Here’s a great idea: Trade your 100-watt incandescent reading light for a compact fluorescent bulb (CFL) that costs 3X as much, takes a while to warm up, provides poor quality light, causes headaches in some users (and stands accused of causing cancer in others), and contains five milligrams of mercury to make environmentally benign disposal difficult enough that we can be sure that lots of mercury will wind up loose in the air, ground and water.

If that sounds like a government program to you — bingo! The Great State of California has banned incandescents and has set a 2012 deadline for these lights to be completely phased out. So has Canada. Australia is even more aggressive — banned by 2010. Europe, not to be outdone — 2009. Congress is talking about a complete U.S. ban by 2017, although my bet is that it will take them nearly that long to pass any important legislation.

The reason all the politicos are hot to jump on this bandwagon, beside the fact that they can mandate the change and then don’t have to pay the bill, is that there is a real problem in the amount of energy we use in lighting. Incandescent lighting consumes 22% of all the electricity generated in the U.S., and about 33% of all the electricity generated in the world. But the bulbs produce a lot of heat along with their light. This is often referred to by the anti-incandescent crowd as “waste heat.” Funny, but in the middle of winter the two 150-watt spotlights over my desk don’t feel like waste heat. But conceding that, we know that every problem is a photo op for the politician who proposes a solution, good or bad.

If all those incandescents were converted to compact flourescents, we could cut about a third off of that energy bill. But if you’re like me and think that the CFL bulb sounds like a bad idea, how about this: Replace every 100-watt bulb in your house with a white LED (light-emitting diode) light. Unlike the compact fluorescent catastrophe, white LEDs give instant-on, excellent quality light with virtually no wasted heat. And they are on the market today.

While the numbers are a little squishy because incandescents generate heat, which is good in the winter when lights are on longer, and bad in the summer when general lighting usage falls, LEDs could help knock down our nation’s energy usage. If we replaced every incandescent light in the country with a white LED light, we could cut the electricity usage of the U.S. in half or said another way, we could slash the country’s energy consumption by about $18 billion.

Wow! Now that’s a Wall Street concept, well worth running stocks up for and getting excited about. The only problem I see is that the bulbs cost $125 each — no, there isn’t supposed to be a decimal point in there. If the manufacturers can drive costs down 40% a year, which is not an easy curve to stay on, they will get down to 10X as expensive as an incandescent light in about 6 ½ years, and match incandescents in about 11 years. Today, a 100-watt incandescent bulb with a 5600-hour life costs about 72 cents. Because LED bulbs last 50X as long as incandescents, the crossover point for people who change their own bulb comes in about 2012, and the crossover point for commercial users should be just about now.

So, this is a market that will s-l-o-w-l-y build as costs come down and various applications become economic, such as using United Auto Workers janitors to replace incandescent bulbs on the manufacturing line. In the meantime, companies like Cree (CREE) that produce white LEDs will have periodic disappointing earnings reports as their basic business fluctuates. Cree will report higher sales for their June fourth quarter compared to last year, but earnings will be only five or six cents a share compared to last year’s 18 cents. They’ll start the June 2008 fiscal year with comparably crummy results in the September quarter, and it is hard to imagine them guiding up, given the beating that they are taking on profit margins in the cell phone display backlighting business. I still think we’ll get to buy that stock under $15, and I’ll let you know when that occurs.

But with the general push towards green building, and specific interest in saving energy where it makes economic sense, I’ve been looking for a winning technology in the lighting area. I have found two. The first is fiber optic lighting using LEDs for a light source. The second is a better white LED light that has been blessed by the biggest LED company of all, Phillips.

A Bright Idea for Your Portfolio

Lighting is a $58 billion worldwide market, and through governmental action and steadily declining prices for LEDs, it is about to undergo a MegaShift of its own driven by higher energy costs. One way to take advantage of this corner of the New Energy Technology MegaShift is by investing in companies with fiber optic and LED technologies.

Fiber optic lighting is not a new technology, but its time has come and it is being designed into virtually every new commercial building. An LED or high-efficiency halogen bulb at one end of the fiber lights the whole strand, which can carry the light to the end and then, bundled with many other fibers, creates dramatic and useful lighting effects comparable to incandescent lamps, at a much, much lower energy usage. There is no voltage at the light fixture, so they are safer. They require essentially no maintenance, and they emit no heat. And although the basic technology is not new, there are technologically advanced companies that are using fiber optic lighting in new, often patented ways.

In what ways, you ask. Just take a look at some of the changes that fiber optic lighting is making in vacation hot spots. If you were in Las Vegas for the recent Money Show, you saw a lot of fiber optic lighting that has replaced neon lights. Some of the esthetic effects are pretty amazing. You also may have seen hotel swimming pools or hot tubs glowing at night, without the tell-tale hot spot of underwater incandescent lights. And there is one company making great waves in the move away from incandescent lighting.

Energy Focus (EFOI) is the new name and symbol for Fiberstars, the world’s leading supplier of fiber optic lighting. Their big market has been the swimming pool/spa business, where they have a quarter-million installations, but business has turned soft with the real estate slowdown, and commercial lighting. Commercial customers include:

• Fast food restaurants — Sonic, McDonald’s
• Retail stores — Tiffany’s, Nordstrom’s, Footlocker, Starbucks, Gertrude Hawk Chocolates, Toys R Us, Burdine’s, Cheesecake Factory, Macy’s, JR Dunn
• Grocery chains — Whole Foods, Albertson’s, Giant Food
• Theme parks — Disney, Sea World, Universal Studios
• Casinos – Bellagio, Foxwoods, The Mirage, MGM Grand, Caesar’s Palace, The Venetian, The Stratosphere
• Hotels — Marriott, Hyatt, Hilton
• Specialty installations — Trump Tower, AMC and Cinemark theaters, Chevron, New York Life, Marathon Coach, Chuck E. Cheese, Hobb’s Fountains, Wings, and Carnival Cruise Lines

Energy Focus also has a $2.1 million DARPA (Defense Advanced Research Projects Agency) grant to put fiber optic lighting on to three Navy ships, with two already installed and sea trials beginning this year. Word is spreading from captain to captain about this new technology that slashes energy use while providing better lighting to dark areas of the ship, using LEDs and fiber optic cable. There are numerous military applications for their technology, and I expect to see more contracts in 2008.

The company’s new Fiberstars EFO (Efficient Fiber Optics) technology delivers light comparable to incandescent or fluorescent at an 80% or better energy savings compared with halogen or incandescent bulbs. It reduces watts per square foot without reducing light levels, thus helping architects and engineers meet the stringent new energy regulations without sacrificing brightness.

One of their coolest applications is refrigerated and frozen food display cases in supermarkets. In fact, the food in refrigerated display cases looks much better under fiber optic lights than standard fluorescents. Their new EFO ICE system uses LEDs to create the light outside the case, and fiber optics to bring it in and illuminate the food. The system cuts energy use by 80%, or about $100 per door per year, by not pumping heat into the display case. One EFO ICE light can replace up to five fluorescent lights, with no glass to break and no mercury spills. In California, PG&E offers utility rebate dollars for customers that convert to EFO lights.

Energy Focus is even taking their technology into the solar market as participants in the DARPA Very High Efficiency Solar Cell or VHESC program. The same skills used for EFO lighting like optics, coatings and advanced materials are key for solar power. The VHESC project target is a very high conversion efficiency — 50% efficient solar cell that doesn’t require active tracking of the sun’s path. That’s about 3X the efficiency seen in the majority of solar cells sold today.

The EFO technology is protected by 40 issued patents with more pending. Energy Focus does about a third of its sales through distributors, mostly in Germany but also in 29 countries, including Australia, India, China, Japan, and several European countries. Many of their products are manufactured to specifications given to the company by architects, professional lighting designers and swimming pool builders.

EFOI is a small company, with a decline in swimming pool sales — which is 50% of all sales — masking rapid growth in the new EFO products:

	Q3:06	Q4:06	Q1:07
Total Sales (millions)	$6.80	$7.20	$5.00
% change from prior year	-10.50%	15.40%	-6.00%
EFO sales (millions)	$1.30	$1.50	$1.10
% change from prior year	210%	+nearly 400%	+330%
Earnings per share	-$0.19	-$0.24	-$0.23
% change from prior year	+24.0%	+11.1%	-4.5%

Wall Street has not caught on to EFOI. The company has only 11.5 million shares outstanding, so the market capitalization is only $82 million. Their book value is $2.51 a share, of which 74 cents is in net cash ($12.1 million total cash minus $3.6 million in total debt). The company will do about $30 million in sales this year and $45 million next year. They should grow 35% to 50% for the next few years after that. They’ll lose about 50 cents a share this year, but be close to cash flow breakeven. In 2008, they should be slightly profitable for the year.

The stock dropped from around $8.50 to $5.50 after the December fourth-quarter earnings call, mostly because management said that they had to stop giving so much specific detail on customer deals as their competitors are starting to pay too much attention. EFOI has slowly moved back up to just under $7, and I want you to buy at least a one-half position under $7 for a $15 target this time next year. I have no trouble with buying a full position under $7 right now.

A Bright Little Idea for Your Portfolio

Lighting Science Group (LSGP) is a 44-cent stock that is, surprisingly, a relatively low-risk way to invest in the white LED revolution. With a little over 112 million shares outstanding, its market capitalization is a modest $50 million or so. While that doesn’t look cheap compared to sales so far of $73,000 in 2005 and $436,000 in 2006, their financial life is about to change, drastically.

The company designs, assembles and markets products for the commercial, industrial and consumer lighting markets. They sell a wide range of lighting products, including flashlights, cabinet lighting, floodlights, parking garage lighting and outdoor lighting products. Their commercial and industrial business focuses on municipalities, utilities, universities, large mall owners and parking lot owners. LSGP reaches these customers mainly through lighting and electrical distributors and parking garage operators. They have specialty distributors for the spa, hospitality and leisure markets, and they sell to consumers via retailers and their own web site.

The reason that the company is interesting is that Iroquois Capital, a major New York private equity firm focused on “green” investments, put $4 million into the company at 30 cents a share in March, and they have warrants for another 33 million shares at 30 cents to 35 cents. They will end up owning about 29% of the company for about $8 million. Iroquois Capital was the #1 most active institutional investor in public investments in private equity market in 2006, doing 117 deals worth over $110 million.

In early June, Lighting Science Group installed a new President and COO with 30 years of industry experience, most recently as CEO of Acuity Brands Lighting. He said: “The rapid development of solid state lighting technology is unleashing forces of change that promise to transform the way lighting is done — and possibly the lighting industry itself.”

It certainly will transform LSGP, because they are manufacturing white LED lights for Phillips Solid State Lighting, targeting consumer and commercial applications that will earn rebates from utilities like PG&E. In a deal announced on January 22, Phillips will both market and distribute the lights worldwide, and they have already started taking delivery under the contract. These are “lowbay” lights designed for parking garages and other industrial and commercial settings with a ceiling height under 16 feet.

Lighting Science Group is the first company to make a high-output, dimmable, Edison-base white-LED light bulb. The company has 25 patents in LED lighting and 30 different products so far, including bulbs equivalent to 100-watt, 75-watt, 60-watt and 25-watt incandescents, the latter using less than six watts of power for a warm, flicker-free light.

LED lights use only 10% to 20% of the electricity as incandescents for equivalent light, and they last about 50X as long. They use about 50% of the electricity as fluorescents and last about 5X as long. Flourescents can’t be dimmed, but Lighting Science LED bulb can.

