Tuesday, August 26, 2008

Marvell Downgrade, Round Two (or, Analyst Bull)

This column is not called Dissecting the Bull for no reason.

In this entry I am going to dissect games sell-side analysts play, using today's downgrade of Marvell Technology (MRVL) by Jefferies as an example. The stock price plunged 7% so far today. Marvell is about to hold its analyst conference for the quarter ending August 2, 2008 this Thursday, August 28th.

This looks suspiciously like events the week before the last Marvell analyst conference. See my Marvell Reality Tops Goldman Downgrade to make a comparision, and my summary of the fiscal Q2 2009 Marvell Technology analyst conference for real information.

This does not mean that I know that Jefferies is wrong in this particular case. Rather I want to put this and all analyst upgrades and downgrades into a broad perspective.

First, for those who don't know me, a reminder of my credentials and possible biases. I work freelance as a buy-side analyst for an investment management company. I also do a variety of things for technology companies, let's just call it consulting. I also am developing a web-based business that will be beta-testing soon. This year my only paying tech client has been Microsoft, but that is just a coincidence. I was asked to do a job for Cisco, but refused it due to a scheduling conflict. I also have investments in the stock market, including Marvell. That's why I noticed the price drop today.

Buy-side analysts are under pressure to give an accurate picture of reality for their clients, who are investors. Publicized upgrades and downgrades come from sell-side analysts. Their job should be to give their ultimate clients, individual and institutional investors who follow their advice, an accurate picture of reality. Sell-side analysts are paid by their employers, who are investment banks and brokerage houses. Their employers make money two ways: from their own speculation, and from fees, including trading fees. Generating fees requires getting clients to trade. Upgrades and downgrades induce clients to trade and generate fees. In addition, the tempatation to use the upgrade/downgrade for an internal trading edge, or to give priviledged clients an edge, is always present.

That said, the vast majority of buy-side analysts do their jobs in as honest of a fashion as they are able. Some are better at analysis than others, but that is just human nature. I've been very impressed by some of the sell-side analysts I know through participating in analyst conferences.

Now take a look at varying types of downgrades (flip them for upgrade equivalents). The most common kind is news-based. Usually a company says it had lower than expected revenues, or had some kind of foul-up, and says it to the public. Analysts issue downgrades. You don't need the analysts for that, so you can trust them.

Sometimes, using actual research, a particular analyst will come up with something no other analyst has, at least at first. The woman who picked Enron apart is a good example. Unfortunately, chance playing the role it does, sometimes even this does not help investors much. These downgrades are often difficult to verify independently, until it is too late. Sometimes a plus on the other side of the balance books, perhaps a client making an unusually large order, makes the analysis less important than it would be if all other things were equal.

Finally, we have the Hail Mary downgrade, which could be a cover for just getting clients to sell some stocks to generate commissions. In a time of economic turmoil, these are a good bet for analysts, because something could have already gone wrong, or could go wrong in the near future, so if you are right you look like a genius. There is always some sort of cover story, that makes it look like it is based on actual research. Often these downgrades just look past the truly predictable event horizon and lower earnings estimates for a year from now by a few pennies.

The problem for investors, of course, is that it is difficult to sort out the types of downgrades. Failure to believe a downgrade, when it has a real basis, can be quite dangerous.

At the Marvell analyst conference this Thursday (I'll have a summary [Marvell August 28, 2008 analyst conference] posted soon after it is over) questions will be asked, and Marvell management will give its answers. Could Marvell be hurt by the economic downshift? Sure, it has many large clients. A downturn in a client's business would effect Marvell. But I would not bet against Marvell at this point. I would not want to be any company competing against Marvell head-to-head. Marvell is ultracompetive and has crushed its competition repeatedly. It is in the process of entering several new fields, and seems to be preparing to repeat its history of success. Most notably in the past 2 years it acquired a money-losing division of Intel and turned it into a money maker.

Short term players have no choice but to panic when an upgrade or downgrade goes against their short term bets. Long term players can stick with their basic analysis and change it when real news warrants that.

