wall street nuggets

ADE Corp. [ADEX] was up 24% on Tuesday, closing at $32.18 as KLA-Tencor [KLAC] changes the terms of its acquisition offer from an all-stock deal to an all-cash deal at $32.50 per share of [ADEX]. There was very little change on Tuesday for [KLAC].

Innovex [INVX] was down 15% after it cut Q3 revenue guidance by 14%.

Covad Communications Group [DVW] was down 11.5% when they provided guidance for 2006.

TriQuint Semiconductor [TQNT] closed down 9.2% to close at $4.76, on volume that was up about 125% over the 3 month average, with no apparent news on the company. This was despite its relatively good quarterly report and recent upgrade by Piper Jaffray that was noted in this blog on May 16^th. [TQNT] would appear to be a Strong Buy at this point. In general, the field appears littered with great value opportunities.

We are experimenting with a new format for the Daily Sector Performance Chart (below). Big losers for the day were the Airlines (down 3.1%) and the Online sector (down 3.5%), but no sector escaped unscathed. Across the entire SigmaInverse Universe, the average loss was 1.8% and only 14% of the universe made it into positive territory.

In an earlier blog, we had commented that, in the past, fuel conservation effects were relatively short lived after the initial sticker shock effect and that people tended to grow accustomed to the higher prices and quickly return to their old consumption patterns. This time around, however, should be quite different. According to an article by Bradford Wernie in the May 22^nd issue of Automotive News, there has been a significant shift in the market share for 4-cylinder and 8-cylinder vehicles, starting in April of 2006. To the extent that this shift persists over time, it essentially locks in fuel consumption rates at a lower level over the long run, even if fuel prices drop and people return to their old driving habits. The effect of purchasing a new 4-cylinder car or a 6-cylinder vehicle in lieu of an 8-cylinder car over the course of the next 6 months will have a very significant impact over a much longer horizon. Likewise, a decision to install a heating system in a new home is probably more likely to involve natural gas than oil at this point, and again, over the longer horizon, will cut into oil consumption. Some rough, back-of-the-envelope calculations suggest that we might finally have seen the peak in world-wide oil consumption.

While it was supply-side issues that drove oil prices up, the reaction to higher prices appears to involve permanent effects noted above, which will tend to cap demand and most likely relieve the supply-side issues in the short term. However, continued uncertainty on the supply-side and increasing price elasticity will undoubtedly increase volatility in prices, which should lead to some great opportunities.

As Aristotle Onassis once said, the key to success in business is knowing something that nobody else knows.  There is a lot of folk wisdom in this assertion, but like most proverbs, some qualification and elaboration are needed.  For example, we would probably all agree that some unique tidbits of information have little or no potential economic value.  Knowing the exact number of grains of sand in the Sahara Desert might be an interesting fact, but undoubtedly of little or no real value even if it could be ascertained.  Furthermore, while exclusive knowledge is usually more advantageous, it often suffices to have knowledge that is generally not known.

In the markets, the question could best be phrased, “How much homework do I need to do, before I have an edge?”  Unfortunately, there is no easy answer to this question.  For each tidbit of information, there are two important attributes that we should like to assess.  First, there is the “probability” of the “event.”  In other words, given a tidbit of information or a fact, how likely is it for that fact to have become reality in a large number of parallel universes, compared to alternative “facts.”  This is essentially the key insight in Claude Shannon’s Information Theory, where information content is proportional to the negative logarithm of the probability of a message.  Another way of looking at this attribute is as a measure of surprise in discovering the fact.

But information content alone is not enough.  We also need to have some insight into the relevancy of the facts we are able to uncover through our homework.  This is an area where more research is needed.  Unfortunately, the assessment of relevancy tends to be a subjective judgment call, where there is a need for some better modeling.  Ceteris paribus, we might have a pretty good idea how to rank company metrics in terms of impact.  For example, in the current environment, we might rank the relevancy of various fundamentals in the following order:

• Current Quarter’s guidance for Earnings per Share
• Current Quarter’s guidance for Revenue Growth
• Last reported Quarterly EPS
• Last reported Quarterly Revenue Growth
• Etc.

The full list probably doesn’t need to have more than 50 or so concepts and will tend to vary by sector or industry.  For example, book-to-bill ratios are important to semiconductor manufacturers but not Biotechs.  In the area of Healthcare Insurance, the Medical Cost Ratio (MCR), is an extremely important driver at this point.  In Retail, the same-store sales (or comps) are a key driver.  We also need to be aware of threshold effects, so that when certain levels are exceeded, the relevancy ordering can quickly change.

