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The Internet Financial Connection, October 1, 1998 Presented by Mark Johnson, Editor of the IFC techstocks.com It appears exclusively on Silicon Investor techstocks.com -------------------------------------------------------------- To Subscribe to this Newsletter: Send an email to <mailto:ifc-request@mLists.net> with "subscribe" in the message body. Please tell a friend about this newsletter :) -------------------------------------------------------------- This newsletter can be viewed at techstocks.com In This Issue: 1. Deflation: "Highly Likely" for the U.S.? 2. Uniphase 3. Andrx 4. Sabratek & Biogen 5. Interesting Articles On The Internet by Joe Dancy 6. Highlights on SI: 3DFX 7. Highlights on SI: by Tom Taulli 8. Highlights on SI: From Limos to Lemons By David Z 9. Disclaimer ---------------------------------------------------------- 1. techstocks.com Joe Dancy of The Lone Star Growth Investor members.aol.com provides the following commentary. Subscriptions to his newsletter are FREE. members.aol.com Deflation: "Highly Likely" for the U.S.? "Economist Gary Shilling, author of a new book on the phenomenon of falling prices entitled "Deflation" (Lakeview Publishing, $16), says deflation is heading our way and we ought to be preparing for it. Shilling is a consulting economist and columnist for Forbes. The United States has not had falling prices since the 1930's. But last year inflation was at 1.7%. Shilling was an early forecaster of falling inflation, writing a book on the topic in 1983. Now he thinks deflation "is not just possible but highly likely." Causes of Deflation In his book Shilling examines the numerous causes of looming deflation, which include: (1) defense spending cuts; (2) shrinking government deficits around the world; (3) overly tight monetary policies in many major countries; (4) restructuring; (5) deregulation; (6) technological advances and the Internet information explosion; (7) global sourcing of goods and services; (8) less restricted world markets; and (9) intensifying Asian woes -- all pointing to an excess supply of goods and lower prices. Shilling says that the seeds of deflation have already been sown - and the trigger event will prove to be events in Asia. As Asian economies struggle to survive in the face of their own falling consumer demand their only recourse is to export their products - in large measure to the United States. That's already happening as we see falling prices on everything from imported computer disk drives to consumer products. The other side of that coin is a falling demand in Asia for many of the products the United States exports: airplanes, agricultural machinery, grain and lumber. That lack of consumer demand in Asia is also depressing prices - and cutting profits for U.S. companies that export. Of the elements in place to cause deflation, peace is the least appreciated - but most important - on the list. "We've been in a wartime stance in terms of inflation-deflation since the late 1930's," Shilling says. "If you go back before that, deflation is the norm in peacetime - and this is the first real peacetime we've had" since then. In the 1920's, consumer prices fell by about 1% per year, as new technology introduced radios, cars, and electric lights - and these items became cheaper with advances in production capabilities. "Good" vs. "Bad" Deflation Although deflation conjures up recollections of the problems of the 1930's, Shilling points out that there is "good" deflation and "bad" deflation. The 1930's' bad deflation was a result of a shortfall of demand, as incomes vanished and unemployment spread nationwide. Japan is currently in the midst of a "bad deflation" - where falling prices are not perceived as a benefit to consumers who are too frightened to spend their money, even at bargain prices. In contrast, Shilling predicts a relatively benign deflation for the United States in the coming years - caused by massive increases in supply, pushing prices downward. In the next economic upcycle he expects a "good deflation," something like the 1920's or the years 1876-1896, in which prices fell an average of 1.7% per year. The United States had good deflation after the Civil War, and between 1870 and 1896, wholesale prices dropped at a 2.6% annual rate. That was a period of great technological advances in milling, weaving, carpet- making, printing and the like, and railroads were expanding across the land. Productivity was rising. Great fortunes were building. Similarly, the 1920's was a decade of good deflation, accompanied by great technological advances. Shilling believes that "bad" deflation caused by a lack of demand can be avoided in the U.S., and that Japan will pull out of the morass. But a lot of things could go wrong -- say, a sudden unwinding of trillions of dollars worth of derivatives. Shilling admits that some of the derivatives are so complex that even he doesn't understand them. "The whole (international financial) system may be in for another severe test if U.S. stocks take a header." Impact of Deflation on Investments What would be the result of deflation in the United States? Shilling is predicting that one of the immediate results of this period of upcoming deflation will be a sharp decline in the U.S. stock market. As companies' earnings come under pressure, so will their stock prices. In fact, he wouldn't be surprised to see a 