Observations from TECD- All is well in Tech land?

TECD had fairly positive commentary on overall tech spending especially in North America from SMBs. Question remains if the strength continues as oil prices move back up, dollar continues to devalue and if interest rates pick up.

TECD sales grew 8.6% Y/Y and 4.2% sequentially, with steady growth in most markets especially in the SMB market in North America. Company also raised guidance for next quarter. Growth in the Americas was little softer than in Europe as this was a seasonally strong quarter for Europe. The end of fiscal year for US Government helped in Septembe. Strength from Government continued into October, which should benefit most tech companies who do not necessarily look for the continued strength from US Government in October. Gross margins were down a bit due to pricing pressure. Price competition is still intense in Europe as well as in America. Inventory balance grew a little but mgmt didn’t seem concerned about it. TECD seeing strength in: mobile computing (INTC, HPQ, maybe RIMM), IP telephony (AV, CSCO) is very strong, security appliances (CHKP, JNPR, SNWL, WGRD) storage (QLGC, NTAP), software licensing, and Plasma monitors(GNSS, PXLW). There was some weakness in desktop computers which is little strange given what DELL had said. But might point to that the SMB market is spending on notebooks where as larger corporations are working on upgrading desktops? But TECD did mention that they are seeing corporations upgrading both notebooks and desktops in Europe due to favorable exchange rate. Another example of why the Bush administration likes to keep its hands off of the falling dollar.

Why Eddie Lampert should talk to Carly Fiorina

Most tech investors remember the HP & Compaq merger, which was announced in September 2001. The recently announced KMRT and S merger have some similarities and differences with the HP/Compaq merger. I believe HPQ and DELL rivalry is similar to KMRT/S and WMT rivalry. DELL (just like WMT) at the basic level is nothing more than a very efficient supply-chain which both HPQ and KMRT/S are striving to become. WMT and DELL both have tremendous buying power and technology prowess to adapt to changing needs of consumers. DELL even has the ability to price items real-time depending on various factors such as demand for certain features/models and supply of components. Like DELL gained market share after HP/Compaq deal was announced WMT has the ability to gain on any missteps by KMRT/S.

The HP/Compaq was a stock-swap deal worth about $25 Billion when announced versus the $11Billion price tag for this merger. The HPQ deal was suppose to change the PC industry, unfortunately if you bought into that spin you have been on the shorter end of the stick. Since the deal was announced HPQ has gained 10.9%, DELL has outperformed that performance 7 times over with gains of 79.6% and even the Nasdaq has gained 18.5%. The two companies had high degree of customer and product overlap. DELL gained market share while HPQ was too busy in integration (wholesale head count reduction), streamlining product lines, supply-chain management and customer transitions. Compaq jewels’ like high-end servers and storage systems which had a commanding market lead were left in the dirt of integration shuffle. HPQ wanted to take on IBM and other companies which were offering everything from servers, storage, services and even software.

HPQ was inheriting a complex and diverse product lines in addition to the services effort at both firms were in their infancy which made achieving even mediocre success a stretch. Very similar to what the KMRT/S will be dealing with new apparel efforts at KMRT and general branding/positioning overall for combined entity. HPQ wanted to be everything to everyone and did not "reinvent" itself fast enough to compete with the super efficient, marketing machine powered by DELL. Like KMRT, HPQ worked on improving its free cash flow by selling off business, cutting back on inventory and capital expenditure. Eddie Lampert is using the KMRT real-estate to generate cash and looking to invest that cash in other companies such as S. That would be fine if you were an investor in Eddies' ESL Investment Fund which gets to buy growth and more free cash flow by this cash. But when you invest in KMRT or S stock you hope you are buying an operating company for its ability to grow profitably and generate cash not for asset liquidation.

HPQ and KMRT both suffered from revenue growth as KMRT saw same store sales drop by 13% in the most recent quarter. KMRT executives say they are less interested in increasing sales than improving profits. Falling same-store sales reflect on where the consumers are spending their dollars and it is not at KMRT. This is an unsustainable trend in the long-run since WMT just like DELL can grow sales and do it profitably. Similar to Compaq and HP prior to their merger, both KMRT and S have conflicting customer demographics and target markets in everything from apparel, appliances, tools, grocery. KMRT plans to let the "market place decide" what merchandise customers want in which store, something that WMT already knows very well thanks to its state-of-the-art IT systems. Shuffling inventory in 2400+ stores is no easy task which could affect the generous free cash flow generation and profitability of the merged entity.

Some of the differences between the HP/Compaq deal and the KMRT/S deals are that KMRT stock carries a rich valuation which makes it a good currency to buy others with such as S. KMRT generates enough free cash flow that the merger disturbance might not matter immediately. Another difference in KMRT & S deal is that S shareholders were at least given a 11% premium where as the Compaq shareholders did not receive much of a premium at the time of announcement by HPQ. But S will have to pay a hefty $400M in "Break-up fee" if it decides to end this merger.

