Sunday, March 24, 2013

Positioning For A Pullback

"Call 'em like you see 'em and to hell with it." - Ernest Hemingway

Big profits have been racked up since the early November elections. The Dow Jones Industrial Average and S&P 500 are up about 12%-13%, with most of the gains coming since January 1st. The Dow has been the biggest beneficiary rallying 10% since we rang in the New Year, and the S&P is not far behind at 9%. Both are at, or nearing all time highs. We could continue to experience a market melt-up, but from my vantage point, markets don't continue to run without frequent corrections. Five months without a break is a substantial run.

As we approach Q1 earnings season, I'm betting that some up and coming organizations will miss guidance with the weakness in Europe. If the stars align correctly, I may be able to find some bargains, and limit my downside risk by setting the bar low. I'm not big on market timing or shorting individual stocks, but playing for a retrenchment in the next few months with limit orders on a few selected securities: Millennial Media (MM), Broadsoft (BSFT), Fusion-io (FIO), and Ruckus Wireless (RKUS). Three of these stocks are fallen angels, with the recent IPO of Ruckus being the only one that hasn't taken a nosedive.

Millennial Media

Millennial Media hit the tape twelve months ago when it IPO'd at $13/share. The mobile advertising company originally priced at $10, about midway of its price range, then jumped to $25 after only one day in the market. Although it climbed to $27.90, it has fallen off a cliff, and currently trades under $7. Even with this price erosion, there is still a 37% short float on the equity.

After reading the transcript of their presentation at the Barclays Internet Connect Conference, I was very impressed with their potential. Clients include 85 of the top 100 brands in Advertising Age. However, other pure play companies in the mobile advertising sector like Velti (VELT) and Augme Technologies (AUGT.OB), also show lots of potential, only to disappoint investors from lack of execution, or lack of adoption by advertisers. It's an unproven young industry.

What was supposed to be a growth technology business, is now being valued like the media sector. Most earnings and revenues are back end loaded for the fourth quarter when large corporations set advertising budgets for the next year. So although Millennial Media is growing, it's a very lumpy growth. Analyst estimates are for it to earn only $.13/share for 2013, and $.38/share for 2014. Sales growth is projected for 55% this year and 47% the year after. The limit order I have is for $3, a roughly 60% reduction in its current listing. That would give it a forward P/E ratio of 23 if I catch it at that price.

Ruckus Wireless

Ruckus Wireless has been in business for over ten years, but became a publicly traded company only five short months ago. My original article about the Wi-Fi provider will give you a detailed description of its business model and a company background. They basically provide the plumbing for telecom carriers and corporations to grant Wi-Fi access to large numbers of customers.

The stock opened at $15 during its IPO, and got as high as $26, only to sell off after the Q4 conference call. In the presentation, the CEO stated that Q1 would be weak. However, a recent article by GigaOM reports that Ruckus landed a substantial contract from Airtel Africa to roll out a massive Wi-Fi network in 17 different countries as a substitute for a 3G network. There has been no official news from Ruckus about this potential bonanza. However, rumor or not, it helped stop a stock that was descending, and in fact, goosed it.

Ruckus currently trades at $23, and I've got a limit order on it for $16. I thought it was fairly priced at $15, and consider it overvalued when we examine the earnings estimates. They are expected to earn $.18/share this year, and $.30/share for 2014. For 2013, that's a forward P/E Ratio of 127. They are only projected to grow 25% per year for the next few years. That's much too expensive for my portfolio. In addition, consensus analyst price target for the next twelve months is $25. We are almost there now.

Fusion-io

For a short period of time, Fusion-io was the darling of Wall Street. If you follow the markets, you're probably aware MarketWatch columnist Cody Willard likened Fusion-io's price appreciation potential to Apple's (AAPL). With a 52 week high of $33, and a current price of $16, you'd think this would be a great time to pony up some dough, and take a flier on it. Not according to Wall Street. There is still a 41% short float on the equity. Credit Suisse (CS) was pounding the table on Fusion-io with a $50 price target, but that has been lowered to $17. Because of that downgrade, I set my limit order to $12.

The problem with this company in the short term is their dependency on two companies, Apple and Facebook (FB). They derive 50% of their revenues from these hyper-scale clients, and these revenues may be flat for the next quarter or two. Although there may be additional hyper-scale clients in the works, this may not pan out until the second half of the year when both Cisco (CSCO) and NetApp (NTAP) start selling Fusion-io products. That's a lot of boots on the ground. However, there is fear on the street that Fusion-io's flash storage products may become commodities. The company refutes that stating they sell systems.

If we examine the consensus analyst estimates, the company is expected to generate only $.18/share in earnings this year. For 2014, that projection rises to $.31. However, the high for 2014 is $.59/share. There is much potential for this company, but fears of competitors with deeper pockets like EMC (EMC) and IBM (IBM), and the commodity aspect of their products are causing the investment community to run away in droves. An upcoming IPO of rival Violin is also weighing on the security.

Broadsoft

I don't find Broadsoft that overvalued at this juncture, but it's the slowing growth going into 2014 that is the concern. The company provides software and services that enable mobile, fixed-line, and cable service providers to deliver cloud-based unified communications over Internet protocol based networks. This is the future for telecom carriers and cable companies, but there is saturation in the United States, and Europe just isn't spending at the moment.

The stock has been T-boned twice this year, getting as high as $45, and selling as low as $20. It currently crosses the tape at about $25. Consensus analyst estimates expect the company to make $1.24/share this year and $1.70/share in 2014. That's a very nice growth rate. However, I think this quote from the company CEO really sums up the current year: "There aren’t a lot of new customers out there and the rate of growth is slowing". This stock is a 2014 story, and with macro conditions deteriorating in Europe, I'm playing for another pullback if the markets correct. I've got an order in for $20.

Conclusion

The three and a half year market rally that's resulted in explosive returns for the major equity indexes is no secret to most Americans. Lately, it's front page news for many major newspapers, the leading story on broadcast television news, and all over the Internet. That's usually a contrarian indicator for a pullback. It's also a contrarian indicator that markets will continue their ascent when a majority of money managers are looking for the long awaited correction. Pick your poison.

I believe investing in individual securities is all about probabilities, in both the stock itself and the economics that surround it. Right now there is a high probability that we do get some sort of a retrenchment in the next month or two. I'm not a soothsayer, so I can't tell you when. I'm not suggesting that I will get these prices for the discussed securities in this posting, it's just what I'd pay for them to what I perceive is a limit to my downside risk.