Microsoft (NASDAQ:MSFT): Corporate PC Refresh around the Corner and Multiple Product Cycle, Upgrade to Outperform - FBR

Microsoft (NASDAQ:MSFT) is getting positive comments from several firms following yesterday's sell-off, which coincidentally made Apple (NASDAQ:AAPL) the largest tech firm out there.

- FBR Capital Markets is upgrading Mr. Softee to Outperform from Market Perform with a $32 target (prev. $31) noting the co is in the midst of a massive product cycle across many of its divisions. Most importantly, they believe we are in the early stages of the corporate PC cycle refresh that should provide a boost to the company’s flagship desktop offerings (Windows 7 and Office 2010). FBR thinks the risk/reward profile is attractive given the underperformance of the shares. Microsoft shares are down 18% YTD compared to –3% for the NASDAQ and –5% for large-cap technology. Microsoft is trading at the bottom of its forward P/E range of 11x to 21x of the past five years (excluding the height of the financial crisis in late 2008 to early 2009). While concern over the European economy is valid, they believe that is represented in the stock’s underperformance over the past month. FBR thinks the risk to the call is if Europe materially worsens and spreads globally. They are raising their price target to $32 from $31 in order to reflect their increased estimates and confidence in the company’s product cycle. FBR's new $32 price target represents 14x their FY11 EPS estimate.

Massive Product Cycle—Breadth and Duration
Microsoft is in the midst of a massive product cycle with Windows 7, Windows Server 2008 R2, SQL Server 2008 R2, Windows Azure, and the upcoming releases of Office 2010, Project Natal, and Windows Phone 7. They note that every business unit should benefit from a major product release or partnership (Yahoo! search partnership). Given the timing of release and adoption of the products in this cycle, FBR believes the impact on Microsoft will be felt for the balance of CY10 and throughout CY11.

Raising estimates. FBR is raising their FY11 revenue and EPS estimates to $66.5 billion and $2.31 from $66.0 billion and $2.24. Their CY10 revenue and EPS estimates increase to $64.1 billion and $2.11 from $63.9 billion and $2.08. CY11 revenue and EPS estimates increase to $69.6 billion and $2.50 from $68.4 billion and $2.35.

- Goldman Sachs notes Microsoft shares sold off sharply on Wednesday afternoon (closing -4.1%, vs. S&P -0.6%, and large-cap tech generally down 0.5% - 1.5%). Much of the selling has been attributed to comments CEO Steve Ballmer made on Tuesday night in Asia, where he acknowledged general concerns over European contagion. While European contagion is a concern of Goldman's broadly, they note 1) Steve Ballmer’s comments were not Microsoft specific and 2) the shares underperformed large-cap tech despite having relatively lower exposure outside of the US and the backstop of several product cycles. The day furthered the stock’s ytd underperformance.

Implications
Given significant underperformance and attractive valuation levels, they are buyers of the shares. Next catalysts will be E3, the week of June 13 in LA where we will get a look at Project Natal, the innovative controller-less gaming addition; FY4Q earnings (announced in July), which should show signs of a corporate PC refresh cycle and initial Office 2010 traction; followed by the company’s analyst day, where we expect FY11 cost commentary.

Valuation remains very attractive, with the stock currently trading at a CY10E and CY11E P/E (including ESO) of 12.1X and 9.7X versus the software medians of 20.6X and 18.8X and the S&P 500 of 14.1X and 11.9X, respectively. Goldman's triangulation of historical P/E, EV/adjusted FCF/growth multiples, and DCF leads to their 12-month price target of $38, implying 52% upside potential.

- Morgan Stanley notes that in concert with their Fallen Angels report, which reveals MSFT is at their bear case of $25, coupled with recent multiple compression across the broader market, the firm is adjusting their stock risk/reward scenarios and lowering their target price to $35 (reiterates Overweight). While they understand some of the mechanics of the pullback, the "liquidity" factor, and the relative low cost to short, the stock may have overshot to the downside. Despite MSFT's projected CY11 EPS growth rate of 16.7%, the stock now trades at only 10.2x CY11 EPS, and is below 1 on a Price-to-NTM-EPS-Growth basis for the first time since Mar-09 lows. At current levels, their What's In the Price tool reflects only 1.3% terminal growth, which is unlikely.

Large cap software has been hammered over the last month on concerns about Europe, currency and more recently some "peaking" rate of change indicators. While MSFT is not immune to potential foreign weakness, the company has much less foreign exchange rate exposure than our other large cap names with both natural (OEM deals are in USD) and synthetic hedges. Ests. for FY11 look reasonably conservative given the strong product cycle, which in turn should enable MSFT to absorb macro weakness better than most. Morgan Stanley also believes MSFT is likely buying back stock at current levels. The -20% decline in the stock over the last month (vs. the Nasdaq -13% and the S&P -12%) likely overshoots the real estimate risk. With limited downside, and 40% upside to their new PT, they like the risk reward here.

Notablecalls: I suspect FBR is going to make money for their clients w/ this upgrade. The stock has gotten pummeled over the past month, down 6 pts from its $31 highs and is likely to bounce (along with the market).

Valuation looks compelling and I'm starting to hear some rumblings of an upcoming dividend. It's not something that will happen overnight but could very well be a H2:2010 event.

Trading Mr. Softee is usually a tough gig - one needs to have a lot of patience or take huge size for the 20c move to really have any impact on P&L.

Not making a trading call here but the comments are out there.

Oh and btw, have you seen Project Natal? Worth taking a look.

Con-Way (NYSE:CNW): Better Days on the Horizon; Upgrading to Outperform - RCB

RBC Capital is upgrading Con-Way (NYSE:CNW) to Outperform from Sector Perform while raising their target to $44 (prev. $38).

- While the LTL space still has a long road to hoe with regards to solving its excess capacity dilemma, fundamentals have begun to materially improve.

- During the 1Q'10 earnings season, most LTL carriers reported y/y tonnage improvements in each month of the quarter with these trends significantly accelerating in March and April, a trend that continued into May.

- RBC believes that the company's operating losses are in its rearview mirror. Management has been vocal of late stating that volumes were up 37% y/y in April and up 30% y/y so far in May. Additionally, management has stated that it was profitable in April.

- Recent channel checks confirm their belief that the industry as a whole has found religion with regards to taking freight rates higher. They believe that CNW is beginning to gain traction with regards to price and will begin to see y/y yield improvement as it works through contract negotiations this bid season.

- CNW has a material amount of operating leverage in its model and once this re-priced freight begins to trickle in RBC believes the carrier could see some significant upside to estimates. Remember, the company is already absorbing the cost of running a much larger network and can handle a significant increase in volumes without layering in a material amount of expense.

The recent pullback in the stock price has provided a much more attractive entry point into the name. Given the magnitude of operating leverage in the LTL business model coupled with the improving macro environment, they believe now is the time to layer on more aggressive LTL exposure, thus their upgrade of CNW to go along with their previous Outperform rating on Old Dominion Freight Line (ODFL).

All in, RBC believes that the company has weathered the storm and that it stands to be one of the few standouts in the LTL space once the recovery is in full swing. Most compelling is the fact that CNW has a lot of operating leverage in its model and once its re-priced freight begins to trickle in they believe the carrier could generate some significant upside to estimates. Remember, the company is already absorbing the cost of running a much larger network and can handle a significant increase in volumes without layering in a material amount of expense. With that said, they do caution that recovery in the LTL space could take time as a significant amount of excess capacity exists. However, they believe that CNW has taken the necessary measures to position itself better than most in the LTL space and will likely be rewarded quicker than most once a more robust recovery commences. With that said, RBC reminds investors that the time to own these names is well ahead of a recovery.

Notablecalls: Gutsy upgrade by RBC's team as this is a very economically sensitive sector.

The stock, CNW is prone to big swings on analyst rating changes so I would not be surprised CNW trade to $34 kind if the market doesn't fall apart on us again.

Worth watching.

I think the whole space was held back yesterday following the carnage in Arkansas Best (ABFS) - see below.

Alcoa (NYSE:AA): Upgraded to Outperform, $18 target at Macquarie - Aluminum’s Not that Bad, Honest

Macquarie (USA) Equities Research is upgrading Alcoa (NYSE:AA) to Outperform from Neutral with a $18 price target (prev. $17), equating to 60% potential upside.

Macquarie believes the aluminum market is more healthy than most investors realize as physical premiums continue to move higher and demand growth is accelerating. US premia have risen 23% YTD while European premia are up 74%. The strong upward move in premiums reflects significant physical tightness in the market as excess warehouse inventory remains tied up in refinancing trades. Also, they note that ali prices hit $1.13/lb this year, above firm's price forecasts through ‘13.

