Saturday, December 22, 2007

2007 Wrap Up

This month and the first half of January 2008 I am working on a project for Microsoft; I have not had time to write blogs, though a lot of interesting things have happened with the stocks I cover. So here's a quick summary of 2007, recent events, and my thoughts on 2008 before I dive back into Windows Server 2008.

2007 was a good year for me, but not for my stock portfolio. Fortunately I resisted the temptation to try to flip houses in 2005-2006, which would have left me bankrupt. Instead I paid down my mortgage, which guarantees me about 5.5% in long term savings. So while my residence has declined in auction value, there is still a lot of net worth in it. I live in California, I've seen a couple of downturns, and as they say, you can't make new real estate near the ocean. So I'm not worried. My apple trees brought in a good crop this year, and that is a good metaphor for how I think about investing. I planted the first ones 9 years ago and now just about all I have to do is water them 4 times each summer and I get top-quality organic apples to eat or trade. The best investments may require a long time frame.

My portfolio is another matter. It was an evil year for me; I did worse than the market. There were two major killers: AMD and Marvell (MRVL).

AMD had just introduced Opterons when I made my initial investment. It looked like an Intel killer for a while. Then it bought ATI at the same time Intel tried to crush it with a price war, resulting in a string of net losses. In 2007 the quad-core Barcellona Opterons were supposed to save the day, but they never came. Now AMD says Q1 2008; we'll see. On the other hand the law suit against Intel is probably worth more than AMD's entire market capitalization today. But lawyers, judges and juries are a tricky thing. Intel was caught red handed, but will hide behind their lawyers as long as they can.

Marvell has been a profitless wonder story, which is alright with me. In 2006 they acquired Intel's mobile processor division. The costs from that and heavy investment in research has meant GAAP (and even some non-GAAP) net losses. But revenues have climbed rapidly, and Marvell management says revenues will continue to climb in 2008, but promises to hold research costs steady. Today's bargain stock price will seem cheap if management delivers on that promise. If they screw up, or if the macroeconomic picture gets worse, then the price could fall further.

The massive stupidity of both lenders and real estate investors is creating turmoil that can benefit those who were more conservative and have cash to spend. Most (but not all) stocks are cheap right now. Real estate varies by geographic area; I would not call it cheap, but low ball a house you like and chances are the owner will bargain with you. The global economy is strong with a few weak spots, but that it as usual. Agriculture is strong; land prices in Iowa and other grain-production area are actually rising. Note that sovereign investment funds are jumping in to use cash to buy U.S. assets. They may make some mistakes, but I think foreign investors will see the value in U.S. assets (stocks, bonds, and real estate) first because the dollar is weak and they can be less emotional from a distance.

The main economic problem for the U.S. is the Republican Party's "No New Taxes" pledge. It has been good for partisan politics, but bad for the nation's economy. There is still plenty of government waste, and imperialistic adventures are bleeding the U.S. dry. But mainly low taxes are the cause of the deficit. Pay now or pay more later is a rule for taxpayers. Say half the Bush tax cuts for the wealthy were eliminated. Couldn't the billionaires live with that? They'd still be paying lower tax rates than at any time since World War II, but the deficit could be eliminated and there might even be some money for infrastructure that is not Congressionally earmarked crud.

One last note: Celgene (CELG). Boy, did I think I was smart to buy this company earlier this year. Then they announced an expensive merger. Okay, I could live with that. Recently there has been speculation that a rival will cut into their Revlimid franchise. Ouch! I can't decide whether to buy more stock because it is cheap or to be cautious here.

My best stock in 2007: Microsoft (MSFT). Despite all the mud slung at it, it does a number of things way better than any of its competitors. Internet bandwidths are just not sufficient to allow serious office productivity to run on the Internet. After years of Google hype, when you look at Google numbers, all its revenues come from ad sales. That is great, it is a great, profitable, and useful company (this blog is run on Google). But it is little or no threat to Microsoft's core business, or Adobe's for that matter. Modern PCs are supercomputers; those who know how to use this amazing tool can run circles around those who use them as glorified typewriters.

Monday, December 3, 2007

Amgen Valuation (AMGN)

Amgen (AMGN) is a well-established biotechnology, pharmaceutical company that is included in the NASDAQ 100. As I write its market capitalization is $59.8 billion. That is with a share price of $55.04. In the past 52 weeks its high has been $76.95 and the low has been $48.30.

For such large market capitalization stocks usually you can just look at the P/E ratio (price to earnings per share, which equals the ratio of market capitalization to net income) and get an idea idea of whether the stock is over or under valued. If revenues and earnings are growing rapidly the P/E should be higher than if growth is slow or stagnating.

Nasdaq lists Amgen's trailing P/E ratio (today's price divided by earnings per share from the past 4 reported quarters) as 13.17. Which inverts to a rate of return of 7.6%. That is real cheap for a famous biotechnology stock. So is it time to grab Amgen shares, or is something going on that urges caution even at this price?

Amgen has been hurt by questions about two of its blockbuster drugs, Arenesp and Epogen. Both drugs saw year-over-year revenue declines in the latest quarter. Both drugs are ESAs (Erythropoiesis Stimulating Agents), which means they cause red blood cell levels in the blood to increase. They are used to compensate for anemia induced by chemotherapy for cancer. The problem is that if the resulting hemoglobin level is kept too high, there appears to be increased risk of heart attack, stroke, blood clots, and accelerated tumor growth. This was not discovered during the clinical trials. When it was announced, naturally doctors cut back on using the drugs. (See also Amgen's November 8 press release).

Sales continue, and Amgen management says the medical consensus is that the risk from ESAs is far outweighed by their benefits. In addition, now that the risk is known doctors can monitor their patents' hemoglobin levels more closely. The economic problem with this is that with more cautious dosing, Amgen revenues from these drugs will be lower than they might have been otherwise. In addition some competing products may be causing pricing pressures.

Amgen markets other drugs besides Arenesp and Epogen. In Q3 2007 sales of Neulasta and Neupogen combined increased 10% from year-earlier. Enbrel sales were up 16%, Sensipar sales were up 47%. On the other hand Vectibix sales were down 9% due to unfavorable colorectal cancer evaluation results.

Amgen also has a large pipeline of potential drugs. See Amgen pipeline. Some of these may be the big revenue generators of future years.

Given that background, let's look at the Q3 numbers (See also my summary of the Q3 Amgen analyst conference). Revenue was $3.6 billion, flat from year earlier. Net income was $201 million, down 82% from year-earlier, giving EPS (earnings per share) of $0.18, down 81% from year-earlier.

The company has cash and equivalents of $5.95 billion, but debt of $11.3 billion.

Management says adjusted (non-GAAP) EPS for the full year 2007 will range from $4.13 to $4.23 per share. For Q3 it claimed non-GAAP net income was $1.18 billion, down only 4% from year-earlier and resulting in non-GAAP EPS of $1.08, which is actually up 4% from non-GAAP EPS of the year-earlier quarter.

So a big question is, do you go with the GAAP (Generally Accepted Accounting Princples) numbers or the much better non-GAAP numbers. Investors always argue that one both ways. The reason for the big difference a combination of a $590 million charge for acquired R&D expense from the Alantos and Ilypsa acquisitions, plus a $383 million in charges related to the ESA problem. There will be more charges for the ESA-induced restructuring in Q4.

So between the lower revenues for Epogen and Arenesp and increasing revenues for other products, if you are willing to ignore unusual charges, Amgen revenue and profit has been essentially flat for a year. If I thought it would be relatively flat I would want a return equating to a P/E ratio of about 12.

