Saturday, March 28, 2009

Red Hat (RHT) Runs Through Open Field

Red Hat (RHT) is my favorite company to watch because of all the stocks I know its history most clearly demonstrates the need to differentiate between the stock value and the finances of the underlying company. I became interested in Red Hat in the last years of the last century. I am now invested in the company, so you might want to take that into account in case I fall into the cheerleading for my own stocks trap.

Investors often talk of overvalued and undervalued company stocks. Typically one looks at the market capitalization of the company: the value of the stock shares times the number of the shares. This gives a total value for the company. Then one looks at the "true" criteria, which typically is some measure of future profits the company can generate, times some multiplier of how much capital it would typically take to generate those profits. If the market capitalization is higher than the "true" value, the company is overvalued.

Red Hat was one of many companies billed by Wall Street as a "next Microsoft" during the technology boom of the 1990's. Given that Red Hat was already establishing leadership in commercializing the Linux operating system, this was not an altogether dismissible line of reasoning. After all, the Microsoft empire was built around its original operating system, MS-DOS, which later evolved into Windows. The problem was that the stock was bid up to prices implying that being the next Microsoft was a done deal.

Several easily discernable obstacles stood in the way of Red Hat becoming the new Lord of the Computerverse. First, it really did not have very many paying clients in the year 2000. Second, Linux is Open Source, and can be had for free, which really cuts into profit margins compared to a proprietary system like Windows. Third, there was a lot of competition within the Linux space for the few commercial dollars available to it.

Red Hat stock took a big plunge in 2002. In retrospect, that was the time to buy. The stock was almost free. Investors did not want it. Partly they finally understood the three points I made above, but mostly investors don't like to buy stocks that are falling in price.

This week, on March 25th, Red Hat reported on its fourth quarter of fiscal 2009 that ended on February 28. Red Hat is still not the next Microsoft. But it is a highly profitable company with a secure niche in the computing space. Red Hat Enterprise Linux (RHEL) is the gold standard for Linux. Other closely related open source spaces are now attached to it, notably virtualization software and JBoss middleware. In addition, Red Hat has a huge cash reserve. Its profits on a cash basis are typically far above its profits on a GAAP basis.

It is a good company, and its earnings per share are a lot higher than what you can get on T-Bills right now. So it is not too late to buy in. But it is not the next Microsoft. Open Source people just don't bring the predatory hunger to the table that Bill Gates and crew had in their first couple of decades. Red Hat will continue to grow because it enhances the business goals of its customers. It will run profitably, but it won't be able to create the kind of monopoly profits Microsoft has been able to create.

I expect that as soon as IT budgets loosen up again, a lot of enterprises are going to make the shift to Red Hat products. But how big of an income and profit bump that will provide is not easy to predict.

So keep diversified.

And see my Red Hat Q4 fiscal 2009 analyst conference summary for details on the latest quarter.

Monday, March 23, 2009

A Tale of Two Tech Stocks: Adobe and Oracle

I listened to two analyst conferences last week. Each was interesting in its own way. Adobe (ADBE) had its conference on March 17, 2009, for its 1st quarter of fiscal 2009, ending February 27, 2009. Oracle (ORCL) had its conference on the 18th, for its third quarter of fiscal 2009, ending February 28.

You can read my extensive notes on the conferences, including the questions asked by analysts, at:

Adobe analyst conference summary for Q1 2009
Oracle analyst conference summary for Q3 2009

Neither company was acting much like a growth stock in the latest quarter, but both did pretty well considering how the global economy has tanked. Oracle revenues were up 2% from the year-earlier quarter. But that flatness hides the fact that Oracle was doing better in mid 2008, so it appears to have come off the top of a wave.

Oracle management talked a lot about exchange rates, how they did really well in the quarter if you ignore the effects of exchange rates. They explained that they manage the company based on constant U.S. dollars. Which sounds something like fiction when the tale is told to an American investor. Maybe my memory is weak, but I don't recall them putting such emphasis on exchange rates when the dollar was low, and so caused them to have strong quarters from Euros and Yen being converted into dollars. The reality is if the Euro is low, they could compensate by jacking up prices in Europe. Probably it is better to keep the customers happy, that is what I would try to do, but I would not pretend I had a great quarter when my receipts from outside the U. S. were down so much, no matter what the cause.

Mind you, Oracle is a great company. When they saying they are taking market share from SAP, IBM, and Microsoft, they are not kidding. They have found a way to build on their success of their database products. No competitor has been able to match their strategy of buying companies that have technologies that can be sold as add ons to current Oracle customers. They claim there is much interest in new products like Fusion middleware and the Exadata system.

Adobe is another great company, but they have been hit harder by the economy than Oracle. Revenues were down 12% from a year ago despite the introduction of CS4, which in normal times would probably be selling far better.