The contango has remained favorable and they believe it is unlikely the significant amount of material tied up in these warehouse deals (~80% of LME inventory) will unwind in the medium term, keeping the physical market tight. Also, rising power costs in China coupled with the recent selloff in aluminum has put ~40% of Chinese capacity below breakeven, which should limit downside to prices here.

With Chinese efforts to eliminate discounted power tariffs to key energy intensive industries such as aluminium and global cost creep outside of China,the firm believes that aluminium prices have significant support near the $0.85-90/lb level and thus believe downside is very limited. With the price now at $2,000/tonne they estimate that 40–50% of all Chinese capacity is losing money and thus would expect production curtailments in China if the price were to remain at these levels, which would clearly be a positive catalyst for the aluminum price and Alcoa.

Alcoa’s Share Price has Performed Far Worse than the Aluminum Price
Aluminum prices have declined from their peak of $1.13/lb in March to reach $0.90/lb recently while Alcoa’s share price has performed much worse, falling 22% since March and 33% since the start of the year. Clearly, Alcoa’s weak earnings result in the first quarter led to increased concerns that AA wouldn’t be able to leverage the benefit of higher aluminum prices owing to rising energy input costs as well as unfavourable fx. Importantly, the firm believes that the recent decline in oil prices coupled with significant strengthening of the US dollar and still resilient LME aluminum prices should greatly increase AA’s leverage to a rising aluminum price environment going forward.

They believe that aluminium prices have reached a bottom in the short run and expect shares of AA to rally as Chinese macro concerns abate over the next few quarters and the European sovereign debt risks stabilize. FIrm believes aluminium prices have significant cash cost support at current levels given ~40–50% of Chinese capacity is now losing money and Chinese power prices continue to rise. Unlike the aluminium market we see that the coking coal, iron ore, and copper markets all trade at price levels significantly above marginal cost of production at current price levels, especially for the bulk materials.

Alcoa Valuation too Attractive to Ignore – See 60% Upside to Share Price
Macquarie commodity analysts forecast the long run aluminum price at $1.10/lb. However, under Macquarie's current forecasts they don’t see the aluminum price reaching this price level until 2014. To be conservative they used 2012 as their mid cycle earnings year for Alcoa, a point in time when they expect the downstream businesses to have recovered to 85–90% capacity utilization rates and much better margin performance to be realized in the Primary and Alumina segment as aluminum prices move gradually higher and LME alumia prices move higher on the heels of aluminum and higher linkage rates. Also, Alcoa’s cost reduction and restructuring efforts should be largely completed by 2012 as well, providing a better view on long-term earnings power of the company. Firm forecasts 2012 EPS for AA of $1.60 per share and total EBITDA of $4.7bn and their aluminum price assumption is $1.00/lb, which is not far off the current three-month forward price of $0.93/lb.

Over the cycle Alcoa has traded in a forward EBITDA valuation range of 6-8x with brief periods where the multiple exceeded these ranges as shown in the chart below. The historical average multiple for Alcoa is 7.4x forward EBITDA and thus the firm would argue that Alcoa should be worth at least 7x EBITDA on 2011 earnings expectations given the market usually awards a higher multiple on below average earnings years just as the market discounts earnings closer to the peak. The shares currently trade at 5.4x 2011E EBITDA and only 3.9x 2012E EBITDA, both levels which are well below historical averages and indicate the market has become overly pessimistic on Alcoa earnings and cash flow potential over the next several years in our view.

Macquarie's $18 price target assumes Alcoa trades at 7.4x 2011E EBITDA and only 5.4x their 2012E EBITDA forecast, which they believe represents mid cycle earnings for the company.

Notablecalls: The metals space had a nice run along with the general market yesterday & we may see some follow-through today.

Many of the names names like Alcoa are on the cheap side and could see nice gains in the n-t as the market retraces some of its recent losses.

As Macquarie highlights, Alcoa may actually have more upside leverage here as:

- Recent decline in oil price lowers the production costs

- Dollar's recent strength provides a tailwind (vs. the usual headwind)


I would not be surprised to see AA trade up 5%+ today putting $11.80-90 level in play.

Arkansas Best (NASDAQ:ABFS): Concessions Voted Down - What's Next for ABF?

Several firms are out very negative on Arkansas Best (NASDAQ:ABFS) this morning after Teamsters at ABF Freight, Arkansas Best Corp.’s LTL division (93% of the company’s revenues), rejected a plan that called for 15% wage cuts but included an earnings plus plan that would have made them nearly whole as the company returned to profitability (vote was 3,764-2,936, with 80% member participation).

- Merrill Lynch/Bac is downgrading ABFS to Underperform from Neutral with a $24 price target (prev. $35) saying this is a shocking move, in their view, given the near death spiral that high Teamster wages put YRC Worldwide in over the past year, and given Arkansas Best’s 6 consecutive quarters of earnings losses with a 6-quarter cumulative free cash flow loss of $123 million. With subsequent cuts, including a 15% wage cut and suspended pension payments, YRC was able to reduce its operating costs, leaving Arkansas Best with the highest cost structure in the LTL industry. The vote rejection ensures that its non-flexible cost structure continues.

- Baird is lowering their target to $26 from $28 while maintaining Underperform rating on ABFS noting the proposed wage concessions and structural pay change was significant, would have resulted in nearly $70 million in annual savings or $1.80/share. The proposed variable pay structure tied to operating profit would have been ground breaking.

ABFS remains unprofitable, so what is next? Pricing and legislative pension relief are the two major potential changes on the horizon that could help ABFS move toward profitability. Baird believes the change in industry pricing has more near-term opportunity than pension relief.

- Stifel is reiterating their Sell rating noting they believe the employees rejected the concessions for many different reasons, right or wrong, including the following. 1) some think management had not exhausted enough cost-cutting options before asking the employees to take significant cuts, 2) some worry that lower wages will lead to more aggressive ABF pricing to gain more volume [even though that is uncharacteristic of historically price disciplined ABF], 3) others feel the concessions were thrown at them without input from
employees and little push-back from their union representatives, 4) some see ABF's $138mm net cash (balance sheet) position and believe the company should have to burn through those funds before asking for any money from its workers.

What now? Stifel believes the company will reconvene with Teamsters leadership to try and work out some other wage reduction proposal; however, it is unclear what concessions, if any, would be agreeable to the members. Even when YRC workers were threatened the company would likely not survive the year if they voted NO, the second round of concessions in August 2009 only passed by a 58%/42% margin. ABF workers do not have the same immediate threat of closure.

ABF is in a tough spot, in their view, because the company was prudent to build a cash war chest going into the great freight recession but now has higher relative labor costs, as a result of YRC's multiple concessions and bailouts, and a difficult time arguing that it needs money from its employees.

They are maintaining their Sell rating on the shares of ABF, as a lack of earnings forecast for the next several quarters, a potential re-vote and/or redraft of the concession agreement and uncertainty surrounding YRC's long-term viability and pension bailout could lead the stock to drop to approximately $19 (tangible book value) this year.


Notablecalls: This one's heading to the slaughterhouse today. Stifel is calling for $19/share this year, so I think $23/sh level is where it's headed here.

The company will reconvene with Teamsters leadership & likely iron out a deal at some point but it's not likely to be a good one.

US Airways (NYSE:LCC): Estimates Poised to Rise, We Figured We'd Go First; LCC Upgraded to OW - J.P. Morgan

J.P. Morgan is out positive on Airlines and specifically on US Airways (NYSE:LCC) upgrading the name to Overweight from Neutral while raising their price target to $11.50 (prev. $8.50).

Annualized industry fuel costs have declined ~$5.5 billion in recent weeks, yet estimates have barely budged while equities have suffered. JPM believes early June will be characterized by several rounds of upward revisions, likely one of the few sectors so fortunate. Estimate revisions are expected to prove particularly robust for LCC, given its lack of fuel hedges and limited European exposure.

Remain bullish on the space – The broader thesis is unchanged; manageable fuel, tight supply, incremental revenue streams, disciplined managements and rapidly recovering demand portend a multiyear profit run for U.S. operators, in their view. Add to this the recent decline in equities (CAL & AMR recently triggered “Down 30 in 30”) and the fact that all Legacies & Discounters are trading <5x style="font-weight: bold;">

Figured they’d go first – Despite the ~$5.5 billion in recent industry fuel savings, estimates have barely budged. They’re not sure why, though they believe others may be awaiting the release of May traffic data. Thus, the first two weeks of June are likely to be characterized by several emails hitting investors’ inboxes, largely echoing their thoughts from today.

One of three outcomes is likely – Raising estimates by the full $5.5 billion seems aggressive, as it ignores the potential for softer demand. Lowering fuel and revenue by a like amount – hence leaving estimates unchanged – similarly seems aggressive, as the removal of $5.5 billion of revenue would imply GDP slips by over 2%. They’ve therefore elected the middle ground.

