|Moderated By: Mark Johnson -- (Not Moderated) -- Started: 12/12/1998 3:08:00 PM Revision History|
The Internet Financial Connection, December 11, 1998
Presented by Mark Johnson, Editor of the IFC
It appears exclusively on Silicon Investor
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Charles LaLoggia, recently selected Brylane as a
buyout candidate in the November 19, issue of the
IFC. See the link below to view the article.
Brylane received a buyout offer within 2 weeks
after this article was posted and their stock
doubled in price. Thank you Charles and to
the all the other stock contributors!
This newsletter can be viewed at
In This Issue:
1. Michael Murphy's Technology and Biotech Outlook
2. American Xtal
3. Analog Devices
5. Highlights on SI: Ask Trader J
6. Interesting Articles On The Internet by Joe Dancy
7. Highlights on SI: Books A Million! Oil $5?
by David Z
8. Highlights on SI: by Tom Taulli
Michael Murphy, Editor of the California
Technology Stock Letter ctsl.com
and mutual fund manager, provides the following
interview with Mark Johnson, editor of the IFC.
An annual subscription to his newsletter is
$295 for 24 issues and can be contacted by phone
at (650)-726-8495. Information about his Mutual
Funds can be found at the above Web Site.
Q: Have technology stocks got ahead of themselves in the short-term?
A: No! I don't think technology stocks are ahead of themselves. They have been very strong. This is not your ordinary seasonal rally. Even if it was, tech stocks have not gotten ahead of themselves but they have caught up to where they should have been. There were worries earlier this year, such as the PC, semiconductor and equipment market falling apart. Other worries were the affect Y2K spending would have on enterprise software and systems. Most of those worries were wrong. What we have seen are stocks coming back to reflect earnings and what is going to be a normal 1999. Beyond that, there is something else going on here, the Asian Flu is really infecting the old economy at this point. For example, Asian fears have hit Boeing. Money managers ran to a number of larger cap companies on the theory that they were safe havens from Asia and they were running away from technology stocks. Larger companies are turning out to be dramatically impacted by deflationary times.
Q: Have these fears been factored in already?
A: Wall Street analysts are still looking for fairly strong earnings growth in the current quarter. They pulled in their horns quite a bit from their 14% year over year numbers and are down to 6% or 7% at this point. The numbers for 1999 are still sky high. They project over 12% growth and that is just not going to happen. As Asia struggles through their economy, it causes substantial slowdown in corporate earnings. People realize they cannot raise prices, then valuations have to adjust. You get a company like Coke that is a 15% grower and trades at 35 times earnings. One half of their growth over the last five years is from cost cutting. Revenues have only grown by 7% during that period. Half of their revenue growth has come from raising prices. Essentially, you have a 3% grower based on actual unit volume. What the heck is it doing selling at 35 times earnings? Cash is coming out of the larger consumer growth stocks, consumer cyclicals, deep cyclicals and flowing into the area that is showing real growth, which is with technology.
Q: Obviously, you are looking for the technology stocks to outperform the S&P 500 and the Dow Jones Industrial Average?
A: Yes, substantially between now and the middle end of February. I think we are clearly in a good December quarter, in absolute terms and relative to the rest of economy. A terrific quarter in terms of earnings growth. The outlook for the March quarter is pretty good. People will start to worry looking forward about the summer of 1999 in March, April or May and will see the outperformace come to a halt. This is the seasonal strong part of the year for technology. It tends to rally in November, December, January and February. We are getting that rally again. It might have legs, if it turns out as I believe that 1999 is going to be a good year.
Q: What about the semiconductor area? The SIA (Semiconductor Industry Association) reported that we are going to see a recovery here. Many of the stocks in that area have moved. Is this rally for real?
A: Yes, it is. It is a 2 part deal. What we are seeing right now is just based on pricing. Pricing is starting to get better in a lot of areas. For example, certain chips have fallen 80% in 1997 and have dropped in the first quarter in 1998 and have currently stopped declining. Companies are continually bringing their costs down. They are getting breathing space to get caught up and get those chips profitable again. There are also some spot shortages. Some of the Intel chips are on allocation. Intel invested $500 million in Micron to make sure they do not have a shortage of DRAM chips next year. You have not heard the word shortage and the word DRAM in the same sentence in about 3 years. We are headed for a shortage in silicon, which is phase 2 of this whole rally. First, we need decent pricing, which is what we have right now. There could be a fair size shortage of silicon in the 2nd half of next year and you will see terrific pricing.
Q: Are there some companies that you think will benefit in that area?
