It’s a rodeo market–if you can stay on the bull more than eight seconds, you win. Rodeo bulls are experienced, tricky animals that twist, jump and drop in explosive ways to unseat their riders as quickly as possible. Sound familiar? Beginning bull markets do the same thing, chasing everyone to the sidelines before they start their big up-move.
Bear markets, in contrast, are like a lazy summer day by a sweet-smelling river, lulling everyone to sleep just before the flash flood comes roaring down to wipe everything out before anyone can get to high ground. A market this frustrating and dangerous almost has to resolve to the upside.
Falling oil prices should continue to help. I still think the Israel/Syria peace deal is on, although an announcement might be delayed past the Israeli elections in September. Prime Minister Ehud Olmert announced he will resign in September due to a corruption probe. The top contender to replace him is Shaul Mofaz, a hard-line former defense minister and retired General of the Army. He can close the deal without any accusations of being weak.
I also think the public quarreling over Iran’s nuclear activities, where six countries including the U.S. agreed to seek new United National sanctions against Iran, is just the usual stuff for public consumption. Vice President–oh, excuse me, Secretary of State Condoleezza Rice needs this win to boost the McCain-Rice ticket into the White House, and President Bush wants some win to end his second term on a positive note.
Iranian President Mahmoud Ahmadinejad said Saturday that his country would not give up its “nuclear rights,” signaling that it would refuse demands to stop enriching uranium or at least not to expand its enrichment work. So now the deal is: You can keep enriching, just don’t increase the level and huge sums of Saudi money will rain down on you. Sounds like a deal to me.
If either of these political deals happens, oil can get down to $100 a barrel. If both happen, we should see $80.
But the market doesn’t care what I think and predict, so let’s check in with the S&P 500 to see what it is telling us. On March 17, right on the expected turn date, the S&P spiked down to an intraday low at 1257, before recovering and heading up for two months to 1440. From that energy level, which I identified for you well in advance, the S&P slid all the way down to a spike low of 1200 on July 15, with a close at 1215. While this was an undercut of the March 17 low due to the extraordinary amount of bad news in the financial sector that day, in retrospect it was a double bottom. Since then we have seen a successful test on July 28 that found buyers at 1234, followed by a steady march up to yesterday’s close at 1289. Then today developed into a another bronco ride back down to successfully test the 1260 level from above.
While there is a lot of energy stored up to move this market higher next week, the next couple of days are likely to show a necessary short-term consolidation. I think we will break through the 50 day moving average at 1302 next week, as our old friend 1326, a key attractor/repeller level going either up or down, pulls the market up. If there’s as much energy available as I think, after a bit of consolidation around 1326 we should see the S&P climb above its 200-day moving average at 1377 and move pretty quickly back to the 1440 level than stopped it on May 19. From there, we will find out if the next stop is new highs and a possible parabolic leg up, or a very serious leg down in an ongoing bear market.
I had a question from Jack S.: “Normally, does the business cycle lead the stock market, or does the market lead the business cycle? What do you think will happen this time?”
Jack, the business cycle always tops after the stock market, and bottoms six to nine months after the market bottoms. The stock market is in the Leading Indicators index you hear about each month, and of the 12 indicators in that index, it is the single best indicator of the economic future. In the last upturn, the market bottomed in June 2002 and again in October 2002, but the economy really didn’t show any signs of turning around until March 2003. If you wait for the economy to get better, you will always miss the bottom. At the top, you will be puzzled by declining stock prices while the economy is strong, and brokers will knock themselves out telling you the low price/earnings ratios mean you have to buy–just before the earnings start to disappear.
I don’t think this cycle will be any different. The market has turned up. Financial sector earnings are terrible, dragging down all the macro forecasts. But non-financial earnings are pretty good, and guidance is OK, if cautious. I’ve been saying that even as the mature economies slow in 2008, emerging nation growth in Asia and the CRIB (China, Russia, India and Brazil) would support decent worldwide growth in 2008. I’ve also been saying that capital spending will slow, but what there is will be tilted towards technology in both mature and emerging economies. That’s essentially what Cisco said this week, confirming earlier reports from Intel, IBM and a host of others.
