Author: Gehman Capital
Covestor model: Undervalued Growth Companies
Disclosure: Long all stocks down below
My stocks have performed poorly this year. The Undervalued Growth Companies model is up 0.7%* year to date as of September 7, 2012, vs. 14.3% for the S&P 500 Index.
In my opinion, the stocks in the Gehman Capital portfolio are severely undervalued. Below, I will review each stock and comment about why I think each stock will trade significantly higher.
As a general comment, most are technology stocks that have been seriously affected by (1) the slow recovering economy, (2) the pending introduction of Windows 8 by Microsoft (MSFT) and (3) the delayed spending by telecommunication companies to increase their broadband capacity to accommodate the gushing demand for video traffic.
Small Cap stocks are all about the risk/reward profile. My stocks are suffering from the risks – I believe they are getting closer to enjoying the rewards. Unfortunately, it is taking longer than I expected.
EZChip Semiconductor (EZCH) shocked investors when they reported Q2, 2012 earnings in line with expectations, but guided significantly lower earnings in Q3, 2012. The company blames the reluctance of telecommunication companies to make capital expenditures build their network capacity and the time it is taking their customers to write software to accommodate EZCH’s new, NP-4 network processor.
Eli Fruchter, EZCH’s Chairman, insists that capital expenditures to build network capacity will have to grow within the next several quarters to avoid serious bottlenecks with Internet Traffic. He also insists that projections for volume and profits for the new NP-4 chips are not changed – just delayed because of the need for new customers to develop software to accommodate the processor.
Delays in profits have happened with EZCH in the past. EZCH is a small company with gigantic customers – Cisco (CSCO) is the largest. When business picks up, the orders, and profits, will return.
The really good news was that their new NPU-4 is now in production for CSCO with a number of other companies lining up to use the chip in production.
Of greatest significance, on September 5, EZCH released the details of a new product line that I feel will revolutionize network processing – in Edge Routers and Data Centers.
There is a substantial short position in the stock. The stock price is subject to serious gyrations. I am not
trading the stock – I just close my eyes and keep waiting for the extremely attractive earnings that I expect to
appear in 2013.
On July 30, Anadigics (ANAD) reported disappointing second quarter net sales of $25.1 million and net losses – GAAP and non-GAAP. Fortunately, cash, cash equivalents and short and long term marketable securities totaled $73.1 million.
Ron Michels, President and CEO announced that new products were receiving design wins and production was ramping up. “…Anadigics is now well positioned to target growth areas in the wireless and infrastructure markets.”
Prior management had production problems and stressed customer relationships. Current management continues to develop what I believe is a superior product line and has gone a long way to re-build customer confidence.
ANAD is a world leader in radio frequency (RF) solutions. ANAD has patented, differentiated technology. Their power amplifiers deliver world-class efficiency across all power levels that extend battery-life in mobile devices (such as smartphones and tablets).
I believe the market for ANAD products in the wireless area is growing rapidly. Profits from these products and the security of adequate cash reserves should lead the stock to higher prices.
DragonWave (DRWI) is the leading independent provider in the high capacity “packet microwave backhaul” market. Unprecedented mobile demand is driving investment in that market. Packet microwave is new, but DRWI projects that the market will grow at an annual rate of 38%.
DRWI closed their purchase of Nokia Siemens Network (NSN) on June 1, 2012. The DRWI and Nokia Siemens Networks partnership is projected to “accelerate innovation in backhaul products and technologies to deliver world-class solutions for mobile operators,” according to the company.
To date, DRWI sells pure broadband backhaul (wireless networks) in densely populated areas. The Nokia Siemens acquisition provides opportunities to sell packet or hybrid (not pure IP) solutions that are frequently used in emerging markets and rural areas.
On June 4, 2012, DRWI announced some operational restructuring following the merger. They will streamline the operation with lay-offs in some areas, establish a distribution capability in the Netherlands and staff new regional subsidiaries in Mexico and Brazil. These announcements are positive, especially if DRWI can close some contracts in Latin America.