Is the KMRT/S merger another in a long list of "merger of losers" or can putting together two struggling retailers create enough synergies and cost savings to make them into a good retailer? Only time will tell. But history does have a tendency to repeat itself.

P.S: I do not profess to have much retail industry knowledge.
Eddie Lampert is the Chairman of Kmart Holdings, Carly Fiorina is the Chairman & CEO of HPQ.

Observations from MRVL

MRVL, one of the darling semiconductor companies, reported earnings after the close today and for the most part it was not all that bad. Some important data: revenues grew 7% sequentially but the EPS was a penny better due to higher gross margin and lower R&D expense. The growth is pretty nice given the tough demand and pricing in the markets MRVL supplies. Management had guided to 7% growth so results were at par with guidance. But closer look (DSO went up to 55 days from 49- DSO's Explained ) does show that management had to push hard towards the end of the quarter to make that number, which they acknowledged was the case in the consumer market and had guided to last quarter. The company kept a tight lid on expenses with operating margin growing to 22.7%, on gross margins of 52.7% which is no small task given all the pricing pressure in tech especially in consumer markets like WLAN chips. Days of inventory increased as well since inventory balance grew faster than sales and most probably inventory will again grow in next quarter. Guidance for next quarter was for 5%-7% sequential growth which might fall short of some of the estimates on the street and gross margin guidance is also for slight decrease (pricing pressure continues).

MRVL saw nice pickup in disk drive units especially from consumer related devices such as iPod, which continues to point to very strong AAPL quarter coming up. Gigabit ethernet transition has been concentrated at high-end and sophisticated enterprise systems for now and MRVL sees no change yet which means the installed switches from CSCO, FDRY, NT, EXTR are not yet getting ripped out to be replaced in broad fashion yet, but the trend is improving. Mass adoption of gigabit ethernet to the dektop combined with VoIP to the desktop are the two main drivers of network upgrades currently and the rate of adoption for these two technologies is very important for the health of the networking industy. MRVL acknowledged that the inventory issue still existed in the networking components but hopefully will be resolved by end of Q4.

For most part MRVL didn't paint a dire end market picture- could it be because they are at high-end in most of their markets? MRVL has always been at the cutting edge of technology and innovation which has led it to gain market share in almost all markets MRVL participates in and for it has enjoyed a premium valuation. The revenue growth has been driven by past investment in R&D, making current investment very important for future. This could hinder maintaining the high operating margins. Premium valuation depends on both high growth and operating margin, and general view is that one has to give sooner or later especially as company moves more into consumer market. But their focus on high-end highly integrated solutions has allowed MRVL to keep delivering on both uptil now and hopefully in the future as well.

CRM changing the tech landscape

CRM's on-demand model continues to gain traction and is becoming more mainstream. Revenues grew 82% from last year, and 14% from last quarter, that kind of profitable growth is tough to come by these days. Company is on a path to end vertically focused applications which would mean that smaller niche CRM providers are in trouble. CRM is also changing the software model and in their opinon ending software as we know it today. This means applications getting pushed to consumers/enterprises will be the future. CRM model threatens the enterprise software industry as we know it today. Seems like we are heading back to the thin-client computing. So where does this leave INTC and AMD who want to make our desktops more powerful? I certainly don't have a clear answer but one thing is clear about CRM: its not your daddy's SEBL. One thing to worry about in the near-term is the lock-up from IPO expires on December 19th and 4-5x the current float will be free to trade on December 20th. I am not suggesting all who get the shares will sell on that day but its certainly creates a lot of overhang especially given relatively rich valuation.

The "strong Dollar policy" explained

I have talked about affects of the weakening Dollar on the macro economy few times before. Today I was reminded of why we call it the "Strong Dollar Policy" even though the Dollar continues to weaken. HPQ on its conference call commented that the weaker dollar will help it generate $500M extra next year. Now with $500M extra at the top line and 7% operating margin that translates to $35M extra of operating income and about $7M extra in tax income to Uncle Sam. Imagine the same scenario being played out for almost all big companies and you can understand why they call it a "Strong Dollar policy". Its the policy of Strongly driving dollars to top line of U.S. companies.