Biotech MegaShift
The biotech sector has been relatively strong, up about 12% over the last four weeks, as investors look for something that is immune to both the credit mess and a weaker U.S. economy. If we get the rally I am expecting, investors may shift money towards more cyclical areas like computing and communications, but I still think the aging baby boomers pretty much guarantee the future of this MegaShift.
BioCryst (BCRX) reported June quarter results this morning, and missed the consensus on both the top and bottom lines. They did $2.7 million in sales and lost 33 cents a share, well under the $14.3 million and 21 cent loss analysts were looking for. Not only were current peramivir program revenues from Health & Human Services at the low end, due to less activity, but the company took a $4.9 million reserve for monies previously paid by HHS for the Phase III intramuscular program that was discontinued earlier this year. BCRX is in “discussions” with HHS about what the reimbursement will be.
The company still has a comfortable cash level of $74.2 million. They now expect the total 2008 cash burn to be at the low end of their $25 million to $30 million guidance, and that includes getting nothing from HHS on the $4.9 million reimbursement at issue.
We bought this stock for the intravenous clinical trial that would make permavir the leading antiviral to treat avian flu, and that program is on track. We will get an update on the Phase II trial in the December quarter. Another Phase II trial of intramuscular peramivir for seasonal flu is ongoing in the Southern Hemisphere, and we’ll also see results from that in the December quarter. In addition, their Japanese partner had good results in a single-shot, outpatient intravenous Phase II trial for seasonal flu, and is going to start a Phase III trial.
It’s pretty clear that peramivir works well against flu, with the main questions being dosage, needle length, and whether intramuscular can work, or intravenous is the way to go. If it also works against avian flu in the hospital setting, BioCryst can start generating revenues before completing a Phase III trial, simply by getting on government purchase lists. I still think this one is going to work out well, and BCRX remains a buy all the way up to $8 for a $30 target after peramivir is shown to be effective against avian flu.
CombinatoRx (CRXX) reported a 51 cent loss in the June quarter, bigger than the consensus expectation for 41 cents due to lower than expected revenues of $3.4 million. But they did not change their revenue guidance for the year of $15 million to $20 million. They burned $18 million in cash in the quarter, and have $81 million left, plenty to get to mid-2009.
There will be multiple events to drive the stock price up in the second half of 2008. The most important will be the Phase IIb COMET-1 trial for Synavive in knee osteoarthritis is due in October. The trial enrolled 279 patients, a few more than the 250 originally planned. Remarkably, about 80% have elected to continue on into the 12-month active-drug extension trial. All subjects who have reached three or six months in the extension trial have elected to remain in the study. The company has developed an aligned release formulation of Synavive that gets rid of the main side effect, a headache.
In the next four months we also will see Phase IIa data for CRx-401, their Type 2 diabetes medication composed of an anti-cholesterol agent (bezafibrate) and an aspirin derivative (diflunisal). Finally, they will start a Phase IIa trial for CRx-197 in plaque psoriasis and atopic dermatitis before the end of the year.
They are in discussions with prospective dermatology partners for CRx-191 after the good Phase 2a clinical data in plaque psoriasis reported earlier this year. At their recent R&D day they talked about preclinical programs targeting Hepatitis C virus infections and B-cell malignancies. It is a very full plate.
CombinatoRx has a market capitalization around $150 million, or only $70 million net of cash. They have spent over $140 million on R&D in their relatively short life, most of it successful. We can buy the stock today for half of what they’ve spent on R&D, net of cash–an extremely low multiple. I don’t see how we can miss. I am making CRXX a Top Buy, while keeping the buy limit at $7 and my first target at $16.
Dendreon (DNDN) said the Data Safety & Monitoring Board will take their interim peek at the data from the current Phase III Provenge trial in October. If there is a statistically significant survival benefit, the drug will be approved early next year. If not, Dendreon will complete the trial in the second half of 2010.
This could be explosive, because DNDN is one of the most hated stocks in America. A stock screen of the Russell 3000 for a short interest ratio in the top 10% of all stocks, a consensus analyst rating in the lowest 10% of all stocks, and put option open interest relative to call option open interest in the top half of all stocks returns eight stocks, including DNDN. It has a short interest ratio of 28.1, which is how many days of average trading volume it would take to cover all the shorts. It has an average analyst rating of 2.4, which is halfway between “sell” and “neutral.” It has a put/call open interest ratio of 1.4. Also, it has the best performance in 2008 of all eight stocks.