I think Amgen will return to revenue growth and net income growth in 2008, but I have to weigh in a substantial chance that the ESA problem will not be so easily resolved.

If revenue do turn up in 2008, I expect to see the P/E ratio return to something more normal, like 20. Of course if any of the pipeline drug candidates gets approved for a large market, Amgen could return to rapid growth.

All in all I would say Amgen is currently fairly valued to somewhat undervalued. I don't own Amgen stock, but if I were making a broader biotechnology portfolio I would not think it a big risk to buy some at today's price. Also, there are many other undervalued stocks in the market at this point in time due to the mortgage-market turmoil.

More data:

My Amgen Page
My biotechnology investor help page

Thursday, November 29, 2007

Marvell Technology (MRVL) Valuation

Marvell (MRVL) management, employees and long-term investors were probably shocked by the huge drop in the stock price yesterday, the day following release of Q3 data (really fiscal Q3 2008, the 3 months ending October 27, 2007). While there are specific reasons that make a valuation of Marvell's stock widely open to interpretation, for the most part the drop reflects Wall Street trading program and analyst focus on short-term profits being mismatched with Marvell's strategy for long term growth.

I'm assuming you've have some background on Marvell Technology, which I've followed for a number of years and which I own stock in. If not you might want to check the following before reading further:

my Marvell page at Openicon (which has links to my prior articles on Marvell and to my summaries of Marvell analyst conferences).

No one is disputing, now, that Marvell is able to grow very quickly, both growing its interal divisions and by making strategic acquisitions. Q3 revenues were $758.2 million, up 15% sequentially and 46% from the year-earlier quarter. They were also well above guidance management gave at the beginning of the quarter. That is exceptionally fast growth for a company of Marvell's size. But it is just getting back to trend for Marvell. Here are annual revenue figures for the past few years:

2002 $505 million
2003 $819 million
2004 $1,224 million
2005 $1,670 million
2006 $2,238 million

The current annual run rate is $3,032 million. Call that $3 billion. Six times 2002 revenues.

But where's the beef? Using GAAP Marvell lost $6.4 million in Q3. And I like to use GAAP. On the other hand I like companies that make short-term sacrifices in order to be able to dominate an industry in the long run. The semiconductor chip industry is very diverse. What Marvell has done successfully is pick an area, become dominant, then pick a new area (or two or three) to compete in. Marvell always starts at the high end of the markets it chooses, introducing revolutionary technologies. Then it gains market share as these technologies spread to the middle market and then to the low-priced market segment.

Wall Street is mad because Marvell invests a lot of money in research. Not me. This investment is going to bear fruit.

Unless we enter a global recession 2008 is going to be a year of good profitability, on top of continued revenue growth, for Marvell. Here's why.

First, the profit figure is not as bad as the GAAP figure indicates. Marvell also released a non-GAAP figure, which was a Q3 profit of $86.2 million. This figure eliminates (from the GAAP numbers) $37 million in amortization expense and $56 million in stock-based compensation expense, which is a non-cash expense.

Well, GAAP requires stock-based compensation to have a $ equivalent because it dilutes shares. It is non-cash, and I believe in giving employees a stake in the company. The amortization expense is real too.

Keeping that firmly in mind, nevertheless on a cash basis Marvell was up $33 million. So they are cash flow positive. They also increased inventories in line with business to the tune of $85 million.

Going forward, Marvell announced a decrease in headcount of 400 workers or 7% of the workforce. In Q4 there will be a $8 million one time charge and about $4 million of benefit. In Q1 benefit shoud rise to around $10 million.

In addition, revenues (which are somewhat seasonal in semiconductors) should rise at least $30 million in Q4, which was management guidance. With operating expense being held nearly flat, and cost of goods sold should increase less than $15 million, a good guess is that net income will icnrease by about $15 million.

So at very least I expect GAAP net income to be in the black in Q4, with rapid acceleration upward after that.

There are a number of other factors that should accelerate profit growth. One is that the former-Intel application (cell phone) processor division's costs are set to go down as Marvell will no longer have to buy the processors from Intel at contracted prices. Instead they will be made in an Asian fab, which has already made sample chips and will be gearing up in 2008.

Marvell Technology has also had a large number of design wins that are going to ramp up revenue in 2008. They have introduced advanced video processing chips that will go into an increasing number of flat panel displays. They also announced breakthroughs in a Green technology for analog power supplies that are the result of 5 years of research and development.

Marvell could please the nearsighted wage-slave analysts of Wall Street by drastically cutting back on research and development ($252 million in Q3) and just marketing the hell out of the technologies they already have. Short-term traders would love that. But with a $3 billion revenue run rate, $1 billion a year in R&D begins to look reasonable. If Marvell cuts back R&D slightly and hits a $4 billion a year revenue run rate by the end of 2008, everyone will be heaping praise on CEO Sehat Sutardia and his team for their wisdom and perseverance.

All stocks are risky. At $15 a share today, I don't think Marvell has much risk left in it, aside from macroeconomic risk, but always diversify your portfolio and remember, if you don't buy low you can't sell high.

Saturday, November 24, 2007

Celgene (CELG) and Pharmion (PHRM)

I own Celgene (CELG) stock, so naturally I am wanting to know whether the Pharmion (PHRM) acquisition will be a good thing. The rational question to ask is: would I buy Pharmion at its price prior to the Celgene offer, and would I buy it at the agreed price of $2.9 billion ($72 per share) if I were running Celgene. Truth be told, I have never paid any attention to Pharmion in the past.

In October Pharmion, which has just under 37 million shares outstanding, was running mostly between $45 and $50 per share, so its market capitalization was roughly between $1.7 billion and $1.9 billion. But as late as in July it could be bought for under $25 per share, or the whole lot for well under a billion dollars. Congratulations to those brave souls who bought at under $25.

The numbers only tell part of the story of a company like Pharmion, but they are worth looking at. Q3 2007 revenues were $67.3 million. Annualized that is $269 million. Revenues have been growing, but not at the kind of rate that awes: revenues for all of 2005 were $221 million.

As to net income or earnings, there are none. But losses are substantial, amounting to only $21.4 million in Q3 2007 (after an only $9 million loss in Q2). That is a number that makes it look like break even could be a long way away. But it includes "a charge of $8 million for a milestone payment triggered by the acceptance of our marketing authorization application (MAA) for Satraplatin for the treatment of second-line hormone-refractory prostate cancer by the European Medicines Agency (EMEA)."

Where do the revenues come from, and how much might they grow in the next couple of years? Vidaza for myelodysplastic syndromes (MDS) is marketed in the U.S. and had $43.2 million in Q3 2007 sales. Sales of Thalidomide were $20.2 million.

End of Q3 Pharmion had $258 million in cash in its coffers, so it could have gone on alone, without a partner, until expanded sales took it to profitability.

Pharmion more buys rights to drugs and markets them (if they are approved by the FDA or EMEA or other nations) than develops them from scratch. It has the right to sell Celgene's Thalomid (Thalidomide) for multiple myeloma in Europe. It is seeking approval of Vidaza in Europe, where it is already sold on a compassionate use basis. The latest clinical results for Vidaza are very encouraging; it is hoped that physicians will be impressed and use it more than competitors.

Pharmion has a pipeline of promising drugs as well, notably including Amrubicin for small cell lung cancer in a Phase 3 study, MGCD0103 early studies in solid tumors and CLL for and it has commenced a program targeting sirtuin inhibitors.

