Following the (Smart) Money

Although it’s been more than forty years since Watergate informant “Deep Throat” advised Washington Post reporters Woodward and Bernstein to “follow the money”, that advice is just as valuable now as it was then – especially when it comes to tech stocks. As you should know by now, our stock-picking theory of ‘innogration’ is based entirely on the precept that precisely how a company invests its Capex budget will dictate its eventual success.

While one could argue that is true in any business, nowhere are the results more quickly revealed than in technology. Combined with the generally accepted notion that the entire information technology sector is rapidly converging onto a small number of end-point categories, you have the ingredients for a particularly volatile market that quickly weeds out companies that make sub-optimal strategic decisions, and handsomely rewards those that make the right calls.

So today we’re adding a small-cap name to our Equity Trades portfolio that we believe has the potential to more than double in value within the next couple of years, even if the overall stock market goes nowhere. That’s a bold prediction to make, but it has happened many times before in the tech sector and we think it’s about to happen again.

That company is Silicon Image, Inc. (NSDQ: SIMG), which is sitting squarely in the middle of the massive migration to portability by providing video, audio, and data connectivity products that facilitate the use of high-definition content on mobile phones and other handheld devices. These devices can then be seamlessly connected to HDTVs and PC monitors to display content, enabling the wireless distribution of video content, images, online games, and social networking.

Now here is where it gets interesting. Recently telecom giant Qualcomm (currently a recommendation in our Investments Portfolio) acquired a 7% stake in SIMG’s Qterics subsidiary, which SIMG acquired less than a year ago when it was known as UpdateLogic. Qterics manufactures a fairly specialized product line that includes “DRM Dynamic Provisioning”, which allows for connected digital devices to securely receive and manage digital communications without wires or cables.

By itself that transaction may not mean much, but combined with Qualcomm’s earlier acquisition of Wilocity last July it suggests a strategic focus in the so-called “Internet of Things” (IOT), which is currently the fastest growing component of the I.T. industry. Wilocity is a pioneer in 60 GHZ WiGig technology, which is critical to facilitating high-speed wireless communication of HD-ready video content.

We view this transaction as a good sign for both SIMG and Qualcomm. It only cost Qualcomm $7 million to make this purchase, a tiny deal by their standards but one which gives them a leg up on eventually acquiring all of SIMG in the future if it wants to. And even if that doesn’t happen, having Qualcomm as a customer ensures SIMG of always having a ready buyer for its products in a huge market.

Additionally, if this exercise in innogration turns out to be correct then Qualcomm should also move into a lead position in the race to be a leading player in the IOT space. Just as Apple blew by Blackberry in the smartphone market by acquiring the apps and features necessary to offer a fully robust product that its competitors could not, Qualcomm’s interest in SIMG suggests it understands the need to integrate additional functionality into its IOT offering.

Buy SIMG up to $8.00

NASDAQ Composite Index:                                                                        

Friday, January 9 = 4,704.07                                                   

Trailing 12 months = + 13.8%                                        

Trailing 7 Days = – 0.5%                                       

Trailing 4 Weeks = – 1.5%

Next Wave Portfolio Update

By Rob DeFrancesco

Shares of Ebix (EBIX) last week surged 26% after the provider of cloud-based software solutions for the insurance and financial services industries announced that it had come to a resolution with the IRS regarding a previously disclosed audit related to income tax returns for the years 2008 to 2012. The tax issue had been an overhang on Ebix shares because of concerns about the outcome and penalties.

The company expects the tax assessment, related solely to non-recurring issues associated with some acquisitions during the 2008-2012 period, to come in around $1.4 million (the charge is to be taken in the fourth quarter of 2014), below what some had been estimating. It’s important to note that no assessments or deficiencies were found with respect to any of Ebix’s recurring operating transactions.

In December, Ebix agreed to give activist investor Barington Capital Group, owner of a little more than 1.6% of the outstanding shares, two board seats, expanding the board to eight members, seven of whom are independent.

This move was in response to pressure from the activist, which in the past has pointed out several issues it has with Ebix—including modest organic revenue growth, questionably high executive compensation packages and what it considers to be second-rate corporate governance. Ebix nominated James Mitarotonda, cofounder of Barington Capital, and Joseph R. Wright, suggested by the investment firm, for board seats.

Ebix remains a ‘Buy’ in the Next Wave Portfolio up to $18.

Last week, BofA/Merrill named FireEye (FEYE) a top security pick for 2015, with a price target of $44. The firm looks for FireEye this year to deliver above-industry revenue and billings growth in an already robust enterprise IT security-spending environment. BofA/Merrill is forecasting cash burn to slow in 2015 and 2016, leading to positive free cash flow in 2017.

Topeka Capital in late December reiterated its ‘Buy’ rating and $45 price target on FireEye because it sees the shares having a better year in 2015 based on: (1) the company’s strong positioning in defending against advanced targeted attacks; (2) total addressable market  (TAM) expansion via entry into endpoint protection; (3) heightened awareness in the enterprise market about the importance of incident response (FireEye’s Mandiant unit is among the best) following several highly publicized breaches; and (4) operating expense discipline.

In late December on CNBC’s Fast Money program, an FBR Capital analyst said he thought FireEye would be a good acquisition target for Cisco Systems (CSCO). While I agree FireEye could be in play this year, Cisco’s $2.7-billion purchase of SourceFire in October 2013 limits the probability of the networking giant doing another big security deal so soon.

FireEye remains a ‘Buy’ in the Next Wave Portfolio up to $33.