides of the same coin, and no smartphone manufacturer can afford to give away an inch on either of these directly conflicting must-have features. The cellular service providers are demanding that the manufactures improve both of these features. VEE is the answer to meeting both needs.

Meanwhile, most consumer electronics and smartphone manufacturers want to introduce not a product, but a product line. The entry-level, mid-range, top-of-the-line paradigm is thoroughly embedded in both their and their customers’ mindsets. The manufacturers also need to be able to respond quickly if a new feature suddenly becomes popular, like a built-in iPod dock. Products made with custom chips hard-wired to do specific things are a little cheaper if produced in very high volumes, but are not flexible and require separate designs for each product in the line. Using programmable logic provides the flexibility to quickly add features, either to create different variations of the basic product for a product line, or to respond as the markets change. QUIK’s CSSP chips provide both low cost and high flexibility.

This capability is especially important right now in the emerging Mobile Internet Device (MID) market. PC manufacturers are targeting this market with netbooks, while cellphone manufacturers are coming at it with smartphones or, in the case of Nokia, introducing netbooks. Nokia’s Asian cellular service provider customers are giving away netbooks with two-year service contracts, using the same model that U.S. cellphone service providers pioneered.

No one really knows what form factor will win out or which features consumers really will pay for. It is an ideal environment to use CSSP chips to get into the market quickly, respond to changing consumer preferences, find a combination of features, functions and form factor that customers want, and then quickly roll out a full line of products with frequent new models and upgrades. Products that combine mobile communications and portable computing will be the Next Big Thing, the killer market that pundits have been waiting for to take the lead from personal computers.

I believe QuickLogic is better positioned and better equipped to execute today than it was a year ago, when the stock was at $2.60. The run from 90 cents to $1.95 after the Flash Alert went out was too much, too soon, and QUIK backed off 30 cents today. It’s still double last Friday’s close, yet it’s still cheap. In an S&P 500 retest of 750, QUIK might get back to $1.00. Keep nibbling away on down days until you have a very full position – the same advice I have below on Towerstream (TWER). QUIK remains a Top Buy up to $4 for my $8 target price.

Content on Demand MegaShift

Cisco Systems (CSCO) made a very important announcement this week, and I intend to go into it in detail in next week’s Radar Repor. The company announced its “Unified Computing System” solution, which combines servers, storage, connectivity and virtualization. Cisco, of course, has long provided the connectivity part of this package. Now they’ll also provide the server, based on a yet-to-be-announced Intel processor. It is a direct challenge to Hewlett-Packard, Dell, Sun Microsystems and IBM. H-P knew it was coming, which is one reason they bought EDS to get more heavily into the services business against IBM. Now IBM is in talks to acquire Sun Microsystems to beef up its offerings against H-P/EDS and Cisco. Let the wild ruckus begin!

Cisco says now is the time to make this move because virtualization has proven to be the best way to provide more resources while significantly cutting costs. Virtualization just means software that sits between the user and the hardware, and treats the hardware as one big thing. The user doesn’t have to worry about which server he is using, or exactly where the data is stored. By balancing the workload, the virtualization software makes better use of the actual hardware, reducing the need to add additional, expensive resources. Cisco now sees virtualization extending to communications, so they decided to take the lead in providing a completely virtualized computing, storage and communications package – the Unified Computing System.

While Cisco will sell the system and provide the servers and communications, who will provide the storage hardware and virtualization software? Snaps to you if you said “EMC” and “VMware,” which is majority-owned by EMC. I’ll go into this a lot more next week In the meantime, Cisco sells for only 13X the July fiscal year estimate of $1.25. EMC (EMC) sells for 13X their December fiscal year estimate of 90 cents a share. VMware (VMW) sells for 25X its December fiscal year estimate of 99 cents a share.

