Friday, March 28, 2008

Red Hat Tricks

Red Hat (RHT) reported it results for its fiscal Q4 2008, which ended February 29, 2008, on Thursday. Analysts were particularly interested in seeing if any slump in sales occurred in January or February due to the turmoil in the mortgage security market and its effects on the U.S. economy. For a detailed report on results and answers to analysts' questions, see my summary of the Red Hat (RHT) analyst conference on March 27, 2008.

Red Hat distributes and supports the Linux open source operating system and the complimentary middleware, JBoss. It clients are mainly large corporations that have datacenters running large numbers of servers.

From Red Hat's point of view, the economy is doing just fine. Revenues were $141.5 million, up 5% sequentially from $135.4 million in the November quarter and up 27% from $111.1 million in the year-earlier quarter.

Usually rapidly growing, profitable companies have a high price-to-earnings (PE) ratio. But there are different ways to calculate earnings. The safest bet is usually (but not always) GAAP earnings per share (EPS). GAAP means Generally Accepted Accounting Principles. But there are other measures worth looking at if you are trying to value a stock.

Red Hat's GAAP EPS were $0.10, flat sequentially from $0.10 and from $0.10 in year-earlier quarter. Which would seem to mean profits are flat despite growing revenues, which is usually a negative sign.

Non-GAAP EPS measures have been used unscrupulously at times in the past to inflate the value of a stock. But some times they are more realistic than GAAP measures; it just depends on what you exclude from GAAP EPS and why. Red Hat reported non-GAAP EPS of $0.20, up sequentially from $0.19 in Q3 and up from $0.16 year-earlier. That is 25% annual growth.

Difference with GAAP numbers is due to stock-based employee compensation of $10.0 million and $10.7 million difference in provision for income taxes. These are not cash expenses, but the stock-based employee compensation does tend to dilute the shares of people already owning stock.

If you want to exclude history and see how a firm really did in a quarter, a good indicator is cash gains. Operating cash flow was $71.6 million, or about 50% of revenue. That is $0.32 per share. In addition, the company has $1.3 billion in cash and equivalent securities on its balance sheet.

How do we choose? Red Hat is a relatively new company that has had high startup costs. Under GAAP, many of the cash expenses of yesteryear show up in today's profit and loss statements. So the money, which came from venture capitalists and those who bought into the IPO, was spent long ago. But the money coming in today is real. As long as everything is kept in perspective, I think the cash is the leading indicator in this situation.

Take the low extreme and you have a company generating GAAP earnings of $0.10 per share per quarter, or $0.40 per year, and not growing profits. Even in normal times you would not want to pay more than about $8.00 per share for its stock.

Keep your eye on the cash and you have $0.32 per share per quarter or $1.28 per year, and rapid growth. A ratio of 30 in that situation would be considered conservative in a bull market, plus you would add in the $1.3 billion. That would make Red Hat worth about $38 per share. But of course we are not in a bull market.

Any price between those extremes $8 and $38 per share is arguable. Red Hat stock ended trading today at $18.49 per share, up over 5% during the day on a day the stock market fell considerably.

I own Red Hat. My portfolio rules allow me to buy more, and I might, but there are a lot of undervalued stocks to choose from right now.

Keep diversified.

More data:
Red Hat investor relations page
My Red Hat (RHT) page (with links to past analyst conference summaries)

Wednesday, March 26, 2008

Positive Yield Curve

Remember the negative bond yield curve? Negative yield curves are supposed to predict recession, and there is some good reason for that. Now if we are not in a recession we are in what might be called a pause. With only a slight return to normal consumer spending patterns and house sales, however, the pause could turn into a ramp. You have heard enough dire predictions for the rest of 2008; I won't repeat them here, and they remain a possibility.

However, lets look at that yield curve. One place to see it is at CNN-Money. It looks extremely positive to me.

