Correcting for the Correction

Okay, it looks like the long awaited correction is finally here. Like waiting for the first snow storm of the winter, usually the reality of its destruction is far greater than the excitement of its arrival. Regardless, the fact of the matter is it’s here, and now we all have to deal with it whether we like it or not. The good news is a lot of tech stocks are sitting on a pile of cash that should see them through whatever near term revenue shortfalls may arise; the bad news is it seems a lot of shareholders aren’t willing to stick around while it happens.

So, we have to ask ourselves the same question we ask every time the market goes into correction mode: Do we try to bottom fish and double-down on some of our favorite names, or play it safe by waiting it out? The temptation, of course, is to make the aggressive play, but the prudent thing to do when the market is this volatile is to pull in our horns and avoid making a bad situation worse in case the bottom falls out.

For that reason we are only making a few minor changes to our portfolios this week, moving FireEye to a ‘hold’ in our Next Wave portfolio and selling Oracle and Intel out of the Investments portfolio now that they have dropped below their stop loss levels. Other than that its steady as she goes, at least until we see what the coming week brings!

Investments Portfolio Update – Qualcomm (QCOM)

by Linda McDonough, CFA

Can Qualcomm Be Saved by the Internet of Things?

Woe is Qualcomm.   The world-leading provider of wireless technology and services for mobile devices has seen its stock slump 17% since January. Revenue and earnings in its mobile chip division continue to erode as it loses deals to low end competitors and one of its largest customers transitions to internally developed chips.

Despite a settlement with the Chinese government the company contends that certain licensees are not complying with royalty terms. Even the news that Jana Partners, the activist investor, had taken a stake in the company failed to lift the stock.

Yet Qualcomm is a remarkable company.  Almost two thirds of the cell phones in the world function due to Qualcomm’s telecommunications intelligence.  Early on the company wisely chose a two tier structure to distribute its extensive intellectual property.  Allowing third parties to license Qualcomm’s technology for their proprietary devices in addition to selling its own internally developed chips to handset makers has allowed Qualcomm to blanket the world with devices tied to its wireless standards.

While it is not surprising that smaller, more nimble competitors would start to chomp at the leg of the market champion, the degree of pain these competitors have caused has taken many by surprise.  Qualcomm’s QCT division, which represents sales of proprietary chips sold to third party handset manufacturers saw revenue decline 22% and profits drop 74% in the third quarter.

Samsung – Qualcomm’s second largest customer – began using an internally developed chip earlier this year for its recent product releases, including the popular Galaxy phone. In addition, many manufacturers have switched away from Qualcomm’s chips to cheaper chips to reduce the cost basis for lower end phones.

On the surface it may appear that Qualcomm is a sleeping giant, precariously perched on the deteriorating laurels of its extensive intellectual property.  Yet two significant acquisitions will help launch Qualcomm back into growth mode. The recently closed purchase of Cambridge Silicon Radio (CSR) immediately transforms the company into a formidable player in the Internet of Things product revolution.  CSR dovetails nicely with the wi-fi capability that came along with the 2011 purchase of Atheros.

For those still flipping light switches off with their fingers or manually hauling up their garage doors, the Internet of Things (often nicknamed IoT) is a wave of innovation that allows people to control any type of, well, thing, via a smart phone or handheld device.  Forget to turn off the air-conditioner as your family jets off to Europe?  Simply dial the temperature back up via software on your cell phone.  Worried a guest may be stranded outside of your home while you’re stuck in traffic?  There’s an app for that, unlock your front door wirelessly from your cell phone.

It makes perfect sense that Qualcomm, who spearheaded CDMA, 3G and 4G wireless connectivity standards would want to team up with CSR, the company who created a Bluetooth product on a single chip. This purchase, along with its 2011 purchase of wi-fi chip maker Atheros, firmly cements Qualcomm as a go to supplier for any manufacturer wishing to include wireless connectivity to its products.