DRWI’s stock price has been under pressure since the merger. It will take a little time, but I expect the benefits of the merger to pave the way for significantly higher stock prices.
Finisar (FNSR) makes an innovative line of fiber optic products. Their products are “cutting edge” and are in demand. Demand for 100 Gbs transceivers is exceeding supply and will probably not equalize until later in 2012, according to the company.
Also demand for ROADM’s (Reconfigurable optical add-drop multiplexer) is strong with FNSR gaining market share.
Demand for fiber optic products – internet backhaul, data centers and wire-line telecom – has been slow for two years now. The market is seeing increasing demand for broadband capacity but carriers are not increasing spending on wireline products.
(Note: they are spending on wireless products – that will force them to start spending on wireline capacity to avoid logjams on the internet.)
FNSR has a relatively high ratio of fixed expenses. Telecommunications companies could increase spending later this year, but definitely should increase spending in 2013. Higher volume will generate higher profits and I believe that FNSR’s stock price should move up significantly.
The slow recovering economy is taking its toll on all chip companies. Altera and Xilinx are the two largest competitors of Lattice Semiconductor Corp. (LSCC). Both companies have reported lower revenues and earnings because of the economy.
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 earnings on July 19th with revenue in line with projections and earnings slightly below. Future guidance was moderate, reflecting economic conditions.
Fortunately, LSCC has over $180 million in cash and equivalents as of their last quarterly report, so it is well prepared to work through this slow economic recovery.
The company is executing well. The stock is trading at $3.89 as of the end of August, which is only about 13.5x trailing earnings. I believe this is very attractive for a growth story that will benefit from the continuing recovery of the world economy.
There is big news at Microvision (MVIS) this year. On May 31, 2012, the company announced purchase orders from Pioneer Corporation (JP: 6773) for over $4 million. Pioneer is the first customer to purchase components and pay license fees and royalties for MVIS’s patented Pico projector.
Pioneer is utilizing MVIS technology to manufacturing a new projector that allows automobile drivers to view data, in all viewable conditions, in front of the windscreen.
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. The Pioneer order is the first of hopefully many orders that will increase MVIS sales significantly.
Analysts now speculate that the Apple (AAPL) and Samsung verdict will force smartphone manufacturers to differentiate their products – which will provide many opportunities for MVIS.
On Sept. 5, 2012, MVIS and Intersil Partner announced an agreement to partner on the development MVIS’s high definition display technology. This partnership will integrate advanced features such as “virtual touch and proximity sensing, increased brightness, reduced power consumption and component size, and lower the cost of the product.” This will help make MVIS’ PicoP display technology optimal for embedding in mobile devices. Intersil will provide strong marketing and distribution support as well as technical assistance.
Since 1996, MVIS has been developing their PicoP ® display technology platform that is designed to enable next-generation display capabilities for consumer devices and vehicle displays. MVIS now has the technology and the price structure that makes their products attractive to the consumer market. I believe the stock price should move up substantially.
QuickLogic Corp (QUIK) has announced some production orders for 2012, but most likely the real revenue increase will start in 2013. For the first time, QUIK is developing chips that are suitable for “mass distribution” which could generate very large earnings growth. (See my recent report on QuickLogic.)
On July 23, 2012, QUIK announced a complete, ready-to-use solution for the Sitara™ AM335x ARM™ A8 processor from Texas Instrument Inc. (TXN) Russell Crane, product manager, Sitara ARM processors, said “this gives QUIK an opportunity to make significant breakthroughs into the portable device market where camera and video input in required.” By teaming up the Texas Instruments, this gives QUIK an opportunity to “mass produce” one of their products.
One of the most exciting products is a chip that bridges the “processor” with the display function of smartphones. QUIK’s chip is competitive in price with other competitor’s “bridge” chips, but also includes QUIK’s exclusive VEE/DPO technology that significantly improves screen visibility –especially in bright sunlight – and conserves battery strength.
