Highlights:
1. nVidia is convinced that the future belongs to a new architecture in which both a CPU and a GPU share the tasks that they are more appropriately designed to perform. Jen-Hsun Huang likened the use of a CPU to perform all functions to the use of a Bugatti Veyron’s 1001 HP engine for city commutes [generates a lot of heat].

The CPU/GPU model is one that he reiterated some forty times. The CPU/GPU co-processing model has been embraced by both Microsoft [for Win-7 - DirectX] and Apple [for OSX-Snow Leopard - OpenCL]. They (NVDA) had a bunch of impressive demos.

Comment: Demos are demos. Even if you are “driving”, they are designed to feel good.

2. Extolled the virtues of Atom+ION. The benchmark numbers were impressive. To make a long story short, Atom (by itself) cannot run HD 1080p video at forty plus fps. Atom+ION can! Video transfer and video conversion [from HD to iPod] were 5x faster with Atom+ION [when compared to an Atom - which was unassisted]. In other words, this re-iterates the CPU+GPU model for all future computing (per nVidia).

3. Tegra is designed to deliver the highest performance at the lowest power. The nVidia philosophy is to start at zero power and go upwards from there. Tegra shuts off anything that is not working, and “divides the work” among multiple CPU’s. These CPUs are strategically chosen after a review of the types of jobs that can/will be run on the computer. Tegra has eight CPU’s [all of them have an ARM core]. The eight are:
a. 2xARM [CPU]
b. GPU
c. 2D Engine
d. HD Video Encode
e. HD Video Decode
f. Audio – Poeral Player
g. Image Sensor

4. NVDA already has 42 Tegra Design Wins. Of the 42, 18 are SmartPhones+MID [sans modem] subsidized by wireless carriers. The 42 design wins are at 27 unique manufacturers.

5. 27 wireless carriers have been engaged worldwide.

6. Opportunity is 25M smart-phones in 2010. OEM/ODM paired with carriers. First launches end of this year.
Comment: That is a very optimistic number.

7. Tesla and Tegra will drive future growth.

8. Migration to 40nm will further improve margins.

9. On the near-term, inventories have been whittled down from 150 days to 64 days.
Comment: Good for new product launch, and profit margins.

10. NVDA claims that Tesla is a desktop supercomputer [so was the Power Mac when it debuted], and this opens up a huge market that wasn’t previously served by nVidia.
Comments: This could possibly blind-side Intel. nVidia has about a two year edge when it comes to “middle-ware”

11. To improve gross margins, NVDA wants to:
a. Drive sales UP.
b. Increase ASP by transitioning product mix to higher ASP products.
c. Decrease COGS by eliminating waste, and by transitioning to 40nm [complete transition will take about eighteen months].
d. Moderate OPEX.

Final words:
1. Nothing we did not expect.
2. NVDA seems to have a good read of the future of computing, but almost all of the future is partly based on the assumption that Intel will not counter nVidia’s version of parallel computing with one of their own. In fact, Intel has significant experience deploying supercomputing centers.
3. Most of this will play out in the end of 2009 or early 2010.

© Bapcha’s Stocks, 2009.

a. Applied Materials. With pristine financials and the enviable position as the #1 purveyor of machines that the semiconductor industry needs to make their chips, Applied flies through the initial screen.
b. nVidia. With little debt, and already having survived a brush with bankruptcy, nVidia is flush with over a billion in cash, and a winning portfolio of graphics chips and cards. nVidia gets through the initial screen too.
c. Silicon Storage Technologies. This one is a little harder. This manufacturer of NOR flash is extremely tight fisted [and I like that]. Their off-balance sheet assets easily exceed the company’s current market value. Add to this, a steady stream of royalties [$30 to $40 million per year], SSTI squeaks through the initial screen.
d. SanDisk – I have this eerie feeling that this is the only memory chip maker with the possible chance of making it to the final five.
e. Lam Research – has done well in the last few years, and has decent financials, but they are looking at several very difficult years ahead of it. Lam does not make it through the initial screen.
f. Novellus – similar to Lam.
g. Kyocera – this maker of ceramic packages for chips is flush with cash, and has survived Japan’s nuclear winter through the last two decades. They sure need a break.
h. Intel – the #1 chipmaker is still profitable. I am sure it will make the top five.
i. Texas Instruments – has a chance.
j. Linear Tech – with gross margins in excess of 70% and a current yield of over 3.5%, Linear is sure of making it to the top five.
k. Maxim – with a current yield of 6.5%, a billion in cash and no debt, and gross margins close to 60%, maximum gets through round one with ease.
l. Marvell – This one gets a reject due to corporate governance issues.
m. Broadcom – yes! These guys easily make it through round #1.
n. Altera – with gross margins in excess of 60% and a history of profitability, ALTR makes it through round #1 with ease.
o. Xilinx – numbers are similar to Altera’s and with excellent products and software.
p. Lattice Semi – CUT.
q. Actel – CUT again.
r. Micron – CUT. No need to explain things here.

So, let’s see. The survivors are:
Applied Materials, nVidia, Silicon Storage, SanDisk, Kyocera, Intel, Texas Instruments, Linear Tech, Maxim, Broadcom, Altera, and finally, Xilinx.

With gross margins in excess of 50% despite manufacturing Flash memories, Intel will obviously survive this economy, and thrive. Intel has a cash hoard of almost $12 Billion, and with debt of a little over $2 Billion. While INTC was barely profitable last quarter, the fact is that they were profitable! While AMD, and Via technologies make clones of Intel’s CPU, even when AMD was gaining ground on Intel with their Opteron Processor a few years ago, Intel’s market share has never dipped below 80%. Added to this, the fact that Intel’s Atom has cornered the low-power net-book market, and found its way to becoming the processor of choice for Apple [who resisted for almost two decades], Intel is the undisputed leader of the semiconductor industry.

