Large Caps, Small Caps Taking Advantage of Advances in Molecular Analysis

The announcement that Johnson & Johnson may sell its $2.2 billion Ortho Clinical Diagnostics division for blood and cholesterol tests was no surprise to those who watch the genetics/molecular diagnostic space. Nor was it a surprise that J&J  wants to dump this division to “focus on genetic screening to complement its drug pipeline,” according to Bloomberg Businessweek.

Graphic courtesy of UKhumanrights blog

Graphic courtesy of UKhumanrights blog

Thanks in part to the much lower cost of genome sequencing, a crowded field of health care companies is vying to take advantage of the recent significant advances in molecular analysis. The cost of genome sequencing, a hefty $300 million only 10 years ago, is now on its way down. Way, way down. A recent Motley Fool article suggested it will be less than $1,000 in the near future.

We have been watching a few small cap molecular diagnostics companies in the past few months. Here is an update on a few we selected at random and last noted in May 2012.

Carlsbad, CA-based GenMark (Nasdaq: GNMK, http://www.genmarkdx.com/) is a molecular diagnostics company that develops the testing equipment used by labs for the detection and measurement of DNA and RNA targets in patient treatments. Its eSensor detection technology enables the detection of up to 72 distinct biomarkers in a single patient sample. Its XT8 System has been cleared by the FDA and is designed to support a range of molecular diagnostic tests with a workstation and disposable test cartridges. Back on May 11, GNMK closed at $4.95 with a market cap of $106 million. It closed Feb. 1 at $11.09, up 33 cents for the day. Its market cap is now $362 million.

Menlo Park-based Pacific Biosciences of California (Nasdaq: PACB, http://www.pacificbiosciences.com/) has developed an integrated platform for genetic analysis. The company is focusing on the DNA sequencing market and has created what it  calls its single molecule, real-time (SMRT) technology to record individual biochemical events as they occur. PACB is considered a development stage company. Back on May 11 PACB closed at $2.52 with a market cap of $146.3 million. The stock closed Feb. 1 again at $2.52, up 4 cents for the day with its market cap unchanged.

San Diego-based Sequenom (Nasdaq: SQNM, http://www.sequenom.com/) made headlines last year with the announcement of its fetal Down Syndrome test. SQNM operates in two segments: molecular diagnostics and genetic analysis. The company is focused on translating the results of genomic science into solutions for biochemical research and other areas. SQNM still trades actively (a daily average of more than 4 million shares). The stock price last May 11 was $5.18 with a market cap of $593 million. It then dipped during the summer to about $2.70 but has rebounded since. It closed Feb. 1 at $4.16, up 1 cent for the day. Its market cap is now $478 million.

Mountain View, CA-based Complete Genomics (Nasdaq: GNOM, http://www.completegenomics.com/) is a life sciences company that has developed a DNA sequencing platform for human genome sequencing and analysis. Its genomic analysis platform provides its customers (academic and government research centers, biopharmaceutical companies, healthcare providers) with data to be used for genome-based research. GNOM closed May 11 at $1.98, with a market cap of $70 million. Its made a nice gain since then, closing at $3.12 Feb. 1 with a current market cap of $108 million.

Irvine, CA-based CombiMatrix Corp. * (Nasdaq: CBMX, http://www.combimatrix.com/ operates mainly in molecular diagnostics and genetic analysis with a specialty in pre-natal chromosomal microarray testing. Combimatrix focuses its efforts on the developmental (pediatric) and pre-natal markets and is the only independent public company specializing in genomic arrays.  CombiMatrix closed May 11 at $1.01 but since then has done a 1-10 reverse split of its common stock. It closed Feb. 1 at $4.34, down 58 cents on the day. Its market cap is now $4.6 million.

Los Angeles-based Response Genetics (Nasdaq: RGDX, http://www.responsegenetics.com/) develops and sells clinical diagnostic tests and pharmacogenomic tests used in the treatment of cancer. It offers tests for non-small cell lung cancer, colorectal cancer and gastric and gastroesophageal cancer. The company also develops tests for other types of cancer that identify genetic profiles of tumors that recur after surgery. RGDX closed May 11 at $1.50. It closed Feb. 1 at $1.45, down 4. Its market cap is now $47 million.

* Denotes client of Allen & Caron Inc., publisher of this blog

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Warren Isabelle: 2013 Will Be A Stock Picker’s Market

Warren Isabelle is a Managing  Member of Ironwood Investment Management LLC, located in Boston.  Ironwood is a prominent small-cap investor, defining small-cap as below $2.5 billion in market cap.  Prior to forming Ironwood in 1997, Warren was Head of Domestic Equities for Pioneer Capital Growth Fund, Pioneer Small Company Fund and  several institutional portfolios.  Before joining Pioneer in 1984 he was an analyst with Hartford Insurance Company.  He is a bit of a polymath, with a U Mass BS in Chemistry, an MS in Polymer Science and Engineering, and an MBA from Wharton.  He has been the subject of articles in Barron’s, Business Week, Forbes, Fortune and The Wall Street Journal.

I first met Warren at Pioneer in the early 1990s, and had the pleasure of talking to him late last week about his outlook for the year ahead.

WIPhoto

JA:  What are your predictions for 2013 overall, and what kind of market do you think we will be seeing?

WI:  This year my crystal ball is as murky as I have ever known it to be.  The crosswinds that are blowing are not gentle breezes; they are pretty stiff gale winds.  I think we will see some growth spurts in the market this year, and some retreats, but frankly I don’t see a heck of a lot of progress being made this year for the overall market.