How do you value all that? Truthfully, you can go in many directions. Pipelines should always be heavily discounted because most drugs fail to reach market for one reason or another; even drugs with promising Phase III results may not be approved by the FDA. For instance in an 8-K filed 10/31/2007, Pharmion said Satraplatin failed to achieve its goals in a Phase III trial when combined with Prednisone for treatment of patients with hormone-refractory prostate cancer. But that does not mean Satraplatin will not prove effective for other types of cancer.

Approval of Vidaza in Europe are highly probably; that is worth quite a bit, since revenues from Europe should help cover overhead and push Pharmion to profitability. Apparently approval for Thalomid for multiple myeloma in Europe is also very likely.

Still, as a Celgene stockholder I wish the price were more conservative. Celgene feels it is buying an international sales operation, but I suspect they could have put one together for far less than the price of Pharmion.

In the last couple of years two of my companies have made major acquisitions that were supposed to be long term strategic, and might still out to be, but killed the stock price in the short run. One was AMD, which bought ATI (which I also owned). The other was Marvell, which bought Intel's cell phone microprocessor division. I'm not going to sell my Celgene stock just because of those bad experiences (and I kept the MRVL and AMD stock, too), but I am not inspired with confidence.

I felt I had a grip on Celgene's history and prospects when I bought it. Now I feel it is a far riskier proposition. I am not at my limit for Celgene in my portfolio model, so I might have bought more on the dips. Now I'll leave it alone, at least until the acquisition is complete and we start seeing more meaningful Vidaza revenue.

More data:

My Celgene page (with links to Celgene Analyst Conference summaries)

Wednesday, November 21, 2007

AMD Valuation

Last year AMD bought ATI for $5.4 billion. Today AMD is valued by the market at $5.9 billion. What gives? What sort of valuation should be put on AMD stock?

AMD, of course, makes microprocessors, or CPU's, the cores of computers. It traditionally competed only in the PC space until it introduced its Opteron processor for servers in 2003, and usually had less than 10% of the market, with Intel having about 90%. From 2003 until 2005 AMD had a good run, gaining market share and hitting a stock price over $40 in January 2006. Then Intel struck back. By slashing its prices and promising a new generation of chips for later in 2006, Intel first cut into AMD's profit margins and then began to regain market share. The new chips introduced in 2006 had their faults but were overall on par with AMDs. Then came the ATI acquisition, which saddled AMD with a lot of debt. To add to this toxic brew, AMD's quad-core chips, code named Barcelona, were delayed in 2007. For more AMD background and history check out my AMD page.

Because of the necessity of competing on price and the poor sales of ATI chips after the acquisition (competitor NVIDIA introduced new graphics chips that put ATI behind), AMD has had a very bad year. The good news is that the stock is now astonishingly cheap, if you are willing to pick up on the risk. Last week a wealthy shiek bought some $600 million's worth, so you would not be alone in your gamble. [I own AMD stock and also owned ATI stock before the merger. I also once owned NVIDIA stock but foolishly sold it.]

Lets use the numbers from AMD's latest quarter, Q3 2007, as a proxy for its current condition [See also my AMD October 18, 2007 Analyst Conference Summary]. Revenues were $1.63 billion, up 18% from Q2 2007 and up 22% from year-earlier.

Which would seem to say that AMD is accelerating out of its 2006 slump, at least on the revenue side.

Q3 2007 net loss was $226 million, which tells you the core story of AMD's low stock price. While it was better than the net loss of $457 million in Q2, it was a reversal of a net income of $121 million in Q3 2006. Q3 2006 in itself was not a good quarter for profits.

The main reason I think AMD is underpriced is because in Q3 2007 it reached positive cash flow. That is, much of the net loss was for non-cash expenses, including ATI acquisition costs. AMD spent the money on ATI last year, but under generally accepted accounting principles (GAAP) some of that expense is written off over time.

Also, AMD shipped a record number of processors in Q3. Despite predictions by Intel fans that AMD would sink back into the obscurity from whence it came, and claims that AMD notebook chips sales would be down, AMD's processors for notebook computers had 68% better unit shipments than the year-earlier quarter.

After some real problems marketing graphics chips after the ATI acquisition, that segment seems to be getting on track with a 29% sequential increase in graphics revenue.

Intel has always led AMD in process technology (the ability to put more logic gates in the same area of a chip). Just a few years ago AMD was typically two years behind Intel. This month Intel introduced chips using 45nm technology, though they don't seem to be actually available in any quantity yet. AMD said it 45nm chips will ramp in Q2 2008. My guess is that means a May release, so AMD has closed that gap down to 7 months. But AMD has a lead in putting 4 processor cores on a single semiconductor chip, and in design architecture.

If AMD were a recent startup investors would probably consider it a tiger, given all these trends. Intel is a heavy competitor, of course, so heavy that many nations are looking into Intel's reputation for illegal anti-competitive practices and AMD had to file a lawsuit to force Intel to allow computer makers to by AMD chips without retribution.

While Intel is AMD's main danger, a secondary risk would be the possibility of a slowing of the expansion of the computer market. Given the booms in India, China, Russia and elsewhere, I'd prefer to bet on a strong global market even if the U.S. market weakens.

One place AMD shines is giving its customers (the computer makers) what they want, in contrast to Intel's take-it-or-leave-it approach.

Another downside concern is the slow pace of introduction of quad-core Opterons. If AMD does not get its act together on this soon, it could lose all the gains it made since 2002 in the relatively high profit margin AMD market.

On balance, I see AMD growing in 2008, with positive cash flow and progress probably positive GAAP net income by the second half. AMD's stock price probably won't move above $15 per share until this current run of market turmoil ends and AMD shows 2 consecutive quarters of profitability.

But with a current revenue annual run rate of $6.5 billion, and apparently accelerating, I think a rational market would put the market cap at no lower than $7 billion. Which works out to $12.65 per share.

And if indeed AMD continues to gain revenues as quickly as it has lately (possible with its new Phenom processor, quad-core Opteron, and Spider graphics system), it could go a lot higher a lot sooner than most analysts and investors think.

AMD believed it would have a long-term competitive advantage if it became the only company with high-end graphics and general microprocessor capability. It might still be proven right.

Strangely, while I've been writing this its AMD's stock price has risen to $11.05, from $10.55 or so when I started writing.

More data:

Tuesday, November 20, 2007

Applied Materials (AMAT) Valuation

Applied Materials, Inc., (AMAT) is a maker of semiconductor fabrication equipment. It has a long history of profitability. This year it is gearing up selling equipment to make solar panels, so it is part of the Green Technology boom. So how should we value its stock?

Unfortunately these are not boom times for silicon equipment manufacturers. Reported results for the fiscal 4th quarter ending October 29, 2007 (See Analyst Conference Summary), included revenues of $2.37 billion that were down 6% from year earlier. It was also a 7.5% slump from the fiscal 3rd quarter.

Net income was roughly down the same, to $422 million.

Still, that shows there is plenty of profit margin built into AMAT's products. Net income was 5.6% of revenues.

Generally, you want to believe that this is just a slow period due to macroeconomic uncertainty. So revenues will go up again. But in this situation you can argue what the P/E (price to earnings) ratio of the stock should be. A wide spectrum is possible.

Today AMAT stock ended at $, giving it a market capitalization of $25.1 billion. Multiply Q4 net income by 4 and you have an annual run rate of $1.69 billion. So the current P/E is 15, and inverting that you get a rate of return on the stock of 6.7%, which is not bad at all. Unless earnings continue to decline; then it would not look so great.