2010/2011 estimates raised – JPM's 2011 industry operating profit rises by $2.7 billion to an all-time record $13.4 billion, reflecting the combination of lower fuel and slightly softer revenue. Improvement in 2010 is not as material, given changes are largely to 2H10 and fuel hedges diminish some of the benefit. They now stand above consensus for every U.S. airline they follow.

LCC should thrive in this environment – The dust seems to be settling around the rhetoric of LCC being “frozen out” by industry consolidation (never JPM's view). Turning back to fundamentals, LCC’s lack of fuel hedging results in one of their largest upward estimate revisions (2011 $2.08 to $3.68 vs. $1.94 consensus). Additionally, while they aren’t expecting any pronounced decline in transatlantic demand, LCC’s exposure is the lowest of any Legacy at 12% of system revenue vs. ~20% for others. Their changes propel their earlier $8.50 target to $11.50, prompting an equity upgrade from Neutral to Overweight.

While Europe has proved the catalyst for the market’s recent correction, they do not believe demand to be particularly jeopardized. JPM estimates that U.S. point of sale generates 75% of U.S. Legacy demand to/from Europe (including the domestic portion of the journey), with only 25% coming from Europeans themselves. Put differently, they doubt many Germans start their day by declaring "Ich muβ einfach nach Amerika kommen! Wie ist die Telefonnummer von US Airways.”

For this reason, the increased affordability of Europe may actually cause total demand for U.S. Legacies to rise, while the opposite may occur to their European peers. That said, should current European dislocation ultimately impact financial services (a disproportionate consumer of aircraft between here and there), the impact would likely be felt by U.S. operators.

Notablecalls: JPM is the Airline powerhouse - their team is very well respected & influential.

I would not be surprised to see LCC trade green today, even in this horrific tape.

2011 EPS of $3.68 vs. $1.94 consensus. Wow.

Correction Hits Sweet Spot; Favor FCX, CLF and NUE; Upgrade AKS - Citigroup & Merrill

Citigroup is out positive on Metals plays saying the recent correction has hit the sweet spot; They favor FCX, CLF and NUE & upgrade AK Steel (NYSE:AKS) to a Buy from Hold with a $19 target (46% upside, prev. $22).

Sweet Spot – Citi's coverage of ferrous and base metals have fallen by 26% since April, placing the current correction in line with annual bouts of 24-33% declines that marked the last cycle (2004-07), which was followed by outperformance.

Base metals, steel and iron have corrected by roughly 26% over the past several weeks on growing concerns of a slowing Chinese economy and Eurozone contagion. Citi believes caution is warranted but similar equity corrections have also represented buying opportunities in the past should these rational concerns prove more severe than reality. As illustrated above, throughout the last cycle (2001-2008), their coverage of steel, iron and base metals experienced multiple bouts of sharp share price corrections on the order of 24-41% following a steep initial appreciation on the heels of a cyclical recovery. In hindsight, many turned into buying opportunities for investors with the exception of 2008.

Key Question – The value or value-trap debate will be answered by the direction or pace of economic recovery. Citi’s base case calls for an “uneven” scenario where Europe lags. They believe metals stocks offer good value here under tempered expectations given recent declines.

Top Three Ideas – FCX is Citi's Top Pick because of high current utilization rates across global copper mines, scarcity value longer term, and Citi’s expectations for a 430k tonne deficit in 2010. Dropping their European demand growth to 0% from 6% still results in a deficit forecast of 196k tonnes. CLF is #2 where despite weaker spot iron ore, 3Q selling prices are likely to exceed guidance which suggests 2010 EPS of $7.50/sh, or 6.7x P/E. 4Q prices for CLF have yet to be determined. NUE is #3 for its leverage to the US recovery, industry leading balance sheet size and quality, high dividend yield of 3.4%, and exposure to lagging construction spending where Citi sees more upside than downside risk. They expect NUE margins to expand in 2Q as a result of lower scrap costs.

Upgrade AKS - Despite cutting their estimates and their target price to $19, the firm ise upgrading AKS to Buy following a 46% share price free fall. On their lowered numbers, AKS is trading at less than 10x 2011 P/E. Negatives appear priced-in with low sell-side ratings (2 Buy, 11 Hold and 1 Sell) and high short interest of 17 mln shares (15.5% of outstanding). Iron ore cost headwinds are well known but the market may be ignoring AKS’s stainless exposure where producers have announced base price increases of 6-9% during 2Q.

- Merrill Lynch/Bac is out with a Steel, nonferrous & coal sector call saying they remain positive following pullback, upgrade AKS & RTI Global macro concerns related to slowing growth in China and the decline in the Euro has the metals & mining sector discounting lower commodity prices. With the sharp reversal in sentiment, the firm re-evaluates their group strategy and maintain a positive view. Their group should underperform in a market correction, though they see attractive values for investors. Importantly, the firm does not expect a hard landing in China. Merrill upgrades AKS and RTI to Neutral on valuation. Their top picks (in order of preference) include CLF, ANR, BTU, and FCX. Aside from valuation upside potential and catalysts ahead, their top picks all have very clean balance sheets.

Merrill is upgrading AK Steel (NYSE:AKS) to Neutral from Underperform with a $16 target citing concerns on slower growth in electrical steel and raw material cost impacts appear discounted in valuation. They remain cautious as steel price declines and additional disclosure on raw material impacts represent near term risks. AK Steel appears well positioned in carbon steel, though profits in this business are well below electrical steel at present. While debt appears to be at manageable levels, pension/OPEB liabilities remain a consideration.

Negative raw material views appear largely discounted
AK Steel has sharply underperformed the steel group since early April (-46% vs. S&P 500 -10%). Raw material concerns have been the main overhang on the stock with the company continuing to assume a modest 30% increase in iron ore costs in 2010. Merrill expects more volatility near term as the company is expected to release a weaker mid-quarter outlook and quantify impacts from higher iron ore and met coal costs. That said, their revised PO (which values AKS at discount to group) suggests there is modest upside in the stock as profit/ton recovers toward average levels over the next 1-2 years. A strategic fix to the company’s lack of integration in iron ore can also be a positive catalyst for the stock, in their view.

Notablecalls: Needless to say, one needs to have some cojones to buy anything in this tape but buying some AKS (2 upgrades from tier-1 firms) or FCX/CLF today could yield some nice upside.

These are basically high-octane bets on general market bounce today.

Tight stops & small positions, if you do decide take the leap of faith.

Sequenom (NASDAQ:SQNM): Bullish on the technology and Sequenom’s prospects for commercializing T-21 in 2011 - Barclays

Barclays Capital is out surprisingly positive on Sequenom (NASDAQ:SQNM) ahead of of forthcoming data on sequencing for trisomy-21 (T21) screening, saying they are bullish on the technology and Sequenom’s prospects for commercializing a test in 2011. Firm is raising their target to $9 (prev. $7) and is reiterating Overweight rating on the name.

Now that the funding overhang has been removed, investor focus is returning to the company’s in-development sequencing-based T21 test. Barclays has reviewed the history of non-invasive prenatal diagnostics (NIPD), academic literature on aneuploidy testing using sequencing, identifies and discusses major issues with sequencing, and updates their patient-based model assumptions.

Lo sequencing data likely to be positive. Based on evidence to date, sequencing is a valid, universal method for NIPD of aneuploidy, with the three small proof-of-concept studies in literature all demonstrating a 100% detection rate. The father of Sequenom’s technology, Dr. Dennis Lo, will this summer publish a ~700 sample T21 sequencing NIPD study, the first large-scale test of sequencing for prenatal screening. Barclays expects a positive outcome, and investors are likely to read-through to Sequenom’s indevelopment test; they think the risk-reward for SQNM over the coming months is favorable.

Target Market
Barclays notes they have changed their assumption for the test’s target market. Firm now anticipates that the test will be targeted as a first-line screening test for the high-risk pregnancies and secondline (reflex from serum screening) for low-risk pregnancies. “High risk” is likely to be defined as maternal age of 35+, and/or other risk factors.

The company’s clinical trials evaluate the high-risk population as a practical matter (it would be prohibitively expensive to run a prospective clinical trial on the general population for a condition with the prevalence of T21), so clinical performance in a high-risk population will be the data that the company uses to sell the test. They think there could be potential regulatory issues should the company launch the test and then market it as for use in lowrisk pregnancies without any data to this effect.

There are more than 600,000 pregnancies annually in the US by mothers over 35 years of age. The risk of aneuploidy increases substantially after this age.

