Monday, June 30, 2008

The Federal Reserve May Have a Hidden Agenda

If I had a seat on the Federal Reserve, I would have voted for a quarter-point increase in rates at the latest meeting. I believe that the low federal rates are not being passed along to consumers partly because of inflationary expectations. In other words, low rates are not helping as much as they normally would to get the economy back in growth mode because they are fueling short term inflation and long-term inflationary expectations. They are helping to prop up the idiots who run the nations major banks by allowing them to borrow at low rates and lend at high rates, but a quarter-point increase would not have cut into that game substantially.

A quarter point rise would have had an immediate positive impact on the dollar, which would have the effect of decreasing the contract price of oil, which in turn would reduce gasoline prices and give consumers some cash (or credit) to buy other items.

Gradual quarter point rises would not hurt the housing market or dampen the economy in any way. Four quarter point rises over the course of one year would only raise interest rates to 3%, which is still extremely accommodating.

The bankers who have been given seats on the Fed presumably know all this. Do they want to keep gasoline prices high? Are they willing to sacrifice the economic health of the middle class and working class to achieve an extra quarter-point differential in bank profitability? Well, yes, after all they are bankers. But I think there is another item that has been on the agenda for decades now. The Federal Reserve statements don't mention it, and neither does the financial press, at least not in the context of interest rate decisions.

Interest rates have an large long-term impact on the size of the national debt and the annual payments on that debt. This is not a new problem, but the size of the national debt has reached a magnitude that it impacts the Federal Reserve's leeway to raise rates. This is the real reason rates have been kept consistently too low for the last two decades.

The national debt as I write stands near $9.37 trillion [See debt clock]. Interest paid on it is an average over different time terms for the debt and different points where the debt was auctioned off. However, choose a nice round number like 1%. Over the course of 10 years most of the bonds representing the debt are turned over, so if my hypothesis is that the Fed is keeping rates on average 1% lower than would be ideal for their basic mission (economic expansion with minimal inflation), we are talking about saving the federal government 1% a year on debt. In round numbers, that is $94 billion a year. Over ten years, you can round up to a trillion dollars.

Now look at a truly bad scenario. What if, to fight inflation, the base rate was raised from 2% to 5%? Over ten years we are talking $3 trillion.

What should have happened during the late 1990'2 was the Fed should not have accommodated Congress, the President, and stock market speculators. The Fed is accommodating a federal budget that keeps taxes low on rich people and corporations, but spends a lot of money that mostly goes into corporate coffers. The War on Terror is great for defense contractors, but it is killing the economy. And the terrorists know it.

American Seniors pay for all this in another way. They tend to have their liquid capital in CDs. Low interest rates set by the Fed hurt senior retirement income disproportionately.

The war on terror should be handed over to the CIA and military special operations groups. Having a lot of soldiers on the ground, like we do in Iraq, is an ineffective waste of taxpayer money.

I believe we are in a situation where we can have better long term prosperity by raising interest rates modestly, cutting federal spending modestly - mainly in the Defense budget, and raising taxes modestly. But given the control of the Federal Reserve by the self-serving banking industry and the weakness of the current President and both major party Presidential candidates, I am not using that scenario to model the future.

I am modeling an ever-expanding national debt that will at some point hit a tipping point and turn the United States into a 2nd rate economic and military power. It happened to England after World War II, it happened to the USSR in the 1970s, and it is going to happen here, the only question is when.

Which, by the way, does not mean I'm pessimistic about my stock portfolio. Many individual corporations will survive this calamity, if necessary by basing themselves in countries that run their economies on a more rational basis. Owning companies that have strong intellectual property and management teams is the best economic bet Americans can make right now.

Thursday, June 26, 2008

Red Hat (RHT) Accelerates Growth

Red Hat's stock price plunged today with most of the rest of the tech stocks. Perhaps RHT investors were overly optimistic about quarter results released yesterday, or they did not think Red Hat's guidance was robust enough. I think Red Hat is doing great. That said, it has a relatively high price/earnings (PE) ratio for this market. If growth flattens, that PE will need to come down.

However, if anything Red Hat growth is accelerating. It may even have been helped rather than hurt by the current macroeconomic environment. Its Red Hat Enterprise Linux operating system and JBoss middleware offer great value propositions for companies using a lot of data servers; the more servers, the greater the savings over competitors. We have a growing server market combined with Linux variations continuing to win market share from Unix and Microsoft OSs. It is a pretty rich field to plow.

View my summary of the Red Hat June 25, 2008 analyst conference and fiscal Q1 2009 results for more details; here I'll analyze the data.

