Wednesday, January 30, 2008

Singing More "Bad Days" At Warner Music Group


The bankruptcies of record retailers (bye-bye Tower Records and Musicland) and wholesalers, growth of new formats for recorded music distribution (legal downloading of digital music using the Internet), maturation of the CD format, and digital piracy—factors which continue to negatively impact the operating results at Warner Music Group (WMG-$7.59), which generates more than 80 percent of its annual revenue from recorded music, split 90/10—physical (such as CDs, cassettes, LPs and DVDs) and digital (such as downloads and ringtones) formats, respectively. The remainder sales are generated from music publishing.

Aiming to effectively address the continued development of digital distribution channels along with the decline of industry-wide CD sales, Warner Music, home to acts such as Faith Hill, Green Day, Led Zeppelin, Red Hot Chili Peppers, and R.E.M, announced a re-alignment plan in its second-quarter of fiscal year 2007. New business initiatives included cost-structure savings (i.e. layoffs) and the evolution from a traditional record and songs-based business to a music-based content provider (across online and mobile platforms).

Shares in the world's third-largest record company are up almost 60 percent in three-weeks, primarily attributable to investor anticipation that the music label is close to signing a deal with Yahoo! for ad-supported online music offerings. A digital distribution partnership of this kind would be the best action—to date—to jumpstart its sputtering digital marketplace and offer leverage in future content-pricing negotiations with Apple, whose iTunes product remains the dominant online distribution outlet (controlling more than 70 percent of digital download music sales).

Financial Trends

We do not favor buying Warner Music, for we do not believe that Chairman & CEO Edgar Bronfman [not a big fan!] and his management can
embrace the digital world fast enough to offset plummeting CD sales and lost revenue due to counterfeiting (approximately $63.0 million, according to our estimates), and digital piracy.

A public service announcement followed me home the other day.
I paid it nevermind.
Go Away.
Shits so thick you could stir it with a stick-free Teflon whitewashed presidency.
We're sick of being jerked around.Wear that on your sleeve.


In addition, we believe the 52 cents a share annual dividend—yielding 6.8%--will be cut in coming months.

Broadcast me a joyful noise unto the times, lord,
Count your blessings.
We're sick of being jerked around.
We all fall down.


It will take time for Warner Music to adapt to the changing economics of the music industry. As for now, the Company remains highly leveraged. As of fiscal year ended September 30, 2007, total net consolidated indebtedness was $1.94 billion, with shareholder equity of $(36.0) million.

Have you ever seen the televised St. vitus subcommittee prizeInvestigation dance?
Those ants in pants glances.
Well, look behind the eyes.
It's a hallowed hollow anesthetized
"save my own ass, screw these guys"
smoke and mirror lock down.

Warner Music recorded a loss of $21 million, or 14 cents a share, on revenue of $3.385 billion during the fiscal year ended September 30, 2007. That compared to a profit of $60 million, or 40 cents per share, in the 2006 fiscal year.

Broadcast me a joyful noise unto the times, lord,
Count your blessings.
The Papers wouldn't lie!
I sigh, Not one more.

We caution investors that the Company has limited financial flexibility (debt covenants) to absorb operating losses in the coming year. In 2007, the interest coverage ratio fell to 1.08 times EBIT, down from 1.57 times EBIT in the prior year.

It's been a bad day.
Please don't take a picture.
It's been a bad day. Please….

Our risk assessment also includes the massaging of accounts receivable (decrease) and accounts payable/accrued liabilities (increases) of $73.0 million and $78.0 million, respectively, to positively impact cash flow from operations (which totaled $305.0 million)—barely enough to fund debt service, capex requirements, and quarterly dividends of $199.0 million, $30.0 million, $76.0 million, respectively.

Broadcast me a joyful noise unto the times, lord,
Count your blessings.
We're sick of being jerked around.
We all fall down.


In addition, Warner Music has firm commitments (in the aggregate) owed to signed talent (such as artists, songwriters, and co-publishers) that approximated $424 million, as of September 30, 2007 (usually payable over a ten-year period).

Its been a bad day...
Pleaase...
~ R.E.M. [
Bad Day Lyrics]

In fiscal year 2008, analysts are expecting a loss of 12 cents per share on sales of $3.16 billion, on average, according to a poll by Thomson Financial.

The Company will release fiscal first-quarter financial results (for the period ended December 31, 2007) prior to the opening of trading on Wednesday, February 6, 2008.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Friday, January 25, 2008

Trading Alerts: Monday, January 27, 2007


Alberto-Culver (ACV-$23.52) reports earnings on Monday before the market opens. Analysts, on average, are expecting a share-net of $0.26 on revenue of $376.9 million, according to a poll by Thomson Financial. Citigroup analyst, Wendy Nicholson, recently upgraded her rating on the household and personal products company shares to "buy" from "hold" and raised the target price to $28 a share from $25 a share.

Is billionaire Wilbur L. Ross Jr. considering a bid for bond insurer Ambac Financial Group (ABK-$11.54)?

San Diego-based Amylin Pharmaceuticals Inc. (AMLN-$32.46) is projected to post a loss of 44 cents a share in the fourth quarter on revenue of $202.58 million. The catalyst for any sustainable upswing in the drugmaker’s stock price will be FDA marketing approval for its investigational diabetes drug exenatide LAR (once-weekly injection), the likely successor to Amylin's current diabetes drug, twice-daily Byetta.

Shares of Elizabeth Arden Inc. (RDEN-$18.28) climbed higher in after-market trading, after an analyst upgraded the company on Friday, saying the cosmetics maker's positioning and global nature could shield it from an economic downturn.

Phenix-based electronic components distributor Avnet (AVT-$33.55) recently reported healthy earnings and management said neither of its two major businesses show signs of slowing from a weakening economy. "Avnet seems to be an underappreciated growth machine"and "the stock seems to discount any coming weakness," Barron's reported on Sunday.

Baxter International (BAX-$61.00) issued an “urgent” recall of batches of its blood-thinner heparin due to reports they have caused severe allergic reactions—including diarrhea, chest pain and fainting—in some recipients.

Black & Decker (BDK-$69.98) announces fourth-quarter results on Monday morning before the market opens. In December, the power tool and home-improvement product manufacturer
lowered its sales growth outlook, citing the slumping housing market. Analysts, on average, are expecting a profit of 1.03 cents per share on sales of $1.61 billion, according to a poll by Thomson Financial.

Corning Inc. (GLW-$22.37) is forecast to post fourth-quarter earnings of 39 cents a share on sales of $1.55 billion. The flat-panel liquid crystal display glass supplier is expected to deliver solid results thanks to continued worldwide growth in the TV and computer monitor market as well as demand for fiber optic cable.

Shares of Cubist Pharmaceuticals Inc. (CBST-$18.51) continued to sink an additional 3 percent in after-market trading on Friday as concerns lingered about the possibility of a patent challenge to its only marketed drug, the antibiotic Cubicin.

Investors bought up E-Trade Financial Corp. (ETFC-$3.76) shares, overlooking a massive quarterly loss
on expectations the discount brokerage can revitalize its flagging business. But analysts warned exposure to potentially toxic mortgage debt could hamper the financial services company's growth.