You can see why I use words like “explosive” when describing what will happen to the stock if the results are significant. Remember that this interim peek was powered from the beginning to show statistical significance if the characteristics of the patient population are the same as in the two earlier Phase III trials. DNDN remains a buy up to $8 for a $40 target after Provenge is approved.
eResearch (ERES) reported record transaction volumes, record revenues, record orders, record backlog and very strong margins. I guess that’s why Wall Street only knocked the stock down from $14.90 to $14.00.
Revenues hit $35.5 million, up 43.4% from last year’s $24.7 million and just about on the consensus for $35.7 million. They did 13 cents a share, a penny ahead of the consensus and up 62.5% from last year’s eight cents. Orders were up 42% to $49.0 million, and came from a wide range of customers, including 16 new ones. They booked a record 15 new Thorough ECG study agreements, with an average value just over $900,000 each. Pricing is stable. The backlog is up to $157.9 million, and the book-to-bill ratio was 1.4X. That indicates 40% growth over the next 12 months.
The company is strongly net cash flow positive. Operating activities provided $10.4 million in the quarter, and they added $7.0 million of that to their cash hoard, which is now up to $55.9 million.
So what’s not to like? Guidance, I guess. They said the summer quarter would show revenues between $33 million and $35 million, flat to down with the June quarter due to summer vacations that reduce study activity. They’ll report 10 cents to 12 cents a share. The “consensus” (one published analyst) wanted to see $35 million and 12 cents, and while the company probably will hit the high end of its range, that lone analyst might be about to cut his numbers $1 million and one penny.
eResearch reiterated revenue guidance for the full year, between $133 million and $140 million, and raised the lower end of its earnings guidance from 44 cents to 46 cents, while keeping the top end of the range at 49 cents. The “Lone Analyst” is at $141.4 million and 50 cents, just above management’s guidance, so there was no positive impact on the stock.
On the conference call, management said that if all cardiac safety trials used centralized EKG processing, the market would be about $750 million today, and growing. Only about 30% of the market is centralized today, or around $225 million. ERES has about 61% of that market today, and the rest is split up among numerous small, private competitors. ERES remains a Top Buy up to $16 for my $30 target.
Geron (GERN) reported a couple of hundred thousand in revenues and a 17 cent per share loss. Far more important, they ended the quarter with $187 million in cash. Their gross cash expenses run about $55 million a year and their net cash burn after revenues, interest income, milestones and deal fees runs about $40 million a year. So they have over four years of cash on the balance sheet. It’s hard to tell whether their stem cell program or their anti-cancer program will pay off first, but I expect both of them to pay us eventually. A new administration in Washington will help, too, no matter who wins. GERN is a buy up to $9 for a trade to $18 when Wall Street gets excited about a press release or feature story.
Rochester Medical (ROCM) reported $8.2 million in sales for their fiscal third quarter and six cents a share pro forma. Revenues were down 2% from last year only because Private Label sales are very lumpy and were down 36%. Management said they will bounce back in the September fourth quarter. Branded product sales, which are the company’s future, grew 23% to an all-time quarterly high of $6.0 million and accounted for 73% of total sales. That was the third straight quarter of better-than-20% growth. Earnings were lower only in part due to the low Private Label sales; most of the decline was due to their increased marketing efforts to take advantage of the pending October 1 Medicare reimbursement changes.
Management said the company is seeing strong interest in their infection control products, thanks to the pending change. Another change, already implemented, has Medicare reimbursing patients for up to 200 catheters per month instead of four catheters per month under the previous policy. That is helping growth of intermittent catheter sales, as long term care facilities switch from cleaning catheters to using a new, sterile one every time.
The stock dropped sharply and traded under $10 for a few minutes, and then came right back to the area it was in before the report. On the conference call, management said many hospitals are doing formal evaluations of the Release-NF infection control technology, getting ready for the October 1 Medicare rules. The company recently introduced the anti-infective technology in the U.K. ROCM remains a buy all the way up to $20 for a $40 target after the impact of the new Medicare reimbursement policies become clear.
SXC Health Solutions (SXCI) reported this morning.
