Annual Review — Tech Speculations

by Travis Johnson, Stock Gumshoe | January 17, 2014 5:23 pm

Continuing our annual review with check-ins on Ligand, Invensense,, Rosetta Stone, and Aware, Inc.

Some more stocks from our list of speculative ideas to run through today, let’s jump right in with a look at Ligand Pharmaceuticals (LGND) and Invensense (INVN), two of the faster-growing stocks I’ve covered that are seeing rapid change, and do a quick check-in on some other tech-related stocks in our speculation list that haven’t changed as much since my last writing:

Ligand Pharmaceuticals (LGND) — Hold or buy little nibbles, look for pullbacks.

This is a stock I’ve had to continuously re-evaluate because it’s growing so very fast, just about doubling in the six months since we covered it and I bought shares. I did sell covered calls against the stock when it was heating up very fast in November or December and reinvest the proceeds from those covered calls, and do a bit of nibbling along the way, but otherwise I’ve just been watching and wishing it would dip more substantially. It’s tough to buy in the mid-$60s if you remember it being in the $20s and $30s, but the past doesn’t help us on that front — is the price justifiable today?

The numbers are ridiculous — it’s trading at well over 100X trailing earnings, with a forward PE of about 50 based on expected 2014 earnings. Revenues doubled in the last quarter,and they’ve blown out analyst earnings estimates by 70%, 40%, and 70% in the last three quarters, but they’re also trading at almost 30X sales. Ligand is a royalty company in the pharmaceuticals space, with a combination of drugs they developed and drugs they’ve bought in and drugs that are being developed based on their Captisol delivery platform, which bring in royalties and material sales revenue. Their goal is to have a large number of compounds in development (they call them “shots on goal”) and not to pay for the development themselves, so a partner like GlaxoSmithKline or Pfizer partners in with them, runs and pays for the clinical trials, and Ligand earns milestone payments as drugs pass various checkpoints, then a royalty based on the sales of the drug if and when it’s approved.

This is a relatively new business model for them, they used to be a money-blowing biotech like so many others but are now very, very focused on costs and distributing risks. Margins are extraordinarily high for a pharmaceutical company, which is what you would expect for a firm with only 20 or so employees that outsources most of their development — so over the last two years, since 2011, the gross profit has climbed about 50% but the operating expenses (SG&A and R&D) have remained pretty flat, that gives some confidence that the leverage we expect from this kind of firm will really emerge with climbing revenues from their emerging drug royalties.

The key reason LGND’s price has risen so dramatically in the last few months? Well, other than the fact that the biotech sector in general is on a tear and arguably in a bit of a bubble I think a lot of that movement can be attributed to this sentence from their investor day back in November: “Ligand projects a compound annual growth rate in adjusted net income of at least 85% for the next three years.”

And that was followed by a raise in Q4 expectations back in December as they boosted their non-GAAP earnings forecast to at least 86 cents per share for 2013 (they cut a lot out to make it non-GAAP, including in-process R&D as well as stock-based compensation, so the real number will be meaningfully lower … but that’s still a bump up of more than 10% over their prior guidance).

So that has the stock riding a wave of optimism at the moment — for these kinds of stocks I can never convince myself to jump in with large investments as a growth pick is booming without real catalysts (their next earnings release will be in about four weeks, though deals or good or bad drug news could come at any time), so I think the stock is tremendous and very well run, with huge growth potential, but I would only consider taking on a small position here. The likelihood of disappointment or “sell on the news” behavior with any new data point is quite high, so my hope continues to be that we’ll see a buyable pullback to the mid-$50s for taking on larger positions … but really, with a forecast from the company itself of 85% compound annual growth for the next three years we might not see $50 again without a real crisis or failure of a product. My personal impulse is to chisel off some profits from rapidly growing stocks like this, but with growth far from topping out for Ligand I am trying very hard to resist that urge. If they are indeed able to post over $3 in adjusted earnings in 2016 as they forecast, the stock could easily be well over $100 at that point. Holding on tight for now. Ligand stays on the list as a favorite speculation, just be careful about betting heavily at high valuations.

Invensense (INVN) — Buy up to about $20, but I wouldn’t chase the stock higher before earnings. If you don’t have a position and want to buy it might be wise to split a purchase and buy half before and half after earnings, it could be very volatile. Earnings are expected to come out next week but I haven’t seen a specific date yet. Don’t own this one personally, though a chunk of my Intel (INTC) shares are likely to be called away after covered call sales so I may consider it, I will personally wait until after earnings to decide.

INVN earnings are right around the corner, which shouldn’t provide huge surprises because they already lowered expectations for the quarter, but with a 35% short interest now in the stock there is plenty of reason to be worried that so many folks are betting against the stock … and also to expect spikes upward if any good news reinforces the valuation, because the stock is primed for a short squeeze if that happens (a short squeeze is when the shorts see the stock jumping upward and have to buy quickly to cover their short bets, which drives the shares up still further). Invensense has been heavily touted by the Motley Fool as well, which we noted in our teaser deciphering article last week[1], and my opinion hasn’t changed — the company still has a technological lead in motion-sensing chips, particularly in Android devices, and is very well positioned for the “wearable computing” trend that so many people see becoming increasingly important in the next few years. They are not the only player in this space, and the stock is not cheap, but they’ve been able to keep revenue growing rapidly and have kept their margins nice and high even with the collapse of what used to be their largest customer (Nintendo, where their chips got their first wide consumer acceptance in the Wii controllers). The short position still raises red flags, and they will continue to battle with STMicroelectronics (STM) over both patents and market share, but the company’s growth and focus still have me leaning on the “buy” side.