Price
The likely price of Sequenom’s test, somewhere in the $1,500 range, is significantly more expensive than other non-invasive tests (in the $100-$300 range), but cheaper than invasive sampling ($1,500-$3,000). The final price will be set based on the clinical performance of the assay, with higher clinical performance justifying a higher price. Some may consider this test to be very expensive, though we think that in a high risk setting this price could be achievable. Barclays' uptake assumptions are purposely low and slow as a result of price.

The molecular diagnostics market is relatively young, though there are clear examples of successful commercialization and managed care coverage of multi-thousand dollar tests. The most well-known example of this is probably Myriad Genetics’ BRACAnalysis test, which costs $3,340 and has reimbursement from managed care.

Margins
They estimate the cost of goods for the sequencing test at launch is likely to be approximately $400. This means that if the company can get $1,500 reimbursement as they have estimated, gross margin on the test could be as high as the mid-70s%. Barclays assumes 75% probability of success for T21, and U.S. risk-adjusted revenue of $326M in 2015. The company estimates the U.S.-only market opportunity for this test at $1.5B+. They assume ex-US introduction occurs with a 1-2 year lag to the U.S.

Notablecalls: First of all, I must say that I skipped about 16 pages of this 19 page call as the science part of the trisomy-21 test is just way over my head. So, Barcap's Anthony Butler, Ph.D is basically saying the test works. That is, at least in his opinion.

When you have a tier-1 firm out positive on a binary situation like Sequenom, people tend to notice. Despite their conviction, Barcap's $9/share target isn't even the Street high.


All in all, I expect the stock to be strong today. Should trade at least above the recent swing high, putting $6.30-6.50 levels in play.


PS: Note that Lazard is also out positive on Sequenom this morning, following meeting with management. Firm remains bullish on Sequenom and expects the company to be able to commercialize a Down Syndrome test by the end of 2011. They expect shares could run upwards on Dr. Dennis Lo’s data this summer. Reits Buy and $13 target.

Assured Guaranty (NYSE:AGO): Colour on recent sell-off

Couple of firms are out with defensive comments on Assured Guaranty (NYSE:AGO), the financial insurance guarantee provider.

The company has seen its stock price fall off the cliff over the past weeks, down to $14 level from $24 in April. Last night AGO has announced today that the company repurchased 707,350 shares at $14.74 per share.

- Piper Jaffray notes that in their view, the announcement by Assured Guaranty regarding the completion of its share repurchase authorization offers a glimpse into the future performance of AGO in the quarters ahead. More specifically, they continue to believe the credit portfolio remains well managed and, as credit performance continues to improve, will result in an excess capital position, leading to positive revisions to the firm's ratings and outlook along with multiple expansion on the shares. Piper reiterates their Overweight rating.

For some time, management withheld from acquiring shares due to its concern around the potential impact on its capital position and ratings. While on the surface the announcement does not offer a meaningful change with regard to the financials, the bigger picture offers a glimpse into management's confidence of where Assured Guaranty stands in the quarters ahead. In Piper's view, investors can anticipate management continuing to manage capital toward rating upgrades, portfolio acquisitions and perhaps further share repurchase. Regardless, they believe management's actions speak volumes toward the future performance of Assured Guaranty and its shares.

Expect the continued run-off of RMBS and focus on municipal underwriting to result in the financial guarantor showing an increasingly stronger capital position. Considering the continued improvement in delinquency trends, the run-off in RMBS by the end of 2011 and that rating agency models view municipal underwritings as being capital accretive, Piper finds it difficult to imagine AGO ratings and outlook won't move up from here.

Continue to view shares undervalued, reiterate Overweight. Currently, AGO shares trade at just 0.75x current book value and nearly 0.50x year end 2011 book value. With momentum gathering on credit and ratings, the firm believes shares are poised to experience multiple expansion from these levels. Beyond expected GAAP book value of $23.45 twelve months out, they forecast an adjusted book value to reach roughly $57 by year end 2011.


- J.P. Morgan notes this repurchase completes the 2M share buyback program authorized by AGO’s board in November 2007. The size of the buyback is relatively insignificant, and the share count does not change enough to materially impact our EPS estimates. However, the fact that management used up its entire remaining buyback authorization in such a short period makes this a notable event, signaling mgmt’s frustration over the recent sell-off.

Expect further share repurchase authorization. With the latest repurchase activity, AGO has used up its remaining buyback authorization. Given the strong capital position that AGO is in currently, J.P. Morgan expects further repurchase authorization to be granted by the board in the near future in order to give AGO the ability to take advantage of market opportunities and provide a deterrent to short sellers.

The firm reiterates Overweight rating and $40 price target.

Notablecalls: I think AGO is one the financial stocks one should keep on radar for a potential bounce:

- The stock has gotten whacked because of sovereign debt losses out of Europe, but the company has no direct exposure to sovereign risks.

- They do have a lot of U.S. municipal bond exposure but they have not insured any of the Florida "dirt" bonds.

The thing with U.S. municipal exposure is that even if some municipalities default the likelyhood of of a full-blown bankruptcy is very low. They can always raise taxes and sell some assets. Meanwhile, AGO would be on hook to cover the interest payments but they would eventually get their money back from the municipalities.

I spoke to a pretty well known Assured Guaranty (NYSE:AGO) bull this morning and this is what he had to say:

'... Ok, I went back and analyzed every muni bankruptcy ever and looked at the outcome for bondholders and then went through AGO's MBS stuff and looked at their exposure - basically, it's a $40 stock. In 2011 I think it earns $7/share...'

So there you have it. Not making a trading call here but I think AGO is worth keeping on the radar.

Oh and btw, here's his market prediction: "...My prediction for today: we bottom at 10am and then go up for next 3 months. Like 9/21/01..."

Research in Motion (NASDAQ:RIMM): Downgraded to Underperform at Cowen; Consensus EPS at risk

Cowen is making a significant call in Research in Motion (NASDAQ:RIMM) downgrading the name to Underperform from Neutral.

According to the firm, RIMs's aggressive push into international markets has helped the company to offset fierce competition in its core North American market the last two quarters. Looking forward, however, they believe that to reach F11 consensus forecasts (Cowen F11 revenue/EPS are ~10% under consensus) RIMM must either continue to grow international sales rapidly or improve its market position in North America. They do not believe prospects for either outcome are promising; Cowen's latest non-U.S. industry checks have begun to soften while competitive smartphone trends in N.A. are intensifying. Firm believes their below consensus F11 EPS of $4.85 more appropriately discounts the risks they see appearing over the next 6-12 months and are downgrading RIMM to Underperform from Neutral.

N.A. Operators Aggressively Pushing RIMM Competition. Though the North American market overall remains healthy, the firm expects Android’s share to increase at Verizon, Sprint and T-Mobile through the summer of 2010 as both high-end (HTC, Motorola) and low-end (incl. Chinese OEMs) arrive with new products. An iPhone update at AT&T also looks likely to dent the impact of RIM’s upcoming product refreshes due in that (HSPA) channel. Finally, they note that HP’s acquisition of Palm will most likely help keep webOS a viable competitor in North America.

International Expectations High as Channel Pressures Increase. RIM’s push into international markets has helped to mitigate recent share loss in N.A. CDMA channels; non-North American revenue more than doubled y/y and accounted for 48% of RIM’s F4Q10 (February) sales. Cowen's latest industry checks show channel confidence has waned over the last few weeks. They note that during the 2008 downturn similar worries quickly converted into channel de-stock when consumer weakness did appear. Finally, new low-priced Nokia QMDs and smartphones (C3, E5 and C6) are set to arrive shortly and challenge RIM’s 8520 franchise.

Cowen vs. Consensus
RIMMs's low 12x multiple on consensus F11 EPS of $5.42 has helped it withstand recent market pressure, but Cowen sees previously discussed headwinds increasing for the company over the next two quarters that could pressure consensus EPS. Consensus may also be underestimating growth in amortization costs most likely tied to IPR and NOC costs that they anticipate will increase in coming quarters. As indicated earlier, the primary risk to their view on RIM shares is the number of new products (both hardware/software) RIM is set to launch in coming months.

The company’s new OS should improve the browsing experience on RIM phones, but overall Cowen worries whether consensus fully discounts launch costs and execution risk tied to the opportunity. WThey expect to see the new BlackBerry OS 6.0 in F3Q11, but the companys's push into prepaid and international markets should be a greater factor, pressuring ASPs. They see hardware ASPs dropping from $330 in F10 to $289 in F11. Their strong unit/weak ASP outlook suggests RIM can still grow sales outside former core NAM CDMA/HSPA channels but that a slowdown could occur when Nokia, iPhone and still more Android products arrive in 3Q10.

Notablecalls: I think Cowen has discovered something the more savvy investors have known already for quite some time - RIMM is facing significant competition not only from the iPhone but a host of Android-based devices as well (namely HTC). The reason why they have been showing strong unti growth outside of North America, is because of pricing. ASP's have been coming down to push units. Their product is increasingly becoming commodity. Now even Nokia is coming out with Bberry look-a-likes.

