Thread: Nice summary of excellent EMC prospects by Jo Arena from his newsletter
At 03:03 PM 5/23/99 -0400, you wrote:
>EMC UPDATE
>The High Tech Arena 5/23/99
>By Joe Arena
>Editor
>
> With the recent correction in EMC resulting in a 23% decline from the
>highs, it is incumbent upon every astute investor to determine whether this
>pullback represents a change in the underlying fundamentals, or is merely a
>market driven event. It is our contention that the reaction in the stock
>price relative to the recent change in EMC's relationship with Hewlett
>Packard (HWP) is overdone as well as unjustified. Before analyzing the
>reasons why, there are several other factors to be considered.
>
> First and foremost, the sector rotation that is occurring right now in the
>market accentuates any news which does represent a perfect world scenario.
>In the case of EMC, not only does the market perceive the HWP news as
>negative, but is overlooking the long term positive aspects. Secondly, the
>valuation of EMC at the 130 level was extremely high by historical measures,
>and simply could not withstand any surprises. Wall St. has a proclivity to
>sell first and ask questions later when any salient change in a company's
>business model occurs. Finally, one could argue that the stock had come too
>far too fast, and was ripe for a correction. Certainly, this correction is
>well within the boundaries of normal volatility for EMC stock, and should be
>considered healthy from a technical perspective.
>
> In providing a rationale which best exemplifies the market's overreaction
>to the HWP news, a good starting point is the fact that in this market
>environment, it is easy to see the glass as half full when your largest
>customer terminates an agreement to resell your products. However, delving
>into the EMC/HWP relationship, we can deduce that the case for an adverse
>impact on revenue is specious at best.
>
> Consider the fact that the relationship with HWP was actually an impediment
>to top line growth at EMC. While EMC overall growth should remain in the
>area of 35%, the increases in terms of the HWP alliance were projected to be
>a paltry 12%. Also bear in mind that in 1998, HWP represented about 18% of
>EMC's business, versus 13% currently. Moreover, the agreement with HWP
>represented a relatively low margin business. Overall, EMC gross margins are
>in the range of 53%; HWP gross margin contribution is somewhere in the
>neighborhood of 40-45%.
>
> It is also important to note that EMC has been planning for a change in
>their reseller agreement with HWP for quite some time. Over the past year,
>EMC has tripled the size of their sales force from 500 to 1500. Not only is
>the size of this salesforce adequate to make the transition to a
>direct/versus reseller strategy, but it also eliminates the need for a costly
>ramp up of the sales force, which would obviously be a short term hit to the
>bottom line. In taking a proactive approach over the past year, EMC is well
>positioned to take even more of its business direct. The advantage of this
>strategy is that it facilitates a greater opportunity to sell more software
>(which is EMC's highest margin business) and services.
>
> In addition, we believe the short term revenue concerns are unfounded as
>well. While there is undoubtedly a threat of this happening, the mitigating
>factor here is that storage customers do not change direction immediately,
>and it will take some time for HWP's new relationship with Hitachi to achieve
>results. Another salient point to understand is that the reseller agreement
>was executed in terms of HWP installing storage equipment with the EMC brand
>name; this equipment was then serviced by EMC technicians. Compare and
>contrast this with an OEM relationship, which would entail HWP installing and
>servicing the equipment. With the installed base that EMC already has
>achieved, it is easy to see how their direct sales force will be able to
>offset any shortfall to the top line. It should also be noted that HWP
>salespeople are now in the unenviable position of having to go into accounts
>and recommend solutions that are diametrically opposed to those they were
>recommending several weeks ago. (e.g., "Hitachi storage solutions are better
>suited to your needs than EMC storage solutions") Anyone with a background in
>sales can comprehend what a difficult if not impossible task that is in the
>short run.
>>From the standpoint of salesforce execution, it is also noteworthy that EMC
>salespeople will now be free to pursue HWP accounts, which should provide
>another source of incremental sales.
> Notwithstanding, it is evident that EMC will have to surmount competition
>in the future that is more formidable than what it has faced in the past.