And our other tech stocks to think about? (MAIL in London, MLRUY on the pink sheets) — a hold in the $43 range, I’d look for a return to the high-$30s to buy pending any news about VK or other growth initiatives (back in November I was holding out for a pullback too[2], but it has jumped 20% since then so maybe I’m being too cautious). Russian stocks require a certain margin of safety so I don’t want to chase it even though growth in the core operating businesses and in the underlying internet sector in Russia is excellent. is one of the two dominant Russian internet companies available to investors (the other is Yandex, YNDX, the “Russian Google”), and both have done very well over the last couple years — but over the last six months or so Yandex has pulled ahead as a stock, partly because is embroiled in the dispute over Vkontakte and partly because has paid out about $8 in special dividends (releasing the gains it made from being a venture investor in facebook, Zynga and Groupon). Yandex is now a bit more steeply valued, but both are in the range of 30X earnings, and both are excellent plays on the future growth of the Russian internet market — I like both because of that underlying growth engine, Russia is the “highest potential” country for internet services growth because it’s highly educated but has had a very slow rollout of internet access and an even slower rollout of ecommerce. I bought initially partly because of their “hidden” share of facebook well before facebook’s IPO, but that’s gone so now we have a company growing earnings roughly 30% on the back of successful online gaming and advertising businesses, and beyond that underlying growth they have another large catalyst that could go either way: Vkontakte. VK is the biggest social network in Russia, and owns just under half and is voting their shares (40%) with the founder of VK (who owns 12%) against a private equity firm that owns 48% bought from the co-founders. It’s estimated that VK is worth at least a couple billion dollars and is growing fast, it is by far the biggest social network in the Russian speaking world and one of the top two or three websites in Russia, and it’s also a lightning rod for criticism of Russian copyright protection (like Baidu in China in its early days, VK has grown early on largely because it’s the easiest place to find free streaming video and music, often unauthorized) political division (foes of the government can and do use it to communicate, and the 48% owner is a Kremlin friend).

So I have no idea what will happen with the VK stuff, it could be a washout or it could bring another multi-billion-dollar payday to in a few years if they lose some of the controversy and go public or get bought out by, say, facebook. Or could wrest full control and grow on the back of this social network (they already own the lesser social networks that were beaten out by VK in recent years). That’s a sideshow that I’m happy to watch, but in the meantime with this growth rate (I expect 25%) and this valuation (about 30X trailing earnings) is a hold. I’d like to see the shares drop down to the high $30s, a drop of at least 10%, before considering adding to this one again. We may well see a boost of interest in and Yandex as the Olympics come to town, and there’s certainly the possibility that this event will give them a small advertising boost, but I expect any impact will be short-lived and die out before they share more earnings info — the preliminary earnings press release will likely come out in late February. I still own it, still not buying more just yet.

Rosetta Stone (RST) — Buy between $11-12 but keep on a tight stop loss leash, extremely undervalued relative to the value of their brand but need to quickly turn that into strong digital download and subscription sales. I wrote about this one after their last earnings report, and it is still a “show me” stock. They’ve been buying small app companies and trying very hard to expand their strong brand into new areas, particularly education for kids, and it’s really too early to tell what’s working and what isn’t — their core earnings are still dominated by sales of those yellow boxes and by online downloads of (and subscriptions to) their expensive language learning software. The new(ish) management team is clearly managing the company very aggressively, including cutting back on some weak markets in Japan and Korea to avoid their past problems of expensive overmarketing and overexpansion — though it’s worth remembering that the aggressive marketing and aggressive expansion in the past decade is what built the brand into one of the most recognizable learning brands in this country. I still think they can make it and could quickly leverage themselves into a company several times this size if they get the consumer and education sales pitch working, but they’re at a bit of a precipice now and I’m not willing to ride the stock much lower if they aren’t able to click with consumers and get growth restarted. As of now it’s a tiny $250 million company with a struggle in product transition but $100 million in cash (before their recent smallish acquisitions) and a billion-dollar brand, I think it’s worth buying if you have some hope for this continued turnaround but will likely sell if the market drives the shares down much further and the company’s fundamentals (like subscription sales or education sales) aren’t ticking up. They report in late February, so we’ll know more soon.

Aware, Inc. (AWRE) — Buy up to $6. We are still waiting to see whether Aware can emerge with a meaningful and/or profitable business in biometrics, their core operations are very much obscured recently by the decision to cut loose their nonprofitable DSL assurance business so they are really focused on biometrics now. This is a $135 million company with $75 million in cash thanks to some patent sales in past years, so that story hasn’t changed much since we first wrote about them in July. The stock has climbed about a dollar since them, mostly in the last two months. There is no great instant catalyst I’m aware of, though the anticipation among investors is that there might be big licensing deals for (or sales of) their biometrics patents — that seems unlikely to me, though I’d like to see the company buy back a lot of stock with their huge cash pile as they try to create a consistently profitable business with growth potential. A stock this tiny with a huge cash pile makes me nervous, because they could easily do something foolish with the money, but it does provide a bulwark for the shares and I think it’s still worth buying this one if you’re willing to wait and see how it plays out — the downside potential is essentially the value of the cash on the books, which is $3.30. I would not pay more than $6, though, not until we have some more evidence that the company can become profitable. I don’t own this one personally. They will probably report in the second week of February.

More to come as we go along this month — and yes, at the end of this annual review we will put all the stocks into one big list and be clearer about favorites for new money now.

  1. noted in our teaser deciphering article last week:
  2. in November I was holding out for a pullback too:

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