Trailing earnings (the sum of the last 4 reported quarters) are higher than 4 x Q4, so if you want to use that for your annual earnings estimate you get a lower PE and a higher rate of return.

I agree with management that if macroeconomic turmoil increases 2008 could be a rough year. But if people calm down, they will see that demand for electronic devices is booming globally. Many fabs are running at pretty near capacity. So 2008 could also see an increase in equipment orders to keep up with demand and with changing technologies.

When you throw in that Applied Materials has really just gotten started in solar with their SunFab equipment, I think the chances of an improved 2008 are pretty good. The downside risks are relatively low.

That means I believe Applied Materials is undervalued at today's price. On the other hand the stock market is in a funk right now, so you can pick stocks randomly and most will prove to be undervalued.

More data:

Applied Materials Investor Relations page
My Applied Materials (AMAT) page

Sunday, November 18, 2007

Altera (ALTR) Valuation

Altera (ALTR) makes programmable logic devices (PLDs). Before doing a valuation of this company's stock price, I need to remind myself about numbers. Numbers sometimes hypnotize tech guys and gals. Stock prices are about the future, so unless you are doing quick, in-and-out momentum trading or some similar strategy, you need to be careful with numbers. The future of a technology company, and hence its stock price, is tied to how broadly its technology will be adapted in the future, and how well it can shift to new technologies when they become the future.

If you don't know about PLDs and their variations known as CPLDs and FPGAs, check out my Altera, FPGAs and FPGAs blog entry from March.

I tend to go with the future of PLDs is rosy theory, but keep in mind that does not mean every PLD maker will be successful. With that caveat in mind, let's look at recent Altera numbers and trends.

Altera's last reported numbers were for Q3 2007. Revenues were $$315.8 million, down 1% from $319.7 million in Q2 and down 7% from year-earlier $341.2 million.

That is pretty grim, and net income was $69.0 million, down 14% sequentially from $80.5 million and down 21% from $87.4 million year-earlier. Not good, but here's what is good: even in a slump the company has enough profit margins in its products to earn investors substantial net income.

Because Altera is not a rapidly growing company, you can buy its stock at a pretty fair Price-to-earnings ration (PE). It closed Friday, November 17, 2007 at $18.90 per share, giving the company a market capitalization of $6.5 billion. Using Q3 net income, annualizing by multiplying by 4 we get $276 million. Dividing that into market cap we get a current PE of 23.6. Inverting that we get a rate of return of 4.2%.

There are worse things than a rate of return of 4.2%, but it is not exactly an encouraging number. Nor does Altera management see a quick turn around. They expect Q4 2007 revenues to be sequentially flat to down 4%.

Maybe this is a bad year because of macroeconomic uncertainty, but there is going to be macroeconomic uncertainty in 2008 too. I suspect inventories are lean at this point, so a pick up in demand could cause customers to up their inventories as well. I think PLDs have a good future because they can cost less than ASICs for smaller production runs, which means the when a technology needs to be updated frequently PLDs are the way to go.

Still, at this stock price, for my portfolio needs, Altera is in the upper end of the fairly valued range. It is a safe, well run, profitable performer, but my local Credit Union will give me more return on my money with much less risk.

But I'll keep an eye on the stock. If it goes below its 52-week low of $18.47, based just on a general stock-market drop rather than on any negative Altera news, I could see picking some up. These are some real smart people at Altera trying to figure out how to sell some new designs they are introducing.

I have never owned Altera or a direct competitor, but I own other makers of semiconductor chips.

More data:

My Altera page (with links to my summaries of Altera analyst conferences)

Friday, November 16, 2007

Akamai Valuation

Akamai (AKAM) continues to be the premier accelerator of Web content and is growing profits rapidly. But its stock price has been all over the place this last year. Some investors will buy at any price when they feel Akamai is their transport to great wealth. Yet this high price-to-earnings stock gets subjected to periodic waves of fear, often driven by rumors of competitors cutting in on the business.

For background on what Akamai does you might try my Understanding Akamai blog entry. For summaries of Akamai's recent quarterly reports and analyst conferences see my main Akamai page.

Your standard data for how unstable a stock's price is, the 52 week high/low, today ended at $59.69 high, $27.75 low. So if you bought at the low this year, then sold at the high, you more than doubled your money. On the other hand that would make you a time traveller or a short-seller, because the low came in September after the high in February.

Looking at a chart of Akamai's price for the past ten years (See NASDAQ's AKAM chart), we see that Akamai IPO'd back in 1999 as one of those "it could be the next Microsoft" stocks. It went to well over $300 per share before reality set in. It went below $1 per share in the summer of 2002. I wish I had bought some then! [I have never owned Akamai stock.] But in 2002 there were lots of technology stock bargains and some of them were making a profit; Akamai was not.

The funny thing about a stock actually making a profit is that instead of being priced on hype the stock starts getting priced more on its earnings. Such stocks may have a sky-high price-to-earnings ratio, as Akamai had back as recently as December 2006, when its P/E ratio was 156.

What I am trying to say here is that different investors price stocks by different criteria. As a result there is no set price where Akamai should be. You should develop criteria for your portfolio, and do your own analysis, to decide whether a stock's price is too high or too low for you. I like to use a conservative pricing model. That minimizes the risk that I am buying an overpriced stock.

Today Akamai stock ended at $36.15. That gives the company a market capitalization (stock price times number of shares outstanding) of a shade under $6 billion.

In the last quarter GAAP (generally accepted accounting principles) earnings for AKAM were $24.3 million. That was up 6% from Q2 and 73% from Q3 2006, so I think we can use the number and still be conservative. Multiply by four and you have an annual net income of $97 million. Using that, dividing into the market capitalization, we get a P/E ratio of about 62, or a return on capital of just 1.6%. Of course you can do better with a CD. Investors are hoping that Akamai keeps growing its earning rapidly, so in 2 or 3 years, even if the stock price is flat, earnings will rise to 5% or more. Okay, what investors really want is for earnings to triple in short order and the P/E ratio to stay high, because then the stock price has tripled in short order (say within 2 years).

There are two main dangers in high P/E stocks. One is that earnings will flatten or even fall, taking away the justification for the high P/E. The other is that as the company becomes larger, investors will become reluctant to project as much earnings growth into the future, and the P/E will decline even with rapid earnings growth. So you had better have a really good reason to buy a stock if it has a high P/E ratio.

Akamai management and its favorite analysts and investors will say that you should not judge the company by GAAP earnings at all. Non-GAAP earnings are far higher. Non-GAAP earnings, in Akamai's case, amount to what they call "normalized net income." In Q3 that was $62.4 million. That is over twice GAAP earnings. If you use that figure, annualizing it as I did above, you get a "normalized" P/E ratio of 24.

Hey, that is cheap for a rapidly growing company. But how real is "normalized?" One test is cash flow. It is not an infallible test, but it is a good one to apply. According to Akamai Q3 cash from operations was $77.4 million, which is even higher than the normalized income.

I think other companies would like to cut in on Akamai's market, but they are trailing its leadership. The market for Web acceleration services is growing rapidly, so even if Akamai just holds onto its market share, it should grow rapidly in the next few years. Risk is not negligible, but it is well-outweighed by opportunity at this point. There is the usual macroeconomic risk that all companies have some exposure to.