There is a big challenge in estimating the level of surprise in a new nugget of information.  In some cases, there are analysts’ estimates for key concepts, and, if there are at least three such estimates, my experience is that the estimates are usually at least reflective of company guidance and provide not only a measure of expectations, but also a measure of uncertainty.  (Consider the range of the estimates as a crude measure of uncertainty.)  In the absence of at least three analyst estimates, you can always look at both the relative change from the previous quarter or, in the case of strongly seasonal patterns, the year-over-year change, comparing with the same quarter in the previous year.  Interestingly, the market seems to quickly identify a linear trend in setting expectations, so the surprise is the extent to which the actual change differs from the expected change coming from a linear trend.

The biggest decline on Friday (an incredible 28.6%) was posted by Credence Systems Corp. [CMOS], maker of semiconductor testers, which appears to have been blind-sided by some recent decisions by Intel. In particular the company’s development of a next generation flash memory tester, Kalos III, has been terminated, and the current inventory of Kalos II testers has been written-down to the tune of $11.8 million. The company’s future hopes seem to be riding on System-on-Chip testers, their Sapphire line, and analog mixed signal testers. However, the reported Q2 loss of $14.2 million ($.14 loss per share versus expected earnings of $.04) on revenues of $124.8 million, does not appear to be the end of the red ink. Additional restructuring costs will impact Q3 as well and the guidance was for a loss of $.09 to $.11 in Q3 on revenues of $125-129 million. Looks like the next upside opportunity for this stock is probably Q4 or Q1.

Traffic.com Inc. [TRFC] appears to have been cited for ignoring traffic signals. The business model appears to involve a core data subscription component that represents about 10 to 15% of the revenue and an advertising component that is buying more inventory than they can resell. Analyst William Morrison of JMP Securities cited weakness in the radio and TV advertising component of the business and indicated that another round of investment in the range of $15 to $20 million would be required to reach cash flow break even. The hardest issue to discern here is the extent to which advertising inventory that is acquired for pure cash ends up as advertising revenue, compared to inventory acquired in exchange for traffic data services. More transparency is needed in this area. If they are ever going to reach cash flow break even, it would also seem they have to focus their technology a little more. Not all traffic sensing technologies are likely to be equally economical and focusing is likely to get [TRFC] to break-even earlier. The advertising revenue coming from the Internet and wireless areas is still very thin at $100K, reflecting relatively little web traffic. There is some inherent weakness in the model in this area. Most people today would only want to be alerted if there is traffic jam on their usual commuting route and would find it inconvenient to check a web site periodically to see if there are problems. Of course you can get email alerts or cell-phone alerts with the service. On the other hand, the advertiser wants to place ads on sites that enjoy relatively high frequency rates. Unless traffic.com site became entertaining and compelling on a daily basis, this revenue component will continue to disappoint.

Overall the markets appeared healthy on Friday with about a 60/40 split between advancers and decliners. Given the Biotech hype on Jim Cramer’s Mad Money on Thursday, it was no surprise to see the Biotech and Pharmaceutical sectors leading the charge on Friday with average gains of 2.35% and 1.86%, respectively. Leading the group with gains in excess of 10% were Cubist Pharmaceuticals Inc. [CBST], Epix Medical Inc. [EPIX], Dov Pharmaceutical Inc. [DOVP] , Avanir Pharmaceuticals [AVNR], Sirna Therapeutics [RNAI], Stemcells Inc. [STEM], and Pozen Inc [POZN].

Both Yahoo [YHOO] and eBay [EBAY] were up (3.6% and 12.2%, respectively) on the announcement of a new online alliance that is perhaps most notable for alternative alliances that it blocks. With the Online sector up 2.3% for the day, the [YHOO] response does not appear to warrant much of a cheer. On the other hand, the [EBAY] response is very impressive, and we tend to agree that [EBAY] should enjoy relatively more benefit from the alliance.

Stone Energy Corp. [SGY] picked up a second bidder with Energy Partners Ltd. [EPL] on Thursday and closed up 22.5% at $49.95, reflecting a bid representing about $52 per share. On April 24^th, Plains Exploration & Production Co. had submitted a bid valued at $41.20 per share. [EPL] closed down 2.3% at $21.07 per share.

Big Lots Inc. [BLI] was up big time closing at $16.31 up 20.7% over Wednesday’s close, after posting very strong numbers for the quarter ending April 29^th. Analysts had been expecting earnings of $.05 per share, which the company easily beat with $.12 per share. An upgrade by KeyBlanc Capital Markets was also helpful. Same store sales were up only 2.5%, but the company pointed to cost cuts to explain the improved earnings.

Both XM Satellite Radio [XMSR] and Sirius Satellite Radio [SIRI] recovered from Wednesday’s damage, although [SIRI] overcorrected and was actually up for the two day span, while [XMSR] is still significantly down based on its revised subscriber projection.