Once VEE/DPO is available on one high volume smartphone, the public will probably demand similar technology on all smartphones. I believe the technology is that compelling.
In addition, QUIK has announced they received a contract to sell chips for one PoP Video projector (Pico) and has the opportunity to sell their chips to other Pico Projector manufacturers.
The management of QUIK likes to say the company is a venture capital firm wrapped in public cloth. The risks are high, but the potential rewards are very high.
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 in this facility will shift from memory chips for MU to higher margin chips.
Although the company is executing well, the stock price is affected by Capital Notes (convertible to common stock) that were issued in 2006 to avoid bankruptcy. Technical legal restrictions prevent these notes from being converted to common stock, but their existence causes the threat of dilution to stock value.
In the worst case, 399 million new shares would be created to increase the total number of shares to 732 million. Hopefully, negotiations will result in fewer shares being created.
TSEM’s 2012 revenue is projected at $718 million. The stock had a reverse split last month and closed the month at $ 7.90 per share.
TSEM commands major strategic technologies, continues to buy and quickly absorb new plants. TSEMis actively recruiting and landing many new large customers.
On September 4, 2012, TSEM announced a new contract to expand its contract with Vishay Siliconix that will generate hundreds of millions of dollars of revenue for TSEM over the next five years. This will allow TSEM to have a steady stream of revenue with a long-term, strategic customer in Japan.
I believe the company is executing well but because of the slow economy, guided for slightly lower revenues in the third quarter.
Hopefully the economic recovery will pick up momentum, the Capital Note issue will be resolved, and we can enjoy significantly higher stock prices.
Towerstream Corp (TWER) legacy business provides enterprise broadband service from rooftops. Their model is successfully utilized in high density cities such as New York, Chicago, and San Francisco. Recently, TWER purchased a fixed wireless broadband carrier in Houston, the fourth largest city in the US.
In addition, TWER can leverage their real estate assets, which have established AC power, for wireless carriers to seamlessly offer interaction between Wi-Fi, 3G and 4G systems.
TWER announced its first “national” carrier contract on March 30, 2012, their second on May 10, 2012, and a third trial agreement in August, to provide Wi-Fi networks. TWER also announced a trial agreement with a wireless, national media company.
In Q2, 2012, TWER installed 600 nodes (transmission facilities) that put the company on track to install 5000 nodes by Q1, 2013. The company feels that 5000 nodes will give them the concentration to successfully land larger contracts.
Carriers have entered into a phase of “sustained and long-term growth” that incorporates small cell architecture. TWER’s rooftop assets are very valuable to the carriers as the simple, quick and flexible way to deploy small cell strategies.
TWER has a high fixed cost structure. The company will need cash to continue to expand but is making progress in building their base of business where they can show profits that I believe will lead to higher stock prices.
WAVE Systems Corp (WAVX) has the leading solutions with Trusted Computing technology. Trusted Computing exists because over 600 million chips (TPM’s) are installed on business computers.
When the chips are activated, a thief will need to steal a person’s machine in order to steal their account – and that is difficult because the information is encrypted in the computer. Once the thief alters the BIOS of the machine, that will machine will not be able to access network information.
Wave writes the software that provides strong authentication, data protection, network access control and the management of these functions. Corporations pay fees to WAVX when they “turn on” WAVX’s software to manage their trusted computing technology.
WAVX has written larger 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.
Disclosure: Performance discussed is net of advisory fees. The index comparisons herein are provided for informational purposes only and should not be used as the basis for making an investment decision. There are significant differences between client accounts and the indices referenced including, but not limited to, risk profile, liquidity, volatility and asset composition. The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry, among other factors.
The investments discussed are held in client accounts as of September 24, 2012. These investments may or may not be currently held in client accounts.The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.
Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Covestor believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
