Beating Estimates with Netease (NTES)

I hope you understand how difficult it is to avoid resorting to pun-throwing when talking about NTES ...

Back on Netease-y street.

It's Netease-y being a Chinese gaming company.

Netease-y does it.

OK, got that out of my system.

Netease (NTES -- click to register for free RT streaming quote) is one of the titans of Chinese internet gaming, and a top tier web portal and wireless services firm (that wireless stuff is what pummeled the stock more than a year ago if I remember correctly, as the wireless fortune telling business got the ol' tsk-tsk from the People's Government). While they're still the largest free email provider in China, lately their earnings reports tell us that they're really just an online MMPORPG company -- most easily comparable to The9 or Shanda, though they seem to me to be both more diversified than The9 and much more stable than Shanda.

But the news is, they released their fourth quarter this week (transcript of the call is on the China Stock Blog), and all is once again well for NTES. They had a little hiccup in the third quarter, but they had a remarkably busy Q4 that included significant increases in the number of game players of their two core titles -- a nice recovery that made a mockery of my prior guess that Fantasy Westward Journey (the most popular game in China right now, according to them) and Westward Journey Online 2 had plateaued. It's nice to be wrong in this case.

So we're back on the climb with NTES ... the chart is pretty odd looking for this one -- tremendous moves on earnings the last three quarters, a huge move up that shocked everyone when their earnings blew expectations away in August, then the dramatic fall when that growth rate stalled a bit last quarter, and now another huge climb back to where we were six months ago now that we are again allowed to believe that NTES is growing.

This is exhausting. But I think if we can ignore the short term blips caused, in large part, by how difficult it is for analysts to guess what's happening in the Chinese internet space these days, NTES looks to me to be very well positioned for the continuing overall growth of gaming and internet use in the middle kingdom.

While Shanda (SNDA) has moved to a free-play model (trying to sell avatar accessories, etc., instead of charge for game play), NTES seems to be doing quite well with continuing to charge for games. That means they're handling the development cycle significantly better than SNDA, since their current hit games are continuing to grow in popularity and they're now just a few months out from release of their next generation 2.5D and 3D games while Shanda's next generation games seem to be continually delayed and they gamble their future on hardware.

(And no, I have no idea what 2.5D means. How can you have half a dimension?)

So my opinion of NTES hasn't changed in the last month, though I'm happy to see that this latest swing was to the upside. I'm holding my shares, but with this and my Shanda position already giving me plenty of exposure to MMPORPG's in China I'm not interested in adding any more -- I think I've got enough, especially for someone who thinks this particular kind of entertainment is totally unappealing.

It's certainly worth checking out the transcript of the call and the recent Piper analyst notes over at the China Stock Blog -- with the lack of between-quarters information that we get out of China, it's that much more important to really pay attention to the filings and, as far as it's possible to understand what they mean, to the conference calls.

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Another small step for PANL

Universal Display (PANL -- click to register for free RT streaming quote) is a research company and intellectual property bank that conducts research on and holds patents in phosphorescent LED technologies.

The bear case on them was clearly made by ClearFish Research over at Seeking Alpha a few days ago: They don't make money, and they're probably not going to start turning a real compelling profit for quite some time.

But I am invested, with a small position at least, in PANL ... so as you might guess, I find the bullish case more compelling. As I wrote in my annual checkup on PANL a while back, I like that they use research grants to subsidize their R&D to some extent, and I like that they seem to be in the lead in developing PHOLED technology. Competitors like Cambridge Display (OLED) are using different technologies or pointing their research in different directions and seem to me to be a bit behind, and PANL continues to rack up new incremental gains in the capability of their PHOLEDs and, slowly, gains in their development of licensing partners for possible manufacture of PHOLED-based products.

The stock is pretty wild. When I bought in last year, the hope was that Samsung's licensing deal with PANL would grow and lead to some significant product development sooner rather than later. It hasn't happened yet, nor have we heard much in the way of news about specific new products that might use this technology (Samsung and it's affiliates generally hedge their bets -- I think they've licensed other bleeding edge display technologies as well). Lately we've been hearing about their lab advances -- stronger blue PHOLEDs for a nearly complete spectrum, and about new small research contracts with the US government, most recently for lighting using PHOLEDs.

