Petroquest Energy (NYSE:PQ): Compelling Valuation with Near-Term Catalysts; Upgrading to Overweight - J.P. Morgan

J.P. Morgan is out with a major call on Petroquest Energy (NYSE:PQ) upgrading it to Overweight from Neutral with a $12 price target.

The 21% stock price decline over the past week offers an attractive entry point for investors, in JPM's view. Catalysts include the near-term drilling and completions of four Woodford Shale wells and the results of a Gulf Coast exploration well. The company has acreage in East Texas that is 14 miles from CHK’s recently announced 9.4MMcfepd Bossier Shale well, so PQ has potential in the Bossier as well as the Haynesville.

Re-starting Woodford drilling. PQ re-started its drilling program in the Woodford two weeks ago. During 4Q09, PQ plans to drill and complete two wells and complete another two wells that it drilled last year. The well it is currently drilling was AFE’d at $4.1 MM. The company’s current plan is to continue utilizing 1 rig in 2010 to drill 8 wells, and PQ might add a second rig during 1H10.

Approaching TD at Whistling Straits. PQ is currently drilling its Whistling Straits prospect and is close to TD. Whistling Straits is high risk, with an expected chance of success of 25-30%. However, the dryhole cost of the well is $1.9MM net to PQ with un-risked net reserves of ~25 Bcfe and the potential to add ~10 MMcfepd of net production.


Rights to Haynes ville uncertain but not to the Bossier. PQ has 23,900 net acres in southeast Panola County, Texas, and it has rights to the Bossier Shale on all of this acreage. PetroQuest’s acreage is 14 miles northwest of CHK’s Bossier Shale well that had an IP rate of 9.4 MMcfepd. The company has rights to the Haynesville on at least 1,100 net acres and possibly more depending on its partnership with CVX. Based on other operators’ publicly disclosed maps, PQ’s acreage appears to be on the edge of both the Bossier and Haynesville Shale plays. JPM gives PQ no credit for Bossier potential and value PQ’s Haynesville potential at ~$1/share.

Compelling valuation. JPM's $12 price target implies 100% upside from the current share price compared to the group's median upside potential of 26%.

Thesis. PQ currently is trading at a discount valuation to the group. The group is trading at 78% of our NAV, and PQ is trading at 48% of NAV. The market perceives greater risk in the name, but the company’s 2009 cash build-up and equity offering have greatly improved its liquidity and debt metrics. Operationally, the company’s two gas shale plays (Woodford and Fayetteville) have shown steadily improving results. PQ expects to keep its Gulf Coast/Gulf of Mexico production flat and could get a boost with successful exploration from that region.

Notablecalls: There is very little doubt in my mind this one will fly today.

Petroquest has always been a kind of a controversial E&P player but with a firm the size and reputation of J.P. Morgan giving its blessing people will scramble to own it. The co sold 10M shares back in June so the financial position is now secure and the co can again spend money on exploration again.

- Low valuation vs. peers

- Catalysts on the horizon

- J.P. Morgan's target price is now about TWICE that of the competition. This is bound to generate strong interest.

I think PQ will trade up 10% today (if not more), putting $6.50 in play.

Apollo Group (NASDAQ:APOL): Colour on news - Overreaction?

Apollo Group (NASDAQ:APOL) is under pressure this morning after announcing its results and yet another SEC inquiry into its revenue recognition practices:

- Merrill Lynch/BAM is downgrading the stock to Neutral from Buy with a $73 target (unch)

- RBC Capital is downgrading APOL to Underperform from Sector Perform and lowering their target to $66 from $73.

- Morgan Stanley is downgrading APOL to Equal-Weight from Overweight.


The downgrades are what they are. I'm going to focus on the defenses and other comments:

- JP Morgan maintains their Overweight rating and $95 target noting that two most obvious areas of SEC review could be revenue impact of refunds and bad debt. In general, both of these areas use a relatively limited amount of “judgement”, thus perhaps limiting the exposure. They acknowledge that Apollo’s (and for-profit sector’s) business model is highly attractive from the cash flow perspective, as majority of cash is paid upfront and then recognized over the appropriate periods. Importantly, APOL’s cash flow from operations has consistently exceeded net income, (comprising 1.6x of net income in FY2009, for example), which also gives us some comfort on revenue recognition. Firm also notes that APOL’s revenues are shorter cycle (based on 5-9 week courses) which leaves less room for timing differences across reporting periods.

While JPM's review of similar inquiries in the for-profit industry (COCO in 2005) and other industries found individual cases of SEC inquiries, the outcomes varied widely. For example, COCO was forced to restate its revenue recognition for certain diploma programs with a limited impact on financials.

Apollo stated that the Enforcement Division of the SEC has started an informal inquiry into the revenue recognition practices. Management has not been able to identify specific items under review, but feels comfortable with the existing policies. Importantly, APOL's auditors have signed off on the 10K without qualification. JPM's research of similar inquiries in this and other industries found a wide variance of the possible outcomes and that resolution could take more than a year

Taking a longer-term approach. Before a retrenchment today, shares of APOL trade at 13x firm's revised CY2010 estimate of $5.48 vs. the sector’s average of 15x. They think that APOL is compelling given company's dominating market position, strong growth/margin balance, and more consistent execution. Their new Dec 2010 price target of $95 implies 16x FY2011 EPS of $5.80, and suggests NTM multiple expansion from the current level, but below historical levels.

- Piper Jaffray is maintaining their Overweight rating but are lowering target to $91 (from $108) saying that while the scope, duration, and outcome of the inquiry are unknown at this time, they understand Apollo's revenue recognition practices to be straightforward.

Based on past SEC inquiries in the education space, it is not uncommon for such inquiries to span several quarters, with little if any information flow. Given the uncertainty surrounding the outcome of the SEC inquiry, they expect APOL shares will likely be range bound over the next several weeks, but ultimately believe investors with a longer term investment horizon will be rewarded by owning the shares.

The company received notice from the SEC of the informal inquiry last week, and it is interesting to note that despite the SEC informal inquiry, Apollo filed its 10-K yesterday, signed by the company's auditor, Deloitte and Touche.

- UBS notes management announced the SEC recently began an informal inquiry into revenue recognition. While it is too soon to accurately assess the impact, they think it is likely to be small and so the sharp sell-off after market was likely overdone. UBS believes management is closing in on a settlement of the Qui Tam case. They think the $81mm reserve looks reasonable relative to the $1bb face value of the charge.

Q4 results were solid as starts, enrollment, revenue, margins, and EPS all beat UBS estimates, and bad debt was lower than expected. UBS maintains Buy and $120 target.

- CSFB wonders if the SEC is seeking clarity on how/when Apollo’s revenue recognition is impacted when an online student stops attending class or how it relates to the pace at which students “earn” Title IV student aid funds. They believe that the DOE is focused on a related issue that will be discussed in the upcoming negotiated rulemaking (negreg) regulatory review sessions. As such, they believe it is prudent to await more detail on the outcome of the DOE’s negreg process and on Apollo’s inquiry before speculating on the potential results of the inquiry.

Maintains Neutral and $65 target.

Notablecalls: This is not the first time the SEC has probed APOL's revenue recognition policies. Last time around, in 2008 the case ended in this:

http://www.sec.gov/Archives/edgar/data/929887/000000000009005672/filename1.pdf

The thing ended in: 'We have completed our review of your Form 10-K and have no further comments at this time.'

If you read the letter you can probably see there were no smoking guns found. This in turn makes the new inquiry (albeit informal) somewhat surprising. But I guess maybe DOE asked SEC to double check.

Anyway, I think the market may be somewhat overreacting to the SEC inquiry news here.

Would be buying on dips sub-$60 level.

PS: I discussed the APOL news with a trader that had done some prelim. work on it overnight and according to him the downgrades look silly.

'Even the analysts downgrading APOL this morning see only minor one-time expenses related to the inquiry (or in some cases even seeing the thing end in nothing) but they are still cutting their EPS multiples from 20x to 12x. This is silly.'

Fyi.

PPS: The stock was trading around $58-$59 while I wrote the comments but has taken off since then and is trading around $60-$61. Bit of a missed opportunity.

Lorillard (NYSE:LO): UBS raises target to $100, sees takeout in 2 yrs- Bounce?

Lorillard (NYSE:LO) is getting some surprisingly positive commentary from analysts this morning after yesterday'd hefty sell-off:

- UBS is raising their target to $100 from $80 noting every stock has its role in a given portfolio. Investors own companies because they are best-in-class, others look for cash return/income stories and another type of investor looks for event driven ideas. Lorillard has all 3 of these traits. UBS believes Monday’s 7% (unwarranted) pull back offers many types of investors an opportunity to buy a best in class company that is a legitimate M&A candidate.

