Dear New World Investor:

For a few years, I’ve been saying that April 19, 2009, would be a significant day in the stock market, based on the work of Martin Armstrong at the Princeton Economics Institute. He analyzed the history of stock market prices based on a number that seems to permeate the natural world: 3.1416, or pi. The result was a remarkably accurate series of major peaks and troughs that were 3,141.6 days apart, with interim peaks and troughs also based on derivatives of pi.

The major peak of 2007.15 was February 24, one trading day before the Shanghai Composite fell 8.8% in a day. Although the major indices set a higher high a few months later, that was the day the world’s attitude towards financial risk began to change, marking the end of the credit- and leverage-fueled boom. The 2008.225 interim trough was March 22, 2008, a few days after Bear Stearns was sold to JPMorgan. While that was a long way from the trough in stock prices, it did mark the introduction of the solution to the problems that the February 24 top revealed: Weaker competitors have to disappear into stronger competitors, one way or another.

So I was watching the April 19/April 20 action with great interest this week. April 19 was a big down day based on doubts about the real profitability of the banks, which are reporting operating earnings more than offset by continued large asset writedowns. April 20 got back much, but not all, of the decline. The message to me is that we are still in the eye of the storm, with investors willing to wait out the known bad news as it works through the system, but still cautious about believing there is any lasting solution to our economic problems in place. The failure of Treasury Secretary Geithner to make his case, as he continues to look like Hank Paulson Lite, is not helping. In Tuesday’s Congressional testimony, he admitted that he has no actual financial markets experience at all. He looks like he has no idea what he’s doing, which leads everyone to assume is just following orders from Bernanke, Summers, Rubin and the current, past and future partners of Goldman Sachs.

The S&P 500 seems to agree with the “eye of the storm” metaphor. The 850 level continues to exercise its considerable attractor/repeller power, as shown by today’s late-day rally, with much of the recent consolidation centered around 845. Consolidations that stay near previous highs are bullish. The daily and shorter-term charts are pretty much loaded up for another big move, and I still think 1060 is the target. Depending on how the news breaks, that could be all we get for this counter-trend rally, or the eye of the storm might last long enough to get all the way to 1250. We shall see.

Biotech MegaShift

I’m beginning to feel like this is turning into a prostate cancer newsletter, but the good news at Dendreon (DNDN) just keeps coming, and next Tuesday’s American Urological Association meeting should be a lulu. On Monday morning, Dendreon announced results for its Phase III PROTECT study of Provenge in men with androgen-dependent prostate cancer. The recent IMPACT study was in men with androgen-independent prostate cancer, which in English means they were not responding to hormone therapy. In this larger target market of those who do respond to hormone therapy, Provenge was found to produce a long-term “memory” response against prostate cancer cells that can be maintained with booster treatments.

Subscriber Robert S. asked a series of questions about Dendreon that may be on your mind, too.

1. Why isn’t the approving agency (FDA) doing the analyses and conclusions, or some accredited testing agency. Isn’t Dendreon’s analysis bound to be self-serving?

This is how all drug applications are processed by the FDA. The company is required to do all the work to explain what the drug is, how it works, describe the testing procedure, present the raw data, and do all the analysis that shows the drug should be approved. Then the FDA reviewers and statisticians go through everything with the proverbial fine-tooth comb, asking the company hundreds of questions to clarify points. The FDA will use outside consultants if they need to.

2. I get the drift that the BLA application no longer suits Dendreon; they now want to do a Type 2 resubmission. What is a Type 2 resubmission? Would you care to speculate what Dendreon’s Type 2 resubmission would consist of?

Type 2 resubmissions are a BLA, and are commonly done after receiving an FDA approvable letter, as Dendreon did in 2007. An approvable letter basically says: “If you do X and Y, and can show Z, we will approve the drug.” Dendreon will resubmit all the data it has previously submitted, updated for any newer post-trial monitoring information, plus the analysis from the IMPACT trial. It will be a big submission, but the FDA will focus on the IMPACT trial. We already know that the longer post-trial monitoring goes on, the better the Provenge survival data look.

3. What are the implications of this projected April 15, 2010 FDA approval that will result from said Type 2 resubmission?