But today, some more news ... and a typical jump up on the news. PANL cagily announced that an unnamed company has licensed their technology for an active matrix PHOLED for the first time to a "leading display manufacturer."

Of course, that doesn't mean much ... what we're really waiting for is announcement of a manufacturing deal, not just an exploratory license. PANL does not itself make anything, though it contracts with a manufacturer to supply their patented materials for use by their licensees. But still, this confirms to some degree that active matrix displays are possible with PANL's PHOLED technology, not just the simpler passive matrices, and that can only be good -- opening up another potential market for their patents.

I'm treating my PANL investment as a long term option on what I believe to be a compelling technology, and it's nice to see some more of their work validated today. If they keep on signing contracts for lighting and display research work and building up relationships with potential manufacturers, we're still on the right track and I'm happy to be patient.

And I really want one of those windows that turns into a TV screen on command. And one of those flexible PDAs with a screen that rolls out of a tiny tube would be handy too, please.

They might lose it all, but they also might be the holder of the patents that enable the next revolution in display technology -- I guess you can tell what I'm guessing, even though I wouldn't bet more than I can afford to lose on this one.

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Still patiently pleased with Marvel (MVL)

Marvel Entertainment (MVL -- click to register for free RT streaming quote) gave the street a reason to breathe a little sigh of relief with this morning's earnings. They reported more or less what was expected for 2005 results, but boosted their guidance a little bit thanks to their large share repurchase program.

EPS should now come in between 44 and 55 cents, their previous guidance in the last conference call was for 37 to 52 cents.

Now, neither one of those numbers is really impressing anyone -- at $16 you're still looking at an awfully high PE for a company that is expected to have a very weak year.

But the stock is up about 10% as I type this, partly because they raised guidance for this year and largely, I think, because people are now starting to think about 2007. The short term mentality of Wall Street would have allowed us to buy into Marvel's expected blockbuster 2007 at very low prices in 2005 ... no surprise there, of course.

This year, as I wrote in my annual checkup, Marvel's stock may ebb and flow with their licensed feature films, but now the fact that 2007 should be a great year for them is starting to get some attention -- Spiderman 3 will be out that year among other expected solid films, their new toy contract goes into effect, and they'll be providing us by then with some stronger visibility into the casting and stories for their first few self-produced films moving forward through 2008. CNNMoney ran an article on this potential as well recently, which probably reflects this new tide of cautious optimism for Marvel that's playing out in force today.

To be honest, I was hoping that they would continue to downplay 2006 -- which will see an Xmen film and could be much more successful than we're guessing. I would like to own a little more Marvel, and I'll be looking for depressed prices later this year to get a chance to buy in before the good news for 2007 and beyond really gets priced in.

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Alternative Energy?

I got a question a few days ago from a reader about why I don't own any alternative energy stocks:

"You have several up-and-comer stocks in various sectors, but one thing I was curious about is why you don't seem to be in any alternative energy plays (both of which have become "major policies" for both the U.S. as well as China), especially given all the recent hoopla over oil prices. Do you simply not like the sector in general? Or are you just unsure about the best way to play it? The reason I ask is because I am trying to find a "good play" in that group at the moment, and thought I would see if you had any ideas. The most commonly mentioned stocks in the category are STP, ESLR, DESC, IMCO, BLDP, PLUG, and CPST."

Well, the short answer is that I do like the sector in general, but haven't done a lot of research yet or otherwise found any particular companies that I like.

I have looked in the past at Ballard Power (BLDP), but they look like they're just as likely to go bankrupt as they are to find success. I haven't looked at any of those other ideas in great detail, but I commend you to the alternative energy thread of articles over at Seeking Alpha -- they have articles and commentary and conference call transcripts for several of those names from folks who certainly know more than I do about the sector. I've been looking there for some ideas myself.

The longer answer is that I do have some exposure to solar energy, at least, through my investment in MEMC Electronic Materials (WFR) and a smallish LEAPs position in Cypress Semiconductor (CY).

WFR I've written about a lot lately, but I like that they are exposed to the solar cell manufacturing industry in that they sell the silicon to those companies -- but thanks to their broad customer base they aren't subject to the whims of national subsidies in solar power to nearly the degree that the pure play solar companies are. I am a little nervous about what happens to solar power subsidies across Europe and in various US states if the oil shock of the last year wears off or oil prices drop significantly.