How Much Do You Get Paid to Wait for the Take-Out? 15% Per Year
While they have limited visibility on when Lorillard will get taken out, they would be surprised to see the company as a stand alone entity beyond 2 years. Firm sees Reynolds American or Imperial Tobacco as logical buyers. They estimate investors waiting for an eventual take out can expect 15%+ total shareholder return per year to wait (10% EPS growth, 5-6% dividend yield).


What’s Driving Lorillard’s Fundamentals?
The key pillar to UBS investment thesis on Lorillard is beatable and sustainable EPS growth targets of 5-7% per year, driven in large part by the company’s exposure to the Newport brand (91% of total company sales). Below are summary points about the key drivers of Newport’s growth:

It’s menthol: The primary driver of Newport’s growth is the migration of smokers towards menthol products (Newport is the highest share menthol brand). Menthol has been gaining share of total cigarette volumes for several years and we expect that to continue over the next few years.

It’s more popular than other menthol: On top of the share gains that the menthol category has been capturing from non-menthol cigarettes, Newport has been gaining share within the menthol segment, despite already being the largest menthol brand.

Plenty of “white-space” for menthol left: While menthol cigarettes compose 28% of all cigarettes smoked in the US, there is a distinct geographic skew to the menthol smoking population. Most menthol consumers are east of the Mississippi. They believe there is an opportunity for menthol brands in the Midwest and the Western US. This is evidenced by the fact that menthol gained share in 43 states during 2008 (based on insights from UBS' industry contacts and other data sources). UBS thinks that as the menthol category goes westward, so will Newport.

Economics Are Why Holders Shouldn’t Be Fazed By FDA
UBS reiterates that their views on a potential menthol ban are guided primarily by the economic implications of such a ban, and secondarily by political motivations or the semantics of the actual FDA regulation bill. They are hard pressed to see how state and federal governments could part ways with the large sums of tax/MSA revenue generated by menthol cigarettes (30% of total cigarettes).


All in, they estimate banning menthol would: 1) cost the federal government over $2 billion in annual tax revenue ($5.5 B in excise and sale tax revenues for states), and 2) likely create a large underground/illegal market for menthol that could not be taxed or regulated.

- Morgan Stanley is out with a positive Research Tactical Idea (RTI) on LO saying they believe the share price will rise in absolute terms over the next 30 days.

This is because the stock has traded off recently, making short term valuation much more compelling. Although LO's 3Q09 results trailed MSCO forecast, they do not believe there has been any change in the Company's long-term prospects and/or value, and as a result, they believe that the 7% decline in Lorillard's share price is both an over-reaction and unwarranted.

Firm expects strong absolute returns to be driven by: 1) Improved reported shipment volume, with a declining negative impact from trade inventory movements. They forecast LO's shipments to decline by 5.2% and 2.4% during 4Q09 and 2010, respectively. 2) Stronger pricing (note PM USA's 3-4% hike on Friday). 3) More favorable menthol competitive conditions (e.g., the Blend 54 launch impact will moderate). 4) Increasing share repurchases. 5) An attractive valuation at ~8.0x 10e EV/EBITDA (=RAI), and a 5.4% dividend yield.

Morgan Stanley estimates that there is about a 70% to 80% or "very likely" probability for the scenario.

Notablecalls: I think that following these two comments (there are several other defenses from tier-1 firms) LO has a decent chance of getting a bounce going.

The $100 target from UBS will get attention. Takeout speculation isn't nothing new but with UBS saying they are convinced a deal will take place in the next 2 yrs adds some fuel to the fire.

Also, LO is kind of a defensive stock. People are increasingly looking for plays like LO to generate them good dividends and medium growth.

LO is a tough stock to trade but given the comments and with some help from the general market I think it can retrace at least half of yesterday's losses. That's about $76-$77 range.

Leap Wireless (NASDAQ:LEAP) & Metropcs (NYSE:PCS): Bounce time?

I'm seeing some interesting comments on Leap Wireless (NASDAQ:LEAP) & Metropcs (NYSE:PCS) after T-Mobile USA launched its new pricing plans, which have been speculated about recently as part of "Project Black/Dark".

- Piper Jaffray notes the the new plans are more benign than investors' initial fears and could relieve some pressure on wireless stocks.

Firm notes they think T-Mobile's new plans most directly target Sprint's prepaid and Simply Everything plans, as well as AT&T's new GoPhone offer. The pricing levels are generally too high to be a major competitive threat to Leap or MetroPCS, yet don't offer the robust 3G networks of AT&T or Verizon.

It will also be interesting to gauge consumer interest in plans without a handset subsidy; recall iPhone sales were tepid prior to a price drop when first introduced and really accelerated once subsidies were included with a higher monthly recurring fee.

- Goldman Sachs says new pricing appears more rational than recent reports, which had indicated potential “all you can eat” unlimited talk/text/data plans for $60/month (Project Dark introduced this for as low as $80/month). So, this is not as bad as perhaps many had feared. However, on net this is another viable competitor at the lower end of the market, with an offering around no contract unlimited that more directly competes against Leap, MetroPCS and Boost in particular. Additionally, the plans aim to reinforce the company as the value alternative at the higher end of the postpaid market.


- Oppenheimer notes that as they expected, T-Mobile unveiled new prices between $50-80/month for unlimited voice+text+web contract/no contract options, which validates information leaks over the past few weeks that its new pricing scheme was not going to be as deeply discounted as originally feared. They believe this is the last major price move in the 2008-09 Wireless Price War, and expect pricing stability for at least a year. The headlines that T-Mobile is cutting prices could pressure industry shares, however we believe these less aggressive price points putting T-Mobile at a slight discount/par with Sprint should help stabilize stock prices in the industry.

Positively for LEAP/PCS, T-Mobile's new pricing remains at a premium which could relieve some pressure on its shares. We expect T and VZ to maintain their premium pricing, given the high family/enterprise plan mix (~80%) of their customer base, and the fact they continue to gain share with their handset/network/customer advantage.

- Jefferies is out positive saying investors are concerned that heightened pre-paid competition threatens LEAP's/PCS' survival. They believe that LEAP/PCS will weather the storm because of their favorable cost structure & rapidly expanding dist. Reit Buy rating.

ARPU Pressure Moderating Post Project Black. T-Mobile's expected unlimited, no-contract offering is expected to be priced at $49.99 for voice, $59.99 for voice and text and $79.99 for voice, text and web. These price points are $10-$30 above LEAP's/PCS' price plans.

LEAP's Broadband Initiative to Turn EBITDA Breakeven in Early 2010. The company expects to be near EBITDA breakeven by YE09 and expects incremental customer profitability for the segment to be similar to its existing voice business in 2010 and could represent over $100mm in run-rate EBITDA.

Significant Spectrum Value. Jefferies believes that there is significant spectrum value in these firms. LEAP has 2.9bn MHz-POPs, which they estimate would be worth $2.9bn using valuation data pointsderived from precedent spectrum sales over the last seven years. The value of LEAP's/PCS' spectrum supports a liquidation/break-up value of at least $24 & $8/share, respectively.

Notablecalls: LEAP/PCS have been taken to the back and SHOT! In five months both stocks have lost almost 2/3 of their value.

One of the major drivers behind the moves is the looming competition (read: pricing). Yet, now it looks like the DT's Project Darkness isn't that of a big deal.

I think that given the very low valuations and increasing potential to be acquired, buyers will step back in at least in the s-t.

Not going to press it but I'm looking to buy some PCS and LEAP.

Citigroup (NYSE:C): Burndown & SOTP uncover more value - Merrill Lynch/BAM

Merrill Lynch/BAM is out positive on Citigroup (NYSE:C) raising their valuation ranges on the stock. They now see $8 to $12 valuation as mid-best case SOTP.

Firm notes their decision to upgrade Citi to Buy in August was based on a detailed Burndown analysis that showed, in their view, the stock had little downside and significant upside potential as it was trading around “Burndown” Book Value. In their original Burndown analysis, they sought to determine the value of Citi’s shares after putting the balance sheet through a very punitive stress test. In this initial Burndown scenario, the firm assumed Citi absorbed $141bn in losses, $38bn of which came from the Special Asset Pool. Citi recently released improved disclosure on the Special Asset Pool, and Merrill has reassessed their loss estimate in light of the new information, in addition to updating their analysis for 3Q:09, during which gains were recorded in the SAP. The new disclosure clarified exposure to specific asset classes within the SAP, and indicates that their original total loss estimate of $141bn for Citi was perhaps $21.4bn too high. They have lowered expected losses on the SAP to $23.4bn from $37.8bn in the Worst case scenario.