Observations from HPQ

HPQ revenues grew 4% year over year(after adjusting for weaker dollar) nothing to be too happy about but given the low valuation, its not that bad for HPQ. Strong storage and server quarter with nice turn around from last quarter leading to largest number of INTC based servers shipped during a quarter. Might have shipped bit too many inkjet printers into the channel in October due to new product launches, but how they move out of the channel remains to be seen. The big trouble this quarter was HP Financial Services which saw profitability drop due to increased reserves for aged recievables, which in normal speak would mean that they lent money to people they don't expect to collect from now. Enterprise spending continues to track higher while consumers have softened, similar to what DELL was saying as it drove higher than usual discounts towards the end of the quarter due to soft demand. According to HPQ, consumer spending has started OK but nothing spectacular. Notebooks have softened little bit whereas desktop has improved. HPQ will drive higher discounts in Printers in 2005 to win market share for future growh of its highly-profitable printer-supplies business, not really a good thing for LXK, Cannon, Epson, DELL or, XRX who compete with HPQ in the printers. I would expect many of the PC related semiconductor companies such as INTC, AMD, IDTI, TXN, ICST, FCS, IRF to trade up due to better than expected trends right now, the end demand in consumers still leaves fair amount of uncertainty though.

"Fatally Flawed"

I have never understood the economics behind NFLX and how it could survive. I had never owned NFLX shares for this reason, nor was I ever short because timing it is tough. But now some on the sell-side are finally singing to the same tune. Check it out at CBS MarketWatch.

Did someone say Inflation?

PPI index reported this morning had the biggest gain in nearly 15 years. When producers pay more for raw materials, they usually pass those price increases to the consumers which leads to inflation. Core PPI which exlcludes food and energy was also stronger than expected. So its not just oil that is causing the PPI gains. The weakening dollar certainly does not help this situation and if the economy is really picking up steam and employment picture improves the inflation hawks will be out in force.

Shareholder value

AMCC announced last night that it will let go of about 20% of its workforce, which is about 150 people. This move will save the company about $6-$8M/quarter by March 2005. Sounds nice at surface, where the management is taking the right steps to bring company to profitability. But this is the company that in last few years had decided to buy into storage and embedded processor markets. Wasn't any one thinking about profitability then? AMCC and many other Comm IC companies have seen their core transport market decline and have been "buying growth" and usually buying growth ends with "restructuring". Usually what gets restructured is part of old business that has not picked up and some of the new "growth". So why doesn't management just avoid all the banking fees, severance pays and the hoopla with "buying growth" by gracefully exiting or pairing-down exposure to the old markets? I am still trying to figure this one out, but most of you get my drift. Returning shareholder equity to the shareholders is not always the most advantageous for management which only owns 1% of the equity.

What now?

The recent run up in stocks driven by lower oil prices, big money inflow into mutual funds, possibility of Social Security reform and certainty about the Presidency has me thinking "What now?" I am not the one to fight the trend but I do like to think about what could go wrong in this bullish run up: the biggest worry remains the pace of the economic growth. With rising interest rates, commodities index being at a 20yr high, lower dollar value, and no real trend of improving employment picture it's really tough for me to be overly bullish.

However, I do think that there is improving trends at the margin especially after listening to DELL and CDWC last week. But there was plenty of not so rosy commentary from CSCO and A. Also, I believe that the SOX index which usually is a good leading indicator has not been very convincing except for AMD (I believe INTC is strong due to the large weighting in Nasdaq). We get a good mix of earnings this week and guaging what companies like WMT, HD, HPQ, NTAP, AMAT, INTU, ADSK, MRVL, MCDTA have to say will be important in determining how we position ourselves into the final month of the Year, which usually is seasonally strong. Unless the commentary this week is pessimistic (which I doubt), I believe the markets will continue the uptrend with the usual healthy small retracements.

I apologize for not being able to post for past few days.

Thinking Alike- Part Deux

AMD was upgraded by Merrill after Lehman upgraded yesterday. Merrill upgraded to Buy from Neutral, due to expanding profit margin and market share gains against INTC. They believe the product roadmap for INTC looks troubled. Same stuff we talked about previously. I like it when the hits keep on coming.

Lower Christmas spending ?

The "Cost of Christmas" survey in England estimates that consumers spending on Christmas will be the lowest in 5 years. This is due to lower consumer confidence, five interest rate hikes and slumping housing market across the pond. The survey could give us some sense of what consumers might do in the U.S given eerily similar scenario playing out in the U.S. However, there are plenty of differences in the U.S. economy versus the U.K. Our job is to watch trends to get a sense of direction.

Thinking alike

I don't really like to talk about stock upgrades and downgrades but there are two moves this morning that are noteworthy because we talked about these in the past. AMD is getting upgraded by Lehman since they believe that AMD will see improving margins due to manufacturing effeciencies and share gains. Stock has moved up in last few weeks. But like I said few days back, I believe AMD is a better play then INTC. Lehman did say that INTC guidance of 1-9% may prove conservative. I would think so since historic average is up 8% in Q4 and if you give yourself enough upside potential then there is a good chance of a upside, no? I am still worried about margins and enginnering missteps.

