CEOcast commentary >>>>>>>>>
Volume XIII
The markets pulled back this week as investors began earnings season by taking some profits. The Dow fell 215 points, or 2.1%, the Nasdaq fell 4.5%, or 92 points and the S&P 500 fell 1.6%. This week’s decline left each of the indices down by approximately 2% for the year.
We believe that closer inspection of the earnings results that drove the markets this week provides important insight into key trends for this year. So far, with 107 Standard & Poor's 500 companies reporting quarterly results, earnings have edged out Wall Street's lowered forecasts by an average of about 3 percent. Sixty-six companies, or nearly 62 percent of those reporting, have exceeded analysts' expectations. In the tech-heavy Nasdaq 100 index, of the 19 companies reporting, earnings exceeded analysts' expectations by nearly 16 percent on average. Despite technology leaders International Business Machines (NYSE: IBM) and Microsoft (NASDAQ: MSFT) beating estimates, the market and these stocks fell heavily on Friday as IBM plunged over $5 and Microsoft dipped $3.76.
Why? We believe that there are several reasons. From a technical perspective, the market is overbought, giving investors a reason to "buy on rumor and sell on news". IBM had increased by 33% since late September, Microsoft by approximately 40% and Intel (NASDAQ: INTC) by 75%. The valuations on these companies were extremely high. As a result, investors chose to focus on IBM’s reduced revenue numbers and Microsoft’s lower future guidance rather than the fact that each bested analyst’s forecasts by a substantial margin.
Also, with the recent surge in the markets, stocks are now "priced for perfection". The S&P 500 sell at or near historically high P/E multiples (price to earnings ratios) of between 35 and 40 times earnings. In order to see further increases, investors are assuming that there will be a sharp improvement in the economy. While there have been signs, such as increasing consumer confidence and new unemployment claims stabilizing, many of the CEO’s that we speak to say that there is still little forward visibility. This is likely to constrain corporate spending on technology and other areas that are critical for a broad-based recovery. More importantly, it is likely that CEO’s will remain cautious with their guidance and that investors who were expecting a V-shaped recovery will be disappointed. Intel was a perfect example of that this week as it announced that it would cut its capital spending by 25% causing a sell-off in the markets.
We are likely to get even more corporate data this week, as 155 companies in the S&P 500 are scheduled to announce earnings, while nearly half of the Dow companies will release financial results. All of this will be compressed into four days, as the markets are closed Monday in observance of Martin Luther King Jr. Day. Companies reporting Tuesday before the market opens include Amazon.com (NASDAQ: AMZN), Ariba (NASDAQ: ARBA), Bank of America (NYSE: BAC), Johnson & Johnson (NYSE: JNJ), Lucent (NYSE: LU) and Merck & Co. (NYSE: MRK). After the market closes, Motorola (NYSE: MOT) and Emulex (NASDAQ: EMLX) among others, release results. Tuesday will be a busy day for the highly influential semiconductor sector, as the widely-watched book-to-bill ratio for December will be released. Fairchield Semiconductor (NYSE: FCS) and a host of smaller companies in the sector will also post results.
Wednesday will bring Pfizer (NYSE: PFE), Exxon Mobil (NYSE: XOM) and DuPont (NYSE: DD) before the open and Broadcom (NASDAQ: BRCM) and Siebel Systems (NASDAQ: SEBL) after trading ends. Thursday, Eli Lilly (NYSE: LLY), EMC Corporation (NYSE: EMC), SBC Communications (NYSE: SBC) and Nokia (NYSE: NOK) will post results before trading begins, while Qualcomm (NASDAQ: QCOM) and JDS Uniphase (NASDAQ: JDSU) provide results after the bell. We believe that investors should pay close attention to the guidance that these companies offer, as many of these companies have rallied strongly in the past several months, giving investors an opportunity to take profits.
On the economic front, Tuesday will bring leading economic indicators, which are expected to jump by 0.8%. Thursday will bring Alan Greenspan’s closely watched speech on the state of the economy before the Senate Budget Committee. After his speech on September 11th, the markets fell significantly, as he noted that there were still significant risks to the economic recovery. Thursday will bring initial jobless claims, while Friday existing home sales are expected to decline 1.2% due to seasonal factors.
Several of our Special Situation stocks will post results this week. One of our favorites is Pinnacle Systems (NASDAQ: PCLE), which makes broadcast, desktop and consumer products that provide video professionals and consumers digital video tools to create, store, distribute and view digital video. We believe the company will meet analyst’s forecasts AND issue positive guidance for the coming quarters. The company reports after the market closes on Tuesday. The company hit $10 earlier this month before profit-taking set in. We believe that after results are announced that the stock could rally from its closing price of $8.24. Latitude Communications (NASDAQ: LATD), which is a leader in providing enterprise e-conferencing solutions, announces its fourth-quarter results on Wednesday after the market closes. We believe that it will provide positive guidance on visibility, as demand has been increasing for its technology as travel concerns still exist. However, the stock has tripled from its lows, so investors should proceed with some caution.
