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Monday, April 26, 2004 5:10:13 PM
Stocks fell after a report on new home sales added to speculation that the Federal Reserve may increase interest rates because of an improving economy. More than three- fourths of the members of the Standard & Poor's 500 Index that have posted quarterly results have beaten analysts' estimates. The S&P 500 shed 5 points (-0.5%) to 1135, for its first drop in four days. The Nasdaq fell 13 points (-0.6%) to 2036. The DJIA lost 28 points (-0.3%) to 10,444, erasing its gain for the year. Nine stocks fell for every five that rose on the New York Stock Exchange. Some 1.3 billion shares changed hands on the Big Board, 12 percent below the average for the past three months.
Strong Sectors: biotech
Weak Sectors: hardware, networking, semiconductor, storage, wood products, personal services
Top Stories . . . U.S. sales of new homes rose to a record 1.228 million annual rate in March, reflecting mortgage rates near a four-decade low and an improving job market.
UnitedHealth Group, the biggest U.S. health insurer, may announce the acquisition of Oxford Health Plans Inc. after the close of regular U.S. trading, the Wall Street Journal reported.
Electronic Data Systems , the world's second-largest seller of computer services, said its first-quarter net loss narrowed to $12 million.
Boeing, the world's second-biggest maker of commercial aircraft, said All Nippon Airways agreed to buy 50 7E7 planes for about $6 billion, the premiere order for Boeing's first new model in more than a decade.
TXU Corp., the largest electricity supplier in Texas, agreed to sell its Australian unit to Singapore Power Ltd. for $3.72 billion as Chief Executive C. John Wilder seeks to exit overseas businesses and cut debt by $5.8 billion.
Computer Associates, whose accounting has been under federal investigation for two years, restated $2.2 billion in sales it had booked too early and named Kenneth Cron interim chief executive officer.
Quotes of Note . . . “I wish this were a one-handed market because on the one hand, earnings and economic news remains up beat, while on the other hand rates and geopolitical fears provide headwinds.” Rob Black, Portfolio Manager and good looking fellow.
``We're having a great year on the earnings front. The fear though, is that the economy is too strong and the Fed is going to have to pull the punch bowl away.'' Rick Jandrain, chief investment officer at Banc One Investment Advisors, which oversees $187 billion.
``We're having a great year on the earnings front. The fear, though, is that the economy is too strong, the Fed is going to have to pull the punch bowl away and that we'll see a big move up in interest rates.'' Richard Jandrain, chief investment officer at Banc One Investment Advisors.
``I'm not surprised to see the market consolidating. Investors right now are waiting to see when the Fed is going to bump rates up.'' Peter Goldman, who helps manage $1 billion for Chicago Asset Management.
All about the Future . . . The S&P 500, which rallied 26 percent last year when earnings were bad, has fallen 1.9 percent since reaching a 23-month high on Feb. 11. Since then, more than half of the benchmark's members have posted quarterly results and 77 percent of them beat the average analyst estimate.
Gurus . . . On the Rukeyser Show, Dan Rice, energy expert for State Street Research, warns that energy is tight, and oil prices could move higher. He also sees rising prices for natural gas and coal. Some favorites include Newfield, Western Gas, Consol Coal, and Peabody Coal. Recommendations from panelists include Royal Dutch, Union Pacific, Marsh Mac, Coach, Burlington Resources, Progressive, and Caterpillar. Countrywide Financial. Panelist Laz Birinyi says the market lacks a dramatic theme.
Mark Leibovit, editor of the Volume Reversal Trader told the Nightly Business Report that the Dow will range between 9,800 and 10,800. He has tempered his enthusiasm for gold.
Back to the bottom line. . . . Thomson Financial says second-quarter projections call for gains of 20%. If this pans out, it would be the fourth straight quarter of +20%, the first such stretch since July 1999 to June 2000.
Japan . . . Barron's held an interview with Raj Gupta, a principal of Manhattan's RHG Capital. Mr. Gupta's record of returning 16% a year on average after fees is also mighty impressive. In discussion of Japans economy, Mr. Gupta believes that there could be a vicious correction in Japan. The extremely overheated Nikkei OTC index is up about 100% from its 2003 low. It has gone up 37% this year. When things rise that crazily, the end is near. There are a couple of Japanese stocks that are very interesting on the short side. Yahoo! Japan's valuation is laughable. It is trading well over 100x forward earnings assuming a growth rate of 50%. Its basic businesses and its growth rate are best compared with U.S. Internet stocks such as eBay. On that basis, its P/E ratio is 2 1/2x those company's. One reason the stock isn't coming under pressure is it is very hard to borrow shares in order to short the stock. There are some changes coming in Japan that will make borrowing easier, and if something along those lines unfolds, that could have a pretty big impact on the Nikkei OTC index.
Atkins Friendly . . . The WSJ's "Tracking the Numbers" column highlights Cal-Maine Foods that, by one hedge-fund manager's calculation, investors in Cal-Maine were shelling out $23 per hen in mid-Feb, when Cal-Maine stock reached its all-time high of $45.60. Considering the number of eggs the average hen produces over her life span, egg prices would have to remain at 58 cents or more for a dozen for investors to at least break even, not counting the price of feed and upkeep. Yet the fund manager, like plenty of others, says he is bearish on Cal-Maine, considering the stock's dizzying run. Cal-Maine has been boosted by the Atkins diet craze and Americans' increased reliance on eggs as a protein source. It's this overall run-up that has enticed short sellers who are betting the rally will be scrambled. The shorts have built up a bearish position of 1.5 million shares, almost 40% of Cal-Maine's public float of 4.1 million shares. These Cal-Maine bears say they've been emboldened by the company's executives, who have sold more than 730K shares during the past 6 months, according to regulatory filings. But there are still hard-boiled optimists who say the Atkins trend won't fade soon, egg prices will remain generally high, and Cal-Maine is relatively cheap, since it trades at less than 7x its prior 12 months' earnings. In the bulls' view, the large short interest will turn into a source of buying, once the chicken hearts realize how wrong they've been and rush to cover their positions before the sky falls on them. Fred Adams Jr., Cal-Maine's chairman and CEO defends the insider selling, as merely a matter of veteran employees at a previously sleepy agricultural co seizing a once-in-a-lifetime opportunity.
Of Note . . . China's two largest steel makers to increase capacity by 80%
Market Comment . . . Expect a durable expansion with mild inflation and higher, still-accommodative interest rates. Looking forward, more of the economy’s growth will come from business investment and inventory rebuilding and less from consumption (though it should still be resilient.) Corporate profits should continue to grow rapidly. Expect a durable expansion with mild inflation and higher, still-accommodative interest rates. This favors equities but
not bonds.
• An important shift is taking place in the business community – it is losing its fear of deflation. Some markers: the sharp increase in CEO sentiment, Greenspan’s recognition that deflation is behind us, the acceleration in the manufacturing sector, more talk of pricing power, the February inventory build, and the 513,000 new establishment survey jobs in the first quarter.
• Looking forward, more of the economy’s growth will come from business investment and inventory rebuilding and less from consumption (though it should still be resilient.)
• Corporate profits should continue to grow rapidly based on favorable operating and financial leverage, pricing power, strong growth in U.S. final demand, stronger global growth, and still-accommodative interest rates. Emphasize the difference between this cycle and previous ones due to its deflationary roots.
• If inflation rises faster or higher than we expect or interest rate hikes create more of a shock, it would weaken the expansion.
Some Key Variables
• The inflation problem will be a mild one because the inflationary dollar weakness came immediately after a deflation. To an extent, they cancel out. The dollar is roughly 30% weaker than its 10-year average, indicating an inflation problem on the order of the 1987-1990 bulge.
• The first several interest rate hikes will act as an accelerant to the economy, providing a final “get it while you can” opportunity for more leverage.
• Most of the reaction of currencies and commodities to the coming interest rate hikes has already
occurred, but won’t know for sure until the rate hikes start. This creates an important uncertainty in the outlook.
• The number and price of houses has risen sharply in recent years. Higher interest rates will slow these trends, but not stop them. Expect distress to be localized.