They completed the acquisition of National Medical Health Card Systems on April 30, so the results include two months of contribution from the acquisition. They now separate pharmacy benefit management activities from health care information technology sales. For the quarter, revenues in millions and gross margins were:
| |
PBM Segment 2008 |
PBM Segment 2007 |
HCIT Segment 2008 |
HCIT Segment 2007 |
Totals 2008 |
Totals 2007 |
| Revenue |
$204.90 |
NA |
$22.90 |
$23.10 |
$227.80 |
$23.10 |
| Gross Margin |
8.2% |
NA |
56.9% |
58.2% |
13.1% |
58.2% |
They earned 21 cents pro forma, clobbering the consensus estimates for $142.8 million and nine cents. To be fair to the analysts, it was difficult to tell in advance what the merged company would look like. Management reconfirmed its objective to generate $6 million to $8 million of cost savings in the first 12 months following the closing of the NMHC acquisition, and $12 million to $14 million of synergies in the subsequent 12 months.
They also increased consolidated revenue guidance to a range of $825 million to $875 million, from $545 million to $600 million, and said pro forma earnings would be at the high end of their 61 cent to 70 cent range. The consensus is way low at $563.6 million and 49 cents. The stock jumped $1.47 or 11% today, but SXCI remains a good buy up to $15 for my $30 target, some time between the end of 2008 and next April.
China MegaShift
UTStarcom (UTSI) reported $633 million in sales, up 18% from last year and well ahead of both guidance and the $603.4 million consensus. While they ran a bottom-line loss of 31 cents a share, that was better than the 51 cent loss last year. They took $22 million out of operating expenses to get there, and they beat their guidance, but were still a few cents worse than the consensus estimate of a 28 cent loss.
After the sale of the Personal Communications Division on July 1, they have about $470 million in free cash ($3.75 a share), another $24 million in escrowed cash related to the sale, and about $29 million in debt. The new CEO is doing a good job of tightening operations and slimming the company down, but this still feels to me like putting lipstick on the pig just before putting the whole company up for sale. They need to get the gross profit margin up from the current abysmal 13% before they can cash out.
On the conference call, they guided for $170 million to $190 million in sales, seasonally lower than about $240 million in the just-reported quarter if you take out the Personal Communications Division results. However, they said the December quarter revenues would be very strong.
UTSI has some real strengths in Internet Protocol TV (IPTV) in China, where they have a 62% market share, but the customer line-up is a bit muddled right now due to recent mergers. They are also growing in India. For the second year in a row, VARIndia named UTStarcom as India’s Most Trusted Company in the areas of IPTV and broadband. Worldwide, their IPTV product now has 956,000 live subscribers, up 100,000 subscribers or almost 13% since the last earnings call.
With $3.75 a share in net cash, improving margins and strong worldwide growth in IPTV and broadband access, I still think you should hold UTSI for my $10 target.
Content on Demand MegaShift
Akamai (AKAM) is now a Top Buy with the stock so depressed. It wasn’t the swiftest move to raise guidance last quarter and then have to lower it this quarter, but the company continues to add customers at a good clip, and drive average revenue per customer up by adding new features to their service. Akamai’s problem is not competition in providing plain-vanilla dispersed servers–AKAM offers far more services than that, and essentially has a monopoly in high-speed, high-throughput managed services. The company’s private network of 36,000 servers running under a patented algorithm carries more than 20% of the world’s Internet traffic. It’s the new “competitors” like AT&T that ought to be worrying about their futures, not Akamai. AKAM is a Top Buy up to $30 for my $60 target.
Harmonic (HLIT) must have been cheering about the Cisco conference call this week. Cisco said their enterprise customers were strong, especially overseas, while their service provider customers were a bit soft. Why? Because some of the service providers that installed first or second generation IP networks during the last few years (when CSCO was reporting 30% year-over-year growth) are now filling up their networks with new revenue-generating services, rather than expanding as rapidly to new customers. And what is the #1 revenue-generating new service? Video! Adding a small amount of video infrastructure equipment to an existing network can dramatically increase its revenue potential. That is really good news for HLIT, although I hope it comes as no surprise to you by now. HLIT remains a Top Buy up to $12 for my $18 target–more than a double from current levels.
