Today, the Dow Jones Industrial Average closed less than five points below its January 14, 2000 record of 11,722.98. This marked the fourth straight day that the Dow closed up. As I said last week, there have been very few negative earnings preannouncements, although we won’t hear from the software companies until next week. Worries about the hurricane season are fading, and even housing seems stronger than expected. The 10-year bond market has rallied enough to bring mortgage rates down recently. And the 10-year yield is well below the short-term yield, signaling a recession ahead.
So all this is pretty standard. The lagging sectors and industries in the business cycle, like capital spending, are doing well. The coincident sectors that make up most of the GDP figures are slowing quickly. The leading sector, housing, is already starting to bottom as the rest of the economy slows down. I still expect a mild, two-quarter recession, possibly starting as soon as the December quarter, but more likely in the first half of next year.
We are also nearly through the typically weak September-into-October period, with only three or four weeks left, and little damage so far. If there is going to be a market decline or shakeout to anticipate the coming economic weakness, it should happen now. But if the market decides to look over the valley, we will start buying stocks again as earnings are announced for the September quarter.
Answers to Your Questions
In the closing weeks of any quarter, there usually isn’t a lot of news on our companies. So aside from a few significant developments, I decided to answer a bunch of your recent emails. As always, none of this is personalized investment advice for any one subscriber’s position, which would be O.K. under the U.S. Constitution but is not O.K. under a higher authority, the SEC.
Before we jump into updates and subscriber questions on specific MegaShifts and stocks, I want to address Tim’s question, as I have received a number of similar emails. Tim wrote: “I bought BCRX, CRXL, ERES, MOBL, PLAY, TKO, TRBM and ZHNE and the total drop in value is 33%. What is the reason for such a drop and what should I do with these stocks? Should I just ride this out and stay invested in these stocks? Do you think they will come back?”
Tim, the market drop in May, June and July was characterized by a sharp reduction in liquidity for riskier investments. Any stock in a developing country, any stock involved in hedge fund leverage and any small capitalization stock was hurt. That’s one reason the Dow is up 9.3% for the year at today’s close, while the NASDAQ Composite is only up 2.9%, the Amex Biotechnology Index is down 1.5% and the Philadelphia Semiconductor Index is down 4.0%. Even though all the companies you cite except PLAY made substantial forward progress in their businesses so far this year, their stocks are down.
But there is good news. The next, and probably final, up-leg of the recovery from the 2000 to 2002 bear market should be starting soon. I would not be surprised to see the Fed start cutting short-term interest rates early next year. I also expect the usual 50% or better broad market upturn from the fall low in the second year of a Presidential term to the end of the third year of the term. This upturn is likely to be led by technology, replacing energy as the main market driver. Technology is likely to be led by our MegaShift stocks, including some recommendations to come in the PC area once we know when Windows Vista will really ship.
So the answer to your last two questions is yes — ride it out, stay invested, buy more if you can, and I think they not only will come back, but go on to surpass my target prices.
Avian Flu MegaShift
A 20-year-old man died of bird flu in Indonesia, raising this year’s death toll to 70, a double from last year. His brother died four days earlier, but no specimens were collected before the brother was buried. This is a common problem in Indonesia, Thailand and other countries with remote villages, and almost certainly means that the real death count is quite a bit higher.
The annual Interscience Conference on Antimicrobial Agents and Chemotherapy (ICAAC, pronounced “ik-aak”) is on right now in San Francisco. On Saturday morning, BioCryst (BCRX) will present late-breaking data with positive results in preclinical testing of injectable peramivir in mice and ferrets infected with bird flu. (Ferrets are the standard animal model for flu.) It could make a big story in the Sunday papers. BCRX is a Top Buy up to $19 for my $30 target as peramivir wends its way through the shortened BioShield approval process.
Crucell (CRXL) took a nice jump after the World Health Organization recommended their five-in-one Quinvaxem vaccine for childhood diseases. The vaccine — which protects against five major childhood diseases: diphtheria, tetanus, whooping cough, hepatitis B and Haemophilus influenzae type b (the leading cause of meningitis) — is targeted at developing countries. And the WHO stamp of approval means worldwide government and nonprofit organizations will get on board the program. The company will book revenues this year, and management repeated their target for cash breakeven in 2007, thanks to this.
Although we bought CRXL for their cell line technology, as a faster way to produce vaccines, including one against bird flu, this vaccine is really good news for shareholders and should push the stock higher. But I personally have mixed feelings about it. I am leery of anything-in-one shots for children, as there is no reason to hit their undeveloped immune systems with such an overwhelming amount of antigens. It may be more convenient for the healthcare system and cheaper for the patients, or whomever pays, but it can cripple and kill children. It escapes me why people allow babies to be vaccinated in the hospital, when mother’s milk will protect almost all of them for months against infectious diseases. It also escapes me why people think the standard DPT three-in-one shot is a good idea, given the possibility of severe side effects or death.