40% to 50% decline in the S&P 500 index, followed by a long period of more "normal" returns of about 6.5% a year. But he notes that in a world of falling prices technology companies will be one of the investment "winners" as they "have a huge advantage, because what we're forecasting is nothing new to them." He lists as areas that will be favorably impacted by deflation semiconductors, computers, telecommunications, software, biotechnology, and Internet related products. "Lower prices," he continues, "far from reducing sales and profits, open up new markets that increase volume so much that earnings grow robustly. It is very similar to the post-Civil war era when huge declines in prices vastly expanded markets to include those who, for the first time, could afford manufactured products." "Another advantage that new tech companies will carry into deflation is the rapid obsolescence that rapid technological advances bring." Like the auto industry in the early part of this century, buyers did not wait for price declines to purchase vehicles due to rapid technological improvements. Future Earnings Growth Worth More Compared to older industries Shilling forecasts that companies that utilize technology will be able to better retain and expand earnings in the future. Part of this will be due to innovation, part to demand for new products, and part to the legal protection afforded technological advances. One point that was not emphasized in the book, and should have been, was that in an economy where deflation is occurring the present value of future earnings soars - which is why companies that can grow earnings in such an environment are worth much more today than they have been historically. When discounting future earnings to the present the impact of deflation on the value of future earning streams compounds. This results in a fair price/earnings ratio in a deflationary environment being a multiple of the price/earnings ratio you would expect in a mildly inflationary environment like we have experienced the last few years. While the current valuations of some technology stocks - especially Internet stocks - are absurdly high in our opinion given the risk, a deflationary environment could justify such valuations for technology companies that could grow earnings. Summary Well written and documented, "Deflation" makes a compelling argument that powerful forces are in place that will take the economy back to a situation we have not seen since the 1930's - falling prices. Even if the author has overstated the case, and we don't think he has, the book stands for the proposition that inflation is highly unlikely to be a problem in the near future. In such an environment technology will drive the economic engine of the U.S., and companies who can expand and grow earnings in such an environment - and their investors - should be well rewarded." ----------------------------------------------------------------- 2. techstocks.com Jerry Apodaca of Apodaca Investments, provides the following stock ideas. Below is the write up. Uniphase is a maker of laser subsystems for the WDM (Wavelength Division Multiplexing) market. Their products essentially allow greater bandwidth along communications lines, which in turn creates faster access speeds on the Internet. Click here to read more about what they do. Uniphase's clients include Lucent, Alcatel and Ciena. When Ciena announced in mid August that a major potential customer, AT&T, would not be using their products and instead be using Lucents', along with pressure of a failed merger, that news sent their shares from around $60 to about $10 within one month. Companies that supplied products to Ciena, such as Uniphase does, were directly affected by this news and suffered also. "It does not matter who wins the contract to AT&T, because Uniphase sells to both Lucent and Ciena. Uniphase will be a beneficiary no matter who wins", says Jerry Apodaca of Apodaca Investments. "Uniphase dominates in the area that they operate in. Other companies have similar technology but do not have the contracts and customers that they have." He thinks their stock can hit $90 to $100 within the next 18 months. Jerry favors and is bullish on the contract manufacturing area. He notes that for several years now, the PC industry, networking and healthcare industry, have been outsourcing the manufacturing process instead of making products in-house. He thinks the next big area that will be outsourced to contract manufacturers is the telecommunications area. A few companies that he likes in that area and will benefit are; Flextronics, Jabil Circuit and SCI Systems. He adds, that they are undervalued when compared to their growth and trading at relatively low PE valuations, while growing in the area of 30% annually. "There will be big growth for these companies looking forward over the next few years... I think they have hit bottom here." There is a thread that discusses UNPH on SI. Subject 8777 ------------------------------------------------------------------ 3. techstocks.com The Sturza Medical Investment Letter provides the following stock idea on Andrx (ADRX 34). An annual subscription to their newsletter is $320 for one year, which includes 50 issues. For more information call 212-541-8200. Below is their write up. "Florida-based Andrx Corporation uses its proprietary drug delivery technology to develop and market generic versions of controlled-release, branded