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| IN THIS ISSUE – January 27, 2012 | www.bullmarket.com |
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Feature Article By BullMarket.com: Apple Steamrolls Expectations with Huge Fiscal Q1 By BullMarket.com: Conceptus Looks to Give Birth to a Turnaround By NextInning.com: Member Q&A - Inphi's (IPHI) Rising Stock Value By BullMarket.com: Member Q&A: A Natural Gas MLP
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Apple Steamrolls Expectations with Huge Fiscal Q1 It was an absolute monster quarter. The company sold 37.04 million iPhones around the world, up 128% from a year ago. It sold 15.43 million iPads, 111% better than the year-earlier period. Each result easily outdistanced the already heady expectations for holiday sales. Analysts on average had predicted Apple would sell about 31 million iPhones and 13.5 million to 14 million iPads. As Evercore Partners analyst Rob Chira put it this morning: "That a Lotta iPhones." The Macintosh also outstripped expectations as Apple sold a quarterly record 5.2 million of the computers, which was 26% better than last year and ahead of the 5 million Wall Street was looking for. The only negative, and it wasn't a surprise since it is a mature product, was that sales of the former engine of Apple's growth, the iPod, slipped by -21% year over year to 15.4 million. The iPhone and iPad now represent 72% of Apple's revenue and neither existed five years ago. "We’re thrilled with our outstanding results and record-breaking sales of iPhones, iPads and Macs," said Tim Cook, Apple’s CEO. "Apple’s momentum is incredibly strong, and we have some amazing new products in the pipeline." Apple earned $13.1 billion for its fiscal first quarter ended December 31st, equal to $13.87 per share. It compared to a year-earlier profit of $6.0 billion, or $6.43 per share. Analysts were looking for the company to report about $9.63 billion in net income, or $10.11 per share. Revenue surged to $46.3 billion, compared with the $39.1 billion consensus estimate and the $26.7 billion the company reported last year. Gross margin also smashed expectations at 44.7% for the quarter compared with 38.5% a year ago. Wall Street's gross margin consensus was 40.7%. The company guided for Q1 sales of $32.5 billion, compared to $24.7 billion last year, and EPS of about $8.50 per share. It guided for gross margins of around 42%, reflecting approximately $60 million in stock-based compensation. Famous for its conservative guidance, Apple's projection was still ahead of the Wall Street consensus estimates of $32.1 billion in sales and $8.04 per share in net income. Looking at the details of the quarter, the stunning sales growth of 128% for the iPhone compared with overall 40% growth of the smartphone market, CFO Peter Oppenheimer told analysts. Apple recognized $24.4 billion in revenue from iPhone handset and accessory sales during the quarter, compared to $10.5 billion in the year ago quarter, an increase of 133%. It started shipping the iPhone 4S to China and 21 additional countries earlier this month. The newest model is now available in over 90 countries. The demand in China "has been staggering," Cook said last night. "We are selling through our reseller stores and our online store. We're not currently selling through a retail store and the demand is off the charts." In another sign that Research In Motion's (RIMM, $16.30, 1.29) BlackBerry handsets are in trouble, Oppenheimer made a point of saying, "nearly all of the top companies in the Fortune 500 now approve and support iPhone on their networks . . . In addition to accessing e-mail, calendar and contacts, many of these companies are developing and deploying mission critical iPhone apps to help improve productivity and give employees secure and immediate access to information anywhere." iPad sales surpassed management's expectations with sell through exceeding sell-in by about 200,000 units, Oppenheimer said. The company recognized $9.1 billion in revenue from the iPad and accessories, a 99% increase from $4.6 billion a year ago. Most large companies have also approved the iPad for use on corporate networks and are developing internal applications for the tablet. Combining iPhone, iPad and iPod touch, Apple surpassed 315 million cumulative iOS-based device sales, selling more than 62 million in the December quarter. The Mac's performance also surpassed the company's internal projections. Sales of all of Apple's products benefitted from a 14th sales week in Q4, but Opppenheimer said, "Mac sales outgrew the market in each of our geographies with particular strength in our Asia Pacific segment, where sales were up 58% year over year. The increase in Mac sales was fueled by very strong growth of MacBook Pro and MacBook Air as well as the continued strong performance of iMac." Though sales for the iPod declined to 15.4 million units from 19.4 million a year ago, the product still exceeded the company's expectations. The iPod Touch accounts for over half of iPod sales and the iPod remains the dominant MP3 player on the market, with a 70% share in the U.S. according to data from NPD. Oppenheimer said it continues to be the top-selling music player in most countries that Apple tracks. The iTunes store generated $1.7 billion in revenue. Apple's retail stores, meanwhile, generated $6.1 billion in revenue, up 59% from last year. The company opened four new stores during the quarter, including a showcase store in New York's Grand Central Station. The other three were in Europe. With an average of 358 stores opened, average revenue per store was $17.1 million compared to $12.0 million in the year-ago quarter, an increase of 43%, the company said. The company's huge quarter generated $16.2 billion in free cash flow and left it with a mind-boggling $97.6 billion in cash on the books, equal to $104 per share. The huge cash horde is likely to increase pressure on the company's board to return some of that cash to shareholders through a dividend, buybacks, or some type of growth-oriented acquisition. Management was typically circumspect about its plans for that cash, but Oppenheimer said management was "examining all uses of our cash balance; what we might do in the supply chain, what we can do from an acquisition perspective, and otherwise. And so I don't have any perspective to share with you today specifically on dividends or buybacks, other than again, we are actively discussing the cash balance. And in the meantime, we're not letting it burn a hole in our pockets." Asked about its supply chain, Cook said that the "component environment is favorable. That was one of the things that allowed us to overachieve on gross margin, and we would predict that the component environment stays favorable on most key commodities with the exception of hard drives, which as you know was very much affected by the tragic situation in Thailand. And I don't predict Apple having a material supply issue during the quarter, but we will pay more for drives during the quarter, and that's reflected in our (margin) guidance." Oppenheimer expanded on the point by saying, "overall we would anticipate our gross margin to be down by about -270 basis points. And we see that largely coming from the loss of leverage on the sequentially lower revenue from the December to March quarter, the non-recurrence of one-time items which benefited us in the December quarter, and the stronger U.S. dollar that we have seen." From a competitive standpoint, Cook said the company saw no evidence the new Kindle Fire from Amazon.com (AMZN, $187.80, 0.80) impacted sales of the iPad in the U.S. either positively or negatively. "The thing that is very different about the iPad is you can see it beginning to appear virtually everywhere. The enterprise has adopted it in a very large percent of the Fortune 500, as Peter talked about earlier. That number is also quite large when you look at the global 500. In education, in K-12, we sold twice the number of iPads as we did Macs, and generally speaking, education adopts new technologies fairly slowly, so that's somewhat surprising. And of course the consumer has moved in a huge way to iPad. And so it's winning market by market by market," Cook said. BMR Take: There is nothing else to say except to acknowledge that this was an absolute blowout of a quarter, but here's something to ponder: Apple could have sold even more iPhones had it made enough of them. Despite planning for a big sales gain for the iPhone 4S, management acknowledged the surge in demand outstripped its most-optimistic projections. Pent-up demand was one driver as some customers held back over the summer in anticipation of the new version, which led in part to the "miss" in the prior period. The other factor was that despite some initial criticism for not being "new" enough, people clearly like features like the Siri voice-recognition system and the internal improvements like a faster processor and better camera. iPhone is also now available through all three of the major U.S. cellular carriers. The March quarter will be sequentially slower because is lacks the holiday season sales driver and it is also a 13-week quarter as opposed to the 14-week fiscal Q1, so a sequential drop in unit counts is almost a given. The week between Christmas and New Year fell in the March quarter last year but was part of Q1 this year. The stronger dollar versus the euro will also impact sequential comparisons in one of the few headwinds facing Apple. Year-over-year comparisons should show another big gain in unit sales. Apple also did something it almost never does and that was to guide above the consensus. We'd wager its guidance is still conservative, but we'd be hard-pressed to find someone to take the bet. Several analysts suggested the company's guidance implies a March refresh of the iPad, possibly even an iPad 3. The company never pre-announces products, however. Remember as well that the iPhone 4S was just introduced into China this month. Apple has been one of the Recommended List's best performers. Including its two stints (we sold the stock in 2007 and then bought it back much cheaper in 2008), the stock has generated an over cumulative 600% return. Despite that astronomical gain, the stock still remains one of our favorites going forward given its solid growth opportunities despite its huge size given that its market share is still relatively low in the rapidly growing smartphone and PC markets and it is still expanding its penetration overseas. The iPad dominates the still fledgling tablet market with no clear competitor, as the Kindle Fire, despite its low price, doesn't match the iPad's functionality and other pretenders have failed to resonate with consumers. Bottom line, we could make a legitimate case that Apple's shares should be trading at $1,000 per share, which is about a 22.5x multiple on the $40 per share in EPS it is projected to generate in FY13 plus adding back its over $100 per share in cash. Given its size that might be a bit of a stretch, but when looking at its growth rate and cash flow generation it certainly isn't. That said, we're going to raise our target from $550 to $650, which is a modest 14x multiple excluding its cash.