If gross margins were the only way to judge a semiconductor company, the easiest pick for this list of five would be Linear Tech. Linear Tech makes a multitude of analog and mixed signal chips, and has always been a favourite of mine. In fact, I discussed in a previous article, the only super-profitable niche in the semiconductor industry – where Linear Tech is the obvious leader. In the three months that ended Dec 28, 2008, Linear Tech had revenues of $249 Million. For the first time in almost a decade, Linear tech had lower revenues in the current quarter as compared to the same time period a year prior. The reason for this is because automobile manufacturers buy a lot of LLTC’s products, and that market as we all know is in the tank.

Yet, Linear’s chips are cheap – with ASP of $1.56 in the current quarter, UP from $1.49 in the corresponding quarter in the previous year – due to decreased sales to cell-phone companies and increased sales to industrials. Gross profit as a percentage of revenues decreased to 75.8% and 76.5% in the second quarter and the first six month period of fiscal year 2009 as compared to 77.1% and 77.2% of revenues, respectively, for the same periods in the previous fiscal year. The decrease in gross profit as a percentage of revenues for the three and six months ended December 28, 2008 was primarily due to spreading fixed costs over a lower sales base.

Linear’s current dividend rate of 4.1% [88c/share/year] is easily earned by the company. So. LLTC is my #2 pick.

If I had to pick one stock in the memory market, it would be SanDisk. While SNDK has negative gross margins in the current [brutal] Flash pricing environment, they do have a royalty stream that amounts to anywhere from $350 to $400 Million dollars per year. This number will increase as more Flash companies are taken to task for violating SNDK’s strong patent portfolio [but they need to start making $$$ first]. I do not see a recovery in the memory market till at least calendar Q3 of 2009. In fact, I expect SNDK to have positive product gross margins only in calendar Q1 2010 – and that will be due to migration to tighter geometries and their ability to successfully push from X3 to X4 across their product line. [X3 is the ability to store eight (2³) different threshold levels in every storage bit - while X4 will represent sixteen (2⁴) "levels" in every storage bit].

But the real reason for my picking SanDisk is due to the fact that it is run by an “owner/founder” CEO – as opposed to employee CEO’s. While they might have overpaid for M-Systems and Matrix Memory [for which they took an asset impairment write-down recently], they are still the company to beat.

Another “owner/CEO” that I respect a great deal is Jen-Hsun Huang of nVidia. NVDA is cheap on a valuation basis, and the next version of the Apple OS [snow leopard] will take advantage of the processing power of the multiplicity of cores in NVDA’s chips. I have written about NVDA’s technology, and processing power in prior articles. For the sake of brevity, I will not repeat myself. I expect NVDA to NOT be profitable in 2009, but this is an article about the ability to survive the nuclear winter that semiconductor issues are in the middle of. NVDA’s cash position is sufficient to let them innovate over the next two years – and the only way that they will lose is by directly challenging Intel. For starters, only AMD and VIA tried to challenge Intel in the processor wars, and they have both lost market share due to the success of Intel’s Atom. NVDA needs to launch a flanking attack – meaning, sell the computing power of a GPU and do not market it as a CPU.

NVDA has a cash hoard of $1.25 Billion, and very little debt of about $26 Million. They have been buying back their stock aggressively, and have spent in excess of $1.46 Billion so far, with $299 Million spent in the quarter ending Oct 28, 2008. I think that they have bought back enough shares, and while they are authorized to buy back up to $2.7 Billion in total, further buyback of their own stock will seriously affect nVidia’s competitive ability to thrive after the current lean spell. So, I am picking NVDA at slot #4, but will keep a close watch on their cash position, and competitive position [as AMD's ATI division has a line of excellent GPU's that compare favorably with NVDA's offerings].

My final pick was a toss-up between Marvell and Broadcom. While I expect BRCM to lose a nickel a share in Q1-2009, they should break even or make a little money in 2009. While Marvell might do better financially, I have more doubts about MRVL’s corporate governance than I do about BRCM’s. Moreover, since Dr. Henry Samueli was my graduate student advisor at UCLA, let’s call this my “sentimental”, yet well researched pick. BRCM has a cash hoard of $2 Billion, with $0 in debt, and a product offering that is better than everyone else’s in the enterprise networking sector. Plus, I know for a fact that BRCM has some of the most brilliant minds designing their chips.

So, there we are. The five companies that will survive this down-turn in the semiconductor market, and thrive afterwards, have a few things in common.
a. A strong balance sheet, with a large cash position [or in Linear's case, a manageable debt, and a fantastic competitive position as reflected by gross margins].
b. An excellent competitive position.
c. Strong management that is still “invested” in the company.
d. Has survived prior attacks on its competitive position.
and finally,
e. Pass my rigorous standards.

If I had doubts about a single pick, it would be about SNDK, but, people NEED memory. There is no way that computing can move forward without flash memory. Sure, rotating hard-disks have “out-Moore’s-Law’d” Flash memories, but heck, if you hate memories, pick Altera or XIlinx. They are rivals with excellent balance sheets, gross margins in excess of 60% and split the market for Programmable Logic [with small concessions to Cypress, Actel, QuickLogic, etc.], but I chose to not pick them.

The final list: Intel, Linear, nVidia, SanDisk and Broadcom.