• Investors should still discount some of the widely-discussed concerns. We don’t expect a consumer rollover, a dollar crash, a problem financing the U.S. current account deficit (the bigger risk is over-financing), a fiscal crisis at either the federal or state/local levels, or an unstable hard landing in China.
Real Estate . . . Banc of America Securities downgrades Post Properties to Sell from Neutral. $21 target. Firm states that due to concerns about the fundamentals of southeastern apartment markets, they are decreasing 2004 FFO estimate to $1.75 from $1.83 and 2005 est to $1.89 from $2.02. Firm states that PPG's valuation represents an 11% premium to its peer group of multifamily companies and is 41% above the long-term average multiple for sector. In addition firm believes PPG's market have performed worse than average during the apartment downturn over the last three years, and they have no reason to believe that these dynamics will change in the expected recovery. Firm believes that company's markets will continue to struggle with new supply and robust home sales, and thus will have a slower and shallower recovery than peers.
Oil & Gas . . . Barron's highlights Halliburton, suggesting it is undervalued and could be a much better company after the smoke clears. According to the article, the simplest way to value the company's shares is just to pretend its troubled KBR unit doesn't exist. The oilfield-services business contributed 43% of HAL's total rev last year, but the lion's share of profit. That segment alone is valued at $15.13 bln, or $30.41 a share, if it were to trade at the same multiple of enterprise value to operating cash flow as its large-cap peers. Also KBR unit is worth something, aside from government work, the unit is the undisputed leader in liquefied natural-gas engineering. Applying the average EV/Ebitda multiple of its peer group, the KBR unit has an implied valuation of $1.9 bln, or $3.88 a share. The last chunk of the valuation has to do with the asbestos settlement itself. HAL has already settled with its largest reinsurer, Equitas, and will get $575 mln, representing 60 cents on the dollar. The co believes the other insurers will settle this year or next, and the recovery rate should be a bit more than the Equitas settlement, or about $2 bln. In the meantime, that amount is being financed by the co's own borrowing. Conservatively assuming Halliburton receives the same 60% recovery it got from Equitas, the settlement would total $1.8 bln, or $3.62 a share. Putting the three pieces together results in a sum-of-the-parts valuation of $37.91 a share, a 23% premium to the current share price. Applying the company's somewhat higher projection of insurance recoverables yields a target of $38.31. "What's holding back Halliburton right now is the aversion to suffer any headline risk," says Robert Mackenzie, oilfield-services analyst at Friedman Billings Ramsey. "A lot of portfolio managers don't want to deal with that."
Metals . . . JP Morgan downgrades AK Steel to Underweight from Neutral, as they believe that the co is in a poor competitive position in the U.S. industry due to its high legacy cost obligations ($3.1 billion), weak profitability metrics, and high-cost labor situation; firm also notes that the stock trades at a significant premium to its domestic peers on an EBITDA and FV/shipment basis, which they believe is unwarranted given its structural cost disadvantage.
Goldman Sachs raises their view of the Gold sector to Attractive from Neutral based on the following factors: 1) Comex reported on Friday a sharp decline of non-commercial net long gold positions to 228 tons, which is half the peak level of only two weeks ago; 2) valuation, as firm's models suggest 30% upside if gold trades to $450; 3) firm forecasts a weakening dollar over the next 6 months and reaffirms its view that the Fed remains on hold through the year; and 4) Barrick's commitment to reduce its 450 ton hedgebook and AngloGold's potential reduction of Ashanti's book after merging this month likely provides gold price support on weakness. Top picks are Newmont and Placer Dome.
Transports . . . Lehman upgrades General Motors to Overweight from Equal-Weight and raises their target to $57 from $54, and upgrades F to Equal-Weight from Underweight and raises their target to $16 from $12. The firm is saying they have underestimated the earnings power of the automakers; firm says the upside they see is coming through the finance company's, where asset quality is improving, and they say they now prefer the autos over the auto suppliers, since history suggests the automakers will outperform in a rising rate environment. Firm's European analyst also upgrades DCX to Equal-Weight from Underweight.
Lear reported earnings of $1.30 per diluted share, $0.13 better than the Reuters Research consensus of $1.17; revenues rose 15.2% year/year to $4.49 billion versus the $4.26 billion consensus. The company also guides, sees 2nd quarter EPS of $1.55-1.65, versus the consensus of $1.66, and revenues of approx $4.3 billion versus an estimate of $4.27 billion. The firm sees 2004 EPS of $5.85-6.25, versus the consensus of $6.17, and revenues of approx $16.6 billion versus an estimate of $16.5 billion.
Harley-Davidson raises dividend 25%, approves 20 million share repurchase.
Food & Beverage . . . Sysco reported earnings of $0.30 per share, in line with the consensus of $0.30. Revenues rose 9.9% year/year to $7.03 billion versus the $7.02 billion consensus.
Barron's highlights Coca-Cola, which is currently in search of a new CEO. Last week there was rumor that Gilette's CEO Jim Kilts will replace Coke's current CEO, but by the week's end The WSJ reported that Kilts would stay at Gillette, he was merely the latest to reportedly turn down the Coke search committee. According to the article, citing WSJ, among the remaining candidates are R. Kerry Clark, vice chairman of Procter & Gamble, and Coke's current president and COO, Steven Heyer. There's even talk that Coke might try to lure to the post E. Neville Isdell, who was a former Coke executive and later the boss of one its biggest bottlers. In a recent report by Morgan Stanley consumer-products analyst William Pecoriello, a number of challenges were listed that any new CEO might find daunting. Most important: The market for carbonated soft drinks has flattened in the US and other developed markets, whether because of saturation-induced "boredom" and product fatigue, or younger consumers' preference for healthier alternatives such as bottled water and fruit juices. Unfortunately, Coke hasn't developed as strong an array of noncarbonated brands in the States or elsewhere in the world as has archrival PepsiCo. One of Coke's biggest problems revolves around its "independent," but controlled, bottling network, which the parent co has unabashedly exploited over the past decade. Product innovation will be a key to Coke's future. But, according to Mr. Pecoriello's report, line extensions such as Vanilla Coke and lime-flavored Diet Coke aren't cutting it, they merely cannibalize sales of existing brands. Gone are the days in which Coke delivered annual earnings gains of 15% with metronomic regularity. It will be hard-put to come up with even the 10% Wall St expects over the next two years.
Office . . . Goldman Sachs upgrades Xerox to Outperform from In-Line based on the substantial progress the company is continuing to make in gaining market share, improving the balance sheet, and introducing new products that should increase page volume and rev per page. Also, firm views the stock's 8% price decline after 1st quarter earnings as overdone; while gross margins fell 210 basis points to 39.8%, primarily reflecting a shift in product mix, the co expects a more traditional mix in subsequent quarters, which should allow full year gross margins to average 41-42%.
Retail . . . Leap Frog traded up 9%, following the release of 1st quarter 2004 results. EPS were in line with revised guidance. Gross margin, lower by 836 bps y/y, was worse than our revised forecast. Operating expenses, up by nearly 1,400 bps year/year, were slightly better than forecast. As a result EBIT margin, down 2,230 bps year/year, was basically in line with our previously-revised forecast. This marked the first quarter the company reported a y/y decline in U.S. Consumer revenue, which was attributed to a weak retail environment. Sell-through was reportedly up 20% YTD at the largest retailers. Management refused to provide details on channel inventories, however, which we find concerning. Margin weakness is forecasted to continue for the balance of 2004, with 2004 gross margin now anticipated to be flat to down 100bps.; we now forecast FY04 EBIT margin down 220 bps. y/y. As a result, we are lowering our
FY04 EPS estimate to $1.21 from $1.30 (within a guided range of $1.18-$1.28) and FY05 to $1.38 from $1.50. LF shares now trade at a P/E multiple of 19.3x 2004 and 16.9x 2005 estimates. This compares to 2004 multiples for HAS of 15.5x and MAT 14.5x, and 2005 multiples of 13.6x for HAS and 13.3x for MAT. Analysts are reiterating a peer perform rating as we believe the share price reflects a fair multiple on our new earnings projections for 2004 and 2005. That said, LF makes an attractive acquisition candidate, which could provide downside protection, while the heavy short position could provide a healthy catalyst.
