A new wave of small tech stars seen on the horizon
M-Flex, Unova, Oplink seen cashing in on hot trends
By Scott Banerjee, MarketWatch
Last Update: 6:17 PM ET Dec 23, 2005
SAN FRANCISCO (MarketWatch) -- Small technology companies often find growth in some obvious yet overlooked places.
Take Multi-Fineline Electronix Inc. (MFLX: news), which makes flexible circuit boards for Motorola cell phone models like the wildly popular Razr.
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While many investors rode Motorola to solid gains in 2005, some investing pros looked for opportunity beneath the hot-selling device's plastic shell, and there they saw the value of Multi-Fineline, also called M-Flex.
Because the device has complicated functions and displays on both sides of its handset, Motorola designers couldn't use the rigid circuit boards that had been popular with cell phone makers in the past. Instead, they chose the more advanced flexible ones like those made by M-Flex.
"When it went public, no one wanted to buy it," said Rich Hunter, co-manager of Lighthouse Capital Management, a Houston-based fund that owns the stock.
Now it's easy to see why investors started paying attention.
Anaheim, Calif.-based M-Flex's sales leaped 41% this year on the strength of its supply relationship with Motorola, which made up more than three-quarters of the small company's business.
M-Flex 's stock doubled in 2005 and has risen fourfold since its IPO in June 2004, but Hunter says it has more room to run. Wall Street analysts expect the company's profit to rise 24% and sales to jump 39% in the new fiscal year.
Flexible circuit boards are just one story of how an unglamorous but lucrative underlying technology can propel a little-known company's stock. MarketWatch asked investment professionals to name prime candidates to follow that path in 2006, and came up with an array of trends and stocks to watch.
Among them are companies whose chips can extend the battery life of handheld devices. Others let wireless carriers expand their coverage areas. And an emerging group provides technology that allows retailers to track inventory better.
Radio frequency identification
With retailers such as Wal-Mart, Best Buy and Target getting more tech savvy in running their businesses, technology companies are staking out a money-making opportunity in systems using radio frequency identification.
Unova Inc. (UNA: news) has a number of RFID patents, some of which it purchased from IBM (IBM: news). "They have a lot of intellectual property that went into recent standard settings for RFID and the tracking of packages," said Sebastian Thomas, U.S. head of technology research at RCM.
And it's not just about retail. RFID also is an important tool for government agencies including the Pentagon and the Department of Homeland Security.
Although Unova's sales were inconsistent in 2005, analysts expect Unova to boost its profit by 41% next year as revenue grows 11% to $973 million. "They are in a position to collect royalties on the deployment of technologies around RFID," Thomas said.
Unova shares have had a wild ride in 2005, starting off around $25 then dipping as low as $16.69 before rocketing up above $37. The shares now trade about $34.
In the wireless universe, some investors are bullish on a technology that allows carriers to add coverage to rural areas without spending on more expensive, third-generation network upgrades. Carriers like Cingular that use the GSM mobile standard are using the technology, dubbed Edge (which is much easier to remember than its full name, enhanced data rates for GSM evolution).
"Many handset manufacturers bet against it, notably Samsung and LG," said Albert Lin, head of research with American Technology Research. "Now, many of the U.S.-based and European wireless carriers are behind it. They're building hybrid networks, using 3G networks in urban areas and using Edge in rural areas."
Nokia and Motorola are incorporating the technology into their phones. Lin pints to RF Microdevices Inc. (RFMD: news) and Freescale Semiconductor Inc. (FSL: news) among the chip specialists that are taking the lead in developing Edge components.
RF Micro, its shares stuck in a $4 to $7 trading range, is expected to see profit growth of more than 60% in its next fiscal year. Freescale, spun off by Motorola in 2004, tripled its profit in its most recent quarter and the stock has climbed 50% this year.
Battery efficiency
The growing importance of squeezing more battery power out of wireless handsets has propelled the race to find technology that gives manufacturers the ability to add more features and cooler functions.
That translates into a potential bonanza for chipmakers that optimize power control on handhelds.
"Whether it's a cell phone, a PDA or an iPod, all these devices require controlling chipsets for each of their different electrical currents," said fund manager Hunter. Beneficiaries include International Rectifier Corp. (IRF: news), Fairchild Semiconductor International (FCS: news) and National Semiconductor (NSM: news).
Fairchild's stock has seen little movement for a year-and-a-half, but analysts surveyed by Thomson First Call expect the South Portland, Maine-based company to quadruple its profits next year.
For its part, International Rectifier is on pace to post sales of $1.1 billion this fiscal year. Next year, analysts expect a 31% jump in profits as sales rise to $1.25 billion.
National Semiconductor, the largest of the three in terms of market capitalization, is on pace for 20% profit growth next year.
Survivors
In the telecom world, a couple of small, mostly forgotten companies that went public in 2000 in the fiber-optics networking boom -- and subsequent bust -- could finally be poised to perform again.
"A handful of struggling companies are starting to see the light at the end of the tunnel," Hunter said. Among the players that have survived leaner years are Optical Communications Products Inc. (OCPI: news) and Oplink Communications Inc. (OPLK: news).
Both have seen their stock prices crash since 2001, yet both could benefit from a strengthening demand from the likes of Nortel Networks Inc., Tellabs Inc. and Cisco Systems Inc. Optical Communications Products and newcomer Mindspeed Technologies Inc. (MSPD: news), which made its initial public offering in 2004, could benefit from the same trend.
At the same time, the move toward Internet-based phone calling is making waves.
As Yahoo Inc., eBay Inc., Google Inc. and Microsoft Corp. make forays into the increasingly popular technology, their involvement could boost the fortunes of networking equipment makers. At the mid-cap level, the likely winners include Juniper Networks Inc. (JNPR: news) as well as former high-flyers Lucent Technologies Inc. (LU: news) and Nortel Networks Corp. (NT: news).
Software
The delivery of software using Internet-based technology, or so-called "on-demand" software, is fundamentally changing the way software is sold, distributed and deployed. Since it runs on the vendor's computer servers as opposed to those of their customers, it cuts out the hassle and cost of installing programs on their customers servers.
The poster child for on-demand delivery of software, Salesforce.com (CRM: news), has seen its shares rise more than 100% in the past year -- yet it's hardly a diamond in the rough these days.
But in the procurement business, Thomas of RCM, says Ariba Inc. (ARBA: news) might be able to further capitalize on its move to "on-demand" -- as well as shifting from software license accounting to software subscriptions. Ariba, whose shares began to rebound in October, is also now taking 75% of its large deals on a subscription basis -- instead of the more inconsistent license accounting.
While these fundamental moves have forced Ariba to alter its expense planning and salesperson compensation, says Thomas, it should benefit the company as its shares try to regain previous 52-week highs.
Scott Banerjee is a reporter for MarketWatch in San Francisco.
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