Q1 revenue was $156.6 million, up 11% sequentially from $141.5, and up 32% from $118.9 million year-earlier.

Look back further and it gets more interesting. From my summary of the RHAT June 27, 2007 conference:

Q1 2008 revenues were $118.9 million, up 7% sequentially and up 42% from year earlier.

Two things: annual growth slowed to a mere 32% from 42% for the quarter year-earlier. On the other hand sequential growth (Q4 to Q1) increased from 7% to 11%.

You could read too much into such figures since Red Hat revenues are still small enough to be impacted by single deals, or income recognition that slips from the end of one quarter into the beginning of the next. But the 11% sequential growth is better than recent annual growth rates in a quarter that is not normally a strong quarter.

I think Red Hat has an ideal combination of high-quality, robust, easy to manage products and low pricing compared to rivals. There is plenty of competition for Linux server software, but Red Hat has established itself as the premium brand without charging premium prices.

With IT departments desperately needing to innovate to keep pace with the data explosion (driven in part by audio and video data), Red Hat offers open source solutions that are at least as well-tested and capable as proprietary solutions. With IT budgets strained and CEOs demanding high returns on investment, Red Hat software begins to look like a bargain.

The main danger to Red Hat is the possibility of a larger company using its financial muscle to sell competing software and services at uncompetitive prices. Microsoft (MSFT) could afford to do this, as could Oracle (ORCL), but they are locked in struggle with each other as well as SAP and IBM. Novell (NOVL) is treading in Red Hat's footsteps, but they don't have any profits to fight with. Sun (JAVA) is becoming an open source powerhouse, but their profits come from their hardware arm, which is still struggling.

So Red Hat is a risky stock and is not dirt cheap right now. It was cheaper when I bought some earlier this year. It has its risks, but I believe over a 2 to 3 year time horizon the risks are minimal and their is a great potential upside. Management seems to think the main constraint lately has not been demand, but the ability of its sales force to keep up with demand. That is not a bad problem to have.

More data:
Red Hat investor relations
Red Hat summary at NASDAQ

Sunday, June 15, 2008

Celgene Trial Data: REVLIMID, VIDAZA, Amrubicin

There has been a fair amount of new data analysis coming from Celgene (CELG) in the past two weeks. All of it reinforces the case for the continued growth of Celgene revenues. Before looking at the results, a review of Celgene's financials are in order.

At the latest quarter results and analyst conference (See my Summary of the May 8, 2008 Celgene analyst conference and Q1 2008 results), Celgene reported revenue was $462.6 million, up 12% sequentially from $414.6 million and up 58% from $293.4 million year-earlier.
GAAP net income was negative $1.64 billion, down sequentially from positive $75.3 million and down from positive $57 million year-earlier. However, the GAAP loss was due to Celgene's acquisition of Pharmion. Non-GAAP net income was $159.3 million; EPS was $0.36.

Even if Celgene pauses in revenue and earnings growth, Q1 results annualize to $637 million of non-GAAP net income. At market close on Friday (6/13/2008) Celgene's market capitalization was $22.6 billion. Using those numbers for forward Price to earnings, you get a PE ratio of 35.5. That sounds pretty pricey in today's illiquid stock market.

The case for the stock valuation is one of proven rapid revenue growth and its likely continuation. Since the global market of Celgene's major products, Revlimid and Thalomid, are still expanding on a country by country basis, and since Revlimid's revenues almost doubled between Q1 2007 and Q1 2008, this is not an unwarranted assumption. But at some point there will be market saturation. To grow beyond that either one or more of the currently approved therapies has to by approved for treating another disease (or variation of a disease) or new drugs will have to be brought to market. Celgene already is reporting revenue of Alkeran, Focalin, Ritalin, and Vidaza in addition to the blockbuster drugs. Vidaza, which was picked up in the Pharmion acquisition, is believed to have potential revenues of over $200 million this year.

In that context the three recent data announcements are go-go indicators for investors.

Vidaza (azacitidine) was reported to provide "a significant overall survival benefit for patients with higher-risk myelodysplastic syndromes (MDS) regardless of whether patients were treated with low-dose Ara-C or best supportive care in the control arm. In aggregate, the survival benefit for VIDAZA across all countries was 24.4 months versus 15.3 months (hazard ratio 0.36) (95% Cl: 0.20-0.65) (p=0.0006)) compared to the other treatment arms." Vidaza is already approved in the U.S. for treating MDS. This is the kind of data that convinces doctors to use it rather than, or in addition to, other therapies. If you look at the Celgene product pipeline page, you will see that Vidaza is also in trials for treatment of solid tumors and AML (Acute Myeloid Leukemia).

