Sunday, June 27, 2010

Software Industry Gains in Second Quarter 2010

I follow three software companies that reported quarter results last week: Adobe (ADBE), Red Hat (RHT), and Oracle (ORCL). All of them showed sequential and year/year increases in revenues and profits. While there may be exceptions, it is fair to conclude that businesses are back to upgrading or even buying new software now that the worst of the business panic of 2009 is behind us. [I don't currently own any of these three companies, but I have owned Red Hat in the past and I do some freelance work for a competitor, Microsoft.]

Red Hat, the open source provider of enterprise ready Linux and JBoss middleware, had revenues $209.1 million for the fiscal quarter ending May 31, 2010. That is up 7% sequentially and 20% y/y. For details see my Red Hat Q1 fiscal 2011 Analyst Conference Summary or

Adobe is known for its content creation programs like Acrobat, now mostly wrapped up in its Creative Suite. Its revenues for the quarter ending June 4, 2010 were $943.0 million, up 10% sequentially and up 34% year/year. For details see my Adobe Q2 Fiscal 2010 Analyst Conference Summary or

Oracle, the enterprise database and data resource management company had revenues of $9.51 billion in its fourth fiscal quarter 2010 ending May 31. That is up 49% sequentially and up 39% from year-earlier. However, some of that increase is from the acquisition of Sun, which is largely a hardware company. So Oracle is no longer a pure software play, but is more like IBM. For details see my Oracle Q4 Fiscal 2010 Analyst Conference Summary or

Red Hat is probably taking market share from Microsoft, but the market is expanding so fast this should have little effect on Microsoft revenues. Oracle execs claimed to be taking market share from IBM and SAP. Much of Oracle's gain came from the release of Creative Suite 5 during the quarter. Many companies skipped Creative Suite 4, which came out during the recession. A lot has changed in content creation in the last four years, so version 5 will probably be seen as a necessity by most designers.

All of these companies are trading for spectacularly low P/E ratios compared to past technology bull markets. Investors are skeptical after being burned by technology stocks in 2001 and then by almost everything in 2008. I would say the best way to restore confidence is to give profits back to investors in the form of dividends. Every one of these companies could pay an attractive dividend and still earn plenty of cash for operations.

Tuesday, June 22, 2010

Is the Dendreon Sky Falling?

When I checked a few moments ago the auction price of Dendreon (DNDN) stock had fallen to $34.70 per share. That gives Dendreon a market capitalization of just over $4.7 billion. It is a big disappointment for all those investors who bought Dendreon during the last minute run up to the announcement that the FDA had approved Provenge for prostate cancer, or even as the stock soared briefly above $57 per share in late April. Dendreon first moved above $34 per share in March 2010.

I listened to the Dendreon presentation at the Goldman Sachs Global Healthcare conference of June 16. You can access audio files of Dendreon presentations at the Dendreon Investor Page.

The number of American patients who fit the label today for castrate-resistant, metastatic, non-symptomatic prostate cancer was estimated at 103,000, with about 30,000 new patients per year. Obviously the global number would be much larger. Dendreon is already treating patients, but this year will be able to treat only 2000. In 2011 they could treat 8,000, if new capability comes along on schedule. Pricing was not discussed at the conference, but rumors are the charge per patient for the 3 treatment course is around $90,000. Given that Dendreon expects $500 million in revenue (that might be an end-of year run rate) the first year, and $1 billion per year in sales from their New Jersey facility when built out, and $1.25 billion in annual revenue by 2012, I think they need a higher price are a larger number of patients served to hit those numbers. Apparently insurers and Medicare are not balking at the price, but I would bet the health agency in Great Britain will. In any case approvals outside the U.S. will probably take at least a couple of years.

Dendreon expects to be cash flow positive in 2011. Which means GAAP, and possibly non-GAAP, net losses due to depreciation and amortization on the vast sum invested to get us to the current day. My guess is the first GAAP profits may be in 2012.