Thornburg Mortgage (NYSE: TMA) will also post results on Wednesday, before the market opens. In December, it forecast that fourth-quarter earnings would exceed its third-quarter earnings of $0.52 per share and that it would beat analyst’s consensus estimates by at least 10%. We believe that the recent decline in interest rates will keep refinancing activity high, and that the company should be well-positioned to issue strong guidance for this year. Valicert (NASDAQ: VLCT) will also announce results on Wednesday after the markets close. The company, a leading provider of secure solutions for paperless e-Business, already warned that revenues would be disappointing for its fourth quarter, but that it would post a narrower loss due to aggressive cost cutting. We believe that the company will need to articulate a clear path to substantial revenue growth in order to regain the confidence of investors.
The advantage of doing research on many smaller companies is that it is often possible to identify investment opportunities before the media and Wall Street brokerage firms. One example is Questcor Pharmaceuticals (AMX: QSC), a specialty pharmaceutical company we featured last week due to its broad portfolio of products and its announcement that it anticipates that it will eliminate its burn rate before the end of the year. The stock was up 16% this week and the company announced that it was featured on CNBC this weekend, which should give it another boost next week. Many of the smaller stocks we cover have recently also had a series of positive developments. SurgiCare (AMX: SRG), which has ambitious plans to roll out its ambulatory surgical centers nationwide, announced that it will use a major industry meeting in April to launch its marketing strategy.
Investors who took our recommendation on Oncolytics Biotech (NASDAQ: ONCY) on December 9th are still well below the Special Situation price. However, those who that took our advice and purchased the stock earlier this week at $1.80 have been rewarded, as the stock increased to $3. The stock had lost over half of its value when it announced that it had terminated its agreement with Pfizer to develop its reovirus as an animal health product. We could never understand why a company, whose clearly stated mission is to develop the reovirus for humans, and one that has reported substantial progress in that area, would lose so much of its value after terminating a program that was not part of its core business. Now, it appears that investors have realized that the sell-off was overdone. The stock has increased all week on heavy volume, and should regain the levels it formerly traded at, which were in the $4-$5 range.
We mentioned several weeks ago that Galaxy Foods (AMX: GXY) had worked out many of the operational issues that plagued it last year, as the company experienced its share of growing pains due to difficulties in adding new production lines as a result of delays from the equipment’s manufacturers. The company just announced that it expects to break-even for its current quarter, a substantial improvement versus the $0.27 loss it posted last year at this time. It also announced that it should continue to gain efficiencies from operational improvements in the coming quarters, a sign that usually bodes well. The stock trades for $5.20. I-Trax (OTCBB: IMTX) continues to make substantial progress in its relationship with the Pentagon, as it deployed its healthcare management solution eImmune at four cure units within the Pentagon. The stock is currently priced at $1.46, but could test its 52-week high of $2.00 as it further develops this and other relationships.
International Mercantile Corporation (OTCBB: IMTT), a biometrics company has a promising payroll application for its technology. We believe that the company could announce contracts in the coming months as a result of the marketing and distribution relationships it has formed in Arizona and Nevada. The company finally eliminated the overhang in its stock this week as it completed the process of going public by finalizing its merger and assuming control of the Board of Directors. This should pave the way for an upward move from its current level of $0.48. One can often gain important information from regulatory filings, and we believe that we have uncovered a real gem in the filings for CT Holdings (OTCBB: CITN). The company reported there that it has developed a relationship with telecommunications giant SBC Communications. This could have substantial implications for the distribution of its security products, for if it is able to reach SBC’s millions of, it could dramatically increase the company’s revenues. Since this relationship has not been publicly announced, we believe there is a compelling opportunity for investors at just a $0.40 stock price.
SPECIAL SITUATIONS
Wave Systems (NASDAQ: WAVX) $2.44
One of the areas that continue to be a focus for us is computer security. We believe this will likely be a key growth area this year, as companies and consumers increasingly seek to protect their data. The company is engaged with many of the industry's leading companies to make secure computing a reality for consumers. The company has based its fortunes on its EMBASSY Trust System, which is the industry's first comprehensive trust infrastructure, tools and device components required to create, deploy, and manage trusted client hardware devices which are open, shared and programmable. Although single function security devices are prevalent today, the breakthrough architecture achieved by the EMBASSY Trust System provides the capability for multiple entities, such as service providers and individuals to share a single device while trusting that their individual interests have each been strongly protected from both local and network sources of attack. Although the company has a market capitalization of approximately $125 million, it has relationships with leading companies such as AMD, Samsung, Compaq, SSP Solutions and EDS. Wave and Samsung Electro-Mechanics Co., Ltd. recently announced that they will work together to manufacture and market low-cost, secure keyboards that will enable PC OEMs and other suppliers to assemble and market trusted personal computer products. The events of September 11th have also created interest in the company’s technology from Federal and state governments. The company appears to have the capital to grow its currently nominal revenues, as it had over $50 million in cash and marketable securities as of its September 30th reporting date.