CSR’s technology is already being incorporated into connected car solutions, multi-function fitness trackers, wireless gaming controls and hands-free Bluetooth dialing in cars. Although its revenue base is not large enough to make an immediate impact on Qualcomm’s behemoth $26 billion in sales, access to CSR’s engineers and customers gives Qualcomm the ability to expand into new markets.

For example, CSRmesh technology is already being used in smart light bulbs made by SK Telecom which function as Bluetooth beacons throughout a building.  Not only can the light bulbs be turned on or off remotely, they act as collectors and transmitters of information.  A large retailer for example, could monitor traffic at check-out counters or specific store aisles and realign employees or inventory to improve customer flow.

“It’s clear that more large-scale retailers and service providers are now looking to harness the power of location-based communication offered by beacons,” said Alex Jinsung Choi, CTO and Head of Corporate R&D Center at SK Telecom.

Interestingly this acquisition probably makes it less likely that Qualcomm will split itself in two.  Jana Capital proposed, amongst other changes, that Qualcomm separate its chip business and its royalty business into two independent entities.  The rationale is that QTL, Qualcomm’s licensing and royalty division, is still growing and would be awarded a higher valuation without the shrinking profits in the chip division (QCT) diluting growth.  

In addition, Jana Partners included in its letter to Qualcomm a quote by an analyst suggesting that the chip division would be an attractive take out target: “We also think a QCT listing would make for an attractive take-out by Intel, who has long struggled to keep up with the radio features of Qualcomm’s modems and is losing over $3 billion a year in its mobile division.”

The licensing division produces a highly durable stream of cash flow that finances innovation in the chip division. As Jana points out, Qualcomm’s technology encircles the dominant standards in wireless communication.  Contracts using these standards are very long term, ensuring that Qualcomm’s royalty stream will endure for at least the next decade.  Qualcomm can employ a similar strategy with its Bluetooth products; either buy the Qualcomm chip or license the technology and create your own.

Although Qualcomm’s cash flow is shrinking, the company still produced $2.29 per share in cash flow in the first 9 months of this year.  This cash flow adds to the already monstrous net cash balance of $24 billion that Qualcomm housed at the end of June.  The stock provides a 3% dividend yield and trades well below industry valuations.

Ongoing competition in the chip market and charges from the company’s strategic realignment plan will continue to cut profits in the short term. However, the company is clearly listening to Jana Partners and recently provided a roadmap for boosting shareholder value through cost cutting, increased dividends and share buybacks and an infusion of new blood in the Board of Directors.

After subtracting the company’s $15 cash per share, the stock trades for a meager 10 times 2015 earnings.  This price more than compensates investors for the risks involved in this business.  Patient investors can take comfort in Qualcomm’s abundant cash flow as growth in new technologies and consumer applications take root.  

The stock is an original member of the Smart Tech Investor Investments Portfolio, added on December 16, 2013 at a closing price of $70.85. Qualcomm remains a buy in the STI Investments Portfolio up to $66 and carries a Smart Tech Rating of 10.2.


Medical Profits Portfolio Update
by J. Duarte MD

In this issue:

  • The Big Picture: Chart Trio- Making Sense of a Dangerous Market
  • In Depth: New EBS Pick – Greatbatch Inc. (GB) An Industrial Medical Equipment Turnaround Story with a Twist
  • EBIS Portfolio Alerts: EBIS Portfolio Components Again Hold Up Better than Market
  • News Update: Big Biotech Bets by Big Companies

The Big Picture:  Making Sense of a Dangerous Market

Investors may be in for a wild ride over the next few weeks or months if the 531 point decline in the Dow Jones Industrial average on August 21st is any indication of what could lie ahead.  The biotech sector, as measured by the Nasdaq Biotech Index (NBI) fell along with the market on the week ending August 21st. The Biotech Index (NBI) is now below any reasonable support and is off nearly 11% from its July high.  A look at the charts comparing the S&P 500 (SPX) and the biotech sector index, though, shows that the S&P 500 has suffered worse technical damage, breaking very decisively below its 200 day moving average while NBI is still testing the key support level that is the first line of defense between bull and bear markets.

