Dear New World Investor:

The market rally is on track and beginning to show signs it will head for my mid-range targets, 1060 on the S&P 500 and 10,000 on the Dow Jones Industrial Average. This in spite of the fact that the President of the United States just fired the CEO of a company in the Dow Jones Industrial Average. Forget Kansas, Toto, I’m beginning to think we’re not in America any more. Or even on Planet Earth.

I have no problem with GM’s CEO being fired. Since Rick Wagoner became CEO, GM lost $90 billion and the stock went from $70 to $2. That’s world-class terrible performance. GM lost $30 million a day during his tenure, killed and literally crushed the EV-1, and continued to sign deals with the union that would eventually kill the company and many of the employees’ jobs. My two problems are:, first, shouldn’t the Board of Directors have fired him, instead of President Obama? And second. by elevating the Chief Operating Officer who was Wagoner’s right hand man during this disastrous reign to the CEO slot, what has Obama accomplished? One can only hope that Fritz Henderson, the new CEO, has paid all his taxes, unlike so many other Obama appointments.

But the market likes it. A consolidation period between 820 and 850 would have been an even stronger pattern, but the recent 770 to 820 range consolidation is a close #2. The bears were not able to build on Monday’s retest down to 780, based on the “bad” news that GM and Chrysler are probably headed for formal bankruptcy proceedings instead of the nibble-to-death version resulting from endless government bailouts. Instead, the strong slingshot rally off 780 that continued today indicates there is lots of upside energy. I think this consolidation is about over and we will most likely see another run to 850, a brief test back down to 820, and then (finally!) the breakout to 910 and 1060.

There is a big market turn coming in mid-April, and I thought that was likely to be a peak, followed by a nasty decline. I expected a similar peak in February 2007, yet the market did not peak until July, with a marginally higher peak in October. But on the exact day of the expected February peak, the Chinese market crashed nearly 10%. Looking back, that was when the tenor of the market changed, and risk because something to worry about and avoid, rather than welcome and pursue for higher returns.

It is getting more and more possible that this April’s “peak” could be similar – a change in tone rather than a nominal peak in prices. The change would be from worries about deflation to worries about inflation, with money flowing out of bonds and fixed income instruments that are now around record highs, into stocks, gold, commodities and real estate, most of which have been killed. April also could mark a top for the dollar in its bear-market rally, as fears of inflation and hyperinflation stoke a rush out of the dollar into other currencies. All of these changes are going to happen, the question is whether they happen in April or we get an actual peak in stock prices and another decline before the inflation/hyperinflation thesis kicks in. Either way, April looks like a great month for stocks and I still expect to recommend a number of swaps to focus our portfolios on a smaller number of the best companies to get through 2009 and 2010 with big profits, no matter what happens.

Biotech MegaShift

Arena Pharmaceuticals (ARNA) is my newest recommendation, sent via the Flash Alert on Monday that analyzed their Phase III lorcaserin obesity drug results. If you didn’t read it, lorcaserin hit all its clinical trial endpoints and had no meaningful increased impact on heart valves. It is effective and safe. It was a 95% victory. It wasn’t a 100% victory because there is a draft FDA standard that there should be a five percentage point difference in the percentage of weight lost by the drug and placebo groups. For those who took the drug for 52 weeks, there was a 4.8 percentage point difference. For the entire study group, there was a 3.6 percentage point difference, and that is what clobbered the stock on Monday.

Even the bears on the stock agree that if the BLOSSOM second Phase III results match these results, which I expect, lorcaserin will be approved by the FDA. It will be approved because the FDA has two specific requirements to approve weight-loss drugs based on a one-year trial, and an approvable drug has to meet only one of these standards:

1. At least 35% of the patients on the drug must lose 5% or more of their total body weight, and the percentage has to be at least double the percentage that lose 5% on the placebo. Lorcaserin met this requirement, as 47.5% of the drug cohort lost 5% or more of their body weight, while only 20.3% of the placebo group hit that mark.

2. The difference in average weight loss in percentage terms in at least five percentage points. On average, patients on the drug lost 12.7 pounds or 5.8% of body weight, compared to 4.7 pounds or 2.2% for patients on the placebo. The 3.6 percentage point difference is below the FDA’s 5 percentage point threshold, but because lorcaserin only had to meet one of these two requirements, it worked under the FDA’s definition.