Burndown scenario puts downside at $4.22
Merrill has revisited their original Burndown analysis on review of improved disclosure on the Special Asset Pool. They deem their original “Worst-Case” loss scenario somewhat too severe. Their new Worst-Case downside valuation is $4.22 (was $3.44) on a Burndown Book Value per Share of $4.14 (was $3.88).

Sum-of-the-Parts values C at $8.73
Merrill's Sum-of-the-Parts analysis yields a $199bn valuation, or $8.73 per share on 22.9bn shares. As a “reality check”, they test their SOTP by applying its assumed losses to a “Burndown”, and arrive at an $8.12 valuation, providing support.

“Excess capital” scenario puts upside at $11.67
Firm's Best Case scenario examines possible eventual share repurchase ability due to excess capital in a “normalized scenario”. Best case scenario yields a value of $11.67 on a 15.9bn share count.

Long-term value compelling, maintain PO for now
They think the long-term value thesis for Citi is compelling but are leaving their PO of $5.75 in place, as it represents a small discount to current BVPS and they continue to expect Breakeven earnings at best well into 2010. PO’s are established on a 12-month basis. Merrill's PO still provides 30% upside potential.

Reits Buy.

Notablecalls: So now Merrill is starting to call a double in Citi in the next 12-18 months? Kind of looks like it.

Should create some buying interest in the name.

Interesting to see if this one can trade over the $4.60 level today.

15% correction coming in SP500?

Notablecalls: FYI ONLY -

Sandisk (NASDAQ:SNDK): Negative commentary following results

Sandisk (NASDAQ:SNDK) is getting some negative commentary this morning following blow-out results announced last night:

- UBS is out reiterating their Sell rating (while admittedly raising their target to $20 from $18) noting that SNDK Q3 results were significantly above their forecasts on newly ramping OEM sales that drove a third of the sales growth, and GM and royalties that were above mgmt’s prior outlook. Despite the strong OEM backlog for Q4, they still believe order momentum will moderate by late Q4 as AAPL and other smartphone vendors launch products for the holidays. UBS views retail demand as performing modestly better than expected, but still subject to price elasticity.

They expect demand to moderate by late Q4 as holiday builds conclude.

- JP Morgan is reiterating their Underweight rating saying SNDK beat 3Q09 expectations, in part owing to one-time benefits, but also due to strong sequential growth in the OEM market, atypically strong NAND pricing, continued improvement in COGS, and disciplined expense containment. Guidance points to further improvement, but future earnings power still seems weak by 2005-2006 standards, and fragile to the extent that pricing and margins are still dependent on the behavior of larger competitors. They are raising estimates,increasing their price target to $18 (from $15.50), but maintain their Underweight rating.

- Morgan Stanley notes that despite strong beat and raise results on better than expected handset OEM unit demand and cost reductions, they recommend investors to take profits as they see signs of NAND component pricing peaking in October ahead of 1Q seasonal decline. SanDisk stock shows a 90% correlation to NAND component pricing. Morgan Stanley's checks in the memory food chain suggest that spot pricing is getting choppy, which is typically an early sign of pricing peak. In addition, SNDK retail sales were flat Q/Q in 3Q, which shows that the consumer is not willing to pay more at the current price levels. Longer-term, they remain constructive on NAND supply-demand fundamentals but believe stock pulls back in Nov-Jan period on NAND pricing softening.

Despite better than expected results, they see stock fairly valued ~$23 (18x 10' EPS) with risk to the downside ~$18 in the near-term given impending seasonality. Firm prefers MU to SNDK on lower retail exposure (less seasonal) and PC related DRAM enterprise demand next year.

Morgan Stanley is also establishing a negative Research Tactical Idea on SNDK saying they believe the share price will fall relative to the industry over the next 60 days. They estimate that there is about a 70% to 80% or "very likely" probability for the scenario.

* In order to stay objective here are the more positive comments on SNDK: *

- Goldman Sachs maintains Buy and $24 price target on the name saying they are comfortable with investors continuing to own SNDK as long as NAND supply/demand dynamics remain favorable. However, with SanDisk approaching their price target for those looking to put new money to work, they would recommend SPE names such as LRCX that are most leveraged to a pick up in NAND spending, as they see greater relative upside in the SPE stocks vs. SanDisk

- Deutsche Bank reits Buy and raises their target to $32 (from $23) saying that although inventory benefits are likely to moderate they believe the company is poised to deliver organic margin improvement due to ongoing cost reductions and benign pricing. Combined with superior rev growth (+3% y/y in 2009E vs. industry -15%) and a focus on free cash flow suggest further upside is likely.

Notablecalls: I think SNDK is an ACTIONABLE SHORT above the $23 level today. Here's why:

- It did beat expectations but so did INTC, CAT, TXN etc. All of these are trading below the beat levels.

- We have Morgan Stanley out with a negative RTI (Research Tactical Idea) - people follow these and are out shorting/selling SNDK today.

- I have said it before and I will say it again - this stuff is not sustainable. SNDK isn't even generating free cash flow despite all the ga-ga. Pricing will decline.

Boeing (NYSE:BA): Downgraded to Underweight at Morgan Stanley, target to $43

Morgan Stanley has turned negative on Boeing (NYSE:BA) downgrading the stock to Underweight from Equal-Weight while lowering their target to $43 from $50.

According to the analyst BA shares may face downward pressure given likelihood for further delays on the 787, negative 2010 cash flow, poor aircraft order demand and negative EPS revisions ahead.

1) Further delays on 787 – Morgan Stanley notes they have concerns that first flight will be pushed to 2010 and even more concerned first delivery could be 6 months delayed to Spring 2011. Technical challenges may delay first flight, but either way it is something of a distraction. Bigger issues are ahead. They would not be surprised to see delayed first delivery and program ramp given scope of redesigns, weight overruns, high fuel burn, and high manufacturing costs. If our concerns are borne out, 787-8 may fall short of contractual guarantees, entitling airlines to remuneration. BA still has its work cut out for it and while they trust management’s effort, they believe that the risk of unforeseen delays is not baked into the stock.


2) Cyclical downturn ahead – Morgan is cutting their mature plane forecasts, projecting a trough in 2011 vs. Street’s 2010. They also project a book:bill less than 1 next year; BA’s stock price to orders is still 0.82. They are slicing 2010-2011 EPS & expect that over time consensus will follow.

EPS estimate cuts: From $4.50 to $3.85 in 2010 and from $4.85 to $3.55 in 2011

3) Mounting cash outflow ahead – i) Enduring 787 challenges, ii) supplier claims which likely come to a head next year, iii) fewer less profitable aircraft mix and iv) possibly higher BCC financing point to sizable stresses on BA’s balance sheet 2010-2011. Firm projects negative cash flow of $2.7B (next year and a pale recovery (breakeven in 2011) through 2012.

Street estimates too high – Morgan believes consensus estimates may be too high and declining, thus the shares may not prove to be as cheap as they first appear. At $53, BA is trading at 12.5X consensus 2011 EPS of $4.26. They are meaningfully lower in 2010-2011 EPS vs. consensus, projecting $3.85 in 2010 and $3.55 in 2011.

Notablecalls: I think that at least in the short term this is an important sentiment call in BA. Morgan Stanley is not only highlighting 787 related problems but also supplier claims and a potentially less profitable mix which should result in hefty negative free cash flow.

Note that late last week FlightBlogger highlighted another possible 787 delay but the market didn't pay much attention. The stock gapped lower on Friday but squeezed higher helped by Boeing's PR team that sent out another 'all is well' message via Dow Jones.

It now looks like Morgan Stanley isn't buying the PR hype anymore so I guess the stock is set to give back at least the squeeze gains (and dim sum).

So I think BA will trade closer to $51 level in the s-t.

Link: Unanswered questions, cautious optimism define 787 wing fix
http://www.flightglobal.com/blogs/flightblogger/2009/10/unanswered-questionscautious.html

Potash (NYSE:POT): BHP could pay USD 125-130 for Potash Corp. (POT), bid would be 13% EPS accretive - Merrill Lynch

Merrill Lynch/BAM is out with a major call on Potash (NYSE:POT) saying BHP Billiton should buy the potash producer.

Firm estimates that an all-cash bid for POT at a 30% premium could be 13% EPS accretive in years 1 and 2. From discussions with clients during recent marketing, they believe the market is receptive to BHP acquiring potash assets.

Why is POT the right deal for BHP?
1) BHP has an interest in being a world-scale producer of Potash. This deal provides instant scale. 2) BHP wants to own world class long life, large scale, low cost assets. We think POT ticks all these boxes. 3) POT dovetails nicely with BHP’s existing land position and Greenfield project in Canada. 4) BHP’s balance sheet is ungeared and the company generates huge cashflows. An all cash acquisition regears the company and adds an appropriate, complementary asset. Merrill believes that Potash as an industry matches BHP’s core competencies i.e. 1) Project development 2) Resource operation management 3) Resource marketing.