Halliburton (HAL-$33.09) reports its fourth-quarter earnings on Monday. Citing growth in
the Eastern Hemisphere (Africa, East Asia, and the Middle East), analysts, on average, are expecting the oilfield service provider to earn a profit of 69 cents per share on sales of $4.06 billion, according to a poll by Thomson Financial.

Shares of contract driller Helmerich & Payne Inc (HP-$35.77) are poised to climb at least 40 percent, helped by its standard-setting equipment and solid management, Barron's said on Sunday.

When McDonald's (MCD-$54.10) announces its
fourth-quarter numbers before the start of trading Monday, investors will be listening to management numbers for new-store (worldwide) openings in the coming year and an explanation of how a U.S. economic slowdown might affect McDonald's same-store sales growth in coming quarters (considered a key measurement of retailer health because it evaluates growth at older locations rather than newly opened ones). Analysts polled by Thomson Financial expect the restaurant chain to report a profit of 71 cents per share on $5.61 billion in revenue.

For the first time, Merck (MRK-$47.79) and Schering-Plough (SGP-$19.02) have released details of how a key study of their cholesterol drug Zetia, also used in the combo pill Vytorin, wound up being delayed for more than a year after its findings were originally expected.

Harbinger Capital Partners Master Fund, a Cayman Islands-based hedge fund, is aiming to do proxy battle with The New York Times Co. (NYT-$14.66), as it seeks to get its own nominees elected to the board of the publisher.

Memory chip-maker SanDisk Corp. (SNDK-$25.62) reports
fourth-quarter earnings on Monday afternoon. Analysts, on average, are expecting a profit of 64 cents per share on sales of $1.27 billion, according to a poll by Thomson Financial.

Southern Copper Corp. (PCU-$82.78), a leading global metals producer, reported profits fell 53 percent in the fourth quarter to $311 million (from $655 million in the same quarter a year earlier) as a labor strike stalled production at Mexico's biggest mine, diluting the year's record sales.

Shares of Systemax Inc. (SYX-$15.59), a seller of computer hardware, electronic and industrial products, may dip in response to inquiries into the rebate-accounting practices of its TigerDirect retailer, according to Barron's.

Potential rewards outweigh the risks of holding shares of athletic apparel maker Under Armour Inc. (UA-$34.87), according to Barron's. However, analysts believe results hinge on consumer reaction to its new cross-training footwear.

Analysts, on average, expect VMware Inc. (VMW-$80.55) to post solid
fourth-quarter results on Monday morning of 24 cents a share on revenue of $417.4 million, though competition is looming for the virtualization software maker from Microsoft Corp., which is expanding its presence in the market.

Wireless and broadband growth should drive Verizon (VZ-$37.76) to post a profit of $0.62 a share on revenue of $23.96 billion. Earlier this month, Verizon's President and Chief Operating Officer Dennis Strigl said the company
has not seen any effects of the weakening economy hurting its business.

WellCare Health Plans Inc. (WCG-$43.12), a managed care provider undergoing a federal probe, announced the resignations of top executives and said its latest annual report and other filings will likely be late.

Wet Seal Inc. (WTSLA-$2.54) said that it laid off 41 employees as part of its planned cost-cutting initiatives to increase profitability. The teen apparel retailer expects the workforce reduction to result in pre-tax savings of about $4.3 million annually, beginning in fiscal 2008.

YRC Worldwide Inc. (YRCW-$18.86) is estimated to post fourth-quarter earnings of 54 cents a share on sales of $2.29 billion. The biggest U.S. trucking company (by sales) will probably dim 1Q:08 prospects when it meets with analysts in New York on January 28, Bear Stearns’ analyst, Edward Wolfe, said today in a report.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Thursday, January 24, 2008

Will Motorola Hang Up On Icahn Again?


Shares in Motorola, Inc. (MOT-$10.04) plunged 19 percent on Wednesday, after the struggling cell-phone maker released dismal results for the 4Q:07 and said it was taking longer than expected for a recovery in demand for its mobile devices.

Shareholder activist Carl Icahn beneficially owns about 3.3% of shares outstanding (as of September 30, 2007 filing)—much of it acquired at prices between $17.73 and $19.80 a share. The billionaire financier has consistently
criticized the management of Motorola for its poor financial performance and unsuccessfully ran for a seat on its board in May 2007. He is rumored to be agitating for a break-up, according to traders.

"My significant stock ownership is many times that of the entire board. It represents both my commitment to Motorola and your assurance that I am solely interested in what is best for the Company and its stockholders." ~ Carl Icahn in open letter to shareholders [May 1, 2007].

Throwing good money after bad? Icahn—unlike most of us—can afford to 'double-down' on his gamble. Investors should note that today Fitch Ratings
downgraded the issuer default rating for Motorola (to 'BBB' from 'BBB+'), saying that it was skeptical of the company's ability to return operating income margin to double digits over the longer term (because of the need for further restructuring and lower margins in the low-cost models—for emerging markets—that is driving growth).

Given the significant decline in the company's market valuation, we suspect that the stock price will find support at $10.00 a share, helped by the rumored Icahn activity and the potential for aggressive share repurchase activity by management (the Company had approximately $3.8 billion outstanding under its stock buyback authorization as of December 31, 2007). This is offset, however, by our longer-term concerns that the share-price remains tethered to prospects for growth in the handset segment.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Monday, January 21, 2008

U.S. Equity Markets Brace for Price Plunge



World stocks nosedived and demand for safe-haven bonds and currencies soared on Monday as fears gripped investors that a deteriorating U.S. economy would drag others down with it. Will Wall Street join the global equity markets plunge—that may usher in a bear market—when trading resumes on Tuesday?

Sunday, January 20, 2008

Trading Alerts: Tuesday, January 22, 2007


Abbott Laboratories (ABT-$59.43) said that it secured U.S. Food and Drug Administration approval to market HUMIRA as a treatment for adult patients with moderate to severe chronic plaque psoriasis, an autoimmune disease characterized by skin lesions that are sometimes painful, itchy, and may bleed.

A downgrade of bond insurer Ambac Financial Group Inc. (ABK-$6.20) is likely to have far-reaching effects, making it more difficult for cities to issue new bonds and forcing further write-downs at financial services companies, analysts said Friday.

Apple Inc. (APPL-$161.36) will post results for its first-quarter after the close of trading on Tuesday. Analysts polled by Thomson Financial expect the iPod maker to report earnings of $1.61 per share on sales of $9.46 billion, on average.

In this Web-pervasive atmosphere, investors in China more often view Internet plays as consumer rather than technology stocks. This is the reason that amid the past week's sell off, Credit Lyonnais Securities said recent risk aversion in markets is a good reason to again buy Baidu.com (BIDU-$273.04), China's leading search portal, whose stock price fell 12 of the past 15 sessions and is 35% off its Nov. 5 high.

Bank of America Corp. (BAC-$35.97) reports fourth-quarter earnings Tuesday. Analysts expect BofA to report profit of 18 cents per share and revenue of $13.24 billion on average, according to Thomson Financial. Investors will be watching for news on mortgage-related write-downs and the recent Countrywide acquisition.

Bank of Marin Bancorp (BMRC) reported net income for the fourth quarter of $3.26 million or $0.62 per share, compared to $3.23 million or $0.57 per share in the same quarter last year. Two analysts polled by First Call/Thomson Financial expected the company to report earnings of $0.57 per share.
Biogen Idec (BIIB-$59.91) could make a large-scale acquisition this year following its recent failed attempt to sell itself, the company’s CEO Jim Mullen told Financial Times’ mergermarket.