A: I don't think Intel is overpriced but we have had a $120 target for awhile. It is at a fair price. Their stock could go above my target and to $150. I think Intel will hit that target at the end of 1999. Behind Intel, there are a number companies such as LSI Logic, which is just starting to move. This stock is down from $45 in 1997, bottomed to around $12 and still has a way to run back up. About a 1/3 of their chips are consumer electronics related, which is unusual for a U.S company. I think both Cypress and Integrated Device, 2 SRAM companies have been badly hurt by the drop in SRAM prices. Both have been developing higher value logic chips. We had been buying the semiconductor equipment stocks, which typically move with the semiconductor companies. We are not chasing Applied Material, KLA-Tencor or Lam Research because we already own them. Mattson Technology is a smaller company that we like, who has been announcing some huge orders for their rapid thermal processing product. In the semiconductor area, one of the smaller companies that I really like is SEEQ Technology, which is a tiny company. They make communications chips. They have a broad portfolio of about 8 different chips that they can sell. I think they will have substantial, sequential gains in revenues.
Q: Were there other stocks that you were buying in that area?
A: There are a lot of things that we are buying but those are the highlights. There are 2 better areas and they are quite depressed. One is biotechnology. We have seen a move recently with the Roberts & Stephen conference in New York. We have a big Hambrecht & Quist conference in the second week in January. The second area I like is Enterprise Software. There have been problems at PeopleSoft and Baan. There seems to be a misconception that the Y2K problem is bad for enterprise software companies. I think that is wrong. I was a COBAL programmer back in the 60's. I can promise you that if you are starting today to fix the Y2K problem, it is a lot easier to bring up a new system and parallel that. The software from companies such as; Informix, PeopleSoft and Ross Systems could be used.
Q: The companies that you just mentioned can benefit from the Y2K problem?
A: Informix has beaten the street estimates in the last 2 quarters substantially. They will do it again in the December quarter. Ross Systems, is in software process manufacturing. They should substantially beat street estimates in their December quarter. Remedy is a help desk software company. Their stock has come down from $40 to $11. They have taken their product and generalized it, so it does a lot of other applications besides help desk. For example, keeping track of fixed assets. Their sales people will be out selling essentially 4 or 5 different products instead of just one. I don't think spending on enterprise software will slow down too much next year. The reduction in hardware costs is helping in a sense because, it is freeing budgets to spend on software to get into the client server world.
Q: Any other areas that you have been following, such as the integrated device manufactures that would fit in with the semiconductor manufacturers?
A: We own some unusual ones like Power Integrations, for example. They make a chip that can replace the big transformer brick used to recharge your laptop computer. A lot of those bricks weigh more than the products they are supposed to charge. They have a very simple semiconductor based product. Their stock has had quite a run at this point. Another software company that we are buying is called Rogue Wave Software. They make object oriented software for tools and software modules. They moved their headquarters from Oregon to Colorado and had a couple of bad quarters. Fundamentally, they have great technology and a lot of new products.
Q: You mentioned a couple of biotech conferences?
A: Yes, there is one coming in the second week in January. Wall Street really does not want to hear about development stage companies. What they can't ignore for long are drug approvals. There were a couple recently. Isis Pharmaceuticals received FDA approval in August. December will be their first full quarter of shipment. Their stock has hardly moved at all on the news and is selling at $12 per share. That is where their stock was when they filed for approval. Ligand just got an approval letter from the FDA. They should have final approval by the end of the year and start shipping in the March quarter. Cephalon should receive approval for a drug called Provigil within the next 2 weeks. They could earn $1 per share in 2000. All of these companies will be making presentations at the Hambrecht & Quist conference and will be talking to thousands of people which include; biotech money managers, analysts and interested folks.
Q: Will there be close to 50 drug approvals this year?
A: Yes, and the FDA is making approvals like crazy. They are doing a good job and have been very good about approvals.
Q: How many drug approvals do you expect next year?
A: About 80. There are about 230 drugs in late Phase III trials and should have about 80 approvals next year. This is a big drug pipeline coming. It should level off at about 100 a year for a few years. The important thing is that there are about 8 or 9 pure biotech companies that are profitable now and 240 that are not. As they turn profitable, their valuations will really skyrocket. There are so many portfolios that are willing to buy a pharmaceutical company, but are not willing to buy a developing stage biotech company.
Q: Chiron is a larger biotech company that you follow and is profitable. How is their outlook?
A: Chiron is actually an interesting situation. Of the larger, more profitable companies, it is one we are buying most actively right now. Their story is that they have new management. They hired in the former head of Glaxo's international operations, who is a terrific guy. He has focused the company, and is cutting costs. They sold their diagnostics division for $1.1 billion. They will receive $800 million after taxes and will use this cash to acquire late stage products or maybe some smaller companies. I think he will execute extremely well. Chiron has an internal project called "project 40", which just requires them to consolidate all of the acquisitions that they have done and do sensible things. One of the goals of this project is to get their stock up to $40 per share.
A: Will Chiron be a consolidator in the biotech area?
Q: They are. There are 3 or 4 obvious consolidators in this business. Chiron, Amgen and Ligand as it turns out will be one. With the 240 biotech companies that are not profitable, there are a number of them that should not be stand alone companies. Some of them have great technologies, but do not have the infrastructure to develop drugs, sell the them or the cash to get the things done. Chiron is careful about what they do. They have $1.3 billion in cash to make these acquisitions, plus they can use stock. Between the 2, the investment bankers bring them everything first and they are actively looking.
Q: Are you buying the other larger names such as Amgen?