So I would not be surprised to see the economy go back into positive territory in Q2. And if the Federal Reserve, as usual, ramps interest rates too slowly, we could start seeing rapid expansion of the economy, and unwelcome inflation, as early as Q4.

For my analysis of specific companies see my Company List page.

Monday, March 24, 2008

Can the Federal Government Avoid Bankruptcy?

The ultimate economic catastrophe for citizens of the United States of America would be a default by the Federal government. As far as I know, the government of the U.S. has never defaulted, not even during the Great Depression. Scenarios leading to default are unlikely. However, given the current situation I think we should consider the possibility in a serious manner, if only to avoid the eventuality.

The federal government is deeply in debt. Despite a fair degree of economic growth from 2002 until 2007, the debt expanded rapidly during this period. As of today the debt clock puts that debt at about $9.4 trillion (That is 9.4 thousand billions. Billions are thousand millions). That is about $31,000 per person living in the United States.

Instead of increasing taxes (or decreasing expenses) this year to get the budget in balance, Congress in its election year desire to get re-elected decided to send every adult taxpayer in the U.S. a $600 refund, plus some more dough for child dependents.

Now the really scary part. This is going according to plan. Only the plan was made by Osama Bin Laden. It might seem ludicrous that a 2 bit terrorist made up a plan in the 1990's that could make the U.S. default on its debt at some point in the future, so before I detail that story we should look at what it takes to make a national government go bankrupt. Because national governments have gone bankrupt in the past, and it could happen here.

Suppose the U.S. continues to run up debt, only interest rates on the debt rise. They would rise if confidence were shaken enough. Suppose they rise to a scary (but not unprecedented) level, say 10%. Suddenly the government would need a trillion a year just to cover interest.

Now suppose that at the same time the economy tanked. We'll call a 25% tank extremely serious, but not impossible. In fiscal 2007 the federal government collected $2.4 billion in revenue. Reduce that by 25% and you have $1.8 billion. So, in our doomsday 10% interest with 25% revenue reduction scenario, if the budget were balanced and the interest were paid only $0.8 billion would be left for everything else, from the Pentagon to federal earmarked projects that use tax dollars to buy votes for incumbent congressmen.

But federal policy since FDR is to spend, spend, spend the nation out of recessions and depressions, because otherwise a political party's goose would be as cooked as Herbert Hoover. Since taxes would not be raised, the money would have to be borrowed. At 10% interest. In a year or two the full faith and credit of the U.S. government would be finished. Kaput. Zero.

Wait a minute, did I not say the feds did not default even during the Great Depression? That's right, but then was then and now is different. The Federal Government entered the Great Depression almost debt free (most of its debt in 1929 was from World War I expenses).

Any way, at that (currently imaginary) point something has to give, and all options are bad. Raising taxes would hurt the economy, although it might restore investor confidence in U.S. bonds. The Fed could print money, and that might not even cause very much inflation in a depression economy, but it might just give the country depression plus inflation, as happened in Germany after World War II and to a lesser extent in the U.S. after the Vietnam War ended. At some point Congress will have to choose between defaulting on bonds, raising taxes, and cutting domestic and military spending to the bone.

And Al-Qaeda wins. Cutting back military spending means that the U.S. global military empire falls apart. Keeping up military spending would mean defaulting on bonds, and the U.S. global economic empire would collapse. Raising taxes would be the least best option for Al-Qaeda, but would make Americans really angry and could kill what was left of the economy. Al-Qaeda wins.

So let's just review how Al-Qaeda sees the world. Islamic militant fanaticism is not something new. What is new is that these guys can read more than the Koran. After the army of the U.S.S.R. withdrew from Afghanistan (where it had supported a secular, non-Islamic government) Western analysts said the real cause was economic. Not that Osama and crew were not fierce fighters, or that the advanced technologies the CIA equipped them with weren't a bother for the Soviet army. When the Soviet Union later collapsed, its emphasis on military rather than consumer spending was given (by Western analysts) as a leading cause.

