Author: Gehman Capital
Covestor model: Undervalued Growth Companies
Disclosure: Long EZCH, QUIK, FNSR, LSCC and TWER
In my March, 2012 report, I said that “2012 will be an extremely exciting year for US equities.” Boy, was that ever a true statement.
The US stock markets rallied very nicely until the last several weeks. The market needed this correction. I believe that after this period of adjustment, the stock markets will regain their positive trend.
Europe will take a while to get back into a growth phase, but the low cost of money will speed the recovery. Each country has specific problems that will create headline news from time to time. Each country is doing what is necessary to start the recovery process. Even Germany is making sounds like they will tolerate some stimulus to speed up recoveries.
China has experienced a “slow down” period. Inflation numbers are improving. The government has started to stimulate their economy again – as they need to do to keep their economic machine growing.
Aside from the recent $2 billion (or maybe more) loss from JP Morgan (JPM), the US banks financial conditions have improved significantly. It is not acceptable that gigantic losses from major banks will derail the U.S. recovery. That said, JP Morgan could still have a $4 billion profit this quarter, even after this significant loss.
Confidence in the markets is being restored. I expect equity prices to be significantly higher by the end of the year. I believe the small/micro cap stocks in my Covestor portfolio will be much higher by year end.
Small Cap stocks are all about the risk/reward profile. My Covestor performance chart (as of May 11, 2012) shows that the Gehman Capital model has returned +7.7% for 2012 year to date as of May 25. This compares with +6.9% for The Russell 2000 index and +3.5% for the S&P 500 index.
Stocks such a EZ Chip Semiconductor (EZCH), Microvision (MVIS), QuikLogic (QUIK), Tower Semiconductor (TSEM) and Towerstream (TWER) stocks are starting to show some life. The rest of the companies, are doing well, in my opinion, but need more time to work out their business plan.
EZCH reported very solid revenue of $14.4 million for the first quarter of 2012. Gross margins were at record high levels with $.27 fully diluted EPS on a Non-GAAP basis.
The really good news was that their new NPU-4, that has about double the profits of the NP-3, is now in production for Cisco Systems (CSCO) with a number of other companies lining up to use the chip in production.
The stock is highly volatile. The company is projecting revenue in 2016 that could be 4 to 5 times the $63.5 million revenue in 2011. There is a possibility I believe these results can be achieved because most NP-4 customers are expressing strong interest in using the NP-5, which will sample at the end of 2012 and go into production in 2013.
I am not trading the stock – I just close my eyes and keep watching the good results come in.
Anadigics (ANAD) has superior products for cellphones that produce cost savings. Prior management had production problems and stressed customer relationships. Current management continues to develop a superior product line and has gone a long way to re-build customer confidence.
I believe ANAD should have enough cash to get back to cash flow positive. ANAD is a high risk – high reward situation.
DragonWave (DRWI) is buying Nokia Siemens Network in a deal that is scheduled to close on June 1, 2012. DRWI is buying a much larger company that will continue to be a very big customer for the company’s products and services.
The market for broadband Ethernet backhaul (DRWI’s market) is growing substantially. This acquisition may significantly improve the odds of DRWI’s success. The stock has been under pressure with the merger pending. There is good upside potential.
Finisar Corporation (FNSR) builds a very competitive line of fiber optic products. Late in 2011 and in the first quarter of 2012, demand for fiber optic products – internet backhaul, data centers, wire-line telecom and wireless telecom – entered a “slow patch.”
Analysts project that the increasing demand for broadband capacity will force carrier spending to increase significantly in the second half of 2012. FNSR has a relatively high ratio of fixed expenses. FNSR’s stock price may move up with a higher volume of business.
Lattice Semiconductor (LSCC) operates in the programmable logic business. LSCC specializes in the low power, low cost, high volume market – especially when they can add some low cost innovation. The company completed their acquisition of Silicon Blue for $62 million in cash on Dec. 16, 2011.