Kmart Martha Stewart Living Omnimedia announced an agreement extending and amending several terms in their long-term distribution contract for the Martha Stewart Everyday brand label. The revised agreement better aligns the two companies' mutual business interests by extending the Martha Stewart Everyday partnership two years, through 2009; expanding the scope to several new product categories; eliminating the product category minimum guarantee but not the aggregate minimum guarantee features of the contract; and making other adjustments that, taken as a whole, benefit both companies. In conjunction with this amended agreement, KMH also announced that it will withdraw the lawsuit filed against MSO IP Holdings Inc. in February.
Healthcare . . . Humana reports 1st quarter earnings of $0.41 per share, in line with the consensus of $0.41. Revenues rose 12.1% year/year to $3.29 billion vs the $3.24 bln consensus. Company sees Q2 EPS of $0.37-0.39 vs Reuters consensus of $0.40; for Y04 sees EPS of $1.60-1.65 vs consensus of $1.62 on revenues of approx $13 bln, consensus $13.18 bln.
Priority Healthcare signed an agreement with Bertek Pharmaceuticals, a unit of Mylan Labs to be a preferred specialty pharmacy provider of Apokyntm. Approved April 20 by the FDA, it is the first and only therapy in the United States indicated as an acute intermittent treatment of hypomobility, or "off" episodes, in patients with advanced Parkinson's disease.
Biotech . . . Genentech and Roche announce a Phase III study of Tarceva, an investigational HER1/EGFR-inhibitor agent in previously treated patients with non-small cell lung cancer, met its primary endpoint of improving overall survival, with patients receiving Tarceva living longer than those in the placebo arm of the study. The trial also met secondary endpoints including improving time to symptomatic deterioration, progression-free survival and response rate.
Genentech target raised to $180 from $150 at UBS following Tarceva data.
Hotel & Leisure . . . UBS upgrades Hilton, Star Hotels, and Lasalle Hotel to Buy from Neutral, and upgrades Host Marriot to Neutral from Reduce. Although lodging stocks have traded higher in the past year, firm says lodging fundamentals have only recently begun to improve; and unlike other cyclical industries where positive news may be moderating, firm says lodging demand growth is improving since it is tied to business activity/rev growth, which is rebounding.
Jeffries upgrades Boyd Gaming to Buy from a Hold and increases its target to $29 from a range of $17-$18 as the firm is now switching its valuation over to 2005 forecasts and basing its price target on its 2005 EBITDA estimate of $597 million. The firm believes 2005 should be a blowout year for the company, as it will receive the benefit of its first full year of operations with its Coast Casino and Harrah's Shreveport acquisitions.
Media . . . Barron's highlights Lions Gate Entertainment, a small producer of movies with a library of some 8,000 films. The company's shares are up from 2 to about 6 in the past year, as investors have warmed to the company's niche franchise in Hollywood and have applauded its acquisition of Artisan Entertainment. The studio has a knack for making provocative independent movies in which big stars work cheap. Lions Gate keeps its financial risk low and looks to milk the upside from home video and overseas releases. According to SG Cowen's Lowell Singer, the release of Open Water this summer could generate nice financial leverage. And with an acquisition cost to Lions Gate of just $2 mln, Mr. Singer thinks the upside is considerable. Its library can be mined for DVD releases for years to come, even if its backlist isn't nearly as storied as that of MGM. The co, with an equity market value of $540 million, is projecting positive free cash flow of $80 mln in the current FY. Rob Routh of Natexis Bleichroeder thinks the stock can trade at 20x his slightly lower estimate of $70 million in free cash flow, which translates to more than 11 for the stock.
The New York Times reports sales of digital video recorders are finally gaining momentum, according to a study by IDC, with TiVo increasingly being left behind by the success. TiVo, by IDC's measurement, had just 39 percent of the United States market for D.V.R.'s in 2003. The balance is largely made up by combined recorders and set-top boxes that are being offered by satellite and cable television companies, which, unlike TiVo, don't require users to purchase hardware upfront. Instead, they generally charge users about $10 a month for a set-top box that includes a D.V.R.
The WSJ reports that DVR-enabled set-tops could threaten other parts of cable-industry business, most significantly in the case of Time Warner, which owns a lot of programming assets. According to the article, TWX's DVR product costs just $8-10/month and customers lease a DVR-enabled box from the company. In comparison, TIVO's service costs $12.95/month and $150 for the box, although says TIVO might be easier to use. A consumer who uses such a device "is getting all that content and recording it real easily, paying nothing extra to get it and stripping out the advertising," Comcast CEO Brian Roberts told an industry gathering.
The WSJ reports that Comcast plans to test an advanced TV set-top box designed by Digeo, the latest sign that the Paul Allen-backed start-up has become a credible competitor to Microsoft in the cable field. Comcast will announce today a commercial trial using about 40,000 of the devices, which are manufactured by Motorola using a Digeo design called Moxi. Charter Communications also is announcing plans to launch a Moxi-based service in Rochester, Minn., after a trial there. The devices make use of Digeo's software for navigating through TV channels and managing other entertainment options, including digital video recording, games, stored photos and music.
The New York Post reports that Comcast appears likely to withdraw its bid for Disney in the coming weeks. Executives at the cable giant are currently weighing the timing of such an announcement, sources say to the paper. While one could come as soon as this week, when Comcast reports quarterly earnings on Wednesday, a more likely scenario is that the co would take its bid off the table in the weeks leading up to its annual shareholder meeting in May. The co is also considering announcing a stock buyback and perhaps a shareholder dividend to coincide with the announcement that it is bowing out of the battle for Disney. The announcement is expected to reiterate the strategic rationale for a Disney-Comcast combination, and it also may suggest that the co could reenter as a bidder at a later date.
Telecom . . . Raymond James upgrades AT&T Wireless to Market Perform from Underperform based on the view that the majority of the bad operational news is now priced in the stock. The co reported weak 1st quarter 2004 results, which were even worse than the firm's lowered estimates. Net customer adds came in at a negative 367,000 versus the firm's estimate of negative 189,000, churn was at 3.7% versus the firm's estimate of 3.5%.
The Financial Times reports that SBC Communications has filed a lawsuit seeking at least $141 million from AT&T in fees it claims it is owed for calls that the long distance carrier routed partly over the internet. The lawsuit, filed in a St Louis federal court, follows a landmark ruling by federal regulators earlier this week that AT&T and other long distance carriers must pay full "access fees" for calls routed partly over the internet if they begin and end on ordinarily local telephone lines.
Network Equipment . . . Schwab Soundview upgrades Corning to Outperform from Market Perform and raises their target to $16 from $10.50 following stronger than expected 1st quarter results and raised guidance; firm says the surprising breadth in results, with further improvement in Environmental, Life Sciences, and Equity Joint Ventures adding to the LCD ramp, demonstrates that the co is capable of prospering in the absence of a fiber recovery.
Barron's highlights Motorola, questioning whether the company can keep up its big gains. Last week, the co reported a rare "blow-out" quarter, but it might be wise to wait to toast the turnaround for at least a few more quarters. "In all my years of covering this co, I've never seen all of the segments line up and report like this. Which means it probably won't last," says telecom analyst Ed Snyder of Charter Equity Research. The long-time observer of the co wonders whether Motorola can maintain its newfound momentum. Mr. Snyder isn't telling his clients to jump into the frothy shares right now. Instead, he is advising folks to watch how Nokia responds and to wait for potential dips. While the co may not be capable of whipping up competitive designs overnight, it can reclaim customers and coveted market share by slashing prices. "Nokia all but said that it would take back market share, which is very aggressive [guidance] for them," Snyder says. "Nokia's price cuts will squeeze everybody this quarter." Snyder fears that Motorola might be too content with its recent success. "I don't think that Motorola is taking [Nokia's pricing] threat seriously, based on their comments on the conference call. The good news for both company's is that handset sales for the rest of the year are expected to remain strong, with Motorola hoping to match its 1st quarter sales performance in the 2nd quarter. But it depends largely on how "deep" and "fast" Nokia starts bringing prices down, Mr. Snyder says. If Nokia does indeed launch a price war, inventory probably would evaporate quickly, which is good for company's in the supply chain, such as Qualcomm. The company earns royalties on designs for semiconductors used in CDMA phones, which are made by Motorola.