So the guys at Al-Qaeda, enjoying war and wanting an excuse to continue their lifestyles, picked a new enemy. But they re-used the plan from the prior war, because it worked.

They wanted the U.S. out of Saudi Arabia. They wanted the U.S. to stop backing the governments of Egypt, Pakistan and Israel. They were aware that the U.S. economy was far larger than the Soviet one. So if the Afghanistan war took years to win, the War Against the Christian Imperialist Dogs (what we call the War on Terror) might take a couple of decades to win. And it did not require them to conquer the U.S. Just as they did not conquer the Soviet Union.

All they needed to do was bankrupt the U.S.

Which is what has been happening with the U.S. wars against Afghanistan and Iraq.

Al-qaeda has no better friend than George W. Bush. He decreased taxes and greatly increased military spending. The very things that could still lead, eventually, to a default on U.S. government issued bonds.

America's long-term economic and military strength depend on keeping the federal debt at a manageable level. And while many variables go into that equation, the most important thing to restore confidence in the economy is to get the U.S. military out of Iraq and Afghanistan ASAP.

Friday, March 14, 2008

Dot Hill Q4 2007 Results

Dot Hill (HILL) stock plunged today on the news that ... there was no real news. I always wonder who is being stupid here, the people who bid up the stock when Dot Hill announced a new deal with HP, or the people who dumped the stock when the HP deal did not retroactively make Q4 2007 a wonderful quarter. Maybe they are the same people.

There was, of course, the illusion of news, or lack thereof, and the analyst conference did offer some insight into the trajectory of Dot Hill, a storage technology company. It was mostly glass half full stuff.

The biggest item was a non-cash write-down of goodwill. At $40.7 million it swamped everything else. I've seen quite a few of these lately, mostly at companies that have made acquisitions and then seen their stock prices drop. They are required when reporting GAAP (Generally Accepted Accounting Principles) numbers under rule SFAS 142. This is one of the rare cases when I think GAAP numbers are misleading. Goodwill is mostly an accounting fiction, and writing down a chunk in a single quarter tells you nothing about how a company performed in that actual quarter.

Revenue was $51.8 million, up 13% sequentially from $45.7 million in Q3 but down 14% from $59.4 million year-earlier. Non-GAAP net revenue loss was $5.7 million or $0.12 per share. See my summary of the Dot Hill Q4 2007 analyst conference for more data.

On the one hand Dot Hill management always seems to think profitability is just over the horizon. Years of losses keep the stock price low, with occasional bouts of optimism. The company had $82 million in cash at the end of the quarter, but it used to have a lot more and cash has been draining out quarter by quarter.

On the glass-half-full side, Dot Hill has transitioned out of a difficult situation and shown truly substantial progress on this. Dot Hill is in the data storage component business. A few years ago most of its business was acting as a supplier to Sun. Even then the situation was competitive, but then Sun bought a storage equipment company and is gradually phasing out the Dot Hill products. Yet the Dot Hill products were quite good. Sun is still the single largest customer, and sales to Sun were better than expected in Q4.

So Dot Hill has been looking for new customers and creating new products for them. They reported they now have 26 customers, mostly relatively small OEMs. But they work with big OEMS too. NetApp (formerly Network Appliances) became their second biggest customer after carrying a new line of products starting in Q4.

The problem with the transition has been the time required to develop new products, and the cost. Dot Hill has handled this well, conserving their cash better than most companies would. R&D expense in Q4 was only $5.9 million. They have also been finding cheaper ways to manufacture their products (while keeping quality high), which helps them compete and have a chance at being profitable.

It costs money to service any new customer, and quite a bit of money to get started on a volume ramp, as they have done with NetApp and are doing with HP. There is the danger that you can spend this money and then not sell enough goods to recoup costs, much less make a profit.