We own the Cisco January 2010 $20 LEAP call (WCY AD), closing today at $1.26. CSCO has to go from just over $16 today to over $20 by the expiration date in order for the LEAP contract to have any value. I continue to think CSCO will roughly double to $32 before expiration, pushing the price/earnings ratio up into the mid-20s. Wall Street is forecasting 10% long-term growth for the company, while management forecasts 20% growth. I think they know their business much better than Wall Street does, and the opportunity to grow at that rate certainly is there. So continue to buy the Cisco January 2010 $20 LEAP call up to $6 for my $12 target price – just about 10 times on your money from current levels.

We also own the EMC January 2010 $15 LEAP call (WUE AC), closing today at 83 cents. EMC has to go from about $11.50 today to over $15 by the expiration date in order for the LEAP contract to have any value. EMC would have to more than double to get to my $26 target price before expiration, and I think that is now too enthusiastic. But they can double to $23 by then, due in large part to an acceleration in VMware’s growth. It is entirely possible that Cisco will buy EMC and VMware. The CEO of EMC has made it clear that their 80%+ of VMware is not for sale in a separate transaction. Cisco could buy them, keep the VMware stake or even buy the public out, and later spinoff EMC’s storage operations in an IPO. Or not, just keep them. Cisco has $30 billion in cash, more than EMC’s current $23 billion market capitalization, which includes $6.7 billion in cash that Cisco could keep.

However it happens, if EMC gets up to $23 it would push the price/earnings ratio up into the mid-20s. Wall Street is forecasting 12% long-term growth for the company, while management targets something closer to 15% growth. I am reducing the target price on the EMC January 2010 $15 LEAP call to $8, and moving it from a Hold to a buy under $2.

NetLogic Microsystems (NETL) has been the subject of two rumors, one that arch-competitor Integrated Device Technology was going to drop out of the network search engine or Ternary Content Addressable Memory (T-CAM) business. A CAM is a special, expensive type of memory that works the opposite of RAM. With RAM the operating system provides an address, and receives the data stored at that address. With CAM, the operating system supplies the data, and the CAM returns a list of addresses where the data is stored, if it finds any. Because a CAM searches the entire memory in one operation, it is much faster than RAM. Routers like those made by Cisco and Juniper Networks can store their entire routing table in these T-CAMs, allowing for very quick lookups. T-CAM is not generally used in computers, but it’s very useful in networking devices. I am pretty sure the rumor is true, so the only remaining competitor for NetLogic will be Renesas, a big, very diversified Japanese company that manufactures a small line of T-CAMs for Cisco. They also are about to drop out of this highly specialized business.

The other rumor is that Cisco will stop their R&D project aimed at making their own T-CAMs. My checks indicate that rumor is wrong. Cisco bought SpansLogic, a small, private semiconductor design company, in 2007, and I expect them to announce the first T-CAM chip this year.

Although Cisco is NetLogic’s largest customer, NETL sells them many other kinds of chips and would still have a substantial business even if the T-CAM portion went completely away, which it won’t for many years, if ever. At the same time, many of Cisco’s competitors have been buying their T-CAMs from Integrated Device Technology, and they are highly likely to become NETL customers now. NETL remains a buy on dips back under $23 for my $47 target.

SanDisk (SNDK) will be a main beneficiary of the growth of Mobile Internet Devices, because flash memory gives much longer battery life than hard disk drives. Sun Microsystems announced this week that they would produce servers with flash memory replacing the usual hard disk drives. SanDisk has important blocking patents on multi-bit per cell (MLC) technology that allows a single memory cell to store several bits of information. Thus, they can produce a much larger memory per square inch of silicon than single bit per cell flash, with concomitantly lower costs. NAND flash memory is the only memory technology that will grow this year, and whether SanDisk is bought out by Samsung or Toshiba, or just swings into profitability as flash prices rise, I want you to buy SNDK up to $15 for my $30 target this year.

Telkonet (TKO) CEO Jason Tienor, 34, needs to hear from you. Write him an old-fashioned letter at Telkonet Inc., 20374 Seneca Meadows Parkway, Germantown, MD 20876. Tell him in your own words that:

- You oppose removing the equity cap from the convertible bond
- Every management you know that has gone this route has wound up losing the company to the bondholders
- Suggest he take a look at MobilePro (MOBL) and give CEO Jay Wright a call at 301-571-3476 to ask him what happened in a similar situation
- Tell Mr. Tienor that you will be voting against removing the cap.