The U.S. market alone is huge: Four billion light sockets are now filled by incandescent lights. Phillips and Lighting Science Group won’t get all of them, but even a modest market share will skyrocket this stock. Obviously, at 44 cents a share, we are in this for a 10-bagger to $5 or better over several years. I want you to buy LSGP up to 50 cents a share, with targets of $1 in 2008, $2 in 2009, $3 in 2010, $4 in 2011 and $5 in 2012, when the California conversion deadline hits.

China MegaShift

UTStarcom (UTSI) dropped recently when the wrong guy resigned. After hiring Merrill Lynch last October to find a buyer, the company said that it has “concluded its review of strategic alternatives and decided to make no changes to the current plan.”

The Chairman, Tom Toy, said: “After careful consideration of a number of short- and long-term alternatives, we have determined that our best course of action is to move forward with the company as it exists today.”

Since UTSI isn’t doing very well today, that left investors scratching their collective heads. Then Ying Wu, the CEO of Starcom before the merger and the well-liked CEO of UTSI’s operations in China, resigned. He was the heir apparently to the CEO slot, which is now occupied by Hong Lu. But Hong Lu is widely regarded as not having done enough to get UTSI straightened out.

So, I got a flurry of emails on this change, including from Steve asking: “Who is going to replace Lu as CEO now that Wu has left?”

Unfortunately, there is no obvious second in command now and, perhaps more important, the Board certainly backed Lu over Wu. So, I think that we have to deal with the management situation as it is.

Walter pointed out that: “They have not issued earnings in over eight months and the stock price continues to sink. I have a large holding and am concerned about their future.”

Remember that they have not issued earnings because of a voluntary investigation into possible stock options backdating. Either there was none, which would be a small win, or there was backdating and Hong Lu has to resign — which probably would move the stock up sharply. We should find out soon.

John emailed: “Would appreciate your take on UTSI since it has lost about half of its value over the last four months. Does it have any chance to recover or should we just give up?”

I think recovery is all but certain. When the company finishes its internal investigation and publishes earnings, I think we will see growing sales and slowly improving margins, based on the numerous new products that they have been introducing.

Finally, Russell asked me to comment on the very negative article in the June 18 Barron’s, especially if I disagree about the company’s IPTV outlook. Russell asked something almost no one does these days: “Is this a buying opportunity?”

The Barron’s article was written by someone that I’ve talked to many times, Mark Veverka, and supra-headed: UTStarcom Flaming Out. Mark conceded that UTSI is introducing lots of new products at this week’s huge NXTcomm trade show in Chicago, but said: “Critics contend that the company’s IPTV products are more hype than substance.”

I don’t know who those critics are, but UTSI is rolling out IPTV on its own in China and in collaboration with Yahoo Japan in that country, and I haven’t heard any complaints. Essentially, I think the article was a free shot because the company has chosen not to report results until the internal investigation is done. I don’t know what else they could do under the yolk of Sarbanes-Oxley. The “cure” for this whole situation is to get the reports, and that’s coming next. I think the numbers will be better than the pessimistic assumptions now built into the stock, so UTSI remains a buy up to $9 for my $15 target.

Content on Demand MegaShift

Intel (INTC) drew a question from Kenneth: “Congratulations on your recommendation to buy the INTC LEAP calls. It looks very strong at the moment. I do have a question relating to it though. I recently heard a rumor that INTC might buy Nvidia (NVDA) later this year. How would that affect our INTC LEAP calls, and how can we best protect our positions and gains?”

A few years ago, I was in Jen-Hsun Huang’s office — he is the CEO of Nvidia — and he explained to me step-by-step how he intended to kill Intel by slowly sucking everything into the graphics processors that Nvidia makes. The company and stock have been up and down since then, especially versus their competitor ATI Technologies, which was recently acquired by Intel’s arch-rival Advanced Micro Devices.

I think an Intel/Nvidia merger would be welcomed by Wall Street, and Intel’s stock would go up, not down — especially if they paid cash. So, I would not worry about that as a threat to your LEAP position. I am raising the buy limit to $5 on the Intel January 2009 LEAP call (VNLAX), while keeping the target price at $12.50.

Silicon Image (SIMG) drew a good question from Michael K: “What impact will Blockbuster’s announcement to stock only Blu-Ray discs have on SIMG?”

It shouldn’t have any impact, as the HDMI standard is used to move audio and video to and from both Blu-Ray and HD DVDs. To the extent either standard is perceived as “the winner” it might cause consumers who are holding back to go ahead with a purchase, and that would be good news for SIMG. But I think it is still too early to call a winner. SIMG remains a buy up to $13 for my $20 target.

New Energy Technology MegaShift

There’s lot going on in Congress and the world, some of it helpful for our companies and some not. Gasco Energy (GSX) and Infinity Energy Resources (IFNY) should benefit from the new energy bill by supplying gas to utilities that provide the power to heat Colorado oil shale for extraction. If you drive Interstate 70 from Glenwood Springs, Colorado to Grand Junction, you will see more than 20 drill rigs at work compared to none a couple of years ago. There is enough oil in the shale to fuel the entire U.S. for at least 100 years. Oil shale development is a winner in the new energy bill so far.

Peter commented: “IFNY has been in a holding pattern for some time. When do you expect it to come back to life? Seems like an outstanding value at this price.”

The company is negotiating the sale or partnership of several of its assets right now, and it sure doesn’t hurt that oil went over $70 a barrel for a while this morning. I expect to see announcements of deals beginning any day, and continuing for the rest of the year. That should move the stock, and IFNY remains a Top Buy up to $5 for my $10 target. And it is an “outstanding value” simply because it has so little downside, given what is happening.

Coal-to-liquids (CTL) took a small hit when the Senate rejected two amendments, one for up to $10 billion in loans for liquid coal plants and another requiring liquid coal to comprise six billion gallons of the nation’s fuel supply by 2022. In regards to the Senate’s decision, Michael K. asked: “What now for Rentech (RTK)?”

Michael, loans and mandated purchases are the icing, but RTK’s patented CTL process is the cake. As long as oil is over $45 a barrel or so, which looks to me like a sure bet, the coal companies will continue to license RTK’s process to convert their low-value coal into high-value liquids. Customers are extremely interested in moving to petroleum alternatives.

In fact, there was just a successful first test of a 30% biofuels blend in the commercial jet engines that power Boeing’s Next-Generation airliner. This was a vegetable oil blend, but CTL blends and, indeed, 100% CTL fuels have already been tested by the military. When the Rentech process plants start to open, there will be no shortage of customers no matter what Congress does. RTK is a Top Buy up to $5 for my $11 target.

New World Economy MegaShift

Omniture (OMTR) has performed like a champ, approximately tripling since I recommended it eight months ago. It’s well over my target price for this year, and even though it would move higher if the broad market continues to be as strong as I think it will, other stocks on our list are likely to move more. So, I recommend that you sell OMTR for now for a 226% gain, and I will continue to follow the company closely for another buying opportunity in the future.

Video iPod MegaShift

Burst.com (BRST) moved up to $2.50 as rumors spread that the Apple iPhone needs to license Burst’s technology for handling video. That is probably true, but two recent Supreme Court decisions have me worried that Burst’s business model is now in a weaker position. Last year, in MercExchange vs. eBay, the Court set aside the idea that courts should issue permanent injunctions to stop patent infringement. The Supreme Court rules that a fair royalty was good enough, especially when the plaintiff is not itself using the invention.

Then in May in KSR vs. Teleflex, the Court made it much easier to attack patents on the grounds that they are “obvious in light of prior art.” I don’t think this is the case for BRST, but it is an issue that Apple could raise and pursue for many years through the Patent Office revalidation process. With the stock over $2 and a better than 100% gain in nine months, sell BRST.

WiMAX MegaShift

Airspan Networks (AIRN) won a Vodafone contract for its first commercial WiMAX network in Malta. Many wireless phone companies will be offering WiMAX as a data alternative in the future, so this is a showcase win for Airspan. Buy AIRN up to $5 for my $10 target. Just based on this win, I almost made it a Top Buy, so it’s definitely a great time to add to your holdings.

Market Outlook

As the dollar falls against other currencies, things in the U.S. get cheaper and the rest of the world shows up to buy them. There are already organized shopping trips from the U.K. to New York, because prices in pounds are about half what they are in London, Edinburgh and Dublin. The same is true of real estate, companies and stocks, and I think world demand will be a big driver of the next upleg in the stock market, as global investors realign their portfolios to go where investments are cheap.

But in the short term, we certainly are getting tested. I am personally long August calls on the SPY, which matches the S&P 500. But 1513 was a critical support level coming down, and now it is a critical resistance level going back up. As Del and several others reminded me: “Oh, by the way, the S&P broke the 1510 point, so now we are in the spot you did not want to see happen last week, when it went below 1510 but did not stay. Well, what now?”

When the S&P broke 1510, it seemed likely to me that it would drop back to the next support level down at 1491. That was the low on May 10 and May 11, before a bounce back up to 1530 at the end of May. It again was the low on June 7 and June 8, before another bounce back to intraday levels over 1535 from June 15 through June 20. Now, as Ronald Reagan used to say: “Here they go again.”

Yesterday’s intraday low at 1484 practically matched the June 8 low at 1487, and showed the same kind of bounce. It’s hard to stay long in such an environment, but when these kinds of test-test-test markets finally turn, they can really move. Look what happened coming out of the March 5 low at 1374 — next stop, 1538, 90 days later.

As long as the S&P does nothing worse than drift around under 1513, I believe it is consolidating and gathering strength (in the form of growing negative sentiment, short selling, put buying and the like) for a similar move up to 1552 (the all-time high) and then on to 1605. But it needs to shake everyone out first, longs and shorts, to get enough sideline cash energy to make such a big move. So, I don’t think July is going to give us much respite from the recent volatility.

The International Energy Agency (IEA) said this week that world oil demand is rising faster than previously expected, while the non-OPEC supply is growing slower than expected. The IEA warned of growing tightness in oil supplies in the second half of the year, and urged OPEC to raise its output. You know what that means: Oil prices are bound to move up as the supply dwindles and demand grows.

Oil neared $70 a barrel this morning, but the important factor to remember is that oil over $50 a barrel changes everything in some of the largest industries and markets in the world, including autos, electricity generation, chemicals, plastics and, it can be argued, consumer spending patterns. When the Saudis are saying that they are now comfortable with a $50 to $65 range for oil prices, I think it’s time to forget about the last comfort level at $28. When even an oil-state Republican President talks about global climate change in his State of the Union address, and Congress flips from Republican to Democratic control, we could be looking at one of the biggest MegaShifts of all time.

That’s why I am excited about new energy technology. Fifty dollars a barrel for oil opened the window for innovative new companies to find oil in better or cheaper ways, or provide technologies that conserve or replace oil in all the industries and markets listed above. These are worldwide markets, so they are huge. A new company that is the first mover in a new technology can grow into a Fortune 500-size operation, with dramatic long-term returns to investors that stick with them.

The Wall Street Journal recently asked Ray Lane, former president of Oracle and now a venture capitalist with Kleiner Perkins Caufield & Byers, founding investors in Google, Amazon, and Netscape, just how big the clean tech trend is going to be. He said: “Bigger than the Internet by an order of magnitude. Maybe even two.”

As you probably know, an order of magnitude is 10X, and two orders of magnitude is 100X. That sounds like a pretty worthwhile MegaShift to be invested in.