Couple days ago British bank Standard Chartered said its employees could switch from the BlackBerry to the iPhone. All 75,000 of them. That is another worrisome datapoint as RIMM has always been considered to have a rock-solid place in the corporate world.

At this point, I really have no idea how RIMM could stop the upcoming slide in growth & eventually consensus expectations.

I guess that is the reason why this powerhouse is trading 12x EPS. But what if consensus is 10-20% too high?


All in all, RIMM will trade down on this downgrade, likely towards the $62/share level.

The risk?

The main risk I see here is a possible snap-back rally in the market. Note that Stifel was out with a curious market call yesterday intraday saying:

We are seeing something odd going on in the Options Markets today

The CBOE Intra-Day Put-Call ratio leapt as high as 2.44, and is near 1.6 now The last 4 times it approached 1.2, it signaled a impending 5-8% rally in the SPX.

British Petroleum PLC (NYSE:BP): The Hardest Trade?

Merrill Lynch (UK) is making an interesting call on British Petroleum PLC (NYSE:BP) adding the name to their Europe 1 List. Merrill is reiterating Buy rating and $65 tgt on the name.

Worst case for Macondo spill priced-in; adding to Europe 1
Since the Macondo (GoM) spill news broke on 20-Apr, BP lost c20% of its market cap (FTSE -9%), implying a US$28bn market-adjusted gross cost for Macondo (BP owns 65% of it). This is c2x the proposed US$10bn spill liability limit plus the US$3.5bn run-rate clean up cash cost (180 days) and shows that the market has already priced-in the worst case scenario for Macondo. With BP progressing in stemming the 5kb/d leak – 40% of it is now captured, the well-kill solution could stop the leak altogether next week - and strong valuation support, the firm sees BP as a compelling risk/reward proposition among Euro Oil majors.

What next for Macondo?
Now that the spill containment efforts appear to be making tangible progress – only a limited amount of oil seems to have reached the shoreline – the focus has turned to stopping the flow (killing the well) injecting heavy drilling mud through a manifold connected to the bottom of the blowout preventer (BOP). Merrill notes that this is a proven procedure in the industry and – despite the technical challenges faced – they believe that it offers a better chance of success than other proposed solutions (top-hat, containment dome). The two ongoing relief wells (results due in 60-90 days) offer back-up in case the near term solutions were to fail. Importantly, although containing the leak is the top priority, the rest of the business appears still to be performing well, re-enforcing their view of BP’s deep operational strength.

Importance of the US GoM to BP
The US Gulf of Mexico (GoM) remains a key region for BP, in Merrill's view, particularly because of the prospectivity of its acreage (the Tiber discovery is a case in point) and the relatively low taxation that makes these barrels one of the highest-margin barrels in the portfolio. The US accounts for almost a third of BP’s hydrocarbon reserves (1P) basis – the highest amongst the European Oil Majors – and the firm believes that any tightening of the regulations/ tax increase is set to have a larger impact on BP than on any other European player.

As a result, controlling the spill and making sure that the environmental and political consequences are minimized is key to the long-term prospects of the company.

Cheapest Global Oil Major; solid dividend
BP now trades on 7.3x 2010E P/E – a c15% discount to the sector that makes it the cheapest global oil major in our coverage – and offers a compelling 7.3% dividend yield (sector 6%).

Merrill notes that the dividend yield relative to UK gilts has widened significantly over the past few weeks and is now close to the highs seen during the Lehman-crisis. They continue to believe that BP’s quarterly dividend of US$0.14/sh remains solid even if the spill were only to be plugged through the relief wells (90 days). They think that the market is yet to distinguish the cash costs resulting from the clean up - that will impact near term cashflows - from the LT impact of environmental liabilities/damages - a settlement that could take years.

Taking 1Q10 as a guide, at current oil prices, BP generates cUS$4.5bn of free cashflow (ex working capital) per quarter, 1.7x the current dividend. Post dividend, this leaves cUS$2bn to pay for Macondo – enough to cover BP’s share of the US$32m/d (gross) clean-up costs. With BP boasting sub-20% financial gearing, Merrill regards the dividend as relatively safe - albeit with little scope for an increase this year.


Notablecalls: Sometimes, the right trade is the hardest one. Buying BP here is indeed hard. Especially with the general market tone (S&P is again down ~1% in the early going) and oil getting slashed as well overnight.

But consider this:

- MLCO is saying the leak could be stopped as early as next week. This is hardly the consensus view.

- BP is yielding 7%+ around current levels & the dividend looks to be safe. So, as a fund manager - would you favor buying let's say Amazon.com (AMZN) here or would you go after the 7% yield + say 10-15% equity upside if all goes not-as-bad-as-feared-currently?

The risks?

- All-goes-as-bad-as-feared-currently. Another 90+ days to kill the well. (Div's still safe, btw).

- Oil price tumbles as China hits the fan.

- This guy gets it right. Would be a 1st.


'...He's been bearish since Jesus walked on water. Maybe longer, when Moses parted the red sea. Actually, he does look like a dinosaur...so, perhaps even longer..' - Quoting an NCN member.


The hardest trade.. here we go..

DreamWorks (NYSE:DWA): Shrek 4 to disappoint?

DreamWorks (NYSE:DWA) is getting some cautious commentary ahead of the domestic release of ’Shrek
Forever After’ this Friday (5/21):

- Cowen says they are adopting a more cautious view of the film’s likely opening weekend box office. Their checks of tracking data point to an opening weekend box office below the $110-$140MM range they think the film needs to hit in order to meet investor expectations. Though the firm ise not changing their $330MM DBO estimate at this time, holders of DWA shares may want to adopt a more defensive position heading into this weekend. They continue to rate DWA Outperform as they still view DWA’s valuation as attractive on their expectations for long-term annual EPS power of $3.00+.

Indicators Suggest a Soft Open. Cowen believes the Street is currently expecting a $110MM+ opening weekend for ’Shrek’, though they think the recent weakness in DWA shares has been at least partly driven by investor concerns about the film’s prospects. The data they are seeing (tracking data from industry sources and B.O. prediction websites) suggest an opening of $100MM or below. They do note, however, that ’Shrek’ faces virtually no competition in the family market and will be the only major 3-D film in theaters until the release of Pixar’s ’Toy Story 3’ on June 18. Firm also notes that ’How To Train Your Dragon’ opened well below expectations, but has achieved pre-release DBO estimates via strong box office legs.

- Thomas Weisel is downgrading DreamWorks to Market Weight with a $38 price target (prev. $44) saying their channel checks indicate to be lower tracking expectations for Shrek 4. Their new estimate for the film domestically is $315mn down from $375mn, which is where they understand that consensus lies. TWP's global box office estimate is now $756mn compared to the $900mn figure for consensus.

Why It Matters: TWP's tracking channel checks for Shrek 4 indicate a $75-90mn opening weekend estimate, where consensus is likely around $110mn mark. While to be fair kids movies are difficult to track, given these tracking results the $375mn figure is too much of a stretch in their view. While the firm ise not generally partial to downgrading ratings on the performance of just one title, Shrek is no ordinary title for DWA as it is both the anchor to this year's EPS estimates but also critical to the 2011 spin-off of Puss In Boots. Furthermore, as DWA enters distribution renewal discussions, such an outcome is not optimal for DWA's bargaining position.

International Results May Be Challenging
So far TWP is continuing to estimate that international box office will index 1.4x that of the domestic box office. However that as well may prove optimistic. For starters, with the bulk of the international results being Euro driven, the recent Euro weakness will hurt results. Secondly, while the company has well telegraphed that the World Cup will lead to a staggered international release schedule, with Toy Story 3 now having released its international dates, the runway which Shrek 4 has domestically is more limited internationally and that may impact results as well.

Notablecalls: I'm sure everyone remembers the 10% drop in DWA stock back in March when ’How To Train Your Dragon’ box office #'s came in below consensus.

Shrek ain't Dragon. Shrek is the cornerstone of DreamWorks' business. Shrek 3 didn't get great ratings (box office was OK), so less people may turn up to see the 4th. So the issue may be somewhat bigger than it seems at first glance.

I'm not sure how the stock will react to these comments today (given the strong tape) but I suspect people will be looking to sell some shares ahead of the weekend. This should keep the pressure on the stock.

A name you can visit, when/if the market rolls over again.