SPX chart 2015 08 21

NBI biotech index 2015 08 21

This big picture viewpoint tells us two major things.  First, the overall market is in some trouble. And second, biotech – although not immune from the selling – is also showing just a bit of resilience.  But there is no reason to be over confident. This is a dangerous market and all investors, especially those who own stocks in the fairly high risk biotech sector, should be highly engaged in monitoring their portfolio and prepared to act accordingly.   Expect continued volatility in biotech stocks and the overall stock market over the short to intermediate term.

This week we are featuring a third chart, that of the ProShares Ultrashort Nasdaq Biotech ETF (BIS). This ETF, which we have suggested to our subs over the last few weeks as a hedge for their portfolio risk, has acted as you would expect, having risen nicely while the Nasdaq Biotech Index (NBI) has sold off aggressively.  We have adjusted the sell stop on BIS. See below for details.

BIS biotech index 2015 08 21

So, now that we are clearly in a different situation compared to two weeks ago, it is very important to remain calm and objective. Again, here are three sensible things to do in the short term:

  1. Monitor the price of all current positions in your biotech portfolio. If your biotech stocks are not being aggressively sold off and sell stops don’t get triggered, keep them in your portfolio.
  2. Watch the response of your positions to external forces, especially the Fed, China’s economy, and the current political climate.  Always monitor your portfolio’s response to the market and only sell stocks that are showing significant weakness and fall below their sell stop.
  3. Consider using BIS to hedge your biotech portfolio. Our July 27th, 2015 update has an excellent tutorial on how you may go about doing this.  For further reading on portfolio protection techniques and risk management also consider a copy of Dr. Duarte’s “Trading Options for Dummies.”

In Depth:  New EBIS (Emerging Biotech Investment System) Pick: New Recommendation – Greatbatch Inc. (GB)

Alert New Pick:  Greatbatch Inc. (GB) – Buy up to $55.  Sell Stop at $44.

Greatbatch Inc.: An Industrial Medical Equipment Turnaround Story with a Twist

Greatbatch is a restructuring story which looks ready to move higher over the next 6-12 months.  The company manufactures medical equipment under contract to original equipment manufacturers with a focus on the cardiac pacemaker, orthopedics, and spinal cord stimulation segments.  And, here is the twist; it also manufactures batteries and electronic equipment for oil drilling rigs. 

GB gets an 8 EBIS rating, garnering a BUY recommendation.  The company has a diversified product line and has been making strategic acquisitions and selling off unprofitable business lines as it restructures.  And here is the big news.  Even as GB moves through a transitional period, in a challenging environment, it has continued to make money.   Consider the following:

  1. It’s spinning off its spinal cord stimulator business into a separate company it will call Nuvectra, while it continues to generate revenue from manufacturing the equipment for Nuvectra. Spinal cord stimulation is likely to be a money loser or a reduced revenue generator under the Affordable Care Act, despite the fact that it may be expanding its focus beyond pain management into the treatment of paraplegia.
  2. GB has recently bought CCC Medical, enhancing its cardiac neuromodulator equipment line and has already seen an increase in sales contribution from the acquisition. Cardiac remains profitable for now.
  3. It’s growing its orthopedics equipment business. Although the Affordable Care Act could lead to some pricing pressure on this line of products, the demographics for joint replacements are only improving as the population ages. Also, the trauma related product line, including equipment to repair fractures, could benefit from defense related developments in the future if the geopolitical climate worsens.
  4. The company is on schedule to move significant manufacturing capacity to Mexico, expecting significant cost reductions and a positive contribution to the bottom line. This could be a negative in the current political environment but it is something that could lower costs and increase earnings for GB.
  5. Most of the company’s product lines are growing except for the vascular related segment, which is separate from its cardiac product line. In its recent conference call, the company cited improving visibility for this line of business in the second half of 2015 and into 2016; as its customers work through inventory and new products are introduced, especially in GB’s catheter line.
  6. GB has a strong engineering and design team which is addressing issues in the energy sector, including improving design for batteries and exploration equipment. Any turnaround in energy could also provide a boost to the stock price.

Here are the EBIS details:

The EBIS Score for GB is 8 based June 30, 2015 data.  