Adobe has always charged a premium price for premium products. Enterprise demand remained strong, they said. But the little guys apparently decided that in these uncertain times Creative Suite 3 was good enough for now. The cost of buying Adobe products, or even of upgrading them, is significant for professionals. The software costs more than the computers that run it.

But you know what will happen. The amateurs may find a way to make do, but all the pros will want CS4. They know that if they don't pay to upgrade to CS4, eventually they will fall behind their competitors and lose their right to upgrade to CS5. To the extent that this economic shake out causes people to leave the computer graphics business, Adobe will be hurt. But the most likely scenario is that the need for graphics professionals will grow, and sooner or later they will budget the money for upgrades. So I expect that as soon as the economy shows some life, Adobe will recapture any money it did not make last quarter. The world can no longer live without Photoshop, Acrobat, and Flash.

Thursday, March 12, 2009

Have We Hit Bottom Yet?

What every investor wants to know: have we hit bottom yet? Business people want to know that too. Should we lay off more people, buy that new ERP software, or cut that dividend?

Smart people will use a cover your bets approach. We have already seen a number of worst-case scenarios starting in 2007.

Typically, in the post-Depression recessions, the stock market averages started recovering before the rest of the economy. Stock markets are believed to be forward looking. But that may not be the case this time.

There are a number of differences between this recession and prior post-New Deal down cycles, and a number of similarities. Sorting them out may not tell them if we are at a bottom yet, but they can help us understand how to get our footing once there is a bottom.

Fortunately, many major corporations were cash rich going into this downturn, and are well-positioned to weather anything thrown at them short of the collapse of civilization. Some are taking advantage of their cash positions to buy assets cheap, which is what I believe investors with cash coming in should be doing right now.

Most people who are losing their jobs are getting unemployment compensation. More than any other New Deal reform, this tends to put the brakes on recessions.

The big obvious problems, of course, are banks and housing. The Federal Reserve System was set up to deal with banking credit cycle issues. Unfortunately the Fed is run by people, and in particular it was run for a long time by a certifiable idiot, Alan Greenspan. Alan drank the Free Markets are God kool-aid. If free markets were not sometimes a problem, we would not have needed the Federal Reserve in the first place. Free markets are not magic. They have their own mechanics, and don't care too much about human beings.

It is a tribute to the resiliancy of capitalism, the safety valves and safety nets of socialism that have been grafted onto it in the United States, and the good sense of most business persons that the crew of the likes of Alan Greenspan, Robert Rubin, Bill Clinton, George W. Bush, et al, actually did so little damage to our economy.

I am glad the American people, as a whole, started saving more money in 2008. Even though it hurt the holiday shopping season, even though it hurt the auction prices of some of my stocks. It was the right thing to do. Shopping on credit that has to be paid at high rates of interest is no way to run a family economic unit, and no way to run an economy. Lowered household debt as we go into 2010 will mean people will be paying less interest, and have more actual money of their own to shop with. I just hope we all remember this lesson.

Housing remains an interesting dilemma. As far as I can tell, there is no longer a surplus of housing in the U.S. as a whole, though some areas remain overbuilt, like the central California valley. If the banking system starts functioning in a healthy manner, surplus of houses for sale right now will shrink throughout 2009. In 2010 new home construction will become necessary in at least some areas. That in itself should get the economy back to normal.

But I don't feel the bottom under my feet yet. One more part of the down cycle has not really kicked in, and it could force us further out into the stormy seas. This is the bankruptcy cascade. Businesses can fall like houses of cards when this cycle starts. A business that seems solvent, with plenty of receivables to use to cover its payables, can be put in jeapardy if its receivables disappear in customer bankruptcies.

On the other hand, this is also a healthy, important part of business consolidation. Week, poorly managed businesses with insufficient profit margins or cash reserves get punished. Well-capitalized companies get a licking, for sure, but they can then pick up any paying customers of the losers and enter a new expansion cycle.

This is a stock pickers market. If you are in index funds, you are a fool. The only stocks worth buying now are those with large cash reserves built from profitable business practices. Those cash reserves stand for conservative management. They represent past profits, and they are the ticket to future profits.

Today Gilead (GILD) [I own Gilead stock] announced it will buy CV Therapeutics (CVTX). Gilead is your prototypical well-managed company. Even after it buys CV, it will have a huge cash balance. That's the way to do it.

Keep diversified!

Tuesday, March 10, 2009

Marvell Technology In Recession Mode

Marvell Technology Group (MRVL) reported revenue of $513 million for their quarter that ended January 31, 2009 (4th quarter fiscal 2009). That was not a good number for Marvell; it was down 35% from the October 2008 quarter, and down 39% from the year-earlier quarter.