Conceptus Looks to Give Birth to a Turnaround According to the company's website, the procedure involves implanting soft, flexible inserts into a woman's fallopian tubes through the cervix without incisions. Over the next three months, the body forms a natural barrier around and through the micro-inserts to prevent sperm from reaching the egg. The procedure can be performed in a physician's office in less than 10 minutes without hormones, cutting, burning or the risks associated with general anesthesia or tubal ligation surgery, the company says. Three months after the Essure procedure, a doctor performs a test to confirm that the inserts are properly placed and the fallopian tubes are fully blocked, giving the patient reliance on Essure for permanent birth control. Once confirmed, the company said the device is 99.95% effective based on one year of follow up with zero pregnancies reported in clinical trials. Health insurers cover the procedure and under the new healthcare legislation the patient is responsible only for a co-pay. The company said that over 550,000 women worldwide have undergone the Essure procedure. Cantor Fitzgerald, in a report that cites data from the Centers for Disease Control and Prevention (CDC), described the company's market potential. "There are approximately 38 million women aged 15-44 in the U.S. using some form of contraception. Within that total, roughly 14.3 million women still plan to have more children and use temporary birth control; Conceptus views this cohort as its 'future market' once those women decide they are finished having children. The rest of the market consists of women who do not intend to have any more children. Of these, about 14.1 million have already opted for permanent birth control, while the remaining 9.3 million use temporary birth control; this last segment represents Conceptus’ addressable market," the firm reported. Another opportunity comes from the Medicaid market. According to the company, Medicaid programs pay for 60% of all tubal ligations performed in the U.S. Tubal ligation also results in permanent contraception but at twice the cost of Essure. Tubal ligations require hospitalization and surgery, which also adds anesthesia risk, but most Medicaid programs won't cover products like Essure. It's a situation the company and its competitors are seeking to change. According to Barrington Research, which has the stock on its "Best Ideas" list, Conceptus has been faced with three big headwinds over the past year or so. One problem has been increased competition; two was the economic uncertainty in Europe; and the third and toughest issue has been the economy and the related weak job market, which has been a headwind for healthcare utilization generally. Poor management also appears to have been part of the problem as the board replaced the CEO in early December after the company pre-announced disappointing results for the third-straight quarter. The company blamed weak sales in November and further deterioration in France and Spain for what it indicated would be a below-expectations quarter. It put off an annual price increase until the market strengthens in the hope the delay would spark stronger sales in December. The new guidance assumed a flat sequential fourth quarter, which analysts said is typically the company's strongest of the year. Conceptus generated $141.7 million is sales in 2010 but its top line was expected to drop to $126.7 million in 2011 when it reports final results. Analysts think sales can grow to $137.6 million in 2012. The company has a market cap of around $360 million and the stock has traded between $9.68 and $15.70 in the past year. Wall Street analysts are leaning bullish on the stock, with seven buy recommendations offset by six analysts that are neutral on the name. The Street's consensus target priced is $14. Barrington is the most optimistic for the stock with a $20 target. Keith Grossman, 51, was installed as the new CEO in December. He's the former CEO of Thoratec (THOR, $30.06, 0.92), which makes circulatory support systems, and most recently was a managing director at Texas Pacific Group, where he started up and led the huge private equity investor firm's medical device investing fund. "Conceptus is an industry leader with a truly differentiated product that improves clinical and economic outcomes for patients, a strong network of physician relationships and exceptionally dedicated employees. We have a solid foundation on which to build, with several recent key achievements, including affirmation of our patents, the launch of our new national direct-to-consumer advertising campaign, and several regulatory actions that expand the Essure market. In addition, the inclusion of permanent birth control under the Preventive Care Provisions of the Patient Protection and Affordable Care Act is a very positive development. We are confident in our ability to position Conceptus for long-term success and reach our full potential," Grossman said in a statement at the time. He has not appeared at any investor forums since his appointment. Grossman moved quickly to cancel a partnership with the Ethicon unit of Johnson & Johnson (JNJ, $65.00, -0.27) that most analysts thought would provide little benefit to Conceptus. Under the deal, Conceptus' sales force was going to promote Ethicon's Gynecare Thermachoice product. The rationale is that it would give the reps another reason to call on doctors, but analysts thought it would only detract their attention from the core Essure product. Grossman evidently felt the same way. He also canceled the company's line of credit rather than risk running afoul of its terms and incurring penalties from lenders. Conceptus has also been involved in litigation with Hologic (HOLX, $19.17, -0.18), a $5 billion market cap maker of a variety of diagnostic, imaging and surgical products for the obstetrics and gynecology market. Hologic is selling its own permanent contraceptive solution called Adiana that Conceptus says