So if you think (and I do) that Dendreon is going to be able to extend its technology to earlier forms of prostate cancer and to other forms of cancer, it makes sense to build gradual a position in 2010 and 2011 if shares are in the $30 to $40 range.

This scenario has happened to other companies, notably Onyx Pharmaceuticals (ONXX). Bullish enthusiasm is tempered when profits don't flow in immediately. What could be profits from Provenge may get spent, in part or maybe even in whole, trying to generate clinical trial wins in other forms of cancers. This discourages short term investors, and only pays off for long term investors if indeed other indications get FDA approval.

The good news (for investors, not for patients or taxpayers) is that at $100,000 a pop Provenge should have a very high gross margin. The expense is mainly in the research, not so much in the actual operation of immunizing the patients.

We will know a lot more after the Q4 2010 results are reported. We'll see in numbers how much revenue is generated, cost of goods sold, and operating expenses. The reality of building further capacity will also be easier to estimate.

Right now most investors are risk-averse, and most willing to take on risk are doing so in very short time frames. So if you believe we are in a typical, protracted macroeconomic upcycle (I do), you can buy 2012 profits now in a wide variety of growing companies for very attractive prices. Just because there was a market run up in 2009 after the panic does not mean that all stocks are now overpriced. Each stock requires individual analysis.

You can also learn a lot from history. See my Dendreon page for what this situation looked like in the past. For the latest financial numbers, check out the Dendreon Q1 2010 press release.

Wednesday, June 16, 2010

Dot Hill, Xiotech and NetApp: new plan

Yesterday Dot Hill revealed more details of its plans for achieving profitability by the 4th quarter of 2010. The big surprise is that they may stop selling to NetApp in 2011. In another announcement, they are selling or licensing their storage software, iSN, to advanced storage provider Xiotech.

Dot Hill used to provide data storage equipment primarily to Sun Microsystems, but that segment started to go away several years ago, and is essentially gone now, representing less than 1% of revenue. In the meantime they designed new storage hardware and sold it to premier OEMs HP and NetApp for rebranding. In 2008 they looked like that strategy was going to make them profitable by 2009. Then the recession hit.

Another problem has always been profit margins. In particular, to get the NetApp business Dot Hill sold devices for less than cost. There was a small margin on the actual price of the devices over the cost of manufacturing, but it did not cover operating costs like corporate overhead, R&D, and sales. It was hoped that costs for the devices could be lowered over time, and they have been, but the profit margin is still not there. Apparently NetApp is not willing to pay more, so they will begin manufacturing the devices themselves in 2011, or discontinue that line.

In Q1 Hill reported that NetApp represented about 30% of revenue, or $18 million. It may be a big deal to give up that much revenue, but I agree that Dot Hill should not stay in the business of subsidizing a larger, profitable company like NetApp.

HP represented 50% of revenue in Q1; without NetApp, Dot Hill will be in the same position with HP that they were with Sun a few years ago. To remedy that they are both working with a large number of small, value-added data storage companies (the channel) and looking for at least one more large OEM customer. Discussion continues to be underway, but even if a deal is made it would take several months for a new OEM to introduce a new line.

The brightest part of the picture is in software. Software has far better margins than hardware, and Dot Hill's new iSN (Intelligent Storage Networking) platform is highly regarded. Dot Hill is already selling some software with its systems through HP, and of course its channel partners will sell this too. Apparently you don't need Hill hardware to run the software; it should work with most storage hardware. The hope is that the new deal with Xiotech is the first of many. Again, it takes time to get a product to market. Dot Hill's R&D costs for software have gone up, so in the short run it makes the profit line look worse, but that should improve in a quarter or two.

The main method for achieving profitability will be the classic: cutting costs. In this case salaries are being cut 5% and 10% of the work force will be laid off. Manufacturing is being consolidated.