But the market likes this five-in-one vaccine, and the change in sentiment should push the stock higher from here. Buy CRXL up to $28 for my $50 target, based on widespread adoption of their cell line vaccine production technology.
Biotech MegaShift
John asked an interesting question: “How do you see the $4 generic prescriptions playing out from that pilot program at Wal-Mart, and do you see a play in our portfolio?”
The big picture here is the effort to get control of the increase in healthcare costs, especially drug prices. One of the purposes of the new prescription drug program for Medicare recipients is to move the issue of price from consumers to healthcare payers, who presumably will bargain harder for deals and play one drug chain against another. So the losers are the pharmaceutical companies.
The direct winners are the generic companies, but that has turned into a low-margin, difficult business. We may get an opportunity there from time to time, but I am not interested in that sector today.
From a stock point of view, money committed to healthcare should flow out of pharmaceuticals and into an area with better-protected profit margins: Biotech. The discussion of reimbursement for a biotech product never focuses on the cost of production or the profit margins. It focuses on how much money the new biotech drug can save the healthcare system by reducing hospitalization times, curing a chronic disease that today has only treatments for the symptoms, and so on. So, our Biotech MegaShift as a whole will benefit, and I am always looking for new, interesting companies to add.
Biogen Idec (BIIB) drew a question from Ralph: “How much longer do you want us to hold the January 2007 call on Biogen Idec? Are you still expecting some news to break that will move the stock back up?”
Yes, I sure am. I think their guidance for Tysabri sales in the December quarter will be a very positive surprise for the Street, and it is easy to see BIIB at $60 to $70 a share based on excitement around increasing estimates for Tysabri sales. Buy the BIIB January 2008 $45 contract (YZUAI) up to $12 for a $23 target. And you can continue to buy the higher-risk, higher-reward January 2007 $45 LEAP call (IDKAI) up to $10 for my $21 target.
Mike asked a series of questions about Dendreon (DNDN): “I am really high on the potential of Dendreon. Could you further clarify your opinion on: 1) When the final decision from the FDA will come down? And projections for what the ramifications of their decision will be for the underlying stock. 2) What you see the stock doing until that time period? 3) Do you feel it will be approved? If so, when will Dendreon be able to capitalize on a positive decision via sales figures? I am thinking of loading up and I noticed the stock has pulled back a little and it maybe the time to back up the truck?”
Dendreon is on track to complete their BLA (Biologics Licensing Application) by the end of the year. The clock then starts on their fast track review, with the FDA obligated to respond in six months. Because the FDA let DNDN do a “rolling” application, the agency has already reviewed much of the data previously submitted. I expect the FDA to ask for an Advisory Committee meeting, which they could schedule for May.
In the meantime, Dendreon will be releasing data at various scientific conferences and presenting at brokerage firm conferences. So, I expect the stock to maintain its current level or move up slightly on the data announcements, and then take a significant jump when they announce that the BLA is complete and filed After that, more data announcements should let them hold the new price level until the Advisory Committee meeting. Approval from the Advisory Committee will jump the stock sharply, as will final FDA approval. I do think it will be approved, and as you know this is the major area of disagreement on the Street. Bearish analysts say that the company missed its primary endpoint of tumor progression. Bullish analysts, like me, say that they met their secondary endpoint of extending survival, which is the gold standard for approval of a cancer drug, and there is no reason to deny that benefit to men with prostate cancer, given the excellent safety profile of Provenge.
After approval, it would be typical for the stock to sell off as the company goes through the process of getting Medicare codes and reimbursement from healthcare payers. Then there is the excitement of the launch, with a lot of volatility in the stock price, followed by the steady year-by-year growth that I’m expecting.
Of course, there could be a partnership announcement any time, if only to put the Provenge process back into the clinic for other solid tumor cancers, like head and neck or breast cancer. As far as “loading up” on the stock, I have no problem with someone making it a major position at today’s prices. If we do see a big market drop in the next few weeks, DNDN will get hit, but it will be transitory because of all the good news coming. So buy DNDN up to $7 for my $14 target, which I expect after Provenge is approved.
China MegaShift
UTStarcom (UTSI) drew a brief but broad question from Mark: “Hi, what are your thoughts on UTSI, thanks.”
Well, my thoughts are that this is a very cheap stock due to their operational problems for the last six quarters. UTSI appears to have those problems behind them, and they are ahead of expectations on getting their costs back under control. Their basic PAS phone business is slowing but still a cash cow, and they are a serious contender in many of the new Content on Demand areas — Internet Protocol TV over copper and optical fiber, high-speed broadband access and 3G cellular handsets. UTSI is just under my buy limit, and is a buy up to $9 for my $15 target.