Scotsman.com cites a The Business article suggesting China is to deliver a blow to the west's mobile-phone makers by shelving plans for a £45 billion third-generation (3G) network. The country was expected to start issuing 3G licenses later this year, but officials are believed to be about to drop plans for state investment. In addition, the article suggests the buoyant global recovery is here to stay, finance ministers and bankers form the world's richest countries said at the end of meeting of the Group of Seven (G7) in Washington. In their most bullish statement since the dotcom bubble burst, G7 finance ministers and central bankers downplayed the remaining challenges to the global economic recovery.
Semiconductors . . . BofA Sec out on RF Micro Devices saying they believe that shares may trade up from current levels for two reasons. First, firm's checks indicate that the March Quarter may come in slightly above consensus and that the June Quarter is trending in line with expectations with positive order momentum. Second, there seems to be more upside than downside to their estimates for 2nd half 2005 from the Polaris II (EDGE RF) radios. While the timing and magnitude of these design wins is uncertain, the firm believes their estimates reflect only 30-40% of the potential outcome if Polaris II does indeed see solid design traction. Yet, intense pricing, commoditization of RF PAs, and short design cycles prevent BofA from raising their rating saying a design loss could severely impact profits given relatively fixed SG&A and R&D expense. Target goes to $10 from $12.
The Financial Times reports that these are crucial times for Jen-Hsun Huang, CEO of Nvidia. Mr Huang has taken a big bet by developing a technology aiming at leapfrogging the company's rivals. Last week the first fruits of that development, a graphics chip called GeForce 6, capable of displaying more realistic computer images, was launched. Article suggests that if the chip lives up to its promise, Nvidia will be able to boost its nearly 60% share of the market and may even recover some of its former glory.
Lucent has selected Xilinx FPGAs for its new 10Gb/s Tunable Optical Translator Unit, a key component in one of its DWDM-based metro optical equipment offerings.... Separately, the co announces the availability of a new RapidIO Serial Endpoint intellectual property core. Coupled with Xilinx' parallel RapidIO endpoint IP core and PICMG-compliant AdvancedTCA Development platform, this combination provides the industry's only complete FPGA-based solution.
Caris & Co upgrades Intel to Above Average from Average for the four following reasons: 1) The business spending cycle is in full swing from a combination of better than expected corporate profits and new computer cycles, 2) seasonal weakness in consumer computing markets will shortly morph into a back to school build leveraged by the global wi-fi and mobile PC boom, 3) In spite of challenges, INTC retains leadership in key server and mobile markets, which carry premium ASPs, and 4) Q1's $0.26 per share represents the co's 2004 low water mark and EPS should progressively mount throughout the year.
Boxmakers . . . While everyone is encouraged by AAPL’s recent results and we can see further potential 2nd half catalysts (iPod from H-P, new iMac, PowerMac G5 speed bump), the real concerns are that the G5 cycle has disappointed, Apple is still ceding PC share, and at some point iPod mini supply will catch demand (“white” iPod supply/ demand are already in balance) which could derail the stock’s momentum and temper further EPS upsides.
Despite phenomenal success of iPod, Apple's stores are not generating PC market share gains, according to the latest data from IDC. Despite opening 78 stores in the US since 2001, its domestic market share has declined from over 4% to 2.8%. The stock valuation seems to already reflect investor optimism on iPod. AAPL's agenda with its is to capture non-PC revenues associated with Mac sales. In other words, its efforts to diversify revenue streams are intended to offset market share erosion. While this strategy may work near term, it may lead to challenges if AAPL’s share further erodes.
In the last 3 quarters
Market Share
WW desktop is at 1.4%
US desktop is at 2.0% (new lows)
Europe’s is at 1.8%
Positives
• Strong brand name, fiercely loyal customer base, defensible installed base
• Innovative products and design strategies
• Incremental market opportunities through “digital lifestyle” initiative (iPod, iTunes, iDVD, iMovie, iPhoto, iTunes
Music Store)
• Ongoing efforts to monetize beyond-the-box revenue streams (e.g. software, paid subscription services, iTunes Store downloads) to help offset cyclicality of hardware business
• Excellent cash position – around $12.15 per diluted share in net cash
• Long-awaited G5-based hardware could spur Power Mac desktop upgrade cycle and new wave of demand for professional users
Concerns
• New G5 chip doesn’t eliminate the real or perceived “megahertz gap” with Intel and could lead to a stall in other product line sales (i.e. can Apple synchronize growth in multiple CPU product segments)
• Risk associated with our view that Apple may migrate to the Intel architecture owing to the megahertz gap with PowerPC, corporate IT issues with PowerPC chips and lower cost of implementation
• High-cost of non-standard architecture and constraints of Motorola’s processor roadmap
• Inability to capture a wider customer base and grow market share without a more compelling product offering to attract new users and penetrate the Wintel world
• Shortening product lifecycles
• Could face difficulties reconciling channel conflicts between retail stores and resellers which Apple is prepared to face to have greater control of its customer relationship
• Methodology suggests the stock’s valuation is rich and already factoring in much of the good news in the near term
Software . . . WR Hambrecht downgrades THQ Inc. to Hold from Buy. The firm thinks Street consensus quarterly 2005 estimates for THQ do not reflect the degree to which the year will be back-end loaded. Therefore, the firm thinks June Quarter Street consensus is too high and that guidance may disappoint the Street.
Computer Assoc files with the SEC restating certain financial data for the Company and its subsidiaries for the fiscal years ended March 31, 2000 and 2001, and providing certain quarterly data included in those fiscal years. The Audit Committee found that a total of $2.2 billion of revenue was booked prematurely by quarter within fiscal 2000 and 2001. A total of $1.782 billion was prematurely recognized in fiscal 2000 and $445 million in fiscal 2001. CA will host a call at 11 ET to review announcements made earlier today.
Barron's reports Linux has hurt Sun Microsystem's sales of large server computers, and might eventually make a dent in Microsoft's PC empire. After establishing Linux in the market for servers, the Linux community is preparing its assault on the software market for Intel-compatible PCs. The highlight of Novell's user conference last month was the announcement that Hewlett Packard will pitch Novell's Linux software to corporate PC buyers. Novell has been building a portfolio of desktop Linux products. It acquired SUSE, which shrink-wraps the Linux OS for PCs, and Ximian, which supplies Linux applications that are compatible with Microsoft Office products. While HPQ has gotten behind Linux desktops, there's been no official action by Linux's biggest commercial backer in the server market, IBM. Big Blue has a vital interest in Microsoft's only existing desktop rival, Apple, as the processor-chip supplier for the Macintosh. But IBM invested $50 million in Novell last month and IBM employees have told to Barron's that the company is closely watching the development of Linux desktops. Novell shares have quintupled over the last year, pushing the company's market value to $4.3 billion. That's four times the $1.1 bln in sales that Novell totaled for the 12 months ended Jan, and more than 140x earnings. But compared to Linux champ Red Hat, Novell is only heinously expensive. Prudential analyst Brent Thill recently bought a Lindows PC from Wal-Mart's Website. In a note to clients, Mr. Thill said that the system was easy to set up and to use. It cost $231 with shipping, which is about the list price for Microsoft PowerPoint. Mr. Thill predicts that within 3 to 5 years, the consumer applications, like games, will appear and Linux will start making a dent in Microsoft's pricing.
Monolithic System Tech sues Synopsys for breach of contract following the abrupt termination of a merger agreement by Synopsys on April 19. The complaint seeks to force Synopsys to complete the merger agreement or otherwise seeks monetary damages. MOSY says SNPS waited until the last minute to pull out of a lawful agreement, causing significant damage.
ITWO’s stock was down 10% last Friday (versus the COMP up 0.8%) after reporting
weak 1st quarter results. Management provided a target cost structure—excluding restructuring charges—of $83-$86 million for 2nd quarter, but was reluctant to provide top or bottom-line guidance, underscoring the lack of visibility at ITWO. ITWO continues to be hampered in the marketplace by its re-audits and continuing investigation by the SEC, which have adversely affected the company’s ability to build pipeline and close license deals. Given continued weak visibility to license growth, expectations of material cash burn going forward, and ongoing legal risks, it is our view that the risk/reward profile at ITWO remains unattractive—even at current depressed trading levels. Consequently, analysts are maintaining an Underperform rating on ITWO.