Cree Inc. (NASDAQ:CREE): Upgraded to Buy at Lazard

Cree Inc. (NASDAQ:CREE) is getting some positive commentary this morning:

- Lazard is upgrading CREE to Buy from Hold with a $90 target saying they believe LED demand for general lighting will grow at a >30% Y/Y CAGR in 2010-14. Firm projects Cree’s rev growth to outpace that of the industry in 2010 and 2011 as the company takes advantage of its early lead in this space. Therefore, they recommend that investors take advantage of the recent pullback in the stock.

No longer just universities and gov’ts. With payback periods coming down as low as 12 months, the firm is seeing increasing adoption of LEDs in general lighting, especially in the commercial space. Lazard's checks suggest that in 2009 there were ~50 commercial projects using LEDs, and in 2010 lighting contracts for LEDs should reach 200+ multimillion-dollar projects. They are also seeing utilities creating rebates for LED fixtures and introducing unmetered rate schedules specifically for LED street and area lighting. Cree is at the center of this trend.

Cree still at the top of vendors’ lists. Three of the top four N. American light fixture vendors are largely using Cree’s 1+ watt LEDs for indoor and outdoor applications. Many other players on the floor mentioned Cree as being among their major suppliers. The company announced a five-year warranty on all of its components and fixtures and is making it easier for fixture makers to innovate with its new modules that integrate driver electronics, optics and primary thermal mgmt plus Cree’s IP and true white

Updating estimates. Lazard is updating their ests. to reflect their expectations for gen. lighting. For F4Q they est. rev/EPS of $269M/$0.52, up from $260M/$0.50 previously. For FY11 they see $1.273B/$2.42, up from $1.230B/$2.35 previously.

- JMP Securities is reiterating their Market Outperform rating and are raising estimates on Cree following positive checks last week for four leading LED driver IC companies and Cree’s announcement of several noteworthy milestones in revolutionizing LED lighting. Each of the four LED driver IC companies the firm spoke to detailed improved LED lighting performance is driving gains in near- and intermediate-term market demand and interest, and several of them gave detailed color around the differentiated position Cree holds in the market. In conjunction with these confidence-inspiring checks, at the Lightfair tradeshow last week Cree announced new milestones in cost/performance and cost/watt in both the residential and commercial solid state lighting markets, and they believe this will translate current market momentum into sustainable intermediate-term gains. As a result, JMP is revising up their June quarter Non-GAAP EPS estimate from $0.48 to $0.52 (Street $0.51) and their FY11 EPS estimate from $2.15 to $2.35 (Street $2.27). JMP's price target of $100 is based on DCF calculations assuming a 9% WACC and 4% terminal growth rate, and represents ~40x their CY11 non-GAAP EPS estimate of $2.48 (up from $2.36 previously).

Notablecalls: I was rather surprised to see CREE move up 5 pts on a Sidoti (?!) upgrade last week. The stock retracted all of these gains in two days and is now back where it started. I think the bulls (if there are any left) may want to have another go around these levels. Not a high conviction call, btw.

Also note the NY TIMES is out with a positive piece on LEDs

LED Bulbs for the Home Near the Marketplace
http://www.nytimes.com/2010/05/17/technology/17bulb.html

Monsanto (NYSE:MON): Trading Darwin Award of the month goes to Morgan Stanley

Morgan Stanley's agricultural products analysts Vincent Andrews and Megan Davis are making a call on Monsanto (NYSE:MON) that I think deserves at least Trading Darwin Award of the month. After quarters & quarters of being positive on the name, the firm is finally getting off their Street high target of $95/sh and are lowering it to a more conservative $70.

They have also published a Negative trading call (RTI) articulating their belief that Monsanto’s shares are likely to decline in the near-term if they are correct about Roundup gross profit.

And get this - Morgan Stanley is keeping MON Overweight-rated.

Roundup likely to disappoint relative to guidance. At F2Q10 reporting, Monsanto lowered its Roundup chemical F2010 gross profit guidance from a range of $650 to $750 million to plus/minus $600 million. MSCO is lowering their Roundup gross profit estimate from $575 million to $500 to reflect both lower volume and pricing. While Monsanto has guided to at least 250 million gallons of combined branded and generic volume in F2010, they believe that volume could come in below that with the bulk of the lost volume coming out of the branded segment. They expect this lost volume to come from a confluence of:

1. The very early planting progress in US corn destroyed some product demand;

2. There is still too much generic product in the channel and that is partially a function of point #1 as the demand that was destroyed was generic product demand (i.e., less “burn down”);

3. As in fertilizer, MSCO believes that both dealers and farmers are looking to exit the spring season with as little inventory on hand as possible.

Additionally, the firm expects pricing to be pressured by both the above and Monsanto's branded competitors bundling their branded glyphosate at attractive price points with their other more proprietary crop chemicals.

Summary & Conclusions
While the firm remains bullish in the long term about Monsanto the company’s prospects, they believe that Monsanto the stock is increasingly dislocated from Monsanto the company’s prospects. They believe that continued strategic and earnings’ disappointments have forced Monsanto the stock to remain narrowly focused on the current continuously disappointing “state of play” rather than focusing on the more forward looking opportunity set provided by a best in class technology pipeline. Until Monsanto is able to prove out the value proposition of its newest technology (SmartStax in corn and Roundup Ready 2 Yield in soybeans), they believe that investors will not be inclined to credit Monsanto the stock for the potential earnings power of the $1.70 per share of R&D expensed annually.

Where is valuation today? Monsanto currently trades at 16.1-times MSCO F2011 EPS estimate of $3.45. They believe that this breaks down to approximately 8-times ~$0.15 of chemical EPS and 16.5-times seeds and traits EPS of ~$3.30. Historically, they believe that the seeds and traits business has traded between 20 and 45-times seeds and traits EPS (assuming the chemical business at 8-times.

How low can the stock go? MSCO Bear Case valuation of $45 per share assumes that all of the above goes wrong. In that case, they believe that Monsanto’s chemical business could trade at 8-time EPS and that the multiple on the seeds and traits business could contract as low as the ~14-times market multiple (likely conservative given Monsanto’s substantial R&D spend and net cash balance sheet). In this scenario, they would expect the stock’s valuation to look no further than NTM EPS which they believe would be $3.34 in this scenario.

Notablecalls: So, let's see - the stock peaked around $85/share back in January. Back then the Andrews & Davis duo yapped about how the OTHER analysts were cautious-negative (less than 50% Overweight vs. > 85% in 2008) on the name but they saw 'business and investor momentum' turning. So they reiterated their Overweight rating and $105 target on the name.


And today after a 30 pt. slide, with the stock at $55 they are issuing a negative Research Tactical Idea (RTI) ahead of June 24 results. After all, their Bear Case scenario (if all goes wrong) foresees a $45/share target.

But they are keeping the stock Overweight-rated, which means they don't see everything going wrong? Right?

Right?

Boy, I would like to overhear a phone conversation today where the Andrews & Davis duo explain to their institutional client(s) that are way under water the logic of keeping Monsanto OW-rated (a.k.a Long) while at the same time telling the fast money accounts to short the name.

I believe all this is symptomatic of a much wider issue. The research coming out of these Tier-1 firms very often lacks the quality one would expect from Tier-1 cabal. Sure, they still have the large client bases and are therefore able to create some directional pressure but it surely ain't the good ole days.

Maybe it's because their coverage lists have gotten so long that the analyst teams just don't have enough time to devote to each single name?

Notice lately how little credibility Goldman Sachs' equity research has in the market? Most of their ratings get faded aggressively.

The game has changed - small, more specialized shops is where the hedge-fund desks are turning to in order to gain an edge. Shops that cover single sectors or even sub-sectors. That's where the best research comes these days, in my opinon.

Back to Monsanto (MON), I have no clue how this MSCO call will work out. But I do think MSCO has lost their Street cred. in the name.


Sorry, had to get it off my chest.

Devon Energy (NYSE:DVN): The Death Throes of the Barnett Shale? Downgrade Devon - Bernstein

Bernstein Research is making a rather significant call on Devon Energy (NYSE:DVN) downgrading the name to Market Perform from Outperform and lowering their target price to $79 (prev. $88)

Recent frac data from the Barnett Shale shows a play in severe decline, with operators over the second half of 2009 expending more and more effort and capital to recover less gas per well. A number of operators continued to drill new wells in the Barnett through the second half of 2009, despite the deteriorating economics. We believe that F&D costs will continue to rise sharply in the Barnett, providing a headwind for companies that are exposed to the play.

The average number of frac stages per well surged in 2009 for Devon; the company went from an average of 5.0 stages in the first quarter to 6.2 stages in 2Q09 and eventually 7.0 stages in 4Q09. Over the same period Devon's average IP rate hovered around 1.3 mmcfd, and the 2009 average IP rate was flat from 2008 despite the increase in stages. Similarly, Chesapeake increased its number of frac stages by 46% in 2009 but saw average IP rates rise just 10%. This means that in a flat service price environment, both companies would see significant inflation in F&D costs.