Content on Demand MegaShift
Telkonet (TKO) is a stock of great interest to all of us. Todd asked: “I am perplexed with the action in TKO. It appeared you had a pipeline to some significant information that resulted in your feeling confident about this strategic partner. Yet there is no news and no action in the stock to reveal anticipated news. The stock is $2.75 with a buy up to $5.00. This looks like the Mother Load should be played. Yet you are now somewhat quiet on this stock. Should I now be concerned? Relative to the $15.00 target you speak of, how much market action is a piece of the target price versus strategic partner and fundamental news?”
I do have good contacts into this company, and I believe the strategic investment is still on its way. I’ve tried to update TKO in almost every issue of the Radar Report, especially in regard to the big military contract with EDS that finally got announced. This week, the company signed a deal with Ameren Energy Communications to provide BPL access to all commercial and apartment facilities in the Ameren utility’s Missouri and Illinois service areas. River City Internet Group will be the Internet service provider, and TKO will do all the in-building work. This is a huge win for the company, yet it is only a tiny fraction of the business available in the U.S., which in turn is about 10% of what is available in the rest of the world. I still think the stock is a great buy up to $5 for my $15 target. That target is based entirely on the company’s performance and getting the strategic partner, and has nothing to do with my outlook for the market. Realistically, though, the price will be achieved when people are more positive about small cap and development-stage companies. I expect we’ll be in that environment in 2007 and 2008.
Seward had a concern about Silicon Image (SIMG) that I should have addressed a while ago: “I am hearing that Apple might introduce a streaming video technology next week in conjunction with the rollout of its iTunes movie download service. What effect, if any, does this have on Silicon Image and its array of HDMI products? Does wireless streaming technology make SIMG’s hardwired solutions obsolete? Obviously, I am a little confused on the technology here and would appreciate some input from you.”
Although you probably already know this, Seward, the streaming videos are a big boost to the use of HDMI. The forthcoming Apple iTV media center control box has HDMI output, as well as component outputs. It supports an industry coding/decoding standard, H.264, that is supported by both the Blu-Ray and HD-DVD camps and is the key to high-definition TV.
Most important, it means that many users will want to connect their iTV or other media center device to their TV, along with their existing DVD player or home theatre in a box. Today, most sub-$1000 screens only have one HDMI input. Multiple inputs have been a feature of more expensive, and often larger, screens. But if Apple drives the adoption of iTV and competitive products into most homes, we are likely to see two or even four HDMI ports on each screen, in addition to the wireless connection. That’s good news for SIMG, which is a buy on any dip under $10, if the market takes a drop, for my $18 target. I will raise the buy limit after we get through the next few weeks.
Zhone Technologies (ZHNE) pre-announced a poor September quarter after the close yesterday, blaming the shortfall on weak international sales. Instead of $54 million in revenues, they will book $41 million to $43 million. The shortfall will pull down gross profit margins from the 38% to 40% area. I’d been looking for 35% or 36%.
The stock was hit for 34 cents today, down to $1.06. This should be as bad as it ever gets, as the September quarter is the hardest one to close international business. While the old products run down, their new DSL products are still growing rapidly.
Management should guide very conservatively for the December quarter if they have any sense. I’m going to keep ZHNE as a buy based on price, not on timing, but reduce my buy limit to $2 to reflect this latest disappointment. I’ll cut the target price to $5 for next year, although there’s no reason they can’t hit the $7 figure if they execute better in a more favorable stock market environment.
Nanotechnology & Materials MegaShift
Integral Technologies (ITKG) is a small, development-stage company and therefore a volatile stock. John wrote: “Michael, ITKG dropped 10% today and you didn’t comment. Please do!”
There wasn’t any news for me to comment on — this was just the illiquid market getting hit with a sell order. ITKG announced receipt of its 19th patent. They started filing patent applications in September 2002 with four applications. By October 2004 they had filed for 37 patents, and since then they have filed for 72 more. It takes 18 to 24 months these days to get a patent, so the 19 that have issued should be followed by many, many more. Every patent is a new licensing opportunity.
It is best to use 10% down days as an opportunity to pick up a few more shares, instead of worrying about it. This is going to be a long-term holding for us, and after the next few weeks I expect to increase the buy limit. Until we get through the last of this seasonally dangerous period, though, I would continue to only buy ITKG on dips under $2.50 for my near-term $4 target.
New Energy Technology MegaShift
Art asked: “We are invested in oil sands and Shell along with natural gas. What’s the future of those investments after the recent big change in prices. Are we going to be sitting on dead money?”
No. There are two issues with oil. One is price and the other is volume. The price can flip around quite a bit at the margin, based on the weather, geopolitics and how the hedge funds are feeling. Recently, all of those have pointed to lower prices, and we seem to have bottomed around $60 a barrel. I still think the low end of the range for the next year will be $50 to $55. On the high side, $75 to $85 seems reasonable.