The Amrubicin announcement was probably the most exciting. Two different Phase II clinical studies of amrubicin in patients with extensive-disease small-cell lung cancer (SCLC) either sensitive to platinum-based first-line therapy or refractory (non-responsive) to platinum-based first-line therapy. Results of the studies demonstrated improved overall response rates that compare favorably with topotecan, as well as no evidence of anthracycline-induced cardiotoxicity.

In the first study, the primary endpoint was response rate, and secondary endpoints were time to disease progression, progression-free survival, overall survival and safety. This was met with patients receiving amrubicin demonstrating an overall response rate of 34 percent, compared to 3.8 percent of patients receiving topotecan and the median progression-free survival time for amrubicin patients is 138 days compared to 106 days for topotecan. In the second multi-center international study, patients with SCLC who were refractory to first-line platinum based chemotherapy were treated with IV amrubicin . The primary endpoint was response rate, and secondary endpoints were time to disease progression, progression-free survival, overall survival and safety. The overall response rate for the study was 17.4 percent with one complete response, which compares favorably with those seen historically with topotecan. Additionally, median progression-free survival is 97 days. Amrubicin is generally well tolerated in both studies.

Of course, this is only Phase II data; Amrubicin is already in a Phase III trial, and often drugs that do well in Phase II fail in Phase III. With that warning in mind, the announced results are bullish, but actual approval and revenues from the drug are out in the post 2010 domain.

Finally, more proof came in of the efficacy of Revlimid came in. A pooled study presented at the 13th European Hematology Association (EHA) congress showed "multiple myeloma patients taking REVLIMID(R) (lenalidomide) plus dexamethasone significantly increased their survival rates. A lifetime simulation yielded an estimated mean survival of 5.6 life-years with REVLIMID in combination with dexamethasone (2.2 life-years with dexamethasone alone) for patients with one prior therapy, and 4.2 life-years (1.5 life-years for dexamethasone alone) for patients with multiple prior therapies."

Again, this just pushes doctors to get Revlimid going as a therapy earlier, rather than trying it only as a second or third line defense.

It takes time for knowledge to spread among the medical community, and of course it sometimes seems to take forever to get a new drug approved. Celgene is in the enviable position of having several approved drugs in the marketplace, a couple growing revenues very rapidly, as well as a variety of promising drugs in its pipeline. As biotechnology companies go, it is a relatively safe bet on growth.

I own a bit of Celgene stock.

Keep diversified.

More data:

Monday, June 9, 2008

AMD Revival?

Are AMD's troubles mainly behind it? If they are, the stock price is way to low. But after watching Intel (INTC) swat down AMD with aggressively priced but inferior products, and the subsequent AMD fumbling of the transition to Barcelona quad-core Opteron processors, I can understand why confidence in AMD is not high and could take some time to rebuild. I kept the AMD stock I accumulated, but I have not yet added more to my position despite recent tempting prices.

There are three big variables to look at. One is the competitiveness of AMD's technology. This has many moving parts, including many moving parts at rivals Intel and NVIDIA [NVDA]. The second is financial: what does the hard, historic data look like and tell us about future potential. The third is about markets. A number of nations have accused Intel of using illegal tactics to keep AMD out of the market. And many well-place decision makers own Intel stock. And Intel advertises heavily in the trade journals that help technology purchasers make decisions. As in other businesses, having a better product is no good unless you can develop channels for selling that product.

I think the best way to see the financials is to look at past quarterly reports and analyst conferences. Of course you can look at SEC filings, but for a comprehensible overview I rely on my own analyst conference summaries. Follow this link for a summary of AMD's April 17, 2008 report on the quarter ending March 1. AMD's investor relation page is also useful.

The biggest change over the last year is the decrease in the write-down of ATI acquisition charges. Graphic chip maker ATI was barely holding on against an NVIDIA onslaught when AMD purchased ATI for about $5 billion. Today the combined AMD/ATI operation has a market capitalization of about $4.5 billion. Hence the write-downs. AMD's Q1 cash flow from operations was $16 million, and they generated $50 million more by selling obsolete (to them) tools. More interesting, revenues were $1.505 billion, down 15% sequentially from $1.77 billion, but up 22% from $1.23 billion the year-earlier quarter. The seasonal drop was a bit worse than expected, but the 22% pop from year-earlier seems to show the worst of the revenue slump is behind.