Disclosures: I own a small long position in INTC, BRCM. No positions in other companies.

© Bapcha’s Stocks, 2009.

Which beings us to the still-profitable niche players – like Altera (ALTR), and Xilinx (XLNX). But, even in this niche, Lattice (LLTC), QuickLogic (QUIK), and Actel (ACTL) are just surviving.

NVDA is doing fairly well in their niche – GPU’s, and AMD should probably think about spinning off ATI to the public. In fact, the latest ATI chips are as good as or better than NVDA in processing power. Among the large memory makers, most of them are for all practical purposes, dead. In fact, they will get to lose less money – if they just shut down the FAB’s and stop selling chips – even if they had no change in staffing. Among the memory makers, only SNDK and SSTI have a stream of licensing/royalty revenues – which will fall directly to the bottom-line, but hardly sufficient to stop the haemorrhaging of cash and other assets.

Now, why are they in such a predicament?
a. Technology improvements. The migration to smaller geometries – allows for 60 to 70% more storage per unit-area. This is fantastic for the consumers though.
b. Overbuilding of fabs. This remains the #1 scourge of all semiconductor companies. When the cycle swings to the upside, the industry usually goes on a fab-building binge – which hurts them when things go bad.
c. The hiring of engineers who are clueless about chips – especially from Asia. While I might be biased when I say this, I have seen many hundreds of “engineers” – who are clueless about what it takes to actually put a chip out in the marketplace.
d. Being too complacent about taking on debt or being forced to “invest” in FABs for guaranteed wafer-starts. Even fabless companies like SanDisk are forced to take equity stakes in FAB’s – making the fabless model irrelevant for larger chip-makers. In fact, any company that wants guaranteed wafer-starts, purchases an equity stake in their respective FAB/FABs [examples: SNDK, BRCM].
e. While idling FABs in lean times is a good idea, it usually fails to serve its purpose [to reduce supply] – since one cannot just shut off $3M a pop machines from AMAT, NVLS, LRCX. Instead, they are on a production “rotation” which might affect yields [negatively of course].
f. And finally, the most important reason for their failure is the fact that no Product Line Manager ever plans for two consecutive years of price declines of 70% annualized. In other words, no PLM [that I know of] planned that a newly introduced product, woud be decimated in price in two short years. Most assume a price decline of 40% [and that is aggressive], and possibly, a migration to a more advanced technology after two years [to cut manufacturing costs].

And if this wasn’t bad enough, the Jan book to bill ratio was one of the lowest that I have ever seen – 0.48 [that means that if a company ships a dollar worth of product in Jan 2009, they have on their books, only 48 cents in orders]. This means that Gartner and IDC are wildly optimistic about the future of the semiconductor industry – at least for 2009. A 33% shrinkage of the semiconductor industry will mean a book to bill ratio of 0.67.

Despite all of this gloom, some companies are positioning themselves for success – when the market bounces back. Among the contenders are:
a. Applied Materials.
b. nVidia
c. Silicon Storage Technologies
d. SanDisk
e. Lam Research
f. Novellus
g. Kyocera
h. Intel
i. Texas Instruments
j. Linear Tech
k. Maxim
l. Marvell
m. Broadcom.
n. Altera
o. Xilinx
p. Lattice Semi
q. Actel
r. Micron

In Part-II, I’ll pick the five best positioned to survive this nuclear winter. In fact, I’ll pick the companies with the least debt and the highest profit margins – since they alone can possibly survive and then thrive when things get better.

© Bapcha’s Stocks, 2009.

Today – April 22nd 2009 was Intuitive Surgicals’ investors’ day. Apart from a rehash of numbers from Q1 2009, and a predictable slate of votes, there was much to be impressed, and I learned a lot more than I thought I would from the meeting.

It was held in a smaller hotel on El Camino Real in Sunnyvale – not too far away from ISRG’s Headquarters on Kifer – next to the Costco on Lawrence and Kifer. I counted about fifty people who attended the meeting – including some from the East Coast and Washington State. In fact, there were about three stockholders who were once patients themselves and all of them had only the nicest things to say about DVP [da Vinci Prostatectomy].

I sat in the first row [not knowing that it was reserved for the directors of the company]. When a gentleman told me about that, the CEO Lonnie Smith rushed over, and said “please – no seat is reserved for anyone – sit wherever you want to”. I quipped with a “well, I just got a promotion” – which was hmmm….. well received. The important thing is that the management has their head screwed in the correct way and has no ego when it comes to superficial things that do not affect the company’s results.

They put the patient FIRST, doctors SECOND, hospitals THIRD, and every thing else follows from there. About a third of daVinci sales are outside the US, and the company expects that number to be constant moving forward. It was reassuring to note that the gross margins on disposables is the same both with the UK’s national Health Service, and the United States’ Medicare reimbursement system – meaning that they see more value in a dVP as opposed to paying a few thousands of dollars for some disposable sterile tools needed uniquely for every surgery.

ISRG demonstrated the latest daVinci Si – which enables TWO doctors to remotely work on the same patient. It could also be use for training say a doctor with less eperience – while guided by someone who has done several hundred surgeries with daVinci. In fact, both physicians can look at the region of surgery in 3-D and talk to each other. The robots are wired with three channels of data monitoring – per channel. Meaning – say you are using a cauterizer or a scalpel, it is controlled with dual circuits – with a third “overseer” making sure that the two circuits that are “doing the job” are doing it right.

ISRG has written a tremendous amount of software to remove the “shake” from a surgeon’s hand, and each hand movement can me set with a multiplier – meaning if the factor is set to 0;2; then five inches of movement of the surgeon’s hand – moves the robotic arm by an inch – exactly.