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Strong Sectors: biotech
Weak Sectors: hardware, networking, semiconductor, storage, wood products, personal services
Top Stories . . . U.S. sales of new homes rose to a record 1.228 million annual rate in March, reflecting mortgage rates near a four-decade low and an improving job market.
UnitedHealth Group, the biggest U.S. health insurer, may announce the acquisition of Oxford Health Plans Inc. after the close of regular U.S. trading, the Wall Street Journal reported.
Electronic Data Systems , the world's second-largest seller of computer services, said its first-quarter net loss narrowed to $12 million.
Boeing, the world's second-biggest maker of commercial aircraft, said All Nippon Airways agreed to buy 50 7E7 planes for about $6 billion, the premiere order for Boeing's first new model in more than a decade.
TXU Corp., the largest electricity supplier in Texas, agreed to sell its Australian unit to Singapore Power Ltd. for $3.72 billion as Chief Executive C. John Wilder seeks to exit overseas businesses and cut debt by $5.8 billion.
Computer Associates, whose accounting has been under federal investigation for two years, restated $2.2 billion in sales it had booked too early and named Kenneth Cron interim chief executive officer.
Quotes of Note . . . “I wish this were a one-handed market because on the one hand, earnings and economic news remains up beat, while on the other hand rates and geopolitical fears provide headwinds.” Rob Black, Portfolio Manager and good looking fellow.
``We're having a great year on the earnings front. The fear though, is that the economy is too strong and the Fed is going to have to pull the punch bowl away.'' Rick Jandrain, chief investment officer at Banc One Investment Advisors, which oversees $187 billion.
``We're having a great year on the earnings front. The fear, though, is that the economy is too strong, the Fed is going to have to pull the punch bowl away and that we'll see a big move up in interest rates.'' Richard Jandrain, chief investment officer at Banc One Investment Advisors.
``I'm not surprised to see the market consolidating. Investors right now are waiting to see when the Fed is going to bump rates up.'' Peter Goldman, who helps manage $1 billion for Chicago Asset Management.
All about the Future . . . The S&P 500, which rallied 26 percent last year when earnings were bad, has fallen 1.9 percent since reaching a 23-month high on Feb. 11. Since then, more than half of the benchmark's members have posted quarterly results and 77 percent of them beat the average analyst estimate.
Gurus . . . On the Rukeyser Show, Dan Rice, energy expert for State Street Research, warns that energy is tight, and oil prices could move higher. He also sees rising prices for natural gas and coal. Some favorites include Newfield, Western Gas, Consol Coal, and Peabody Coal. Recommendations from panelists include Royal Dutch, Union Pacific, Marsh Mac, Coach, Burlington Resources, Progressive, and Caterpillar. Countrywide Financial. Panelist Laz Birinyi says the market lacks a dramatic theme.
Mark Leibovit, editor of the Volume Reversal Trader told the Nightly Business Report that the Dow will range between 9,800 and 10,800. He has tempered his enthusiasm for gold.
Back to the bottom line. . . . Thomson Financial says second-quarter projections call for gains of 20%. If this pans out, it would be the fourth straight quarter of +20%, the first such stretch since July 1999 to June 2000.
Japan . . . Barron's held an interview with Raj Gupta, a principal of Manhattan's RHG Capital. Mr. Gupta's record of returning 16% a year on average after fees is also mighty impressive. In discussion of Japans economy, Mr. Gupta believes that there could be a vicious correction in Japan. The extremely overheated Nikkei OTC index is up about 100% from its 2003 low. It has gone up 37% this year. When things rise that crazily, the end is near. There are a couple of Japanese stocks that are very interesting on the short side. Yahoo! Japan's valuation is laughable. It is trading well over 100x forward earnings assuming a growth rate of 50%. Its basic businesses and its growth rate are best compared with U.S. Internet stocks such as eBay. On that basis, its P/E ratio is 2 1/2x those company's. One reason the stock isn't coming under pressure is it is very hard to borrow shares in order to short the stock. There are some changes coming in Japan that will make borrowing easier, and if something along those lines unfolds, that could have a pretty big impact on the Nikkei OTC index.
Atkins Friendly . . . The WSJ's "Tracking the Numbers" column highlights Cal-Maine Foods that, by one hedge-fund manager's calculation, investors in Cal-Maine were shelling out $23 per hen in mid-Feb, when Cal-Maine stock reached its all-time high of $45.60. Considering the number of eggs the average hen produces over her life span, egg prices would have to remain at 58 cents or more for a dozen for investors to at least break even, not counting the price of feed and upkeep. Yet the fund manager, like plenty of others, says he is bearish on Cal-Maine, considering the stock's dizzying run. Cal-Maine has been boosted by the Atkins diet craze and Americans' increased reliance on eggs as a protein source. It's this overall run-up that has enticed short sellers who are betting the rally will be scrambled. The shorts have built up a bearish position of 1.5 million shares, almost 40% of Cal-Maine's public float of 4.1 million shares. These Cal-Maine bears say they've been emboldened by the company's executives, who have sold more than 730K shares during the past 6 months, according to regulatory filings. But there are still hard-boiled optimists who say the Atkins trend won't fade soon, egg prices will remain generally high, and Cal-Maine is relatively cheap, since it trades at less than 7x its prior 12 months' earnings. In the bulls' view, the large short interest will turn into a source of buying, once the chicken hearts realize how wrong they've been and rush to cover their positions before the sky falls on them. Fred Adams Jr., Cal-Maine's chairman and CEO defends the insider selling, as merely a matter of veteran employees at a previously sleepy agricultural co seizing a once-in-a-lifetime opportunity.
Of Note . . . China's two largest steel makers to increase capacity by 80%
Market Comment . . . Expect a durable expansion with mild inflation and higher, still-accommodative interest rates. Looking forward, more of the economy’s growth will come from business investment and inventory rebuilding and less from consumption (though it should still be resilient.) Corporate profits should continue to grow rapidly. Expect a durable expansion with mild inflation and higher, still-accommodative interest rates. This favors equities but
not bonds.
• An important shift is taking place in the business community – it is losing its fear of deflation. Some markers: the sharp increase in CEO sentiment, Greenspan’s recognition that deflation is behind us, the acceleration in the manufacturing sector, more talk of pricing power, the February inventory build, and the 513,000 new establishment survey jobs in the first quarter.
• Looking forward, more of the economy’s growth will come from business investment and inventory rebuilding and less from consumption (though it should still be resilient.)
• Corporate profits should continue to grow rapidly based on favorable operating and financial leverage, pricing power, strong growth in U.S. final demand, stronger global growth, and still-accommodative interest rates. Emphasize the difference between this cycle and previous ones due to its deflationary roots.
• If inflation rises faster or higher than we expect or interest rate hikes create more of a shock, it would weaken the expansion.
Some Key Variables
• The inflation problem will be a mild one because the inflationary dollar weakness came immediately after a deflation. To an extent, they cancel out. The dollar is roughly 30% weaker than its 10-year average, indicating an inflation problem on the order of the 1987-1990 bulge.
• The first several interest rate hikes will act as an accelerant to the economy, providing a final “get it while you can” opportunity for more leverage.
• Most of the reaction of currencies and commodities to the coming interest rate hikes has already
occurred, but won’t know for sure until the rate hikes start. This creates an important uncertainty in the outlook.
• The number and price of houses has risen sharply in recent years. Higher interest rates will slow these trends, but not stop them. Expect distress to be localized.
• Investors should still discount some of the widely-discussed concerns. We don’t expect a consumer rollover, a dollar crash, a problem financing the U.S. current account deficit (the bigger risk is over-financing), a fiscal crisis at either the federal or state/local levels, or an unstable hard landing in China.