Adding more frac stages seemed to increase IP rates on average, but the correlation within 2009's wells between stages and IP remained weak. Doing more frac stages also failed to prevent very small wells, which lowered average results. For Devon, 15% of all horizontal Barnett wells had IP rates below 0.5 mmcfd, which is very poor, and 17% of wells drilled with 6 or more frac stages were that small, too. For Chesapeake, only 3% of all wells had IP below 0.5 mmcfd, but 7% of wells drilled with over 6 stages did, illustrating that doing more frac stages doesn't decrease risk, and may increase it.

The Barnett's well failure rate also continues to rise over time. As of the most recent data available, 15% of Barnett horizontals drilled in 2004 were no longer producing, and 14% of wells drilled in 2005 had failed, as well. The trend appears clear that after 3 years operators can expect around 12% of wells to have failed, and that the failure rate shows no signs of flattening yet.

Bernstein believes that the Barnett provides a helpful case study in what the end of shale play's life looks like. Despite clearly declining economics, operators continued to drill more and more complex wells in 2009, hoping that their strategy would yield results. It is particularly surprising that the Barnett declined so sharply in 2009, since a dramatically lower well count should have enabled operators to pick their best prospects. Due to the declining economics, investors are best advised to look ahead to other operators and other plays, where the probability of improvement over time is much higher.

Devon, in particular, is too exposed to the Barnett, which accounts for over 30% of pro-forma production. Devon's wells are worse than Chesapeake's, yet the company continues to invest there, which will lead to structurally higher F&D. Although the firm is bullish on gas prices, they think Devon faces too many challenges to recommend it at these levels.

Large E&Ps tend to have diversified asset bases across many plays but often there is one field that is so large that the company's performance is inextricably tied to it. This, Bernstein believes, is that case of Devon, with regard to the Barnett Shale. Devon was a first mover in shale gas, entering the Barnett long before others believed in the possibility of producing gas from shale, but the company has remained concentrated in the Barnett such that it will account for around 30% of production once the asset sales currently underway are completed. Since shale wells have a high decline rate, this means that if the Barnett stops growing or declines it will be very challenging for Devon as a whole to increase production. However, their work suggests that the returns and economics in the Barnett are becoming continually less attractive for Devon in the Barnett, suggesting that the company finds itself in a strategically challenging spot.

Notablecalls: First of all, to really understand the significance of the call, read this:

A contrarian makes another call – this time, natural gas
http://www.theglobeandmail.com/globe-investor/investment-ideas/features/taking-stock/a-contrarian-makes-another-call-this-time-natural-gas/article1538686/

Henry Groppe, the grand old man of oil & gas forecasting says shale gas ain't the miracle cure.

Bernstein's comments seem to confirm this theory.

So, what to do with Devon (DVN) here?

Barnett Shale (and possibly all of shale gas) may not be working out as expected and that's partly the reason why natty gas price is beginning to lift its head.

But what good is a higher natty gas price, if Devon can't get much from Barnett?

That's the question.

I think DVN should trade down on this downgrade. But I'm not sure.

Maybe buying natty gas is THE trade here?

eBay (NASDAQ:EBAY): Turnaround Underway + 10% FCF Yield; Upgrading to Overweight - Morgan Stanley

Morgan Stanley is out upgrading eBay (NASDAQ:EBAY) to Overweight from Equal-Weight with a $32 price target.

Why upgrade eBay shares now? – Morgan Stanley believes eBay’s multiple will expand as management innovates + executes on their turnaround strategy. They are increasing C2011E estimates by 2% and upgrading their rating to Overweight with $32 DCF value.

Turnaround is turning – Their conviction lies in the belief that: 1) Marketplaces business has stabilized given recent trends; 2) PayPal’s outlook continues to improve owing to especially strong + accelerating growth in Merchant Services (off-eBay); and 3) the shares are now compelling due to a recent pullback. On C2010E, EBAY trades at a 10% FCF yield and at 7x EV/EBITDA vs. 6% / 15x eCommerce average.

Marketplaces (53% of CQ1 revenue and 76% of operating profit) – stabilizes as key initiatives around pricing, user experience and trust sustain eBay’s eCommerce share, and the shift from offline retail to online commerce provides a tailwind for revenue growth.

Payments (35% of CQ1 revenue and 24% of operating profit) – continues to post growth rates above market expectations as an increasing number of merchants and consumers choose PayPal as their payment platform of choice for a growing number of transactions.

At a 10% C2010E free cash flow yield, the market seems to be valuing eBay ex-growth. eBay’s multiple has contracted significantly over the past five years as investors have transitioned views of eBay from an open-ended growth story to a value stock. MSCO believes there is proof that the market’s areas of concern have been overstated and a 10% free cash flow yield now overly discounts the long-term opportunity.

Increased confidence in eBay's business outlook and management's ability to execute. Recent initiatives focused on improving the buyer and seller experience in the core Marketplaces and extending the PayPal platform to new merchants / customers / geographies / markets (mobile + social) have increased Morgan Stanley's comfort level with management’s strategic direction. As a result, they are more confident that eBay has the ability to turn its business around and regain its status as Internet innovator after several years of playing catch up.

Notablecalls: I would call this one an out-of-consensus call as the sentiment in EBAY has gotten really negative. Deutsche was out last week saying things had worsened at eBay over the past month.

Yet, Morgan Stanley is now out with a 54-pg (!) call saying they think the co is close to turning a corner. A real head turner from Mary Meeker.

I expect the stock to trade up 5-7% today, putting 23.50 - 24.00/share range in play today. Definitely an out-sized move for EBAY but I think the snap-back will be a violent one.

Halliburton (NYSE:HAL): The Causes of BP's Macondo Blowout Are Becoming Clearer--Upgrading HAL - FBR

FBR Capital Markets is upgrading Halliburton (NYSE:HAL) to Outperform from Market Perform and is raising their target back to $44 (prev. $35).

Firm notes that since their last piece analyzing the potential causes of BP's Macondo blowout, several questions have been answered, but new ones have also arisen. They also have a much clearer time line of events, thanks to disclosure by the House Energy and Commerce Committee. Yet, there are new questions raised by the log of the final two hours before the blowout, including what procedures were performed (and why) once traces of gas started to show on surface nearly two hours before the blowout occurred.

FBR's current theory as to the causes of the blowout is that either before or during the cement job, an influx of natural gas entered the wellbore and was circulated up the well during the cement job. After waiting for cement to harden for 16.5 hours, a negative test was performed on the wellbore below the blowout preventer (BOP) and the wellhead assembly failed to seal. At this point, it was reported by the committee that additional pressure tests were conducted and that BP officials deemed them acceptable to proceed with well operations. Next, the data suggests that during the displacement of the riser to seawater, natural gas that was below the BOP was circulated to the surface, reducing the hydrostatic head enough that it caused the well to start flowing, which had not been stopped by either procedures performed on the rig or by the BOP. It remains unclear as to why the blind shear rams, which were last tested less than 10 hours before the blowout, failed to seal the well, but industry participants seem to universally agree that an unforeseen obstruction is preventing full closure.

The bottom line. The bottom line for the oilfield service companies involved with this tragic incident seems to be that absent a court finding them to have been grossly negligent, an exceedingly difficult standard to prove, that the well owner will undoubtedly end up footing the bill for remediation, clean up, and associated damages.

Upgrading HAL. FBR is upgrading HAL back to Outperform (from MP) with the stock down 8% from their downgrade on April 30 (vs a drop of 1.3% for the S&P). While the cement must have failed to seal the production zone to allow flow to occur, the firm believes that other circumstances and decisions were far more central to creating the conditions where the integrity of the cement job became relevant. Apart from setting the record straight that foamed cement has been pumped many times, questions posed towards HAL's Tim Probert at recent congressional hearings were more focused on relevant wellsite procedures, which seemingly lessens HAL's headline risk. They are restoring their prior $44 target (from $35), representing 20x our 2011 EPS estimate.

Why not upgrade RIG ? FBR feels a combination of falling deepwater rig day rates combined with headline risk into the procedures performed on the rig leading up to the blowout are likely to keep RIG range-bound for at least several weeks.

New BOP information. Much was made of modifications to the rig's BOPs during the hearings, but it was also disclosed that the modifications made were requested by and paid for by BP. Furthermore, it also came to light that BP discovered leaking hydraulics and a dead battery. However, later testimony indicated that these conditions should have been noticed on the rig if they had been present before the blowout.

Impact on other service companies. Based on their review of the available information, FBR continues to see no circumstances where MI-Swaco, the drilling fluids company that is jointly owned by Smith International and Schlumberger, would have made any independent decisions that contributed to the blowout. During the hearings it was disclosed that Weatherford performed the casing running services, but no information suggesting any errors, much less gross negligence, was disclosed.