The technologies I am recommending — tar sands, oil shale, coal-to-liquids and wavepower — generally turn profitable between $35 and $45 a barrel. As long as volume holds up, which is to say as long as China and India continue to grow faster than 5% a year, all of these projects will produce needed product at an attractive cost. Of course, they will get a windfall every time prices push into the high end of the range, but we don’t need that to make money in the stocks.
Expectations for these companies are very low. For example, Chevron just entered a joint venture with Los Alamos National Laboratory to study new ways to unlock oil shale. The U.S. Geological survey estimates that the U.S. has two trillion barrels of oil shale resources, with about 1.5 trillion of that in the Green River Basin in Wyoming, Colorado and Utah. That’s 65 years of the current world daily oil production of 85 million barrels. But the Department of Energy (DOE) thinks that oil shale production will only hit 100,000 barrels a day in 2030 — 24 years from now. That is flatly ridiculous. Oil sands production was about one million barrels of oil a day last year, and the DOE is projecting only 3.6 million barrels a day in 2030.
Royal Dutch Shell (RDS.A) is the technology leader in extracting oil from shale, and in addition to their Green River Basin work that has been in development for more than 10 years, they have a joint venture with Jilin Guangzheng Mineral Development to explore oil shale resources in China. If the U.S. is only producing 100,000 barrels a day from oil shale in 24 years, we may not be in even the top 10 oil shale producing nations.
The truth is that the world needs to spend about a trillion dollars a year on unconventional oil and alternative fuel production in order to avoid the “peak oil” problem. If the money is spent, our companies will benefit tremendously from the increase in volume. If the money is not spent, our companies will benefit tremendously from the increase in prices.
While oil prices are low and hurricanes are absent, we can buy oil sands cheaply with Connacher Oil & Gas (T.CLL) and oil shale cheaply with Royal Dutch, Gasco (GSX) and Infinity Energy Resources (IFNY). We can pick up bargains in one of the best sour crude refineries, Holly Corp. (HOC), and the clear leader in coal-to-liquids technology, Rentech (RTK). We can get into the early winners in the hydrogen economy, with real products on the market today, by buying Fuel Cell Energy (FCEL) and Plug Power (PLUG). Ocean Power Technologies (OPWT) gives us a very alternative technology that is price-competitive with oil right now, and we can expect more developments to come. I’m still expecting to buy back Cree (CREE) and Energy Conversion Devices (ENER) in the near future — preferably lower than where they closed today.
Charles asked an incisive question: “Are environmentally safe products in your list of MegaShifts? I’m thinking of Winning Brands Corporation’s (WNBD) solvent-free Winning Colors product with its water based cleanup for paint and other solvent messes, as well as another solvent free-product that dry cleaners will probably be forced to change to in the near future that will turn traditional dry cleaning into the environmentally safer ‘wet clean.’ Any thoughts here?”
The New Energy Technology MegaShift is just one of the Green Tech MegaShifts that I am following. I’ve been involved in alternative energy, organic food and green technology for many years, and it certainly looks like a breakout is underway. So the first answer is that there will be a Green Tech MegaShift at some point later this year.
However, Winning Brands is a pink sheets stock that sells for six cents a share, down from 15 cents at the end of August. It was formed by a merger in April, and probably is too small and early stage for the New World Investor.
General Questions
Henry asked: “Do you agree with Forbes’ lead article “The Cheap Revolution” that the “wholesale shift by corporations to cheap chips and open-source software such as Linux” will create a new boom to the detriment of Microsoft, Oracle, Cisco, etc?”
Not exactly. We tried implementing Linux on our desktops — it is very difficult, with very little support available. Linux on servers will spread. So Microsoft has a great opportunity to upgrade one billion existing PCs with Windows Vista, an operating system that can’t be stolen and duplicated. They have a fight in the server market with the Windows Vista Server against Linux. They are vulnerable on the Office side, because there is very good freeware, Open Office, that will run under Vista as well as under Linux.
Oracle databases and applications run under Vista or Linux. They wisely removed themselves from this fight, and win either way as long as they can take seats from IBM and SAP, both of which also will run under Vista or Linux.
Cisco uses Linux in some of its router products, but their customer generally doesn’t care as much what the operating system is in a dedicated product like a router.
And although you didn’t ask, Intel can run either Vista or Linux in native mode, so Dell, Apple, H-P and everyone else also don’t care who wins.
The net of this is that Microsoft is the most vulnerable in the long run, but they have an unbelievable opportunity in the short run — one billion computers times an average of $150 each for Vista is a $150 billion market, theirs for the taking. As long as they don’t blow it by putting out an insecure, crummy product, they have what Scott McNealy of Sun Microsystems used to call an insurmountable opportunity.