In fact, all of us attendees were invited back to the HQ to “play” with the dV Si. It was actually easy, and I could interact with the other “surgeon” and exchange pieces of plastic, and thread rings around cones [basic training on the dV Si I suppose]. It all works brilliantly, and the “wrist” movement of the physician is translated into a wrist movement of the robot.

I came through the exercise impressed. Also, I made a note of the ramp rates of procedures that ISRG wants to be involved in, and the scope of the robot might far exceed what the company initially estimated. But that is a topic for a different day.

Bottom-line:
1. Fantastic management. Focussed on what matters, while not giving a hoot about what does not.
2. Has an excellent handle on their financials. Their cash flow will fund their growth for years – even if they choose to expand into newer surgical techniques.
3. The next frontier is dV Hysterectomy.
4. The ramp rates of all of the procedures are following rates that both the company and I expect.
5. Excellent profit margins in both the US and abroad.
6. ISRG has an insurmountable lead in the robotic surgery market [for now]. Sure someone else could beat them, but it will be a decade before that happens.
7. The stock’s valuation – though not cheap, is reasonable.
8. For now, the only thing holding the stock back is the ECONOMY, and nobody can do anything about it.
9. Hansen Medical [HNSN], and Luna [LUNA] were mentioned in the meeting, but ISRG is not worried about either company.

Disclaimers: No positions in ISRG [yet]. Used to be long ISRG at much higher levels, and sold out when I posted that it was severely overvalued, and opined that a floor on the stock was about $75/share. Needless to say, I was very close.

© Bapcha’s Stocks 2009.

The most elegant solution to managing these “clouds” is already on the market c/o the near-forgotten ex-manufacturer of software for mainframes, but now blazing a new trail for themselves – BMC Software. But I will cover that in a following article.

When one talks about virtualization, or “cloud computing”, the first company that comes to anyone’s mind is – VMWare. VMW backs up its street cred with some amazing numbers [mixed with ample amounts of concern]. While sales growth was a torrid 25% yoy in Q4 2008, high margin license revenues grew only 10%. The fact that VMW guided lower going forward into calendar 2009 – is no surprise to anyone. Additionally, Microsoft is planning an assault on VMWare by packaging virtualization-lite with Windows-7. In other words, virtualization is getting commoditized – which erodes VMW’s economic moat.

Analyzing VMWare’s numbers raised one important question. The TTM tax rate is about 10%. Their tax rate in 2007 was a tad below 10%, but the 2006 tax-rate is 30.1%. The latest 10K of VMW’s clearly states that their tax rate is not too predictable, and can vary significantly from quarter to quarter. The question is – can the tax rate go back to 30%. The short answer is – yes – depending on the geographic mix of sales. In fact, a recovering US economy will mean a higher tax rate for VMW – as their current US rate stands at 35%. In fact, their GAAP and non-GAAP earnings could decrease by up to 25% from current levels, and this is on top of lower projected revenues for calendar Q1-2009.

But, there is a better way to “own” VMWare, and that is through EMC Corp. – which owns over 80% of VMW’s outstanding shares, and more importantly, 98% of all the voting stock of VMW – effectively making VMW a “controlled company”. While Corporate Governance has not been a major issue till now, this explains the ease with which a former founder of VMWare was let go of. While EMC’s own business in the SAN world will shrink in 2009 – (like everyone else’s in recent times), they have been gaining market share from and earning double the profit margins that their next largest competitor – NetApp. In fact, EMC closed out calendar Q4 2008 and the year 2008 on a positive note – with quarterly revenues up 5% yoy to a little over $4 billion, and annual revenues up 12% yoy – to $14.88 billion [of course these numbers *include* VMWare's].

Looking at EMC’s valuation numbers, 2 Billion shares at $11.37/share ~ $23 Billion. Subtract cash, add in their debt, and the number drops to $19 Billion. EMC generates about a billion in cash flow every quarter [about three-quarters of a billion in FCF]. EMC has bought back about 300+M shares over the last several years, a billion dollars worth [of the bought back stock] was financed with notes yielding 1.75%. This is in our opinion, a very efficient use of capital – since most of the shares were bought at or below $11.40/share.

But, EMC’s current valuation is significantly influenced by VMW’s numbers. In fact, moving forward, VMW’s sales and profitability will be significantly lower in 2009 [vs. calendar 2008] – but EMC’s sales and profits will erode at a much slower rate than VMW’s – affording us a discounted entry into either stock – which would not have been possible if the two had been separate. In other words, VMW’s impending negative growth rate is weighing on both VMW and EMC.

At this point in time, each share of EMC controls a little less than a fifth of a share of VMW. Add to this EMC’s fundamentally sound business, and I see no compelling reason for buying VMWare – except, I’d rather buy EMC.

In short,
1. Gross margins > 80%
2. Revenues growth rate of 30%
3. Owns the datacenter market.
4. Very little earnings hit from stock options.
BUT,
1. High margin license revenues grew only 10% [bad if you want a premium valuation].
2. EMC owns over 80% of common and 98% of votes making VMW a “controlled company” where the common stockholder has NO rights.
3. No independent directors.
AND,
4. Virtualization is getting commoditized.

Bottom-line:
When looking at a “controlled company” like VMWare, one needs to analyze and determine if it is better to own the controlled company or the controller. In this case, since the sum of EMC’s parts far exceed what one pays for EMC, it is a better idea to buy into EMC than it is to buy into VMW.