Altogether Management (Dan Kammersgard) believes that by Q4 Dot Hill will be able to break even on a EBITDA basis with just $60 to $65 million in revenue. They are projecting Q2 revenue of $62 to $65 million. Prior to the loss of NetApp, my guess is revenue is likely to ramp to more like $70 million by Q4 because of seasonality and the general health of the data storage industry. EBITDA (earnings before interest, taxes, depreciation and amortization) is usually the lowest standard of profitability. Non-GAAP net income would be nicer, and GAAP net income is the gold standard for reporting.

I consider Dot Hill to be one of my most speculative investments. On the other hand the stock is dirt cheap today at about $1.16 per share. That gives it a market capitalization of about $64 million. They expect to have a cash balance of at least $40 million at the end of Q2.

For more data on Q1, see my Dot Hill Q1 2010 Analyst Conference Summary . For past conference summaries and my earlier commentary see my Dot Hill main page.

And of course see

Monday, June 7, 2010

Can AMD Ignite Fusion?

AMD is the perpetual also-ran in the CPU and GPU (graphics processing unit) sweepstakes. According to AMD, their next big thing is Fusion, in which a CPU and a GPU are combined on a single chip, or APU (Accelerated Processing Unit). Is it possible that in 2011 AMD will make serious profits from this innovation? Or is this more like the power from nuclear fusion program, which after decades of work and billions of dollars of investment has yet to make commercially available electricity?

In my April 17, 2010 story, Paint AMD Black?, I discussed AMD's latest financial results. The second quarter ends with June, and that readout will tell us how well demand is holding up. But the real value in AMD stock, or lack thereof, is in whether it has made the right choices in its roadmap, given its difficult position versus rivals Intel and NVIDIA. While there are other aspects to that roadmap, Fusion is probably the most important in the 2011 time frame.

There are two major forks in the computer processor road in the 2009-2011 time frame. One is about graphics processing, including using processors designed for graphics to compute other types of problems. The other fork is between traditional PC processors and mobile processors, where low power requirements are as important as computing and graphics capabilities.

Intel is the largest of the three rivals, so I will describe its known roadmap first, then contrast that with the roadmaps of AMD and NVIDIA. Intel dominated the market for PC computer chips almost from its inception, but it has traditionally supplied only minimal graphics capabilities. Keep in mind that a regular CPU can do graphics calculations. A GPU speeds up graphics calculations. GPUs can do this because graphics calculations use a relatively small number of well-known algorithms to accomplish their tasks, and these algorithms can run in parallel, all at the same time. In addition to letting the CPU do graphics, as that became unsatisfactory even on low-end computers, graphics were added to motherboard chip sets. This is called integrated graphics, and Intel (as well as NVIDIA and AMD) developed low end-graphics for motherboard chip sets.

Intel also tried to develop what are called discrete graphics chips. These are not on a motherboard, but on a separate card, called a video or graphics card. Intel recently abandoned its Larabee (see Anand's Thoughts on Intel Canceling Larrabee) project for a high-end discrete graphic chip, but will be putting its expertise to work by adding the failed Larrabee circuitry to its own CPUs, some time in the future. So right now Intel has no clear strategy for dealing with GPU computing on desktop or server computers. If you want that, you need to add an NVIDIA or AMD ATI GPU card to an Intel-based machine, and we are already seeing a lot of that.

In the mobile space Intel sold its floundering mobile application processor unit to Marvell, which in retrospect was a mistake, as Marvell is quickly becoming a big player in mobile devices. Instead Intel concentrated on Atom, which was originally used in the netbook space. Intel's strategy is to make Atom more powerful, yet less energy needy, to move more into the smartphone and tablet computer space.

AMD has decided to focus on the PC (desktop and notebook) and server market with graphics capabilities being a major weapon to win market share from Intel. The last time AMD won a lot of market share from Intel was also due to a roadmap decision, when Intel tried to bifurcate customers into 32 bit and 64 bit users. AMD instead integrated 32 bit and 64 bit capabilities on its Athlon and Opteron chips, which was so popular that Intel had to change it roadmap.