I don't think it is crazy to buy Akamai at today's price. If I could see the future more clearly I might call it a bargain for a long term investor. Obviously it is a speculator's favorite, so it is likely to be volatile. Given other opportunities in the market, I think if you did not buy it at under $30 per share in September, you should not be doing more than nibbling at it here.

Remember, diversity rules.

For more data:

Tuesday, November 13, 2007

Adobe (ADBE) Valuation

It is always fun to put your independent value on a stock and compare it to the current selling price. More than just fun, it is the way smart investors make money. Today I'll be looking at Adobe Systems Incorporated (ADBE). I have never owned Adobe stock though I have followed it for a while. What Adobe reports in its quarterly analyst conferences (see my Adobe summaries) does give insight into some of the stocks I do own and the health of the technology sector in general.

Adobe is on a different fiscal year than most companies. Its third fiscal 2007 quarter ended August 31, 2007, and it released the results for the quarter and held the analyst conference on September 17, 2007. That means the current quarter will end November 30th, which is soon, and the conference will be in mid-December.

Revenues for fiscal Q3 were $852 million, up 14% from Q2 and up 41% from year-earlier. Net income was $205 million, up 35% sequentially and up 117% from year-earlier.

So if you like to draw straight lines, you might guess that in fiscal 2008 Q3 will generate some well over $400 million in net income, and in 2009 $600 million. Of course you can also use the same percentage increase each year, which gives well over $800 million.

Multiply those numbers out by 4 to get annual net income, and you get $1.6 billion in 2008 and either $2.4 billion or $3.2 billion in 2009. Adobe looks like a gold mine. Therefore, the bulls would argue, it deserves a stock price that gives a high price-to-earnings (PE) ratio, if you base it on past earnings.

Right this moment Adobe is having a bad day. It is priced at $39.72 and its resulting market capitalization (number of shares x price) is $23.4 billion. Its Nasdaq page gives it a trailing PE of 27.4.

Trailing earnings, the total of the past 4 reported quarters, are lower for a growing company than what you get if you multiply the recent, highest quarter by 4. Hoping that the future is always onward and upward, or at least flat, take the annual rate based on 4 x $205 million or $820 million. Divide that into today's market capitalization and you get - 28.5. So invert 28.5 for the rate of return of earnings on what you pay for a share of stock. The result is 3.5%.

You can do better than 3.5% on a CD. But suppose we look further out, using the most optimistic assumption based on recent data. Suppose fiscal 2009 net income is really $3.2 billion. What then. Why, at todays price and market capitalization, the PE ratio would be an ultra-low 7.3 and the earnings on your hard-saved dollar would be 13.7%. That does look like a gold mine.

Which is why valuing stock is such an art. If there is a recession or depression, Adobe won't be seeing $3.2 billion in net income in 2009. If some other company brings out a new product that cuts heavily into one of Adobe's lines, growth could slow down. On the other hand if all the new designers in India and China decide they need Adobe's software and actually pay for copies instead of pirating it, the $3.2 billion mark could be passed easily.

I prefer to go on conservative assumptions. Adobe has had periods of rapid growth and of slow growth in the past. This year new versions of old products were introduced, and that tends to give a burst of speed. If I had to choose a number rather than a range of numbers, I would actually do more research, but for this blog I'd say expect about 20% growth in revenues in Q3 fiscal 2008 over Q3 fiscal 2007.

A useful benchmark is that a PE of 20 is a return of 5%. Me, I like some of those earnings returned in dividends, which may seem old-fashioned but which tends to preserve stock prices in general market downturns.

If I were actually thinking of buying or selling Adobe I would do a lot more research and number play. But this is just an exercise, or a screening that I would do to many stocks before choosing one or more to invest in.

I'd saw that a PE of 30 is in the ballpark for Adobe. So today it is somewhat undervalued by my standards. That, I believe, is mainly because the market as a whole has been weak lately. I believe most tech stocks, excluding Apple, Google, and a few other high-flyers, are at least slightly undervalued right now. That is based on my macroeconomic assumption that the risk of an actual recession in 2008-2009 is low, the risk of a depression is near zero, and in fact the most likely scenario is slow growth in Q1 of 2008, then some acceleration in 2008 as people begin to build and buy houses again.

Truthfully, the best bargains right now are probably in real estate, not the stock market. However, an ordinary investor can get much better diversity in the stock market. For an ordinary investor buying a single piece of real estate is putting a lot on a single roll of the dice, as many ex-flipper found out this year.

Thursday, November 8, 2007

Selling Cisco Low

Its a bargain hunter's dream today. There are two big trends in the stock market right now that are creating some bargain stock prices. One is the mortgage-backed securities meltdown, which has depleted many portfolios. People running these portfolios are reballancing them, which means selling stocks. They are selling stocks regardless of their underlying values.

The second is fear. People lost bundles in 2000-2001 and take flight easily. Many of the stocks that sank in 2001 had no earnings, some times they did not even have revenues to back their market capitalizations. Today stocks that are very profitable are being dumped - that is just plain fear.

Of course if there is a world-wide Great Depression starting next month, selling today will seem smart. But all reports are that the global economy is robust. There are weak spots like Japan and the U.S., but the weakness is mild and probably temporary.

There are, of course, frothy stocks out there. There are always some, just as even in an overpriced market you kind find some bargains. For froth, Apple, Google, and Intuitive Surgical (ISRG) leap to mind. But even with these three, they are solid companies that generate substantial profit; it is investor enthusiasm, the idea that these stocks only go up, that makes them frothy.

I have listened to a lot of analyst conferences this last two weeks. Some I am paid to listen to (I can't list those). Some I own, like Napster, Microsoft and Dendreon. Others I cover because of their general interest in the techonology domain and because I have taken to posting summaries of them at Openicon. These include Maxim, Onyx, and yesterday Cisco. Almost all these companies are doing well and have lower than reasonable stock prices right now.

Cisco (CSCO) is a good example of an undervalued stock. It is a gigantic company, yet its revenues for Q3 2007 grew over 16% from Q3 2006. Its earnings rose an amazing 37% over the same period.

Given that safe cash-like instruments that pay even 5% interest are getting hard to find, you would think that today a rock-bottom price for Cisco stock would be at about 20 times Q3 earnings. Given its growth rate, even thirty times earnings would not be adventurous. As I write you can buy the stock for $30.04 per share. If you could buy the whole company for that you would get the market capitalization, which is $182.7 billion. GAAP earnings in Q3 were $2.2 billion. Annualized that is $8.8 billion. Divide into the market capitalization and you get a P/E (price to earnings) ratio of 20.8.

But the most likely scenario is that a year from now revenues will be up again in the 15% range and earnings will be up 20% to 35%.

The only thing I don't like about Cisco is that it does not pay a dividend. I like dividends; I am not a fan of stock repurchases unless a company has a lot of cash and has very undervalued stock.

Be sure to see my summaries of Cisco analyst conferences.

Buy low, sell high. To be able to sell high you have to buy low. Yet I watch investors, even professional investors, buy high and then dispair and sell low. Today Cisco is low. And always balance the risk in your portfolio.

Always be careful how much you spend, no matter how rich you are or think you will become.

Monday, October 29, 2007

AMD Virtualization Wars

For years now AMD (AMD) and Intel (INTC) have been slugging it out in the microprocessor market. The next arena for this slugfest is virtualization, the process in which a single computer can run multiple instances of an operating system, or even entirely different operating systems (typically Linux and Microsoft).