Second downgrade of my liking this morning is downgrade of Semi Cap Equipment industry by Morgan Stanley to Cautious from In-Line. Like I have said before, the Semi Cap Equipment industry has too much capacity, very little to no pricing leverage, shrinking customer base and capital efficiency is not there any more for Semiconductor manufacturers. These are more of a long-term issues then quarter to quarter issues, but these issues could drive the group multiples lower than past downturns.

Nothing pretty about Cisco

There wasn't any thing pretty about CSCO earning report. Lets begin with what went wrong (with usual amount of paranoia-no pun intended) :

1)Gross margins declined because a) they shipped more new switches which aren't being produced as profitably as before b) they didn't ship enough GSR routers because JNPR keeps winning at carriers like VZ c) Linksys product shipments increased because we are moving into the holiday season and those have less than half of the overall gross margins.

2) Orders were down and book to bill was below 1, did you hear that - they said "below 1" not slightly below. After nice order pickup last quarter, what happend? No explanation except that it was a seasonally slow quarter. Both router and switch orders declined- isn't that their bread and butter?

3) Didn't see any big budget flush from Government and do not expect any year-end budget flush from carriers or enterprise customers.

4) Chinese are coming! oh really? Huawei made Cisco play on the pricing field and Cisco lost with revenues from China down and hurting on the gross margin level as well.

5) Inventories were flat after being up for last 3 quarters, flat is not good since most people expected a decline. This is not really good for Communication IC guys like BRCM, PMCS, CY, IDTI, MRVL

6) Cash declined because they bought more stock than they ever have in one quarter, and on top of that they convinced the BoD to authorize another $10B to buy more stock. Now does this mean they can not fine enough companies to buy to drive the next leg of growth or they think they can buy this stock and lower shares outstanding therefore showing EPS growth even if the top line doesn't grow? Nice trick if you have the cash to play it.

7) They think the revenues will grow 1-3% in January quarter, below what most people had been expecting and that is before we get into April which is also a slow quarter- so that means basically very little growth for next six months.

Now to what went right at Cisco:

1) Linearity improved into last weeks of quarter.

2) Think about L4-L7 as the next growth area, good for PKTR, FFIV and RDWR which are already there. (that's really not a positive - is it?)

3) I am looking for more!

Tuesday November 9,2004

Dow and S&P 500 closed in red where as Nasdaq held onto some gains, that makes it seven days in a row that Nasdaq has had a gain. Broader markets however had positive breadth. Check out the difference in the return on the Dow and the Russell 1000 (up 8.4%) or Russell 2000 (up 11.9%) for this year. There is more to the markets than just the Dow. Dow this year has been battered by various components being under scrutiny of one sort or another- like MRK. The Morgan Stanley Healthcare Payor index rose 3.2% on news of ATH and WLP merger allowed to proceed by California . The Housing Index also closed up 1.3% at a 52-week high drive by gains in BZH and USG. Ivory Coast, the largest producer of cocoa, shut down cocoa exports due to unrest inside the country. The unrest caused cocoa futures to climbed sharply Monday, rising more than 10%. This could mean higher costs for HSY and other chocolate dependants. Crude oil closed down to $47.21. Dollar gained some ground against the Euro and the Yen, but gold continues its upward march. Expect the Fed to raise interest rate by 25bp tommorrow. Of note was L increasing its stake in NWS , two media moguls at there best. MSFT decided to enter the cable set-top-box business in collaboration with CMCSA, which means the largest cable operator has no plans to work with TIVO- how does this company make money?

Managed care upside

According to SacBee the California Insurance Commissioner John Garamendi is supposedly thinking of backing down from his previous stance of not allowing ATH WLP merger to go thru. As highlighted last week, I believe managed health care stocks have more upside given less uncertainty from Washington and this merger certainly will help fuel other deals, such as CVH FHCC announcement. The stocks mentioned last week were ATH, AET and PHS all of which are up over 5% in 3 days.

CDWC monthly sales positive for tech spending

CDWC reported monthly sales for October of $498M , which is above expectations. The sales grew 11.2% over last year and were down 5.4% from September. It could mean two things: either CDWC is gaining share from IM especially in large corporate sector or that the overall IT spending is improving into year-end. I would lean towards the latter. Both IM and CDWC are large channels for CSCO products, which could mean that the month of October was better than expected for CSCO. This uptrend in October could make management have a slightly positive tone. CDWC press release also stated that both SMB and public sector sales posted solid growth in October. Which means government spending did not fall of the cliff after government's fiscal year end in September, another positive. Its important not to take this one data-point out of context, but bias could be turning positive.