Businesses have been on a roll the last four or five years in terms of improving productivity, cutting expenses, improving margins, and so forth.  A lot of companies are making money hand over fist, but until we get some macro issues sorted out, those crosswinds are going to make forward progress difficult.

2013 should be a stock picker’s market.  We will be looking for companies that can maneuver through the times ahead.   The market will have a hard time breaking higher ground, but we are stock pickers and always have been, and if we can continue to do our job well, our investors will be rewarded.  The world is so concerned with the macro issues; it pays dividends for us to pay attention to those.  On the plus side, we do have easy money – the cost of capital just seems to get lower and lower and though the recovery does not seem all that well established, you might say that time tends to heal all wounds.  There are green shoots here and there, and that will continue.  Small caps generally do better in a developing recovery, and we expect that to continue.

On the other hand there are plenty of mines that could explode and cause big problems.  As such, we have to be careful of stock trading liquidity.  One thing that has benefitted us at Ironwood over the last few years is that we have been much more willing and able to maneuver with individual holdings and as a result, our performance has not suffered from liquidity issues as it has in the past.  Before that we used to be dedicated buy-and-hold investors, period.  But since 2008 we believe we have reconsidered on that issue, and we are not afraid to hold cash now if the environment warrants.

JA:  In many recoveries, there are a lot of new companies started by people who either were laid off in the downturn, or who lost faith in the ability of their employers to continue growth.  Are you seeing any of that this time around?

WI:  Here’s my take.  I do a lot of work with the University of Massachusetts, both on the investment side for the Foundation, and on the intellectual property side with the Lowell campus.  I can tell you that the entrepreneurial spirit is as alive as it ever was.  But what has happened is that the traditional venture capital model of relatively long-term funding with an eventual IPO – has been impacted negatively by this ugly downturn.  As a result, many providers of early-stage capital have largely lost patience for long-term investments.  The era of that model being dominant, I think, is over, and that VC model has run its course.  The VC money that is being invested now, and there is less of it, appears to be being put into narrow areas like Software as a Service and Cloud Computing.  The model is shifting, and I am sorry to say that I do not think that crowdfunding will be the answer.

There just are not a lot of IPOs.  We don’t see the new-company formation process in as high a gear as it was before.   The risk-return equation is now much more weighted toward return, and light on risk.  That means deals are later-stage, and valuations are higher.  The early-stage companies are not in the mix.  Is the model totally broken?  All I can say is that later-stage deals are what we see happening now.

JA:  Do you think we will get a budget this year?

WI:  I think the House will produce a budget, and then it will be up to the Senate to modify it.   There will be a good deal of hemming and hawing and a lot of finger pointing, but I think we will get there.  A lot depends on whether President Obama will negotiate or not.

JA:  Let’s talk about sectors to watch for 2013.

WI:  I can tell you what we’re looking at.  First of all we think that because of the general uncertainty about our economic situation, “discovery” names will be interesting this year.  For example, there are many unmet needs in healthcare – therapeutics, diagnostics, and even medical devices to some extent.  If we can continue to find the names that have potential, not only will that help in meeting  medical need, but  large pharmaceutical companies and the bigger and successful biotech companies will be standing in line seeking to replenish their product offerings.  Those big companies have become distribution channels to a large extent, and they need the discovery companies to help in coming up with new products.

We tend to like companies that are local – not exclusively, but that is a bias we have.  We like to be close to the companies we invest in, knowing what makes them tick, and close geographically if possible.  If your investments are in the neighborhood, it’s a lot easier to fill in the information blanks, it seems to me.  One local healthcare company that we have owned for a while that is still relatively small is Synta Pharmaceuticals Corp (SNTA), which is in Lexington.  One thing I noticed early on about them is that with new financings, the senior management consistently invested serious money into the future of the company. Their most recent offering was also heavily subscribed by insiders.  We consider it very favorable when management is willing to take the same kind of risk that we are exposed to.

SNTA has a number of products, but I will mention its lead product, Ganetespib, an Hsp90 inhibitor.  Hsp90 is a protein that is necessary to the growth of tumors, and if you can inhibit it, the theory is that you can degrade or destroy the tumor, the more so in combination with other cancer drugs.  I believe it has shown pretty good results in non-small cell lung cancer, for instance, which is a notoriously difficult cancer with high mortality rates.  And, as I said, the insiders have put their own money on the table, which is encouraging.  SNTA has gone from $4 to $10 in the last year, but we think there could still be good upside if, with clinical success, some big pharmaceutical company decides to make a bid for them.

Another company, and one that took us a long time to get involved with, is Repligen Corp (RGEN), which is also close by, in Waltham.  I visit them every few months to make sure I stay on top of developments there.  About 18 months or so ago, they had change in their board of directors which turned out to be the first clue that the company was finally undergoing a transformation. Their legacy and main business currently is the supply of Protein A, which is essential to Protein A affinity chromatography, considered the gold standard in the purification of monoclonal antibodies.  They went on to develop some drugs, but  were never adequately structured for that, in my opinion, though over time they actually built up a pretty good cash balance.  Following several disappointments and apparent lack of focus, they came dangerously close to being perceived as something of a zombie.  Then the Board changed and they seemed to find direction and began to employ that cash.  They acquired their only competitor in Protein A and are now in a dominant position, with opportunity to really ramp up profitability by rationalizing costs and capacity.  In addition they have developed a line of disposable “column” products that are used in chromatography for the downstream purification of biologics.  This new modular approach to development and production is rapidly gaining acceptance by their customers which now include CROs, discovery companies, successful biotechs and big pharmaceutical companies.