Kudos for being ungeared into downturn but missed bottom
BHP Billiton was widely admired by investors for entering into the downturn with little/no debt having walked away from its bid for Rio Tinto. However, whether because it couldn’t move quickly enough or because its bids for available assets were too low, in firm's view BHP did not use its balance sheet to its advantage during the downturn. To be fair, the high quality assets that BHP wants to acquire are rarely going to be distressed and the downturn was relatively short lived.

Why now? Sentiment regarding potash nearing a low
Merrill believes that negative sentiment regarding Potash gives BHP a second chance at acquiring assets at a cycle low. Consider the following:

- Ag chemical companies have issued profit warnings.

- Price dropped below Merrill's estimate of long term price for the first time in years.

They think that bearishness is likely to persist up until China settles which could be 2-3 months out and could be a powerful catalyst. Distributor inventory levels in the Americas are low and will need to be restocked.

In Merrill's view if there ever was a time to buy a big potash producer, this is it.

BHP already owns Potash assets
Potash assets would not be a new M&A target for BHP, with the company having previously commented that potash is a good industry that suits its skill set i.e. mining, project development and product marketing and trading. In mid-2008, BHP acquired Anglo Potash for C$263 million. It has also secured numerous attractive mining permits in Saskatchewan.

Earnings accretion analysis
Merrill's simple earnings accretion analysis assumes an after tax cost of debt of 4% and a 30% acquisition premium. They also assume a simple 1% of sales as synergies although, from previous discussions with BHP, they believe that they think there is potential for material improvements by bringing “best practice” from their other mining operations. Is it surprising that an all cash transaction is so accretive? Not really, in our opinion, given that they are comparing after tax cost of debt to a return on equity. Still, given that BHP is perceived as undergeared, a transformative transaction of this size provides the releveraging that many in the market perceive as necessary.


Notablecalls: WOW - I sure didn't expect a call like this one from a firm the size of reputation (no pun) of Merrill/BAM. Surely, there have been hints from other firms and even speculation that a deal may be in works but nothing on the scale we are seeing this morning.

There were some positive rumbling regarding the coming Chinese potash price settlement on Friday, so I think the stage may be set for a large upside move in Potash shares.

Note the co reports this week but given they have already pre-announced there isn't much headline risk.

I think POT will trade up today to the tune of 5%+ meaning anything below the $100 level is a buy.


PS: This is what RBC Capital's Technical Analysis team has to say about Potash (NYSE:POT) today:

POT is of interest as it appears to be on the verge on reverson 4+ month downtrend. Similar to MOS, MON, IPI, POT will need to break its 4+ month relative performance downtrend to confirm technical relative reversal developing:


Notablecalls: This is exactly what it feels like - STAGE IS SET FOR A MAJOR UPSIDE MOVE.

Make sure you keep it on your radar.

Apple (NASDAQ:AAPL): Apple could report disappointing F4Q09 revenue, according to checks - Oppenheimer

Oppenheimer is out with a potentially venomous call on Apple (NASDAQ:AAPL) saying they Apple could report in line to slightly disappointing F4Q09 revenue ($9.0B-$9.2B) and would keep some powder dry to buy shares following the print, rather than ahead of it.

The focus of their concern is the iPhone. While demand for the product appeared to run ahead of firm's 6M unit target, they believe component/manufacturing hiccups may have prevented Apple from fully meeting demand during F4Q09. They'd use any pull-back as an opportunity to aggressively accumulate additional shares ahead of several near-term catalysts: a potentially gargantuan December quarter for iPhone (assuming no further component issues); re-acceleration of Mac growth with the release of the new MacBook and iMacs; and the likely announcement of the tablet in early 2010.

The first hint of trouble for the iPhone surfaced during the iPod event on Sept. 9, when Apple implied that ~3.5M phones had been sold with only 21 days left in the quarter. Subsequent checks showed the iPhone 3GS sold out in many markets. Something was clearly preventing Apple from shipping to demand.

- Recent carrier surveys suggest the supply constraint has eased. But it's difficult to judge when the bottleneck was resolved, or how many iPhones might have shipped in the final 21 days of the quarter. Consensus estimates imply that 3.5M phones flowed out to customers in the final weeks of 4Q09, which may be too aggressive.

- With demand for the iPhone apparently outstripping supply, December could be a substantial catch-up quarter, both in terms of sell-through and channel replenishment. Barring any additional component or manufacturing disruptions, Oppenheimer believes their 8M unit assumption for F1Q10 could prove conservative, especially given the iPhone's expanding carrier footprint.

- On Mac, they believe upside potential relative to the consensus range of 2.7M-2.8M units is limited, as persistent chatter about a new MacBook and iMacs likely delayed some purchases. Oppenheimer believes F1Q10 YoY growth rates will be significantly more impressive than for F4Q09.

- On gross margin, they expect Apple to significantly outpace consensus on a GAAP basis (they're at 37.3%), as a result of higher iPhone mix and a strong software contribution. Non-GAAP gross margin is likely to be only slightly above the consensus 40.3%—if iPhone caution proves true.

Notablecalls: Wow, calling a potential miss for Apple (AAPL) this is a bold statement from Oppenheimer's Tech/Applied Tech team!

INTC, IBM etc have sold off on pretty stellar (well, at least seemingly stellar) quarters so you would imagine the reaction when Apple actually misses on revs. When was the last time that happened? 4 years ago? Intstant -10-15pts in the cards?

This is a major (sentiment) negative for the stock here, I suspect. Supply issues or not, AAPL's current valuation is not built for that here.

I think we will see some hefty early downside in AAPL stock once the call starts to circulate the trading desks.

I see 3-5 pts of downside today if the market cooperates.

Par Pharmaceuticals (NYSE:PRX): Upgraded to Overweight at Barclays; target raised to $30

Barclays is upgrading Par Pharmaceuticals (NYSE:PRX) to Overweight from Equal Weight with a $30 target (prev. $18)

Despite admittedly strong YTD performance, the firm sees sufficiently significant upside in the stock to justify the higher rating based primarily on attractive valuation on their upwardly revised, high-conviction EPS ests. & high probability of further upside to their forecast. Specifically, they view the unexpected approval/ launch of generic Catapres in Aug as a "thesis changer" given the windfall cash flow which will increase Par's financial flexibility. Potential delayed competition for Catapres & approval/ launch of generic Ultram ER offer EPS upside, the latter potentially adding +$0.50 on annual basis. With the stock trading at only 8.6x Barclays' revised FY11 est, they see ample room for outperformance as the story gains greater appreciation.

As a reminder, in May, Barclays first highlighted Par as an interesting special situation which warranted diligence, based on very achievable FY09 estimates, characterized by strong visibility and potential significant upside, the latter from potential delayed generic competition on generic Toprol XL, Imitrex, Antivert, and Marinol. However, despite confidence in their estimates, tempering their stock conviction was the view that management still needed to build a more consistent track record of solid earnings and communication (neither of which it had done in the past).

While we are still in the early stages of the latter, the “thesis-changer” for Barclays was the completely unexpected FDA approval of Par’s generic Catapres (announced Aug 18) -- after the application sat at the agency for 8 years and, deservedly, was viewed by the Street as a near zero probability commercial opportunity before the approval. Close behind Catapres in importance was a favorable lower court patent litigation decision on Ultram ER (announced Aug 17), which is an attractive first-to-file generic opportunity for Par. It is these two events which also drove much of the recent stock outperformance, in otheir opinion. What makes generic Catapres particularly attractive is that, unlike most first-to-market generics, limited competition can be expected for quite some time, with Mylan and perhaps an authorized generic as the only likely additional competition owing to very high technological and regulatory barriers to entry. As a result, the firm expects this long-tail product to raise Par’s earnings base and provide a fairly sustainable source of cash flow. With this windfall, they expect management to have greater flexibility to potentially renegotiate existing product partnerships on more favorable terms, increase new business development activities, and/or restructure Par’s balance sheet as it sees fit (with yesterday’s announcement to repurchase outstanding senior convert notes an example) – all which should further strengthen the company’s long-term outlook. At the time of the FDA approval of Par’s generic Catapres, some uncertainty remained on launch timing and near-term competitive outlook. Now, nearly two months after launch, Par has shipped product to 90% of the potential customer base, and has captured over 50% share of total prescriptions. With our current assumptions, they estimate the product adding at least $0.35 in annual EPS versus their previous estimates

Raising FY09 EPS est to $2.19 from $1.81. Critical FY11 breakout year est. moves to $2.57 from $2.11.

Notablecalls: Nice target raise, nice chart. It's not too hard to see the logic behind Barclays' upgrade. I think this one will work.