We already have a number of new energy companies in our portfolio, and as you know, I’m not limited to recommending companies in one area of the energy chain. I’m interested in companies with the right technologies to find more oil and ways to use it more effectively, as well as those with alternative forms of energy. At this point, our New Energy Technology Portfolio looks like this:

New Sources of Oil

• Gasco Energy (GSX) — natural gas to power utilities providing heat for Colorado oil shale operations
• Infinity Energy (IFNY) — also natural gas for utilities providing energy to heat Colorado oil shale, plus they have a huge new oilfield in the Caribbean Sea off Nicaragua
• Royal Dutch Shell (RDS.A) — technology to extract oil from Colorado oil shale
• Connacher Oil & Gas (CLL.TO) — technology to extract oil from Canadian tar sands

Alternatives to Oil

• Energy Conversion Devices (ENER) — solar and hybrid car batteries
• FuelCell Energy (FCEL) — hydrogen fuel cell stationary power plants
• Ocean Power Technologies (OPTT) — wavepower
• Plug Power (PLUG) — hydrogen fuel cell back-up power
• Rentech (RTK) — coal-to-liquids (synthetic petroleum)

There are real problems that need to be solved with all of these technologies, and there are also FUD problems — Fear, Uncertainty and Doubt spread by the folks with fiefdoms that are threatened. I have quite a collection of these, as I have to check out every one to be sure that our investments are not impacted by them. Here’s a look at just one FUD problem that you might hear in each major new energy technology area:

• Solar — The FUD problem is that solar energy can never have more than a minimal impact on U.S. energy consumption. Reality is that if we set aside an area 10 miles by 10 miles in the Nevada desert and used only today’s 15% efficient energy technology, that 100 square miles could provide all the electricity that the U.S. uses.
• Hybrid cars — The FUD problem is that the batteries will wear out and need to be replaced at a cost of $4,000. Reality is that hybrid batteries like those made by Cobasys, the joint venture between Energy Conversion Devices and Chevron, last for the life of the car. Toyota has never had a recharge battery warranty claim. And incidentally, the next time you hear someone say that hybrid buyers will never earn back the price premium, ask them what the most expensive single factor is in owning a car. It is depreciation. Then ask them if they factored the very slow depreciation of hybrid cars into their calculations. (They didn’t, because they were more interested in spreading FUD than being helpful.)
• Ethanol – The FUD problem is that ethanol production uses corn that is taken away from human consumption. Reality is that ethanol production is best with feed corn, not sweet corn, and after the ethanol is extracted, the remaining material, called distillers grain, is an excellent livestock feed. Another sort-of-FUD issue is that “it takes more energy to make ethanol than the ethanol produces.” Wrong, but I have always thought the underlying numbers on corn-based ethanol will not be compelling in the long run. It takes about 75% of the energy in ethanol to make the stuff, using fossil fuels. (Nobody counts the solar energy used to grow the corn.) So there is a net energy gain, but it isn’t overwhelming.
• Wind – The FUD problem is that wind turbines are inefficient because they only operate a small percentage of the time. Reality is that wind turbines are usually located in areas where they operate 65% to 80% of the time. That’s why the Department of Energy says that the windpower potential in the U.S. equals 100% of our current electricity consumption. Looking at maintenance cycles, no power plant operates 100% of the time. The closest is geothermal, with about a 98% uptime record.
• Geothermal – The FUD problem is that geothermal is too new and experimental, and limited to areas with hot springs or other evidence of near-surface extreme heat. Reality is that geothermal energy has been generating electricity for over 100 years, and today in the U.S. alone there are almost 2,800 megawatts of geothermal energy connected to the power grid, displacing around 25 million barrels of oil.

We have a few recommendations in a number of these areas, and today I want to look more closely at geothermal, since I have a new recommendation in that area for you.

It used to be true that geothermal plants had to be near hot springs, as Calpine’s plants are. (Calpine is a major power producer, only part of which is geothermal, that went bankrupt during the California energy crises and just filed its reorganization plan yesterday.) But there is a new technology called Advanced Binary Cycle that allows geothermal plants to use water in the 200 degrees F to 360 degrees F range. As you can see in the diagram below, this water is pumped to the surface and used to heat a second “working fluid” that has a low boiling point. So, instead of driving the turbine with steam from the water source, the working fluid vaporizes and turns the turbine. The vapor then condenses back into working fluid to be reused in a closed system, and after the heat transfer, the cooled water is returned to the reservoir through a second well.

Source: Raser, Inc.

There are many more lower-temperature hot water fields than steam fields, so this opens up many more areas to geothermal energy production. Plus, because the energy production process is a closed loop on both the water and working fluid side, there are zero emissions. The geothermal resource itself is sustainable and renewable.

This is why I want to get us into geothermal — it makes so much sense. The worldwide opportunity for geothermal energy is huge. In 2005, geothermal generated almost 36 gigajoules of energy, which is enough to run every house in Florida for a year. A recent MIT report estimates that the U.S. has 5.6 million exajoules of recoverable geothermal energy, more than enough to run our whole economy forever. And it is all done with no carbon dioxide, no smog, no ash, no smoke and no nuclear waste.

Plus, geothermal lowers oil imports and lowers emissions and saves money. Here’s how:

You may know that just about six to 10 feet below the surface, depending on where your frost line is, the earth is normally a steady 55 degrees F year-round. Well, I’m going to take advantage of the earth’s typical temperature and save some energy in heating my house. I am planning to put in a simple system that buries a 24″ diameter pipe in a deep ditch around the house. In the winter, air from the pipe enters my heat pump to be heated (it works just as well with a furnace). But I only have to heat this air 15 degrees F to get a comfortable 70 degrees F, instead of from sub-freezing. In the summer, the 55o F air comes in to air condition the house, and the only energy expenditure is for the fan to distribute it.

Going down deeper into the earth in most places, the temperature remains a steady 55 degrees F. But as we know, there are many areas where the hot internal core of the earth comes much closer to the surface — within 5,000 feet, or easy drilling distance with current technology. Looking at the total costs of generating electricity to convert to heat, geothermal is about 3.3X as efficient as that process. So instead of heating your Vermont house in the winter with oil ($3,000 for the season) or electricity ($5,000), geothermal can do the job for about $1,500. That’s compelling, even before you get to the environmental benefits.

But is it practical? Yes, just take a look at what some companies are already doing with geothermal technology. There is a public company headquartered in Indiana, listed on the Toronto Exchange, named WFI Industries (WFI.TO). They make single-home systems that tap underground energy — often only five or six feet down — for around $12,000. The stock has moved up about 25% recently, and I need to do more work on their capitalization to understand what we are getting before I would recommend it. Also, I expect them to move to the NASDAQ at some time, and I don’t want to get caught in another Ocean Power Technologies snafu. So, just keep it on your radar for now.

At the other end of the scale are the utility-size geothermal producers that can take advantage of the new binary cycle technology. The biggest of these is Ormat Technologies (ORA), a Reno-based subsidiary of the Israeli company Ormat Industries. Its Electricity segment develops, builds, owns and operates geothermal and recovered energy-based power plants, and sells electricity in the United States, Guatemala, Kenya, Nicaragua and the Philippines. Its Products segment designs, manufactures and sells power units for geothermal power plants, power units for recovered energy-based power generation, and remote power units and other generators.

Ormat Technologies is a $1.4 billion company selling at over 60X earnings, and I am not a big fan of buying stock in subsidiaries as opposed to the parent. The Israeli parent trades in the U.S. but only on the pink sheets. So, we’re not going to invest in this one either.

I am interested in Raser (RZ), which makes binary cycle geothermal equipment. The company, though, has been a long-time promoter of a new type of efficient electric motor that really hasn’t gone anywhere. I will watch them to see if they get any traction in geothermal equipment before making an official recommendation.

The company I have found for you has a much more exciting outlook, despite its small size.

Buy US Geothermal

US Geothermal (UGTH on the Bulletin Board) is building its first geothermal utility plant in Idaho, and the company will open it at the end of this year. They’ll start at a modest 13 megawatts but plan to expand that to 200 megawatts over time. They have the capital to get the first plant into production, with $35 million in cash and no debt, but nobody knows about this company and the total market value is under $100 million.

But there is a lot more to the story than that. After the great gas line crisis in the early ’70s, the Department of Energy spent over $40 million developing a geothermal reservoir and binary cycle power plant at Raft River, Idaho. It sits on 8.2 square miles of active ground, and the DOE estimates that it can produce 1,000 megawatts, or about five power plants the size of the first one that UGTH is developing. (A very conservative projection from the company’s independent consultant says that the site has a 50% probability of a power production capacity of 15.6 megawatts per square mile, which translates to 100 megawatts or more.) When lower oil prices returned, the DOE lost interest and shut down the project in 1982.

Twenty years later, US Geothermal acquired control of the geothermal rights and started planning their first plant. It is being built for them by Ormat. The Raft River Rural Electric Cooperative has finished construction of a 3.2-mile power transmission line that connects the power plant to the Bonneville Power Administration substation at Bridge, Idaho.

US Geothermal already has a contract with Idaho Power to sell them 10 megawatts of power and also has two other contracts near completion for 13 megawatts each for future production. The whole state of Idaho uses about 370 megawatts of power a year, so eventually UGTH could sell almost all of the output from two 200 megawatt plants to Idaho Power, making that state completely non-polluting in electricity production, and still have another three plants worth to offer to nearby states. One of the 13 megawatt contracts is with Eugene Water and Electric in Oregon. US Geothermal is also conducting exploration activities at Neal Hot Springs, Oregon.

The stock has moved up this week while I was finishing this report, and I would not chase it. Buy only a 25% position in UGTH under $2.25, and let’s see if we can use a multiple buy strategy to get more under $2. My target price is $5.

New Energy Technology MegaShift

One of the reasons that energy prices have soared over the past couple of weeks is that hurricane season officially began last Friday. If your name is Andrea, Barry, Chantal, Dean, Erin, Felix, Gabrielle, Humberto, Ingrid, Jerry, Karen, Lorenzo, Melissa, Noel, Olga, Pablo, Rebekah, Sebastien, Tanya, Van, or Wendy, you may be in for some kidding this year. Those are the names selected for North Atlantic hurricanes in 2007.

Gasco Energy (GSX) has gone from well under $2 in the middle of May to $2.73 at today’s close. The reason this happens, and the reason that I stay calm when the stock is down, is that natural gas prices follow crude oil prices, but with much more volatility. As the government’s Energy Information Administration said in a research report: “A significant stable relationship between the two price series is identified. Oil prices are found to influence the long-run development of natural gas prices, but are not influenced by them.”

In the short term, the correlation is not perfect. Natural gas was very cheap relative to oil in mid-2006. It’s now approaching a normal relationship, but it typically overshoots and gets expensive relative to oil, so now is not the time to exit. This happens because many utilities can substitute oil for gas and vice-versa, but it takes some time.

The warm winter of 2006 was a 1-in-100 years event, unless global warming is accelerating, and even in that case, the huge natural gas surplus that developed is now gone. U.S. natural gas production was 2% lower in the March quarter than in March 2006, and even though there are nearly twice as many gas wells being drilled, we are getting less natural gas out of the ground. The wells being drilled are much lower yield, or they are high-yield wells with short lives as high-tech production techniques suck the gas out at record rates. These wells deplete 40% to 50% of their gas reserves in 12 months or less. Just like crude oil, as supply diminishes and demand rises, we’re going to see higher prices, which is ultimately good news for a natural gas driller like Gasco.