In the stock world, approval always means the stock either runs up in advance of the expected date or jumps immediately afterwards.

In the real world, Dendreon will have to work out labeling issues (six weeks or so) and get on the reimbursement list for Medicare and private payers (two to four months to get them all). As soon as the label is agreed to, they can start selling Provenge.

4. Will FDA require full testing of each future Dendreon product-and-clinical patient match-up? For example, will it take another 4-5 years (each) to prove that Dendreon products are suited against lung or breast cancer?

Dendreon does not have to repeat the Phase I tests to do a label expansion study for each type of cancer. It would be smartest to do a Phase II dosing trial with a couple of dosage levels to be sure breast or other cancers react like prostate cancer. That could take a year. Then they can go right into a Phase III trial that takes two years. Add a year to that for analysis, submission and approval, and you are looking at four to five years for a label expansion approval. Of course, they can run simultaneous trials for several types of cancer.

But…

Once a drug is approved, doctors can prescribe it for whatever they want to. Oncologists are very aggressive in trying new therapies, especially for terminal patients. So I expect to see off-label usage and doctor-sponsored clinical trials, with results reported in the literature in as little as a couple of years.

5. We are all hungry for detailed plans in scaling up from 1,000 subject to 20,000 and up subjects; selection of reliable partners, process contractors, etc. More and more it looks like DNDN will have to do a GENE or an AMGN. I don’t see how they are up to the challenge, though I’m not saying they can’t do it.. I hope they are able to transition.

The FDA has completed their examination of Dendreon’s manufacturing. The scale-up numbers that I used in yesterday’s post on the Provenge revenue model showed the following number of patients:
Year Number of Patients
2010                  2,604
2011                  5,289
2012                10,738
2013                21,794
2014                27,641
2015                33,646

Remember that each patient only requires one round of processing to produce three doses of Provenge, which are given two weeks apart. While it is true that Dendreon has to double its production capacity each year, the overall numbers are not huge. At any point, they can qualify a contract drug producer as a primary or second source. It is possible their forthcoming European and Japanese marketing partners will also produce the drug; if not, that would add to Dendreon’s capacity requirement. This is certainly an area to keep an eye on, but it really won’t be an issue for at least 18 months.

Subscriber Phil B. in Texas tipped me off to a press story on a British treatment that kills tumors with heat, and the reporter rather enthusiastically suggested it could provide a cure for prostate cancer within three years. According to the story, “Prostate glands will be blasted with millions of charged magnetic nanoparticles which illuminate tumors and then heat them until they are dead…Radio waves are then used to heat the particles to 42 degrees (Celsius, or 108 degrees Fahrenheit) which kills the tumor by hyperthermia before it can spread.”

Well, maybe. To continue the hype: “Survival rates for advanced prostate cancer are one in three but researchers believe that rate could be improved to 99 in 100 men using the new treatment.” As I replied to Phil, this is interesting, but all methods of attacking the tumor – surgery, chemotherapy, focused radiation, radioactive seeds, photosensitive therapy or this one – don’t deal with the underlying problems of an immune system too weak to kill cancer tumors and prostate cancer cells still circulating in the body. One of the biggest lies in medicine is: “We got it all.” They never get it all, because there are cancer cells circulating in everyone’s body all the time.

Having said that, if this works it is many years away from approval. In the 1980s there were similar efforts with fluorescent particles that accumulated in the tumor and then ultraviolet light to blast them. I actually did the procedure for a skin cancer and got a world-class sunburn all over my face. Fortunately, it was Halloween, and as I flew back to the Coast from Reno, my fellow passengers just assumed I was going to a masquerade party.

Even if it works perfectly, it might be used as combination therapy with Provenge to lower the risk of recurrent cancer – and that’s what almost always kills the patient. By the time it is approved, Provenge will be a $4 billion drug worldwide. I don’t want to raise my buy limit again until after the April 28 meeting, so DNDN remains a buy under $16 for my $40 target. Technically, it should not be a Top Buy because it is well over the buy limit, but I don’t want to take it off until after the meeting, in case I need to raise the buy limit. Recognizing that the call premiums are very high, you could put a small amount of trading money into the $20 call (UKO ED) around $3.60 for a possible double if the stock goes to $28.

