The Barnard Observer

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Home  Picks  Figures  Great Investors  Vault  OpEd Contact   c2003-04 Thomas Barnard

    Sometimes when looking for investment ideas it pays to look around and see what's hot or going to be hot soon.  And the thing that is clear as day to me is that VOIP (Voice Over Internet Protocol) will be the next big thing.  It's cheap, it's convenient, and it's going to happen.  Vonage is the big player now, but everyone is going to have to get on board or be forgotten.  Vonage, now privately-owned, looks to me to be a company that will be acquired by a baby bell, SBC, for example.

    It could be one of those very exciting events for investors.  Stocks that have been clobbered and beaten down, but with an unbelievably exciting future.  So, who will be the winners of VOIP?  Perhaps the baby bells SBC, Verizon and the like because they own the fiber-optic networks companies like Vonage and Skype surf on top of.  But not right now, Verizon and SBC are none too happy about the free-grazers (for those who've recently seen Open Range).  Perhaps there is a money-making opportunity among the networks, but I have not figured that one out yet.  And I think they're trying to figure it out, too, because an article I spied in the Wall Street Journal shows they're trying to figure out how to deal with those people who are eating up their bandwidth - the VOIP telephone users, music downloaders, video downloaders.

Trouble for the Free Grazers

    The article in the Wall Street Journal (Peter Grant and Jesse Drucker, October 21, 2005, Page A1) pointed out that Verizon Wireless and Vodaphone Group PLC already stipulate that customers can't used the company's high-speed Web-access networks for internet calling.

    A representative from Time Warner complained that those swapping music or video files slow down the network for other users, who are doing more mundane things like using email to send a picture of kids.  Apparently, just one video-file-sharing program, BitTorrent accounted for 18% of Internet traffic on cable operators' networks this year.  And they worry that left unchecked, they could eat up all bandwidth available on the network.

    One company, Verso Technologies, is offering "Skype Filtering Technology" to block the use of Skype, a VOIP telephone company that piggy-backs for free on top of the networks.  Other software may end up delaying or re-routing traffic which may slow down the downloaders.

    I don't know how well this re-routing will work because when my own internet connection slowed down, I waited for a while to see if it would right itself, but then I was on the phone to my provider.

Enter, the Network Builders

    The only really happy solution to this is to ramp up the networks, and maybe charge for extreme bandwidth use.  But networks need to be robust because VOIP is coming, and so are videophones, which will be used primarily by business to start (along with video-conferencing).  Bandwidth usage is going nowhere but up. 

    Conference calls are getting more sophisticated. HP has a very exciting and expensive product for conference calls.  It's too small a part of their business to recommend HP for one product, but it shows the need for more bandwidth and networking equipment. 

    No, the clear thing to me is that network manufacturers, Cisco, Juniper, Lucent, Nortel, JDS Uniphase are going to be winners.

    Already, there is some good news.  Juniper's earnings were up 72% in the most recently reported quarter to $84 million (up from $48 million last year), and it was up on very good revenue gains, sales increased from$375 million up to $546 million (45% increase). 

    I think Cisco (CSCO, $17.87) is due to be one of these winners.  It is the largest provider of internet equipment, and their business should be one of the biggest benefiiciaries.  Most of my friends know, I am no fan of large cap stocks, simply because if you are as big as a country, you can only grow at the rate of its GDP, which is typically 3% to 4%.  However, I am making an exception for Cisco because this stock has enough compression built in to allow it to double in a very short time.  To illustrate the compression look at profits for the past few years against the average of the high and low of the stock price for that year.

            Profit                                            Average Stock Price

2001    $1,970,000,000                                        $27.75

2002    $2,873,000,000                                        $14.95

2003    $4,287,000,000                                        $18.45

2004    $5,337,000,000                                        $23.47

2005    $5,741,000,000                                        $18.65

    I see the profits going up dramatically, while the stock price has done nothing.  I call that classical compression.  The stock price is sitting below the average of this year's high and low as well as the two prior years.  The range for the stock price for the most recent 52 weeks is $16.83 and $20.35.  It is a particularly stagnant range.

    If I am correct about demand, and it is hard to imagine that if the networks are being taxed by huge use, that I could be far wrong, then Cisco will be a winner.  If not this quarter, soon.