Monday Nov 8, 2004

Broader markets closed slightly in red as talk of rise in interest rate came back into the picture but both the Dow and Nasdaq etched out a gain. Dow was helped by MRK, BA and JNJ. In technology the Internet names, Semiconductors and EMS companies (upgraded by Smith Barney) ended the day in green column. Merrill Lynch downgraded the Internet sector and upgraded Software. S&P retail index also saw some gains. NYSE composite had a positive ratio of advancers to decliners. Crude price decline to below $49 and helped drive energy stocks down and gold stocks were red as well, but gold reached a 16yr-high.

After market today, ARXX reported revenues and earnings below expectations and management guidance, which was thought of as being conservative. Miss was attributed to lower semiconductor testing equipment shippings, another indication that the inventory burn-off is not progressing well. Company also guided lower for Decemeber.

Expect market to remain in trading range with CSCO reporting after market tomorrow and Fed meeting on Wednesday. Market sentiment on CSCO report is fairly neutral to negative, any indication of somewhat positive tone could be helpful in moving the market higher.

JAMDAT fizzles in first inning

JMDT reported earnings for third quarter after market today. The company reported results that were below analyst expectations (one analyst) which is certainly not a great way to come public. Risk of lower gross margins came to fruition combined with higher operating expenses resulted in operating margin dropping 300 basis points. Gross margins dropped due to higher percent of revenue coming from licensed brands. Licensor payments increased which is due to more licensed games being downloaded, which is troubling given large internal engineering capability. The risk of JMDT being a one-hit wonder with Bowling is coming to head sooner than expected. The licensed game gross profit contribution dropped signifcantly indicating that there is less than anticipated pricing leverage in company's control and competitive landscape is very cut throat. .

JMDT is now in 83 wireless carriers, in 39 countries with over 90 applications. But with all that said the company announced that only just over 20% of handsets in the U.S. are capable of downloading JAMDAT applications. Company also announced that they have just started in Europe and Asia which means don't look for too much absolute revenue from either of those markets any time soon. Company expects that almost all handsets will be capable of downloading games by 2007. Can you imagine the competitive landscape by 2007 for gaming applications? That is without considering gizmos like the PSP. Expect R&D expenses to increase as the company tries to come up with another hit like Bowling since only 20% of revenues contribute 80% of revenues.

JMDT provided guidance of 11.5% sequential revenue growth to $10.6M, where as street was looking for $12.5M revenue another disappointment. With shares already trading at very rich P/E, the lower guidance implying lower growth trajectory will certainly result in lowered estimates as well as the multiple placed on those estimates.

Few things that were clear from JMDT discussion were that gaming is no where close to being as proliferated as ring-tones and companies providing the capabilities to do mobile gaming such as QCOM providing the BREW platform are the ones making the real money right now (even though its a very small portion of their total revenues).

Airlines choking to death

Forbes.com story highlights ten reasons why the airline industry in its present form will not survive. I am not inclined to be long airlines stocks that are moving higher due to lower crude prices, unless the economic model is changed lower crude pricing alone can not save the airlines. It basically boils down to economics of having too much capacity in the industry. Blaming high oil prices or terrorism is not the solution, the current model does not work and bankruptcy driven reorganization is the best option. The reorg of airline industry is certainly bad for airline manufacturers and their suppliers, travel agents, internet travel sites, airlines labor force. The beneficiaries will be smaller more economical airlines, web conferencing providers, and fractional jet ownership.

JAMDAT Mobile in Wall Street Journal

The Wall Street Journal has a small piece on JMDT which is more focused on cell phones and how they are becoming the "next platform". I wrote little bit more indepth about JMDT yesterday.

Programming Note: CNBC Wednesday Nov 10

I do not do advertisement for network TV but CNBC will run a report on WalMart on Wednesday Nov 10 at 7PM ET. I think it is crucial to understand WMT since the decisions and direction of WalMart have very far reaching consequences. WalMart is the largest non-governmental employer in the U.S. which can affect everything from health insurance providers to unionized competitors like ABS and SWY. Its purchasing power affects not only U.S. powerhouses like PG or K but entire nations like China and Taiwan. Its IT budget is far greater than any one else and its adoption of new technologies like RFID have long-term implications. Having a understanding of WMT is crucial for all investors (foe or friends of the WalMart way).

I am not making a political statement about what is good or bad about WalMart, I have no affiliation with either side of that debate.

Earning watch: JAMDAT Mobile

You may not have heard about JAMDAT Mobile Inc, it could be the one to watch after market close on Monday, Nov 08 when it reports results. The company is based in Los Angeles and went public last month. It is profitable mostly due to the success of Jamdat Bowling, one of the most successful cellphone based games. In this fairly nascent and fragmented market JMDT is one of the leading players and the only public pure-play. But there are many competitors both private and public.