Keep diversified!

More data:

My Marvell page

Monday, August 25, 2008

AMD Divests TV Unit to Broadcom

Today Broadcom (BRCM) announced it would buy AMD's - consumer television chip division for $192.8 million. AMD had announced that this division was up for sale, and was being treated as a discontinued operation, at its July 17, 2008, Q2 AMD analyst conference (summary).

This segment was acquired when AMD bought ATI in late 2006. It is difficult to make direct value comparisons because this particular line has not been singled out by AMD or ATI. For the quarter ending May 31, 2006 ATI reported its consumer segment revenues, which included more than the TV chips, were $143 million, but it also had quarter revenues of $652 million and was heading into a steep overall revenue decline even before AMD acquired it. By the time the acquisition was complete, reporting for Q3 2007 (see AMD analyst conference summary for Q3 2007), AMD was reporting consumer revenue of only $97 million, and that also included more products than the television chips.

Broadcom, by the way, provides chipsets for AMD's Opteron server motherboards, so they have a prior relationship.

AMD paid almost $5 billion for ATI, a major overpayment in retrospect, since NVIDIA (NVDA) was about to capture much of ATI's business. AMD desperately needs cash as it continues it's David and Goliath game with Intel. But it is important to note that at one point AMD management was calling video chips for large-screen TVs a growth area.

You hear that sort of thing all the time at technology companies: our sorry asses will be saved because we are into the next big thing. Forget that we failed at the last big thing. How many technology companies were going to make a mint for investors by plunging into wireless Internet (WiFi & etc.) back in 2004? How many actually did? As usual, the companies that won the last round, like Cisco, mostly won the new round.

That said, I think AMD is wise to focus on its core competency, computation, including graphics computation. It wisely shed its memory chip division before it picked up ATI's graphics expertise. Some things are going right for AMD now: quad-core Opterons are performing impressively, Intel's upcoming Nehalem chips don't appear to be anything great, and the ability to have high-end graphics and high-end CPUs is pulling customers away from both Intel and NVIDIA. On the other hand AMD's stock price is in the swamp, and both Intel and NVIDIA have been happy to compete with price drops when they could not compete with AMD's advanced technologies. AMD needs to start generating cash from operations in Q3; the cash infusion from the Broadcom deal and last quarter's sale of fabrication equipment is needed just to help balance the debt from the ATI acquisition. If AMD can't sell enough chips at a profit, Intel wins by default no matter. Intel's legal problems won't come into play in a meaningful way until 2010 or even 2011. Even then, paying a few billion dollars to AMD will be worth it to Intel; it will have been a small price to pay for stopping AMD in its tracks in 2004-2005, when ordinary competion could have led to Intel's overthrow.

AMD is a very risky stock, but I like the fighting spirit of the AMD team, believe the stock is currently undervalued, and own the stock.

But keep diversified.

More data:

My AMD main page
My Intel main page
My NVIDIA main page

Sunday, August 17, 2008

Shaking Up Tech: NVIDIA, AMD, and Intel

Technologies may come and go, but technology powerhouses can be much more durable. IBM, the champion of mainframe computing, is still around today and generating lots of profits for its investors. The mainframe also rans mostly did not make successful transitions to new technologies and business models.

The last three years have been rough for investors in the dominant computing technology, the PC. The funny thing is that PCs are more powerful than the mainframes of the 1980's, and many of them are not really personal; they are the servers of datacenters, internet web farms, and local networks.

Companies that dominate the end PC market like Dell and HP are dependent on the makers of the semiconductor chips that are the building blocks of the PC. Some components have multiple sources, but when it comes to the core, the Central Processing Unit (CPU, or just "processor"), there are only two AMD and Intel (symbol: INTC). In the graphics department at the high end we have only AMD (symbol: AMD) and NVIDIA (symbol: NVDA), but Intel competes in the low end of the market where graphics are integrated into motherboards.