infringes on two of its Essure patents. A U.S. district court jury agreed with Conceptus and awarded damages of $18.8 million for lost sales through June 30th, 2011. Presiding Judge William Alsop earlier ruled against Hologic's motion seeking to overturn the jury verdict but at the same time he denied Conceptus' motion for a permanent injunction that would prohibit sales of Adiana in the U.S. He also denied Conceptus' request for supplemental damages, though he did say the company could file a supplemental complaint seeking additional damages since June 30th. "While the judge did not grant our motion for a permanent injunction against our competitor's product, the court's decision today reaffirms the jury's verdict and represents the next step in the process to finalize damages in connection with the jury finding that Hologic infringed on Conceptus' patent," Grossman said in a statement. "We are currently evaluating our options, including filing a supplemental complaint to seek lost profits." Conceptus' stock fell on the news, accelerating a decline that began after the stock closed at $13.73 on December 20th. The stock had previously dropped to around $10 in late November, and then advanced, aided by the news of the CEO change. BMR Take: Conceptus is a turnaround play that has the potential to be taken out by another company looking to expand into the birth control market. Given the new CEO's pedigree and experience with Texas Pacific Group, he appears to be the kind of leader that would look out for shareholder interests and consider selling the company for the right price. In the meantime, he has the industry experience to lead an operational turnaround. We like the fact he's already refocused the company on its core product, which is proven. With Essure now covered by most healthcare plans in the U.S. it has some solid growth opportunities, especially given the company's plans for a consumer-focused advertising campaign to drive awareness. The company would also benefit from reaching a settlement with Hologic. With investor expectations low; signs of the labor market and economy slowing improving; along with easy comparisons and the possibility of improved utilization trends going forward, the company looks poised for a turnaround. The big caveat is that management must show it has a better strategy in place and that it can execute on that strategy, which makes this a stock best suited for more aggressive investors.
Member Q&A - Inphi's (IPHI) Rising Stock Value A) IPHI began trading as a public company in November 2010, and, as I noted in a post we published last July, presents an unique business plan focusing on data center applications. Rather than focusing on the "sexy" knowledge based processor (KBP) markets, IPHI specializes in the unique and challenging analog and mixed-signal semiconductor requirements common to those market sectors. These include products like transimpedance amplifiers (TIAs), modulator drivers, re-timers, clock fan-outs, and frequency dividers for 40G/100G networks. IPHI also makes some very interesting products that substantially enhance interfaces to DDR DRAM memory banks used in server and other high performance computing applications. This is what I think has been driving the recent upside for IPHI. If you look at IPHI's chart, it began moving up slightly ahead of Intel's (INTC) quarterly report, but paused on the 19th (the day INTC reported). This was a classic "anticipation rally" that goes up only so far, and then waits for the anticipated news before setting its final trajectory. What we heard from INTC about the server market was encouraging, and IPHI investors took that as a bullish signal. This is what led IPHI from the low $12s to more recently trade in the $14 to $15 range (and threatening $16.00). There are various ways to enhance DRAM in a server application. Companies like Netlist (NLST) use what's called rank reduction that allows server processors to address larger blocks of DRAM memory. This is valuable and limits latency. IPHI takes it a step beyond rank reduction with a technology called a Load Reduced Dual In Line Memory Module (LRDIMM). With LRDIMM you avoid some of the design complexities inherent to a FBDIMM (Fully Buffered DIMM), as well as the heat issues associated with pushing the higher frequency data paths. The downside to LRDIMM is data line latency can increase under certain applications. However, since most server applications involve what's called consecutive reads where write cycles aren't interleaved, real-world system performance is seldom an issue. As it stands today, at least Micron Technology (MU) and Samsung are both supporting LRDIMM and, I would guess, using IPHI parts in their implementations. Bottom Line: A couple days ahead of IPHI's IPO I wrote that I thought it merited consideration. Following this, when the price of INPI jumped from its $15.45 opening price on the day of its IPO to $25.50, I wrote that I thought the price had gotten ahead of itself. That was obviously an understatement. Due to a near perfect storm of negative events, IPHI fell a low of $7.13 last August and took several months to recover to even low double-digits. As noted above, it didn't begin to mount a serious recovery until just before the INTC earnings report, and once it was clear INTC would deliver on its new Romley server chip promise, it rallied from the low $12s to where it trades today. With a solid balance sheet and the likelihood revenue will grow at least 20% this year, I think there is a reasonable chance that IPHI could move back into the $20s by year-end. However, given the strong rally we've seen, and the fact we can't really map IPHI's growth trajectory at this juncture, I would look for an opportunity to accumulate on weakness here and hold back some funds to build further until after IPHI reports its calendar Q1 results on February 1st. Disclosure: At the time of this publication, out of the companies discussed herein, Paul McWilliams had long positions in INTC.