But it might be smarter to wait for the news and then write, or sell, calls to bring in premium and reduce your cost basis. If DNDN goes to $28 to $30 a share, as I expect, you should be able to write the $30 call for around $3. If DNDN continues up and your stock gets called away, you can then write a naked put just below the then-market for around $3 and get back into the stock that way.

You can also just hold the stock for the next eight years for my $360 target, as outlined in yesterday’s Special Alert.

But for those who want to trade, rather than deal with puts and calls on DNDN, there should be a great opportunity coming up to swap DNDN for Electro-Optical Sciences (MELA) before they file for Pre-Market Approval for MelaFind with the FDA. I expect quick approval, and the filing and/or approval should at least double that stock, maybe triple it. Then we will swap it for Arena Pharmaceuticals (ARNA) in time for the September BLOSSOM Phase III results on their obesity drug, lorcaserin. That should at least triple that stock, maybe quadruple it. After that, back into DNDN for the Type 2 BLA resubmission at the end of the year. Are we having fun yet?

Amgen (AMGN) reported after the close today, booking $3.31 billion in sales and $1.08 per share. They missed the consensus expectation for $3.6 billion and $1.15, but guided the full year earnings in line. Guidance is $4.55 to $4.75 for the year, compared to the consensus for $4.62. However, they lowered revenue guidance $400 million for the year to $14.4 billion to $14.8 billion, compared to the consensus for $14.9 billion. The stock is down $1.07 in the aftermarket after rising $1.71 in the regular session.

In the press release, management said: “Our first quarter sales were affected by the continued deterioration of the global economy which has led to changes in patient and physician behavior.” If the economy is affecting non-cosmetic, reimbursed treatments, that really is news. I’ll be following up on this, and if there’s anything startling on the conference call, I’ll send you a Flash Alert tomorrow.

The big question is: Why is a dominant biotech company that will show 9% earnings growth next year selling for only 10X this year’s estimate? The Amgen $40 2010 LEAP call (WAM AH) remains a hold for my $35 target.

Content on Demand MegaShift

EMC (EMC) reported this morning, and they own 85% of VMware (VMW), which reported and disappointed yesterday after the close yesterday. Reviewing EMC first, they missed on revenues but hit the consensus earnings forecast of 16 cents. Revenues fell 9,2% from last year to $3.15 billion, $100 million under the $3.25 billion consensus. The CEO said the IT spending decline has bottomed; he expects a flattish June quarter and then a better second half. They continue to cut costs, with most of the benefit expected in the second half of the year. With rising revenues and falling costs, we should see a strong earnings trend in the second half to drive our LEAP options higher.

VMware is a bit more complex. They reported $470 million and 25 cents share pro forma. Sales grew only 7% from last year’s $438 million and fell 9% from the December quarter. That’s the first sequential revenue decline since VMW went public, and the stock fell $6.65 or 20.4% today.

Yet it shouldn’t be happening. My thesis has been that in tough economic times, companies would turn to virtualization to cut costs. In addition, VMW is a key partner for Cisco in that company’s new Unified Computing Initiative, also a major cost-cutting program. But the complexity is that VMware just released a major upgrade of its core virtualization software this week, and it could be that customers were just waiting for it. That wouldn’t be the first time that’s happened, and the new vSphere 4 launch could drive a fast snap-back in the current quarter.

I think with the potential for vSphere 4 and a decent earnings improvement at parent EMC in the second half, we should continue to hold the EMC January 2010 $15 LEAP call (WUE AC) for my $11 target price.

Infinera (INFN) said they booked $66.6 million in sales in the March quarter, but had an 18 cent per share pro forma loss. The consensus wanted to see $67.3 million and an 18 cent loss, so the company hit the low expectations that management set in the January earnings call. Management pointed out in yesterday’s press release that their revenues were cut in half from last year, mostly because they have installed a lot of equipment that has not been accepted yet, and therefore can’t be recognized as sales. That puts gross profit margins under pressure, which came in at 31%, down from 36% in the December quarter and down from 43% last year. They expect a further decline to 25% to 30% in the current quarter, and then sequential growth in both revenues and profit margins for the rest of the year.