Real Estate . . . Banc of America Securities downgrades Post Properties to Sell from Neutral. $21 target. Firm states that due to concerns about the fundamentals of southeastern apartment markets, they are decreasing 2004 FFO estimate to $1.75 from $1.83 and 2005 est to $1.89 from $2.02. Firm states that PPG's valuation represents an 11% premium to its peer group of multifamily companies and is 41% above the long-term average multiple for sector. In addition firm believes PPG's market have performed worse than average during the apartment downturn over the last three years, and they have no reason to believe that these dynamics will change in the expected recovery. Firm believes that company's markets will continue to struggle with new supply and robust home sales, and thus will have a slower and shallower recovery than peers.
Oil & Gas . . . Barron's highlights Halliburton, suggesting it is undervalued and could be a much better company after the smoke clears. According to the article, the simplest way to value the company's shares is just to pretend its troubled KBR unit doesn't exist. The oilfield-services business contributed 43% of HAL's total rev last year, but the lion's share of profit. That segment alone is valued at $15.13 bln, or $30.41 a share, if it were to trade at the same multiple of enterprise value to operating cash flow as its large-cap peers. Also KBR unit is worth something, aside from government work, the unit is the undisputed leader in liquefied natural-gas engineering. Applying the average EV/Ebitda multiple of its peer group, the KBR unit has an implied valuation of $1.9 bln, or $3.88 a share. The last chunk of the valuation has to do with the asbestos settlement itself. HAL has already settled with its largest reinsurer, Equitas, and will get $575 mln, representing 60 cents on the dollar. The co believes the other insurers will settle this year or next, and the recovery rate should be a bit more than the Equitas settlement, or about $2 bln. In the meantime, that amount is being financed by the co's own borrowing. Conservatively assuming Halliburton receives the same 60% recovery it got from Equitas, the settlement would total $1.8 bln, or $3.62 a share. Putting the three pieces together results in a sum-of-the-parts valuation of $37.91 a share, a 23% premium to the current share price. Applying the company's somewhat higher projection of insurance recoverables yields a target of $38.31. "What's holding back Halliburton right now is the aversion to suffer any headline risk," says Robert Mackenzie, oilfield-services analyst at Friedman Billings Ramsey. "A lot of portfolio managers don't want to deal with that."
Metals . . . JP Morgan downgrades AK Steel to Underweight from Neutral, as they believe that the co is in a poor competitive position in the U.S. industry due to its high legacy cost obligations ($3.1 billion), weak profitability metrics, and high-cost labor situation; firm also notes that the stock trades at a significant premium to its domestic peers on an EBITDA and FV/shipment basis, which they believe is unwarranted given its structural cost disadvantage.
Goldman Sachs raises their view of the Gold sector to Attractive from Neutral based on the following factors: 1) Comex reported on Friday a sharp decline of non-commercial net long gold positions to 228 tons, which is half the peak level of only two weeks ago; 2) valuation, as firm's models suggest 30% upside if gold trades to $450; 3) firm forecasts a weakening dollar over the next 6 months and reaffirms its view that the Fed remains on hold through the year; and 4) Barrick's commitment to reduce its 450 ton hedgebook and AngloGold's potential reduction of Ashanti's book after merging this month likely provides gold price support on weakness. Top picks are Newmont and Placer Dome.
Transports . . . Lehman upgrades General Motors to Overweight from Equal-Weight and raises their target to $57 from $54, and upgrades F to Equal-Weight from Underweight and raises their target to $16 from $12. The firm is saying they have underestimated the earnings power of the automakers; firm says the upside they see is coming through the finance company's, where asset quality is improving, and they say they now prefer the autos over the auto suppliers, since history suggests the automakers will outperform in a rising rate environment. Firm's European analyst also upgrades DCX to Equal-Weight from Underweight.
Lear reported earnings of $1.30 per diluted share, $0.13 better than the Reuters Research consensus of $1.17; revenues rose 15.2% year/year to $4.49 billion versus the $4.26 billion consensus. The company also guides, sees 2nd quarter EPS of $1.55-1.65, versus the consensus of $1.66, and revenues of approx $4.3 billion versus an estimate of $4.27 billion. The firm sees 2004 EPS of $5.85-6.25, versus the consensus of $6.17, and revenues of approx $16.6 billion versus an estimate of $16.5 billion.
Harley-Davidson raises dividend 25%, approves 20 million share repurchase.
Food & Beverage . . . Sysco reported earnings of $0.30 per share, in line with the consensus of $0.30. Revenues rose 9.9% year/year to $7.03 billion versus the $7.02 billion consensus.
Barron's highlights Coca-Cola, which is currently in search of a new CEO. Last week there was rumor that Gilette's CEO Jim Kilts will replace Coke's current CEO, but by the week's end The WSJ reported that Kilts would stay at Gillette, he was merely the latest to reportedly turn down the Coke search committee. According to the article, citing WSJ, among the remaining candidates are R. Kerry Clark, vice chairman of Procter & Gamble, and Coke's current president and COO, Steven Heyer. There's even talk that Coke might try to lure to the post E. Neville Isdell, who was a former Coke executive and later the boss of one its biggest bottlers. In a recent report by Morgan Stanley consumer-products analyst William Pecoriello, a number of challenges were listed that any new CEO might find daunting. Most important: The market for carbonated soft drinks has flattened in the US and other developed markets, whether because of saturation-induced "boredom" and product fatigue, or younger consumers' preference for healthier alternatives such as bottled water and fruit juices. Unfortunately, Coke hasn't developed as strong an array of noncarbonated brands in the States or elsewhere in the world as has archrival PepsiCo. One of Coke's biggest problems revolves around its "independent," but controlled, bottling network, which the parent co has unabashedly exploited over the past decade. Product innovation will be a key to Coke's future. But, according to Mr. Pecoriello's report, line extensions such as Vanilla Coke and lime-flavored Diet Coke aren't cutting it, they merely cannibalize sales of existing brands. Gone are the days in which Coke delivered annual earnings gains of 15% with metronomic regularity. It will be hard-put to come up with even the 10% Wall St expects over the next two years.
Office . . . Goldman Sachs upgrades Xerox to Outperform from In-Line based on the substantial progress the company is continuing to make in gaining market share, improving the balance sheet, and introducing new products that should increase page volume and rev per page. Also, firm views the stock's 8% price decline after 1st quarter earnings as overdone; while gross margins fell 210 basis points to 39.8%, primarily reflecting a shift in product mix, the co expects a more traditional mix in subsequent quarters, which should allow full year gross margins to average 41-42%.
Retail . . . Leap Frog traded up 9%, following the release of 1st quarter 2004 results. EPS were in line with revised guidance. Gross margin, lower by 836 bps y/y, was worse than our revised forecast. Operating expenses, up by nearly 1,400 bps year/year, were slightly better than forecast. As a result EBIT margin, down 2,230 bps year/year, was basically in line with our previously-revised forecast. This marked the first quarter the company reported a y/y decline in U.S. Consumer revenue, which was attributed to a weak retail environment. Sell-through was reportedly up 20% YTD at the largest retailers. Management refused to provide details on channel inventories, however, which we find concerning. Margin weakness is forecasted to continue for the balance of 2004, with 2004 gross margin now anticipated to be flat to down 100bps.; we now forecast FY04 EBIT margin down 220 bps. y/y. As a result, we are lowering our
FY04 EPS estimate to $1.21 from $1.30 (within a guided range of $1.18-$1.28) and FY05 to $1.38 from $1.50. LF shares now trade at a P/E multiple of 19.3x 2004 and 16.9x 2005 estimates. This compares to 2004 multiples for HAS of 15.5x and MAT 14.5x, and 2005 multiples of 13.6x for HAS and 13.3x for MAT. Analysts are reiterating a peer perform rating as we believe the share price reflects a fair multiple on our new earnings projections for 2004 and 2005. That said, LF makes an attractive acquisition candidate, which could provide downside protection, while the heavy short position could provide a healthy catalyst.
Kmart Martha Stewart Living Omnimedia announced an agreement extending and amending several terms in their long-term distribution contract for the Martha Stewart Everyday brand label. The revised agreement better aligns the two companies' mutual business interests by extending the Martha Stewart Everyday partnership two years, through 2009; expanding the scope to several new product categories; eliminating the product category minimum guarantee but not the aggregate minimum guarantee features of the contract; and making other adjustments that, taken as a whole, benefit both companies. In conjunction with this amended agreement, KMH also announced that it will withdraw the lawsuit filed against MSO IP Holdings Inc. in February.