Will it work this time? One problem is that AMD is typically a half-step behind AMD in the process technology it uses to manufacture its chips, so it either needs a larger chip to accommodate the same number of logic gates, or must make due with fewer gates on a similar sized chip. GPU chips for high-end discrete graphics are big, and so are the CPUs for PCs. Combining both on a single chip could lead to a lot of defects, low productivity, and negative margins. The first Fusion chips will probably have the equivalent of mid-range GPUs mixed with mid-range CPUs. Yet if defect rates are low enough, these could be formidable chips. There would be no need to run to an external motherboard graphics chip or discrete graphics chip in order to do the processing. For many applications that lack of communications lag will make up for the lower processing power of each unit.

AMD has simply decided not to compete in the mobile space except to the extent that its notebook processors are able to pick up some of the netbook or tablet market. Given the importance of the mobile market, that may not seem smart. But the mobile market is fiercely competitive; even Intel has floundered there, against the likes of Qualcomm, Broadcom, Marvell, and many others. AMD has limited resources compared to Intel. It can't afford to enter markets where it has no competitive edge.

NVIDIA has an interesting strategy too, and it involves a different take on each of the forks. It is going heavily into mobile with its Tegra processor. It is ahead of AMD in high-end graphics, and graphical computing, with its Fermi and CUDA technologies. Clearly NVIDIA would like to allow their GPUs to also do the work of CPUs and thereby crash the PC motherboard party. They could do that by adding ARM based processors to Fermi. But it would be a whole new marketing world for them. They might simply wait and watch the ARM/mobile space eat up the old PC space the way PCs once cut into the minicomputer space.

I own AMD stock and think it is currently undervalued, but there is no denying that Intel is much larger that AMD and has lots of profitability, while AMD has just squeaked by for years. Until AMD shows several successive quarters of profits and market share gains, and it is clear that it chose the best roadmap, I don't expect much short-term upward movement of the stock. On the other hand, waiting until all the good news is in means missing out on almost all of the stock appreciation, if it happens.

See also:
AMD Q1 2010 Analyst Conference Summary
AMD 4/15/2010 earnings release
AMD at Wikipedia
my main AMD page

Friday, June 4, 2010

Bonds versus Stocks

Ordinary investors are still not alert to the danger of buying bonds. The potential to get negative returns from bonds, even when the issuing entities remain healthy, is well-known in theory. However, the long bull market in bonds, corresponding to the gradual decrease in inflation during the last several decades, has led to forgetfulness. That is why I wrote Bonds, Danger! on April 4, 2010.

Since then a number of articles have appeared reminding investors of this issue. But the recent Greek bond and Euro mini-crisis caused bond interest rates to drop, and prices to rise, yet again. In a double contradiction, this kind of sovereign debt crisis reminds us of the danger of bond defaults. Even the U.S. government could default on its bonds.

Today there was a very good CNN Money article on this issue, Bonds: Avoid the Next Great Bubble by Paul J. Lim. You should read it, unless you already understand this issue.

It is funny that the Greek bond crisis (it was a crisis for Greek; its effect on the global economy was mainly psychological) would cause people to dump stocks and buy bonds.

In military history it is a truism that, all other things being equal, the generals who fight the previous war lose. Apparently using the latest economic weapons, like mortgage derivatives, does not guarantee success either. It is important to know what has changed and what has not changed. Bonds were safe in the recent past, but they are not now. Stocks of good, profitable, growing companies are safer because they are a better value right now.

The theory that you should balance your portfolio between stocks and bonds is a good one. In a bull stock market it forces you to sell some of your stocks and buy bonds. In a bear stock market it should also force you to sell some of your bonds and buy stocks. The problem is that in a bull market there is incentive to delay selling stocks, and in a bear market there is an incentive to stay in bonds. So most investors wait until what would have been a smart move becomes a stupid one.