Caterpillar Inc. (CAT-$62.81) will release 2007 fourth-quarter financial results on Friday, January 25, 2008. Analysts polled by Thomson Financial are looking for a fourth-quarter profit, on average, of $1.50 a share with sales of $11.8 billion.

Wall Street is awaiting release of eBay Inc.’s (EBAY-$28.33) fourth-quarter results on Wednesday, anxious to hear more about the transformation of the electronic-commerce company's main business, online auctions. For the fourth quarter, the Company previously provided guidance of 39 cents to 41 cents a share, on an operating basis.

Israeli defense contractor Elbit Systems (ELST-$59.04) awarded $40 Million in several contracts for the supply of thermal imaging systems.
GlaxoSmithKline Plc. (GSK-$50.43) decided not to exercise its option to license the experimental drug, XL784, for diabetic nephropathy. Partner Exelixis, Inc. (EXEL-$7.51), in an attempt to reassure investors, said the Company is planning other pivotal trials and partnerships for this year, with several discussions already underway.

Ford Motor Co. (F-$5.92) is expected to post another quarterly loss next Thursday, sideswiped by a slowing U.S. economy, fierce competition at home and abroad, and a dearth of new products capable of turning around its prolonged sales slump.
Getty Images Inc. (GYI-$21.94), the world's biggest supplier of pictures and video to media and advertising companies, has put itself on the auction block and could fetch more than $1.5 billion, The New York Times reported on Monday.
Oilfield services provider Halliburton Co. (HAL-$32.40) said Monday it has secured a three-year, $683 million contract with Mexico's state-owned oil monopoly to manage the drilling and completion of 58 land wells in the country's southern region.

Due to due to general weakness in motorcycles, Wall Street expects Harley Davidson (HOG-$37.00) to post a single digit drop in sales for the fourth quarter when it reports on January 25. Analysts polled by Thomson Financial expect, on average, profit of 82 cents a share, with sales of $1.35 billion. Investors will be listening on the conference call for signs of inventory bloat, pricing sensitivity for used and new bikes, and the possibility of lowered earnings guidance from management.

The U.S. Food and Drug Administration granted accelerated approval for a division of Johnson & Johnson (JNJ-$66.29) to market the anti-HIV drug Intelence (etravirine) to patients resistant to other HIV therapies, the company said late Friday.

Analysts on average expect Microsoft Corp. (MSFT-$33.01) to report earnings on Thursday of 46 cents a share, on $15.9 billion in revenue for the second-quarter ended in December 2007. Highlights of next week's earnings report should include an update on Vista, the latest version of the company's Windows software, and on newer businesses such as online services and sales of the Xbox video game console during the holiday season.
The fitness equipment company Nautilus Inc. (NLS-$4.20) has finalized a $100 million line of credit with Bank of America.

Nokia Corp. (NOK-$32.60) is expected to report a rise in Q4 earnings on Thursday, boosted by buoyant demand for cheap phones in emerging markets and strong holiday sales in Europe. Analysts, on average, are expecting a profit of 52 cents per share on sales of $3.58 billion, according to a poll by Thomson Financial. Over the last four quarters, Nokia has surprised and beaten analyst expectations by an average of six cents, or 16.44 percent and remains a timely buy, according to Zack’s Investment Research.

Sears Holdings Corp. (SHLD-$89.43) plans to reorganize into several companies in another bid to pull the ailing 121-year-old retailer out the doldrums, according to a report published Saturday.

Texas Instruments Inc. (TI-$31.18) reports its fourth-quarter results on Tuesday. The vendor of cell-phone chips is expected to report earnings of 52 cents per share on revenue of $3.58 billion, according to a Thomson Financial survey.

Wachovia Corp. (WB-$30.80) is set to report results for the fourth-quarter on Tuesday. Analysts polled by Thomson Financial expect share-net of 33 cents on revenue of $7.4 billion for the fourth quarter. Lehman Brothers analyst Jason Goldberg expects provisions for losses on loans to hold back results for the fourth quarter.
An insurance broker, Willis Group Holdings (WSH-$35.99), has approached its bigger rival, Marsh & McLennan (MMC-$27.17) about a possible takeover, CNBC reported.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Friday, January 18, 2008

More 'Smoke & Mirrors' at Merrill Lynch


Merrill Lynch & Co. (MER-$49.45) reported a fourth-quarter net loss of $9.83 billion, or $12.01 a share, significantly above the consensus deficit of $4.93 a share forecasted by analysts in a Thomson Financial survey.

The fourth-quarter loss included $12.4 billion in net write-downs on U.S. collateralized debt obligations (CDOs), sub-prime and residential mortgage-related securities. Flowing through the investment bank’s income statement, too, were negative credit adjustments of $3.1 billion to reflect
tainted hedges with bond insurers.

U.S. ABS CDOs

At the end of the fourth quarter 2007, the balance sheet still held $30 billion of senior Asset-Backed Securities (
ABS) CDO at year-end (post write-downs)—of which a significant portion is collateralized with 2006 mortgages!

On its earnings call, management attempted to minimize this exposure by positing that $14 billion, or 46.7%, of the ABS was hedged with financial guarantors. Big deal—bond insurers are currently under review for possible event of defaults (related to failure to hold required levels of over-collateralization) and subsequent rating downgrades (which means that additional credit valuation adjustments might be forthcoming in the 1H:08).

An additional concern, in valuing the $30 billion in gross exposure still in ABS CDOs, the Company--we believe--is using ‘smoke & mirrors,’ for these securities are nothing more than contrived financial instruments, rarely traded.

CFO Neslson Chai said, “I think where the book is marked right now reflects as of December 31 as best we could where we think those positions were. And as you know, under
FAS-157, everything was level three. We triangulated around a bunch of different modeling assumptions and a lot of obviously external metrics to come up with what we thought was the right range, if you will.”

[Ed. note. Management would prefer that investors focus on its net exposure in ABS CDOs, which fell to $4.8 billion at year-end, from $15.8 billion at the end of the third quarter 2007.]

Commercial Real Estate and Leveraged Finance

On the commercial real estate and leveraged finance front, within Merrill’s commercial real estate business, aggregate net write-downs totaled approximately $230 million for the fourth-quarter, driven by spread widening and market illiquidity. Within leveraged finance, net write-downs of approximately $126 million were recorded with respect to these financing commitments.

After the current-quarter’s writedowns, net exposures related to commercial real estate (excluding Merrill Lynch Capital) and leveraged finance commitments totaled approximately $36 billion.

On the conference call, Chairman & CEO John A. Thain concurred on the pricing sensitivity of the commercial real estate portfolio to the overall economic environment, but said: “given where we are, given the types of properties that they are, given the structure of those deals, we’re very comfortable that these things are conservatively marked [$18.0 billion commercial real estate portfolio].”

A concern remains that deteriorating U.S. economic and market conditions could spread to theses business segments, leading to substantial impairment charges in coming quarters.

Outlook

Equity-linked trading and Wealth Management remain two bright spots for the Company.

Equity Markets net revenues increased 23% from the prior-year quarter to $2.2 billion, driven by the global build out of the equity-linked platform and substantial growth in client volumes and asset balances.