JA: Which other sectors are you watching closely?

WI:  It so happens that through individual stock selection, we have increased our weighting in technology, and in particular we’re watching some turnarounds with interesting new agendas that are gaining traction.

First, though, I‘ll mention Extreme Networks (EXTR), which is out in California.  They make data switches, and theirs are the fastest and best products available in that category.  Why is it a great investment now?  We believe the need for ultra-high-speed data switches is here.  What has held EXTR back in the past has been the higher cost of their industry-leading switches, and while we think their management was great on the tech side, they could have been better in marketing.  Recently, a new management has come in and emphasized marketing and how to go to market.  Extreme has great products, a good balance sheet with $100 million in cash such that with good execution,  we believe the stock could  be a multiple of what it is now.

A second one – and again a local company in Westford – is Sonus Networks (SONS).  They are a comeback company who had an earlier gateway product that essentially became commoditized and is winding down now.  That is all people see about SONS today.  But they have a new product line now built around Session Border Controllers, or SBCs.  They basically hold access (a “pipe”) open for a user, something like a traffic cop, so lots of information can get through when desired.  We think that the old product decline will be offset by the growth of the SBCs over the next 18 months or so, and we think that most people in the market are looking only at the old product.  This company has a $600 million market cap with $320 million in cash.  And the new CEO is taking all his compensation in equity.  That’s impressive, and we think there is at least a double in this stock.

JA:  Fascinating.  What’s next?

WI:  We like some agricultural companies as I cannot overstate the importance of food production given the global growth of what we would call the middle class.  We are again looking favorably at Chiquita Brands International (CQB).  It is not a sexy company, but they appear to be back on track.  They went off the rails with pre-packaged salads, as the effort to boost margins and steady earnings never materialized.  They were also hurt by a bizarre tariff structure introduced by the European Union which cut deeply into volumes and profits.  Now they have new management and the emphasis is back on bananas and fruit.   All I can say is that the rough edges are smoothing out; the tariff picture is much better;  and spending is again going to their traditional business.  In past years, at the peak of a cycle, they were earning $3 a share, and the stock approached $30.  Now it’s at $8, but we think they can earn $2 a share in the near future, and if that happens, the stock ought to be at least double from here.  Yes, they have a lot of debt, but their cash flows have always been adequate.

We also like Pilgrim’s Corp out in Colorado.  Most people know them as Pilgrim’s Pride, and they are a chicken and turkey company.  They were bailed out a few years ago by JBS, a large Brazilian company that now owns 75% of the company which dampens investor interest, but we think that also provides downside protection. The stock had gone down to $3 on fears of rapidly rising feed costs, so we increased our position and the stock has rebounded nicely to over $7, with room to grow.

JA:  I have to say those were not companies I was expecting you to mention.  Anything else?

WI:  We like natural gas, and I’ll mention two companies: Rex Energy Corp (REXX) and Carrizo Oil & Gas (CRZO).  They did not help us last year but we think they are good operators which is the key to the investment thesis.  They are developing a lot of properties through fracking and drilling, particularly in areas where gas liquids are significant part of the production.  In the energy industry we are looking for companies that can acquire good properties and develop them efficiently.  Natural gas is currently in abundant supply and pricing is depressed. Of course we would like to see pricing increase, but we are much more  volume-oriented.  Longer-term, we believe we will be seeing natural gas exported from the US, and prices will come up if only because the differential between natural gas and oil is too wide. All good for the stocks, I would suggest.

JA:  That’s a lot to consider, Warren.  Many thanks.

Neither Allen & Caron nor Joe Allen owns the stocks mentioned in this article, nor do we anticipate initiating positions in the near future.  Please do your own research.

Mary Lisanti: Continued Corporate Earnings Growth in 2013 (When the Federal Government Resolves the Budget)

Mary Lisanti is president and portfolio manager of AH Lisanti, an investment management company currently focused on small cap growth companies. She is a 33-year veteran of small cap growth research and investing. For the first 12 years she was a small cap analyst and strategist on Wall Street. During the past 18 years, she has managed small cap portfolios at premier asset management companies. As CIO of ING Investments LLC, (1998-2003) she was responsible for building the active equity management team, and assets under management in her area grew from several hundred million to several billion dollars. Prior to ING, Mary was at Strong Capital Management as Senior Portfolio Manager for both the Small Cap Growth and Mid Cap Growth Strategies and was Managing Director and Head of the Small/Mid Cap team at Bankers Trust Company. Mary was named Fund Manager of the Year in 1996 by Barron’s. She was named #1 small cap analyst in 1989 by Institutional Investor’s All-Star Research Team. In addition, she was ranked #2 and #3 in 1987 and 1986 respectively.

Mary-headshot

I had the pleasure of talking to Mary just before the New Year’s holiday at her office near Rockefeller Center.  We had first met in the late 1980s when she was interested in a technology company that proposed the radical idea of a keyless car ignition or computer security system using a fingerprint.  Interesting how what seemed futuristic now seems almost as old hat as, well, men on the moon.

JA:  How are you feeling about the year ahead?

ML:  Undecided.  I’ll give you some positives and some negatives.  One big positive is that corporate profit growth will still be decent.  Corporations are at very high profit margins, but when you break down what’s going on, there’s no reason they shouldn’t go higher.  Virtualization – the use of cloud computing, and other aspects of today’s high tech should help them cut costs.  For that trend to stop, two things would have to happen: a long period of negative revenue growth, accompanied by fast-rising wages.  Neither of those things is happening.