I suspect it can trade to $23 as soon as today.

Intel (NASDAQ:INTC): Another Quarter, Another Massive Beat and Raise But Several Signs of a Peak; Reiterate Neutral

JP Morgan is making some interesting points regarding Intel's (NASDAQ:INTC) quarter:

Yesterday after the close, Intel reported 3Q09 EPS of $0.33, $0.05 above JPM estimate of $0.28 and $0.06 above Consensus of $0.27 due to higher than expected revenue and gross margins. Revenue increased 17% QoQ to $9.4 billion, well above their estimate of $8.9 billion and Consensus of $9.0 billion due to higher than expected microprocessor and chipset sales. Gross margins were 57.6%, an increase of 680 basis points QoQ and were above JPM 55.0% estimate and guidance of 53%-55% due mostly to higher than expected utilization rates.

- Margins up sharply. Intel guided 4Q09 gross margins to increase roughly 440 bps QoQ to a range of 62% plus or minus 300 basis points due to higher utilization rates, sale of written-down inventory and mix. JPM expects 4Q09 gross margins to increase by 540 basis points to 63.0%.

- Roughly seasonal 4Q09 guide. Intel expects 4Q09 revenue to increase from a range of 3% to 12% QoQ ($9.7-$10.5 billion), with a midpoint of $10.1 billion (up 8% QoQ), roughly in line with the normal seasonal increase of 9% QoQ.

- 2003 all over again. JPM notes they are getting a strong sense of "deja vu all over again" with Intel’s 2009 looking a lot like 2003 from a revenue increase and margin profile standpoint. They believe the company is outshipping demand, as evidenced by Intel getting back to peak revenue while total PC revenue should be down 20% from the peak during 4Q09.

- Several signs of a peak. Although Intel is clearly executing flawlessly, they are seeing several signs of a peak in the stock in terms of gross margins and processor unit growth well above PC unit growth. In addition, as they stated in their preview last week, there appears to be a few signs of softening in orders from the PC food chain. JPM will closely monitor Taiwan notebook demand, the hard disk drive market, and lead times during 4Q09 for signs the upturn is over.

INTC stock follows gross margins – peaking now
Although Intel beat and raised again during earnings season, the firm believes most of the upside is already in the stock due to an imminent peak in gross margins. As they have stated in their rule #7 in their "Top 10 Rules for Semi Investing", Intel’s stock follows Consensus gross margin estimates. JPM believes Intel should reach 63% gross margins during 4Q09, which is roughly one point below the 10-year peak of 63.9%.



As shown in the table below Intel’s gross margin peaks during past cycles over a 15- year period from 1993-2008 demonstrate a pattern of declining gross margin peaks as the company has ventured into non-core businesses that carry lower margins. They expect Intel's peak gross margin during the current cycle to be 63.0% in 4Q09E, just 90 basis points below its 3Q00 peak gross margin of 63.9%.


Intel units far outstripping PC units
While J.P.Morgan estimates for PC shipment growth have been recently revised upwards from -10% YoY to -0.8% YoY in C09, it appears that Intel’s microprocessor units have rapidly outgrown the recovery in PC units during 2009. If they assume Intel’s revenue increases at a normal pace during 4Q09, their proprietary chart of PC vs processor units would result in the biggest inventory build in a decade during C09. Firm would note estimated 4Q09 CPU shipments of 90.6 million units are roughly 15% above estimated PC shipments of 78.6 million units during 4Q09 which would result in an inventory build entering 1H10.

- Raising estimates. JPM is raising their C09 revenue and EPS estimates from $33.6 billion and $0.95 to $34.9 billion and $1.09 due to higher revenues and gross margins. They are also raising their C10 revenue and EPS estimates from $35.0 billion and $1.13 to $40.0 billion and $1.45.

- Reiterate Neutral rating due to concerns on end demand and downside to estimates. Firm is establishing their December 2010 price target of $17.00 on Intel, which is 12X C10E EPS estimate, at the low end of its range of 12.0X-25.0X earnings.

Notablecalls: I'm not making a call here but I thought to highlight these comments from JP Morgan. Things surely look good here and I see mother Merrill raising their target to $27 along with FBR.

How long will this last?

Everyone is going ga-ga but do note Intel's Q309 revenue is about -7% vs. same qtr last year. Cost cuts, sale of written down inventory etc. brought a lot of upside to the bottom line.

Notice how Intel pared back capex for the year? What does that tell you?

Pacific Sunwear of California (NASDAQ:PSUN): Upgraded to Outperform at FBR Capital; $9 target

FBR Capital is out with a major call on Pacific Sunwear of California (NASDAQ:PSUN) upgrading the shares to Outperform from Market Perform with a $9 target (prev. $3).

According to the analyst the upgrade is based on:

1) product focus returning to an emphasis on brands, 2) controlled inventory, 3) guidance and consensus that they believe could be sufficiently conservative, and 4) opportunities in the company’s store base to close underperforming stores. FBR's store checks during the quarter have shown an increase in branded product, with a return to better showcasing “heritage” brands as well as introducing newer brands. They also noted less breadth and depth of markdown than last year. Firm further believes the company’s 3Q09 guidance for negative high teen to low 20% comp and LPS of ($0.16) to ($0.23) should be sufficiently conservative. With a new CEO, easier compares in 2H09, and new brands that could attract an incremental customer, they believe deep-value investors should begin to look at PSUN.

However, on the conference call, it was clear that many of the initiatives of the past 12 to 18 months would be reversed, including a deeper penetration of branded product, reintroduction of footwear and accessories, and returning to the company's core heritage brands. FBR believes uncertainties remain, and they are early to the fundamental turn in the name. Nonetheless, they believe downside in shares is limited, and they believe deep-value investors are likely to support the stock at or close to current $6 levels, as there is potential for open-ended upside if we begin to see improving top-line trends.

Due to their belief that the quarter is sequentially improving, the firm is increasing their 3Q09 comp estimate from –20.5% to –17% and LPS from ($0.19) to ($0.15). FBR's FY09 estimate goes from ($0.64) to ($0.60); FY10 estimate goes from ($0.19) to ($0.15). Price target increases from $6 to $9, which represents an EV/sales multiple of 0.5x FBR's FY10 sales estimate of $1 billion.

Focus on staff training and real estate opportunities. Through their checks, FBR has noted an improved attention to the customer by sales associates. They believe that the company is impressing upon its staff the importance of attention to customer, which they expect will result in increased conversion rates. Additionally, the firm believes approximately 100 leases will come up for renewal over the coming year, and they believe the company continues to take a close look its real estate strategy, as it negotiates better terms.

New CEO is introduced to the Street. The 2Q09 earnings call was the first time that investors and analysts were introduced to the new CEO, Gary Schoenfeld. FBR believes that his prior knowledge of the active sports industry from his time at Van’s should prove advantageous in developing the go-forward strategy for PSUN. They believe that Mr. Schoenfeld will use the 3Q09 conference call as an opportunity to further highlight details of the turnaround strategy going forward, which could serve to generate incremental investor interest in the story.


Tennant curve methodology. Despite the weak top-line sales and margin contraction, they believe we should begin to see sequential comp and margin improvement in 3Q09. FBR believes downside in shares should be limited, with open-ended upside if the company begins to see improvement in top-line trends. As such, they believe shares warrant an Outperform rating

Notablecalls: I suspect PSUN can trade up 10%+ today on this upgrade. Here's why:

- Take a look at what the stock did when Pali Capital upgraded the stock to a Buy back in August (stock was up 15% on the day). Note that Pali was one of the few firms positive on PSUN. I'd like to believe FBR Capital carries way more weight than Pali, especially when it comes to Speciality Apparel.

- As I mentioned, most firms are still farily cautious on PSUN which means expectations coming into the quarter are low. PSUN is scheduled to report on Nov 18.

- The new CEO, Gary Schoenfeld kept expectations low (possibly intentionally) as like most new CEO's he does not want to overpromise and underdeliver. His tone may me more positive this time around.

- The chart looks great. The $9 target from FBR offers 50% upside and there is no way to stop this one here.

- Most small retailers have been on fire lately.

How to play it?

Well, people will drive this one nuts in the pre-market action. Nothing wrong with participating but just remember you can't get decent size until the market opens. Use the open dip (if there is one) to buy.

I see this one trading towards $7 level (or possibly even higher).

Sandisk (NASDAQ:SNDK): Downgraded to Sell at UBS

UBS is making a rather big call on Sandisk (NASDAQ:SNDK) downgrading the stock to a Sell from Neutral with a $18 price target (unchanged).