pharmaceuticals. Andrx's generic formulations are designed to be AB-rated (bioequivalent) to the branded drugs, thus allowing pharmacists to freely substitute the company's generic for the branded drug (unless the physician specifies the branded version). The FDA has approved its generic version of Cardizem CD for marketing, thus triggering cash payments of $10 million per quarter from Hoechst Marion Roussell (HMR). Cardizem CD -- HMR's once-daily version of the calcium channel blocker, diltiazem -- is used to treat hypertension and angina, and has annual U.S. sales of $700 million. Aside from the current market conditions, we believe the key problem is the recent negative publicity generated by two class-action lawsuits filed in August by the same law firm, alleging that Andrx's 1996 agreement with HMR is a conspiracy to keep competing generic drugs off the market. However, based on an abundance of prior court decisions on similar agreements -- which have stood the test of time and the appeals process -- we are confident that there is no basis for these frivolous lawsuits. In fact, the agreement between Andrx and HMR guarantees that Andrx's generic Cardizem CD will be launched immediately upon the resolution of the ongoing patent infringement lawsuit, regardless of the outcome. Even if Andrx loses the patent lawsuit, the agreement allows for the company to license HMR's patent for a modest royalty, and launch generic Cardizem CD; should Andrx win, the company will receive an additional lump-sum payment for having been forced to delay the launch of its drug. Moreover, NO other generic versions of Cardizem CD are available, as the FDA has yet to grant tentative approval to any version which could compete with Andrx's drug. Therefore, we believe that these lawsuits will have no meaningful effect on Andrx's operations, and may even be thrown out of court as frivolous within the next six months. Andrx will become profitable in Q3'98 with breakout 1998 EPS in the $0.55 to $0.60 range. Also, we expect the company -- which was first to file an ANDA for generic version of Prilosec, Astra Merck's $4 billion anti-ulcer/reflux drug -- to ANDA filings and approvals over the next six months. We estimate Andrx to earn $1.52 in 1999 and trades at a low PE multiple considering the upcoming explosive EPS growth. Our one-year target is $60 per share." There is a thread that discusses ADRX on SI. Subject 5760 --------------------------------------------------------------------- 4. techstocks.com Jim Oberweis of Oberweis Investments provides the following stock ideas on Sabratek (SBTK 22 5/8) and Biogen (BGEN 65 7/8). Below is the write up. The shares of Sabratek are well off of their 52 week high of $38 per share. If you look at a chart of their stock, it may mirror that of the last roller coaster you went on with its frequent ups and downs. Sabratek is a maker of cost-effective multi-therapy infusion pumps which can be hooked up to a person in their own home. The pump is hooked up to a phone line so a doctor can change doses in medication remotely. "This is just the beginning of a number of virtual type hospital type products that Sabratek will come out with," says Jim Oberweis of Oberweis Investments. He notes that they are developing more products such as a vital signs monitor that will transmit data from a person in their home such as blood pressure, heartbeat, glucose levels, oxygen.. etc. to a remote location where a doctor can monitor and adjust medication levels based on the data. Another way Sabratek can make money from the product is that they can sell the data from the people that they monitor. That involves monitoring the effects certain drugs have on people which can be stored and then sold. Sabratek is estimated to earn $0.82 this year and $1.14 next year. Another company that Jim likes is Biogen. They are a maker of a drug called Avonex, which is used for treatment in the relapsing stages of multiple sclerosis (MS). Biogen is working on clinical studies that will show Avonexs' effectiveness in later stages of MS. Jim thinks that the results will be positive and when that happens it should move higher. ----------------------------------------------------------------- 5. techstocks.com Joe Dancy of The Lone Star Growth Investor members.aol.com provides the following links to Interesting Articles On The Internet. These articles were from a daily worldwide search of over 150 newspapers and magazines. Subscriptions to his newsletter are FREE. members.aol.com INTERNET AND INTERNET COMMERCE GM Revs Up Web Sales - Regional program rolling out nationally early next year sfgate.com We're on the cusp of a genuine revolution in bandwidth mercurycenter.com SEMICONDUCTOR & ELECTRONICS Tech industry pushing limits on disk drives mercurycenter.com Chip industry finally hit bottom analysts say mercurycenter.com ECONOMIC New hints of rate cut emerging from Fed mercurycenter.com U.S. incomes grow and spending rebounds in shadow of global slowdown detnews.com Analysts want more than a little fed cut chicagotribune.com Fed rate cut may not halt crisis bergen.com Short world recession 'possible' straitstimes.asia1.com World Bank economist warns of global recession triblive.com Dip in economy could threaten Clinton's slippery hold on office detnews.com Global economic upheaval, push to oust Clinton are connected chicagotribune.com, 00.html Long-Term Capital Management L.P. had run out