© Bapcha’s Stocks, 2009.

Disclosures: No positions in VMW, EMC, BMC.

If you are a large market maker, with access to instant efficient execution of trades, yes – you can occassionally make money using a split-strike strategy. For starters, one needs to be a non-newbie investor to even understand this strategy on paper. A more sophisticated investor *knows* that money can be made using this strategy. Throw in the operations of one of the larger market makers, and it is easy to take the next logical mental step that one could consistently churn out positive returns in the market. Add to this a whisper campaign that you are front-running your order queue, and an even further sophisticated the investor, the higher the chances are that you can actually place a value on front-running the market.

Here are the kinds of investors that Madoff hooked.

Type #1. The rich newbie. Daddy told him/her that he had a secret account that churned out a percent a month like clockwork, and that noob could not share this information with anyone else. Noob gets into the club, and has been seeing 1% returns every month like clockwork for the past decade.

Investing mistake: Know how your $ is invested. Just the fact that it made money in the past means nothing.

Type #2. Richer still than #1 above, but still ignorant about investing. This one looks at noob’s statements and the fact that it goes back by a decade, and decides to go “all in”. If he/she felt they were “not rich enough”, they recruited their family to invest in this absolutely secret hedge fund where you got rich slowly – without taking any risk.

Investing mistake: While #1 is “knowledgeable” about investing, but I [#2] know more than he/she does, and want into what #1 has……. Just because your neighbour is into something, it does not make that strategy appropriate for you as an investor.

Type #3. The guy who knows about investing, knows about stocks, and options, and can actually figure out what a split-strike strategy is. Well, this kind knows all about the strategy that Madoff used. He/she thinks they are smart [and probably is]. Knows a lot, but not enough to conquer the snake that Bernie was.

Investing mistake: Sophisticated, but not sophisticated enough. While #3 might know about stocks and options, he/she is ignorant about the size and frequency of possible trades of this nature. In other words, #3 knows about sophisticated trading, but is not aware of [or even wants to know about how large it is] the scalability of his sophisticated strategy.

Type #4. The sophisticated snake. This investor knew exactly how large the size of the option trading market was, and that Bernie was “too big” to pull off what he claimed to be doing. This investor was aware that Bernie had to pull of his strategy multiple times a month to churn the billions that he managed. In fact, investor #4 knew for sure that Bernie had to front-run the order queue to make money. In other words, sophisticated snake knew that Madoff was cheating, but “nobody got hurt”, and we the secret society of sophisticated snakes were making money for tens of years without getting caught. Why spoil a good thing?

Investing mistake: Made an assumption without knowing what the real trading strategy was. Sophisticated snake was smart enough to know Bernie was cheating, but was unaware of how exactly he was pulling off his act. But it did not matter as long as #4′s secret society made money – even at the expense of the generally stupid trading public [and mutual funds and other ordinary investors]. In other words, investor Type #4 was smart, and that is exactly the reason he/she was “taken” by Bernie.

Type #5. The Distributor. This investor started out cautiously, and created a “feeder fund”. Got some of his wealthiest and best friends into this deal mostly for the initial 1% commission. But as time passed by and one year became a decade, it was time the distributor went “all in”.

Investing mistake: The distributor was a sophisticated investor. He was initially enticed solely by the fact that he could make a living getting people to invest in this steady 1% a month deal. After a decade, Type #5 determines that he has “lost” millions by not getting into the same funds himself.

Type #6. The foreign Aristocrat. His blood is blue and he knows it. But he is modest [but for his yachts and Rolexes and Ferrarri's]. Has a deep sense of responsibility and audits every word and every punctuation of every document, and determines that this investment is suitable for royalty [and neo-rich too].

Investing mistake: He/she knows the theory of investing, and thinks that the SEC is there to protect him, and that every rule has to be observed. But is clueless that his best friend is actually a low-life in a bespoke suit. Type #6 never saw anyone like Bernie in the “old world”.

Type #7. Cannon fodder. Type #7 was a sophisticated investor who was out skiing in Verbier. He/she meets this Russian Oligarch who orders $5000 cocktails and stays in the $50K a week chalet. #7 *knows* that he/she is infinitely superior to the Oligarch, but knows that the Oligarch hangs out with other Oligarchs and that Oligarchs really want to be Tsars. So, #7 incorporates a small bank with a name associated with royalty, the Pope and God, and paints him/herself as “old money”. Oligarch “invests” with #7 and soon, all of the nickel and oil is Russia is Bernie’s – through #7.

Investing mistake: Type #7 is clueless. Just wants the money. Oligarchs want him/her dead. NOW.

© Bapcha’s Stocks 2009.