The Daily Sector Performance Chart (below) had all 41 sectors in positive territory, although Retail Apparel at .18% was rather threadbare. The average gain for a stock in the SigmaInverse Universe was 1.45% with almost 80% of all stocks having positive daily returns. Leading the charge were three key sectors: Alternative Energy (sector up 4.3% lead by SunPower [SPWR] up 8.2%), Mining (sector up 3.9% lead by Peabody Energy [BTU] up 8.2%) and Oil & Gas Production (sector up 3.25% lead by Stone Energy [SGY] up 22.5%).

Aside: We are considering using trimmed estimates in the calculation of sector based performance statistics. This would involve not including outliers like Stone Energy in the calculation of the average gain for the Oil & Gas Production sector. However, with 130 stocks currently in the Oil & Gas Production sector, the impact of any single stock is tends to be rather slight. Without Stone Energy the average gain would have been 3.10% rather than 3.25%. On the other hand, in a small sector like the Alternative Energy, the impact of eliminating outliers could be very significant.

Orchid Cellmark [ORCH], which provides DNA testing for human identity and agricultural applications, finally filed its fiscal year 2005 results with the SEC (so they are no longer a white rabbit from our perspective). The stock has been up over the past two days, probably due more to the publicity coming from a case involving a wrongful rape conviction in Florida, which was overturned on Tuesday, based on the evidence provided by [ORCH], rather than the disclosure of operating results.

The 10-K filing reveals virtually no change in revenues, year-over-year, and widening operating losses - a loss from continuing operations of $9.1 million in 2005, compared to a loss of $6.9 million (before income taxes) in 2004.

On Wednesday, Accelrys Inc. [ACCL] filed its 10-Q for the period ending 12/31/2005 and its 10-K and quarterly results for the fiscal year and quarter ending 3/31/2006 and is finally caught up in terms of filing requirements (no longer a white rabbit). The filings include restatements of earlier financial results, reflecting changes in the timing of revenues coming from perpetual and term-based software licenses.

According to the 10-K filed yesterday, the company was cash flow positive for the fiscal year ending March 31, 2006, adding about $3.4 million. The net loss for the year was $7.7 million ($.30 per share), compared to $16.6 million ($.66 per share - restated from $1.00 per share) in fiscal year 2005.

The applications for Accelrys software fall into rather disparate industries (pharmaceutical, biotechnology, chemical, petrochemical, and material industries). We understand that the company does not feel compelled to break down its reporting by business segment (in compliance with SFAS 131) because of the similarities of operations across these industries, but we suspect that the each of these industry segments presents a unique set of opportunities and challenges and some visibility into the current relative penetration and focus by segment would facilitate valuation.

Vonage Holdings [VG] stumbled badly out of the gate. The Voice over IP (VoIP) telephone service company turned in a dismal performance on its first day, closing at $14.85 as it lost $2.15 from its IPO price of $17 per share. Given its lack of profitability since inception in 2001 and increasing competition from many other VoIP suppliers, it appears likely there is still some downside exposure before Vonage stabilizes.

An Indonesian based outbreak of avian flu has epidemiologists concerned that the virus has found a new route to human hosts. Fear and uncertainty has generated market reactions in several areas. First are the companies involved in developing antiviral medicines, like Vical Inc. [VICL] up 6.1%, Biocryst Pharmaceuticals [BCRX] up 9.7%, and Gilead Sciences [GILD] up 3.2%. While none of these is likely to have a near-term solution to a flu pandemic, the scare itself seems to have focused interest on the Biotech sector in general, and by the end of the day generated a very significant impact on the biotech sector as a whole, which was up 1% on average. Many Biotech stocks were up very sharply even though their activities were unlikely to have any role in a flu pandemic and there was no other news on the company.

While Tyson Foods [TSN] was down 2.6%, it appears that the drop is more likely due to the change in CEO’s than to the bird flu scare, since it is unclear whether an H5N1 flu pandemic would affect birds not in the wild. Other poultry related stocks like Gold Kist [GKIS] down 3.3% , Sanderson Farms [SAFM] down 1.7% and Cal-Main [CALM] up .15%, appeared to take some modest downward pressure due to the scare, but we are not sure how much of this is completely rational.

The Online Sector was also up on average 1% on Wednesday, with Stamps.com leading the sector with a gain of 5.9%, due to the press release announcing the fact that PhotoStamps® would be available from within Adobe Photoshop CS2, Photoshop Elements and Photoshop Album Starter Edition software.

While General Motors continues to confound observers with a multitude of questionable decisions, it benefited Wednesday from an upgrade by Merrill-Lynch, possibly attributable to either (i) recent GM restructurings, (ii) reduced pressure from the Bankruptcy Court hearing the Delphi arguments, or (iii) perhaps just the argument that, because the GM price has dropped so much, it must be a bargain.