  • Cash on hand: (+1) GB reported $72.34 million on hand up from $61.58 million in September 2014. 
  • Cash on Hand growth (year over year) (+1): The year over year cash grew by 17.4%.
  • Revenues (present or not): (+1): The company delivered a small revenue growth rate in its June quarter compared to the year earlier. What is important is that its revenues are not falling even as the company restructures.
  • Revenue growth (10% or greater): GB is not growing its revenues currently but has given positive guidance for the second half of 2015 and 2016.
  • Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1)GB has a 0.91 worst case scenario ratio. That means it can cover all of its liabilities in a worst case scenario without borrowing money.
  • Earnings (Present or Not Present): (+1): GB reported flat earnings growth in its June quarter. Again the company is restructuring and still makes money.
  • Net Income Growth (Year over Year): (+1): The company has delivered stable but not growing earnings.
  • Products on the market: (+1):  GB has a broad array of products on the market and a broad customer base.
  • Pipeline Strength: (+1): GB is working with its customers and has a credible pipeline in place.
  • Late Stage Clinical Trials and Product Launches: (+1): The company’s pipeline is nearing launch of new products later in 2015 and 2016.

The EBIS system consists of eleven fundamental criteria that are updated every quarter after the earnings results for each company are published. Each criterion gets a value of +1 or zero.  A total of 8 or more points earn a Buy rating.  A total of 5-7 points earn a Hold rating.  Less than 5 points delivers a Sell or Avoid rating.  EBIS was introduced in the June 15, 2015 issue of the Biotech Report.

Portfolio Update:  EBIS Portfolio Components Again Hold Up Better than Market

Our EBIS portfolio held up fairly well in the week that ended on 8/14/15 despite a volatile market and selling pressure in the biotech sector.  See details below:

Masimo Corporation (MASI) – Buy up to $44.  (Buy issued July 20, 2015. MPP $40.65).  8/21/15 closing price: $41.63

Masimo lost a fraction on 8/21/15 as the Dow Jones Industrial average lost 500 points. The stock is still above our buy point.

Masimo manufactures equipment modules that monitor vital signs during difficult clinical and logistical circumstances.   Masimo pioneered Signal Extraction Technology (SET) a process that lets the pulse oximeter measure the oxygen content of blood without punctures of arteries at states of low blood pressure, where it become a most critical piece of data. 

MASI reported adjusted earnings of 43 cents per share, 13 cents ahead of expectations in the second quarter of 2015, while revenues came in at $ 155 million ahead of the $147.93 million estimate.  The company raised its full 2015 guidance to total revenues of $621 million, up from $608 million and earnings per share from $1.48 to $1.51.    The stock remains well within its buying range of 40-44 and keeps a 9.5 EBIS rating based on its June 2015 quarter.  MASI is a well-run company with plenty of cash on its balance sheet and a growth agenda.  We like Masimo because it has innovative products, an excellent growth rate, and a nice stash of cash on its balance sheet which it could use to make acquisitions or to plow into research and development. 

Meridian Biosciences (VIVO) Buy up to $21 – 8/21/15 closing price $18.26.

Meridian was another stock in our EBIS portfolio which rose on 8/21/15 showing some relative strength.

Earnings/Dividend update:  VIVO met its earnings expectations on 7/23 but fell short on its revenues estimates. The company delivered net income of $9.1 million, 22 cents per share on revenues of 48.2 million vs. expectations of 48.9 million.  Management reaffirmed expectations for the full year of revenues of $193 to $200 million. The stock remains near the lower part of its trading range.   Vivo paid dividend of 0.2 per share on July 20th. The dividend yield is a nifty 4.4%, while the stock price is not particularly volatile. This is a combination which makes having a long term perspective worthwhile.

VIVO has a market cap of $767 million but is a consistent money maker.  The company develops, manufactures, and markets diagnostic testing kits focused on gastrointestinal infections, virus detection, and parasitic illnesses.  It also produces reagents and key testing and DNA amplification and enzyme related materials used in research.  It has recently released a new product, the Para Pak single vial transport system for parasite testing which simplifies the transport of samples to the lab by using one vial instead of the more complicated multiple package systems that are currently on the market. 