I did not see this “either/or” distinction in any of the media commentary on the results or the drop in ARNA stock. So now the bears have the flimsy position that maybe doctors won’t prescribe it after it is approved, or maybe no one will partner with Arena before they run out of cash. In the Flash Alert I used the family-friendly word “baloney” to describe this argument. Doctors are interested in a diet drug that is safe, that patients will actually stay on (lorcaserin has a very good side effect profile) and is effective – they will lose a medically meaningful amount of weight. Patients on lorcaserin lost more than twice as much weight as placebo patients on average, which is to say they packed two years of weight loss into one.

My recommendation in the Flash Alert was to buy ARNA up to $5 for a $20 target after either a financing deal, or the BLOSSOM Phase III trial results in September, or an FDA filing by the end of the year.

If you bought the Arena April $7.50 call that I recommended in the earlier March 17 Flash Alert for around 55 cents to 60 cents, that contract is now trading for 5 cents. If you hold enough contracts to get a meaningful amount of money after commissions, sell it. Otherwise, hold it until expiration, just in case the company announces they are in negotiations for a partnership agreement.

And you can get most or all of your money back by selling to open the Arena July $2.50 put (UGG SZ) for 45 cents or better. This obligates you to buy ARNA at $2.50 if it trades below that price on the July 17 expiration. That seems very unlikely, because investors will be anticipating the results of the second Phase III trial due in September. In the unlikely scenario that you had to buy the stock in July, $2.50 would be a heck of a price. And if you never bought the call option, you really would be paying $2.50 minus whatever you get for the put, say 45 cents, or $2.05 per ARNA share. Such a deal!

Selling a “naked” put like this means the brokerage firm will require you to put up 20% to 30% of your exposure in cash, which translates to 50 cents to 75 cents per ARNA share. So for every 100-share put contract you sell at 45 cents, you’ll get $45 right away, put up $50 to $75 as collateral, and you will be obligated to buy 100 shares of ARNA for $250 on July 17 if it falls below $2.50 a share.

It isn’t a bad idea to buy half a position in ARNA stock under $5, and write puts on an equal number of shares so you could possibly get the second half of your position at $2.50 less the put premium you get paid up front. I don’t really think ARNA will trade that low, so you probably will have to buy the second half of your position in the open market after July 17.

Content on Demand MegaShift

Telkonet (TKO) delayed their earnings report a couple of days to give them time to finish the 10-K filing for the SEC, and held their conference call yesterday after the close. The quarter was impacted by the economic environment as a couple of contracts slipped into the first quarter, and are now being installed. It was even more impacted by a series of non-cash writedowns and writeoffs that I discuss below.

But first, and most important, management said “We have received and acknowledged the correspondences from many of you indicating your concerns.” So, right on, NWI subscribers – you flooded them with letters, and that will be crucial to what happens.

Management also said (with my emphasis added): “In accordance with the original debenture agreement and reiterated in February 20 8-K, the Company is obligated to request the shareholders to remove a 19.9% equity cap in the share limitations. However, we are continuing to have discussions with our debenture holder to negotiate a more favorable outcome for the Company and shareholders.”

So in these negotiations, Jason Tienor needs to be able to say: “Look, the shareholders are in an uproar and they are never going to approve this if it goes to a vote. Look at this stack of letters! Now, let’s talk about what can be done.”

So your letters are making a difference and giving management ammunition – keep ‘em coming! If you haven’t written them yet, please write Jason Tienor, CEO, Telkonet, Inc., 20374 Seneca Meadows Parkway, Germantown, MD 20876, or fax your letter to 240.912.1839 . Tell him you will vote against lifting the cap on the convertible debenture conversion. Even if you have written them, write again and thank them for negotiating a more favorable outcome for the shareholders. Remind them that you will vote against lifting the cap.

A “more favorable outcome” could include fresh money into the company, which they need to accelerate their growth. As discussed below, they are doing a good job of cutting costs and getting revenues while running on fumes, but they can get to cash flow positive faster if they can find an attractive financing opportunity.

So, the numbers. Remember that TKO still owns something under 50% of MST, which they would dearly love to get rid of. I am going to give you most of the numbers without MST, because that represents what is under their control. For example, TKO reported revenues of $4.2 million for the December quarter, down 9% from last year and down 35% from the $5.7 million they reported in the September quarter. But excluding MST, they reported $3.2 million for the quarter, down 18% from last year and down 33% from the September quarter. That is a more meaningful measure of how their business is going.

They attributed the sharp drop from the September quarter to a temporary hold-up of infrastructure spending, especially by the hospitality industry. That continued into January, but now is easing up. Management specifically mentioned one customer who implemented over 1,000 rooms in the third quarter and then made the decision to temporarily postpone over 5,000 rooms of energy management. Another installation that was anticipated for the December quarter is now in process, amounting to over 3,000 rooms. Both orders and installations are picking up now.