I don't expect anything beyond the normal seasonality for the June quarter. Quad-core Opteron sales should be ramping up, and quad-core Phenom too, but neither have enough technological advantage over Intel's quad-core products to cut much into Intel's market share. The same is true on the discrete graphics processor side, where NVIDIA's domination seems solid in the short run.

Looking down the road 6 months to a year, however, I think AMD is going to be able to leverage its technological leadership over Intel in some key areas. AMD will continue to be the low-energy leader, which is especially important in servers and notebook computers. While Intel has increased the efficiency of its chips (largely by copying AMD) and has a 6-month to a year lead in process technology (the constant shrinking of transistor size on chips), its designs still seem to ignore the needs of end-customers.

The single biggest differentiator, however, is in graphics. AMD's Puma [Turion X2 Ultra] technology for notebooks is the best example. Intel cannot make high-end graphics chips and its low end chips are garbage (and the main reason people complain about Microsoft Vista). AMD Puma builds in a high degree of graphics functionality at a low cost, ideal for low-end notebooks. But for more expensive notebooks, manufacturers can simply add a discrete, high-end, graphics chip. The graphics processing power of the two chips is additive.

Everyone is the industry is afraid of Intel. If Intel cuts off your supply of chips, you are screwed. If Intel raises its prices to you (or gives your competitors better discounts for not using so many AMD chips), you are screwed. There are many large corporate end-users that still have Intel-only policies. Consumers usually do not know what to think about AMD v. Intel, although that is an improvement over 10 years ago, when AMD was assumed to be the inferior brand.

On the other hand, if someone else is selling notebooks that are AMD based (AMD makes the processor, graphics processor, and "glue" chips) that are noticeably better (better graphics, faster processing, longer battery life) than more expensive Intel-based notebooks, that could cause some people to rethink their relationships with the bully boys at Intel.

Of course, the Intel camp is promising wonderful, better than AMD notebook chips real soon. And they will buy enough advertising (and reviewers) to make their propaganda seem true, whether it is or not.

So AMD remains a risky stock. It has a lot of potential. But so far betting on the PC industry showing some backbone against Intel bullying has not paid off, and it may not in the future.

I think Intel is going to have to pony up some money to settle the AMD v. Intel lawsuit. There has just been too much evidence accumulating around the world of Intel wrongdoing. Whether it will be for a half-billion dollars or for $50 billion or any point in between is anyone's guess right now.

One Million Opportunities

Last week the headlines screamed that the number of homes foreclosures had passed the million mark [See, for instance, Homes in Foreclosure Top One Million at CNN/Money]

Some see a train wreck the size of the global economy. Smarter people see one million opportunities.

We all know the story of how the opportunities were created. Housing prices started going up after the Internet Stock crash of 2001 because the Federal Reserve set interest rates too low and left them their too long. Stupid people were egged on my news media, real-estate agents (my friend John calls them land pimps), banks and mortgage companies, friends and relatives to believe that housing prices would always go up at 10 to 20% per year. A house was no longer just a place to live in, it was a money machine. Why, it was such a sure thing you could buy a house without a down and be rich in almost no time.

I've seen smarter people who believe a carpenter can raise the dead.

Some people worked and saved and did not fall for the flim-flam. Now they have downs and if they can buy a house at the right price they can eliminate their rental expense. They can build equity the old fashioned, reliable way: by spending less than they make and paying down the mortgage.

It is a good thing. The profligate are punished and the thrifty rewarded.

Not every house in foreclosure is a good buy. You have to ask yourself, what is the real value of this house, and how does that compare to the asking price? Just like stocks. I always ask myself, before buying or selling a stock, what is the market capitalization of the company, and if I were going to buy the whole company, would that be a price I like?

Not everyone should buy a house just because the price is right. It takes energy or money, and sometimes both, to keep up a house. Things go wrong, things wear out. Taxes have to be paid, and they will eat up the original purchase price of the house in the long run. Don't kid yourself, all land in the U.S. is just rented from the government, and taxes are the rental payments.

And people are out there hunting and buying. April used home figures were released today [See April Pending Home Sales Rise As Prices Tumble] and they reflect what I've been hearing anecdotally in California. If a home is for sale and it is priced right, it can sell quickly. People who are trying to sell for imaginary prices, their properties will just sit.

There are scenarios that could make buying homes now look stupid, but they are becoming increasingly unlikely. Buy a home at the right price and ugly scenarios are balanced by some pretty bright ones. Some distressed sellers may sell so cheap that a non-distressed seller to have some equity, aside from a down, pretty quickly.

Most in demand: homes near workplaces or on public transportation routes.