All that said, I'd rather be mainly in stocks than in bonds right now. The main risk to stocks is another macroeconomic downturn. There are two risks to bonds: the risk from rising interest rates and the risk that an economic collapse could cause bond defaults.

There is also the psychological risk with stocks. If you need to sell your stocks today, so sorry, you are going to get a bad price for them, or at least for all but a select few. There are not enough buyers in the market to price most stocks appropriately. This situation could continue for some time. But if the companies you own are profitable, and if you are investing long term, this should not be a problem. My companies, anyway, are earning good profits and socking away cash. The ones that are not paying a dividend could pay one. They can also use their cash to buy back stock, or to expand their business. A profitable company with growing profits can be worth a lot more than today's auction price would indicate. That is how you prosper: buy value for less cash than it is worth. [I also own more speculative companies that have not yet earned a profit, like Dendreon. That is a whole different category, not suitable to ordinary investors.]

Could I be wrong? Of course! An atomic war could start tomorrow. But atomic war has been a possibility every single day of my life. I prefer to bet on high probability events, like the continuing global economic recovery. Within that recovery some companies will be winners, some losers. That is why I like technology companies with global reach. Greeks may be buying less electronic devices right now, but they are more than compensated by Chinese and Indians buying more electronic devices.

Tuesday, June 1, 2010

Marvell Tablet Computers on Way

As a brand, Marvell Technology Group is little known to the general public. Yet if you own a hard drive, odds are better than even that it has a Marvell chip in its interface. In fact Marvell is a key supplier of many semiconductor devices that go into cell phones, wireless and hardwired networking equipment, and printers.

Marvell executives have been talking about tablet computers built around their chips for a while. Yet while they are willing to talk about the superiority of their technology solutions, they often don't say who their OEM partners are, much less pre-announce the end products. Now, however, we are beginning to see the veil of secrecy lift. Most notably we have an announcement of a new eReader by Hawang and the adoption of the Marvell platform for One Laptop Per Child.

Within a few years China will be the biggest national market for both smartphones and tablet computers. Future smartphones in China means OPhones, and Marvell is dominating in design wins for OPhones. For tablets Marvell's design platform is called Moby. For One Laptop Per Child the result would cost in the range of $100. Commercial products will have many variable in their end price, notably the size of the screen and whether it is grayscale like a Kindle or color like an iPad.

In between smartphones and tablets in size are book readers. Hawang has been producing eReaders for the Chinese market since 2008. The Marvell based model is due out by September. According to Hawang it offers "better performance at a better price ... true mass market pricing." This is possible because of Marvell's intellectual property and ability to put many functions on a single chip. Notably this single chip solution (SoC - System on a Chip) includes an integrated e-Paper Display (EPD) controller. It can display standard pdf documents and requires very little power.

Marvell's chips can include application processing, digital signal processing, video processing, and wireless technologies like cell phone modems, Wi-Fi, and Bluetooth. Everything needed for tablet computing.

The iPad tablet computer is a nifty device. We know Apple is famous for its high markups, so there is already room for iPad price drops. But the average American employee cannot afford an iPad (it represents a week's take home pay), much less the average Chinese or developing nation employee. Give them the functional equivalent at $100 to $200, however, and my guess is they will snap up tablets. With the kinds of volumes we are looking at in the China market alone, their should still be reasonable profit margins for Marvell and its OEM partners.

I expect we will see OEM announcements of tablets that are based on Marvell chips as we progress through the year.

Keep in mind that this is a very competitive market. In addition to Apple's internally developed chips (which almost certainly won't be sold to OEMs), top competitors include Broadcom, Qualcomm (Snapdragon chips), Intel, TI, and Freescale.


One Laptop Per Child's Next Move [New York Times, May 27. 2010]

Marvell and Hawang E-Reader [Marvell release June 1, 2010]

One Laptop Per Child and Marvell Join Forces [Marvell release May 27, 2010]

Marvell Moby Technology site

Marvell fiscal Q2 2010 results release