The stock has been range-bound for the past four months, trading between $2 and $3 for most of the time. However, we have recently noticed a very positive sign, as the stock appears to increase on relatively heavy volume and retreat on much lighter activity. This tends to suggest that the stock is under accumulation, and is much more likely to increase than decrease over the near-term. Since the stock is liquid, we believe that investors can trade the stock with very limited downside and are likely to see the stock trend up from here. Of course, if the company announces a significant new deal or some news from its strategic partners, it could break out of its trading range.
DOR BioPharma, Inc. (AMX: DOR) $1.30
Last week we featured Questcor Pharmaceuticals, because we like pharmaceutical companies with broad product portfolios and reasonable valuations. We believe that the recent merger between the two predecessor companies, Endorex Corporation and Corporate Technology Development, creates a highly attractive opportunity here. It is a emerging drug delivery company developing oral and mucosal formulations of small molecule and macromolecular drugs that are traditionally delivered in non-oral formats. While drug delivery companies have traditionally not received the same kind of recognition on Wall Street as other biotech companies, we believe that the company’s current valuation belies its potential. The company trades at just twice its cash value. The Company’s lead ACE drug product, orBecTM, is an oral formulation of beclomethasone dipropionate (BDP) for the treatment of moderate to severe Intestinal Graft-Versus-Host-Disease (iGVHD). Graft-Versus-Host-Disease (GVHD) is a life threatening disorder affecting the skin, liver, and the intestinal systems of patients who have received bone marrow transplants. The company currently has a multi-center phase III trial ongoing for the treatment of Intestinal Graft-Versus-Host disease. It is also evaluating initiation of clinical trials for this disease in Europe. Intestinal Graft-Versus-Host-Disease is an immune-response disease that results from bone marrow transplantation, a well established treatment modality for various types of cancers, particularly leukemias. orBec™ has received orphan drug designation by the FDA for both GVHD and iGVHD applications. It has also received FDA "fast track" designation for Intestinal Graft-Versus-Host. It has also initiated a phase II trial recently in six centers for the treatment of Crohn’s disease, a major gastrointestinal disorder.
The stock has been thinly traded, as the company is still well below Wall Street’s radar screen. It has increased from $0.83 when the merger was announced, but is still well below where other drug delivery companies with late-stage clinical trials are valued. One of the key investors in the company is Paramount Capital, which has had a knack for picking small biotech companies and generating substantial returns on its investments. Its principal shareholder, Dr. Lindsay Rosenwald, recently took a position in another small drug delivery company, Flemington Pharmaceuticals. The stock increased by 150% in just six weeks. We believe that investors in DOR could be similarly rewarded.
Leftbid Corp. (OTCBB: SPCY) $0.78
We watched with great interest this week as eBay (NASDAQ: EBAY) announced a significant price increase for its auctions. Normally, a price hike could cause a company to lose some of its customers, but the last time that this leader in on-line auctions initiated a price increase, it had little effect on its business. This is because the company has had a dominant position in the origination of listings for auctions. We find a tiny upstart in the sector, Leftbid Corp., attractive for many of the same reasons. The company has a value of approximately $15 million, but has developed an origination capability that is impressive by any standard. LeftBid is a transactional system that links auction houses in Europe, North America and Asia, giving collectors around the world access to a wide variety of fine art, antiques and collectibles through a single Internet site. The company is able to forge relationships with these houses because it increases the number of participants in an auction, increasing revenues. For Leftbid, it provides a highly effective origination capability. The company recently added audio to its auctions, increasing a participant’s experience. What is even more compelling than its technology, however, is the scalability of its business model. Although the company has only been public since November 21st, its CEO recently announced that it already expects to be profitable for its current quarter, and that it can grow earnings at a 30% annualized rate. If this forecast is accurate, we believe that the company should generate EPS of at least $0.05 per share for the year on an extremely conservative basis. This would mean that the company currently trades for a multiple of less than 16 times current year’s earnings, with a high growth rate. eBay, by contrast, trades for a P/E multiple of over 100 times current year’s earnings, with a much lower growth rate.
The stock in this company has been extremely volatile, as the spreads have been quite wide and the volume sporadic. However, we believe that the company is taking steps to bring on new market makers, and that the recent increase in volume has been an encouraging sign. The stock hit $2.35 in early December, and we believe that because of some selling from shareholders in Spicology, the shell company that was acquired by Leftbid when it went public through a reverse merger, the stock traded down. However, it appears to have stabilized and we believe is now well positioned to regain the levels it enjoyed in December.
We appreciate the many reuests from our audience for companies to cover. Due to the volume (last week, we received over 3,000 alone), we are not able to respond to each individual request. However, our analysts are carefully evaluating these companies and will likely be conducting interviews with many of these CEO’s as part of our research. These interviews will be on our ceocast.com site. Should you have any suggestions, please e-mail them to us at news@ceocast.com.
Keep the Faith!
M&M Man