Global Wealth Management recorded fourth quarter net revenues of $3.6 billion, up 12 percent year-over-year, reflecting growth in transaction volumes and fee-based revenue.

Equity redeployment and aggressive balance sheet management have gotten a good reception from credit rating agencies, which all affirmed their bond ratings today. However, at the end of the fourth quarter, book value per share was $29.37, down from $41.35 at the end of 2006.

John A. Thain has promised improved
risk management—delivering on that promise would do much to improve stockholder confidence.

Well, I hope you guys help us get credit in our stock price because as you all know, if you simply put a multiple on the earnings out of the wealth management business, you basically get the market value of the whole company, so I assume that you all will help by telling how cheap our stock is. ~ CEO John A. Thain

Unfortunately for Messer. Thain, save for
takeout rumors, brokerage stock investors rarely price their holdings using a sum of the parts valuation.

In our view, despite the 48.2% drop in the Company’s market valuation in the last year, now is not the time to do contrary buying in Merrill Lynch. At a multiple of 11.1 times consensus FY ‘08 estimates of$4.50 a share (on average), the stock of Merrill Lynch carries market risk, selling at a 38.7% premium to its peer (investment banking) multiple of 8 times earnings.

At 1.7 times tangible book value, the stock of Merrill Lynch is priced at a premium multiple to its peers, too (mean, 1.4 times).

The 10Q Detective believes that the Company understated asset impairment charges in the fourth quarter, and we believe that the stock will underperform the market as rising levels of non-performing assets continue to adversely impacting 1H:08 profitability.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Wednesday, January 16, 2008

Do Outside Directors at Super Micro Computer Guard Shareholders' Interests?


The common approach to monitoring related-party transactions has been (i) disclosure of potential conflicts of interest in regulatory filings and (ii) financial governance by ‘independent’ directors on the board, representing the outside shareholder interests. Nonetheless, despite the intended transparency, these ‘best practice’ principles do little to stop insiders from enriching themselves at the expense of ordinary stockholders.

Charles Liang and his spouse, Chiu-Chu (Sara) Liu Liang, who co-founded Super Micro Computer (SMCI-$8.60), and are currently the Chief Executive Office/ Chairman of the Board and Vice President of Operations/Treasurer, respectively, of this provider of high-performance servers and workstation solutions, continue to financially enrich themselves and their families through stakes in related-party transactions, according to a proxy statement filed last week with the Securities and Exchange Commission.

Transactions with Ablecom Technology Inc.

Charles Liang and his wife jointly own approximately 30.7% of Ablecom, a Taiwan-based contract manufacturer that provides product design, outsource manufacturing, and distribution services for SMCI.

Ablecom’s chief executive officer, Steve Liang, is the brother of Charles Liang (and beneficially owns approximately 2.6% of SMCI’s common stock).

In addition, Yih-Shyan (Wally) Liaw, Vice President of International Sales and a third founder of SMCI, and Mr. Charles Liang, Ms. Liang, Mr. Steve Liang, and relatives of these individuals own more than 80% of Ablecom's outstanding common stock.

Ablecom’s net sales to SMCI and its net sales of SMCI products to others comprise a substantial majority of Ablecom’s net sales. SMCI purchased products from Ablecom totaling approximately $95.67 million, which represented about 34% of cost of sales; products sold to Ablecom (for distribution in Taiwan) totaling approximately $7.32 million for the fiscal year ended June 30, 2007.

SMCI intends to increase its business operations in Asia, currently about 14.3% of net sales. In an effort to reduce product costs, the Company plans to expand its warehousing capacity and its manufacturing relationship with Ablecom in China, according to management. This increasing reliance on Ablecom as a limited-source supplier, however, could subject the Company to disruptions in supply, compromising the Company’s ability to satisfy customer orders on a timely basis.

The 10Q Detective is suspect of this ‘cost containment’ defense, for pursuant to contract terms, Ablecom is the exclusive manufacturer of many chassis and power supply products sold to SMCI! In addition, business dealings with Ablecom are not arms-length agreements—which means the commercial terms of these agreements may be less favorable than contracts that might be obtained in negotiations with unrelated third parties.

For the 1Q:08 ended September 30, 2007, cost of sales increased 40 basis points to 80.5% of net sales, driven by an increase in sales of more mature products (which have a decrease in average selling prices).

Corporate Governance

The 10Q Detective is raising a red flag, too, regarding independent director composition. Although the board is controlled by a slight majority of independent outsiders (four out of seven), the founders—Charles Liang, Sara Liu Liang, and Yih-Shyan (Wally) Liaw—collectively control 41.7% of the common stock outstanding, which raises additional questions about the oversight effectiveness of the outside directors in place at SMCI.

There is nothing more corrupting, nothing more destructive of the noblest and finest feelings of our nature, than the exercise of unlimited power. ~ President William Henry Harrison (1773 – 1841)

New signings with Ablecom suggest that the independent directors might not be serving their intended purpose in aligning the interests of management with those of common stockholders.

Investment Considerations

The computer server market is highly competitive, with the Company squaring off against hardware giants like Dell, Hewlett-Packard, and IBM, as well as original design manufacturers like Rackable Systems and Quanta Computer.

In business since 1993, Super Micro Computer went public at $8.00 a share (March 29, 2007), hitting a 52-week high of $11.85 (June 5, 2007). Recent price weakness, however, reflects investor skittishness with the overall softness in the market for core server sales.

Cautionary economic indicators and signals that competitors continue to lower forward revenue guidance would suggest—that short of take-over rumors—few catalysts exist for a recovery in SMCI’s share price.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Sunday, January 13, 2008

Trading Alerts: Monday, January 14, 2007

Apple Computer (AAPL-$172.69) Chief Executive Steve Jobs is set to take to the stage at MacWorld Conference & Expo on Tuesday to unveil some new widgets/services.

Bank of America (BAC-$38.50) said Friday it will buy Countrywide Financial (CFC-$6.33) for $4.1 billion in stock, a deal that rescues the country's biggest mortgage lender and expands the financial services empire of the nation's largest consumer bank.

The Boeing Co (BA-$80.52) won an order for 16 of its 787 "Dreamliner" aircraft and options for eight more from Bahrain-based Gulf Air, in a contract worth as much as $6 billion, Gulf Air said on Sunday.

Citigroup (C-$28.59) is hoping to announce the receipt of $8 billion-to-$10 billion in new investments from a number of investors, likely including Saudi Prince Alwaleed bin Talal and the China Development Bank, on Tuesday when it is scheduled to report fourth-quarter earnings, the Wall Street Journal reported on its Web site. At the same time, the company also could announce writedowns of about $15.0 billion, above previously estimated forecasts of $8 - $11 billion. Because the writedowns will pressure earnings, analysts expect the largest U.S. bank to cut its dividend payment, too.

The Swiss Sunday newspaper Sonntag predicted in its Sunday edition that global banker Credit Suisse Group (CS-$57.00) faces write-downs in its commercial mortgage and leveraged-finance business.

Zacks senior service industry analyst Steve Biggs, CFA, restates his Hold rating on DST Systems (DST-$74.30), but adjusts the target price of the provider of information processing and software services to $78 a share.

eDiets.com Inc. (DIET-$5.11), which runs a Web site that provides weight-loss products and advice, on Friday said its chief financial officer resigned to take a similar position at a privately held company.