If Sun sales continue to ramp down slowly and HP and NetApp and other OEM sales ramp up relatively quickly, I believe management is right that Dot Hill can become (non-GAAP) profitable in some quarter of 2008. Want me to guess? I'll pick Q3.

I own a bit of HILL, so I might be overly optimistic, but I think I'm being pretty cautious. At this moment market capitalization (number of shares times price per share) is $119 million. That is for a company with $82 million cash, ballpark $200 million annual sales, and new contracts with NetApp and HP. I call that undervalued, but risky, since profitability is the key to real value.

Keep diversified.

More data:

My main Dot Hill page

Thursday, March 13, 2008

Waiting for Provenge

Provenge is Dendreon's active immune therapy for prostate cancer. Its development by Dendreon and review by the FDA is an epic tale, which I can't repeat in its entirety here. For more background see my main Dendreon page.

"Waiting for Provenge" is a title I've been thinking about for weeks. Strangely, two days ago Dendreon announced the wait may be shortened. Those of us who are waiting fall mainly into two classes. One is men who have prostate cancer, specifically the type called asymptomatic, metastatic, androgen-independent prostate cancer. It is not that this is the only kind of prostate cancer that may be helped by Provenge; it is the one that they did clinical trials on and for which they are seeking FDA approval.

I would not call Provenge miraculous, but it has some real advantage over current therapies. In addition to prolonging life in some patients, it improved the quality of life over other therapies for all patients. Provenge is created by stimulating the immune response to an antigen that appears only on the surface of prostate cancer cells. So it helps the body kill the cancer. It does not always work, but unlike chemotherapy, its side effects are minor. You can live a relatively normal life. And you only are infused with Provenge once, or at most twice. So men who have tried alternatives, or have seen other men try alternatives, really like to try Provenge. But they can't, because the FDA failed to approve Provenge, even though their own advisory committee recommended that they approve it. I'll come back to that point.

Aside from the people at Dendreon itself, the other people who are waiting to see if Provenge will be approved, and wondering when that will happen, are investors. That includes me. I own a bit of Dendreon (DNDN). I confess I've actually already made some money buying the stock when investors were depressed about Provenge's prospects for approval and selling some of it when investors seemed over elated about its chances.

Today I listened to the quarterly analyst conference (for Q4 2007) [See my Dendreon Q4 2007 Analyst Conference Summary]. The main topic was the ongoing Impact Phase III trial and the acceleration of the FDA schedule for approval (or rejection).

Provenge is in limbo. It was given what is called (in slang) an "approvable letter." The FDA did not approve it, but did say that they would if certain conditions were met, mainly that more solid statistics were needed to get final approval.

There is much speculation among investors, analysts, and patients as to why the FDA did not approve Provenge. There were certainly grounds for approval. Certain individuals who argued and voted against approval appear to have connections with rival drug companies that could see some income go away if Provenge were approved. But the value of the stock is based on the future, so let's focus on that.

Here is how management sees the future, and I tend to agree, but want to caution that there is uncertainty in any clinical study. If you combine the data from the two prior Phase 3 trials, Provenge is marginal only in the sense that not enough patients were included in those studies. Luckily, the current study, Impact, began enrolling patients in August 2003. This being a particularly nasty cancer they are studying, it means many patients have had time to die (deaths are called "events" in this context). The Impact study will have more events than the prior studies combined. Therefore, if the benefit trends are the same, the statistical significance of the trends is more certain.

An independent committee will look at this double-blind, placebo controlled study in the second half of 2008, for what is called an interim analysis. If the benefit trend is as good as or better than the prior studies, Provenge passes, because a larger group of subjects gives a stronger statistical significance. At least management says that is the current agreement with the FDA.

More waiting will be necessary unless Provenge fails this interim test so badly that they have to stop the trial (usually they do that when there is no effectiveness or an unacceptable number of severe side effects). If interim results are marginal it is still quite possible that Provenge will pass the mark on the final analysis. That analysis date has been moved up from 2010 to 2009. Since it depends on a certain number of "events" being reached, the date is vague. Note that events include deaths of patients receiving either the placebo or Provenge.