Even though the stock is up about $1 from its lows, GSX remains a buy up to $4.50 for my $9 target.

Rentech (RTK) is the direct beneficiary of a U.S. Air Force decision to push development of a new jet fuel that is only 50% petroleum based. The plan was announced at the Paris Air Show this week. They want to certify their entire fleet for 50/50 fuel by 2010 — that’s soon! The Air Force burned 3.2 billion gallons of aviation fuel in fiscal 2005, or 52.5% of all the fossil fuel used by the government.

At the same time, at this month’s annual conference of the International Air Transport Association in Vancouver, commercial airline officials said that they have failed to persuade environmentalists and politicians in Europe that they were doing enough to clean up flying, so they are going to push for synthetic jet fuel. All this makes the return on investment for the coal companies look better and better, and the new energy bill wending its way through Congress now has lots of goodies for coal-to-liquids.

And who you gonna call? Not Ghostbusters. I think we are looking at an explosion in joint ventures for Rentech, as other peoples’ money funds one Coal-to-Liquids plant after another using their technology. RTK remains a Top Buy up to $5 for my $11 target.

Avian Flu MegaShift

BioCryst (BCRX) presented the results of two Phase I safety studies of intramuscular peramivir for treating seasonal flu. The data demonstrated a clinical advantage relative to approved flu treatments of the same class, Tamiflu and Relenza, with better activity and a longer therapeutic window.

The upcoming milestones for BioCryst include:

Date	Product	Indication	Event
Q3:07	BCX-4208	Psoriasis	Start Phase II trial
Q3:07	Oral Fodosine	CTCL*	FDA go-ahead for pivotal Phase IIb
Q3:07	Oral Fodosine	CTCL	Start pivotal Phase IIb trial
Q3:07	IM* peramivir	Seasonal flu	Interim peek at Phase II study
H2:07	IV* peramivir	Avian flue	Start Phase II trial
Q4:07	IM peramivir	Seasonal flu	Results from Phase II trial
Q4:07	IM peramivir	Seasonal flu	Start Phase III trial
2007	BCX-4678	Hepatitis C	IND filing to begin trials
2007	BCX-4678	Hepatitis C	Start Phase I trial
2008	IV peramivir	Avian flue	Results from Phase II trial
* CTCL = Cutaneous T-Cell Lymphoma
*IM = intramuscular
*IV = intravenous

There’s a lot coming in the next six months, and BCRX remains a Top Buy all the way up to $19 for my $30 target. It may be the most undervalued stock on my buy list.

Content on Demand

Telkonet (TKO) held a very positive business update call. They’ve made a couple of acquisitions and a partial spinoff of Media Systems Technology that have improved the company. They began by pointing out that the iWire system is more than just in-building Internet access, as it can be used for anything involving Internet Protocol, such as Voice over Internet Protocol, Internet Protocol Television, energy management systems, security and surveillance using Internet Protocol cameras, or simply managing doorbell systems and fire alarms. There are so many applications that Telkonet will never be able to take them all everywhere in the world, so they are focused on getting channel partners.

They also are looking for a Chief Operating Officer, which is sorely needed because the current CEO is not spending enough time in the office (my opinion, not his). I believe the right person will move into the CEO slot fairly quickly. Their current Financial Officer is doing a good job, and I expect him to be promoted to CFO shortly. They have stopped the headhunting process for that slot.

Their next generation product is coming along nicely, and General Electric has asked them to develop a private label version for the GE sales force. The EDS contract is very active, and they have scheduled 800 Navy recruiting sites to be installed between now and the end of the year, at the rate of 20 to 30 per week. Beginning in the late third or fourth quarter, they will start installing the Marine recruiting sites, again about 800 in all.

TKO finally seems to be moving in an operating sense, and if they hire the right COO, we should see a sharp move up in the stock. Buy TKO up to $5 for my $15 target.

WiMAX MegaShift

Sprint is talking about a joint venture spin-off of its WiMAX operations, which would be good news for the industry. The speculation immediately turned to a joint venture with Craig McCaw’s Clearwire, and in one of the most blatant “please call us” statements I’ve ever seen, a Sprint spokesman said: “Having a coordinated, cohesive use of the 2.5 spectrum makes a lot of sense from our perspective and from theirs.”

Clearwire has already signed up 258,000 customers for fixed WiMAX in 39 cities in the U.S. Sprint has a successful lower-speed cellular data service, EV-DO, that can reach 203 million people in the U.S. and had $1.2 billion in revenues in the December quarter. Sprint needs a future network that can handle many more users and much higher speeds, and Clearwire would love to have those customers feeding into a jointly-owned network.

The reason this is good for the industry is that while it may reduce equipment purchases from Clearwire plus Sprint somewhat, it forces many, many other companies to adopt WiMAX or be at a 10X cost disadvantage on wireless data services. That’s good news for all our WiMAX equipment providers:

• Airspan (AIRN), a buy under $5 for my $10 target.
• Alvarion (ALVR), a Top Buy under $9 for my $18 target.
• Terabeam (TRBM), a buy under $4 for my $7 target.

Airspan recently received a contract from a digital television network in Poland to expand its network to include WiMAX. The company, Multimedia Polska, offers voice, video and data services. They will use WiMAX to offload the voice and data services, keeping their digital TV bands for high-definition TV.

Market Outlook

After the quick, scary drop in the S&P 500 yesterday to the 1510 level (and even a little under that, although not at the hourly closes that I focus on), the bear trap is set. I think we are going to see a dramatic rise to the old highs at 1552, probably overshooting to 1560, and then after some more back-and-forth consolidating, on up to 1610. These quick drops really fuel up the energy for the next advance, and from 1560 a drop all the way back to 1535 that only lasts a day or two is a real possibility.

It is shaping up to be a better summer than the “sell in May and go away” robots expected. If we go through 1610 on any good news, we still could see a parabolic move up to 1800. It isn’t the most likely outcome, but it is still on the table. You should be fully invested.

Personalized cancer treatments have been a regular topic in New World Investor for a while now. The most familiar treatment process that we have discussed is probably Dendreon’s (DNDN) prostate cancer vaccine Provenge. But if you recall, this is not the only company revolutionizing the care that cancer patients receive. Back in October 2006, I introduced you to Affymetrix (AFFX) and gene assays.

While Dendreon uses cells from a cancer patient’s tumor to create a vaccine, Affymetrix’ biotech and pharmaceutical company customers create a treatment that is based on the genetic structure of the tumor. Basically, a genetic test, using DNA chips to scan messenger RNA (ribonucleic acid) from the thousands of other genes in a tumor, indicates how active a particular gene is within a cell. This allows pharmaceutical companies to develop very selective drugs, and allows doctors to determine which drugs will be most effective in treating a particular cancer based on the person’s genetic makeup.

DNA chips from Affymetrix and others were revolutionizing biological research even before the human genome was first sequenced in 2001. Then it turned out that sequencing those three billion letters created an ocean of complex data, and the only way to get a handle on it was using DNA chips. Having proven their value in research, these chips are now moving into the far larger markets for clinical diagnosis, and from there they will move into doctors’ offices — an even bigger market — to dramatically improve the practice of medicine.

We are going to be riding this MegaShift for a long time, and I want you to have a solid understanding of this technology and industry, especially since I am making a new gene chip recommendation today. So, let’s start with the process of creating DNA chips.

Glass, Not Silicon

DNA chips, called microarrays, are built using a semiconductor-like process, but on glass substrates instead of silicon. Semiconductor production uses photolithography to build layers of a circuit, with certain areas masked to prevent the light from hitting and hardening photosensitive material that creates circuit lines. In 1991, Dr. Stephen Fodor of the Affymax Research Institute published a paper in Science showing that photolithography could also manage light to activate biological compounds. Here’s how that process works:

From “The Economist,” November 30, 2006

As you can see in the diagram above, the surface of the glass-based array is covered with the basic material to build proteins or DNA. The material only sticks in areas that are exposed to light, and the unneeded material is then washed away. Then another layer of different material (pieces of RNA) is flooded onto the chip, with another photolithographic mask controlling which areas will stick to the layer beneath. At each point, a short vertical strand of protein or DNA that has a unique structure compared to its neighbors gets built up.

The reason this works is that DNA has a unique molecular structure, the familiar double helix or two chains that wind around each other and also connect at certain points, looking something like a ladder that has been twisted. Each chain is constructed from four bases called A (adenine), C (cytosine), G (guanine) and T (thymine). These can occur in any order, but the connections between the two chains are always this: A pairs with T and C pairs with G.

That’s why the single strands of DNA built on a chip can be used to probe the genetic structure of material that passes over the chip. When the gene chip is done, the material to be analyzed flows across its surface and the DNA in the material will bind to the complementary gene fragment on the chip. Points on the chip that react can be detected under fluorescent light, and the computer keeps track of the exact structure of the DNA or protein strand that was made at each point.

The first gene chips carried short molecules called peptides, but the plan from the beginning was to increase complexity and speed to the point that the chips could be used for DNA analysis. And now they’re used for the whole genome analysis.

Affymetrix Appears

Dr. Fodor started Affymetrix in 1993 as a spin-off from the lab, funded with a $3.5 million grant from the National Institutes of Health. After a series of patent fights and licensing deals in the 1990s, AFFX emerged as the leading company in making gene chips. Their first product was a chip to detect mutations in the HIV virus, but they had similar programs in DNA sequencing, gene detection and pathogen analysis, simply because they had no idea what would pay off first.

The sequencing of the human genome turned out to be the driver for an explosion in sales of gene expression arrays in the late 1990s. Affymetrix could not keep up with the demand, even though the equipment cost almost $200,000 for a single analysis station, and the chips cost several thousand dollars apiece. It is a razor-and-blades business, and Affymetrix managed to get the highest market share of workstations (razors) and arrays (gene chips, or blades). The total market is now up to about $700 million.

Some of Affymetrix’s competitors include: Illumina, Agilent and General Electric Healthcare. Its biggest competitor, Illumina, has focused on Single Nucleotide Polymorphisms (SNPs), which are the small genetic changes that account for the differences between individuals, even though we all have the human genome. However, Affymetrix sued Illumina for patent infringement and won, and I would not be surprised to see a 15% royalty rate agreed to in the near future. In the meantime, AFFX has introduced its newest generation of SNP chips and seems to have caught up to Illumina’s technology. SNP chips are useful both for understanding and predicting predispositions to disease and responses to different therapies. SNP chips accounted for only 9% of the gene chip market in 2004, when Affymetrix filed its lawsuit against Illumina, but are projected to grow to 45% of the market by 2009.

Just this week, Nature published a paper based on the work of 256 researchers trying to link specific diseases to specific genes. With the financial support of the Wellcome Trust, they focused on seven diseases: bipolar disorder, coronary-artery disease, Crohn’s disease, hypertension, rheumatoid arthritis, type I diabetes (juvenile) and type II diabetes (adult-onset). They studied 2,000 people with each disease and compared them with 3,000 symptom-free people, using gene chips to look for associations between a disease and one or more of 500,000 SNPs.

They found 24 places in the genome that were so strongly associated with a disease that there was only one chance in two million that the link is accidental. Another 58 associations had less than one chance in 100,000 of being wrong. They had especially strong results in Crohn’s disease with nine near-certainties and type I diabetes with seven near-certainties. Many of the candidates corresponded to already-known genes, but others didn’t, so the next phase of the project will be to search the areas of the genome that these new SNPs point to for likely genetic suspects. Once the gene is discovered, the protein it encodes will become a new target for pharmaceutical research — using gene chips, of course.