That will be a positive for the market.  Corporate profits are growing 8-10% and we believe that can continue, and that is widely dispersed across the board.  Small caps can grow even more,we believe, although again there will be wide dispersion in individual results.  This will be a classic stockpicker’s market.

The biggest negative for the market is that we cannot seem to govern ourselves.  That weighs on multiples.  That’s why, four years into this recovery, multiples are still low, particularly when you take into account where interest rates are and how  GDP growth, although below trend, continues to chug along at 2% or so.  In that scenario, logic would have it that multiples would be in the range of 18-19, but they are not.  Why not? I believe it is because of our inability to govern. Politicans are behind the curve;as they usually are, in addressing our structural issues to bring the long term deficit issues under control. Will they address the longterm issues or not?  If they do so now, it will require only modest changes to entitlements and spending. The extent to which we address those issues will affect the performance of the market going forward.

It is psychologically important to multiples: if you can slow the growth in spending at least a bit, you give people more confidence.  In the Clinton years they managed to slow the rate of growth in spending, and Clinton left office with a surplus.  I believe we will spend most of 2013 arguing about entitlements and other budget issues.  Next year it will be the Democrats saying no to entitlement reform, just like this year it was Republicans saying no to taxes.  I don’t know how much it is possible to get done, because it is being done in a fishbowl and from ideological positions that don’t accommodate compromise.

If they do not get something done, I fear that US debt will get downgraded again.

JA:  And would any of the DC politicians feel responsible if that happened?

ML:  I do not believe so, no.  Politicians, in my opinion, are in the business of passing the blame.  If there were another downgrade, it would affect President Obama’s legacy, and I don’t think he wants to be the president who oversaw two debt downgrades in his time in office.  Both sides will have an incentive to compromise and hopefully they will.  The biggest risk to all of us, and to the market, is that the dollar loses a bit of its luster as the currency of last resort.

When you look at Japan and China and Europe, they are getting their act together with regard to being attractive places to invest and could even potentially be attractive as reserve currencies in a few years.  My biggest concern is that we permanently change corporate behavior: if you have a climate of uncertainty for long enough you make people afraid.  Business overall has been clear with Washington that the uncertainty is damaging.  R&D tax credits, farm and agriculture bills, accelerated depreciation – Congress has been handling these as though they were annual issues, and they’re not.  They affect multi-year planning.  When the R&D tax credit was put in place in the early 1980’s, it was in place for 4.5 years.   That would be better—it would give businesses the ability to plan longer term..

These and other things are casualties of this ideological warfare in Washington.

JA:  What do you see as strengths in 2013?

ML:  It is an enormous positive that housing is recovering, and the recovery should continue, assuming Washington does not cut the mortgage deduction..  Unemployment is declining, although it is declining too slowly.  And we have cheap sources of energy.  . A number of industry sources believe that we will be energy independent in the next decade or so, which is a huge positive for our manufacturing competitiveness.

When you look at these things, once we make it through this budget and debt-ceiling problem, things look a lot better.

Governments all over the world have been spending money to fix the problems that caused the recession, and odds are that things will not fall apart again soon.  Over the past several years, we have had a major issue every year that has “terrified” us: last year it was the potential breakup of the Euro and Greek debt default, and this year it was the budget crisis in the U.S. Beyond the budget crisis, I do not see an issue that has the potential to scare investors as much as these two issues have. We should enter a period of more “normalcy,” where macro issues take a backseat to fundamental issues, and that change should allow multiples to increase. But belief in a more stable future will come slowly.

JA:  What should we look for in 2013 when we look at investments?

ML:  As small cap growth investors, we look for earnings growth.  But one of the great positives in this market is that there are many ways to make money in the market.  When I came into the business in the late 1970s, you could make get 7-8% returns several ways.  You could make money with yields –- those companies with no earnings growth offered very high dividend yields, say about 7%; those companies with earnings growth offered more modest dividends, say 2-4% dividends and 4-5% annual growth in earnings.  Growth stocks offered  very little in the way of dividends, but you could get capital appreciation as earnings would increase 10% to 15%.annually. Then, as we moved through the great bull market of the 1980’s and 1990’s, we got to the point where dividends were out of favor and capital appreciation was the only way to make money.. Now dividends are back and once again there are multiple ways to make decent returns in the stock market, depending upon one’s tolerance for risk..That is very, very positive for the equity markets.

JA: How about sectors?  Any of special interest, or any you would avoid?

ML:  There are good companies in every sector.  I would not recommend the utilities, but there are very good opportunities in materials, energy, consumer products and services, industrials and financial services,  In most of these the small caps usually have something unique about the way they do it, or the technology they apply to it.

Tech spending is not forecast to be up much in 2013.  There will be winners and losers.  We need to keep in mind that the corporate world is moving toward Software as a Service, which allows them to stop buying perpetual licenses, and to pay as they use software.  They are going from buying licenses and maintenance contracts, and now are basically paying just for what they use.  Same with cloud computing.  So they are going from spending $20,000 on software and a server to paying $1,000 month.  So even though tech spending is forecast to be close to flat, the companies that will be winners will have SaaS and cloud computing.  These trends will hold down spending.  It’s hard to see how the semiconductor companies are going to prosper in that environment, unless it is the specialty chipmakers who are specialized in populating ever-smaller chips with ever-larger amounts of circuitry for tablets and smart phones – or those companies that are specialized in the ability to manage the signals for those tablets and phones.  But other than those two, I don’t see a lot of growth there.  And I would be careful about traditional license-oriented software companies.  .

JA: What about healthcare companies?