Motorola (MOT) named Sanjay Jha, the Chief Operating Officer of Qualcomm, as co-chief executive and head of the handset division. When MOT spins it off in the September 2009 quarter, Jha will be the CEO and own 3% of the business. He’s a skilled engineer, and I expect the very first thing he’ll do is focus Motorola’s platforms on one or two technologies, instead of the mess they have now. After that, he will personally lead the iPhone killer project. Look for a steady flow of Qualcomm engineers to Motorola; Jha gets top marks from almost everyone.
Merrill Lynch flipped their recommendation from sell to buy just because he was hired, but of the 34 analysts covering the company, only nine rate it a buy. 21 say neutral and two still say sell. But the company can earn 55 cents to 60 cents a share next year just by stopping the bleeding in handsets and posting modest 12.6% revenue growth back to the $36.6 billion they booked in 2007.
As I said last week, the Motorola January 2009 $17.50 LEAP call (new symbol: MOT AW) is essentially worthless, and we will sell it in December for a tax loss. I still think you can buy the January 2010 $10 LEAP call (WMA AB) for a new or averaged-down position. They closed at $1.68 today and would be worth $7.50 at a stock price of $17.50. I think we’ll see that price long before expiration.
New Energy Technology MegaShift
There’s a big story from the labs at MIT this week–a cheap way to use solar energy to make oxygen and hydrogen from water, then store the gases to be used in a fuel cell when the sun isn’t shining. Getting hydrogen is easy with a platinum catalyst, but getting oxygen is much harder. MIT researchers developed a catalyst that pulls oxygen easily.
Scientists are excited. Photosynthesis expert James Barber, the Ernst Chain Professor of Biochemistry at Imperial College, London, said, “This is a major discovery with enormous implications for the future prosperity of humankind. The importance of their discovery cannot be overstated since it opens up the door for developing new technologies for energy production thus reducing our dependence for fossil fuels and addressing the global climate change problem.”
The inventor, MIT’s Dr. Daniel Nocera, the Henry Dreyfus Professor of Energy, said, “This is the nirvana of what we’ve been talking about for years. Solar power has always been a limited, far-off solution. Now we can seriously think about solar power as unlimited and soon.”
Pretty heady stuff, but I think this is real. It will be five years before we see house-sized systems with decent efficiency, and they will be expensive. But five years after that, look for economical systems to start supplanting the utility grid. My newest recommendation, Canadian Solar (CISQ) is perfectly positioned to provide the panels for such a system.
Energy Focus (EFOI) reported second quarter sales up 14% to $7.6 million, and lost 11 cents a share compared to 16 cents last year. Swimming pool lighting sales fell 24% with the weak housing situation. EFO, the fiberoptic/LED products, accounted for $4 million of the revenues, almost double the prior quarterly record and more than double last year’s $1.5 million. Operating expenses were down a couple of percent, and will continue falling after a reorganization announced this week. They burned $2.6 million in cash and have $12.2 million on the balance sheet, with a goal of getting cash flow positive in 2009.
They still expect to about double EFO sales this year, and raised their percent-of-sales target from 40% to 50%. The reorganization is to reposition Energy Focus. as a turnkey lighting energy solutions provider that can serve customers’ entire lighting needs. They will provide energy assessments, design and engineering services, energy efficient lighting products, third party financing, installation and on-going service. Obviously, they will have to subcontract most of this, because at the same time they are reducing the size of the company and cutting overhead. They also want to expand from new construction to existing building retrofits, a market at least 10 times as large. They committed to expanding the EFO product line to cover more vertical markets.
Assuming the new strategy is not just a smokescreen to cover the usual layoffs and consolidations that hit companies running losses during a credit crunch, I disagree with it. I think they should focus on developing and providing EFO products to other companies that already provide the rest of the value chain. The record high EFO sales this quarter show the company has the right products for high energy cost environment, and I would rather see them press that advantage than go into a bunch of related businesses with longer sales cycles.
One program they have with zero value to the stock today that could be a very big deal in the future is the Very High Efficiency Solar Cell (VHESC) project funded by the government. Energy Focus is responsible for developing the optics, and on the conference call they said the prototypes are hitting the 40% efficiency target. They expect funding to continue for Phase III development, which is building systems that can be manufactured at commercially feasible costs. Combining that kind of efficiency with LED lighting might be able to cut ongoing electricity costs to zero, by taking a socket completely off the grid. We could see products in as early as 12 months.