Expecting peak demand by mid-C4Q to limit further ASP appreciation
With NAND spot/contract pricing up 24%/9% in Q3 and holiday product builds typically complete by mid-C4Q, they downgrade SNDK to a Sell rating based on:

1) negative price elasticity that could limit the potential upside to earnings as a result of higher NAND flash prices leading to weaker unit or total bit capacity sales, 2) the approaching seasonal demand peak in October/November that could lead to weaker NAND flash ASPs starting in December, and thus serves as a negative catalyst for SanDisk shares given that it historically has tracked memory prices, 3) potential gross margin downside risk from the company’s royalty revenue stream which will see a pronounced decline starting in the December 2009 quarter and again in the March 2010 quarter due to new Samsung royalty rates taking effect, and despite ongoing manufacturing cost reductions that should help to maintain or improve gross margin especially in a benign to improving price environment. Furthermore, SanDisk is also on track to move back to a more balanced fab-lite model where 25-30% of bits are sourced from external suppliers and thus could limit the upside to margins in coming quarters.

Greater exposure to retail could limit bit shipment upside
Whilst UBS does expect SNDK margins to improve meaningfully in 2H09, retail card sales could be negatively impacted by higher prices or fewer promotions. Relative to peers, SNDK has low embedded NAND exposure in high capacity smartphones (16GB or higher), a product that the firm believes is driving much of the demand strength in Q3 and similar to late Q1/Q2. Though industry supply growth is moderate, Q1 demand seasonality is likely to be unsupportive for ASPs.

GM upside could be limited by new royalty rate, non-captive mix growth
They believe GM upside offered by higher prices and cost reductions from the 32nm migration could be partially offset by the effects of lower Samsung royalty rates, which have a partial quarter’s effect in Q4, and the shift to a more balanced 30% non-captive bit supply mix in coming quarters.

Seasonal Demand Peak Approaching
The manufacturing of products slated to be sold during the late November through year end holiday selling season typically concludes by late-October to mid-November and typically coincides with the peak in NAND flash price appreciation. Based on DRAMeXchange data, the NAND spot ASP M/M % change in October over the past 5 years was -5%, and compares to the up +9% seen in 2009 thus far. In the two month period ending in November, the 5-year average shows a -14% decline while the three month or quarterly Q4 average over the last 5 years is a -25% decline.

2005 was the last time ASP trends were up in October and the 2 month period ending in November. That period was marked by the strong growth of portable media players as a new demand catalyst, but seasonality still quickly came into play by December leading to a Q/Q ASP decline of -3%. UBS expects a similar trend to play out over the remainder of 2009 given that retailers are likely to not build significant amounts of inventory and the ramp of new smartphone products is likely timed to coincide with holiday launches and sales promotions.

Valuation: $18 12-month PT; Downgrade to Sell Rating
UBS' DCF-based PT of $18 is equiv to 1.3x P/BV. Sell rating. SNDK trades at a P/BV of 1.4x or consistent with a more normalized mid-cycle range.

Notablecalls: So, UBS is pretty much the first one to say the current upswing in NAND pricing is not going to hold. Pricing gets better so Samsung & others will up their production pushing pricing down again. The endless cycle.

They are probably right and will look cool with their Sell rating in a few months.

Research in Motion (NASDAQ:RIMM): Upgraded at Baird, positive comments from RBC

Research in Motion (NASDAQ:RIMM) is getting some interesting commentary this morning:

- Baird is upgrading RIMM to Outperform from Neutral with a $84 price target saying they would be buyers on recent weakness. RIMM has declined almost 20% since reporting Q2 on September 24, presenting what they view as an attractive entry point.

Strong forecast growth. Baird forecasts revenue to grow 34.9% this year and 19.7% in 2011, with EPS growing 22.0% and 17.9% over the same periods. - Smartphone market expanding. In calendar Q2, global smartphone shipments grew 26.9% YOY, with Apple and RIM both taking share YOY (according to Gartner).

- Upcoming device launches positive. They believe upcoming device launches in front of the holiday season, including Storm 2, could provide a positive catalyst.

- iPhone headline risks in the stock? With Apple recently announcing plans to offer the iPhone through three carriers in the U.K. and Canada, they believe at least some of the Verizon/iPhone headline risks are likely in the stock.

- Valuation compelling. RIMM is currently trading at 13.9x Baird's fiscal 2011 EPS forecast, vs. our big-cap tech index at 16-17x and the S&P 500 at 14.8x. Their $84 target price is based on 17.0x their 2011 fiscal EPS estimate of $4.95.


- RBC Capital highlights 10 reasons why they remains bullish on Research in Motion (RIMM):

#1-3) Competitive Advantages Intact. BlackBerry's 'crackberry' messaging, other advantages (e.g. battery life) remain unmatched. Strong Q3 unit guidance (37-48% Y/Y) affirms RIM remains relevant with consumers, carriers. RBC expects RIM to narrow competitive gaps in Browsing, Apps, UI (User Interface), next 6-12 mos. Despite intensifying competition, they foresee a shakeout, with RIM retaining global leadership.


#4) Don't Fear Moderating ASPs. Recent ASP mix-shift is not from competitive pressures, but self-inflicted, positioning RIM to better penetrate the mainstream Smartphone opportunity. Moderating ASPs are part of firm's long-term thesis on the Smartphone market (they expect ASPs to decline at est 8-10% annually to $273 end F12), but unit momentum and market penetration for RIM increases. GM's meanwhile are expected to remain healthy at 40-41%. This yielding growing earnings power with EPS above street at $5.43 F11 and $6.40 F12.

#5-6) Strong Market Growth Mitigates Competitive Impacts. Smartphones to grow est >40% annually to est 35% handsets by 2012. The hypergrowth means RIM can weather a 300bps competitive share loss, and still grow faster than street ests next 3 years. But Smartphones are not a zero sum game; RBC sees 3-4 leaders all taking share from NOK, MOT, etc.

#7) Healthy Margins. RBC foresees LT margins at 40-41% as RIM remains a highly profitable Smartphone to carriers (= healthy subsidy) and benefits from scale, supply chain efficiencies. They do not expect market commoditization.

#8-9) Pending Catalysts. They see multiple catalysts ahead, including product launches, prod/service innovations, financial results, Smartphone share gains, and improving investor visibility. RIM well positioned to capture non-NA Smartphone opportunity, est. 406M units by CY12 at 44% CAGR. Firm also foresees a recovering Enterprise upgrade cycle.

#10) Compelling Valuation. With est 38% F10 growth at healthy margins, valuation at 0.5x PEG and 14x FTM P/E vs. 9-46x historical, and 30x peers (including NOK at 17x and -4% FTM growth) in their view significantly undervalues RIM's fundamentals and opportunity, and has already built in significant competitive impacts. They foresee recovery and upside as competitive, margin fears dissipate and visibility improves to RIM's advantages, retained innovation leadership, margin resiliency and share gains.

RBC reiterates their Outperform rating and $150 target (Street high target).

Notablecalls: RIMM is starting to look like a major battleground:

- The bears tend to point out raising competition from Apple, Androids from MOT & DELL and even PALM. This should lead to lower volumes, lower ASP's and eventually lower margins.

- The bulls on the other hand highlight the international opportunity and the fact RIMM trades around 14x EPS.

Must say I have no clue how this battle will end. Nokia is yet to make its move in the space (I mean a REAL move) which is something that cannot be underestimated. Their R&D budget is bigger than AAPL, RIMM, PALM combined.

Meanwhile RIMM can (and probably will) beat estimates again making shorts look silly.

So RIMM is becoming another mindless trading vehicle with ratings changes slapped both ways depending on 10pt moves up or down.

Tough one.

Sigh.

Rackspace Hosting (NYSE:RAX): Expect growth to accelerate, upgrading to Buy with $23 target - Goldman Sachs

Goldman Sachs is upgrading Rackspace Hosting (NYSE:RAX) to Buy from Neutral with a $23 price target (prev. $16)

Firm notes their proprietary cloud hosting pricing survey indicates that Rackspace is well-positioned to stay ahead of new cloud competition, given its value pricing and reputation for customer service. In addition, small-medium enterprise customer trends seem to be stabilizing, which sets the company up to see accelerating growth from cloud and enterprise customer growth opportunities. They see significant upside to 2010 consensus, which should help drive the 31% upside to their new $23 price target (up from $16).

Catalyst
Despite a tough macro environment, Rackspace has continued to grow through the recession as strength in cloud and enterprise has offset the slowing growth from small-medium enterprises. Recent small-medium enterprise surveys indicate that trends in this customer segment may be stabilizing. This could set a more stable base, off which cloud and enterprise opportunities can drive accelerating growth. Goldman's cloud server hosting pricing survey indicates that Rackspace has a very competitive offering, which should help it stay ahead of new competitors entering the market. As a result, they are increasing their 2010/2011 and out-year estimates to reflect the greater revenue opportunity. Goldman's new 2009-2011 EPS estimates are $0.24 / $0.43 / $0.65, from $0.24 / $0.38 / $0.56 previously.