of capital to support more than $100 billion in financial obligations it had made with borrowed money. washingtonpost.com A huge private investment fund run by Wall Street legend John Meriwether and two Nobel Prize-winning economists teetered on the verge of collapse washingtonpost.com MARKETS & INVESTING A losing investment is never a total bummer if it can be used as a tax write-off. bergen.com The 3rd quarter is shaping up to be one of the worst on record for mutual funds. mercurycenter.com So you think you've taken a beating on the stock market lately? Well, Harvard University's endowment lost about $1.3 billion since July 1. globe.com Why bother trying to understand "puts" and calls" when perpetual options allow you the chance to make money and be able to actually explain how you did it? Simply stated, many stocks which can be purchased for under $10 a share hold this potential. nypostonline.com Individual investors shouldn't suffer from hedge fund's turmoil globe.com Time to Jump Into Rebounding Small Caps? You May Want to Wait members.aol.com Wall Street wants you to believe that investing is a black art, practiced best by brilliant seers - but the lesson for small investors is to buy good companies at good prices and hold on to them for a long time. That's it. Stray from this path at your own peril. washingtonpost.com ----------------------------------------------------------------------- 6. techstocks.com Sun Tzu is an active participant on the 3DFX thread here on SI. He provides the following commentary on 3DFX (TDFX 11 1/4) and what they are all about. Below is his write up. "Few companies have ever inspired such devout following as 3Dfx Interactive (NASDAQ: TDFX). Apple has, Microsoft has, and in their glory days, GM and Xerox did as well. But unlike the above companies and despite being the most dominant player in its niche, 3Dfx is a very young and small company. In fact with a market cap of just over $175 Million, it is considered a "microcap". This however is something that 3Dfx's ardent followers believe will change with time. 3Dfx is the maker of the famous line of Voodoo chips which are the engines of the most popular 3D graphics accelerator cards such as Creative Lab's 3D Blaster and Diamond Multimedia's Monster Voodoo2. These are the graphics add on cards that have become a must have for anyone interested in playing the first person shooter games like Quake, Unreal, and Forsaken. With its new product line, Voodoo Banshee, 3Dfx has diversified into the upper end of the mass-market video cards, which has so far been dominated by ATI Technologies and Matrox. Voodoo Banshee integrates most of the 3Dfx's Voodoo2 core with the world's fastest 2D processor. Some benchmarks have shown it to be the fastest chip around, while others have placed it at number 3. Ultimately, like all video cards, its performance depends on what kind of system you have and which applications or games you intend to use. One thing is for sure though, with a price tag of $90~$160 (depending on the card maker and bundled games) it is a serious contender in the 2D+3D arena. As successful as 3Dfx has been in capturing the market share in the gamer community, it's stock price has been most disappointing to its shareholders, falling from the high of 35 to currently 11. This despite the fact that in each quarter this year, the company has had more revenue and earnings than in its entire previous year. The company is debt free and has a strong cash position. But investors have decided to focus instead on the negatives such as the uncertainty about the size of the gaming market, and doubts about 3Dfx's ability to survive in the highly competitive low margin-high volume OEM market which has been dominated by ATI Technologies for so long. As if this was not enough, 3Dfx faces competition on the high end from nVidia's TNT and on the low end from Intel's i740. 3Dfx insists that Intel's i740 is targeted to a different market than its own chips, and thus it is not a competing product. As for TNT, in a case that will be watched closely by the entire industry, 3Dfx recently launched a lawsuit against nVidia over violation of its multitexturing patent. Analysts believe that 3Dfx stands a good chance of winning the lawsuit. Should that happen, it may delay the next generation of competing products for a considerable amount of time or force other chip makers to license 3Dfx's technology. In the cutthroat world of video graphics cards littered with numerous casualties, 3Dfx has as much chance to make it to the top as anyone has had in a long time. And that is what its shareholders are banking on." For more information see: 3dfx.com op3dfx.com voodooextreme.com biz.yahoo.com ----------------------------------------------------------------------- 7. The Taulli Report, Voices of SI: by Tom Taulli Conflicting stories hurt Nortel stock stocksite.com RealNetworks faces real competition from Microsoft stocksite.com Amazon.com losing giant status as competition heats up stocksite.com Despite controversy, AOL has its bulls stocksite.com IPO market gets a charge out of eBay stocksite.com Many Internet investors yelling Yahoo! stocksite.com ---------------------------------------------------------------------- 8. From Limos to Lemons by David Z A wonderful analysis of telecommunications stocks and how SI members have related to them :) | ||||||||||||
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