Cypress Semiconductor you may have heard mentioned over the past few months by a lot of market commentators, including Herb Greenberg, who I don't particularly endorse but who published what I thought was some solid analysis of this company.

CY is 80% owner of SunPower, a former division that they spun off last year and a manufacturer of solar cells. Thanks to the huge bull market in solar power recently SunPower has really rocketed up the charts ... but no one likes CY nearly as much. CY's shares of SPWR account for something like 75% of their market cap at this price, so if you think solar companies are going to continue growing then CY is a lower risk way to ride SPWR's success -- you get CY's semiconductor businesses, which seem to be in a bit of a turnaround (I hope), for a pittance. The former child is now almost exactly the same size as the parent.

This hasn't been entirely ignored, and CY has climbed a fair amount already, but I'm guessing that sometime between now and 2008 when my options expire CY will see a significant boost from either solar power expansion or from their own businesses.

In the meantime, I agree that the growth in alternative and renewable energy is an important trend -- but I haven't really figured out how to invest in it. This is almost like 2004, when anything with China in it's name doubled in price ... now anything associated with Solar or Hybrid or Alternative Energy is booming, in many cases without much regard for current earnings or even potential earnings.

I have taken a glance at Headwaters (HW), which is an established chemical and coal gasification/clean coal company that shows some real promise and has real earnings, but haven't taken a bite yet. If anyone has ideas for alternative energy companies I'd love to hear them ... especially if they're companies that don't depend entirely on government subsidies.

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Lightening the load (VRTX, MIDD)

**Update February 23** This is why I don't like to sell! I sell off 30% of my Vertex holdings because I think there's too much optimism priced in, and the VERY NEXT DAY the stock has climbed about 10% from my selling point. Arg. Can't complain about 200%+ returns, but it really is remarkable how bad my timing is sometimes for both entry and exit points.**

I've written before that I don't like to sell stocks, and that I try to be even more patient when selling than I am when buying because most of my larger mistakes have been made in selling too early.

But with two of my positions, the valuations have reached levels that I'm afraid may not be sustainable in the intermediate term and I can easily withdraw my initial investment and leave substantial holdings to ride on the whims of the market.

So I've sold a third of my Vertex holdings today, and about 40% of my Middleby holdings.

Vertex Pharmaceuticals (VRTX -- click to register for free RT streaming quote) I've written about several times in the past, including back in November when my holdings were up ONLY 100%, but they have become a a real darling of the Street in the last few months as extraordinary results continue to come out of their clinical trials and Josh Boger, their CEO and founder, has been pounding the pavement promising revolutionary treatments for two huge-market illnesses. That's great, and I'm very thankful that I held on for a gain of roughly 220% over the past year or so.

But it now appears to me as though the market is assuming that both VX-950 for Hepatitis C and VX-702 for rheumatoid arthritis will not only be approved in relatively short order (2008-2009 or so), but they will both be blockbusters. That's a big weight for early stage II drugs to carry, and a long time for which to carry it.

I actually agree, with my limited knowledge of the science and a pea-brained analysis of their results thus far, that blockbuster status is a very possible outcome for both drugs -- but they're also new treatments and it would not be shocking to find significant safety concerns when they move into broader trials, and it's certainly within the realm of possibility that neither compound will see FDA approval in the next five years ... or ever.

So I'm happy to leave most of my position to ride with Vertex as we await (hopefully spectacular) additional clinical results for their two most impressive drugs in the coming years, but I'm going to take my initial investment off the table because it seems like we've already reached a real stage of exuberance about Vertex and my uneducated guess is that the risk for the next year or two is on the downside. I sold shares in VRTX today at $38.38.

And Middleby (MIDD), another favorite of mine for quite some time, is now valued as a very strong growth stock with a PE (trailing) of 32 (the forward PEs are pretty wild guesses, since MIDD does not provide guidance to speak of). In this case, I'm selling a portion of my holdings (and again, recovering most of my initial investment) because my predictions for the company have played out in shorter order than I expected.