Flat Liners

    There have been a number of flat liners among the large caps.  Microsoft has gone nowhere for years, same for Intel.  Cisco is another flat liner.  But Microsoft hasn't come up with a new operating system upgrade for years, and the early word on the new system is that it's nothing special, so there is no impetus to raise bids on the stock price.  Intel, despite its huge capacity and large profits, is seen as stodgy as compared with nimble AMD.

    Once again I think Cisco is in a unique position because they will ride a wave of expansion on the Internet that is the equivalent of Jefferson's Louisiana Purchase.  A second coming much larger than the first.  It is good for the long term and the short term.

Next Year

    But I think after Greenspan leaves office, we could have a very bad year.  So, if we do get a year end rally, I may be out in January.  Bernanke, who appears to have excellent credentials, will be sorely tested in his first year on the job.  Cheap money funded zero percent loans for auto buyers, and a wave of speculation in home buying the likes of which I have never seen or heard about in this country with the possible exception of the Florida real estate bust of the 1920s, and the flood of money has sopped up demand, so that there is hardly a piece of bread around to sop up the rest of the gravy.  We may get through Christmas okay, but at some point I think there will be a problem.  I think the Dow Jones will pierce it's old low of 7,181 on the downside.  But it may also just about hit its old high of 11,908 on the upside before the slide.  It looks like a bumpy flight.  The way I see it, prices go higher for three months and everyone will be thinking the stock market will go up indefinitely and we'll be hearing the old refrain, "it's different this time."

The Junkers

                Recommended Price    Current Price    Incr/Dcr

Lucent                 3.06                        2.78             -10%

Gateway              2.71                        3.08            +13%

JDSU                  2.06                        2.35            +14%

Sun Micro           3.89                        3.90            +  0%

The Junkers are holding their own.  I am adding one more to the junker list.  Nortel Networks (NT, 3.31).  My favorite from the junker list is Gateway.  For a couple of reasons.  It had a decent quarterly report.  The price action is positive.  I like the new leadership in Wayne Inouye.  I was happy to find Gateway represented at Best Buy, and Wayne's bio shows the reason for the connection.  He used to work there.  He has gotten costs down to the Dell's level.  Dell has been growing by doing the Bluejay thing, eating everyone else's lunch.  But now the competition is learning what it has to do to survive, and Gateway may thrive.  If the prices of computers are so low, consumers may not bother calling Dell, because now it's an impulse purchase, and you can put one in your shopping basket at Best Buy.  I think it's entirely possible it may double between now and checkout time in January.

November 6, 2005

Addendum

    Cisco's quarter was not horrible, but it didn't reflect the growth that some its competitors have enjoyed.  A penny above estimates, it took a hit like other large caps have done recently.  Its margin improved to 68%, above the 66% reported in the last quarter.  My conclusion is that it will enjoy a modest rise if there is a year end rally, but I don't sense that the compression I feel is the stock will be released at this time.

    JDS Uniphase also had an earnings report.  Sales were a little above, and earnings came in as expected, a penny loss.  If there is a year end rally, it will rise in line with the market.

    My overall sense is that the networking boom that I anticipate is still in the making.  VOIP is in its infancy.  Television over the internet is its infancy.  I think the demand for bandwidth is going to be terrific, but it may take a while for it to kick in.

    Gateway may do the best in a year end rally.  It's earnings report is past and was fine (a penny above), but it is its prospects are that I like.  They should be ready for Christmas with machines in Best Buy, Circuit City, Staples, CompUSA and Costco, 7,000 locations in all.  And valued at only one billion with 6.4% U.S. market share.  Dell by contrast has 18% of the PC market, and a value of $70 billion.  Dell has three times Gateway's market share, but 70 times its value.  One of these is either grossly overvalued or grossly undervalued.

    Gateway at a billion or two or three could be bought for its market share.  If it were valued at the Dell premium, it would be worth on the order of $20/share.  I don't necessarily think it will be bought, but if it were bought, my money would be that the money would come from the east - Acer, maybe, with 4.7% market share.  But then maybe an Indian conglomerate might want in.

As Amended November 11, 2005