The Provenge naysayers read the statistical tea leaves differently. They don't think the results of earlier trials were that great. They think doing a larger trial will cause Provenge to regress to mean, in other words give results more similar to the placebo. There are finer statistical points to argue as well, but they all amount to a belief that the most likely outcome is that Provenge will fail both the interim and that final analysis. I don't find their arguments very compelling, but I cannot entirely discount them. There is a big chance element in clinical trials. Bigger trials tend to eliminate the chance element, but that can to for you or against you.

So buying Dendreon is no slam dunk. If the interim trial results aren't enough to get FDA approval, the stock will likely sink even lower than it is now.

On the other hand, if Provenge is approved, Dendreon is ready to test active immunotherapies on a variety of cancers, including less aggressive and earlier forms of prostate cancer. This is why big biotechnology and pharma companies are watching closely. Given time and money, Dendreon might change the whole cancer therapy game.

So Dendreon is a risky stock to buy. I suspect even if Provenge gets approved, there will still be time to buy it at a reasonable price. The factory is ready to produce Provenge on a large scale, but it still takes some time for revenues to start coming in after a therapy is approved.

There was good news for a few guys with prostate cancer. Dendreon is conducting a couple more small trials which won't be placebo controlled. In other words, everyone in them will receive Provenge.

More data:

Tuesday, March 11, 2008

Oil Bubble to Burst?

Noticing that there is a bubble is no big deal. I noticed that there was a stock market bubble in the late 1990's. I noticed that there was a real-estate bubble in the mid 2000's.

And I've noticed that there is an oil bubble that started a couple of years ago.

But calling an end to a bubble is difficult. How do you know when investors are going to collectively realize that all their stocks can't be the next Microsoft?

And given how irrational the Federal Reserve has acted in the past 20 years, even though you could predict that the housing bubble would burst when the Fed raised rates high enough, there was no way to predict when the Fed would get around to acting.

We are in an oil bubble. But that does not mean that the price of oil can't go higher, or that it might not take years instead of months for it to burst.

Consider the counter-argument: the globe has reached peak oil production, but demand is still rising rapidly, so prices will continue to be pushed up.

I believe it is likely that we have reached the vicinity of peak oil production, but Saudi Arabia could flood the global market with oil tomorrow if it desired to, and keep the flood running for at least a couple of decades.

Demand is already being pinched, but converting from oil to other energy sources, or to conservation, is a slow process. Yet it is happening. Talk to any car dealer in the U.S. about what has been selling in 2008, and they will tell you: fuel efficiency. People are sizing down. They are going to size down through all of 2008, and in 2009 Americans will be using a lot less gas.

True, demand in India, China, and other developing countries will increase. But these nations are also rapidly adopting non-oil based energy technologies.

Consider Applied Materials (AMAT) [disclosure:I own this stock]. It sells a line of solar panel factories. That is, it makes all the tools you need to make massive, low cost solar panels. You build a big building and move in one of the factories. You spit out solar panels. Another company paves large sections of the earth with them. Soon all-electric cars will run on the energy from these massive solar installations.

Multiply that example by a thousand other innovative companies and the practical decisions of billions of individual consumers, and you have demand for oil that is drying up. In addition, there is plenty of oil and gas. Do you see people lined up waiting for gas? No. There are no shortages. At least half of the current price of oil is pure speculative fever.

Maybe it is a good thing. Maybe these speculators are doing more to ease global warming than the federal government ever did or ever will do. But if federal taxes had been used to raise gasoline prices to today's level, we would not have a huge federal budget deficit in addition to our other troubles.

I can't say when the bubble will burst. And artificial shortages, like the one caused by the Iraq war, or Enron's gaming, could be created.