We expect VIVO to benefit from the global immigration trend and the potential for infectious diseases to expand their territory via travel related transmission channels.  The company has a well-established global platform including a recently opened office in Beijing (January 2015).  Dr. Duarte owns shares in VIVO.

Neurocrine Biosciences (NBIX) (BUY 6/16/16 at 46 – 8/21/15 closing price $43.75 – Sell Stop at $40)

Neurocrine was weaker than other EBIS portfolio components on 8/21/15.  This makes sense since it is a research stage company which has no earnings and whose revenues are based on investors and debt offerings. 

Neurocrine Biosciences reported a net loss of $24.0 million, or $0.28 loss per share, compared to a net loss of $13.4 million, or $0.18 loss per share, for the same period in 2014. For the six months ended June 30, 2015, the Company reported a net loss of $25.2 million, or $0.30 loss per share, as compared to net loss of $25.2 million, or $0.35 loss per share, for the first half of last year.   Estimates were for revenues of $650,000 and a loss of 29 cents per share. 

The stock has the potential to move to the 55-58 area over the next few weeks to months.  We originally highlighted NBIX in our 5/29/15 update.  We like the stock based on the prospects of its Elagolix drug for treating endometriosis a condition of pre-menopausal women linked to the menstrual cycle and pelvic pain.  Dr. Duarte owns shares in NBIX.  Neurocrine is also advancing phase III clinical trials of its NBI-98854 drug aimed at the degenerative neurological disease tardive diskynesia.   Neurocrine expects further input on Elagolix by early 2016.

Neurocrine is a speculative stock. This is a research stage company with no products on the market but several potential blockbusters at key stages of development and nearing the FDA approval process.

Repligen (RGEN) Buy up to $44.  Sell Stop at $32.

Repligen (RGEN) (Trading Buy 4/20/15 – MPP $33.23. Buy 5/11/15 MPP Price $38.45 – 8/21/15 Closing Price $33.65)

Repligen rallied on 8/21/15 showing some short term relative strength. The stock has been losing its up trend over the last few weeks and could hit its sell stop if the market continues to weaken. 

Repligen reported revenues of $21.5 million and net income of 11 cents per share on August 6, 2015. Both were ahead of expectations.  Estimates were for revenues of $20.05 Million and earnings of 8 cents per share.  The stock has been very volatile of late but remains within our buy area.  

RGEN is the world’s leading producer of Protein A, the basic component of monoclonal antibodies used for research and biopharmaceuticals manufacturing.  Biogen and other major drugs are based on monoclonal antibodies (MAB). If the number of new MAB drug candidates decreases it could affect RGEN’s earnings for the future.

In a recent presentation, spring 2015, the company reiterated its expectations for rising organic growth rates in the 25-29% range due to recent and scheduled product launches.  The company also noted that they have 350 potential molecules in their pipeline. 

Emergent Biosolutions – Buy up to $34.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* $30.63 – 8/21/15 Closing price $33.48) –EBS reported earnings of 36 cents per share for its second quarter of 2015 beating analyst estimates of 26 cents.  Revenues climbed 14% from the year-ago period to $126.1 compared to an estimate of 124.25 million.   The company also announced that it will spin off its biosciences unit, whose focus is oncology to investors.   See our news section for details and commentary below.

EBS rose on 8/21/15 as the market crashed.

EBS announced receiving a $44 million contract from the Centers for Disease Controls to increase the supply of smallpox vaccine.  The previous week EBS announced a $19.7 million two year contract from the Biomedical Advanced Research and Development Authority (BARDA) on July 20th an agency of the U.S. Department of Health and Human Services.  EBS also makes BioAnthrax, a preventive anthrax vaccine and is working on a new generation of the vaccine.  Dr. Duarte owns shares in EBS.

Bio-Rad – Buy Limit Raised: Buy until $155.  Sell Stop $138.