All in all, it was a good quarter and a good call. I am going to take the stock off the Top Buy list until we see how the new turnkey solutions strategy works out, but EFOI remains a very strong buy up to $6 for my $16 target.
Gasco Energy (GSCO) reported record oil and gas sales for the June second quarter, hitting $12.6 million, up 146% from last year’s $5.1 million. They had a 16% increase in volume and, of course, higher prices. But they hedged their gas production, and had to report a $5 million loss on their derivatives position, of which $3.6 million is unrealized and could flip back in the current quarter. That brought reported revenue down to $9.1 million, including $1.1 million in gathering revenue. It was still a good quarter compared to the $6.1 million they reported last year, when Rocky Mountain gas prices were so depressed due to a lack of pipeline capacity, but it could have been a blowout. Before the hedges, their realized gas price was $9.25 per thousand cubic feet of natural gas (Mcf), but after the hedge they got $8.10, compared to $4.31 last year. With oil and gas prices now falling, they should be able to get a chunk of those unrealized losses back this quarter. Their average realized price for oil was $98.84 per barrel, double last year’s $49.34. They don’t hedge their crude oil, which accounted for $1.2 million in revenues in the quarter.
For 2008, about 50% of current net production is hedged between $6 and $6.91, compared to the current August price for Northwest Rockies gas of $6.97. In 2009, they have hedged about 60% of their expected production at prices between $7.01 and $7.50. While it is painful to give up the quarterly windfalls, it is safer to run the company at least partly hedged. Given my outlook for energy prices for the next many months (down), I agree with the strategy. But for June, the unrealized derivative losses turned a three cent per share profit into a one cent loss.
Operationally, the company is in great shape. They can now complete a well in 21.9 days, down 5.6 days from last year. They have fine-tuned some recovery techniques that let them revitalize wells to keep gas flow high, and they are going to start using those methods earlier to reduce costs. They’ll be running two drilling rigs through the end of the year, plus partnering some drilling.
Gasco’s stock price has come down with oil, but the company is growing volumes at a rapid clip and seems well-hedged against a lower gas price environment. A cold winter will push gas prices back up. GSX remains a buy under $4.50 for my $9 target, and is very attractive at current levels.
Plug Power (PLUG) reported June quarter revenues of $4.8 million, up from $4 million last year, but that’s where the good news stopped. Product revenue was $1.1 million compared to $0.7 million last year, and the rest was R&D contract work. They shipped 92 units in the quarter, 53 GenCore backup systems and 39 GenDrive systems for forklift trucks. They are negotiating with several utilities to start selling their new GenSys product that drops in to replace a homeowner’s furnace, providing heat and power.
They only got 40 orders in the quarter, bringing the system backlog to 244. They said in the second half of the year they still expect to book 150 to 200 GenDrives and 50 GenCores. They have $127.9 million in cash and are burning about $17 million per quarter, so they need to see a commercial success with GenSys to avoid raising a lot more money. They have reorganized the company to focus on sales and marketing, and I want to see rapid growth in orders and revenues over the next three quarters, or we will be selling the stock next April.
PLUG is an obvious beneficiary of the MIT solar hydrogen breakthrough, but that is some years away from commercialization. This morning, Ardour Capital downgraded the stock from accumulate to hold, knocking it down near $2 Plug Power still has a huge opportunity in backup power for cellphone towers, and PLUG remains a buy up to $5 for a $10 target.
WiMAX MegaShift
Airspan (AIRN) reported June quarter revenues down 3% to $21.4 million, with WiMAX revenues down 10% to $12.7 million. Last year, about 28% of revenues came from the Yozan contract, which has ended. WiMAX grew 25% from the March quarter. Airspan has the largest number of self-installed WiMAX networks in the industry, and more mobile upgradeable commercial WiMAX deployments than any other company. They are the only pure play WiMAX vendor with a Tier 1 mobile WiMAX account.
On the conference call, they said they are negotiating to draw down their bank lines, which probably means changing the covenants, which will be tough in this environment. They have $33 million in cash and they aren’t burning much, but they need to see some of the opportunities in Japan, the Middle East and the U.S. turn into strong revenue growth over the next couple of quarters. At the current sub-$1 price, we should hang in there and give them two or three quarters to perform. AIRN remains a hold for my $5 target, possibly in a buyout.