ML:  Interesting.  It’s hard to guess how ObamaCare will play out.  There are some longterm secular trends in healthcare that are worth keeping in mind.  Keep your eye on the value proposition: better, faster, cheaper, more automated.  One of the most interesting areas is the second generation biotechs.  Think about AIDS, for instance.  Over the last 25 years it has become a livable disease – that is, we haven’t cured it, but we can make it possible to live with it, and to do well, not just to survive for a few more months.  Now the industry is working to make cancer livable in the same way; there are whole new classes of drugs that enable people to live with cancer, and not to just be blown away by it in a short time.  Possibly we are spending the same amount of money making cancer livable as we used to, but now we’re spending it over a longer period, and not all at the end of life.  Diabetes monitoring, for instance – the closer we get to continuous glucose monitoring, the better for diagnosis and treatment; One of our investments is Dexcom (DXCM), which has a promising technology for that.  All those big diseases are interesting, and medicine is getting its arms around them too.

JA: How about healthcare IT?

ML:  It has historically been mostly about billing and insurance, but now the future is to move on to quality of care.  Since we have had health insurance as a society, the focus has been on what you might call “industrial metrics,” such as how many patients you can process.  Now the quality of the outcome is more important, and best practices are more important.  There will have to be penalties for readmissions of the same patient.  Mobile apps for monitoring things like blood pressure, glucose, heart problems and blood gases – these things are going to become standard practice over the next 5 to 10 years.

JA:  You mentioned the impact of technology on industry.

ML:  There are lots of new beginnings now, along with outmoding of old things.  Software as a service and the use of the cloud – this is the biggest piece of cost to cut.  If you can cut your IT costs you have overall better margins, and better processes too.  And industrial automation is interesting too.  The first generation of automation concentrated on, for instance, lasers to cut steel.  Now automobiles are being made with lighter materials, so new lasers are needed, lasers to cut nonsteel materials.  Aerospace is an interesting area for this.  Two things that are driving aerospace are new materials that lower weight and cost, and a continuing cutback on oil-based materials.  There is a bit of a renaissance going on in aerospace.

One of our investments is IPG Photonics (IPGP) for the new lasers needed to deal with new lighterweight materials.  Another is Polypore International (PPO), which is making the membranes needed for new electric vehicles like the Chevy Volt and the Nissan Leaf. By the end of 2013, they are expected to be supplying membranes for 24 models of cars.  That goes back to the fact that fuel efficiency standards by 2025 will be at 54.5 mpg.

Another of our investments is Aspen Technology (AZPN), which basically supplies SaaS for factories and plants.  If you are a refinery, for instance, you are required by law to take your systems down every so often for maintenance and test for a number of things such as safety and pollution.  Doing that manually is difficult; it can be done, but it is hard, and if you are global it is harder.  Aspen automates all of that, and they are in a field by themselves basically.

JA:  And energy?

ML:  The shale revolution will be a big job creator, and the move toward natural gas for vehicles is important.  Fleets will be moving to Compressed Natural Gas (CNG), and we believe the infrastructure will be built out for CNG refueling.  Federal Express, UPS and the other big fleets will be the drivers.  We are interested in Westport Innovations (WPRT) for the CNG engines.  And we are watching Clean Energy Fuels Corp (CLNE) for the CNG supply chain, but big oil will be the installer.  We also believe solar will become economical to use, with panels on the roofs, for instance, of warehouses, and power being sold back to the grid when it is not needed.  Between the increased supply of natural gas, shale energy, coal, oil and renewable, we can get to be energy independent.

JA:  How about housing?

ML:  Housing is fascinating.  What happened with housing is what happened with autos.  Now after a period of low sales, we probably need as a nation to do some catching up.  We could need 1.7 million new housing starts for a couple of years.  That would double the current rate.  The Echo-boomers (who used to be called Generation Y) are starting to buy houses; their demand for houses is growing at 5% per year, and will grow at 10% per year soon.  My personal opinion is that this housing cycle will be a long one, similar to what we saw after the housing collapse in the mid 1970’s. In the first few years, we will see a catchup in pricing, but after that we believe housing prices will probably go up a couple of percentage points per year. If they implement the rules on mortgages that are being talked about, the housing market will become a lot steadier and more stable, more like the Texas market, where they tightened the downpayment requirement and favor 30-year-fixed mortgages.  That will be positive for the housing market and for consumer confidence.

There is nothing better for consumers than to have their biggest asset become more valuable every year.  Three years ago if you hadn’t already lost your job, you were still afraid you might lose it.  Your 401(k) and your house were devaluing.  This recovery is more like the late 1970s than the 1990s.  People got burned in the mid-70s and it took a long time to feel better.  When we are operating at full potential, we should have 3-1/2% to 4% GDP growth, and that will come eventually.

JA:  And in 2013?

ML:  I think GDP this year will be 2-1/2% overall because of federal and state problems, but corporate GDP growth will be a good bit better than that, assuming there is a budget deal at some point.  The first half of the year if we watch the government argue about spending, it could be a bit of a damper on growth.  If we regain faith that the politicians will be able to compromise and come up with some answers, the market will go higher.  Having our debt downgraded shook everyone’s confidence.    So the market is at 12-13 times earnings as a result.

If we get a budget deal we could get much stronger investor confidence, but in the short term, our ability to govern ourselves is the big issue.  Once that is resolved, the market will lift.

JA:  Thanks, Mary.

For AH Lisanti:  For financial intermediary use only.  Not for use with investing public.