Six years ago the picture looked remarkably like it does today, at least superficially. Intel dominated the CPU market. AMD made CPU's, but not profits, largely using technology licensed from Intel and allowed just enough market share by Intel to keep Intel from be accused of monopolizing the market. NVIDIA led the discrete graphics chip market, with ATI sometimes having substantial market share, but basically always in the number 2 position.

AMD is responsible for shaking up that picture two times in the past 6 years. Realizing that Intel's roadmap for future processors was not what PC makers really wanted, AMD came out with its Opteron server chip design, and with the Athlon equivalent for PCs. The Opteron and Athlon introduced 64-bit (as opposed the the prior standard 32 bit) computing to mass markets, integrated the memory controller on the chips, and were designed to save energy (Intel's roadmap was basically use the old design, keep running it faster and hotter). Despite a great deal of resistance for a complacent PC industry, and some hardball tactics Intel used to minimize the erosion of its market share, suddenly AMD looked like it might actually eventually overtake Intel. But Intel had a lot of money, lowered its prices, and even changed its chip design, then used its marketing power to push back at AMD.

AMD also bought ATI. They paid about $5 billion for ATI, more than the value of AMD today. NVIDIA and Intel both executed well at the same time, and AMD looked to be in risk of bankruptcy.

NVIDIA is also shaking things up with its CUDA technology. Let's just say it uses the graphics chip for general computing, and that endangers both CPU makers, Intel and AMD.

The second quarter of 2008 was one of the most interesting of this decade, and Q3 and Q4 are looking to be just as interesting. Both NVIDIA and Intel screwed up, and AMD's plan to sell better designed CPUs, graphics chips, and chip sets (the "glue" chips that go on the computer motherboard) seems to be getting some traction.

You can get a very good idea of the financial states of NVIDIA, AMD, and Intel, as well as hearing what their respective managements have to say about their current and upcoming technologies, by reading my summaries of their Q2 analyst conferences [See NVIDIA Q2 2008 analyst conference summary; AMD Q2 2008 analyst conference summary; Intel Q2 2008 analyst conference summary]. Note that NVIDIA's quarter ended July 27, 2008, and is their fiscal Q2 2009.

NVIDIA's disaster month was July. It was revealed that NVIDIA chips were melting down, particularly in certain Dell and Apple notebooks (Apple, as usual, denies that its products have any problems). NVIDIA took a $196 million charge to deal with the expected costs of replacing or fixing the notebooks. That is bad, but it is the kind of thing that happens from time to time, and should not affect NVIDIA very much unless the problem gets repeated.

Worse for NVIDIA, they had to drastically lower their prices in July. After about 3 years of offering no competitive threat to NVIDIA, ATI (now a division of AMD) had brought out some great graphics chips and prices them very nicely.

Which does not mean AMD is back in the money. Intel's primary weapon against Intel in 2006 was lowering prices to the point that AMD could not match. It is a monopoly tactic that is tried and true. Force out the competition with ruinous pricing, then jack prices back up to highly profitable levels when the competition is done in. The only difference with Intel is that if they had actually forced AMD out of business, they would then clearly be a monopoly. So they just pushed AMD to the brink, gained back some lost market share, and then raised prices again when they introduced their Core Duo technology.

NVIDIA is also far more profitable than AMD, but they have nowhere near the muscle of Intel. They have not yet tried to chase ATI/AMD out of the market with pricing muscle. Instead they have a long tradition of competing (and winning) with better technology. So the price cuts were necessary to their own survival, and will hurt their financial position in the short run more than they hurt AMD.

AMD stock is practially free these days. While AMD has a respite, it is going to have to struggle just to stay alive. It has not made a profit, even on a non-GAAP basis, in years. Its new notebook technology (a combination of CPUs and graphics chips) is very competitive and has had some good design wins, but Intel's (which suffered a delay in introductions) is certainly competitive. AMD is finally producing quad-core Opterons that are being lauded by end users, but they came out over a year late, giving Intel time to up the ante.