a. Applied Materials. With pristine financials and the enviable position as the #1 purveyor of machines that the semiconductor industry needs to make their chips, Applied flies through the initial screen.
b. nVidia. With little debt, and already having survived a brush with bankruptcy, nVidia is flush with over a billion in cash, and a winning portfolio of graphics chips and cards. nVidia gets through the initial screen too.
c. Silicon Storage Technologies. This one is a little harder. This manufacturer of NOR flash is extremely tight fisted [and I like that]. Their off-balance sheet assets easily exceed the company’s current market value. Add to this, a steady stream of royalties [$30 to $40 million per year], SSTI squeaks through the initial screen.
d. SanDisk – I have this eerie feeling that this is the only memory chip maker with the possible chance of making it to the final five.
e. Lam Research – has done well in the last few years, and has decent financials, but they are looking at several very difficult years ahead of it. Lam does not make it through the initial screen.
f. Novellus – similar to Lam.
g. Kyocera – this maker of ceramic packages for chips is flush with cash, and has survived Japan’s nuclear winter through the last two decades. They sure need a break.
h. Intel – the #1 chipmaker is still profitable. I am sure it will make the top five.
i. Texas Instruments – has a chance.
j. Linear Tech – with gross margins in excess of 70% and a current yield of over 3.5%, Linear is sure of making it to the top five.
k. Maxim – with a current yield of 6.5%, a billion in cash and no debt, and gross margins close to 60%, maximum gets through round one with ease.
l. Marvell – This one gets a reject due to corporate governance issues.
m. Broadcom – yes! These guys easily make it through round #1.
n. Altera – with gross margins in excess of 60% and a history of profitability, ALTR makes it through round #1 with ease.
o. Xilinx – numbers are similar to Altera’s and with excellent products and software.
p. Lattice Semi – CUT.
q. Actel – CUT again.
r. Micron – CUT. No need to explain things here.

So, let’s see. The survivors are:
Applied Materials, nVidia, Silicon Storage, SanDisk, Kyocera, Intel, Texas Instruments, Linear Tech, Maxim, Broadcom, Altera, and finally, Xilinx.

With gross margins in excess of 50% despite manufacturing Flash memories, Intel will obviously survive this economy, and thrive. Intel has a cash hoard of almost $12 Billion, and with debt of a little over $2 Billion. While INTC was barely profitable last quarter, the fact is that they were profitable! While AMD, and Via technologies make clones of Intel’s CPU, even when AMD was gaining ground on Intel with their Opteron Processor a few years ago, Intel’s market share has never dipped below 80%. Added to this, the fact that Intel’s Atom has cornered the low-power net-book market, and found its way to becoming the processor of choice for Apple [who resisted for almost two decades], Intel is the undisputed leader of the semiconductor industry.

If gross margins were the only way to judge a semiconductor company, the easiest pick for this list of five would be Linear Tech. Linear Tech makes a multitude of analog and mixed signal chips, and has always been a favourite of mine. In fact, I discussed in a previous article, the only super-profitable niche in the semiconductor industry – where Linear Tech is the obvious leader. In the three months that ended Dec 28, 2008, Linear Tech had revenues of $249 Million. For the first time in almost a decade, Linear tech had lower revenues in the current quarter as compared to the same time period a year prior. The reason for this is because automobile manufacturers buy a lot of LLTC’s products, and that market as we all know is in the tank.

Yet, Linear’s chips are cheap – with ASP of $1.56 in the current quarter, UP from $1.49 in the corresponding quarter in the previous year – due to decreased sales to cell-phone companies and increased sales to industrials. Gross profit as a percentage of revenues decreased to 75.8% and 76.5% in the second quarter and the first six month period of fiscal year 2009 as compared to 77.1% and 77.2% of revenues, respectively, for the same periods in the previous fiscal year. The decrease in gross profit as a percentage of revenues for the three and six months ended December 28, 2008 was primarily due to spreading fixed costs over a lower sales base.

Linear’s current dividend rate of 4.1% [88c/share/year] is easily earned by the company. So. LLTC is my #2 pick.

If I had to pick one stock in the memory market, it would be SanDisk. While SNDK has negative gross margins in the current [brutal] Flash pricing environment, they do have a royalty stream that amounts to anywhere from $350 to $400 Million dollars per year. This number will increase as more Flash companies are taken to task for violating SNDK’s strong patent portfolio [but they need to start making $$$ first]. I do not see a recovery in the memory market till at least calendar Q3 of 2009. In fact, I expect SNDK to have positive product gross margins only in calendar Q1 2010 – and that will be due to migration to tighter geometries and their ability to successfully push from X3 to X4 across their product line. [X3 is the ability to store eight (2³) different threshold levels in every storage bit - while X4 will represent sixteen (2⁴) "levels" in every storage bit].

But the real reason for my picking SanDisk is due to the fact that it is run by an “owner/founder” CEO – as opposed to employee CEO’s. While they might have overpaid for M-Systems and Matrix Memory [for which they took an asset impairment write-down recently], they are still the company to beat.

Another “owner/CEO” that I respect a great deal is Jen-Hsun Huang of nVidia. NVDA is cheap on a valuation basis, and the next version of the Apple OS [snow leopard] will take advantage of the processing power of the multiplicity of cores in NVDA’s chips. I have written about NVDA’s technology, and processing power in prior articles. For the sake of brevity, I will not repeat myself. I expect NVDA to NOT be profitable in 2009, but this is an article about the ability to survive the nuclear winter that semiconductor issues are in the middle of. NVDA’s cash position is sufficient to let them innovate over the next two years – and the only way that they will lose is by directly challenging Intel. For starters, only AMD and VIA tried to challenge Intel in the processor wars, and they have both lost market share due to the success of Intel’s Atom. NVDA needs to launch a flanking attack – meaning, sell the computing power of a GPU and do not market it as a CPU.

NVDA has a cash hoard of $1.25 Billion, and very little debt of about $26 Million. They have been buying back their stock aggressively, and have spent in excess of $1.46 Billion so far, with $299 Million spent in the quarter ending Oct 28, 2008. I think that they have bought back enough shares, and while they are authorized to buy back up to $2.7 Billion in total, further buyback of their own stock will seriously affect nVidia’s competitive ability to thrive after the current lean spell. So, I am picking NVDA at slot #4, but will keep a close watch on their cash position, and competitive position [as AMD's ATI division has a line of excellent GPU's that compare favorably with NVDA's offerings].