Healthcare . . . Humana reports 1st quarter earnings of $0.41 per share, in line with the consensus of $0.41. Revenues rose 12.1% year/year to $3.29 billion vs the $3.24 bln consensus. Company sees Q2 EPS of $0.37-0.39 vs Reuters consensus of $0.40; for Y04 sees EPS of $1.60-1.65 vs consensus of $1.62 on revenues of approx $13 bln, consensus $13.18 bln.
Priority Healthcare signed an agreement with Bertek Pharmaceuticals, a unit of Mylan Labs to be a preferred specialty pharmacy provider of Apokyntm. Approved April 20 by the FDA, it is the first and only therapy in the United States indicated as an acute intermittent treatment of hypomobility, or "off" episodes, in patients with advanced Parkinson's disease.
Biotech . . . Genentech and Roche announce a Phase III study of Tarceva, an investigational HER1/EGFR-inhibitor agent in previously treated patients with non-small cell lung cancer, met its primary endpoint of improving overall survival, with patients receiving Tarceva living longer than those in the placebo arm of the study. The trial also met secondary endpoints including improving time to symptomatic deterioration, progression-free survival and response rate.
Genentech target raised to $180 from $150 at UBS following Tarceva data.
Hotel & Leisure . . . UBS upgrades Hilton, Star Hotels, and Lasalle Hotel to Buy from Neutral, and upgrades Host Marriot to Neutral from Reduce. Although lodging stocks have traded higher in the past year, firm says lodging fundamentals have only recently begun to improve; and unlike other cyclical industries where positive news may be moderating, firm says lodging demand growth is improving since it is tied to business activity/rev growth, which is rebounding.
Jeffries upgrades Boyd Gaming to Buy from a Hold and increases its target to $29 from a range of $17-$18 as the firm is now switching its valuation over to 2005 forecasts and basing its price target on its 2005 EBITDA estimate of $597 million. The firm believes 2005 should be a blowout year for the company, as it will receive the benefit of its first full year of operations with its Coast Casino and Harrah's Shreveport acquisitions.
Media . . . Barron's highlights Lions Gate Entertainment, a small producer of movies with a library of some 8,000 films. The company's shares are up from 2 to about 6 in the past year, as investors have warmed to the company's niche franchise in Hollywood and have applauded its acquisition of Artisan Entertainment. The studio has a knack for making provocative independent movies in which big stars work cheap. Lions Gate keeps its financial risk low and looks to milk the upside from home video and overseas releases. According to SG Cowen's Lowell Singer, the release of Open Water this summer could generate nice financial leverage. And with an acquisition cost to Lions Gate of just $2 mln, Mr. Singer thinks the upside is considerable. Its library can be mined for DVD releases for years to come, even if its backlist isn't nearly as storied as that of MGM. The co, with an equity market value of $540 million, is projecting positive free cash flow of $80 mln in the current FY. Rob Routh of Natexis Bleichroeder thinks the stock can trade at 20x his slightly lower estimate of $70 million in free cash flow, which translates to more than 11 for the stock.
The New York Times reports sales of digital video recorders are finally gaining momentum, according to a study by IDC, with TiVo increasingly being left behind by the success. TiVo, by IDC's measurement, had just 39 percent of the United States market for D.V.R.'s in 2003. The balance is largely made up by combined recorders and set-top boxes that are being offered by satellite and cable television companies, which, unlike TiVo, don't require users to purchase hardware upfront. Instead, they generally charge users about $10 a month for a set-top box that includes a D.V.R.
The WSJ reports that DVR-enabled set-tops could threaten other parts of cable-industry business, most significantly in the case of Time Warner, which owns a lot of programming assets. According to the article, TWX's DVR product costs just $8-10/month and customers lease a DVR-enabled box from the company. In comparison, TIVO's service costs $12.95/month and $150 for the box, although says TIVO might be easier to use. A consumer who uses such a device "is getting all that content and recording it real easily, paying nothing extra to get it and stripping out the advertising," Comcast CEO Brian Roberts told an industry gathering.
The WSJ reports that Comcast plans to test an advanced TV set-top box designed by Digeo, the latest sign that the Paul Allen-backed start-up has become a credible competitor to Microsoft in the cable field. Comcast will announce today a commercial trial using about 40,000 of the devices, which are manufactured by Motorola using a Digeo design called Moxi. Charter Communications also is announcing plans to launch a Moxi-based service in Rochester, Minn., after a trial there. The devices make use of Digeo's software for navigating through TV channels and managing other entertainment options, including digital video recording, games, stored photos and music.
The New York Post reports that Comcast appears likely to withdraw its bid for Disney in the coming weeks. Executives at the cable giant are currently weighing the timing of such an announcement, sources say to the paper. While one could come as soon as this week, when Comcast reports quarterly earnings on Wednesday, a more likely scenario is that the co would take its bid off the table in the weeks leading up to its annual shareholder meeting in May. The co is also considering announcing a stock buyback and perhaps a shareholder dividend to coincide with the announcement that it is bowing out of the battle for Disney. The announcement is expected to reiterate the strategic rationale for a Disney-Comcast combination, and it also may suggest that the co could reenter as a bidder at a later date.
Telecom . . . Raymond James upgrades AT&T Wireless to Market Perform from Underperform based on the view that the majority of the bad operational news is now priced in the stock. The co reported weak 1st quarter 2004 results, which were even worse than the firm's lowered estimates. Net customer adds came in at a negative 367,000 versus the firm's estimate of negative 189,000, churn was at 3.7% versus the firm's estimate of 3.5%.
The Financial Times reports that SBC Communications has filed a lawsuit seeking at least $141 million from AT&T in fees it claims it is owed for calls that the long distance carrier routed partly over the internet. The lawsuit, filed in a St Louis federal court, follows a landmark ruling by federal regulators earlier this week that AT&T and other long distance carriers must pay full "access fees" for calls routed partly over the internet if they begin and end on ordinarily local telephone lines.
Network Equipment . . . Schwab Soundview upgrades Corning to Outperform from Market Perform and raises their target to $16 from $10.50 following stronger than expected 1st quarter results and raised guidance; firm says the surprising breadth in results, with further improvement in Environmental, Life Sciences, and Equity Joint Ventures adding to the LCD ramp, demonstrates that the co is capable of prospering in the absence of a fiber recovery.
Barron's highlights Motorola, questioning whether the company can keep up its big gains. Last week, the co reported a rare "blow-out" quarter, but it might be wise to wait to toast the turnaround for at least a few more quarters. "In all my years of covering this co, I've never seen all of the segments line up and report like this. Which means it probably won't last," says telecom analyst Ed Snyder of Charter Equity Research. The long-time observer of the co wonders whether Motorola can maintain its newfound momentum. Mr. Snyder isn't telling his clients to jump into the frothy shares right now. Instead, he is advising folks to watch how Nokia responds and to wait for potential dips. While the co may not be capable of whipping up competitive designs overnight, it can reclaim customers and coveted market share by slashing prices. "Nokia all but said that it would take back market share, which is very aggressive [guidance] for them," Snyder says. "Nokia's price cuts will squeeze everybody this quarter." Snyder fears that Motorola might be too content with its recent success. "I don't think that Motorola is taking [Nokia's pricing] threat seriously, based on their comments on the conference call. The good news for both company's is that handset sales for the rest of the year are expected to remain strong, with Motorola hoping to match its 1st quarter sales performance in the 2nd quarter. But it depends largely on how "deep" and "fast" Nokia starts bringing prices down, Mr. Snyder says. If Nokia does indeed launch a price war, inventory probably would evaporate quickly, which is good for company's in the supply chain, such as Qualcomm. The company earns royalties on designs for semiconductors used in CDMA phones, which are made by Motorola.