Member Q&A: A Natural Gas MLP A) While we wouldn't necessarily be itching to get natural gas exposure given the big glut in the country, probably the best MLP for natural gas commodity exposure is EV Energy Partners (EVEP, $65.04, 0.92). As a reminder, EV Energy Partners is an E&P firm active in the Barnett Shale, the Appalachian Basin, the Mid Continent area, the San Juan Basin, the Monroe field in Louisiana, the Permian Basin, Central and East Texas, and Michigan. It had total estimated proved reserves of 817.3 billion cubic feet equivalent at the end of 2010. Most oil & gas MLPs hedge multiple years out, limiting their exposure to commodity prices, and EV is no exception. As of December, the company's production was 74% hedged in 2012, 67% in 2013, and 54% in 2014. However, the company owns 159,000 net acres in the Utica Shale in Ohio, which is the hottest new liquids-rich play in the country. A find by Chesapeake Energy (CHK, $23.38, 0.89) in July, leading it to estimate that its 1.25 million net leasehold acres could be worth an additional $15-$20 billion for the company, caused a frenzy for all things Utica. In September, oil giant Hess (HES, $57.31, -3.01) announced a deal to jointly develop Consol Energy's (CNX, $35.87, 1.18) Utica Shale assets. Separately, Hess also acquired a privately held exploration company and other leases in the Utica Shale for about $750 million. Consol, it should be noted, has the second-most net acreage in the Utica Shale behind Chesapeake, with 400,000 net acres. Among publicly traded companies, EV is third. In late September, Chesapeake announced results from its first four horizontal Utica wells, with initial production rates ranging from 1,530 boepd to 3,010 boepd. Wunderlich analyst Irene Haas noted that these results put the wells in the same category as some of the best ones in Eagle Ford, and that based on Chesapeake's $15-$20 billion valuation, she values Utica Shale acreage between $12,000 and $16,000 per net acre, which is also comparable to Eagle Ford. In early November, "a major oil company" bought a 25% interest in a joint venture between Chesapeake and EnerVest, which owns 76.25% of the GP interest of EV and operates 93% of EV's assets, valued at $15,000 per acre. In mid-November, completion results at Chesapeake's Harvey 8H well showed even better potential economics than previous results, with initial production of 603 bbls/d of condensate and 3,811 mcf/d of gas. BMR Take: The story in natural gas right now is wet gas, which has high levels of condensate. That is why the Barnett Shale, the Marcellus, and now Utica are so highly valued. That said, these assets would be even more valuable if natural gas prices increase. Using a price of $14,000 per net acre would value EV's Utica assets at around $2.2 billion. With EV sporting an enterprise value of only around $2.7 billion, its Utica Shale assets obviously represent a big untapped resource, and it has formed a JV with Chesapeake to develop these assets. Right now, valuing EV brings a similar dilemma as does valuing Range Resources (RRC, $59.86, 2.66), in that the takeout value is a lot higher than valuing the company based on its operational results. EV also has the added caveat that Utica is largely undeveloped and its (and others') acreage in the region may not have the same economics as the initial results from Chesapeake suggest. That said, if you're looking for an MLP with natural gas commodity exposure, EV is probably your best bet. The stock currently yields about 4.8%.
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