My final pick was a toss-up between Marvell and Broadcom. While I expect BRCM to lose a nickel a share in Q1-2009, they should break even or make a little money in 2009. While Marvell might do better financially, I have more doubts about MRVL’s corporate governance than I do about BRCM’s. Moreover, since Dr. Henry Samueli was my graduate student advisor at UCLA, let’s call this my “sentimental”, yet well researched pick. BRCM has a cash hoard of $2 Billion, with $0 in debt, and a product offering that is better than everyone else’s in the enterprise networking sector. Plus, I know for a fact that BRCM has some of the most brilliant minds designing their chips.

So, there we are. The five companies that will survive this down-turn in the semiconductor market, and thrive afterwards, have a few things in common.
a. A strong balance sheet, with a large cash position [or in Linear's case, a manageable debt, and a fantastic competitive position as reflected by gross margins].
b. An excellent competitive position.
c. Strong management that is still “invested” in the company.
d. Has survived prior attacks on its competitive position.
and finally,
e. Pass my rigorous standards.

If I had doubts about a single pick, it would be about SNDK, but, people NEED memory. There is no way that computing can move forward without flash memory. Sure, rotating hard-disks have “out-Moore’s-Law’d” Flash memories, but heck, if you hate memories, pick Altera or XIlinx. They are rivals with excellent balance sheets, gross margins in excess of 60% and split the market for Programmable Logic [with small concessions to Cypress, Actel, QuickLogic, etc.], but I chose to not pick them.

The final list: Intel, Linear, nVidia, SanDisk and Broadcom.

Disclosures: I own a small long position in INTC, BRCM. No positions in other companies.

© Bapcha’s Stocks, 2009.

Which beings us to the still-profitable niche players – like Altera (ALTR), and Xilinx (XLNX). But, even in this niche, Lattice (LLTC), QuickLogic (QUIK), and Actel (ACTL) are just surviving.

NVDA is doing fairly well in their niche – GPU’s, and AMD should probably think about spinning off ATI to the public. In fact, the latest ATI chips are as good as or better than NVDA in processing power. Among the large memory makers, most of them are for all practical purposes, dead. In fact, they will get to lose less money – if they just shut down the FAB’s and stop selling chips – even if they had no change in staffing. Among the memory makers, only SNDK and SSTI have a stream of licensing/royalty revenues – which will fall directly to the bottom-line, but hardly sufficient to stop the haemorrhaging of cash and other assets.

Now, why are they in such a predicament?
a. Technology improvements. The migration to smaller geometries – allows for 60 to 70% more storage per unit-area. This is fantastic for the consumers though.
b. Overbuilding of fabs. This remains the #1 scourge of all semiconductor companies. When the cycle swings to the upside, the industry usually goes on a fab-building binge – which hurts them when things go bad.
c. The hiring of engineers who are clueless about chips – especially from Asia. While I might be biased when I say this, I have seen many hundreds of “engineers” – who are clueless about what it takes to actually put a chip out in the marketplace.
d. Being too complacent about taking on debt or being forced to “invest” in FABs for guaranteed wafer-starts. Even fabless companies like SanDisk are forced to take equity stakes in FAB’s – making the fabless model irrelevant for larger chip-makers. In fact, any company that wants guaranteed wafer-starts, purchases an equity stake in their respective FAB/FABs [examples: SNDK, BRCM].
e. While idling FABs in lean times is a good idea, it usually fails to serve its purpose [to reduce supply] – since one cannot just shut off $3M a pop machines from AMAT, NVLS, LRCX. Instead, they are on a production “rotation” which might affect yields [negatively of course].
f. And finally, the most important reason for their failure is the fact that no Product Line Manager ever plans for two consecutive years of price declines of 70% annualized. In other words, no PLM [that I know of] planned that a newly introduced product, woud be decimated in price in two short years. Most assume a price decline of 40% [and that is aggressive], and possibly, a migration to a more advanced technology after two years [to cut manufacturing costs].

And if this wasn’t bad enough, the Jan book to bill ratio was one of the lowest that I have ever seen – 0.48 [that means that if a company ships a dollar worth of product in Jan 2009, they have on their books, only 48 cents in orders]. This means that Gartner and IDC are wildly optimistic about the future of the semiconductor industry – at least for 2009. A 33% shrinkage of the semiconductor industry will mean a book to bill ratio of 0.67.

Despite all of this gloom, some companies are positioning themselves for success – when the market bounces back. Among the contenders are:
a. Applied Materials.
b. nVidia
c. Silicon Storage Technologies
d. SanDisk
e. Lam Research
f. Novellus
g. Kyocera
h. Intel
i. Texas Instruments
j. Linear Tech
k. Maxim
l. Marvell
m. Broadcom.
n. Altera
o. Xilinx
p. Lattice Semi
q. Actel
r. Micron

In Part-II, I’ll pick the five best positioned to survive this nuclear winter. In fact, I’ll pick the companies with the least debt and the highest profit margins – since they alone can possibly survive and then thrive when things get better.

© Bapcha’s Stocks, 2009.

In the nineteenth and early twentieth centuries [and after GLB], bankers and brokers were indistinguishable. Then, after the Banking Collapse of 1933, Congress examined the mixing of the “commercial” and “investment” banking industries that occurred in the years prior.  There were TWO G-S acts passed in 1933.  The second G-S act was called the Treasury Act of 1933, and was passed on 16th of June, 1933. Hearings back in 1933 – revealed conflicts of interest and fraud in many banking institutions’ securities activities [the more things change, the more they stay the same]. A formidable barrier to the mixing of these activities was then set up by the Glass Steagall Act – [only to be pissed away in 1999, by GLB].