Scotsman.com cites a The Business article suggesting China is to deliver a blow to the west's mobile-phone makers by shelving plans for a £45 billion third-generation (3G) network. The country was expected to start issuing 3G licenses later this year, but officials are believed to be about to drop plans for state investment. In addition, the article suggests the buoyant global recovery is here to stay, finance ministers and bankers form the world's richest countries said at the end of meeting of the Group of Seven (G7) in Washington. In their most bullish statement since the dotcom bubble burst, G7 finance ministers and central bankers downplayed the remaining challenges to the global economic recovery.
Semiconductors . . . BofA Sec out on RF Micro Devices saying they believe that shares may trade up from current levels for two reasons. First, firm's checks indicate that the March Quarter may come in slightly above consensus and that the June Quarter is trending in line with expectations with positive order momentum. Second, there seems to be more upside than downside to their estimates for 2nd half 2005 from the Polaris II (EDGE RF) radios. While the timing and magnitude of these design wins is uncertain, the firm believes their estimates reflect only 30-40% of the potential outcome if Polaris II does indeed see solid design traction. Yet, intense pricing, commoditization of RF PAs, and short design cycles prevent BofA from raising their rating saying a design loss could severely impact profits given relatively fixed SG&A and R&D expense. Target goes to $10 from $12.
The Financial Times reports that these are crucial times for Jen-Hsun Huang, CEO of Nvidia. Mr Huang has taken a big bet by developing a technology aiming at leapfrogging the company's rivals. Last week the first fruits of that development, a graphics chip called GeForce 6, capable of displaying more realistic computer images, was launched. Article suggests that if the chip lives up to its promise, Nvidia will be able to boost its nearly 60% share of the market and may even recover some of its former glory.
Lucent has selected Xilinx FPGAs for its new 10Gb/s Tunable Optical Translator Unit, a key component in one of its DWDM-based metro optical equipment offerings.... Separately, the co announces the availability of a new RapidIO Serial Endpoint intellectual property core. Coupled with Xilinx' parallel RapidIO endpoint IP core and PICMG-compliant AdvancedTCA Development platform, this combination provides the industry's only complete FPGA-based solution.
Caris & Co upgrades Intel to Above Average from Average for the four following reasons: 1) The business spending cycle is in full swing from a combination of better than expected corporate profits and new computer cycles, 2) seasonal weakness in consumer computing markets will shortly morph into a back to school build leveraged by the global wi-fi and mobile PC boom, 3) In spite of challenges, INTC retains leadership in key server and mobile markets, which carry premium ASPs, and 4) Q1's $0.26 per share represents the co's 2004 low water mark and EPS should progressively mount throughout the year.
Boxmakers . . . While everyone is encouraged by AAPL’s recent results and we can see further potential 2nd half catalysts (iPod from H-P, new iMac, PowerMac G5 speed bump), the real concerns are that the G5 cycle has disappointed, Apple is still ceding PC share, and at some point iPod mini supply will catch demand (“white” iPod supply/ demand are already in balance) which could derail the stock’s momentum and temper further EPS upsides.
Despite phenomenal success of iPod, Apple's stores are not generating PC market share gains, according to the latest data from IDC. Despite opening 78 stores in the US since 2001, its domestic market share has declined from over 4% to 2.8%. The stock valuation seems to already reflect investor optimism on iPod. AAPL's agenda with its is to capture non-PC revenues associated with Mac sales. In other words, its efforts to diversify revenue streams are intended to offset market share erosion. While this strategy may work near term, it may lead to challenges if AAPL’s share further erodes.
In the last 3 quarters
Market Share
WW desktop is at 1.4%
US desktop is at 2.0% (new lows)
Europe’s is at 1.8%
Positives
• Strong brand name, fiercely loyal customer base, defensible installed base
• Innovative products and design strategies
• Incremental market opportunities through “digital lifestyle” initiative (iPod, iTunes, iDVD, iMovie, iPhoto, iTunes
Music Store)
• Ongoing efforts to monetize beyond-the-box revenue streams (e.g. software, paid subscription services, iTunes Store downloads) to help offset cyclicality of hardware business
• Excellent cash position – around $12.15 per diluted share in net cash
• Long-awaited G5-based hardware could spur Power Mac desktop upgrade cycle and new wave of demand for professional users
Concerns
• New G5 chip doesn’t eliminate the real or perceived “megahertz gap” with Intel and could lead to a stall in other product line sales (i.e. can Apple synchronize growth in multiple CPU product segments)
• Risk associated with our view that Apple may migrate to the Intel architecture owing to the megahertz gap with PowerPC, corporate IT issues with PowerPC chips and lower cost of implementation
• High-cost of non-standard architecture and constraints of Motorola’s processor roadmap
• Inability to capture a wider customer base and grow market share without a more compelling product offering to attract new users and penetrate the Wintel world
• Shortening product lifecycles
• Could face difficulties reconciling channel conflicts between retail stores and resellers which Apple is prepared to face to have greater control of its customer relationship
• Methodology suggests the stock’s valuation is rich and already factoring in much of the good news in the near term
Software . . . WR Hambrecht downgrades THQ Inc. to Hold from Buy. The firm thinks Street consensus quarterly 2005 estimates for THQ do not reflect the degree to which the year will be back-end loaded. Therefore, the firm thinks June Quarter Street consensus is too high and that guidance may disappoint the Street.
Computer Assoc files with the SEC restating certain financial data for the Company and its subsidiaries for the fiscal years ended March 31, 2000 and 2001, and providing certain quarterly data included in those fiscal years. The Audit Committee found that a total of $2.2 billion of revenue was booked prematurely by quarter within fiscal 2000 and 2001. A total of $1.782 billion was prematurely recognized in fiscal 2000 and $445 million in fiscal 2001. CA will host a call at 11 ET to review announcements made earlier today.
Barron's reports Linux has hurt Sun Microsystem's sales of large server computers, and might eventually make a dent in Microsoft's PC empire. After establishing Linux in the market for servers, the Linux community is preparing its assault on the software market for Intel-compatible PCs. The highlight of Novell's user conference last month was the announcement that Hewlett Packard will pitch Novell's Linux software to corporate PC buyers. Novell has been building a portfolio of desktop Linux products. It acquired SUSE, which shrink-wraps the Linux OS for PCs, and Ximian, which supplies Linux applications that are compatible with Microsoft Office products. While HPQ has gotten behind Linux desktops, there's been no official action by Linux's biggest commercial backer in the server market, IBM. Big Blue has a vital interest in Microsoft's only existing desktop rival, Apple, as the processor-chip supplier for the Macintosh. But IBM invested $50 million in Novell last month and IBM employees have told to Barron's that the company is closely watching the development of Linux desktops. Novell shares have quintupled over the last year, pushing the company's market value to $4.3 billion. That's four times the $1.1 bln in sales that Novell totaled for the 12 months ended Jan, and more than 140x earnings. But compared to Linux champ Red Hat, Novell is only heinously expensive. Prudential analyst Brent Thill recently bought a Lindows PC from Wal-Mart's Website. In a note to clients, Mr. Thill said that the system was easy to set up and to use. It cost $231 with shipping, which is about the list price for Microsoft PowerPoint. Mr. Thill predicts that within 3 to 5 years, the consumer applications, like games, will appear and Linux will start making a dent in Microsoft's pricing.
Monolithic System Tech sues Synopsys for breach of contract following the abrupt termination of a merger agreement by Synopsys on April 19. The complaint seeks to force Synopsys to complete the merger agreement or otherwise seeks monetary damages. MOSY says SNPS waited until the last minute to pull out of a lawful agreement, causing significant damage.
ITWO’s stock was down 10% last Friday (versus the COMP up 0.8%) after reporting
weak 1st quarter results. Management provided a target cost structure—excluding restructuring charges—of $83-$86 million for 2nd quarter, but was reluctant to provide top or bottom-line guidance, underscoring the lack of visibility at ITWO. ITWO continues to be hampered in the marketplace by its re-audits and continuing investigation by the SEC, which have adversely affected the company’s ability to build pipeline and close license deals. Given continued weak visibility to license growth, expectations of material cash burn going forward, and ongoing legal risks, it is our view that the risk/reward profile at ITWO remains unattractive—even at current depressed trading levels. Consequently, analysts are maintaining an Underperform rating on ITWO.
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