The Future of Gene Chips

Just as in the semiconductor industry, gene chip prices fall year by year. In the mid-1990s, Affymetrix had to throw away 90% of the chips that they made because they failed quality control. Today, they throw away about 3%. They’ve also gotten better at packing more and more DNA strands on a single chip, to the point that their human genome set is only two chips, and it will soon be one. As costs come down, the chips can move out of the research lab into diagnostics, and eventually into doctor’s offices.

At the various Money Shows, I used to tell the story of the New York lawyer who had an inoperable brain tumor in the mid-1990s. He did his research and then paid $100,000 out of his own pocket to have the tumor tissue analyzed on Affymetrix chips. It was a metastasized breast cancer tumor. A small fraction of men get breast cancer, and it typically metastisizes to the brain. While there is little to be done for brain cancer besides surgery, there is an effective drug for breast cancer: Herceptin. He went on Herceptin and then went into remission. His $100,000 analysis in the mid-1990s would cost less than $10,000 today, and it will cost less than $1,000 in a few years. That’s why the unit volume of Affymetrix arrays will continue to grow at very high rates.

The first microarray diagnostic test was approved in 2004 in both the U.S. and Europe. Roche and Affymetrix collaborated on the AmpliChip to identify over 30 genetic variations in two genes that affect how quickly a person metabolizes many prescription drugs. This is the first of many steps towards truly personalized medicine, where drugs are given to the 25% to 50% of patients who will benefit most from it, not wasted on the 45% to 70% who won’t respond, and carefully kept away from the 5% likely to have serious side effects.

Roche has several other AmpliChip diagnostics in development, all based on Affymetrix microarrays and many for the treatment of cancer. One of them can detect 20 different subtypes of leukemia, while another finds mutations in the crucial p53 gene that may determine a cancer patient’s prognosis.

Of course, one of the biggest applications of gene chips is in drug discovery. Merck, for example, does about 40,000 gene chip experiments a year, and about 20% of their drugs now in clinical trials were developed with microarrays. MIT and Harvard are collaborating on a data base of gene expression profiles for all approved drugs in the U.S. They expect to discover new applications for existing drugs and also to identify new methods of action.

After revolutionizing biological research, this MegaShift is just beginning to create genomics-based diagnostics and therapeutics, and it has a long way to run. I’m not willing to buy Illumina until we know what their royalty rate to Affymetrix will be, as it could take a substantial chunk of their gross profit. But I have found another company, like Affymetrix, that is using gene chips to create the diagnostic tests of the future.

Buy Sequenom

Sequenom (SQNM) has its own genetic analysis platform called MassARRAY, but in addition to selling general-purpose equipment to research labs and biotech companies, as Affymetrix and Illumina do, it develops specific tests to run on its machines and also does contract research. The MassARRAY system is a high-performance nucleic acid analysis platform for DNA analysis, including SNP genotyping and discovery, and gene expression analysis. The company collaborates with Quiagen in Germany to develop prenatal diagnostics, including a more accurate test of placental fluid for Down syndrome to replace amniocenteses. A second collaboration with Lenetix Medical Screening Labs has developed a non-invasive Rh negative test for mother/baby incompatibility, which will be launched in July.

Sequenom is also developing tests for cancer focused on circulating genetic material from tumors. Their other major internal program is run by a UK-based subsidiary that is developing and using genetic tests to select animals to breed for higher-quality offspring.

March first-quarter revenues grew 43% from the prior year to $9.9 million, so they seem to be getting traction in these markets. Both sales of MassARRAY systems and contract research services are growing. However, they are managing their R&D and marketing expenses higher, so the net loss of $3.7 million was about the same as last year. They had $38.7 million in cash after an April private placement of $18.4 million, and they have no debt.

Sequenom is expecting to do $37 million to $39 million this year, up 37% from 2006 to the high end of the range. However, that would mean no sequential growth from the March quarter, in spite of the Rh negative test that’s about to launch, so I suspect they are low balling by a little. They also said that they will report a $23 million to $25 million loss, with a cash burn of $16 million to $18 million. That would be higher than the $12.2 million they burned through in 2006, with almost the whole difference accounted for by increased marketing and R&D.

While I think they will do over $40 million this year, I think their cash burn is on target, so they will lose about 40 cents a share. They can cut that loss in half in 2008 and turn profitable in 2009. I want you buy SQNM before the Rh test launches in July. Buy a partial position under $4.50, and leave room to double up if it goes under $4. My target for this time next year is $8.

Content on Demand

Motorola (MOT), which I recommended in a Flash Alert on Monday, is starting to drift up with the semiconductor group. If you recall, Motorola has great exposure to the cell phone industry, which is growing this year by about 15%. Cell phones are a huge part of the Content on Demand MegaShift, and that’s why I recommended that you buy the January 2009 $17.50 LEAP calls (VMAAW) under $4 for a $10.50 target in 18 months. While MOT’s common stock has moved up this week, the LEAPs are still trading under my buy limit and you still have a chance to get on board.

Silicon Image (SIMG) should benefit in the second half of the year from the pre-holiday build of consumer electronics, because now hundreds of products include the DVI or HDMI interface in the form of chips bought from SIMG or intellectual property licensed from the company. About 80% of SIMG revenues come from product sales and 20% from licensing fees. In addition, it is now clear that PC manufacturers are not going to choose the lower cost DisplayPort standard to save money, because HDMI is required to connect to all the consumer devices, whether mobile or sitting in the living room. Intel essentially blessed the HDMI standard at the recent, huge Computex show in Taiwan when they introduced their G35 Express Chipset with HDMI, using a Silicon Image chip.

The consensus earnings estimates for this year have drifted up from 35 cents a share 60 days ago to 38 cents, and I think the company will do over 40 cents this year and over 60 cents next year. Put this together with the strong balance sheet — $224 million in cash ($2.55 a share) and no debt — and SIMG is a timely buy all the way up to $13 for my $20 target.

Zhone Technologies (ZHNE) has been a disappointment so far, but the world is going their way. As Internet-delivered video takes off, especially high-definition video delivered by telephone and cable companies, the demand for bandwidth is exploding. That includes the famous last mile, with the connection to the home or business being a potential bottleneck. Zhone specializes in solving that problem for both phone and cable companies and has a reputation for delivering rock-solid equipment that is easy to install and backed by knockout customer service. If the current management can’t deliver in that environment, we’ll have to sell the stock next year. But in anticipation of better times, I have no problem buying ZHNE under $2 for my $5 target — on their own or in an acquisition engineered by the active venture capitalists still on the board of directors.

New Energy Technology MegaShift

Energy prices have soared over the past couple of weeks. They started up after a powerful cyclone hit Oman, which shut down a major terminal that ships 650,000 barrels of oil a day. It continued today, pushing oil over $67 a barrel, when the Department of Energy announced both a drop in refinery utilization last week due to maintenance downtime and an increase in gasoline inventories for the summer driving season.

I have been on the road a bit more than usual lately, and it sure looks like a lot more RVs and general traffic than the last couple of years. It could be the weak dollar has convinced Americans to vacation at home this year, but high gas prices are not affecting traffic.

Just a few months ago, the official OPEC line was that they are “comfortable” with oil around $50 a barrel. Now they are saying they are “comfortable” with oil between $60 and $65. That’s because they don’t think there’s any low-cost oil left to be found, and they are not worried about the alternatives being available in sufficient volume to make a difference in the next 10 years. They are right on both counts. All of our New Energy Technology MegaShift recommendations could show incredible growth and make us rich, without putting a dent in oil prices for five to ten years.

In the “oil shock” in 1981, after long lines at the gas pumps, Exxon spent $40 billion to find new oil. Now, with oil prices about double those “oil shock” levels, Exxon spent about half as much on exploration in 2006 as they did in 1981, while paying much higher prices for labor, drilling rigs and everything else.

BP, the old British Petroleum, has been pumping oil from Alaska’s Prudhoe Bay for almost 30 years. Their original estimate for the life of the field was 25 years. To keep it going, they spend billions of dollars maintaining old equipment and pipelines. Recently, they discovered a leak that forced them to shut down a fourth of their production — 100,000 barrels a day — and the news caused oil prices to jump. But the entire field is at end of its life and in the oilfield equivalent of intensive care. It will be gone soon.

The same story is playing out at older oil fields around the world. Worldwide oil production is supposed to hit 87 million barrels per day by the end of 2007, but it is going to be tough. This could be the year of peak oil production. With the low level of new discoveries and the high cost of finding oil, it will take just a few more of the old monster fields going into depletion mode to start annual production shrinking.

What does this mean for us? With the hurricane season officially underway, even a return to normal from last summer’s extraordinarily quiet period would be an additional shock to the system. A higher-than-normal year, as is being forecast by the same folks who blew the forecast last year, would be a disaster for oil prices — but great news for our energy technology stocks.

Energy Conversion Devices (ENER) announced a showcase installation of a 1.1 megawatt UniSolar system for an almond and pistachio grower and processor, Paramount Farms. That’s enough power to run 300 homes, and Paramount said that the system will pay for itself in six years. It’s a wake-up call for other businesses that want to “go green” in a way that makes economic sense. ENER is a strong buy at current levels and up to my $35 limit for my $55 target.

Royal Dutch Shell (RDS.A) is well above my $75 target, and those who bought it are understandably anxious to lock in their profits. But RDS.A can hit $80 to $85 in a heartbeat if a big Gulf of Mexico hurricane takes out a chunk of refining capacity. So I want you to continue to hold RDS.A for a higher exit price, even though I am not going to raise my target price. I’ll let you know when the time is right to sell.

WiMAX MegaShift

MobilePro (MOBL) drew a number of questions after an Associated Press story about how cities across the country that installed their own Wi-Fi systems are getting less interest than forecast, resulting in millions of wasted taxpayer dollars.

Folks, this is good news for MOBL, not bad, and they certainly could use some. These systems are installed by the city themselves, rather than franchise a company like MOBL to do the job. Typically, they refuse to sell advertising and have no sensible revenue model. Then, under pressure from the naysayers, they never deploy the whole system and it limps along, much like — surprise! — municipal transport.

When MOBL won the contract for Sacramento, they were very excited. Then the politicians bowed to the “inclusive” argument and said that the system had to be free, with limits on advertising. MOBL walked away.

Subscriber Ron noted that the article said the technology is wrong, overpromised and underdelivered, and he asked. “Isn’t this technology too big of a gamble right now?”

Ron, a mesh Wi-Fi network like the one MOBL is running in Tempe, Arizona, is not difficult to install. This is not bleeding-edge stuff. And while city councils have a long history of over promising and under delivering, MOBL signs contracts for systems that will be economically viable and then delivers them. They have to. My hope is that articles like this take the municipally-owned, not-for-profit crowd out of the picture, and open up most of the remaining 700 systems that municipalities say they want to build to MOBL and its competitors.

MOBL remains a hold until they sort out their capital structure.

One of the most successful products in the Content on Demand MegaShift is the cell phone. Yet, since our sale of Nokia we have only had a very small exposure to this industry through UTStarcom (UTSI). That’s because although the numbers are great — 890 million phones sold in 2006, growing this year by 15% or so to over one billion phones — the business has turned into a hits or fad business, like movies or music. It’s very difficult to predict the next winner in a fashion business.