The information provided should not be considered a recommendation to purchase or sell any particular security.  It should not be assumed that any security transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein.  The views expressed reflect those of the portfolio manager as of 12/31/2012.  The portfolio manager’s views are subject to change at any time based on market and other various conditions. The performance reflected herein is not representative of performance of AH Lisanti individually managed accounts or comingled vehicles that AH Lisanti advises.

 

Looming Tax Hikes Could Prompt Surge in Corporate Stock Buyback Plans

With new taxes, or at least the possibility of tax changes, looming in 2013, some investment experts are predicting a surge in company stock buyback plans, according to the New York Times (http://www.nytimes.com/2012/11/28/business/companies-are-expected-to-increase-buybacks.html). The Times cites a recent survey by the financial data firm Markit of 100 American companies. Half of them told Times reporter Nathaniel Popper that if tax rates on dividends increase, as has been suggested, they would consider using corporate funds to buy back their own stock.

Photo courtesy of buydearborn.com

Generally speaking, there are two ways a company can return money to investors, the story notes: dividends and buying back stock, also called a share repurchase. Stocks that are bought by a company are absorbed meaning the total number of outstanding shares is reduced, which increases the value of each share still on the market.

Most often, stock buybacks are accomplished in two ways, as outlined in a recent Investopedia article titled “A Breakdown of Stock Buybacks” (http://www.investopedia.com/articles/02/041702.asp#axzz2DY4Vf9xy):

Open market. In this case a company buys shares just like an individual investor, on the open market. That’s the path chosen by Poway, CA-based Digirad * (Nasdq: DRAD, http://www.digirad.com/), which has two business divisions: one manufacturers and sells medical diagnostic imaging systems including solid-state gamma cameras; the other, called Digirad Imaging Solutions, provides diagnostic imaging services to physicians at their offices. DRAD has a market cap of about $43 million and a 52-week trading range of $1.72-$2.44. DRAD closed Nov. 29 at $2.09, down 3 cents on the day. In Digirad’s case, the Board of Directors approved spending up to $4 million in its stock repurchase program.

Tender offer. In this case shareholders are presented an offer, called a tender offer, by a company to submit (or tender) a portion or all of their shares for a certain designated time period. Typically, the company will pay a price at a premium to the market price. That’s the path chosen by Mountain View, CA-based IRIDEX * Corporation (Nasdaq: IRIX, http://www.iridex.com/), which manufactures and sells laser-based medical systems and delivery devices for the ophthalmology market. IRIX has a market cap of $36 million, a 52-week trading range of $3.07-$4.50 and closed Nov. 29 at $4.00, up 1 cent on the day. In its tender offer, IRIX has offered to buy back 5.5 percent of their currently issued and outstanding shares (487,500 shares) at $4.10 until Dec. 7 (although that deadline could be extended).

The Times article outlines some of the criticism of buybacks, basically suggesting that they can lead to the misuse of corporate funds. One of the main complaints is that the money could be better used investing “in their businesses and staff.” But in recent months many large companies have announced stock buyback programs, including Chipotle, Starbucks, BeBe Stores, Proctor & Gamble and News Corporation.

* Denotes client of Allen & Caron Inc., publisher of this blog

Are You Ready for the New Genomics ‘Bubble?’

Are you ready for another bubble? Not a real estate bubble, how about a “genomics bubble?”

Graphic courtesy of Pennington Biomedical Research Center

Yes, thanks in part to the much lower cost of genome sequencing, a crowded field of health care companies is vying to take advantage of the recent significant advances in molecular analysis. The cost of genome sequencing, a hefty $300 million only 10 years ago, is now on its way down. Way, way down. A recent Motley Fool article suggested it will be less than $1,000 by the end of 2012 and it’s now “time to start buying into the next bubble” (http://www.fool.com/investing/high-growth/2012/04/13/its-time-to-start-buying-into-the-next-bubble.aspx).

The article suggests that “automating medical processes with computing power is within reach of many presently mature software companies.” An industry group called The Personalized Medicine Coalition, which is dedicated to promoting molecular analysis, indicates that prominent treatments and diagnostics in its field have grown from 13 to 72 products in six years, according to the Motley Fool article.

Of course, for bubble building, it’s always good to see a big acquisition to get the buzz flowing. In April, Bedford, MA-based Hologic (Nasdaq: HOLX) purchased San Diego-based Gen-Probe (Nasdaq: GPRO), a diagnostic test maker,  for $3.72 billion.  And FiveStarEquities also primed the pump with an announcement May 9 that the biotech industry has become a “hotbed” of merger and acquistion activity due in part to the fact that many large pharmaceuticals are facing major patent expirations in 2012 (http://finance.yahoo.com/news/biotech-industry-hotbed-merger-acquisition-122000039.html).

But these are relatively large companies (market caps $4.51 billion and $3.66 billion, respectively), compared to our small cap focus.

Genomics is an industry with a wide variety of notable companies. Here are a few, selected at random.

Carlsbad, CA-based GenMark (Nasdaq: GNMK, http://www.genmarkdx.com) is a molecular diagnostics company that develops the testing equipment used by labs for the detection and measurement of DNA and RNA targets in patient treatments. Its eSensor detection technology enables the detection of up to 72 distinct biomarkers in a single patient sample, Its XT8 System has been cleared by the FDA and is designed to support a range of molecular diagnostic tests with a workstation and disposable test cartridges. GNMK has a 52-week trading range of $3.63-$6.95 and a market cap of $106 million. It closed May 11 at $4.95, down 4 cents for the day.