I own AMD stock, and it has been the worst-performing stock in my portfolio. Hope springs eternal, so I bought more AMD recently. NVIDIA stock is also dirt cheap; I am keeping an eyeball on it. Intel is a safe bet, but I don't feel it is a great bargain at the current price.

More data:


Monday, August 11, 2008

Onyx Pharmaceuticals Chooses the Long Run

Onyx Pharmaceuticals (ONXX) disappointed biotechnology investors with short time horizons when management announced that most of this year's potential profits from cancer drug Nexavar will be reinvested in research and development.

Nexavar (Sorafenib) has been approved by the FDA as a therapy for liver cancer (aka HCC) and kidney cancer (aka RCC). It is marketed through a partnership with Bayer. Under this arrangement Bayer sells the drug and tracks expenses for marketing and research and development costs. The net proceeds after costs are split, with Onyx receiving 50%. Until this year the revenues from Nexavar did not cover the costs, so Onyx received nothing. In addition Onyx had costs of its own, so it reported net losses.

However, global Nexavar sales for Q2 were $168.5 million, more than doubling Q2 2007 sales of $81.3 million. Mostly this reflects Nexavar being approved for use with liver cancer, in addition to its prior approval for kidney cancer. On a global scale most major nations now allow Nexavar for kidney cancer, but it is still being rolled out for liver cancer. All indications are that sales will continue to grow rapidly well into 2009.

Onyx received $30.2 million from Bayer, down from Q1 despite increased sales because of increased joint expenses. GAAP net income was reported as $4.5 million, because Onyx racked up $28.4 million in operating expenses outside the Bayer partnership. It also had some interest and investment income.

Today Onyx, with a stock price of $39.55, has a market capitalization of about $2.2 billion. That is a lot of market capitalization for $4.5 million net income in a quarter. If anything goes wrong (like serious, previously undetected adverse reactions), a lot of that value could disappear.

But Nexavar could also become a blockbuster. It is the first drug to show good results against HCC. It attacks cancer metabolic pathways at multiple points. Chances are good (but not certain) that it will have some effectiveness against a variety of cancers beyond liver and renal. Under FDA rules clinical tests have to be done for approval for each cancer type.

Of course Nexavar could fail with other cancers, either overall or by not doing as well as other therapies. So investing in R&D presents a risk, the possibility that profits from already-approved indications will mostly be drained away for further research.

On the other hand, a good result in a common form of cancer, say one of the common types of breast cancer, would propel the value of Nexavar through the stratosphere.

So I own some Onyx stock, but I realize it is a risky deal. All the more reason to keep a portfolio within the pharmaceutical or biotechnologies segments diversified.

It may be 2010 or later before Nexavar is approved for more cancer types. In the meantime the ramp for liver cancer should result in improved financial numbers. HCC is rare in the United States, where most liver cancer actually started as a different type of cancer. But it is one of the most common types of cancer in China and some other Asian nations. Approval to market Nexavar in China was recently granted.

Wednesday, August 6, 2008

Dot Hill Accelerates

Dot Hill (HILL) reported on its second quarter today, and it was quite a quarter. The long-promised turn-around has begun with a thundering 34% increase in revenue over the first quarter. See my Dot Hill analyst conference summary for September 6, 2008 to get the gist of what management said about Q2, including its answers to analyst questions.

Be warned, I own some HILL stock because I suspected this was going to happen. The company was in pretty dire straights a couple of years ago. Its stock has been dirt cheap since then, and still is. Management tried a number of initiatives while burning carefully through a pile of cash. The problem was that most of their business was supplying SAN storage products to Sun. First Sun had its well-publicized difficulties, then Sun bought a storage company and so started phasing out Dot Hill products. Adding to diffuculties, Dot Hill settled a patent dispute with rival Crossroads, giving up a substantial amount of cash in the process.