Rackspace well-positioned to benefit from the multi-year cloud opportunity. Goldman expects the adoption of cloud hosting services to be a multi-year process, as customers get increasingly comfortable relying on a virtualized environment for their infrastructure needs. Rackspace, along with Amazon, has an early mover advantage in the field, which positions it well as the market continues to expand. They expect cloud computing revenues to grow to $99mn, up 73% y-o-y, representing 13% of Rackspace revenues by 2010 YE). While this is still a small proportion of their revenue mix, they expect cloud computing to account for 24% of the incremental growth in 2010.

Rackspace to stay ahead of new competition. Recently, there have been investor concerns around whether Rackspace can gain on Amazon’s market share and stay ahead of the increasing number of players who are looking to partake in the growth opportunity. While Goldman believes the market is expanding fast enough that market share shifts have a lesser effect for now, nonetheless, the new competitors are a factor to consider for market share shifts down the road. Terremark, Hosting.com and Bluelock have recently launched their VMWare-based vCloud express offerings and Savvis has announced its beta launch of its cloud initiative as well. There have also been a host of smaller private players such as GoGrid and Softlayer who are competing in the same market. Based on their analysis, they believe that Rackspace’s headstart (over the new competitors), its current managed hosting scale and its reputation for customer service, should allow it to fend off new entrants, while competing effectively with Amazon.

Notablecalls: RAX is a mover stock and getting a blessing from Goldman Sachs will propel this one to a new high, I suspect.

Cloud computing is the new hype word these days and RAX is still trading 0.5x EV/EBITDA vs. 2x EV/EBITDA of CRM for example.

I see RAX trading over the $18 level today with $18.50+ seemingly prudent as an intraday target.

Should RAX keep performing, I see Goldman taking their target higher towards $30 range over the next couple of qtrs.

Wyndham Worldwide (NYSE:WYN): Upgraded to Buy at Goldman Sachs; $26 target established

Goldman Sachs is upgrading Wyndham Worldwide (NYSE:WYN) to Buy from Neutral with a $26 target (implying 60% upside).

Firm notes their recent meeting with management suggests a focus on 1) shifting the company to a recurring and high margin business model; 2) selling off existing timeshare inventory; and 3) managing the selling process for distressed timeshare, condos, and apartments as timeshare weeks without taking on capital exposure. Over the next several quarters they expect Wyndham to continue to push itself towards becoming a fee for service company while in the meantime, generating significant cash flow as it moderates its timeshare development activities.

Catalyst
As WYN continues to surpass earnings estimates and transition towards becoming more fee driven, they expect investors will give the company credit for the strong assets on its balance sheet and more fully value the shares. In Goldman's view, investors may not be applying high enough multiples to these segments given their individual intrinsic value and sustainability of earnings; however, as these divisions demonstrate more consistent performance, they expect a revaluation. In addition, firm's new analysis on the timeshare segment suggests significant “hidden” value exists. Although the value of timeshare may be debated given the current trajectory, they expect less debate as to the significant cash flow to be harvested from past investments in this segment.

In Goldman's view, Wyndham’s timeshare segment appears to the most underappreciated of the three. Rather than use their traditional EV/EBITDA approach to value this segment, they undertook a discounted cash flow assuming it will complete its construction in process but will not begin any new projects. Firm estimates that even if Wyndham does not commence any more timeshare projects and sales continue at current levels, Wyndham’s equity could be worth $26 share in 12 months.

Significant FCF over the next several years
As Wyndham continues to invest less in timeshare Goldman expects that its free cash flow should pickup significantly over the next several years. While they assume that Wyndham will not exit the timeshare business, it currently has enough inventory to sell for the next five years at current sales rates, thus they do not anticipate the company will need to spend on new inventory until 2011 or even beyond. This could create a period of several years where the company generates several hundred million dollars of free cash annually.

Wyndham is trading at only 3.2X 2011 EV/EBITDA vs. the lodging sector of 8.9X. Goldman expects these two numbers will converge as they do not anticipate any need to further lower guidance and in fact, Wyndham could consistently beat estimates.

Notablecalls: I expect WYN to trade over the $17 level today with $18 not out of the question.

- Goldman Sachs upgrading with a 60% price target usually gets attention from traders.

- The chart looks great. New highs are coming.

- Goldman's new target of $26 is the new Street high.

- The call actually makes some sense. It's boring but it makes sense.

I'm sure traders will drive this one nuts already in the pre-market. If you want to join them, fine with me. Personally, I'm looking to get long after the open dip (if there is one).

Neutral Tandem (NASDAQ:TNDM): Stock oversold; Reit Outperform and $33 target - Oppenehimer

Oppenheimer is out with an interesting call on Neutral Tandem (NASDAQ:TNDM) calling the stock oversold and reiterating their Outperform rating and $33 target.

Firm believes the stock has been oversold and would take advantage of the attractive entry point (TNDM trades at a discount to historical multiples, the towers and data-focused interconnection models). Following channel checks, they believe that concerns regarding emerging competition are overblown and TNDM could pull a number of levers to defend its market share. The first catalyst for the stock will likely be the company's 3Q09 report and they also expect a court ruling on patent infringement in November. The key risk to the story is migration to IP (3-10 years out) and consolidation (limited due to regulatory oversight).

- TNDM's horizontal niche, carrier neutrality, stellar margins and low capital requirements have attracted competition. However, they believe the barriers to entry are high, competition is limited and recent selling pressures are overdone.

- Oppenheimer's recent channel checks indicate that Peerless Networks has launched limited service in at least six markets. The competitor has managed to take some traffic away from TNDM, mostly by offering substantially lower prices, but this is also helping to expand the overall interest in tandem services

- They believe TNDM could resort to selective price discounts to retain its market share. Other defensive initiatives include: 1) Bundling new services; 2) Lower prices for new services in new territories; 3) Long-term contract discounts; 4) Focus on nationwide availability; 5) Explore the potential for SIP.

- Expected solid 3Q09 results will likely serve as a catalyst for the stock. Oppenehimer thinks TNDM is currently priced for the worst at 13x EPS and 5.5x their 2010E EBITDA, well below the 13-14x of wireless towers and close to 10x for data-focused interconnection models. Firm expects strong revenue growth and free cash flow generation in the next 2-3 years. They have stress-tested our model and still believe the company can beat its 2009 guidance.

Oppenheimer notes short interest in Neutral Tandem has increased dramatically in the past two months (to 4.6 million shares on September 15 from 2.3 million on July 31).

Another potential catalyst for the stock is the impairment of competition in the next few months. Neutral Tandem has filed a patent lawsuit against Peerless Networks and an injunction could be ruled in the next 2-3 months.

Notablecalls: I must say I like this call.

- Tandem is an analyst darling. Opco defended the stock back on Aug 6 but the stock is down another 10 pts since then. The problem the stock got whacked was because of raising competition from other 3rd party competitors (namely Peerless) but one would think this has been discounted by now.

- Tandem helps Telcos save money they would otherwise have to pay to incumbent local exchange carriers (ILEC's) for traffic. The service is better & it costs less. So TNDM makes sense in current environment.

- Opco highlights two n-t catalysts. 1) Results - TNDM has a tendency to beat expectations. 2) Potential injunction against Peerless.

- Short interest has taken quite a leap higher over the past couple of months and stands at around 14%. This of course means anything positive will propel the shares higher from here.

With the market tone positive this morning, I suspect TNDM may have some legs. I see the stock trading towards $23 level in the n-t.

NetApp (NASDAQ:NTAP): Upgraded to Outperform at RBC Capital

RBC Capital is making a pretty significant call on NetApp (NASDAQ:NTAP) upgrading it to Outperform from Sector Perform with a $33 price target (prev. $26).

Firm notes their checks suggest NTAP is so far witnessing Oct-qtr revenues ahead of expectations, which should enable NTAP to not just beat Oct-qtr estimates but also to guide Jan-qtr ahead of expectations. They view NTAP as an attractive way for mid/large cap investors to play the anticipated IT spending recovery in H209. RBC expects NTAP to exude a positive business tone at its analyst day in New York City on October
8.

Current Checks Suggest Upside to Demand: RBC's checks suggest Oct-qtr is tracking ahead of plan and NTAP is seeing strength across its product portfolio but more so in mid/high-end products. Firm notes they haven't noticed any deal slippage due to loss of DDUP acquisition. While it's early in the quarter, Europe is starting to show strength for NTAP, which if sustained should yield incremental savings. The federal vertical continues to remain strong in Oct-qtr.