Menlo Park-based Pacific Biosciences of California (Nasdaq: PACB, http://www.pacificbiosciences.com) has developed an integrated platform for genetic analysis. The company is focusing on the DNA sequencing market and has created what it  calls its single molecule, real-time (SMRT) technology to record individual biochemical events as they occur. PACB is still in the development stage (it reported revenue of $10 million for the first quarter of 2012 and a net loss of $27.4 million) and its market cap is $146.3 million. It’s 52-week range is $2.25-$12.38. The stock closed May 11 at $2.52, down 13 cents for the day.

San Diego-based Sequenom (Nasdaq: SQNM, http://www.sequenom.com) made headlines in recent months with the announcement of its fetal Down Syndrome test. SQNM operates in two segments: molecular diagnostics and genetic analysis. The company is focused on translating the results of genomic science into solutions for biochemical research and other areas. SQNM trades actively (a daily average of 3,641,360) and a year ago the stock was trading for more than $8.70 (its 52-week range is $3.52-$8.71) but has been declining since. The market cap as of May 11 was $593 million. SQNM closed May 11 at $5.18, down 7 cents on the day.

Mountain View, CA-based Complete Genomics (Nasdaq: GNOM, http://www.completegenomics.com) is a life sciences company that has developed a DNA sequencing platform for human genome sequencing and analysis. Its genomic analysis platform provides its customers (academic and government research centers, biopharmaceutical companies, healthcare providers) with data to be used for genome-based research. The 52-week range for trading of GNOM stock is $2-$18.55 (the high was about a year ago) and its market cap is about $70 million. It closed May 11 at $1.98, down 7 cents for the day.

Irvine, CA-based CombiMatrix Corp. * (Nasdaq: CBMX, http://www.combimatrix.com/ operates mainly in molecular diagnostics and genetic analysis with a specialty in pre-natal chromosomal microarray testing. Combimatrix focuses its efforts on the developmental (pediatric) and pre-natal markets and is the only independent public company specializing in genomic arrays.  CombiMatrix has posted annual growth rates in excess of 35% for the past three quarters. Its 52-week range is $0.76-$4. It closed May 11 at $1.01, up 1 cent on the day.

Los Angeles-based Response Genetics (Nasdaq: RGDX, http://www.responsegenetics.com) develops and sells clinical diagnostic tests and pharmacogenomic tests used in the treatment of cancer. It offers tests for non-small cell lung cancer, colorectal cancer and gastric and gastroesophageal cancer. The company also develops tests for other types of cancer that identify genetic profiles of tumors that recur after surgery. RGDX has a 52-week trading range of $0.81-$3.05 and market cap is about $40 million. The stock closed May 11 at $1.50, down 11 cents on the day.

* Denotes a client of Allen & Caron Inc., publisher of this blog

From Worst Quarter Since 2008 to Best First Quarter Since 1998

Last Oct. 4 we filed a blog post based on the closing of the worst quarter since 2008. We were talking about the third quarter of 2011 that ended Sept. 30. The Dow Industrial Average dropping another 240 points on the final day to close out at 10,913.

The dismal quarter prompted  a predictable outpouring of dire predictions from bears bemoaning  the state of the economy, the lack of job growth and the unfortunate future that lay ahead. In our post, we tended to take a longer view more in line with veteran analyst Otis T. Bradley (then of ICM Capital Markets, now with Gilford Securities), a relentlessly optimistic bull who has insisted for some time that, while we may have been in the midst of a correction back then, we are in the middle of the “Greatest Bull Market of All Time.”

Things have certainly changed in six months time much as Bradley predicted. Granted, the fourth quarter is typically a good one for stocks, and particularly for the technology sector. But the Dow has now climbed over 13,000 and has been there for some time. Stocks have been buoyant almost since the day we filed that post. Is Wall Street now in the middle of a bull market, as Bradley has long suggested? Market watchers say the first quarter of 2012 is the best first quarter since 1998.

New York Times correspondent Paul J. Lim, who is also a senior editor at Money magazine, offered some evidence on March 24 that it is (http://www.nytimes.com/2012/03/25/your-money/bull-market-may-have-much-further-to-go.html?scp=1&sq=Paul%20lim&st=cse). Among his key points:

  • Small cap stocks typically lead a bull rally, with the larger caps following only after bull markets mature. That is certainly the case. The Russell 2000 index has gained 36 percent during the past six months.
  • Economically sensitive stocks like techs and consumer discretionary stocks have been outpacing the broad market, another sign of early bull markets.

Back when we filed our Oct. 4, 2011 post we highlighted four small cap stocks chosen from the Thomas Weisel Partners Asset Management LLC fund, which invests heavily in small caps in technology and healthcare and the consumer and service sectors. We promised we’d report back, so here they are and have a look at what has happened to them:

Atlanta-based Internap Network Services (Nasdaq: INAP, http://www.internap.com), a provider of Internet services to help with cloud-based applications, closed Oct. 3 at $4.48, down 16 cents on the day with a market cap of $240 million. At mid-day on March 29, INAP was trading at $7.37, down 6 cents so far on the day, with a market cap now at $377 million.

Mountain View, CA-based Map Pharmaceuticals (Nasdaq: MAPP, http://www.mappharma.com), which develops drugs for a variety of ailments including diabetes, asthma and migraines, was apparently a big part of the Weisel fund’s holdings (not sure if that is still true). Back on Oct. 3, MAPP closed at $13.76, down 86 cents on the day, but the stock had been on an upswing. Back in early August it was down as low as $11.17. At mid-day March 29, MAPP was trading at $15.35, down 85 cents so far for the day. It so happens that MAPP reported its fourth quarter, year-end results on March 29, showing a fourth quarter loss and a financial restatement.