Intel has been the dominant player in the microprocessor industry since the 1980s and still dwarfs AMD. But AMD gained a great deal of market share earlier in the new millennium with its Opteron and Athlon processors. Unfortunately it did not gain enough to prevent Intel from having a comeback in 2006 that has extended up until at least now. The main cause of AMD's insufficient gains during a period of time when it processors outperformed Intel's on any basis was human nature. Most businesses had standardized on Intel processors; many did not even consider taking advantage of the AMD proposition. I think a lot of this was influenced by the broad ownership of Intel stock among key decision makers, but I can't prove that without doing some costly research.

The question for those owning AMD stock (including me) and those rare people considering buying it should be: what will happen in Q4 2007 and in 2008. This will be highly dependent on the new quad core Opteron processors (code named Barcelona) and their virtualization features.

There are plenty of technical articles being written on virtualization and on AMD's and Intel's versions of it. The reality is, however, that until there have been a number of large-scale commercial installations that use virtualization 24 hours a day for long periods of time, we won't know if one design is superior to the other.

Virtualization seems like no big deal on a desktop or notebook computer. It is basically making possible in software what used to be done, in a clunky way, with a hard disk partitioned between two operating systems. Now using VMware or other virtualization software both operating systems can run at the same time, sharing the microprocessor, memory, and network bandwidth.

But according to Rackable Systems, making a server farm work well with virtualization is not so trivial of a task. Server farms already have issues with interconnecting all of their computers. There is an issue called load balancing: if you are, say Amazon (a Rackable client) and have thousands (or millions) of people searching your gigantic Web site all the time, and the Web site has to be coordinated with a database and a shipping system and a content management system, well, in non-tech speak it gets hairy. A virtual operating system sitting idle is just a waste of expensive equipment.

Rackable has a new line of servers ready for introduction that are engineered from the ground up for virtualized server farms. Probably IBM, Dell, Sun and HP are working on this issue too and will make their claims.

It will sure be interesting to see if this virtualization-ready line is available in only one flavor, AMD or Intel, or if it available for both.

Another area of interest in the AMD versus Intel battle is processors for notebook computers. In this area I see pundits constantly reporting that AMD cannot possibly compete. Yet it seems like every quarter AMD picks up a bit of market share in notebook computers. Partly this is because Intel started with so much market share and does have good notebook technology. Intel likes to charge its customers through the nose when it has no competition (hence accusations of monopoly pricing). Surprise, most people don't feel like they can pay $2000 for a notebook computer that will be broken on obsolete in 2 years. People really like computers to be in the $500 to $700 price range, and to make a profit in that market many notebook computer manufacturers have turned to AMD. With AMD readying a new line of notebook-optimized microprocessors, motherboard chips and graphics chips, it is possible that it may gain even more market share in 2008.

I consider investing in AMD to be a risky business. Investors should always balance the risks in their portfolios by diversification.

More data:

AMD home page
Intel home page
My AMD page with links to summaries of AMD analyst conferences
VMware virtualization

Sunday, October 28, 2007

Rackable Systems New Friend: Facebook

Rackable Systems (RACK) reported Q3 2007 results that showed a second quarter of good revenue improvement and brought the company back from serious losses to break-even. Management reported that at the end of the quarter the backlog of orders had reached a record high. And just in case the analysts covering the conference missed the point, Rackable named the four customers that buy the most equipment from them: Microsoft, Yahoo, Amazon, and Facebook.

Before looking at Facebook and other opportunities, recall that RACK stock has been very volatile (See chart at NASDAQ). In the past 18 months it has been over $50 and as low as $11.25. The highs were reached after Rackable ramped up its highly efficient server system sales in the previous few years. The lows came after bigger server-market players took notice and started low-balling bids on systems, causing Rackable to lose sales and to lose profit margins on some sales that took place (See Rackable, Playing With the Big Guys, April 5 2007). Rackable had to restructure and write off inventory as obsolete. So in 2007, Q1 saw a plunge in revenues and heavy losses; Q2 saw a sequential increase in revenues and heavy losses; and Q3 saw a second sequential increase in revenues and break-even on earnings.

So where do we go from here if we take a ride with Rackable? (Note that I own stock in the company.) It depends on how well Rackable does against its competition. Rackable pioneered energy-efficient server farm designs, but its equipment is not the cheapest on the market. Its servers are easy-to-manage, and it now has some new, very innovative products. One is that is has a line of servers optimized for virtualization, which is a big industry trend. It also has ICE Cube, what might be called a server-farm in a box. These are your basic cargo containers filled with servers. You can buy a server farm ready to go and just put it in the parking lot; there is a lot of interest, and only one other company is trying to compete in this space so far. Once built an ICE Cube server farm uses far less energy than a conventionally warehoused system.

Another boost going forward will further enhance Rackable's reputation for being the leader in Green computing (their slogan is "Enabling the ecological datacenter") is the release of new server systems using AMD quad core Opteron processors. Rackable started as an AMD-only company, then added lines using Intel processors that became substantial over time. Conservative customers, and IT departments whose decision makers own Intel stock, still have Intel-only buying policies. But management confirmed that demand for AMD quad-core based servers is high and systems will be shipping this quarter (I am guessing that is the reason for the record level of backorders). The AMD chips are better designed than the Intel chips and so deliver more overall computing power with less energy consumption.

It is interesting that Google is not a Rackable customer. As the largest Internet company, you would think it would be in there with Microsoft, Yahoo, Facebook and Amazon. Google succeeded in part by stringing a lot of cheap servers together with their own proprietary methods. I'm betting those servers are very un-Green, very energy inefficient, but for now Google is so profitable it probably is not concerned much about its electric bill.

Facebook suddenly has a bunch of cash from Microsoft's buying a part-interest, so don't be surprised if they use some of it to build out their server farms. Microsoft has announced plans to greatly increase their Internet presence, so they will be expanding their server farms as well. And Yahoo and Amazon are expanding too, if not quite at Google's pace.

So I think Rackable systems has a good chance of being an emerging success story in 2008. However, you should be aware that the stock is risky. Rackable is planning on spending a lot of money on expansion; in the short run that will mean even if revenues ramp up, earnings may be negligible. Rackable is playing against formidable competitors like Sun, HP, Dell, and IBM, so they are not guaranteed to win.

Always keep your portfolio well-diversified.

More data:

Rackable web site
My Rackable page
My pages on others companies in this article: AMD, Intel, Sun, HP, IBM, Dell, Yahoo
Openicon Home page

Tuesday, October 23, 2007

Biotechnology Insights: Anesiva Goes Commercial

It has been a busy couple of weeks for me. I've thought of doing blog entries on Biogen-Idec (BIIB), AMD, and Gilead (GILD), but have not found the time. I still have one more installment in my Picking a Biotechnology stock series (but I went ahead and bought Gilead). But I think the most interesting, untold story is about Anesiva.

I would not know about Anesiva (ANSV) except that I invested in a stock called Corgentech a few years ago. At the time Corgentech was having problems with it drug development program, but had a great deal of cash left over from its stock offerings of more optimistic times. A different company, focused on pain drugs and funded by venture capitalists, was looking for a stock listing and more cash for its development plans. The two companies merged and the new company was called Anesiva. This was in 2006.

Anesiva's most advanced therapy was for reducing the pain a blood draws. It was actually a simple idea: take a well-known safe and effective drug, lidocaine. Make it into a fine powder and put it in a single-use device that uses a puff of gas to embed the powder in the skin in a circular patch. Within about 1 minute the skin is numbed. The patient feels little or no pain when blood is drawn or an IV needle is inserted. The treatment is now called Zingo.