Now what makes me shudder is the fact that today, Morgan-Stanley, Goldman-Sachs and American-Express are “banks”. Instead of bankruptcy [that these institutions much deserve], they get to dip into the Fed’s discount window – where they can get greenbacks for almost nothing in interest. Sure, the interest rates are set by the “market”, and the Fed only determines the discount rate, but the fact that a credit card company can dip into a near-infinite pool of taxpayer money is mind-bogglingly stupid.

The real reason that both either political party is getting away with this highway robbery is that highway robbers are not prosecuted these days – and instead, are rewarded with cabinet positions.  Steal a hundred, and go to jail.  Steal a hundred million, and you can write the next set of rules for G-S version 3. Version 3?  In fact, I know a chap who fooled some very smart people and stole in excess of ten billion dollars.  Since he will have a lot of time in his hands, I recommend that he author G-S v3.0.

But I digress…..

I think that it is the responsibility of the new administration – and all the peddlers of hope – to come together and pass a new set of laws that:

1. Reinstate G-S v3,0 – authored by the best hedge fund manager in NYC/Florida .

2. Split up Banking, Credit Card Issuing companies and Investment Banks.

3. If the Investment Banks or Credit Card Companies go under, so be it. Nobody is saving the jobs of much more deserving technology employees in the Bay Area – while incompetent Investment Bankers get their 2008 bonuses from TARP funds.

4. All “saved” banks need to forgive all loans for which they took money from TARP funds.  Yeah – free houses to all those who had the sense to borrow from weak banks.  After all – we want the fittest to survive – correct?  The Banks which received TARP funds aren’t exactly the fittest.

5. No free $$$ to non-US banks.

Burn baby, burn!

© Bapcha’s Stocks, Feb 2009.

Disclosures: No positions in any stock mentioned. I want to be the Secretary of the Treasury when Geithner resigns/steps down/or is forced out.

For starters, ISRG has a competitive edge over any offering from Medtronic or JNJ - who remain ISRG’s biggest rivals that can out-spend or buy out ISRG. Intuitive Surgicals’ daVinci is protected by hundreds of patents in the fields of electrical, mechanical and fluid engineering; and has created a new genre of minimally invasive robot-assisted surgery (MIRAS).

ISRG’s marketing pitch is without equal. If you are a guy in need of a prostatectomy, and want to not visit the John one too many times at night, and want a chance to please your partner – you have three times the odds that you would – if your surgeon chooses the daVinci [as opposed to open surgery].

Per ISRG’s own estimates, the daVinci has a 70+% penetration in the prostatectomy market. In the biggest market [250K hysterectomies/year], their penetration is 14%. I think that in the one thousand large hospitals in the US, ISRG can sell a maximum of one each on average.  Sure, some will buy a couple, or even more, but the company’s stated 80% penetration goal – with 2.5 robots/large hospital is in my opinion too optimistic. Their estimates on the international hospital market is pessimistic. If Intuitive can gain acceptance into a wider range of surgical procedures, the number of daVinci procedures could triple from a base of 85,000 in 2007 – by 2012.

When a surgeon uses a daVinci to perform a surgery, the machine consumes $2000 to $3000 worth of consumables. This currently represents 50% of  ISRG’s revenues, and the gross margins for robots and consumables is similar. In these days when there are very few “economic moats” up for grabs, Intuitive Surgicals for sure has built for itself [and its investors] at least a moderate sized moat [Morningstar thinks that ISRG has a narrow moat, but I beg to differ]. I think that Intuitive’s ability to convince other minimally invasive [laparoscopic] surgeries to migrate to daVinci assisted procedures will become important after the initial install phase that ISRG is in as of now.

The company has also convinced hospitals in Santa Clara and Santa Cruz counties to air TV ads that promote robot-assisted surgery, and the benefits from MIRAS – short hospital stays, quick recovery, less pain, and smaller incisions. So, hospitals are spending their marketing budgets – promoting the fact that they use daVinci [good for ISRG].

But, the most important reason why I am picking ISRG is valuation. At $100/share, there are 39 Million outstanding shares of ISRG – pegging the market value at close to $4 Billion. The company has no debt, and cash in hand of $900 Million. The company earned $5.12/share fully diluted in 2008 [un-audited results].

ISRG’s guidance has been traditionally very conservative, and most of the growth in 2009 will be from services and instruments and accessories.  In fact, Q4-2008 system sales were $114 Million – down from $126 Million in Q3-2008.  While Q1 and Q2 of 2009′s comparisons over 2008 will be relatively “easy”, ISRG will have a more difficult time posting numbers like it did in the past.

The bottom-line: If we assume that ISRG will grow by 15% this year [company's understated estimate], the stock looks cheap at the current quote of a little over $100/share – keeping in mind that almost a quarter of the valuation is in cash. Add to this ISRG’s unassailable position as the king of MIRAS. Additionally, the company is very well managed, and fiscally sound, and does not need to raise capital – as all of their growth can be [and is] funded by operating cash flow. I’d opine that the floor on this stock is a TTM PE of 15 – or $75/share.  Assuming a growth rate in double digits, and operating margins in the low 30′s [it is currently around 38%], ISRG could get to and past the high that it hit in the last twelve months [$357/share] by the end of 2011.  The only scenario in which it could remain at the current level – is if growth grinds down to single digits and if margins drop to the low 20′s.

© Bapcha’s Stocks, Jan 2009.

Disclosures: No positions in ISRG.  Long JNJ.