They said they expect another weak quarter in June, with about $70 million in sales compared to the consensus for $77 million, and a 19 cent to 23 cent loss per share, compared to expectations for 14 cents. They did win contracts with two more Tier-1 European telecom companies that will help growth even as the recession impacts U.S. deployments. On the conference call they pointed out they now have three of the top five Tier 1 telecoms in the world, and every one was won against established suppliers.

The stock was knocked almost $1.50 yesterday to under $8 due to their soft results and guidance, but it got part of that back today. The truth is the Internet is only going to get bigger and faster, and Infinera supplies the key optical components to make that happen. With $233 million of cash and no debt, I don’t expect it trade any lower. INFN remains a buy while it is under $10 for my $30 target price.

SanDisk (SNDK) reported after the close yesterday. My thesis here is that accelerating sales of netbook computers using flash memory “disks” instead of hard disk drives would firm up flash prices and give SanDisk significant earnings leverage. Wall Street was looking for $537.7 million in sales and a loss of 77 cents a share, and the company came through with $659.0 million and a 48 cent loss. The stock jumped $1.83 yesterday, but that’s just the beginning. In the press release, management said: “Industry fundamentals improved in the first quarter. We are encouraged that industry supply and demand balance is becoming better aligned, resulting in higher flash pricing. Our financial results improved substantially from the prior quarter driven by better than expected demand…”

Wall Street was not ready for the news I’ve been forecasting: Flash memory prices will strengthen as demand for solid-state disks runs into reduced capacity throughout the flash supplier industry. Stock prices in the semiconductor memory sector depend much more on the balance of supply and demand than anything else. With EMC now pushing flash-based storage into the data center for enterprise servers, and netbooks taking market share in a big way, increasing flash prices will make SanDisk’s bottom line soar.

Wall Street is estimating $2.55 billion in sales for 2009 with a loss of $1.80 a share. For 2010 they have been looking for very modest revenue growth to $2.83 billion and a loss of 28 cents a share. They are way low. Revenues are likely to top $3 billion this year, and the December quarter could be breakeven or slightly profitable. In 2010, revenues should hit $3.75 billion with earnings over 50 cents a share, including three or all four profitable quarters. We’ve just come through a period for SNDK where Wall Street worried they would spiral down into bankruptcy and pushed the stock under $10. Now, in the mid-teens, that worry has passed. But this week’s report was the first solid clue that the company is headed back to profitability, which means a near-double from here. The stock is just above my buy limit, so I am raising the buy limit $1 to $16 to be sure you can get on board, with an unchanged $30 target price.

Silicon Image (SIMG) also reported after the close today – busy day! Expectations were modest, as the consensus projected $41.4 million in sales, down 38.4% from last year, and a seven cent per share loss. SIMG did $40.5 million in sales but only a five cent per share pro forma loss. In the press release, they issued downside revenue guidance for the June quarter, forecasting $40 million to $42 million compared to the consensus for $43.8 million. They expect gross profit margins to stay in the range of 54% to 55%, after reporting 54.5% this quarter. I don’t expect any fireworks on the conference call, but will send a Flash Alert if anything changes. My advice is unchanged: Hold SIMG for a $4 target price, up just one more dollar from today’s close.

New Economy MegaShift

Omniture (OMTR) reported this morning and beat their revenue guidance, missed on the bottom line by two cents, guided June quarter revenues in line, but guided June quarter earnings below the consensus. The stock took a $2.24 hit today and traded as low as three cents under my $11 buy limit. I am very tempted to make it a Top Buy after it settles down.

The company reported sales of $87.8 million, up 38.9% from last year and at the high end of their revenue guidance. How many other companies do you know that are growing that fast? The consensus was looking for $86.9 million. But earnings came in at 10 cents a share, under the 12 cent consensus. Management said accounts receivable reserves had to be increased as some customers became financially stressed, and they had foreign exchange losses related to their non-U.S. Business. They booked 200 new customers in the quarter, about the same as the December quarter but down from 250 in last year’s March period.