Back then most analysts dismissed Anesiva with the belief that it would not get approval for Zingo from the FDA. They argued that even clinical studies proved Zingo to be safe and effective, the FDA just was not keen on pain killers. They pointed to a record of failure of other pain drugs to be approved by the FDA. I think the real problem for the major brokerage-connected analysts was that Anesiva did not do an IPO, so no one prestigious had got the fees that induce Wall Street to hype companies to investors.

The Phase III studies of Zingo came in with impressive results. The first studies were done for the "pediatric market," which is to say for children. National health guidelines have been adopted to reduce pain and anxiety for children in medical settings. The FDA not only approved Zingo for children; it approved it early. Even Anesiva seemed surprised.

And the stock price is, yes, down. As far as I know, no major brokerage house recommends Anesiva stock. The consensus now: no one is going to pay $15 to save their child from pain, and even if the parents would, the HMO's won't.

But HMO's are only careful with money, not stupid. Time is money, and getting kids to accept procedures without a struggle saves staff time. It also means happier customers.

Anesiva is working to get high-volume production of Zingo units underway. They have a sales staff that is working on getting hospitals to adopt the therapy. There is a group of pediatric nurses that is tired of being seen by children a harbingers of pain. The nurses are advocating for widespread use of Zingo for children.

Commercial sales of Zingo probably won't start until Q2 2008, and like all ramps, may get off to a slow start. Meanwhile the Zingo Phase III trial for adults has been completed with good results. It will take a while for Anesiva to submit the data to the FDA, but approval for use with adults should come in 2008. In this kind of situation we have what is called a label-expansion. All the FDA needs to do is say that what can be given to children can be given to adults.

Just based on the Zingo story, Anesiva is a very undervalued stock. But there is another drug in the pipeline. It is called Adlea and it is used for surgical pain. Basically, Adlea is sprinkled in the affected area during surgery. It appears to relieve pain for 6 to 8 weeks after that. I am guessing that eventually it will become a standard surgical procedure. Because of the way the FDA works, you can't just ask for approval for surgery in general. Anesiva has been trying it out on a variety of procedures, notably knee surgery and bunion surgery. The great thing about Adlea is that is can reduce the need for full-body opioid painkillers. I think the FDA likes that idea.

Nothing is guaranteed in the stock market, but Anesiva is a pretty good bet. Even if the big brokerage houses delay a long time before recommending it, in the next two years sales are highly likely to ramp up and away.

As always, there are all kinds of risks, including the possible failure of doctors to adopt a new therapy. Anesiva, like any stock, should only be held a part of a portfolio balanced for risk.

Again, most sell-side analysts don't like Anesiva. Every time they have been proven wrong, they just find another reason to not like it. That is the main reason the stock price is such a bargain now.

More data:

Anesiva corporate Web site

Tuesday, October 9, 2007

Microchip (MCHP) Dives on Warning

The stock price of Microchip (MCHP) dove over 10% this morning following yesterday's after-hours Q3 revenue warning by the company. I already owned Microchip, so of course I was disappointed. But my portfolio model allows me to buy more of this stock, which pays a substantial dividend. I consider it to be the safest stock in my portfolio because it pays a very substantial dividend for a technology stock. At a price of $32.77 the current yield is 3.6%, which is a bit less than you can get on a 90-day treasury bill right now.

If you read my analyst conference summary for Microchip's Q2, you will see that management's guidance for Q3 was "September quarter revenues expected flat to up 2%. GAAP EPS $0.36; non-GAAP EPS $0.39. " Q2 revenues were $264 million, up from $258 million in Q1.

The warning today stated Q3 revenues will come in around $258 to $259 million, or back to Q1 levels. GAAP EPS is estimated at $0.35 and non-GAAP (which excludes stock-based compensation) will be around $0.38.

So now Microchip is saying it will miss its earnings guidance by one penny per share. Hardly cause for an over 10% price drop on a stock with a high dividend yield.

On the other hand, I had predicted a good Q3 because I believe manufacturers who use Microchip's microcontrollers have been overly cautious about inventory levels and their own final demand. I still think that, because there are stories circulating of microcontroller-based devices like toys (these may be microcontrollers from other manufacturers) not being ready to meet holiday demands. It is lost money all around if stocks are insufficient to meet consumer demand.

Of course I like making more than 3.6% on my investments. Microchip has steadily increased its dividend over the years, so expect more in the future when the demand constraint disappears. I think the stock has considerable upside potential, dependent of course on revenue and net profit increases in future quarters. And compared to the much more risky biotechnology and technology stocks I tend to invest in, Microchip is a no-brainer for my portfolio.

You can see a list of stocks I like to follow at my analyst conferences list page. You can see more commentary at my Microchip (MCHP) page.

Wednesday, October 3, 2007

Dot Hill Withers in Q3

I have been watching SAN (Storage Area Network) equipment maker Dot Hill (HILL) closely lately, hoping Q3 would be the day this company showed traction. The stock is cheap, the company has quite a bit of cash compared to its market capitalization value, but this only will work out for investors if revenues and earnings start a steady increase. (I don't hold Dot Hill, but have in the past).

Hopes were dashed today by a preliminary Q3 earnings report. Instead of getting traction, revenues were down quite a bit. The estimate is $43 to $46 million, a plunge of at least $10 million from Q2, and at least $4 million below the low end of the guidance given by management in August.

The only bright bit of data is that cash may have increased slightly. The company has been taking steps to cut costs.

Dot Hill has been trying to get away from being a parts source for a single customer, Sun. It has made good progress on that score in the past year. It is not clear whether the Q3 shortfall is due to lack of orders from Sun, or a gap in orders from one of the new customers. In any case sales to new customers cannot be ramping very quickly when we see this kind of result. Dot Hill has some impressive new technology, but competition in the data storage industry is fierce.

For more information see my Dot Hill page, which has links to my notes on prior Dot Hill analyst conferences.

Monday, October 1, 2007

Choosing a Biotech Stock 4: Sepracor

What about Sepracor (SEPR)? Isn't Sepracor a lot less of a risk than Gilead, with just about equally good growth potential?

(Meanwhile, since #2 of this series on September 10, saying Gilead would become my default choice if I could not find a better biotechnology investment, Gilead stock has gone from $37.50 to $41.87 per share. Then again, the market in general is well up.)

I have not followed Sepracor closely these last few years, and there is a history to that. Back in the slump in 2002 I bought some Sepracor for $5.06 per share because I thought the price was ridiculously low. In April of 2003 I thought the price had gone ridiculously high, so I sold it at $17.07 per share. It was one of my best trades ever. Imagine how dumb I felt as the stock continued to climb. By 2004 it went over $50 per share.

Sure it was a good company, with a good strategy for developing marketable drugs, and it already had approved drugs and revenues. But I thought the people who bought it at $50 per share were taking an astonishing risk. In my eyes it would take years of increasing sales revenue and net income growth before such a high price could be justified. The price peaked at over $65 per share in early 2005.

But today I can buy the stock for $27.41 per share, and maybe I should. But my experience illustrates an important point about stock speculation: there is a lot of pure chance and investor psychology involved. The idiot who bought my stock for $17.07 per share, even holding it until today, has done fine. Selling it at $65 per share, that guy looks like a genius. But buying overpriced shares is a bad bet. You might get lucky, but it is a practice to avoid.

Today Sepracor ended at $27.41 per share, for a market capitalization of $2.94 billion. If you had $2.94 billion, would you buy the company?