Seriously, do it. He does not know that he is about to be taken to the cleaners by folks who undoubtedly have done this before. TKO remains on Hold with no target price until we get the results of the vote scheduled for late May.

New Energy Technology MegaShift

Canadian Solar (CSIQ) reported the expected poor results for the difficult December quarter, falling in line with other solar companies. Credit constraints on customer projects and a freezing winter in Germany affected sales, and the plunging value of silicon and module inventories required a big inventory writeoff. For the quarter, revenue plunged to $73.0 million from $252.4 million in the September quarter. It was also down from $127.5 million in the 2007 period. Even with the weak fourth quarter, full year revenues were up 134% to $709.2 million. They shipped 167.2 megawatts of modules, up 100% for the year. Management guided for $600 million to $800 million this year, a wide range because they don’t know when the credit markets will ease up, nor when the Obama alternative energy program will kick in. They have contracts in hand to ship 262 megawatts of modules, which accounts for 74% to 87% of their guidance of 300 megawatts to 350 megawatts.

The company reported a $1.42 per share loss for the quarter, but $1.01 of that was from inventory and bad debt reserves. They still have $136 million in cash. While they sounded cautious on the conference call about the next couple of quarters, they expect to return to their historic profit margins in the second half of the year as they continue to cut costs. They are very well positioned to benefit from President Obama’s increased emphasis on solar for alternative energy, but I need to reduce my buy limit and target price to reflect the impact of the credit crunch on private spending around the world. Buy CSIQ under $12 for my lowered $28 target. I still believe they will hit the original $65 target in 2010.

Energy Conversion Devices (ENER) held a business update call the same day with the same message as CSIQ: Business is slow due to the credit crunch, although they avoided the inventory writedowns other solar companies are taking due to the plunging costs of wafers and modules. Even though ENER gave cautious guidance during the quarterly earnings conference call last month, Wall Street did not kill their stock. But now they say they have to withdraw that forecast and they will stop production for two weeks, consolidate production facilities and fire 70 people. The Street responded by taking 23% off the stock.

On the conference call, management said they are very, very happy with what they are seeing in the stimulus package, and think their differentiated product that essentially replaces roofing material will be a major beneficiary of the various incentives and tax credits. They also are able to turn up production very quickly, but they just don’t see the market impact of the stimulus spending yet.

I have no doubt that the Obama plan is going to be a major boost to ENER, and in the short term they are doing the right thing. They’ll save $4 million a year by consolidating production, but last year they were running flat-out and it was not practical to make the physical moves and changes required. During their two-week production hiatus that starts tomorrow, they plan to move all the machinery and get ready to book the savings.

ENER is operating in a tough environment for the moment, but as the credit markets ease up (possibly with Bernanke’s assistance) and the Obama programs kick in, their earnings capacity is undiminished. I will move the stock to a Top Buy just as soon as the Federal funding starts to flow. Meanwhile, I am not changing my $32 buy limit or $65 target for ENER.

Plug Power (PLUG) reported December fourth quarter results and hit their marks for 2008. Fourth quarter revenues were $5.3 million, about flat with last year’s $5.1 million. For the year they grew 10% to $17.9 million. The fourth quarter operating loss was 11 cents a share, and they took an additional 58 cent loss in goodwill writedowns and restructuring charges.

There were 293 GenDrive and 41 GenCore orders in the fourth quarter. GenCore, GenDrive and GenSys products shipments totaled 71 units for the quarter and 283 units for the year, compared to 235 units in 2007. At the end of 2008 they had 481 units in backlog.

Their 2008 milestones were to get 150 to 200 GenDrive (forklift) orders, 50 GenCore (emergency backup) orders, and keep the cash burn at $55 million to $60 million. In fact they got 358 GenDrive orders, including a 220-unit order from Central Grocers announced December 11. They booked 109 GenCore orders and burned $56.6 million for the year.