>The growth of the storage business underscores the need for competitors such
>as IBM, Sun Microsystems, Hitachi, Compaq, and Dell to make it a larger part
>of their product portfolio. Traditional storage users double their
>requirements every year, and ISP's (Internet Service Providers) double their
>storage needs every six months. Obviously, the growth here makes the storage
>business compelling from not only a revenue generating perspective, but a
>strategic one as well.
>
> IBM is scheduled to introduce a new high end system called Shark in the
>third quarter. However, initially this system will only support mainframes.
>Thus, the share gains that EMC has made against IBM (i.e., 35% versus 22%)
>should continue in the foreseeable future. Sun Microsystems will also begin
>shipping a new high end storage system at the end of this year. However, it
>will still be some time before they begin to achieve critical mass, during
>which time the momentum that EMC now has will continue. Hitachi is the most
>competitive versus EMC in terms of their technology. Despite this, Hitachi's
>meager 5% market share would indicate a lack of ability to execute in terms
>of sales and marketing. (thus the agreement with HWP) Compaq acquired some
>competitive storage technology from Digital Equipment, but given the well
>documented problems they are experiencing, it can be surmised that they will
>prove no threat to EMC anytime soon. Finally, Dell is making a greater
>commitment to the storage business via OEM relationships, and at some point
>in time may encroach on EMC's business in the high end. However, near to
>intermediate term, Dell is only a factor in the low and medium segments.
>
> In conclusion, EMC's strengths lie in its installed base, customer
>relationships, management execution, and growing software business which it
>can increasingly leverage strategically and financially. Thus, the barriers
>to entry for competition are high, and the business is still EMC's to lose.
>Recently, CEO Michael Ruettgers stated that EMC's customers would require 12
>times the amount of storage in 2001 that they did in 1998. Such a compelling
>growth story leaves us very confident that even if competitors make inroads,
>the pie is big enough to support several large players. We continue to buy
>the stock on weakness, both from a trading as well as a long term investing
>standpoint.
>
>TRADING UPDATE: The ability of Cisco Systems to display excellent relative
>strength in light of the sector rotation into cyclicals/value stocks rewarded
>us well this month. The Cisco May 110 puts we had shorted for 7.25 expired
>worthless, generating a profit of $7250 for every 10 contracts we shorted.
>The Cisco May 115 puts we had shorted at prices of 10.25, 5.875, and 6.625
>also did well. We covered all these positions on Friday morning at 11/16, or
>0.688. Consequently, these positions generated profits of $9562, $5187, and
>$5937 for every 10 contracts of each that we were short.
> The weakness in EMC forced us to cover the May 115 puts we shorted at 8 for
>11.0, resulting in a loss of $3000 for every 10 contracts. However, we
>rolled them over to the June 115 puts for 13.25, generating a net credit for
>these trades of 2.25, or $2250 for every 10 contracts. (and of course we
>still keep the $8000 per 10 contracts that we took in when we initiated the
>EMC May 115 short put position. In addition, we doubled down on the EMC June
>115 puts, which means we shorted twice as many of this contract as we did in
>May. (all at 13.25)
> Our intermediate term short put trade that we initiated in Feb is also
>working out well. For those new readers, we shorted the CSCO July 105 puts
>for 16.875, these are now down to 4. It is likely that we will cover this
>position soon to free up some more buying power. In addition, we also took
>advantage of the weakness in EMC, buying an initial position in the stock at
>99.625. This will most likely prove to be 1/2 or 1/3 of our ultimate long
>term position, as we dollar cost average during the next 6-12 months.
>
> Since the market is currently focused on interest rates, we are taking a
>wait and see approach to initiating any further June short puts positions.
>The sentiment indicators that we follow are also predominately bullish, which
>makes us short term cautious. Given the strength in the underlying
>fundamentals, we would anticipate that a rolling sector rotation type of
>correction is the most likely scenario to occur during the next few months.