Meanwhile real estate is reasonable and stocks are dirt cheap. Food is another matter. We are in that part of the Malthusian cycle when there is not enough food for all the people who have procreated. If you bought sacks of flour last year your return today would be better than most managed stock funds performed.

It is a strange, new world. The pace of change in the 20th century will prove to be nothing compared to changes this century. And one change is coming fast: the end of the Oil Era.

Friday, March 7, 2008

Marvell (MRVL) Drops on Good Quarter Results

Marvell Technology Group (MRVL) reported its results for the quarter ending February 2, 2008 after the market closed Thursday. Results were far better than the guidance that Marvell management gave at the prior, November 27, 2007 analyst conference. They also beat the street estimates. But the stock price sank like a stone this morning. What is going on?

Only the people who dumped the stock this morning know for sure, but the explanation is not that Marvell's results were bad. I think one or more major players had a leveraged long position, based on guessing correctly that MRVL would report a great fiscal Q4 2008. In after-hours trading the stock bumped up nicely, at first. When the stock price then fell, still in after-hours trading, these longs dumped. When a stock is falling in today's illiquid market, no one wants to touch it, no matter what the fundamentals. Everyone is asking, do the sellers know something I don't know? (Which is always a good question to ask. Some times they do; usually they don't.) On the other hand there are some things that Wall Street does not like, which I'll come back to below.

Let's look at the actual results and the prospects for calendar 2008 (Marvell is now into their fiscal year 2009). For more data see my Summary of the March 6, 2008 Marvell Analyst Conference.

Revenues were $844 million, up 11% sequentially from $758 million and up 36% from $622 million year-earlier. That is a phenomenal growth rate. True, it is partly from acquiring Intel's Xscale division, but mostly it is organic growth from its key semiconductor chips that enable high capacity hard drives.

GAAP net income was $1.3 million, reversing a loss of $6.4 million in fiscal Q3, and a loss of $140.6 million year-earlier (fiscal Q4 2007).

I usually recommend using GAAP net income as a guide to the value of a company, rather than non-GAAP numbers, which in the late 1990's had become largely out of touch with reality. But Marvell's numbers are part of a bigger story. In 2007 it digested the Intel Xscale division (a money loser for Intel), resulting in poor numbers. That digestion is completed now, so the GAAP numbers are getting better rapidly, as you see in the $140 million GAAP net income improvement over the year-earlier quarter.

Non-GAAP net income of $123 million excludes stock-based compensation of $70 million, $8 million for restructuring and $44 million for amortization. Cash was up in the same ball bark, increasing by $100 million sequentially. With $631 million, cash is adequate but not a factor in the stock price, given that there is a $391 million debt from the Intel Xscale acquisition.

Marvell's analog and digital chip business is seasonal due to its consumer components, but I think it is safe to multiply by 4 to get a forward annual non-GAAP net income of about $500 million. As I write Marvell's market capitalization is $6.13 billion. That gives a price to earnings ratio of 12.26.

A well managed, rapidly growing company with a forward non-GAAP PE ratio of 12.26. What more could Wall Street want?

There is a legitimate, but probably overblown, concern that there will be a future macroeconomic impact on the hard-drive industry, Marvell's key customer. But that goes against the strong trends that helped Marvell's results in the latest quarter.

Judging from analyst's questions at the last few analyst conferences, Wall Street does not like Marvell's pursuit of long term growth. They want Marvell to cut its heavy R&D budget. They want stock-buy backs to reward short-term investors and screw long-term investors. They want more certainty, not Marvell taking its business of combining very high level digital and analog engineering skills into an ever wider arena of products.

In an oblique answer to a question about paying down the outstanding loan, management said there were better uses for the cash it has and is generating. I would read that tea leaf as saying they are still looking for appropriate acquisitions. Which means more spending of cash and accounting write downs. In a booming market Wall Street would urge you to buy this stock because of rapid growth, but right now the idiots at Pitigroup and Peril Flinch are hunkering down trying to bury their recent mortgage derivative mistakes. Using your money.