Bio-Rad Labs (NYSE: BIO). Buy (5/18/15 – MPP) $146.25 – 8/21/15 closing price $139.98). Bio-Rad remained in a consolidation pattern as it has been during the last few weeks and is giving investors a rare second chance to enter at the original buy area near $146.

Bio-Rad may be a casualty of the global market selloff due to its reliance on international sales and the currency fluctuations of the moment.

Bio-Rad introduced new product, the IH-500 blood typing system, a self-contained unit that performs a large variety of transfusion related tests. The product is available in Europe, Asia, Africa, Australia and Latin America.

Bio-Rad beat estimates for its most recent quarter on August 6. Revenues were $506.1 million, down 5.7 percent compared to $536.8 million reported for the second quarter of 2014.  Net income was 0.97 cents per share.  Estimates were for revenues of $498.85 Million and earnings of 78 cents per share.  Biorad’s guidance was sketchy as they cited currency effects as being increasingly negative in the future. 

Update:  Trend Following ETF Model

  • ProShares Dynamic Biotech and Genomics ETF (PBE) (Buy 5/11/15 MPP 55.80 – 8/21/15 Closing price 52.74.) Sell stop at $52
  • ProShares Ultrashort Biotech ETF (BIS) – Buy up to $29. Stop Loss at $27. (Buy 7/27/15 MPP* $27.99.  8/21/15 closing price $32.75.)

*MPP – Median Purchase Price

Dr. Duarte owns shares in PBE and BIS.

Results of trades in Trend Following Model

I-shares Nasdaq Biotech ETF (IBB) (Buy 5/11/15 MPP 352.96 – Sell stop triggered at 363 on 6/29/15 – Gain 2.84%.

I-shares Nasdaq Biotech ETF (IBB) – (Bought 7/7/15 at 375 – 7/24/15 closing price 377.78. Sell stop hit at 380.  Gain 1.33%.

News Update:  Big Bets by Big Companies

Last week in this space we wrote about three small research stage biotech companies which were running into hard times as their funding was in jeopardy.  This week, it’s all about the big guys making deals. 

  • Novartis (NVS) is buying a potential multiple sclerosis drug from Glaxo Smithkline (GLX) for up to a billion dollars. Novartis will pay Glaxo $300 million up front for Ofatumumab, an antibody designed to block a key protein.   Novartis will make another payment of $200 million when the drug enters Phase III and another $534 based on unspecified milestones.  This is another sign that GSK is getting out of what it may consider a risky line of business since it sold its cancer division to Novartis for $16 billion last year.
  • Cash rich Valeant Pharmaceuticals (VRX) will buy Sprout Pharmaceuticals for $1 billion. Sprout recently received FDA approval for its female libido drug flibanserin.  Valeant is best known for its aggressive acquisitions of legacy medications and rapidly increasing their prices.  The U.S. Congress is reportedly looking into the company for the practice.

Next Wave Portfolio Update – FireEye (FEYE)

Not only is the overall stock market in correction mode, but tech companies in general and “momentum” stocks in particular are really taking a beating at the moment. This is primarily due to concerns over China’s slowing economy, and to what extent the entire tech sector will feel the effects of a revenue slowdown at the top of the food chain as witnessed by Apple’s share price decline of 20% over the past five weeks.

While we think those fears are overblown, we also recognize the power of negative momentum when enough investors choose to pursue a “risk off” strategy by dumping quality stocks at any price. For that reason we are changing our recommendation on FireEye (FEYE) to a ‘hold’ until it becomes apparent that it has found a bottom and is poised for another run up the charts.

Until then, we’d be surprised to see FEYE drop below its intermediate term support level of $30, about 20% below its current price in the $36. Usually momentum stocks are the last to recover after a correction, so we should have ample time to determine when it’s time to get back into this name again as we should see all of the major market indexes moving back up before then.


NASDAQ Composite Index:                                                                       

Friday, August 21 = 4,607.29                                                 

Trailing 12 months = + 5.4%                                        

Trailing 4 Weeks = – 8.2%

Trailing 7 Days = – 6.8%            

Weekly Portfolio Performance      

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