I own Marvell stock. I had hoped for better, but not expected it. Since a lot of Marvell's revenue comes from the data storage sector, I hoped people's need to store ever-increasing amounts of data might partially offset the recession. As we have seen, for instance, at Dot Hill. On the other hand, I have a backup drive that once seemed capacious and now is getting pretty full, but I am delaying buying a bigger capacity drive right now; I have more pressing needs for cash. Multiply by 100 million.

Marvell is a relatively new company that grew big quickly and seems to aim at dominating the entire mixed digital analog sector. In addition to making chips for Western Digital drives, it makes processors that RIM uses in some of its Blackberry products, chips for printers, chips that combine Bluetooth and WiFi, and video processing chips. It seems to be able to move its engineering expertise from one technology arena to another, taking on the likes of TI, Motorola, Intel and Broadcom. Sometimes it takes Marvell a while to get traction in a new area, but when Sehat Sutardja says "In a year or two, " it is a good idea to take him seriously.

In a year or two, Sehat believes there will be architectural convergence for many devices, including netbook computers, smartphones, and next generation data and communication appliances. He believes Marvell has all the expertise necessary to get there with the best products at prices that enable the magic of mass consumption with good profit margins for Marvell. That looks right to me. Marvell has shown it can do ARM processors as good as anyone, and it is unrivaled at putting analog circuitry on chips.

But I would not discount, quite yet, the ability of rivals to out market, and perhaps even out engineer, Marvell. Motorolla, TI and Intel all have deep pockets and large research establishments.

Of its $513 million in revenue in the quarter, Marvell spent $208 million for research and development. Obviously they could have sent a lot of engineers home in 2008 and pleased short term investors. That is not the Marvell way.

Whether Marvell was profitable in the quarter depends on how you want to do your accounting. On a GAAP basis they lost $65 million. They claim non-GAAP net income of $32 million. On a cash basis, they had free cash flow of $95 million. They ended with $952 million in cash and equivalents, so they are well positioned to keep up their drive for industry dominance.

They have cut costs, and are reducing the work force by 15%. If I know Marvell's corporate culture, that means those lucky enough to be employed are going to work even harder and smarter, if that is possible.

For more details, see my Marvell analyst conference summary for March 5, 2009.

The current economic and stock market troubles provide for a unique opportunity to buy into Marvell, but there is risk in investing in the highly competitive semiconductor industry, so ...

Keep diversified.

Monday, March 2, 2009

Dot Hill Stores Well

Dot Hill (HILL), a maker of data storage devices, reported a solid fourth quarter of 2008, in contrast to many equipment manufacturing in the data storage industry. Revenues were $72.4 million, down 5% sequentially from $76.6 million but up 40% from $51.8 million year-earlier. Dot Hill is still operating in the red, with GAAP losses of $8.6 million or $0.19 per share. That included a non-cash goodwill impairment charge, so on a cash basis they are getting close to break even.

Why the prosperity? Partly data storage equipment is a necessity, rather than a luxury, for modern enterprises. Every bit of data needs to be stored in an accessible manner, and data is generated in ever increasing torrents.

Dot Hill also has picked a pretty sweet space in the data storage arena. The firm was in disaster mode in 2006 and 2007. Most of its revenue were from sales to Sun, which was having its own troubles and then bought a different data storage company. Sun started phasing Dot Hill out. So the engineers at Dot Hill got busy and came out with a variety of new products designed to meet end user needs. HP and NetApp are now big customers, and a number of smaller OEMs are taking the Dot Hill products as well. Surprisingly, the business from Sun has fallen off more slowly than expected. Not only did customers want to build out the Dot Hill products they already had, but replacement parts has become a good business. Even the economic slowdown is helping, as some firms would rather just replace the drives in their Sun-Dot Hill systems than buy totally new equipment.

Of course if tech spending continues to dry up, Dot Hill could get hurt like so many other companies. HP closed the last two weeks of 2008, hurting revenues in the reported quarter. Q1 is traditionally a seasonally slow quarter for data equipment hardware. Management made it clear they don't really know what Q1 revenues will be, but threw the figures of $56 to $63 million to analysts. They said that was a cautious estimate, but it could still be too high in a worst case scenario.

Dot Hill had $56.9 million in cash at the end of the quarter. Management believes that as long as the economy is not too bad, they should be profitable on a non-GAAP, cash basis in the second half of 2009.

If the economy recovers at all, Dot Hill should be a very sweet play. It is an under $1 stock today, trading around $0.52 lately. I own some stock and intend to accumulate it (up to the maximum my portfolio model allows) at this price, presuming the equipment keeps selling.

Keep diversified!

More: My Dot Hill 2/26/2009 analyst conference summary