Which is why you should not let the guys on Wall Street manage your money and take exorbitant fees for that service. What seems nice as they steer their herds one way for a few years never seems to work out very well for the long run.

Marvell of course is a risky stock. Management has a history of taking risks, entering new fields of the semiconductor industry. There are the usual macroeconomic and competitive risks.

I own Marvell stock and would buy the whole company today, at this moment's stock price, if I had that kind of cash.

In the meantime, keep diversified.

More data:
My Marvell main page

Wednesday, March 5, 2008

Applied Materials (AMAT) Solar Play

Applied Materials (AMAT) disclosed a deal to sell $1.9 billion in solar cell manufacturing equipment to a non-U.S., privately held, unnamed corporation on Tuesday [See the AMAT SEC filing]. Applied SunFab thin film tandem junction production equipment and installation/warranty services will be used to construct multiple solar factories.

This comes a few weeks after Applied Material's fiscal Q1 2008 analyst conference of February 12 [See my summary of that.]. Overall Q1 was a poor quarter as semiconductor manufacturers, AMAT's customers, were cautious about investing in new equipment in the face of questionable demand going forward.

The bright spot was the solar energy segment (Energy and Environmental Solutions) which is a relatively new market for Applied Materials. Revenues in the quarter were $122 million, but new orders in the quarter were $260 million.

Management said it was in discussion with 4 major potential purchasers wanting to build solar cell fabrication factories. This $1.9 billion order must be one of those four.

Given that the annual revenue run rate has descended to approximately $8 billion per year, this is a big boost. But what is great is that Applied Materials, even at the low run rate, managed $262 million in net income in the quarter. So its way in the black even in a down cycle.

Applied Materials also has a fair amount of cash, $3.4 billion at the end of the quarter. This despite several fairly recent acquisitions for the solar segment.

I would like to buy Applied Materials, which seemed undervalued to me when I last wrote about it back in November [See Applied Materials Valuation]. On the other hand I have limited cash for investment, and other stocks I would like in my portfolio are also under priced due to the current liquidity crunch.

Even given all this, Applied Materials is a somewhat risky investment due to the uncertain future of the semiconductor manufacturing industry.

Keep diversified.

More data:
My Applied Materials main page.

Sunday, March 2, 2008

Novell (NOVL) Nose Up?

Novell had its analyst conference and released its results for fiscal Q1 2008 ending January 31, 2008 last Thursday.

Investors bid up the price of Novell stock almost 14% on Friday. I don't own Novell stock, though I have been watching it for a couple of years now. Of course I first became of Novell back in the early networking era, let's call it the 1980s.

For the quarter numbers and management presentation, you can look at my Novell Analyst Conference Summary for February 28, 2008. In this blog I'll be looking at some peculiarities in the results.

Revenues were Revenues were $231 million, up 6% from $218 million year-earlier. 6% in a year is not exactly rapid growth, but that might already be reflected in the stock price. In the quarter ending 10/31/2008 revenues were $226 million, so sequential growth was 2%. No questions there; revenue is (usually) revenue.

But how profitable was that revenue? There is where confusion reigns.

The best starting point, in my opinion, is GAAP net income. Novell reported that at $16.8 million. That is not much income for $231 million in revenue, but it is a turn-around from the year-earlier number, when Novell reported a loss of $19.9 million for the quarter.

Then you have non-GAAP net income. This is where corporations cheated a lot during the late 1990's. Whenever you look at non-GAAP numbers you want to be sure why they differ with GAAP numbers. In some cases they are a better indicator than current reality than GAAP because they exclude non-cash charges that are more an admission that the past was not as bright as they thought back then than an indicator of current conditions. But in other cases they are just management spin, so beware.