Yet, at the same time, the cell phone is absorbing function after function, making other stand-alone products obsolete, especially at the entry level. Phones may now have Palm-style organizer functions, high megapixel digital cameras (some with zoom), camcorders, MP-3 music players, GPS location systems, email connectivity and Internet browsing. Only the very highest-level phones have all those functions today, but the relentless drop in technology prices, thanks to Moore’s Law, insures that this high-end cell phone will cost half as much in two years, a quarter as much in four years, and only 12.5% as much in six years.

That’s great news for consumers, but bad news for a lot of Silicon Valley companies that have seen their product become a feature of a cell phone, and their customer change from a leading-edge, hip consumer to a Fortune 500 purchasing agent who negotiates costs out to four decimal places.

Leadership in the cell phone business see-saws between Nokia, Motorola (MOT) and Samsung, with occasional peeps out of Sony Ericsson. In the smaller market for email-connected phones, Palm and Research in Motion’s Blackberry have substantial market share. The imminent launch of the Apple iPhone on June 29 is creating a lot of buzz right now, and assuming it is not another flop like the Apple TV, it should get some market share, as well. (While Apple would seem like a great investment to take advantage of the demand for cell phones, we are not going to buy it until we know Senator Feinstein has negotiated a free pass for Steve Jobs’ option backdating at both Apple and Pixar. If he had to resign from Apple, the stock would be cut in half.)

But there is another company that I think will give us good exposure to the cell phone industry that I’m going to recommend today, and that is Motorola. After a wonderful run with its Razr phones during a time when Nokia seemed to be taking a nap, Motorola is now the odd man out. Why? The Razr is a bit long in the tooth, Nokia has some hot new products, and Samsung’s phones are just as good and cheaper. So, just as Wall Street beat Nokia down below $11 in August 2004, and the stock is now over $28, MOT was hit down to $17.32 at the end of April. I think the stock is sold out, which is to say the risk is low.

But what about the reward? Obviously, in the “hits” business cell phones have become, I can’t predict when MOT will have the hot hand and be Wall Street’s darling again. It could be as early as this fall, or it could take a year or two. Who knows?

But there is something else to drive this stock up. MOT has attracted the attention of several private equity funds — the folks who like to see companies declare large special dividends, sell non-core assets, cut costs and buy back stock. The private equity funds may ask for a board seat or two, or suggest that a company put itself up for sale, or even put together a buyout deal themselves and take a company private. All of these things result in a higher stock price, often a much higher stock price.

Who are these worthies? Carl Icahn, the cover boy on the new issue of Fortune, bought a 1.4% stake in Motorola in January and demanded a board seat. In a private meeting with Ed Zander, the ex-Sun Microsystems President and Chief Operating Officer who has been the CEO of Motorola since January 2004, Icahn said that he would drop the demand for a board seat if Motorola would do a $12 billion buyback. Zander said the equivalent of “we’ll see” and went back to Schaumburg, Illinois. MOT then announced a lousy March quarter, and although they did implement a $7.5 billion buyback, Icahn was mad enough to run for the MOT board. On May 9 he lost the fight, but got an amazing 45% of the vote. So the board is on notice that if the company doesn’t start doing better, fast, they will have to find a new CEO with a better strategy.

Icahn is not the only holder, though. Eddie Lampert bought Sears and only owns six stocks, one of which is MOT. Highfields Capital, Jana Partners, Pzena Investment Management and Third Point Capital, all well-known activist investors, have been buying the stock aggressively under $20. Highfields and Jana have partnered with Icahn before, and Penza recently forced Lear to seek a buyer.

I think something big is going to happen here. It could be a new line of phones that knocks Nokia off its pedestal. It could be a big restructuring with an accompanying special cash dividend. It could easily be a whopping $65 billion buyout at $28 a share. I’m not sure which, or when, but my guess is the restructuring and cash dividend in the next 12 months. One argument in favor of the buyout, though, is that after Zander left Sun Microsystems in June 2002, he was a Managing Director of a technology buyout firm, Silver Lake Partners, through December 2003. He has the connections to orchestrate a friendly buyout and keep his job.

MOT closed Friday at $17.89, and it is down a bit this morning. I think you could pay up to $19 for it. Going from $19 to $28 — my target price for January 2009 — is a 47% return in 18 months. Not bad, but we can do better. I want you to buy the Motorola January 2009 $17.50 LEAP calls (VMAAW) up to $4 for a $10.50 target ($28 minus $17.50) in January 2009. That’s a 162.5% return, more than 3X what you would make on the common stock.

Why not buy the January 2010 LEAPs that are now available? First, I don’t think we need the extra year to have this work out. Second, only a $15 and a $20 strike price are available right now, and it is always awkward to get a position when the stock price is right between two strikes.

When you are buying these LEAPs, do not put in an order with a $4 limit, or even a market order. The Chicago Board Options Exchange floor traders are merciless, and they somehow have evaded the SEC’s drive to close bid-ask spreads to a penny. Instead, put in a limit order at or 10 cents under the ask price. The VMAAW closed on the bid at $3.10 on Friday, with a $3.20 ask, and at this writing is $3.00 bid, $3.10 asked with MOT down 20 cents. A fair price for the next few days would start from half the change in MOT stock on Monday added to or subtracted from Friday’s closing option price.

We have a lot on our plates for the next couple of weeks, as I want to take a broader look at some of our MegaShifts. To be prepared, here’s a quick look at what we’re going to be focusing on this week and next week. In this issue, we’ll take another look at solar power and our sole recommendation in this area, Energy Conversion Devices (ENER), where we have a rare buying opportunity. I also have a $1.50 solar stock that I want to tell you about today, but I am not recommending it — yet.

Plus, since we’ve talked a lot about wireless technology and faster, more efficient broadband services over the past couple weeks, I’ve received a number of questions about Telkonet (TKO). So, I’ve also reviewed Broadband-Over-Power lines and the situation at Telkonet below.

Finally, I suspect we have entered a period of high-level churning in the market that will last most of the summer, which will be frustrating to both the “sell in May and go away” crowd as well as the fully-invested roaring bulls. But it will give us a chance to sell some stocks, buy others and get ready for a big fall/winter rally. See the details in the Market Outlook, below.

Then next week, we’re going to switch our main focus from the New Energy Technology MegaShift to the Biotech MegaShift. That issue will be on gene chips, and in addition to Affymetrix (AFFX), which is a very timely buy, I am working on a $5 stock that could give us another horse in this race.

Now, let’s dive right in and check out what’s going on with solar power.

Fun in the Sun

With the heat of summer just around the corner, it seems like a good time to revisit the solar power sector, especially in light of the recent correction in solar stocks combined with some interesting initial public offerings. Solar power is probably one of the most well-known forms of alternative energy. But surprisingly, it isn’t very cost effective. It costs about four cents to generate a kilowatt hour of electricity using oil, on-shore wind or wavepower. It costs 25 cents to 35 cents to generate the same kilowatt hour using conventional solar. So, solar power makes little economic sense unless it is heavily subsidized by the government or the utilities. But it is heavily subsidized in places as disparate as Germany, the rest of Europe, New Jersey, California, China, Japan and South Korea, and many other jurisdictions, so as an investment solar can make a lot of sense. It is somewhat like corn-based ethanol — a dumb idea, embraced and protected by the government, and therefore to be taken seriously, at least until the subsidies stop.

I generally don’t like investments that depend on foolish government programs, but in this case, the pressures are so strong that I don’t see the funding slowing down anytime soon. So I am setting my personal prejudices aside to take another look at solar to see if we should expand our exposure in the area. (My prejudices, in case you haven’t guessed, are summed up by this capsule review of the original Independence Day movie: “Aliens invade Earth and destroy Washington, D.C., but later prove to be hostile.”)

First, there is no doubt that solar power has captured the imagination of governments, business and homeowners, and installations are growing rapidly. But it will not provide a significant share of the world’s electricity in the next 25 years. It is still limited to showcase installations, like the 4200 watts that I had on my ranch in Half Moon Bay. Other installations: Microsoft has an office complex in Silicon Valley with a SunPower solar system, and Google is out-greening them with the largest business solar commitment so far. But it won’t be holding that title for long. Last December, in an effort to improve its public image, Wal-Mart put out a request for quotes to install solar panels on virtually all of its U.S. store roofs. That is going to be a giant contract, presumably with more than one supplier, including United Ovonic Solar, the profitable subsidiary of Energy Conversion Devices.

Yet, these are all showcase installations by companies willing to ignore the low return on investment, even with government (that would be your tax dollars) subsidies. Enough sun falls on the earth every hour to supply all the electricity needs of the world for a whole year. The Department of Energy says that if solar panels were put on just one-half of one percent of America’s land, they could provide all the current electricity needs for the country.

So why doesn’t it happen? First, do you realize how much 0.5% of America’s land mass is? We have 2.3 billion acres total, but 375 million of that is in our largest state, Alaska. Probably not the best place to install solar power. The lower 48 states have 1.9 billion acres, including lakes and cities. So we would need to install solar panels on 115 million acres (2.3 billion times 0.05) somewhere in the lower 48 states. That’s equivalent to every square inch of Nevada, plus Florida. And if you are thinking “rooftops,” it takes a lot of rooftops to equal an acre — about 30 typical houses, assuming half of the roof faces south.

So solar is going to spread one office building, house or development at a time. But that still means it is a big business. The International Energy Agency says that in 2006, photovoltaic systems produced only four one-hundredths of one percent (0.04%) of the world’s electricity. But that was enough to create about a $14 billion solar equipment market, which has grown 40% a year for the last five years. It will slow to 20% this year due to a shortage of silicon, but then reaccelerate in 2008.

Electricity from Sunlight

To understand how solar power works, we need to take a look back in history to over 100 years ago. The photoelectric effect was discovered by a French physicist, Alexandre Becquerel, in 1839. He showed that sunlight generates an electric current between two metal electrodes that are immersed in a conductive liquid. Around 1880 an American inventor, Charles Fritts, built the first solar cells with selenium and a thin layer of gold. They converted less than 1% of the sun’s energy to electricity. It took another 75 years or so before the first practical solar cell came out of Bell Labs, which also had invented the transistor. Their solar cell was a semiconductor made of thin strips of crystalline silicon and had a 6% conversion efficiency.

Most of today’s solar cells have the same basic technology. Two layers of semiconductor material, usually silicon, are placed against each other. One layer has an excess of negatively charged electrons (n-type). The other layer has an excess of positively charged holes (p-type). Where the layers touch, the electrons fill the holes. When light hits that area, the photons in light knock some electrons free, and these are picked up by a circuit at the back of one layer, which circles around to the back of the other layer. Electricity flows along the circuit. The more electrons that can be knocked free, the higher the efficiency of the solar cell. State of the art cells today run at about 15% to 20% efficiency. By using solar concentrators, cell efficiency can be boosted to 40% (although at higher cost, due to the need to build and aim concentrators).

Back in 1955, the Bell Labs solar cell cost over $200 per watt and might have died due to its cost, but three years later Russia launched Sputnik and the space race was on. In 1958, America launched its first Vanguard satellite, and like Sputnik, the batteries went dead in a few weeks — but it had solar panels that continued to power the radio transmitters for years. Solar had a buyer who could pay and demanded better and better products through continuing R&D.