For the June quarter they guided for $88 million to $89 million in sales, compared to the consensus forecast for $89.2 million, and 11 cents to 12 cents a share as the accounts receivable and foreign exchange issues continue. Wall Street was looking for 13 cents. During the quarter, they are reducing costs by rationalizing their internal operations, but we won’t see the benefit of that until the second half.

For the quarter, they processed over one trillion clicks for their customers. I find that number amazing. There is nothing wrong with OMTR, so I am raising the buy limit to $12 while maintaining my $22 target. I will raise the company to a Top Buy on any significant weakness from here.

New Energy Technology MegaShift

Cree (CREE) reported after the close yesterday, beating estimates. The company did $131.1 million in sales and 13 cents a share pro forma, where the consensus was for $130.6 million and 12 cents. They guided the June fiscal fourth quarter to $137 million to $143 million in sales and 13 cents to 15 cents pro forma. The consensus was at $136.4 million and 13 cents.

At the beginning of this year when CREE was around $16, I said the then-consensus estimate of 41 cents for the June 2009 fiscal year was much too low, and 60 cents would be closer. Since then, the consensus has moved up to 60 cents, and with the company’s June quarter guidance will have to move up to 62 cents or 63 cents.

For fiscal year 2010, the current consensus is at $613.9 million in sales and 68 cents a share, which again is much too low. The used of LEDs for backlighting of LCD monitors and laptop backlighting is now growing rapidly, but the company says they have not seen the expected acceleration in backlighting for LCD TVs yet. That will come in 2010, or a bit sooner.

Lighting accounted for more than 50% of revenues for the first time, yet LED lighting is much less than 1% of the total lighting market. I expect many years of high growth in this sector, where CREE is a leader. I think the company can do $700+ million in the June 2010 fiscal year, and report over 80 cents a share. CREE remains a buy on dips under $22 for my $50 target. In spite of the good news, I am not going to raise the target price because the P/E ratio is still quite high.

Robotics MegaShift

iRobot (IRBT) was our last reporter, announcing after the close yesterday, but not the least. The stock was up $1.55 or 19.3% today. With their consumer exposure, analysts were cautiously looking for a 17 cent per share loss. The company did $56.9 million and lost only seven cents. They guided for $290 million to $310 million for the year, with a profit of four cents a share. That was essentially right on the consensus for $294.3 million and three cents.

The military business may have to carry earnings in 2009 and maybe 2010, depending on how badly the consumer is hurting towards the end of the year. For small luxuries like robotic vacuum cleaners, the hurt seems to run pretty deeply right now, and it may not get much better. But there is some excellent news hidden under the surface numbers: iRobot generated $13.6 million in free cash flow during the quarter. While that was seasonally lower than the $18.2 million they generated in the December quarter, these two quarters taken together tell me something big has changed at IRBT. They used to have very sloppy balance sheet management, building excess inventories and letting accounts receivable go uncollected.

They’ve been promising to improve their working capital management, and they did. They brought inventories down 34% compared to last year, in spite of the crummy holiday season. If they can keep this up, they could generate over $40 million in free cash flow this year. I don’t think they’ve ever been over $10 million before. IRBT remains a hold for my $20 target.

Your checking out the cute chicks at San Jose City Hall Editor,

Michael Murphy, CFA
Founding Editor, New World Investor

TOP BUYS

Biotech MegaShift

DNDN — Dendreon — Timely Buy – More Provenge Phase III results coming on April 28

MELA — Electro-Optical Sciences — Timely Buy — Melanoma detector works! Now on to FDA approval this summer

ROCM — Rochester Medical — Timely Buy — New Medicare regulations are accelerating use of ROCM catheters; earnings conference call after the close on April 30

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

Content on Demand MegaShift

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

HLIT — Harmonic — Value Buy — Leading video processing equipment company

QUIK — QuickLogic — Timely & Value Buy — Superior programmable logic chips plus new backlight technology contract wins

SNDK — SanDisk — Timely Buy — Leading flash memory producer; flash prices going up due to netbook demand

New Energy Technology MegaShift

HTM — US Geothermal — Value Buy — Geothermal electricity producer with actual revenues

WiMax MegaShift

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

TWER — Towerstream — Timely & Value Buy — Leading supplier of wireless business telecom services approaching cash flow breakeven

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