TKO also has built on its hospitality reputation to expand into the education, healthcare and government markets. They’ll emphasize the utility market this year once the Federal stimulus spending is in place, because the Smart Grid initiative is perfect for their technology. It’s hard to find investable companies in this huge effort to rebuild the electrical grid in a way that reduces power loss and increases flexibility to cope with electric cars and plug-in hybrids. TKO’s ability to pass high-speed communications over existing power lines can be applied all along the electricity distribution process, where every transformer and utility pole is going to have a sensor that can be read from the central station. Of course, the ability to read not only up to a building but then inside it – where TKO dominates the market – will be invaluable for power planning. Imagine the utility being able to tell how many rooms at the Sheraton are occupied, even down to whether there are people in the room who need electricity or the occupants are at a seminar, and there won’t be much demand from that room for a while. That’s the Smart Grid, and TKO intends to be an important participant in making it happen.

During this period of revenue weakness, the company has done an excellent jog of maintaining their gross profit margins and reducing their SG&A (selling, general and administrative expenses). There was some criticism on the conference call because management had said they expected to be cash flow positive in the December quarter, and they were not. But the Chief Financial Officer pointed out that they had their cost structure in place to be cash flow positive if revenues had not declined from the September period. I do not fault them for this miss – they couldn’t do anything about the systemic economic problems that raised such fears in the last three months of the year. They did say again that they will turn cash flow positive this year, and even that they might be cash flow positive for the entire year.

In any case, excluding MST they had gross margins of 46% in the December quarter, down a tad from 47% in the September period, but way better than the 19% they reported last year. They said the gross profit margin will stay above 40% in 2009, because their products already are competitively priced and their production costs are pretty much locked in. SG&A was $2 million for the quarter, down 44% from last year, which is excellent given that revenues fell 18% due to shipment slippage. They have gone through the income statement with a scalpel, consolidated facilities, and done everything they can find to cut costs. If they could get away from having to finance their inventory and receivables, costs would come down even more.

Now for the writeoffs – it’s a laundry list. They wrote down the goodwill associated with the EthoStream acquisition by $2 million. They also took a $4.1 million impairment of their investment in 1-800-905-GEEKs. MST recorded an asset writedown of $1.5 million and is in default of its convertible debenture, so $3.3 million in related interest and financing costs were written off, as well as a $2.1 million debenture default penalty. All of these are non-cash, but in total TKO reported a net loss of $11.7 million or 14 cents a share including MST, or $7.3 million excluding MST. This was a “kitchen sink” quarter in which they wrote off everything but the kitchen sink. Managements do that to clear the decks for what they think will be a growth phase going forward.

Telkonet is in better fundamental shape and worse financial shape today than when we first bought the stock. The Smart Grid initiative puts their Broadband over PowerLine technology into a new, big leagues market, and even the rural broadband initiative will play into their strengths in quickly providing broadband inside existing, sometimes old buildings – industrial, apartments, hotels and offices. Their basic Smart Energy products also fit the government’s programs to reduce energy consumption through tax credits and grants. The original Broadband over PowerLine business still has the EDS relationship, now strengthened by Hewlett-Packard’s acquisition of EDS.

The only flies in the ointment are their need for working capital, and the possible shareholder vote on lifting the equity cap on the convertible debenture. Until we know for sure that the convertible situation is resolved, I can’t recommend buying more stock. But neither should we think about selling – there are just too many positives, and this is a good, problem-solving management. Hold TKO until the convertible debenture issue is resolved.

New Energy Technology MegaShift

Cree (CREE) has been strong due to a rumor that Intel might buy them for $40 a share. Intel does not have much expertise in making semiconductors on silicon carbide substrates, nor in using gallium nitride on the substrate. Cree has more knowhow and patents than any other company in this field, and with LED lighting taking off, Intel is bound to be interested. I think the chances of an acquisition bid are less than 10%, but that’s higher odds than most of these rumors. CREE is above my $22 buy limit, but grab it on any market-related dip back below that level for my $50 target.

Ocean Power Technologies (OPTT) received an additional $1.1 million in funding from the U.S. Navy to support testing and continuing upgrades of its PowerBuoy system about 100 feet beneath the ocean a mile off the Marine Corps Base Hawaii at Kaneohe, Oahu. The project is for the installation, testing and grid connection of multiple buoys near the Marine base, and will give Ocean Power invaluable hands-on experience plus a great reference site. OPTT is a buy up to $10 for a $40 target price.