XM Satellite Radio Holdings [XMSR] closed at $13.75, down 11.3%, and Sirius Satellite Radio [SIRI] closed at $3.68, down 5.6%, on the news that [XMSR] was reducing its guidance for future subscribers. The company revised its forecast for the number of subscribers at the end of 2006 from 9 million down to 8.5 million, resulting in subscriber revenues of $835 million and a loss before depreciation of $235 million.

With energy prices dropping today, it was to be expected that the Alternative Energy sector would be a big loser. This sector was down on average 1.1%. The Oil & Gas Production sector was actually also off 1.5%, indicating a very definite non-linear relationship between oil prices and oil related stock prices. While this might appear irrational at first blush, we should expect that there must be a price threshold at which gas prices will lead to a change in behavior and the evidence is beginning to accumulate that we have reached that level. (Actually, we are hearing that demand is flat, but normally at this time of the year, we should be seeing an increase in demand.) With inventories beginning to expand, some of the long-term risks to the industry will begin to become more apparent. The big question is how much persistence there will be to the price response. In the past, consumers have tended to adapt to the higher prices and returned to old consumption habits rather quickly. At certain price levels, however, there should be a residual effect.

With energy prices climbing on Tuesday (light, sweet crude at $71.21 per barrel), the usual beneficiaries performed well:  Pacific Ethanol [PEIX] up 16.9%, MGP Ingredients [MGPI] up 12.5%, Andersons [ANDE] up 9.6%, Active Power [ACPW] up 5.3% and SunPower [SPWR] up 4.2%.  We have added a sector called Alternative Energy to the usual Daily Sector Performance Chart (below) and with an average gain of 5.4%, this sector left the others in the dust.  Of course, the rest of the market generally took this as a reason to retreat.

A few stocks should be noted because, although they followed the market up at the beginning of the day, they managed to hold some of the increased value at the end of the day with no help from any external news sources.  In this group, we would include:  Rambus Inc. [RMBS] up 7%, American Science & Engineering [ASEI] up 7.6%, KVH Industries [KVHI] up 7.6%, Books-A-Million  [BAMM] up 7.7%, Tollgrade Communications [TLGD] up 7.7%, Ikanos Communications [IKAN] up 8.3%, and Tasty Baking [TSTY] up 8.7%.

Bucyrus International [BUCY] closed at $51.01 up 9.7% with an upgrade by Capital One Southcoast.

Midwest Express [MEH] was down 17.2%, closing at $4.10, with a downgrade by Raymond James.  Palm [PALM] also suffered a big hit (-8.4%) with a downgrade from Bear Stearns.

Palm Inc. [PALM] fell 8.4% with the release of Motorola’s Q phone, which is expected to provide some competition for Palm’s Treo phones.

Exact Sciences Corp. [EXAS] closed up $.53 Monday at $2.77 per share for a gain of 23.7% after announcing test results for a new, relatively sensitive (probability of positive test result, given the disease = 88%), noninvasive, stool-based DNA test for colorectal cancer, that should dramatically improve the screening levels for this form of cancer. Currently, the screening rates are quite low and, while survival rates are quite high for colorectal cancer with early detection, the low screening rates due to a reluctance to undergo colonoscopies, leaves this form of cancer as the deadliest after lung cancer. The test results were announced Sunday at the Digestive Disease Week conference being held in Los Angeles.

IRobot Corp. [IRBT] closed at $20.80 down 7.2% on no significant news. In a press release on Monday, the company announced that it has now sold more than 2 million iRobot Roomba vacuuming robots, indicating that the product is well on its way to “Crossing the Chasm.” However, despite this, the stock found few buyers on Monday.

Marshall Edwards Inc. [MSHL] closed at $3.32, down 19% for the day, with no significant news. The company is involved in clinical trials of the anti-cancer drug phenoxodiol, for which it has a license to develop and commercialize. At this point we cannot see a reason for the drop.

InterContinentalExchange [ICE], the leading electronic energy marketplace, fell 14.8% on Monday, closing at $59.63. [ICE] provides a global marketplace for trading energy futures contracts and various over-the-counter (OTC) contracts. The drop in [ICE] must be attributed to the perception that energy futures and OTC energy contracts will be trading less than expected. What investors need is a model that can predict trading volumes in energy futures. The new contracts announced last week seem to indicate a strong demand for the product.

The Daily Sector Performance Chart (below) paints a grim picture of the markets once again. Only 5 sectors barely made it into positive territory on Monday. Travel (down 1.73%), Entertainment (down 1.74%), Mining (down 1.98%) and Electronics & Semiconductors (down 1.75%) were the big losers on Monday.