For 2009, they are setting milestones to get 500 unit orders, keep the cash burn to $33 million to $37 million, release a GenDrive class 2 product in the December 2009 quarter, and announce a path and timeline to profitability. All in all, better than a sharp stick in the eye. Buy PLUG up to $4 for my $10 target.

Security MegaShift

SiRF Technology (SIRF) will be bought out by Britain’s CSR plc (CSR.L on Yahoo), which trades on the London Stock Exchange, for 0.741 shares of CSR for each share of SIRF. This was announced n February and I missed it, which is proof positive I’m following too many companies. CSR closed today at 240 pence, so the value of the deal today is about $2.60 per share. SIRF closed at $2.30, a normal 9% discount. Sell SIRF and redeploy the money into one of the Top Buys.

WiMax MegaShift

Towerstream (TWER) reported an excellent quarter this morning, guided pretty much right on my target for the March quarter and said they will continue to harvest opportunities in the nine markets they currently serve rather than start expanding again, until they get to positive cash flow. It was this latter statement that hit the stock, as some analysts on the conference call clearly wanted the company to announce their 10th and 11th target markets. I was quite surprised. Any management that is rapidly growing the company in this environment while conserving cash and avoiding unnecessary risks should be knighted, not taken out and shot. But TWER traded as low as 82 cents a share today, down 24.8% from yesterday’s close of $1.09. It closed at 90 cents, down 17.4%. Ridiculous!

For the quarter, they did $3.2 million in sales, up 68% from last year, up 12% sequentially and above their guidance. Will all managements growing 68% a year in this downturn please raise their hands? Thought so. The gross profit margin increased to 68%. Their churn rate was a still-low 1.23%. The average revenue per customer for all customers was flat at $828, in part because their 5 megabit service is still outselling their 8 megabit service. They are finishing installing the equipment that will let them offer 8 megabit speed for $999 a month, and that should be a very strong offer.

For the year, they did $10.7 million, up 62%. Six of their nine current markets are generating positive cash flow, and the company as a whole reduced their EBITDA loss from $2.2 million in the September quarter to $1.6 million. They will turn cash flow positive in 2009, and they are starting the year with $25 million in cash to get there. They guided for about $3.45 million in the March quarter, up 65% from last year. They’ll spend less than $5 million on capital equipment this year, conserving their cash.

They can probably do $50 million a year out of the nine markets they are in, so there is no shortage of growth opportunities. The sales force is still maturing, with accelerating productivity. New accounts come in with very low additional operating costs, so their high gross profit margins will just keep going up. What’s not to like? TWER remains a strong Top Buy all the way up to $5 for my $15 target over the next few years.

* * * * *

If you fly a lot, there’s a better way to get upgrades to business class or first class than just saving up frequent flyer miles. When you are booking travel online, look for Y-Ups and Q-Ups – also known as Z-fares in Europe and Asia. Y-Ups, Q-ups and Z-fares are special codes on first-class airfare that mean that seat can be assigned to someone who wants to upgrade from economy. To find these fares, go to your airline’s website and search the first-class seats on the flight you want to take. If any of those seats are tagged to a code that looks like Q***UP, write down the code.

Next, search for an upgradeable coach seat and write down the code for that seat, too. Finally, call the airline’s reservations system. They usually will waive the telephone service fee for frequent fliers, if you ask. Use both codes to request that your coach seat be upgraded to the first-class seat, for the price of coach.

Another trick: Join an international frequent-flier program, like British Midland’s Diamond Club.
BMI is part of the Star Alliance, a group of 25 airlines that work together, including United, Lufthansa, Air Canada and Air New Zealand. Your miles and upgrades can be used with any Star Alliance airline. But the extra benefit is that most foreign carriers allow frequent fliers to use their private airport lounge, while most U.S. carriers charge an annual fee. As a BMI frequent flyer, you will get complimentary lounge access to U.S. facilities, like United’s Red Carpet Club.

Your Organized Wisdom Editor,

Michael Murphy, CFA
Founding Editor, New World Investor

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