Dot Hill used its cash to support a research and development drive that took a while to pay off. Its improved storage devices first sold to a number of small equipment manufacturers and specialty shops. Then NetApp picked them up in late 2007. But the big driver of Q2 revenues was a partnership with HP, which generated about $23 million in revenues for Hill in Q2. Also a plus, Dot Hills old products are so good that Sun customers continue to buy them, to the tune of about $20 million in revenues for Dot Hill during the quarter. The Sun revenue is ramping down, but revenue from HP, NetApp and smaller vendors is ramping up much more quickly.

Dot Hill still has a ways to go to guarantee it won't become another tech has-been. It lost money on its $71 million in Q2 sales. From my point of view this is okay. The money was used to develop new products and market them. HP had special modifications made to the equipment it bought, which was expensive. Now those expenses should ramp down, although in technology there is always the next product cycle to think of. The key to profitability is decreasing production costs. Part of this happens naturally as the product cycle lengthens and the number of units sold increases. Part of it must be driven by engineering for value.

As I see it, while things can always go wrong, we are looking at a company that will soon have $300 million in annual revenues. With cost reductions there is no reason $30 million in annual net income can't be generated, maybe not in 2009, but certainly in 2010. Give that a modest PE ratio of 15, and you have a company that could have a market capitalization of $450 million within a reasonable time horizon.

What was the market capitalization at the close of trading today? Less than $114 million.

Hill has disappointed investors on a regular basis for a few years. It might disappoint again. But with $62 million in cash, guidance to $73 to $78 million in revenues for Q3, and such a low stock price, I think the upside potential far outweighs the down side.

Note again that I own some Dot Hill stock.

Keep diversified!

More data:


Tuesday, August 5, 2008

Rackable Systems Disappoints, Promises

Rackable Systems (RACK) reported Q2 revenues that were up 12% over Q1 ($76 million v. $68 million). There are high expectations for Rackable, so the impressive sequential increase was not enough to compensate for the poor bottom line. Even on a non-GAAP basis there was a net loss of $3.5 million, or $0.12 per share. The GAAP loss was amplified by an impairment charge of $16 million to $28 million or negative $0.95 per share. [See my Rackable (RACK) analyst conference summary for August 4, 2008 for a full report]

The impairment charge was because they are "looking at strategic options" for their RapidScale storage technology, which they acquired only a few years ago, and which was supposed to help them grow into a much larger company. Obviously they expect to sell the division for less than they acquired it for, hence the write-down.

The sequential increase in revenue was marred by a single sale where management decided to make a substantial price cut to get the business. They would not name a client or a dollar amount, but they believe this one-time transaction will lead to future profitable sales.

There are, however, reasons for optimism. Management did not lower the guidance for 2008. They expect revenues of at least $353 million, which implies that Q3 and Q4 revenues will be over $100 million each, which would be quite a jump.

They have some reasons for this optimism. In a bull market the bulls would be swarming all over these "forward looking statements." The backround is their claim, upheld by independent researchers, that their technology is far more energy efficient than that of their competitors (Sun, HP, IBM, etc.). In addition to their standard data center and Internet server farm technologies, they have a product called the ICE Cube, which is a portable server farm in a standard storage container. They have been talking about this for well over a year now, and they finally completed their first sale after Q2 ended. At least as important, IBM has decided to partner with them on the ICE Cube by supplying its own blade servers (BladeCenter); presumably IBM will do the marketing on this joint product. Raytheon is also partnered with Rackable to sell ICE Cube technology to the government; it is particularly attractive for military applications.

For their standard servers (the Eco-Logical line), they had their first sale in the energy (petroleum) vertical market. About 65% of revenues were generated with sales to their current major clients, Amazon, Yahoo, and Microsoft.

And even the RapidScale debacle has its upside. They expect to announce a new, global storage partnership soon. So they don't need RapidScale as badly as some giant computer corporation needs their server farm technology.

They even made their first sale in Japan. Rackable has had weak international sales, but is working on that problem with partners.

I own Rackable stock; I am certainly not selling it at this point. Rackable has disappointed investors over the past two years, and profitability has been elusive. If you don't own the stock you might want to wait until Q3 results are in, to see if management can make good on its promises.

As always, keep diversified.

More data:

Openicon Rackable Page