Novell gave non-GAAP net income for the quarter - for continuing operations - as $29 million or $0.08 per share. Which shows they did pretty badly with discontinued operations.

Usually good non-GAAP numbers are paralleled by good cash flow numbers. But they reported cash flow from operations at negative $26 million. They attributed that to heavy interest and restructuring payments.

Interest? But Novell has been sitting on a ton of cash for years; it has been the main prop for the value of its shares. It ended the quarter with cash and equivalents of $1.8 billion. It reported "other income" of $17 million, which usually (for other companies) is mostly interest on the cash.

Which means GAAP net income would be underwater if not for the interest on the cash.

As to the negative cash flow, the main ingredients are, starting with GAAP net income rounded to $17 million, were plus $11 million for (subtracting back out) stock-based compensation expense. Plus $9 million for depreciation and amortization (because it was non-cash). Plus $5 million for using up NOLs (net operating losses carried forward). And minus $66 million for "Changes in current assets and liabilities, excluding the effect of acquisitions and dispositions."

So you have to ask yourself, are there going to be future negative "Changes in current assets and liabilities, excluding the effect of acquisitions and dispositions?" How would one know? If it were a non-cash charge, I would not care very much, but it is a cash charge. It is real.

And you have to ask yourself how much a stock is worth when, if you subtract out the interest on cash, there are no GAAP profits.

And then there are the acquisitions. The Platespin acquisition due to close soon will eat up about $200 million of the cash, but generate no profit in the short run. How much do you want to bet Platespin will generate profit in the long run?

Of course, there are good reasons for optimism. Novell's new open-source, Linux driven strategy is generating growing revenues. Its partnership with Microsoft has helped it a good deal, in addition to infusing cash.

I don't want to put a valuation on Novell stock at this point. The outlook is too murky for me. With market capitalization ending Friday at $2.6 billion, or $800 million above cash, I would say look at the other opportunities available before plunging in. Don't buy on news you don't understand.

And keep diversified.

Akamai (AKAM) Douses Limelight

Akamai (AKAM) has always been a good technology company, centered around a good idea: the accelerated delivery of Internet pages. Large companies who are selling goods on the Internet don't want to lose sales, or advertising revenue, due to Internet congestion.

For a long time I believed Akamai was overvalued. It was sky-high during the Internet boom of 1999 when it had little revenue. After the bust you could buy it for $2 per share, and it was still growing, but far from being profitable. By 2007 it had everything you could want in a company: rapid growth, with profits growing more rapidly than revenues. But investors who were burned in 2000 were reluctant to plunge back in. The stock did not become cheap until the threat of competition combined with the housing-mortgage-market induced liquidity sqeeze brought it down into the $30 per share range in the second half of 2007. After watching the stock for years, and covering its quarterly analyst conferences (see my Akamai page for links to summaries), I bought Akamai on January 2nd, 2008. I still consider Akamai to be a risky stock, and I was buying at a risky time given macroeconomics, but it appears the level of risk plunged this Friday.

According to Akamai's press release, it won its patent litigation with Limelight Networks. "The jury awarded Akamai $45,526,946 in damages, plus interest." I caution readers that this was a Federal District Court level decision; such decisions are almost always appealed. Even if the decision is not reversed, the award could be lowered, and Akamai will not see the money any time soon.

However, it shows the benefit of being an early leader in a field and patenting your innovations. This decision will certainly make other companies think twice before going into competition with Akamai.

In the short run it does not change how much revenue or profit Akamai will generate this quarter or in 2008. It just adds some color to the argument that Akamai stock is underpriced given its strong record of growth. If you use the NASDAQ AKAM page, they give the trailing price to earnings (PE) ratio as 26.4 and forward PE as 17.3 (these are non-GAAP numbers). And that is after the 5% one-day price bump from the patent litigation news.

Keep in mind that all stocks are subject to unforeseen risks. Keep diversified.

See the list of stocks I follow