With typical price to download a game onto your cell phone hovering around $1.99 its pretty amazing that JMDT is profitable. The key to understanding JMDT is to understand JMDT as a publishing company not as a technology company. The company has developed more than 70 games for 80 wireless carriers through out the world. Jamdat Bowling makes 25% of revenues which makes you wonder if the company has deep talent to expand its success beyond bowling. JMDT earns revenues from licensing applications (games) to subscribers for one-time purchase or monthly subscription fee. The carriers do billing, collection and remit a portion of the fees to JMDT- which helps carriers make a very nice fat profit. The percent of revenues carriers keep for allowing JMDT access to their networks in the U.S. is higher than many Asian markets. As the proliferation and popularity of these games increases in the U.S. expect this revenue share to shift. Carriers are under no obligation to market or distribute games. Some handset makers also embed games in the handset which JMDT earns money from on per phone basis.

Company has worked on publishing titles through licensing brands from NFL, MLB, Nickelodeon, PopCap Games and many others and it also develops its own brands. These games have long shelf-life with low upfront engineering costs which leads to very high gross margins. Company relies heavily on Verizon Wireless and Sprint, as the two carriers combined contribute over 58% of revenues. One of the most important things about the wireless gaming industry is that the carriers control access to the subscribers and carrier relationship is very crucial to success of any publisher. The competition is very fierce in this market with likes of Disney, Electronics Arts , Sony etc. The market penetration for games on mobile phones is very low, which could lead to big growth opportunities for many providers as more powerful mobile phones running on next-gen networks with higher bandwidth become a norm. Expect the quality and adoption of mobile gaming to accelerate further within the next few years.

JMDT IPO was underwritten by Merrill Lynch, Lehman Brothers and UBS. IPO was priced at $16 per share and ended the first day at $22.51, or gain of 45%. Currently JMDT trades at around $32, certainly not cheap if you believe the company will earn $0.70/share in 2005. The company has not filed a 10K yet since the company has not been public for long but it is very essential to read the S1 to understand all the risk factors associated with this company (some I listed above).

Listen to the conference call if you want to learn about the progression of this company and mobile gaming industry. The next big thing in mobile gaming will be interactive games which require higher bandwidth networks. Mobile gaming and other mobile applications are very important in driving transition to next-gen networks which has much deeper implications for various tech companies.

At time of publication I was net long JMDT, although positions can change at anytime without notice.

Falling dollar: who wins and who loses

I was asked about who benefits and who loses from the falling dollar. Lets get one thing clear first, devaluing currency and low interest rates do not go hand in hand, this relationship will cease to exist sooner or later. The falling dollar will evenutally lead to higher yields being demanded by foreign buyers of our debt. Chinese, Japanese, German investors will not accept 4% yield while the dollar losses 10%-15%, there is no money in it for them in that scenario. If you remember, the dollar did gain some ground when the fed started raising interest rates. Foreign buyers were optimistic about earning higher yields and wanted to buy dollar-demoninated fixed income instruments. That didn't last for long because Bush administration never really pushed for a strong dollar. Weaker dollar benefits U.S. companies in selling their products overseas and helps with creating demand for real assets like real estate (assisted by cheap money).

Devaluing dollar does not benefit the equity markets or the fixed income markets. Remember the 1987 market crash was primarily triggered by spike in interest rates driven by the falling dollar. Interest rate sensitive industries are at risk; lenders who have been more than generous to help spur the real-estate boom, Industrials that depend on raw materials purchased overseas, and car makers. Car manufacturers will be hit twice as hard since they buy steel in foreign markets (usually dollar demoniated and when dollar depreciates it costs them more), also car makers cannot create demand by offering zero or near-zero percent car loans. Winners in the devaluing dollar environment will be commodities and exporters.

Friday Nov 5, 2004

Markets continue their streak of gains driven by better-than-expected job data and oil price at a 5-week low (does any one track how many weeks oil prices went up for?). S&P was up for 8th straight day. Strength in Semis, Networking, Biotech, Gold and Cyclical names. Financials and Housing stocks were off due to interest rate hike fears. Treasury market was also kept in red today.

Retailers continued a broad move up but BBY was downgraded by Buckingham after I mentioned it yesterday, I would still own the shares for retail exposure. S was upgraded by Goldman and Pru as speculation regarding attractiveness of its real-estate swirl.