Key Suppliers Suggest H209 Strength: Last week, two of NTAP's key suppliers reported (Jabil and Xyratex), both suggesting enterprise demand and trends at NTAP continue to track positively. Both Jabil and Xyratex experienced better-than expected shipments for their August quarters, and both expect NetApp to remain strong through at least their November quarters.

Pricing Is Stabilizing: RBC believes the pricing environment for enterprise storage systems, while still aggressive, remains at minimum consistent with last quarter, which marked a healthy rebound from calendar 1Q09's gross margin level. This should enable NTAP to maintain healthy gross and EBIT margins.

Forward Expectations. For Oct-09 they increased their revenue and non-GAAP EPS estimates to $863.1 million (was $854.7 million) and $0.30 (was $0.28), which are above current Street estimates of $861.2 million and $0.29. In addition, they increased their FY10 revenue and non-GAAP EPS estimates to $3.58 billion (was $3.56 billion) and $1.27 (was $1.21), which are also above the street estimates of $3.53 billion and $1.22.

Notablecalls: While NTAP stock has doubled over the past 6 months, I suspect it may be setting up for another push higher. This is helped by:

- Raising consensus (I'm sure RBC won't be the only one upping their ests ahead of the qtr)

- The fact NTAP is starting to be viewed as a takeover candidate. NTAP has been as one of the few major storage players that has been able to grow market share (and revenue) over the past year or so. The larger players like EMC, IBM and HPQ may be feeling a slight sting here.

Barron's is out over the weekend noting current CEO Tom Georgens may be a willing seller (sub required)

http://online.barrons.com/article/SB125452419677460573.html

That should add some fuel to the fire.

NTAP isn't a big mover but up to 1pt of upside may be in the cards here.

PS: Check out Brocade (NASDAQ:BRCD) trading up 18% on some pretty vague takeover story from WSJ.

The Manitowoc Company (NYSE:MTW): Upgrade to Buy: See potential for 5x increase over next 3 yrs - Deutsche

Deutsche Banks is out with a major call on The Manitowoc Company (NYSE:MTW) upgrading the crane maker to Buy from Hold with a potential for 5x increase over next 3 years.

The analyst notes they upgrade Manitowoc to Buy with upside of 45% to their revised $12 target price. Although they have very little clarity on when the crane cycle will recover, the firm does not think this is the right question. They even argue that earnings have less relevance during this bottoming process since the direction of the stock is highly likely to be dictated by sentiment on the health of the balance sheet.

In this sense, they argue that the stability of the Foodservice business and benefit from working capital liquidation can generate significant levels of cash flow and therefore bridge the gap to Crane recovery. In this sense, even if earnings recover to only $2/share by 2013 (note consensus earnings expectations peaked at $4.40 in early-2008), then they think the stock is going to significantly outperform from current depressed trading levels.


Foodservice provides a key anchor through Crane downturn
With good reason, the focus for investors is on the crane cycle but with Crane revenues likely to fall from a peak of $3.8bn in 2008 to a $1-2bn trough, the reality is that the Foodservice division is likely to dominate over the next 12-24 months, accounting for an estimated 45% of revenues and 67% of EBITDA in 2010E. While the convenience restaurant and lodging segments have not been immune through this downturn, with revenues down low single-digit and margins expanding next year (due to M&A synergies and headcount reduction), Deutsche sees MTW’s Foodservice segment as a critical earnings anchor. Moreover, they believe with Emerging Market Crane demand accelerating, they do not believe Crane revenues will fall below the critical $1bn level, where the segment could start losing money.

Covenants could come into play but Deutsche sees key mitigating factors
Under recently renegotiated covenants, Deutsche projects headroom of 24% on the key Leverage covenant in 2009 but project this tightening by the end of 2010 and therefore they cannot discount the possibility of another breach. However, they see potential for $400-500m of trade w/cap to be converted into cash over the next 12- 18 months and sufficient FCF in Foodservice to meet cash interest obligations. When they then consider MTW’s quality end market positions, the firm believes that covenant relief would again be granted by the banks, unless Crane starts bleeding significant quantities of cash flow – a bear case scenario.

Corporate bond yields have declined
substantially for the majority of stocks under coverage, but the decline has been especially dramatic for MTW from a peak of 22% in August to 11% currently.

This reduction in perceived risk has been reflected in the stock’s volatility which has fallen from a high in the 180-190% range to its 12m lows in the 60-70% range in recent weeks. Again this is part of a broader trend but has been especially pronounced for Manitowoc. Note that Manitowoc’s equity volatility is still the highest in the DB Universe but Deutsche sees further scope for its volatility to decline from here.

Notablecalls: I like this one, especially in the ultra s-t:

- Deutsche Bank is calling for a 5x increase in stock price over the next 3 years. That's a gutsy call and will surely get people interested in the name.

- The stock is down over 20% from its recent peak of $10.50.

- There is the covenants issue but looking at the corporate bond yields the market seems to agree with Deutsche here. Covenants are not likely to derail the stock's advance.

- Short interest still stands at 10%. That's not huge but it's still 13M shares NOT happy about Deutsche calling for a 5x-bagger.

All in all, I think this one will trade towards $9 level today. That's 10% upside.

Apple (NASDAQ:AAPL): Upgraded to Buy at UBS; $265 price target - New Street high

UBS is upgrading Apple (NASDAQ:AAPL) to Buy from Neutral from a $265 price target (prev. $170):

Firm notes their positive view is predicated upon expectations for greater "recurring" iPhone hardware revenue (due to a growing installed base & stickiness of the App Store) which should drive more visibility into iPhone sales (20%+ of our FY10 iPhone shipments), as well as continued iPhone expansion driven by new partnerships (end of exclusivities). They also believe upward revisions to consensus ests are likely given underestimated gross margin potential.

Apple service could be the next long term driver
UBS believes AAPL may be working on building out a foundation for a service to provide seamless access & mobility of digital content across all its products. They envision a service that seamlessly allows access to media-focused content of iTunes & user-generated content of MobileMe (pictures/videos/email/calendar) as well as social networking integration from any existing Apple product. Firm believes the service may be the draw (halo) that drive additional future Apple product sales.

Capex hints at build of a potential enhanced service, which UBS thinks could help drive further hardware sales. Capex related to infrastructure & corporate facilities has been ramping, reaching $702 million in FY08 and rising to an estimated $840 million in FY09 from $128 million in FY05. They believe a material portion of this capex may be related to the build out of a data center/network operating center (NOC) which they hypothesize will be the foundation for a service that provides seamless access and mobility of digital content across all its products, at any time, and from any place. Similar to Research In Motion’s, the NOC may also help to reduce network congestion through techniques such as compression & push. UBS envisions a service that will seamlessly allow access to the media-focused content of iTunes (music/video) and user-generated content of MobileMe (pictures/videos/email/calendar) as well as integration with social networking sites from any existing Apple product. They believe the service, in the future, may be the draw to purchase additional Apple products.

New products still on the way
From a new product perspective, one thing is certain, in UBS' opinion – Apple will continue to introduce new products across its product portfolio every year. Determining what those new products will be is a part of the buzz (and fun). Apple’s veil of secrecy will likely continue to create that important buzz and they believe the company’s attention to detail and customer experience will help to perpetuate and maintain its buzz/brand image (the “halo effect”). However, the key question is whether that pace of innovation can continue? From a near/medium term perspective, firm believes a potential data-only product at Verizon (potentially a smart book), new wireless operators and a tablet may be forthcoming. With iPods recently getting a complete refresh and the company making adjustments to its MacBook line, the firm believes Apple could focus on a desktop refresh next.

Raising estimates on back of higher iPhone expectations
Although they are leaving their Sept. qtr iPhone units unchanged, UBS has increased their FY10 estimate to 36mm units from 25.9mm previously. As a result their pro forma rev/pro forma EPS for FY10 increases to $51.6b/$11.08.

Notablecalls: The $265 target is the new Street High, even surpassing Piper Jaffray's $255.

Should generate buy interest.

PS: Note that Morgan Stanley is also out positive on AAPL this morning saying they view broader iPhone distribution as the most significant near-term catalyst for iPhone units, EPS, and share price. This opportunity is substantial – it equates to a potential 20.3M unit and $3.76 adj. EPS opportunity or 100%/41% of the LTM units/EPS. Timing remains uncertain but they believe a near term (2010) opportunity exists in Europe, China & Korea with a longer-term (2011) opportunity in the US.

Morgan Stanley raises their CY10 revenue and adjusted EPS estimates to $45.3B/$10.50 from $38.2B/$10.00 as theynow expect 41.7M iPhone shipments in CY10 up from 38.2M previously. Firm's CY10 EPS forecast is 13% above consensus. Overweight is maintained with $210 tgt (prev. $200).