Next phase of Uniphase

What we can learn from Marvell and Broadcom about the fortunes of the chip market this year, and why I will replace Intel with JDS Uniphase in my portfolio.

This week sees a string of investment conferences that will give investors the opportunity to feel the pace of business for the first quarter, which enters its final third this week. Yesterday, CIBC brought together managers of most of the Israeli companies with investors in a ‘one on one’ encounter in New York, while Goldman Sachs is holding a two day technology conference in hot Arizona. Check Point (Nasdaq: CHKP) and Amdocs (NYSE: DOX) are appearing at the Arizona conference today.

Also due to take place in New York this week is a telecommunications providers conference organized by Merrill Lynch & Co., which be will be attended by all the Israeli companies active in this field, including Orckit Communications (Nasdaq: ORCT; TASE: ORCT).

On Wednesday and Thursday, Deutsche Bank (NYSE: DB; LSE: DBK; XETRA, AEX, SWX, ATX: DBKG) will hold a conference of companies in London, in which M-Systems Flash Disk Pioneers (Nasdaq: FLSH) will also participate. Another importance conference of communications equipment manufacturers will be held in Boston by Credit Suisse First Boston.

Yesterday, analyst Craig Ellis of Salomon Smith Barney today upgraded M-Systems and Sandisk CP (NasdaqNM: SNDK) from "Hold" to "Buy", thereby completing an amazing mountain ride in his ratings for M-Systems. He started two years ago in June with a dramatic "Sell" rating and a target price of $15 a share. He then revised this to "Hold", apparently in response to the criticism he received, and in July last year he upped his rating again, to "Buy", with a target price of $33 a share. Ellis returned to "Hold" last October, and today he once again gave the stock a "Buy" rating and a target price of $38 a share. The share is currently traded at $12 lower than this price.

As I see it, throughout this period M-Systems has not experienced any slalom-like trends in its business activities, but rather, it has posted consistent growth in sales and profits. These waves might be good for short sellers and brokers wishing to earn commissions, but they are devastating for the small investor who prefers the "buy and hold" approach, that is, they want to buy in and stay put. In January, the short position for Sandisk jumped 48% and for M-Systems 17% to 2.3 million shares.

The Marvell train just keeps rolling

Speaking of short sellers, I am crowning Marvell Technology Group (Nasdaq: MRVL) as the stock that short sellers loathe in particular, because it kills them anew with each quarter. Everyone understands that a company which is traded at a value of $18 billion but has quarterly sales of $0.5 billion only, will be massacred, shedding tens of points in value the moment it misses a guidance or results forecast. This is the type of opportunity that the short sellers wait for.

Last Thursday night Marvell published its results for the January quarter. The company had sales of $489 million, representing impressive growth of 44% compared with 2005, and an increase of 15% on figures for the previous quarter. The proforma profit was even more impressive, $135 million against $75 million for the previous year. Following publication of the results on Friday, short sellers immediately brought down the stock price $3 to $60 a share, since they were certain that the guidance, due for release an hour later during the conference call, would herald the end of the Marvell magic after continuous growth over 33 consecutive quarters.

Unfortunately for the short sellers, the Marvell train just kept on rolling, with company managers issuing once again strong guidance for sales in excess of $515 million in the April quarter. They also raised the long-term gross margin target to 53% from 51% in the present quarter, despite having achieved 55% in the reporting quarter. In addition, they announced a two-for one stock split to go into effect in the coming months.

In my view, Broadcom Corp. (NasdaqNM: BRCM) and especially Marvell are two chip companies that give an indication of the trend in coming months in the telecommunications and consumer electronics sectors. After the strong results that both companies reported, it is clear to me that there are no signs of slowdown in the offing, since anyone who placed orders for chips during the first quarter of 2006 has done so in the knowledge that demand for communications equipment and gadgets will last right the way through to the summer at least.

As for Marvell, the results in the latest report caused analysts at investment house SG Cowen to write a review in which they stated that not only did they not expect any imminent halt to the company’s growth, but they even forecast that the company will begin a new growth phase as a result of its entry into new core markets, principally in the electronics sector. To illustrate this, they quote, as an example, Marvell’s wireless communications chips (WLAN), which are now being integrated into millions of Nokia (NYSE: NOK) and Motorola Inc. (NYSE: MOT) cellular handsets that are now coming on the market.

A tough life for Intel.

I have now removed from my portfolio a chip manufacturer which, in contrast to Marvell, has missed out on the consumer wave of recent years. That company is Intel (NasdaqNM: INTC), which has a had tough time as it faces stiff competition from AMD in both its key markets for laptops and desktop PCs, as well as in servers. Replacing Intel in my portfolio is a company that recently came in out of the cold in which it had been left in the aftermath of the bubble. That company is JDS Uniphase (NasdaqNM: JDSU), which was once traded at a record value of $100 billion and then shrank almost to the point where it disappeared completely. It recently returned to stability and is now traded at a market cap of $5 billion.

JDS specializes in tiny optical chips for Internet transmission over fiber optic networks. It was a name that encapsulated all the troubles that hit the telecommunications industry following the major collapse at the beginning of the new century. “The worst stock of the last five years,” was how the Wall Street Journal described it. My hope is that it will go on to become the best stock in the next five years, since the world is moving towards end to end optical networking and JDS is set in coming years to be one of the key suppliers of bandwidth.

Published by Globes [online], Israel business news - www.globes.co.il - on February 28, 2006

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