Stung by credit problems, First Horizon National (FHN-$17.48) has tempered its mortgage-business ambitions. But it may be a great time to buy the shares—as the Tennessee-based holding company for First Tennessee Bank—redirects resources to in-state and retail corporate banking, according to Barron’s columnist, Jack Willoughby.

After the bell on Monday, Genentech, Inc. (DNA-$71.50) reports earnings for its fourth-quarter ended in December. Analysts polled by Thomson Financial expect the biotech to report fourth-quarter profit of 67 cents per share on revenue of $2.97 billion. Look for an update on Avastin to move the stock price.

Despite the housing downturn, Hovnanian Enterprises (HOV-$5.90) maintains a positive outlook and sums this up to the cyclical nature of the homebuilding industry. CEO Ara Hovnanian opines that the “housing slump is nearing bottom.” Investors ought note, however, that management called for a recovery in the homebuilding industry —and a return to profitability—back in November, too.

Shares of IncrediMail Inc. (MAIL-$3.24) tumbled 29.1%, or $1.33 a share, in trading on Friday after Google Inc. cancelled the AdSense partnership with the company. In the after-market, shares of the Israel-based entertaining e-mail solutions provider declined an additional 13.2%, or 43 cents a share.

Pricing volatility increased in Logitech International S.A. (LOGI-$30.69) shares last week amid speculation that Microsoft might be preparing to acquire the Swiss-based computer peripherals maker. Anti-trust and strategic obstacles make for difficult bid prospects, a source familiar and several independent lawyers told FT/mergermarket.

After disappointing holiday sales, Macy's Incorporated (M-$21.31) says it will be eliminating 271 jobs in the northern Midwest. The department store chain will also discontinue most of its wine business in the region and shutter several food operations.

Merrill Lynch & Co Inc's (MER-$54.69) move to accelerate vesting on previously awarded stock-based pay to employees could add to the huge fourth-quarter loss already expected by analysts. On CNBC’s Fast Money Friday, On-Air Trading Editor Charlie Gasparino said total write-downs could be as high as $20 billion, too. The troubled financial services giant reports results Thursday before the bell.

Former Hollywood Video CEO Mark Wattles is unlikely to make a bid—as a white knight—for struggling Movie Gallery (MOVIQ-$0.03), according to sources.

The chief executive of Northwest Airlines (NWA-$15.81) sent an internal memo to employees on Friday saying his airline's board and management team would analyze any merger proposal carefully.

Mortgage lender NovaStar Financial Corp. (NFI-$2.92) on Friday cut 85 percent of its work force, according to a regulatory filing.

Barron’s columnist, Christopher Williams, writes all Real Estate Investment Trusts (REITs) aren't created equal, and investors willing to endure volatility can scoop up fundamentally sound companies selling cheaply. The best bargain in REIT landProLogis (PLD-$57.77), a Denver-based industrial REIT whose growing global business and diverse income stream could buffer it against any slowdown in the U.S. The stock price could rally to around 70 a share, according to Williams.

Quebecor World Inc. (IQW-$0.90) received a proposal for C$400 million ($393 million) in funding from its parent and Brookfield Asset Management to recapitalize the company and prevent default. Bond and equity analysts have suggested a sale of the distressed commercial printer would fetch no more than the than the value of the company's debt, estimated at a value of about $2.5 billion to $2.7 billion.

Among the flood of earnings being released this week, The Charles Schwab Corp. (SCHW-$22.55) reports results for the fourth quarter on Wednesday. Analysts polled by Thomson Financial expect a quarterly profit of 26 cents per share on revenue of $1.32billion for the financial services company, on average.

Citing strong petrochemical product demand, Zacks senior Chinese market analyst Paul Cheung, CFA, reiterates his bullish view on shares of Shanghai Petrochemical, or Sinopec (SHI-$55.24), rating the stock a Buy with a six-month target price of $65.00 a share.

After the bell, Sport Chalet, Inc. (SPCHA-$5.82) said it expects to record a loss in its fiscal 2008 third quarter, due to a challenging sales environment, particularly in its core Southern California market. The sporting goods retailer expects a loss in the range of $0.06 - $0.09 per share, on net sales of about $116.00 million.

The Steak n Shake Company (SNS-9.48) forecast a surprise first-quarter loss of 4 – 5 cents, hurt by lower sales, competition and unfavorable weather, and also withdrew its outlook for the full year.

Mad Money host Jim Cramer said when the Fed starts aggressively cutting, it won’t just be the financials that benefit. The industrials should come back, too. Cramer recommended Terex Corp. (TEX-$52.93), the third-largest construction and mining equipment maker in the world.

In the wake of mortgage lender Countrywide Financial’s sale, merger speculation is now centered on Washington Mutual Inc. (WM-$14.69), the largest U.S. savings and loan. Bank analyst Richard Bove of Punk Ziegel & Co said possible buyers for Washington Mutual could be Wells Fargo and Co and JPMorgan Chase & Co Inc.

Jim Cramer said his “absolute favorite gold stock” remains Yamana Gold (AUY-$16.40). Cramer welcomed AUY’s chairman & CEO, Peter Marrone, to his Mad Money cable show on CNBC Friday for an update. Marrone said that his company (i) produces gold at $250 to $270 per ounce and (ii) continues to expand its operations.
Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Friday, January 11, 2008

Arbitrage Play: Potential 42% Gains at Traffix, Inc.

According to the Efficient Market Theory Hypothesis (EMT), it is difficult—if not impossible—to outperform the market by consistently picking “undervalued” securities using fundamental analysis, for EMT postulates that the market price of securities always fully reflects all available information.

Additional EMT research suggests that the market reacts quickly and in an unbiased manner to the announcement of bid-related takeover deals (i.e. on average, EMT correctly assess the financial impact and implications of the news and adjusts its valuations bases and assumed probabilities in an unbiased method).

Behavioral economics has demonstrated time—and again—, however, that not all investors react rationally to similarly received information. Ergo, investors might process identical information dissimilarly, for some may expect a scuttled deal; whereas other investors, analyzing the same information, might predict a successful deal.

In the view of the 10Q Detective, securities arbitrage challenges the EMT framework, especially when price discrepancies arise from a corporate takeover announcement, where a price spread can arise between the market price of the stock being acquired and the actual buyout at the takeover price. The risk for the arbitrageur is that the deal collapsed prior to the merger date.

The 10Q Detective currently holds a
long position in shares of Traffix, Inc. (TRFX-$5.45), a premier interactive media company.

On September 27, 2007, New Motion, Inc. (NWMO-$14.00), a digital entertainment company providing a broad range of online and mobile content services announced that they had entered into a
definitive agreement to merge in a stock for stock merger with Traffix.

Under the merger agreement, New Motion will issue 11,917,520 shares of its common stock to Traffix’s stockholders. As a result of the Merger, each outstanding share of the Company’s common stock will be converted into the right to receive 0.683 of a share of NM common stock based on the Company’s capitalization as of September 24, 2007. In the aggregate, on a fully diluted basis, New Motion shareholders will retain approximately 55% of the shares of the combined company on a fully diluted basis, with Traffix’s shareholders receiving shares constituting approximately 45% of the shares of the combined company.

In a joint statement, the boards said: “the combined companies will have the resources to create a vertically integrated ‘Mobile Entertainment Network’ that can play a major role in the mobile industry.”