In Technology, GOOG was initiated on at Reduce (which means sell?) by UBS and YHOO at Neutral (what's Neutral?). NVDA, a graphic chip maker saw a 14% rise due to better than expected results which were more driven by improved cost control then improving market environment. I am worried about the guidance for January quarter given loss of XBOX revs and big ramp up in GPU units in a flat market at best. AMD gained aginst a downgrade to Sell (they still issue Sell ratings?) from BofA, I prefer to own AMD over INTC currently since INTC has too many product/engineering issues and inventory problems are rarely solved in one quarter. CNXT which is sub-$2 stock dropped 9% after reporting Sept quarter earnings, so what spooked the market? For starters, the management wasn't as up-front about the business as they were just last quarter (bad thing usually). No expectation of demand pick-up with the inventory situation remaining bad. Pricing pressure on WLAN chips remain severe (good for consumers bad for producers). Companies like CNXT give great insights into various tech markets and listening to their earnings call is more rewarding then owning the shares and there wasn't much bullishness on this call. RIMM saw a big drop due to speculation regarding upcoming court decision, I am no attorney but lets hope RIMM hired some smart ones because market doesn't like what it is hearing. TKLC was downgraded by Raymond James due to valuation but it still ended in the green. TKLC is a great way to play both the profilieration of wireless communication and Voice over IP.

INTU the makers of Quicken and QuickBooks products dropped after MSFT announced a competitive product offering. A product due in one year might or might not make big dent in INTU business but markets dislike uncertainties of any kind.

Small side note: This is in no way all-inclusive recap of the market, I only provide high-level recap and try to highlight stories that I can add value or humor to.

At time of publication I was net long TKLC, although positions can change at anytime without notice.

Dropping dollar

The upbeat October's nonfarm payroll of 337K was well ahead of 175K expectations and at a seven-month high, but it did not help the dollar from sliding to all time low against the Euro. That's not the only currency gaining on the Greenback, the dollar fell 0.6% against the British pound, the dollar hit a new nine-year low on the Swiss franc and a 12-year low against the Canadian dollar. Given the improving employment picture and higher interest rates in the U.S. you would expect dollar to strengthen not weaken.

Strengthening economy in the U.S. and higher interest rate should attract world investors therefore propping the dollar higher. But that's not the case due to record balloning national debt, which is very close to the $7.384 trillion limit imposed by the Congress. Treasury announced a delay in the formal announcement for the four-week bill and perhaps in the auction itself if the congress does not enact legislation to raise the debt limit. The other cause of lower dollar is the trade gap we currently run in the U.S.

Don't expect any intervention from the europeans or the Japanese in helping stop the slide of the dollar. European Central Bank president Jean-Claude Trichet, who spoke after the ECB's interest-rate meeting on Thursday was not alarmed about either the rising euro or the high oil prices.

The dollar has been on a slide throughout President Bush's first term and with no near-term plans to reverse the record U.S. trade and budget deficit it still has more downside. On the other hand, U.S. companies that account for large percent of their revenues from international sales should benefit from lower dollar.

All the weakness in the dollar is certainly helping gold with gold futures closing at a 16 year high. As mentioned yesterday, gold stocks (stocks mentioned KGC, FCX, PDG did very well today) should perform well into this decling dollar, higher interest rate, higher deficit and trade balance environment.

Stretching for performance

Whitney Tilson discusses how this year of mediocre returns in both equity and fixed-income markets is making professional money-managers take on extra risk to beat their respective bench-marks. His conclusion: defaults by low-quality companies and suckers left holding the bag with broken momentum stocks.

Another drag on Airlines...literally

A study by CDC, as highlighted in NewsDay highlights how obesity costs the airlines extra $275M, clearly the economics of this business are not getting better with Americans getting fatter.

Google stock under pressure

Ever since briefly trading above $200 intra-day on Nov 3, 2004 Google stock has been under a lot of pressure. UBS which initiated on GOOG with a Reduce rating points to four factors that will keep stock under pressure in the near-term 1) slowing growth, 2) margin deterioration in 2005, 3) increased stock float and 4) mutiple compresion. I think all these factors also mattered at $175 or for that matter at $135 also. The timing on float increasing 233% from approximately 27M shares to 90M shares by end of 2004 matters the most in driving the stock down. Timing is the most crucial part of picking stocks; "you can be right, but can you be liquid?" is one of the most important question to ask.

Myths about Costly Oil

Business Week (latest edition dated Nov 15) has an article discussing research by two economists at Univ of Mich regarding why Oil is a "logical villain". The research paper addresses four points of conventional wisdom 1) High oil prices slow the economy 2) Oil price shocks cause inflation 3)1970s stagflation can be explained by oil and 4) OPEC is powerful and why the conventional wisdom does not hold true. Their conclusion is that Oil price shocks "may contribute to recession without necessarily being pivotal" and "disturbances in the oil market are likely to matter less for U.S. macroeconomic performance than has commonly been thought". I sure hope their conclusions are true this time around as well.

Google: a Value Stock?