Suntech Power Holdings (STP) was up 44% last Thursday because the Chinese government announced a new stimulus initiative: They will subsidize 50% of the cost of installing a solar system. Unlike the Obama-Bernanke-Geithner stimulus program, the Chinese are serious about building infrastructure and getting independent of Middle East oil. While we bail out Citigroup, they build five new high-speed railroad lines across the country and announce 50% solar subsidies. Their subsidy targets both photovoltaic-integrated building projects in urban and rural areas, with priority given to public-use buildings like government offices, hospitals and schools.

Of course, Suntech is a leading solar manufacturer in China and will benefit tremendously from this new source of demand, the biggest solar subsidy program in the world. The stock kept moving up as shortsellers covered the 10% of the float sold short as of March 10, and real buyers appeared to take advantage of this fundamental change in the company’s outlook. Falling polysilicon prices and overcapacity issues may have become yesterday’s worry, overnight. The sold-out “I missed it” bulls are waiting for a retracement to get into the stock, which probably means they will not be given a graceful entry. Buy STP while it is under $16 for my $40 target as the Chinese and U.S. solar subsidy programs kick in.

Canadian Solar (CSIQ) jumped 28% last Thursday and also continues to rise. 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) was up 13% last Thursday, but down a bit since then. Buy ENER up to $32 for my $65 target.

Security MegaShift

American Science & Engineering (ASEI) received a $6.3 million follow-on order for multiple Z Portal systems to secure critical infrastructure in the Middle East. ASEI is just under my $59 buy limit for a $93 target; get it while you can.

WiMax MegaShift

Airspan (AIRN) filed their 10-K and said they have decided to voluntarily delist from Nasdaq and trade on the pink sheets. AIRN remains a Hold to see if they can survive their deep financial problems. I suspended the target price.

Alvarion (ALVR) said their BreezeMAX platform for the 3.65 GHz frequency band received USDA Rural Development acceptance from the U.S. Department of Agriculture Rural Utilities Service. Alvarion was the first vendor to receive this approval for the 2.3 GHz and 2.5 GHz frequency bands in July 2008. Rural Utilities Service (RUS) acceptance is required for operators requesting funds from the Rural Broadband Access Loan program to purchase and deploy broadband systems. This is not a start-up stimulus program – from 2001 through 2007, RUS has provided almost $6.5 billion in telecom grants, loans and loan guarantees for rural development. More grants will be available now through the stimulus program.

The company also said that Main Street Broadband, a strategic partner of Xiocom Wireless, has chosen BreezeMAX for deployment of WiMAX networks in its initial RUS-funded rural market. This is one of the largest RUS funded projects in the U.S., and Alvarion can now deploy its BreezeMAX 2300, 2500 and 3650 base stations in a formal RUS funded project. ALVR remains a Top Buy up to $11 for my $17 target.

* * * * *

I’m going to keep the one-time Subscriber Appreciation Offer open for a while, but then it goes away. Check it out at http://NewWorldInvestor.com/special-offer. We can’t take credit cards directly, but if you have any problems with PayPal, we will be implementing a link to 2co after my IT person gets back from her honeymoon. Or you can send a check made out to the publisher, Next Paradigm Press, Inc., and mail it to me at PO Box 282, Boonville, CA 95415.

Over the next several issues we’ll be riding this rally for all it’s worth, and then doing a series of swaps to concentrate our portfolios in the very best high-growth stocks to take advantage of whatever comes next – a resumed deflationary swoon, or an inflation-to-hyperinflation boom. I don’t want you to miss it, as our real growth companies are solidly outperforming the old value and dividend stocks that have dominated for the last year and a half.

Your habaneros peppers-admiring, but not eating yet Editor,

Michael Murphy, CFA
Founding Editor, New World Investor

TOP BUYS

Biotech MegaShift

DNDN — Dendreon — Provenge Phase III results coming in April

MELA — Electro-Optical Sciences — Melanoma detector works! Now on to FDA approval.

ROCM — Rochester Medical — New Medicare regulations will accelerate use of ROCM catheters

VPHM — ViroPharma — Vancocin continues to grow; Cinryze about to take off

Content on Demand MegaShift

AKAM — Akamai Technologies — Leading Internet acceleration and content delivery company

HLIT — Harmonic — Leading video processing equipment company

QUIK — QuickLogic — Superior programmable logic chips plus new backlight technology

SNDK — SanDisk — Leading flash memory producer; flash prices have bottomed

New Energy Technology MegaShift

HTM — US Geothermal — Geothermal electricity producer with actual revenues

WiMax MegaShift

ALVR — Alvarion — Leading producer of WiMax equipment operating in 80 countries

TWER — Towerstream — Leading supplier of wireless business telecom services

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