The combined entity seeks to expand upon and solidify an innovative business model New Motion has created over the past year. The model evolved in part as a byproduct of working very closely with Traffix as a commercial partner:
  • First, the merger will create a true mobile entertainment network that owns a wide range of digital content, exclusive premium billed mobile subscription services and wide online distribution.
  • Second, the combined entity will be well positioned to serve the growing trend where consumers access digital content online, want to interact with those same or associated services on their mobile device, and are willing and able to pay for the ability to do so.
  • Third, by owning a diverse online distribution network, the combined entity should be to lower its effective cost for acquiring mobile subscribers while creating a larger audience, which could then be further monetized with third party advertising.
  • Fourth, management(s) note that in a difficult credit environment, the new company will have at the time of closing a strong and healthy balance sheet that will enable the company to actively seek additional accretive acquisitions.

The transaction values Traffix’s share base upon New Motion’s Wednesday closing price of $14.00 at $9.56 a share, more than a 42% premium over Traffix’s closing price on Wednesday.

Graduates of courses in Finance and Investment Banking would surely be warned off from potentially investing in an arbitrage play with such an out-sized reward premium. Sometimes, however, it might be best to heed the words of Humorist Mark Twain (1835 – 1910): “I never let schooling interfere with my education.”

Subject to the customary regulatory clearance and shareholder approval, the plan is to consume the merger by the close of the first quarter of 2008.

Wednesday, January 09, 2008

2007 A Good Year for 10Q Detective Predictions


2007 was a good year for The 10Q Detective—even Force Protection finally came crashing back to earth.

HITS: 19 Wins

11-09-07. “Albeit several quarters of poor earnings visibility has already been discounted by investors in high-end homebuilder
Toll Brothers (TOL-$20.89), a further weakening of demand in key markets and the risk of additional inventory impairment charges reflect our view that new monies should continue to stay on the sidelines.” Current Price: $16.04

11-06-07. “The 10Q Detective brings to the attention of investors that a substantial portion of sales at fast-growing
Hansen Natural Corp. (HANS-$58.02) is derived from energy drinks, with more than 89 percent of its 1H:07 sales coming from energy drinks (up from 84.7% of net sales last year)…. Hansen’s management acknowledges that future growth will be even more dependent on the introductions of new energy drinks in the fast-growing, $3.2 billion a year energy-drink market. If the FDA steps in to “leash the beast,” the share price of Hansen Natural could be in for an unhealthy stumble.” Current Price: $42.77

10-24-07. The fact that the market valuation of
Millennium Cell (MCEL-$0.62) was composed of promises rather than actual product performance—or the attainment of previously specified timelines—illustrates why the share price has lost about 49 percent in value over the last 52-weeks….The 10Q Detective does not see any BUY catalysts on the event horizon. Current Price: $0.35

09-07-07. Back in September, the 10Q Detective warned its readers that
Tilman J. Fertitta, the Chairman and CEO of Landry’s Restaurants, Inc. (LNY-$28.12), was treating the restaurant and hospitality chain like “a personal fiefdom….[and] contrary to management’s expectations, the Golden Nugget casinos were not making up for slower organic growth from the restaurant business.” Current Price: $15.99

08-22-07. “Although the 10Q Detective agrees that
Advanced Environmental Recycling Technologies’ (AERT-$1.43) core competency is extracting value from turning recycled plastics into new products, management has yet to demonstrate that it can successfully launch a non-deck product. For example, the Company is behind schedule in launching its new outdoor fencing product (LifeCycle)…. Given the uncertainties as to when and at what pace existing business segments will recover, the 10Q Detective is avoiding purchase of AERT shares.” Current Price: $0.76

08-13-07. “In our view, although
Polo Ralph Lauren (RL-$81.71) is trading at a slight discount to other players in the space—a current P/E multiple of 22 times fiscal 2008 EPS and a TTM multiple of 24.97 times, respectively—we believe the stock price fairly values the expected earnings growth.” Current Price: $56.59

06-28-07. “We believe that investors should be concerned about
Brooke Corporation’s (BXXX-$14.75) business strategy, which remains dependent on growth via its acquisition strategy. However, this roll-up strategy is founded on some questionable lending practices and a balance sheet that appears inflated (given probable reserve deficiencies).” Current Price: $6.65

06-25-07. “Of equal—or greater concern—to the 10Q Detective, is the questionable accounting practices we have unearthed in our review of
iMergent, Inc.’s (IIG-$25.18) quarterly filings.” Current Price: $8.98

05-21-07. “Until the directors and executives start spending less time gazing in front of the store mirrors—and more time looking at how to turnaround this troubled retailer—there are no catalysts in play (such as a sale or spin-off of Barneys) to push
Jones Apparel Group’s (JNY-$28.57) share price back above the $30 level.” Current Price: $14.03

05-07-07. “The stock of
Reddy Ice Holdings, Inc.’s (FRZ-$30.07) is currently trading near 52-week highs, buoyed by investors attracted to Reddy Ice’s 5.5% dividend yield. However, we believe investors ought not ignore that the dividend payout is governed by strict agreements governing Reddy Ice’s debt—and the Company is highly leveraged, too.” Current Price: $21.81

04-25-07. “We have several concerns regarding the quality of
Books-A-Million (BAMM-$17.40) sales/earnings. In our view, growth is actually being driven by artificial and/or temporary sources.” Current Price: $10.05

04-19-07. “In my view, the FDA will not give the nod to ADVEXIN until
Introgen Therapeutics’ (INGN-$5.27) scientists (i) identify a set of prognostic indicators associated with high response rates and increased survival in prior Phase 2 clinical trials of Introgen's ADVEXIN therapy and (ii) design, enroll, and carry-out a NEW clinical trial of aforementioned cancer patients with the predictive biomarkers….Sadly, the empirical data presented—to date—suggests that the pocketbooks of Introgen insiders are doing better than the health of the patients in the Company’s cancer trials.” Current Price: $2.66

04-18-07. “The crux of this exercise is to demonstrate that real estate mogul Donald cares about Donald—not the shareholders of the casino holding company [
Trump Entertainment Resorts (TRMP-$17.10)] bearing his name.” Current Price: $3.55

04-07-07. “The 10Q Detective would prefer to see visible signs of a turnaround—like sustainable improvements in cash flow and margins—before committing monies to electronics retailer
Circuit City Stores, Inc. ($18.47).” Current Price: $4.30

03-28-07. The 10Q Detective sells short 500 shares of
USANA Health Sciences (USNA-$50.10). Current Price: $35.00

03-12-07. “Given the lack of share-net visibility, competitive forces in Asia [market share vs. margins], and the Kim family influence—if downturn lasts longer than anticipated, debtload [high leverage and restrictive loan covenants] could be problematic. In our view, risk-reward favors a cautious outlook on
Amkor Technology (AMKR-$12.02). Current Price: $7.14

03-02-07. “with slowing organic growth, investors might want to temper their expectations—given the coming cycle of lower margins, increasing financial leverage, and stated risks that go with the expansion into new markets….In our view, given the lackluster performance of new restaurants,
Red Robin Gourmet Burger (RRGB-$39.13) is “Mo-Cheese-than-Burger,” and its stock warrants no better than a Market Perform.” Current Price: $27.80