The Solar Power Corporation was formed to bring solar cell costs down enough to make them a commercial product as well as a military product. By using cast-off wafers from the semiconductor industry and applying cost reduction strategies to the manufacturing process, Solar Power cut the price of solar cells from $100 a watt in 1970 to just $20 a watt three years later. By the mid-1970s the oil and gas companies were using solar for remote power on pipelines, and by the early 1980s the Coast Guard had them on buoys. Costs continued to fall, and by the early 1990s there were hundreds of applications like emergency roadside phones, remote telecom equipment, watches and calculators. By the late 1990s, subsidy programs in Germany and California led to an explosion in residential solar installations — that’s when I installed mine. In 2004, solar cells produced electricity for $2.70 a watt. Subsidies like the California “Million Solar Roofs” program ($3 billion in rebates over 10 years) and tax credits cut the cost to the U.S. consumer by about 40%. In Germany, the subsidies go to the utilities that produce solar power and have made that country the second-largest solar market in the world.

From “The Economist” March 8, 2007

An Investment Opportunity

Venture capitalists invested $2.9 billion in clean tech startups in 2006, up almost 80% from 2005, and $308 million or 10.6% of that went into solar. There already has been a shakeout and consolidation in solar cell and photovoltaic module manufacturers, capped by the bankruptcy of Astropower and its subsequent purchase by GE in 2004. Big companies like BP, Shell, Kyocera and Samsung dominate standard solar cell production. So why would the VCs be interested?

New technology. They look at successful stocks like First Solar, a company that doesn’t use silicon in its PV modules, and see a model for a successful investment in this still-early-stage technology. So they put their money in thin-film PV companies, which use much less silicon and therefore don’t have the supply problems that many of the traditional manufacturers do. Private companies like Nanosys, Nanosolar and Miasolé, all in Silicon Valley, hope to combine Astropower’s cheaper continuous manufacturing process with thin-film solar designs to slash the cost per watt.

From that low point of $2.70 a watt in 2004, solar power has seen an increase to $4 a watt in 2006. That is in spite of a steady 5% per year drop in manufacturing costs as cells become thinner and more efficient, and factories get larger. The reason is simple: A shortage of silicon. In 2008, the worldwide solar industry will use more silicon than the worldwide semiconductor industry, for the first time ever. There are not all that many producers of raw silicon wafers, the largest independent being MEMC Electronic Materials (WFR) — a stock that has roughly tripled over the last two years. High prices are causing established producers to expand production and new producers to get funded, so I expect supply to catch up with demand in 2008. Then solar cell prices should go back under $3 a watt in a hurry.

The move to thin-film technologies will help. Silicon accounts for 40% of the cost of a conventional solar module, but thin-film cells that are very good at absorbing photons use only 1% of the silicon for the same area. Thin-film cells are easier to make on a continuous production line, as they can be placed on a flexible backing and come off the line like a roll of paper towels.

The first thin-film efforts in the 1970s focused on cadmium sulphide, but it proved to be very unstable. As the graphic below shows, a number of newer thin-film technologies are in development to compete with standard crystalline silicon. Cadmium telluride is the technology used by First Solar. Their panels run at low efficiency, about 9%, but they are so much cheaper to make that they sell for only $1.40 a watt. Due to the lower efficiency, they take more square footage to produce the same total amount of electricity, but that often doesn’t matter. First Solar focuses on large commercial systems with lots of roof area, or ground systems.

From “The Economist” March 8, 2007

Copper indium gallium diselenide (CIGS) has much better efficiency then even crystalline silicon, in the 19.5% area, but it is difficult to produce. All four materials have to be uniformly distributed on the substrate, which is hard to do over a large area and very hard on a moving, thin substrate. Both Nanosolar and Miasolé are betting on CIGS. Nanosolar, which has raised $100 million to be the best-funded solar startup, mixes nano-sized particles into an ink that is used to continuously coat metal foil. The foil is then heated and the particles self-assemble correctly.

Miasolé deposits the CIGS layer using a sputtering process developed to make the magnetic disks for hard disk drives. They plan to finish the individual cells with a flexible cover, so they can create a photovoltaic roofing material that can be rolled out like carpet. The company is backed by the major venture capital firm Kleiner Perkins, which gives them instant credibility.

SolFocus, a Palo Alto startup, uses lenses and mirrors to concentrate sunlight onto high-efficiency solar cells, using the dramatic efficiency improvement to reduce the cost per watt. They licensed their technology from Boeing’s Spectrolab subsidiary, a large supplier of solar panels for space applications. Spectrolab recently claimed over 40% efficiency under concentrated sunlight. But the extra cost of the mirrors and lenses makes this an apples-and-oranges comparison, and, so far, I have not heard any good data on cost per watt.

I’ve saved the best for last: Amorphous silicon. With silicon, it takes an expensive manufacturing process to give it a uniform crystalline structure. Amorphous silicon, the non-crystalline form of silicon, on the other hand, has a very disorganized structure and can be made cheaply. Its efficiency used to degrade after long exposure to sunlight, but new triple-junction solar cells that absorb light of different wavelengths have solved that problem. Efficiency now comes in at about 12%. The largest manufacturer of amorphous silicon cells, and one of the largest thin-film manufacturers in the world, is the United Ovonic Solar subsidiary of Energy Conversion Devices.

The Bottom Line

The Department of Energy is aiming to get solar cost-competitive with oil and gas-based utility power by 2015. The thin-film companies think they can do it quicker. First Solar says that they will be there by 2010. Nanosolar says that they will be there at the end of this year, when their first panels come to market. I’m doubtful about that one. Plus, all the thin-film companies will have to look out for a glut of silicon in 2008 or 2009 that could help conventional solar producers cut their current prices by as much as 50%.

The stock market is responding by getting cautious on many solar stocks. Trina Solar (TSL) was a December IPO that tripled, and now it is about 40% off its highs. JA Solar (JASO) came public in February and is 17% off its high. China Sunergy (CSUN) came public May 16 at $11, jumped above $16 and now is back around $12. LDK Solar (LDK), which sells silicon wafers, priced last Friday at $27, the high end of its range, and broke below $27 on Monday. There have been eight solar IPOs since November, with more in the wings. Too many suppliers will drive down prices and profitability, all the way back through the production chain.

I looked closely at Solar Enertech (SOEN on the Bulletin Board) for this issue. It’s a $1.50 stock with a quality management team and money in the bank. They are funding an R&D lab at Shanghai University, where their production is. Their U.S. base is in Menlo Park, California, and they have U.S. auditors. But I judged that it was too early to invest in SOEN in light of the coming decline in silicon prices, which will change the competitive dynamics in the industry.

That leaves us with Energy Conversion Devices, and I think that’s an excellent place to be. They have not been buffeted by the doubling and redoubling of crystalline silicon prices, or the supply interruptions. ENER’s recent restructuring announcement focuses the company on getting all the other parts of their business to breakeven or profitable, while United Ovonic Solar is already there. The stock does not often trade under my buy limit, but it is now and I want you to build a position in ENER while it is under $35 for my $55 target.

Content on Demand MegaShift

Harmonic (HLIT) has a hot new product that combines switched digital video with a modular cable modem termination system, creating a one-box solution for cable companies moving to digital video on demand. Comcast is about to do a head-to-head comparison of products that manage bandwidth resources for customers that have their TVs turned on and are using video on demand. The two products they are comparing come from C-Cor and Motorola, and both trials use the Harmonic box.

Wall Street has trouble believing that Harmonic is about to post a string of good quarters, because investors have been burned before by surprises and lumpy quarters. But I think video is the place to be right now in the whole universal connectivity and convergence drivers for the Content on Demand MegaShift, and the new management at Harmonic is very likely to deliver upside surprises for the rest of the year. HLIT remains a Top Buy up to $10 for my $16 target.

Intel (INTC) has entered a joint venture with Asustek, the world’s biggest producer of computer motherboards, to make laptops that will cost only $200 to create mass markets in less developed countries. The Eee PC (“Easy to learn, easy to work, easy to play”) will be introduced this summer under the Asustek brand name, and their 2007 sales target is a modest 200,000. The competing XO computer uses an Advanced Micro Devices processor and is available in the U.S. Don’t rush to get one — the 7″ screen would drive you nuts. But if you are one of the one billion people in the world who has never owned a computer and can only afford to pay $200 for one, it’s going to be a big seller. The Intel January 2009 $22.50 LEAP calls (VNLAX) remain a Top Buy up to $3.50 for my $12.50 target.

Silicon Image (SIMG) licensed their multi-standard video decoder technology to CeRoma, a leading designer and manufacturer of advanced system-on-a-chip solutions for digital video broadcasting. CeRoma is entering the consumer electronics market, beginning with set-top boxes and digital TVs. The Silicon Image technology works with three video standards, H.264, MPEG-2 and VC-1, and can decode two high-definition streams at once in real time, with less than one million transistors and at low heat dissipation. The same technology is already in mobile devices and both new DVD standards, Blu-ray and HD DVD. The video market is moving from “almost HD” showing video at 30 frames per second to true HD at 60 frames per second, and Silicon Image has the only technology to do that in real time. SIMG remains a buy up to $13 for my $20 target.

Telkonet (TKO) has understandably been the subject of many, many emails that I want to address together. First, let’s take a broad overview: The delivery of broadband over power lines (BPL) is finally starting to make significant progress. Regulatory decisions by the FCC and some state utility commissions, especially California, have cleared the path.

There are two parts to this market: BPL over utility power lines to compete with cable and telephone Internet service providers, and BPL inside the building to compete with cabling and wireless. In the utility market, Texas Utilities will deploy BPL to two million homes and 250,000 businesses by the end of 2008. They are working with Current Communications, a private company that is 10% owned by Google, to install 400,000 smart meters in their distribution system this year. They will be able to read the meters remotely, diagnose distribution network problems and provide Internet access.

In the suburbs of Paris, the French utility company SIPPEREC plans to offer BPL service to 1.5 million homes and apartment buildings. Other trials in the U.S. and Britain continue.

BPL at the utility level has some technical issues, such as getting around the step-down transformers that sit on poles outside your home or office and reduce the voltage to 110 for consumer use. It also carries about 100 megabits per second on a medium-voltage cable that is divided among customers, yet in a city there could be 15,000 people sharing a cable. I think broadband starts at one megabit (most DSL is not really broadband, and not suitable for real-time video), so more than 100 customers on line at once could be a problem.

These are not problems for in-building BPL. In-building BPL has other challenges, such as widely varying loads as devices plugged into the wall start and stop. There often is no up-to-date wiring diagram for the buildings where BPL makes the most sense — older structures with ornate décor that would be brutally expensive or impossible to remove and replace for a cable installation. Many of these buildings have walls of plaster over metal lath, which stops most wireless signals cold. A single-point BPL connection on the building side of the electric meter plus a single-point connection to the Internet, which could be coming over a fiber cable, a copper wire, a wireless connection or even a utility BPL connection, solves the problem. That’s what Telkonet does better than anybody.

For the March quarter, they reported $1.2 million in revenues, split about 50/50 between outright sales and rentals. That was down from last year’s $1.9 million because they booked over $1.5 million in sales in that quarter. They lost nine cents a share, the same as last year, but on more shares outstanding. The dollar loss was $5.4 million versus $4.2 million last year, and they finished the quarter with $3.5 million in cash. That’s tight, and although they had $1.3 million in accounts receivable, they also had $3.9 million in accounts payable.

Management’s response to tight cash has always been three-fold: Pay for things with stock ($508,000 this time), sell stock ($9.6 million this time), and make an acquisition that has cash on its balance sheet. The latest buys in March were Smart Systems International and Ethostream. The company thinks that they have enough cash and access to cash to get through 2007, although they would have to raise money to do any more acquisitions.