Wilmington, NC-based TranS1 Inc. (Nasdaq: TSON, http://www.trans1.com) develops minimally invasive instruments and transplants for degenerative disc diseases and is another stock in which the Weisel fund had a large position. TSON closed Oct. 3 at $2.73, down 27 cents. At mid-day March 29, TSON was trading at $3.24, down 3 cents on the day.

Mountain View, CA-based Hansen Medical (Nasdaq: HNSN, http://www.hansenmedical.com) develops robotics for controlling catheters and medical devices and was yet another big part of the Weisel fund. HNSN, which was above $5 in late July, closed Oct. 3 at $3.05, down 25 cents that day. At mid-day March 29, HNSN was trading at $2.97, down 2 cents so far on the day.

Irish Stocks: Some Are Neglected, Many Offer Value Opportunities

As we dig out our kelly-green ties and sweaters to honor St Patrick, and an astonishing number of people rediscover their Irish-ness, we thought it would be a good time to take a quick look at some truly Irish small caps — all of which can be found on US markets.  You don’t have to drink green beer to buy them — and you may well be impressed with the values that can be found in this Celtic Tiger so often these days categorized as the first “i” in PIIGS.  Ireland has taken a tumble, but it is still a hardworking country with an aggressive government program to lure foreign businesses.  If you look around, you’ll find interesting companies, as we did.

Dublin Street Scene: Ready for a Pub Crawl?

A good place to start is with Leopardstown-based ICON plc (Nasdaq: ICLR; http://www.iconplc.com),  a widely respected CRO (contract research organization) that provides clinical and development services to medical device companies, pharmaceutical companies, biotechnology companies across the British Isles, Europe and the USA, working in FDA Phases I-IV.  Leopardstown has always been known for its famous racetrack, but the horses there have nothing on the fast pace of ICLR activity.  ICLR shares trade at about $21.61, vs a year-high of $26.22 on average daily volume of just under 200,000 shares, and a market cap of about $1.3 billion.

Please do your own diligence.  We do not recommend stocks, nor are we financial advisors.  We do not own the shares in this article, and have no intention of buying them any time soon.

Staying with the healthcare theme for the moment, you might want to have a look at Bray, Ireland-based Trinity Biotech (Nasdaq: TRIB;  http://www.trinitybiotech.com ).  Although this diagnostics company is probably best known for its work in kits to diagnose HIV and sexually transmitted infections, it also works with diagnostics for autoimmune diseases/conditions, diabetes, liver disease and a variety of other diseases.  With strategic partners and distributors in 75 countries, TRIB reported revenue for 2011 of about $78 million, down from about $90 million the year before — but profits were up, which says a bundle about the determination of management to right the ship.  TRIB shares are trading at about $10.18 vs a 52-week high of $11.00, on somewhat anemic average daily volume of about 45,000; that says it could be underpriced vs what it might be if the audience were larger.  Market cap is about $215 million.

St Patrick's Day Parade, NYC (St Patrick's Cathedral)

Dublin-based CPL Resources plc (LSE: CPS or Pink Sheets: CPGLF; http://www.cpl.ie ) is a personnel-oriented company that supplies various kinds of skilled and highly trained temporary personnel, recruitment services, payroll services and a large suite of ancillary human resources services to companies across Europe, with an emphasis on eastern Europe (Poland, Hungary, Bulgaria, Czech Republic, Slovakia, et al), Ireland and Spain.  Revenues for 2011 of this company with women in the CEO and CFO positions were €235 million, substantially higher than 2010, with a profit of €7.2 million, and a rising treasury of cash-on-hand.  EPS were €o.19.  In US trading, CPGLF is changing hands at about $3.26 on negligible trading (not unusual for an unsponsored ADR), but volume in London is very low as well, indicating that either interest is low or the market has a very low float (or both).  Market cap is just under $100 million, which seems low based on blossoming results.

Dublin-based Datalex plc (Irish symbol: DLE; Pink Sheets: DLEXY; http://www.datalex.com ) is in the travel merchandising business, with advisory customers across the globe in the form of major airlines such as United Airlines and Air China (plus many more), and marketers such as Expedia.  The company’s very sexy website is helpful and fun, and lets you know just how much goes on behind the reservations systems you may be looking at online.  Revenues for 2010 were in the range of $27 million, with a loss of around $2.1 million, and 2011 results are due to be announced on March 30, 2012.  DLEXY shares are currently noted online at about $0.82 and in Ireland at about €o.40, but all the volume is on the Irish trading, with about 56,000 shares per day — however, since the ADR is sponsored you can buy the Irish shares, convert them in the wink of an eye to ADRs and put them in your brokerage account, which will store them at DTC, reversing the process if you want to sell (at no cost, btw).  We find that many cool small companies have neglected ADRs, which can present super opportunities for value-sniffing investors.

Finally, have a look at Dublin-based Fyffes plc (LSE: FFY or Pink Sheets: FYFFF; http://www.fyffes.com ), a purveyor of tropical fruits and produce: pineapples, melons, bananas: “Feel Good Fruit” according to the Fyffes colorful website.  2011 revenues were about €850 million with EPS of €0.06 per share, and a dividend of about €o.o2 per share.  Shares of the 1888-founded company are trading for about $0.60 on the Pink Sheets or about £o.36 on the London Stock Exchange, with London volume dominating at about 57,000 shares and a market cap of about $195 million.

Like I said, you don’t need green beer to look at these companies — although it couldn’t hurt, as they say.  Happy Saint Patrick’s Day!