What you would get would be trailing revenues of $1.25 billion and net income of $192 million. Dividing net income into market cap is one way to get the PE ratio: 15.3. That is pretty good, a return of 6.5% per year, which is great if profits are growing rapidly.

But yes, there is a major fly in this ointment. Q2 numbers were a disaster. Revenues slumped to $278 million, and net income was a mere $6 million. If that is the picture going forward, this stock is way overpriced. On the other hand if it is a one-quarter, or even 2 quarter blip we are in the midst of a buying opportunity not available since I sold my stock back in 2003.

So what happened? What does Seprecor sell, anyway? You should check out the Seprecor web site, of course; start with the products page. You can see they sell Xopenx for asthma, Brovana for COPD (chronic constrictive pulmonary disease), and Lunestra for insomnia. Note that everything else, their entire pipeline, is in Phase I or preclinical. Which means that they have a lot of time to wait and money to spend, and risk of failure, between them and any of these potential products coming to market. So its nice they have a research program and some candidate drugs, but the real value in the company is the three drugs they already are selling.

The press release of second quarter results tells the story per management. There is a bunch of good news in the press release. Brovana had its commercial introduction. Marketing agreements were made for Lunestra overseas. The company has $890 million cash in its coffers, a very good thing.

But Lunestra sales were up only slightly from a year earlier. Xopenx sales fell from the year before; this was said to be because Medicare and Medicaid reduced what they would reimburse for the drugs usage. Investors beware: government decisions can be a major risk factor for pharmaceutical companies even after they have FDA approval and are marketing drugs.

Brovana sales just began in the quarter, with revenues of $5.5 million.

I would expect revenues and net income to resume growth this quarter; results should be out towards the end of October.

I think at the current price we have a buying opportunity. There should be some growth in the near term from selling Lunestra outside the U.S. and a new income stream from Brovana. Even if sales just get back on an even keel, with profits more like what we saw in the second half of 2006, the stock is priced very nicely.

But Gilead (GILD) or Seprecor (SEPR)? I would still put my money in Gilead. It seems to be on a clearer upward path and its price to earnings ratio, looking forward rather than back, is on par with Sepracor.

Of course you should always look for diversification. If you are looking for several biotechnology stocks to add to your portfolio, both Gilead and Sepracor are worth further investigation.

You can find some links I have assembled to help biotech investors at my Biotechnology Investor Research Help page.

Thursday, September 27, 2007

Red Hat Worth a New Look

I do not own Red Hat stock, but it is now on my list of stocks to consider when I can add a new position. After years in the wilderness, Red Hat has lately proven that it can make profits and grow them rapidly. Strangely, this once red-hot stock has been largely forgotten by investors, so it is reasonably, but cheaply priced.

You can get the latest details in my summary of the Tuesday, September 25, 2007 analyst conference with fiscal Q2 results. But the long-term history of Red Hat is more enlightening. Back around 1999 people were talking about the open source operating system known as Linux as being a Microsoft killer. I got started in technical research after pointing out that Linux was more likely to kill Sun Microsystems and other Unix players than to hurt Microsoft, at least in the short run. I was right: Linux then and now required a great deal of technical expertise to use.

Red Hat was the favorite stock of the Linux and anti-Microsoft crowd back then. It was always a good company with the goal of making Linux an operating system that enterprises could depend on. But you know about investor enthusiasm: Red Had stock was priced as if it was already on the inside track to defeating Microsoft before it had made any profits, even before it had substantial revenue. Recall that Linux is free. Red Hat had to find a way to profit from selling a product that is free, which is not so easy.

Take a look at Red Hat's stock price over the years (at You can see that its IPO price was above today's price. It peaked around December 1999. By July of 2001 it had slumped to $3 per share; I wish I had picked some up then! But in fact in 2001 Red Hat was not profitable and revenues were minimal, so $3 was pretty generous.

But while investors did what they do best, betting irrationally, the workers and management at Red Hat trudged on. Their Red Hat Linux gained traction year after year. It is worth it to corporations to buy a version of Linux that is proven to work at the enterprise level, and to be able to get support when they need it.

In Q2 Red Hat's revenues were $127 million. Microsoft's were $13.4 billion. Other major players are competing in the Linux space now, notably Novell and Oracle. But I think it is fair to say that Red Hat is the Linux brand leader. Red Hat is also a good virtualization play and now owns the JBoss brand; I think both of these will be valuable going forward.

Red Hat should now be able to grow revenues faster than costs, so profits should grow faster than revenues (on a percentage basis).

Another plus for Red Hat is its cash. With equivalents it has $1.3 billion. That is a hefty war chest.

Red Hat's main risks going forward are the usual macroeconomic and competitive risks. Microsoft is enormously profitable; it could lower its pricing on its server software if it ever thought Linux or Red Hat were a serious risk.

Thursday, September 20, 2007

Don't Count On Another Rate Cut

This week's 0.5% rate cut by the Federal Reserve was appropriate. But I would not count on any further cuts. If economic trends run as I expect, further cuts would send the economy fish-tailing.

Much of the economy is moderately strong, including exports. The fall in new housing construction combined with the uncertainty in the mortgage derivative markets has been slowing the overall growth rate. Everyone has reason to reassess our spending habits, from private equity buyout specialists to minimum wage workers.

Hopefully the Federal Reserve cut, combined with injections of credit in appropriate institutions, will mean that mortgage rates will go a bit lower. They never were high in this decade. The problem was stupid people thought lenders would be happy with eternally low returns on their loans. Once the Fed jacked up interest rates to normal levels the handwriting was on the wall. Yet the financially illiterate did not refinance their low-interest, variable rate loans to long-term fixed-rate loans. Some people who are in default were victims of scams, but most were just spendthrifts.

There is a lot of unsold housing, both new and used, on the market. But there is a great deal of evidence of pent up demand; fear is holding buyers back. Why buy a house or condo now if it will be 10% cheaper in six months? The U.S. population increases so rapidly now that all the housing stock is needed.

Housing prices lost touch with reality around 2004, earlier in some markets. But now that developers have cut back on building (permits issued were remarkably low in August), buyers will start digesting this inventory. Already housing in the Midwest is so cheap that I would not hesitate to move a business there to take advantage of the low costs. But every market is different. San Diego, with its near-perfect weather and ocean access, will probably snap back faster than real estate in the Central Valley of California, where most people live only because they can't afford a coastal home.

With the dollar low imports should continue to boom, meaning more hiring in manufacturing and agriculture. As soon as builders start seeing their inventories dwindle they will up their output, putting demand on lumber and other housing components. Selling furniture and appliances will swing back. Of course this process is one measured in months or quarters, not days.

Unemployment is at reasonable levels despite massive layoffs in the housing sector. So if the housing sector even stabilizes, labor availability will be tight.

Of course, there is always a spread of paths to the future, and you can guess at the probabilities to match to the paths. There is some real probability of a recession, perhaps brought on by more turmoil in financial institutions. But there is a real possibility that this summer was a panic for no good reason, and that the Federal Reserve will regret even the cut it made this week.

The most probable path, in my eye, is a return to moderate economic growth in Q4 followed by strong growth in 2008. Of course as more data comes in the Fed will evaluate it, as we all will. But given the most probable path, I think the Feds should hold interest rates steady for about 6 months. Then they will probably have to raise rates again to keep all the people jumping back into real estate and stock speculation from having too big of a party.

Work smart, spend cautiously, then save, and invest wisely.