>(versus a precipitous decline in the entire market) If Fridays strength in
>the bond market proves to be merely a reflex rally that peters out during the
>next few sessions, we will wait to build any further June positions as this
>could likely cause further weakness in stocks. At this time we would look to
>short CSCO June 110 and 115 puts and Qwest June 85 and 90 puts on any
>weakness in the stocks.
>
>LETTERS TO THE EDITOR: Frequently we receive letters about our preferred
>methods of trading. The following letter poses some excellent questions,
>which we are answering in the hope that many of our readers can benefit.
>Dear Joe:
>
>I've been following your analyses and trading updates for some months
>now. In that time I've been purchasing LEAPS in companies such as
>CSCO, EMC, SUNW , etc., (e.g., during last weeks chaos) . At this point about
>40% of my investment cash is invested (LEAPS only, no stock).
>
>I have been interested in your various suggested trades involving shorting
>puts, e.g., CSCO, EMC & to that end have recently upgraded my margin account
>option status to allow me to sell naked puts. I'm comfortable with the
>philosophy of the trade, but a few practical questions remain:
>
>1) You often mention that the funds taken in from shorting LEAPS or
>options are put to work establishing new call or equity positions.
>
>However the broker requires that the premium + a percentage of the underlying
>value are held as margin requirements (i.e., withheld from available funds).
>So how can the cash be employed immediately?
>
>2) If you are shorting in the money puts (e.g., your May 115 CSCO or
>115 & 130 EMC), what is to stop you being assigned the stock?
>
>
>3) What rationale do you use in deciding between shorting LEAPS
>and shorting one month options?
>
>ANSWERS: 1.) We frequently have said that shorting puts is a strategy that
>should only be undertaken by high net worth individuals. When doing so, our
>strategy is based on not utilizing the entire amount of buying power in our
>accounts. This enables you to take the cash immediately and put it to work.
>Obviously, if you used up all your buying power shorting puts, your broker
>would not allow you to do this. This question also underscores the need to
>shop around for a broker, as margin requirements for this trading strategy
>vary widely, from as low as 20% to as high as 50%.
>2.) Early assignment can occur at random and without warning anytime the
>puts are in the money. However, as a general rule, early assignment usually
>does not occur unless there is a major correction in the stock or market
>panic (similar to last October) We have been shorting puts since 1987, and
>every time we have gotten assigned early, it has marked either a market
>bottom or a bottom in the individual stock. (yes, including the crash of
>October 87) This is another reason why we prefer this strategy. While early
>assignment can be seen as a blessing in disguise, (as it forces you to act
>without emotion during times when you would be unable to do so) it can also
>put you in dire financial straits if you do not enter the trade prepared for
>the worst case scenario to occur. The most important criterion in shorting
>puts is to assess whether you are sufficiently capitalized to do so.
>3.) The decision to short leaps puts or front month puts is one based on an
>investors individual objectives, risk tolerance, net worth, time horizon,
>etc., and will vary widely based on these factors. Generally speaking, one
>is a trading strategy designed for generating income, the other is part of a
>long term wealth building strategy. Individual tax planning objectives can
>also be a factor influencing this decision as well.
> Shorting leaps puts is something which we frequently do once or twice a
>year, and only after severe market declines. Given the longer term nature of
>the strategy, being patient and waiting for corrections to occur is the most
>important part of the strategy. With front month puts, it is something that
>we do every month whether the market is up or down, with the intent that if
>the trade goes against us, we plan to: a.) roll over to the next month,
>taking in more time premium as we are paid to wait until we are right b.) get
>assigned early, and use this assignment as either part of our long term
>dollar cost averaging strategy on stocks we want to hold at least 5 years, or
>get assigned early and use these new stock positions as a way to create a new
>revenue stream by writing covered calls against them.
>
>Note: The High Tech Arena will now be published on a monthly basis.
>
>DISCLAIMER: The information herein has been obtained from sources which are
>believed to be reliable, but there are no guarantees as to its
>accuracy or completeness. Neither the information nor any opinion
>expressed constitutes a solicitation for the purchase or sale of any
>security.
>
>THE HIGH TECH ARENA
>Joe Arena
>Editor
>JRArena@aol.com
> |