02-07-07. “Despite a lack of earnings’ visibility, as previously mentioned, the share price of
Toll Brothers ($34.43) is responding to an uncertain turnaround in the housing sector. For investors looking to buy Toll Brothers, we suggest a wait-and-see approach.” Current Price: $16.04

01-08-07. “the current valuation of
Fording Canadian Coal Trust (FDG-$19.95) is unjustified, and presents a compelling inflection point for purchase.” Current Price: $38.15

Misses: Two Losses

05-16-07. “Commercial roofer
Aduddell Industries (ADDL-$0.56) is implementing vertically integrated growth strategies that—if successful—should produce the catalysts necessary to drive organic and acquisition-based growth.” Current Price: $0.09

07-20-07. “
Flamel Technologies S.A. (FLML-$21.72) is a drug delivery company with expertise in polymer chemistry. In our view, recent price weakness is temporary, and affords investors an inflective buying point.” Current Price: $9.40

Sunday, January 06, 2008

Trading Alerts: Monday, January 7, 2007


Alcoa Inc. (AA-$34.87) kicks off the fourth-quarter earnings season for blue-chip companies this week. Impacted by falling metal prices and the weak dollar, the aluminum giant likely won't provide a banner kickoff to the season when it reports on Wednesday. Deutsche Bank this past week lowered its earnings forecast for Alcoa's fourth quarter to 30 cents a share from 76 cents a share.

Amgen (AMGN-$44.80) will present at the 26th annual JP Morgan Healthcare Conference on Tuesday. Given the FDA’s
vocal concerns on studies which found patients with breast or advanced cervical cancer who were treated with anemia medicines died sooner, or had more rapid tumor growth, than similar patients who were not given the drugs, investors will be looking for commentary from management on the future of its anti-anemia drug franchise—Aranesp, Epogen and Procrit (marketed by Ortho Biotech, a Johnson & Johnson unit, under a license agreement).

Officials at Bear Stearns (BSC-78.87) are expected to meet in the middle of January with U.S. prosecutors to discuss the collapse of two of its hedge funds, as first reported by
CNBC.

Celgene Corp. (CELG-$49.65), best known for its cancer treatments Thalomid (thalidomide) and Revlimid, will present fourth quarter and FY 2008 guidance during
a presentation at the JP Morgan Healthcare Conference on Monday, January 7, 2008 at 11:30 am EST. Analysts polled by Thomson Financial are expecting the drugmaker to report quarterly share-net of 31 cents on revenue of $381.91 million. Investors will be listening for updates on its anti-inflammatory pipeline and the ongoing Pharmion merger, too. Pharmion's buyout will add blood cancer treatment Vidaza, the first drug approved by the FDA for treatment of myelodysplastic syndromes, to Celgene's product offerings.

Diversified global growth prospects remain favorable for Cisco Systems (CSCO-$26.12), and the quantitative model employed by the
Forbes Growth Investor suggests that it is a good time to buy shares in the leading global provider of Internet Protocol (IP) network solutions.

The stock of Citigroup (C-$28.25) endured one of its worst annual performances on record last year and was the worst performing Dow component in 2007. Its shares finished the year down 47 percent. Some analysts, however, argue that the financial services giant is at an
attractive price right now for long-term investors - given the company's earnings potential and its global presence at a time when overseas economies are enjoying robust growth.

Constellation Brands, Inc. (STZ-$22.78), will report financial results for its fiscal third quarter ended Nov. 30, 2007, on Tuesday, before the open of U.S. markets. The imported beer, wine, and spirits distributor has about 250 brands in its portfolio, including Corona Extra and St. Pauli Girl, Clos du Bois, Robert Mondavi and Ravenswood wines, and Black Velvet Canadian Whisky.
The Company will fall shy of the average analysts’ estimate of 55 cents a share, predicts Banc of America Securities analyst Bryan Spillane in a client note. Investors will be watching cash flow trends, too, for STZ’s leverage has increased due to successive debt-financed acquisitions and stock repurchases. Albeit, the company currently maintains adequate liquidity and access to the capital markets, required debt repayment over the next five years is expected to be well beyond STZ's cash-generating capabilities, according to Fitch Ratings service.

Zacks senior transportation industry analyst Ann H. Heffron, CFA is restating her
HOLD rating on CSX Corp. ($40.73). Heffron expects improved productivity and strong yields to offset weakening volumes from a slowing domestic economy, and is maintaining her $45 a share target price on the railroad company.

As cheap as Darden Restaurants (DRI-$25.59), whose brands include Red Lobster, Olive Garden, Bahama Breeze, Seasons 52, The Capital Grille and Longhorn Steakhouse chains, may look to some on the Street, it’s only going to get cheaper, said Jim Cramer on his Friday “Mad Money” show on CNBC. “The stock of the casual diner operator should continue its
downward tumble – even more than the 11-point drop since its December second-quarter earnings miss – thanks to sky-high corn prices, a business levered to a lagging U.S. economy and failed brand concepts like Bahama Breeze and Smokey Bones.” [Ed. note. Sun Capital Partners Inc. announced Thursday one of its affiliate companies closed on the acquisition of the Smokey Bones Barbeque & Grill chain.]

deCODE genetics (DCGN-$3.51) reported on Sunday that the
genetic variant on chromosome 9p21 that the company has linked to increased risk of heart attack is also associated with up to 70% increase in risk of abdominal aortic aneurysm and intracranial aneurysm.

Although many in the airline trade believe the stars have aligned for mainline consolidation to occur, industry sources tell
dealReporter that a tie-up of Delta Air Lines (DAL-$13.37) and United Airlines (UAUA-$33.15) may not be realized despite discussions between the carriers.

Home Solutions of America, Inc. (HSOA-$0.95) said late Friday it has withdrawn its appeal to remain listed on the Nasdaq National Market. As a result, its common stock would be
delisted from Nasdaq, effective Monday. The provider of restoration and construction services expects its shares will be eligible for quotation on the Pink Sheets Electronic Quotation System.

Immucor, Inc. (BLUD-$33.68), a global leader in providing automated instrument-reagent systems to the blood transfusion industry, will announce its second quarter earnings on Monday, January 7, 2008, after the close of regular trading hours. Analysts surveyed by Thomson Financial forecast earnings of $0.24 a share, on $61.5 million in revenue. Given a history of conservative corporate guidance, Piper Jaffray
believes the diagnostic testing provider remains a "beat-and-raise" story.

On Friday, chip giant Intel Corp. (INTC-$22.67) suffered another
downgrade, this time from JP Morgan analyst Christopher Danely, who said high inventory levels and soft demand could weigh on the chip-maker in the near-term. Analyst Danely downgraded the stock from "Overweight" to "Neutral."

KB Homes (KBH-$18.67) releases its quarterly earnings report on Tuesday, which could offer further insight into whether the housing market is near its bottom or has much further to fall. In an industry still struggling with excess capacity, the homebuilder is expected to post a loss of $1.08 per share, on average. Nonetheless,
Morningstar believes KB Home's recent strategy of selling noncore assets and using the proceeds to pay down debt should ensure that the company survives the current downturn.

U.S. video game industry
sales growth is expected to slow in 2008 as accelerated demand for software is tempered by a decline in hardware revenue, the Consumer Electronics Association said on Saturday. Video game console makers include software giant Microsoft (MSFT-$34.38), manufacturer of the Xbox 360, and its rivals Nintendo (NTDOF-$578.00) and Sony (SNE-$52.42), console makers of Wii and PlayStation 3, respectively.