I know enough has been written about Google stock, so I will keep this brief. I am not a deep value investor by any stretch of imagination but Bill Miller who runs Legg Mason Value Trust, the only fund to beat the S&P500 for 13 straight years, sure thinks about value. (or you hope)

It's very interesting to read Bill's commentary regarding the funds' performance in 3rd quarter. Even though he admits to being wrong by not owning Energy stocks he doesn't really highlight why he thinks Google deserves to be in a Value fund. He does delve into why the the process of Google's auction-style IPO changes the research requirement for money-managers bidding on a IPO. But it be nice to see how Bill percieves Google to be a value stock. At Sept 30th 2004 GOOG accounted for 1.76% of assets in the fund where as AMZN was the largest Internet related holding at 6.11% of assets. GOOG is up another 42% since end of the quarter. There is increasing short-term pressure on GOOG as the lock-up expires and insiders cash-in their options but perhaps GOOG can help Bill keep his 13 yr streak going. Good luck Bill!

Why Oil matters?

Business Week ran a article on How Costly Oil Will Test the Economy last week. The article highlighted the resiliency of this economy in face of rising oil price. But consumer confidence is starting to fade, falling for the third month in a row in October. Rising oil prices have directly hit the consumers and businesses in the pocketbook and knocked off 75 basis points from growth through the first three quarters of 2004. With Fed set to raise interest rates again on November 10th the Fed hasn't started to worry about Oil (publicly) yet. I hope they start worrying soon. I think rising Oil prices will dampen GDP growth worldwide and would consider a more defensive posture going into 2005.

Thursday Nov 04, 2004

Market had a nice rally today driven by bulls carrying the somewhat fizzled election rally from yesterday. Markets hate uncertainty and obviously Bush re-election is welcomed more than if Kerry had won.

It was a broad base up day, but something interesting to watch was that the Gold/Silver names out performed. Is this market rallying because we don't have to worry about who the next President is going to be? If it is then, why are defensive gold stocks also rising? Some of it was certainly technical bounce with KGC, FCX and PDG all seeing nice uptick in volume also.

I think this might have something to do with the market looking ahead to the next fed interest rate hike, higher oil prices and no support for the Dollar even after the elections. Reading tea leaves might signal uncertainty hasn't disappeared just because we know Bush will lead for another four years. Seems like the above mentioned gold stocks might be something to buy just as a hedge.

Another strong sector was the Retailers with a mixed bag of October comps. I don't delve too deep into retail stocks but I have liked the action in BBY and URBN and see more upside from here. Another one of my favorite SBUX benefitted from "The very successful debut of Pumpkin Spice Latte", try one if you haven't. If you want a little risky name try TLB, strong turn around in comps and nice chart. And the Big Daddy of them all WMT slightly raised its EPS guidance as well.

Airlines are also seeing a nice bounce. I don't like the economics for most the players in this sector so I avoid any names here but if I must pick one, it would be JBLU, the one with best economies in the industry.

Another sector rallying on Bush re-election is managed care. With Republicans strengthening hold on Congress and re-capturing the White House, managed care providers should not see any increase in regulatory oversight and more importantly no change to Medicare re-imbursements which had been a big over hang on the sector. I would be a buyer of ATH, AET, PHS. There is no "clean" ETF for the sector but XLV or PPH should also benefit.

In Technology Software names were the most significant gainers. Semis had a mix day with BRCM being a big gainer, QCOM lost 4.5% after not so stellar guidance yesterday. I believe quality names like QCOM are worth considering on big sell offs in the market, but with earnings related sell off with estimates moving down, I would stay on the sideline on this name for few days. I would be hesitant to start any position in semiconductor names right now since I feel there is still more downside driven by margin compression. Semiconductor stocks are some of the most volatile names and since I don't do day-trading I try to stay clear until I can find a clear catalyst to be in a name long or short. Semi Caps had a mix day after a downgrade by BofA analyst on AMAT, KLAC & LRCX. Another sector to be wary of, with too many players not enough pricing power and shrinking customer base. Telecom Hardware was also mix with RIMM seeing the most action and continuing on its upward trajectory. SONS lost almost 6% of its market-cap after a in-line quarter with good gross margin but no concrete guidance for next quarter. If you listen to the earnings conference call it becomes clear that management was not very forthcoming on a lot of topics and their persistence to avoid the reason on why gross margins jumped last quarter but will fall next quarter, made for one very frustrating situation. Another big loser was DITC, a darling of the bubble days lowered guidance for the quarter due to some slow down in wireless related spending in U.S. and some sales push-outs, this should come as no big surprise as their competitor TLAB also saw sharp decline. With lower gross margin from increasing International sales, expect stock to be re-valued at lower multiple.

Buyer of: Retailers, Managed Care, Gold/Silver
Seller of: Semiconductor, Semi Caps