Smart Systems provides energy monitoring, and Ethostream focuses on installation services in the hospitality industry, so these fit with Telkonet’s BPL business to provide a complete package to hotels, which is a major market for TKO.

But the Microwave Satellite Technologies acquisition, which sells voice, video and Internet services, was a mistake and needed to be sold. MST has to lease equipment to customers, which consumes cash, and it is not a contributor to earnings. Telkonet just spun off 37% of this operation by doing a $9.1 million private placement and reverse merger with a shell company, now renamed MSTI Holdings. Telkonet converted $5 million in debt at $1.00 a share, while new convertible holders come in at 65 cents a share and equity holders at $1.00. The stock symbol is MSHI on the Bulletin Board, and it closed today at $1.43, down 17 cents.

I received a question from Lew about this: “Please explain the TKO spinoff of FITX and your opinion on why this is good for us TKO shareholders.” (FITX was the symbol for the shell company, now changed to MSHI.)

This is good because it gets them out of managing an unrelated business, even though they will have to consolidate financial results until they can reduce or get completely rid of their 63% holding in the new company. It also focuses their story for Wall Street and potential strategic partners on BPL.

Subscriber Michael asked: “What is it the short sellers are saying about TKO that you disagree with? How risky is this investment at current levels?”

The shorts are saying that the company will not be able to raise money on attractive terms, and it is not focused on its major opportunity in BPL. I think now that they are exiting from MST, they can get a strategic partner to put in money at an attractive valuation for the BPL business. Of course, any microcap stock is risky, and TKO certainly is not the place for all your retirement funds. But the flip side of this risk is the very high rewards that we can bank as BPL takes off.

Alan asked: “My concern is that despite all the hype with contracts, I have yet to see this translate into any significant revenues for the company, and Ron Pickett’s letter to the shareholders suggesting $25 million in 2007 is starting to look like a pipe dream to me. Now I find that he is not an on-site CEO. Forgive me but I’m starting to get nervous. Help me out here.”

Telkonet won’t do $25 million in 2007, although they could exit the year at that run rate by doing $6.25 million in the December quarter. Depending on how fast EDS proceeds with the contract to install BPL at Army and Marine bases all over the world, that could happen. But Pickett was counting on MST revenues, so even he would back away from that projection now. I strongly agree with you about the on-site CEO issue, and this may be the biggest problem the company has.

Joseph said: “First, I am concerned about management’s lack of strategy to penetrate the available market for Telkonet products in European countries that build homes and business using concrete slab. I would think that Telkonet’s products would be a hit with consumers in those countries like Albania, Montenegro, Italy, Slovania, Hungry, Kosovo, Macedonia, Bosnia, Turkey, Croatia, etc., that are hungry for broadband technology but cannot afford a cable solution.”

TKO does have distributor partners in Europe, who have won some good-sized contracts. They are looking for more partners to cover some of the countries you listed, but they need very qualified systems installers selling at least to the hospitality industry. And if there is no cable at the curb or high speed point-to-point wireless available, it doesn’t make sense to install an iWire system.

Joseph then added: “I note that Quest Communications seemed to recently suggest that it would be using exiting power lines to provide a triple play solution for its customers. As such, I am wondering if Telkonet has approached the likes of Quest Communication to provide them with a quick answer to its competitor’s cable build-out advantage.”

Telkonet does not do the utility distribution part of BPL, only the in-building part.

And finally: “Third, I am concerned that Telkonet has not secured any investment infusions to be able to execute on its marketing, distribution, and research & development plan.”

They have raised some money, including $9 million in the March quarter. My issue is the number of shares that they have to give up to get money at this level, which is why I would be glad see them sell the rest of their MSHI shares and any other extraneous operations, and get a strategic investor/partner.

While I am uncomfortable with the absentee CEO issue, TKO is the leading company in one of the best growth markets around. With EDS as a partner and MST off their plate, more or less, they have a chance to show us what they can do in broadband-over-power lines. TKO remains a buy up to $5 for my $15 target.

New Energy Technology MegaShift

FuelCell Energy (FCEL) announced good April second-quarter results and forecast major positive news coming in late July or August. First, the numbers. Revenues grew 20% from last year to $11.4 million, which included a 37% increase in product revenues to $8.9 million. R&D contract revenues declined to $2.5 million from $3 million. At the end of the quarter, the product backlog was up to $36.8 million from $23.9 million last year, and the R&D contract backlog was $26.4 million, up from $9.8 million last year. This week, their South Korean partner, Posco Power, came through with three orders totaling 5.1 megawatts of power. That brought the product backlog up to about $54 million, or 14.4 megawatts of power.

But the big news is the Connecticut 100 program, where six projects were selected that used FCEL equipment, totaling 68 megawatts — almost 5X their current backlog. The utility customers for this power are now evaluating contracts, and the company expects that process to be completed in two weeks. That will be followed by power purchase negotiations that will take four to six weeks to the end of July, with contract signings and announcements in August. This is going to be terrific news for FCEL and should move the stock dramatically. It will equal about $200 million in sales over 18 to 24 months, starting in the December quarter and accelerating rapidly in 2008.

The company lost 32 cents a share compared to 37 cents from operations last year, and still has a negative gross margin. But they narrowed the gross margin loss through an ongoing cost reduction program, and they expect to drive the cost of their largest 2.4 megawatt system from $3,250 per megawatt now, building them one at a time, to $2,400 per megawatt when they get into volume production on the Connecticut 100 program.

Business in California remains strong, Connecticut is coming very soon, and South Korea is taking off. This is an excellent time to buy FCEL up to $11 for my $22 target — almost a triple from today’s close.

Ocean Power Technologies (OPTT) picked up coverage this week from UBS Securities with a buy rating. UBS was one of the underwriters of the botched U.S. IPO in early May. The other underwriters were Banc of America Securities, First Albany and Bear Stearns, and I expect one or two of them to initiate coverage as well.

This morning, OPTT announced a $1.7 million Navy contract to provide PowerBuoys for testing as the power source for the Deep Water Acoustic Detection System program, a proposed wide area unattended sensor network for sophisticated data gathering and communications systems. The contract starts immediately and runs for 18 months. It should develop into some very large orders in a couple of years. OPTT is a strong buy under $20 for my $40 target.

Rentech (RTK) got some amazing news as both houses of Congress in a bipartisan agreement put together a coal-to-liquids financing package. If it goes through in the energy bill this summer, it could include $30 billion in loan guarantees for coal-to-liquids plants, a 51-cent-per-gallon tax credit for coal-to-liquids fuels through 2020, automatic subsidies if the price of oil drops below $40 a barrel and permission for the Air Force to sign 25-year contracts for almost a billion dollars a year of coal-based jet fuel. Wow!

Just a couple of days before Congress acted, Peabody Energy, the largest private coal company in the world, decided to pledge nearly one million tons of Illinois coal a year and up to $10 million in development funds for Rentech’s East Dubuque, Illinois, plant, in return for an option to acquire 20% of the plant. Peabody and Rentech have been looking for a project to do together, and it turned out to be Rentech’s conversion of the fertilizer plant from natural gas to coal. When the job is done in 2010, the plant will produce about 400,000 barrels of liquid fuel per year, as well as about 545,000 tons of nitrogen fertilizer. Fertilizer manufacturers are usually at the mercy of widely fluctuating natural gas prices. Illinois has an estimated 38 billion tons of unmined coal, so there’s no danger of running out!

Incidentally, coal-to-liquids can be stored five to 10 times as long as diesel, making it ideal for strategic reserves.

Rentech also said that the Mississippi Business Finance Corporation has approved an inducement resolution for up to $2.75 billion of tax-exempt and taxable Industrial Development Revenue Bonds to build a coal-to-liquids plant in Natchez. This is Step #1 in a process for the state to issue project financing bonds to build the plant, and Step #2 is committing to a location. The company and the city of Natchez have identified a spot, and Rentech is now evaluating it.

The League of Conservation Voters says burning a gallon of liquefied coal releases almost double the carbon dioxide — a greenhouse gas — as a gallon of gasoline, “turning a compact car into an SUV from a global warming perspective.” It turns out that this is from a two-page report by the Natural Resources Defense Council, and it assumes all the carbon dioxide created in the coal-to-liquids process is released into the air. Rentech intends to release nothing into the air, so the whole argument is based on quicksand. Their real issue is that coal mining is environmentally destructive. No argument there, but have they thought about the benefits of diverting some of the current coal production to a CTL process, instead of burning it in a utility boiler? Peabody Coal provides 10% of the electricity in the U.S., and I can guarantee you that they have thought about the higher value-added they can get by selling CTL through a pipeline instead of coal on railcars. Buy RTK up to $5 for my $11 first target, and look for another big move up when the energy bill passes Congress.

WiMAX MegaShift

TowerStream (TWER) completed their $40 million financing on terms that surprised me and the market. I thought the company would get the deal done in the mid-$6 to high-$6 area, and the stock would quickly move up to the mid-$7s. But they had to slash the price to $4 to raise the money, which means issuing an additional three million shares. I can’t blame this weak offering on the investment bankers, as was the case with Ocean Power Technologies’ recent offering. I suspect Wall Street is just not ready for a WiMAX services company, figuring the early profits usually go to the equipment suppliers as the service providers build out their networks. For all the reasons in last week’s recommendation, that is not true of TWER.

Although the terms of the deal were disappointing and caused what I think will be a very short-term decline in the stock, they now have the money, and the extra three million shares won’t even be remembered by this time next year. After the deal, the company has a market capitalization of only $165 million, whereas this time last week they were valued at $244 million. The only difference between this week and last week is that now they have about $45 million in cash instead of $7 million or so!

This makes no sense, and if you are pursuing a multiple buy strategy for TWER, now is the time to finish off your position. If you have not yet bought the stock, or even if you bought a full position, use this decline to buy it or double up. I’ll take my buy limit down $2 to $6 to reflect the market decline and the target down $1 to $16 to reflect the additional shares outstanding, but nothing in their very attractive fundamental outlook has changed.

Market Outlook

Higher bond yields pushing through 5% due to some comments by Chairman Bernanke and some stronger economic data led investors to worry about a Fed increase and also provided an excuse to sell stocks. Today the S&P 500 tested back down to the 1495 breakout area, and it failed the test. Unless it very quickly reverses tomorrow morning, the long-awaited test to 1440 is in the cards.

Yet, this still does not change the big picture of a strong market, and I expect a consolidation between 1500 and 1600 to rule most of the next few months. We will see occasional forays outside those limits, but I think the parabolic move up to 1800 by the end of the year is getting less likely. If the S&P had gone above its old high, sucking in some more underinvested bears, and then collapsed back to build up a lot of fear, we might have seen the parabolic move. Now, we’ll go down enough to let the “sell in May and go away” crowd feel good, then pull the rug out from under them and run back up slightly over the all-time highs around 1552 so the wild-eyed bulls feel better, and then pull the rug out from under them. This game can be played from, say, 1560 back to 1510 or 1518, then back to 1580 or even 1610, then back to 1528, and so on, until everyone is exhausted and confused. At that point the fourth-quarter rally should take off and roll on right through the first half of 2008.

I may make a couple of more buy recommendations if the market drops further, and we’ll have a few more sell recommendations on the upswings. Generally, though, I think we have the right stocks in the right areas to take advantage of what still looks like a two-year tech bull market into the 2008 Presidential election.