Motorola Inc. (MOT-$15.07) said late Friday that it laid of an additional 1,600 employees during the fourth quarter in a company-wide restructuring effort. In a
filing with the Securities and Exchange Commission, the wireless device maker said it would take a pre-tax charge of about $90 million in the fourth quarter related to the layoffs.

Despite continuing problems in the housing market, Standard & Poor thinks online real-estate company Move (MOVE-$2.26) will outperform the S&P 500 in 2008: “We expect real-estate advertisers to spend more of their advertising/marketing budgets online, and expect Move to benefit. We like the recent additions to the management team, new priorities and investment discipline, and greater focus on delivering shareholder value. Move also has what we consider a strong balance sheet. We remind readers that this stock isn't for the faint of heart.”

MRV Communications’ (MRVC-$2.11) plan to take its optical-equipment business Source Photonics Inc. public should
unlock the network equipment company's "tremendous value," says Leo Saraceno, director of North American equities at Sun Life Financial, in a January 6 interview with Barron’s.

Shares in NeuStar (NSR-$28.33), which delivers critical
clearinghouse services to more than 7,300 communications service providers in North America and Europe, have dropped more than 20% since mid-October and ended down 11% for 2007. However, according to the quantitative model employed by the Forbes Growth Investor, the stock is due for a rebound.

Mortgage and vehicle fleet company PHH Corp. (PHH-$15.98) said late Friday it received a $50 million
reverse termination fee from Blackstone Capital Partners, a private equity fund affiliated with the Blackstone Group, in connection with the termination of the merger agreement between PHH and General Electric Capital Corp.

ProLogis (PLD-57.18), an owner, operator and developer of warehouse and distribution centers, could see
its share price climb more than 20 percent in the next year if the global economy remains stable, according to the January 6 edition of Barron's.

Realty Income Corporation (O-$22.65), which engages in the acquisition and ownership of commercial retail real estate properties in the United States, lost 16.2% in value last week on investor fears that the REIT’s largest tenant, family-style dining chain Buffets Inc., is on the brink of bankruptcy, which could affect leases already in place. In a research note, however,
Cantor Fitzgerald said Buffet's financial troubles are old news. The financial services firm said if Buffet's filed Chapter 11, a majority of the Realty Income leases with Buffet's would be affirmed, and continue to pay rent.

Schnitzer Steel Industries, Inc. (SCHN-$63.65), a metals recycler and auto parts and specialty steel products manufacturer, will release first quarter 2008 earnings before the market opens on Monday. Management’s outlook for the 1Q:08—despite the seasonal weakness of its 1Q—is that “it will be significantly better than in prior years, even if it might not be as strong as the second half of 2007.” Analysts surveyed by Thomson Financial forecast earnings of $0.99 a share, on average.

Computer manufacturer and seller Systemax Inc. (SYX-$18.00) said Sunday it has agreed to
take over as many as 16 CompUSA stores from the recently sold electronics retailer.

It's contract-renewal time for companies with oil-rig drillers for hire. But Houston's Transocean (RIG-$142.46), which focuses on deepwater and harsh-environment services, has already secured contracts to 2010. Earnings could jump from $8.32 a share in 2007 to $14.14 this year and to $19.74 by 2010, says Kurt Hallead of RBC Capital Markets. He says the stock is undervalued based on its historical price-earnings ratio of 18. His 12-month target: 163. "No other driller has the same backlog," he says.
Transocean will pay down $5.5 billion in debt by yearend. Robert MacKenzie of Friedman, Billings, Ramsey notes that management has been less aggressive than competitors in asking for higher rates and has room to hike prices. He sees the stock at 172 in 12 months, according to “Inside Wall Street” (BusinessWeek).

Does the prospect of a restructuring loom in 2008 for Internet infrastructure and online security provider VeriSign (VRSN-$35.82)? Standard & Poor expects the Domain Name System (DNS) gatekeeper (servers that support the .com and .net top-level domains) to exit the content delivery network business, and sell its peer-to-peer-focused operations to a strategic buyer looking to diversify its offerings and gain market share.
Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Friday, January 04, 2008

Stop Following the Sheep -- Time to Buy NorthStar Realty Finance?



Recent market uncertainty in REITs affords income-seeking investors willing to tolerate above-average risk the opportunity to buy quality at depressed prices with attractive investment yields.

The 10Q Detective believes that an argument can be made for the purchase of shares in NorthStar Realty Finance (NRF-$8.51), a specialty finance company comprised of a
seasoned executive team of real estate executives that internally manage commercial real estate projects, with a focus primarily on originating and acquiring real estate debt, real estate securities, and net lease (corporate and health-care-related) properties.

“Groupthink [is] mode of thinking that people engage in when they are deeply involved in a cohesive in-group, when the members' strivings for unanimity override their motivation to realistically appraise alternative courses of action.” ~ Yale University Psychologist
Irving L. Janis (1918 – 1990)

Shares have sold off 48.9% from their 52-week high (of $18.15 a share on February 7, 2007). In our view, the stock is oversold—groupthink—as investor sentiment has failed to differentiate specialty finance companies—like NorthStar—that offer more sustainable business models and generally employ less leverage than other commercial mortgage REITs.

Even as U.S. commercial real estate values continue to soften, NorthStar’s credit portfolio qualities remain strong. As of November 2007, NorthStar experienced no delinquencies or non-performing assets.

NorthStar's real estate securities third quarter investments had a weighted average credit rating of A+/A1.

Management’s
competitive advantage has been its focus on a diversified $7.5 billion commercial asset base, avoiding direct exposure to single family housing or subprime residential lending. As such, NorthStar has dodged the fixed income/equity market volatility and asset impairment charges plaguing many of its REIT peers.

NorthStar’s above-average dividend yield of 16.8% reflects the re-pricing of owning a REIT (or any security invested in debt and equity securities). Albeit we believe the uncertainty regarding loss rates is fully priced in NorthStar’s current valuation, investors ought to be cognizant that the dividend could come under pressure if operating earnings fall because of (i) a softening in commercial real-estate activity/values, (ii) slower loan originations in the current capital constrained mentality, and (iii) increases in cost of funds (due to lenders tightening their credit standards)—offset, in our view, from lessening competition for new investments (due to the insolvency of more-levered companies).

Adjusted funds from operations in FY ’08 (of $1.69 a share) are forecasted to be more than adequate to cover payout demands of $1.44 per share.

The race of man, while sheep in credulity, are wolves for conformity. ~ Academic Carl Clinton Van Doren (1885 – 1950)

NorthStar is selling for only 0.87 times adjusted book value of $9.75 a share, a
33.1% discount to other similarly focused specialty finance REITs.

While continued credit disruptions and future investment banking (and home-builder) asset impairment charges will delay a rebound in REIT valuations, we believe new investors to NorthStar are offered a current dividend payout commensurate with the requisite risk/time premium to wait out this cyclical downturn.

When investors—and the Fed—gain better visibility on a stronger outlook for the credit markets and the U.S. economy, we believe NorthStar shareholders could be rewarded with a price-to-book value multiple expansion to 1.5 times, or about $15.00 per share.

Editor David J. Phillips owns shares in NorthStar Realty Finance. The 10Q Detective has a Full Disclosure Policy.