Who will benefit? FBR believes the big winners out of this incident are likely to be the companies that manufacture BOPs, as they expect standards to be significantly tightened, probably requiring substantial upgrades and additional blind shear rams. They also expect more to be made of cement job evaluation on production casing jobs, which should mean incremental wireline logging (cement bond logs) as well as additional remedial cementing work should it be necessary.

Notablecalls: It's increasingly likely that BP people called all the shots that lead to the eventual BOP failure.

That's good news for HAL & RIG, if one is willing to overlook the fact off-coast drilling will be a tough gig following the Macondo incident.

FBR was among the first (if not the only) to downgrade HAL in light of the news 2 weeks back and they are also the first to upgrade their rating back to Buy-territory. This should be rewarded by the market.

I expect HAL to trade up today, towards $30/share & possibly higher if the general market plays ball.

A123 Systems (NASDAQ:AONE): Colour on quarter - Bounce?

A123 Systems (NASDAQ:AONE) is getting some fairly supportive tier-1 commentary following results out last night:

- Morgan Stanley notes that new wins and capacity growth should offset Q1 miss.

AONE announced plans to expand capacity by a further 200 MWh to 760 MWh, enough to power approx 50,000 PHEVs or 380 grid batteries, assuming an average PHEV battery of 15kWh and a grid solution of 2MW. This should instill confidence in potential customers that AONE will be able to meet demand, according to MSCO.

New wins show momentum: AONE announced a new development contract with “one of the largest automotive manufacturers” to develop next-generation battery cells. Firm thinsk working with a large OEM is an encouraging development for AONE, especially if it could lead to a production contract. AONE also won a pilot program with Eaton for a fleet of PHEV medium duty trucks, another win in the company’s impressive commercial vehicle contract portfolio.

Investment thesis: They see substantial potential for upside if the company’s technology and production ability prove out. Risks are many, including need to reduce costs faster than competition over a 5-year curve, need for early wins to build scale, and execution risk in ramping from minimal revenues to potential billions in under 5 years.


Firm maintains their Equal-Weight rating but notes that their base-to-extreme-bull-case scenarios range from $25 to $54/share.

- Deutsche Bank is reiterating Buy and $17 target on AONE saying yesterday's commentary reinforces their positive thesis

Capacity expansion underscores management confidence in revenue pipeline AONE announced a further capacity expansion to 760 mega watt-hours by 4Q11, representing the third 200 mWh expansion announcement since Dec ‘09. The company appears to be planning to ramp capacity by ~200 mWh’s per quarter which, assuming 80% utilization, implies a revenue acceleration of $130MM per quarter. If one assumes two quarters of further expansion and add that to the $450MM - $550MM revenue run rate in 4Q11 implied by the current plan, the firm believes the company can be at a high $700MM run rate by mid-2012, which broadly supports their $800MM revenue forecast in that time-frame.

Development activity has doubled since IPO
The company stated that it is currently involved in 36 vehicle development programs, up from 18 at the time of its late September 2009 IPO. More than 50% of the increase are light-duty (passenger vehicle) programs and 80% of those are PHEV or EV programs (as opposed to Hybrid). Although the firm has no way to calculate the revenue potential from this increase, development activity (particularly for high revenue PHEV / EV batteries) appears to have clearly gained momentum. Taken in the context of the DOE revenue projections that were disclosed at the time of the IPO (significantly higher than DB current estimates), they believe that this is a bullish development.

Notablecalls: I would not be surprised to see AONE stage a bit of a comeback following yesterday's capacity announcements. The results missed consensus by a hair but lets face it - the current $24 mln revenue number is nothing compared to $800 mln run-rate DB sees for 2012.

The stock has been crushed since the IPO & may be due for a bounce. Right now, it's all about capacity & deals with automakers. AONE has both.

Would keep the position small as this is a highly speculative stock.

MetroPcs (NYSE:PCS): Upgrading to Buy, see 80% upside - Deutsche Bank

Deutsche Bank is upgrading MetroPcs (NYSE:PCS) to a Buy from Hold and are raising their price target to $14 (prev. $7.00)

Their upgrade is based on 2 key factors:

1. Higher estimates for subscribers, service revenue and EBITDA due to the success of PCS’ new all-inclusive calling plans, which are having a more positive impact on gross adds, churn and ARPU than we had initially expected; and

2. Attractive valuation as PCS is now trading at the lowest multiple in the group – 3.7x 2011 EBITDA vs. 3.7x to 5.8x for its peers – despite having one of the more robust growth outlooks.

Deutche notes they do not believe that investors should put too much weight on an assumption that PCS will exhibit seasonal weakness in its stock over the next six months. While this has been the historical pattern for PCS following the company’s seasonally strong first quarter results, they consider this a risky trading strategy for 2 reasons. First, the fundamental momentum in the business is much stronger than they have seen coming out of the last few 1Qs, as evidenced by PCS’ material beats on key 1Q10 metrics such as net adds, churn and ARPU. Second, the firm believes that this seasonal trading pattern is sufficiently understood by now that it no longer offers any meaningful advantage.

PCS’ 1Q10 subscriber results were not merely ahead of expectations; they were substantially ahead of expectations. For example, net adds of 692k were more than 2x consensus of 330k and churn of 3.5% was 150 bp lower than consensus of 5.0%. Other results were impressive as well: ARPU of $39.83 beat consensus of $39.17 despite new plans that represented price reductions of 0-10%; gross adds of 1.47 million exceeded consensus of 1.35 million despite lower than expected advertising spending; and EBITDA of $224 million beat consensus of $220 million despite the beat in gross adds, which usually drives higher acquisition costs.

In Deutsche's view, these material beats were driven by forces much more substantial than typical seasonal strength. Instead, they believe they reflect the well-timed collision of PCS’ new allinclusive rate plans with the emergence of prepaid as they key driver of industry retail subscriber growth.

Deutsche is increasing their2010 net add estimate to 1.4 million from 950k and their 2011 net add estimate to 800k from 500k. Their improved outlook is partly due to higher gross add forecasts and partly due to lower churn estimates. For example, for 2010-2011 they have increased their gross add forecasts by a total of 366k, which is a little under 49% of the increase in their net add estimates. The other 51% is from lower estimated churn as the firm is reducing their 2010 churn forecast to 3.9% from 4.3% and 2011 estimate to 3.8% from 4.2%.

Firm is increasing 2010 service revenue estimate to $3.6 billion from $3.5 billion and their 2011 estimate to $4.0 billion from $3.7 billion. They believe these revisions are conservative as they still assume that ARPU trends deteriorate as we move into 2H10.

Attractive Valuation PCS is now Trading at the Lowest Valuation in the Sector

Based on their revised estimates, PCS is currently trading at 3.7x 2011 EBITDA. This represents the lowest valuation within the US telecom service sector where valuations currently range from 3.7x to 5.8x (among the 8 telecom services carriers under Deutsche coverage). In their view, this represents an attractive entry point as they believe that PCS has one of the strongest growth profiles in the sector, especially among wireless peers.

Based on their improved outlook for PCS, they are increasing are targeted valuation range from 4.5 to 5.0x forward-year (2011E) EBITDA to 5.0x to 5.5x. Deutsche's new price target of $14.00 is based on the mid-point (see Figure 7). In their view, this range is conservative as it values the shares in-line with its peer group despite a generally stronger growth profile. But, as highlighted in Figure above, they believe that even within this targeted range the shares have considerable upside potential. For example, at their new price target they estimate potential upside of nearly 80%. In fact, Deutsche estimates that the shares are so undervalued that even if the stock merely traded in-line with LEAP, its closest peer, the potential upside is 40%.

Notablecalls: This is a fairly powerful call from Deutsche's Telecom services team. The prepaid space has been a no-go zone for many institutional players as they have gotten their heads handed to them several times before.

I spoke to a tier-1 firm internal hedge fund desk some weeks ago and their message was fairly simple - they needed to see real improvement in fundamentals to get long. They considered PCS really cheap but acknowledged the fact other people had been burned before and would need to see significant improvement before getting back into the name.

We got that improvement last week as PCS blew away subscriber estimates (net adds were DOUBLE of Deutsche's estimate).

The stock got sold on heels of general market turmoil but with Deutche out with an almost 100% price target on the name, people will take note.

Deutsche estimates that prepaid captured >90% of retail net adds in 1Q10 and will represent >70% in 2010 as lower-end post paid subs migrate to prepaid. I think several of the private equity players know that as well and may be looking to join the party. So, PCS is really a PE takeover candidate here as well.

All, in all I think the stock will trade up nicely today. I expect it to be up 5-7% putting $8.25- $8.40 range in play.