Over the last ten years, LSCC has delivered over one billion high volume chips. Customers operate in many industries including wired and wireless telecom, smartphones, laptops, digital cameras, TV’s and video processing, with no major customer concentration.
LSCC reported results for the first quarter of 2012 that showed a recovery from the inventory glut in the last quarter of 2011.
The company is executing well. LSCC is a growth story that will benefit from the continuing recovery of the world economy.
Microvision Inc. (MVIS) is generally acknowledged as producing the smallest and best Pico Projector (i.e., small projector). MVIS uses three lasers (green, red and blue) and a mirror to project automatically focused images on any surface at any distance.
This year I believe MVIS will increase their sales significantly. Green lasers that were expensive and in short supply are scheduled to become commercially available at a reasonable cost by the middle of 2012.
Three factors will make MVIS Pico Projectors extremely attractive to consumers: First, Projectors will be small enough to “embed” in cell phones. Secondly, QuickLogic (QUIK) is now marketing a chip with VEE/DPO technology that will lower power usage and significantly increase view ability for Pico Projectors. Finally, the cost of the projectors will be reduced significantly.
QuickLogic Corp (QUIK) is a small tech play with big ambitions. On May 12, QUIK reported first quarter earnings and business progress came very much in line with my report on the company back in early April. The company is bringing new chips to market and has a large number of customers sampling, and starting to go into production with their products.
I believe QUIK will report increased sales in the second quarter but significant results will probably have to wait for the end of 2012 and possibly 2013. The management of QUIK likes to say the company is a venture capital firm wrapped in public cloth.
The stock moved from the $2.50 area to $3.50 area in the last few weeks on the announcement of a contract to sell their chips for the PoP Video projector (Pico) and the opportunities to sell their chips to other Pico Projector manufacturers.
Tower Semiconductor (TSEM) fabricates chips. There is a trend for developers to outsource manufacturing because new chip manufacturing facilities are extremely expensive. TSEM purchased a production facility from Micron Technology (MU) earlier this year. Over time, production will shift from memory chips for MU to higher margin chips.
The company is executing well and is projecting increased revenues and increased gross profit margins. I believe the stock has upside potential.
Towerstream’s (TWER) basic business model is the enterprise wireless broadband network, but the real value in the company is that they have installed towers on high buildings in high density markets.
Originally this “real estate” was used for high-speed connections to communication systems. Now that the “real estate” network has been established, the system can be leveraged, cheaply, for other purposes.
TWER is starting to leverage their “real estate” that should steadily generate increased revenue and higher stock prices.
WAVE Systems Corp (WAVX) sells and manages software that uses trusted platform modules (TPMs) to increase data security. Over 500 million TPMs have been installed in enterprise computers.
WAVX is the most frustrating stock that I own in my Covestor portfolio. First quarter earnings were extremely disappointing. The company has established a major position in the Trusted Computing environment–that is, seminars, lectures, research reports, and so on. However, the company has not been able to convert their dominant position into significant profits.
Every quarter, for years, Steven Sprague, CEO, has said that the company has a number of projects in the pipeline. WAVX has written contracts with General Motors ($10.9 million), BASF ($3.5 million) and Price Waterhouse, in addition to a number of small companies. However, they have never signed enough contracts to show a profit.
The company has consistently increased cash flow, but chooses to spend the increased funds on research to expand projects. In the first quarter results, revenue actually declined and expenditures increased because the company wants to adapt their products for the “mobile” (e.g. cellphone, tablets, etc.) markets.
The company has been forced to sell more shares to finance their development. If and when WAVX finally closes large contracts, they should be able to report significant profits, even though they will be spread over a large number of shares.
Finally, there is XOMA (XOMA), which has a number of drugs in stages of development, testing and government approval. These drugs are therapeutic antibodies that treat inflammatory, autoimmune, infectious and oncological diseases.
If the drugs finally get approved, or the company can collect revenue from larger pharmaceutical companies, the rewards of success are significant but the odds are low. The waiting is painful.