I bought Middleby expecting that it might be able to pull down solid earnings growth of 20-30% a year as it rides the buildout of international restaurant chains, and that it might double for me in three or four years. It had already gone up by well over 100% in the year before I bought it, but it really looked like a company hitting its stride and beginning to dominate it's industry (commercial cooking equipment) and I thought it would have a ways to go.

I never expected Middleby to be a better short-term investment than Google, which I bought at about the same time. And while I think growth will continue for this company and I'm going to leave the majority of my investment in place, I think that the rosy scenario that has played out for Middleby over the past few years is leading the market to expect perfect execution from them over the next several years. That's a lot to expect, so even though (as I wrote in my annual checkup last month) it's hard to take money off the table with the success Selim Bassoul had in the past several years, I feel like that's the right move on balance.

So I sold some of my MIDD holdings today at $94.11.

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Question about Tankers (OSG)

I got a question from a reader about Overseas Shipholding Group (OSG -- click to register for free RT streaming quote) a couple days ago:

"What do you think about OSG at this moment? Price is almost equal to book value. PE is a low 3. Earnings are almost 30% of stock price. Is it a good buy? What's your projection on this one? You held this stock couple years ago and not sure, if you still have any interest in this stock?"

I do still track several of the tanker stocks. OSG is a big tanker owning company, not quite the biggest but certainly near the top of the heap. I took a wild ride on some tanker stocks in 2003 and 2004 as they recovered from a dramatic bottom to reach ridiculous heights, but I sold all the shares I owned of Frontline (FRO), OMI (OMM), Torm (TRMD) and OSG in December of 2004, before I began writing this blog.

That turns out to have been a reasonable point to get out -- it was the end of the uninterrupted shot to the moon, though you could certainly have made plenty of money in these stocks over the past year or so as well.

Since my portfolio was overwhelmingly oil stocks and tanker stocks in 2004, that's my frame of reference on prices -- and investor psychology being what it is, I can't face buying oil stocks at today's prices after having sold them about 50% ago. That doesn't make sense on any rational level, but it's still a human being placing the buy orders here and that's one of my handicaps.

But tanker stocks haven't climbed so much since I sold all of mine -- so what do I think of the sector?

Back when I made my purchases, it was an undiscovered sector in many ways and the argument in favor of the shares was almost irrefutable. FRO, the largest operator, was crossing $14 after having hit a bottom the previous year of $3 (it's at about $40 today), so volatility was expected, but the business climate was brewing a perfect storm for any company that owned VLCC or Suezmax tankers, anything that could transport crude oil from the Middle East to the US, China and India. Single hulled ships were being phased out gradually, Venezuela and Africa, which are shorter trips for US bound tankers, were having production or political problems and more oil had to be freighted longer distances, no one had invested in any new large crude carriers for years because of the cheap oil climate and lack of demand for tonnage, and as soon as it became clear that more tankers were needed the rush was on to build them -- but shipyards had full order books already and the backlog for new tonnage reached years ahead.

So any company that owned tankers could charge ridiculous dayrates for them as demand went through the roof. FRO was my biggest holding and a big beneficiary, because they had their entire fleet leveraged to spot voyages at high rates (instead of long term contracts at more moderated prices) and because they were committed to spitting off almost all of their free cash flow as dividends. FRO yielded upwards of 30% for a year or so, in addition to capital gains of more than 100%.

I think that easy money is over for all of the companies in this space, but I think they're also fairly valued and might make reasonable investments here. Here's my thumbnail assessment of each -- but remember, this is based on my memory and I haven't looked into these in any great detail lately:

FRO -- still highly leveraged and with very low book value in comparison to it's competitors. That's because they've spun off all their tonnage to Ship Finance Limited (SFL -- almost a FRO subsidiary, but separately owned and traded), and they lease it back to then charter on the spot market. I think they're still the largest VLCC operator, and due to the fact that they've already spun off their boats they don't have the same downside protection that some of the more stable operators do. This is the best bet for leveraging returns to higher spot rates, in my opinion.

If you want a little more stability but like the buccaneering bets of Frontline, buy SFL -- you get the yield from leasing the tankers to FRO, and this is fairly stable so it almost acts like a REIT, but you also get a profit-sharing kicker if FRO's rates top an agreed number.

OSG is a more stable tanker company, also focused on the large crude carriers in the main, and also with some complex lease and share agreements with other investors to help finance these incredibly expensive boats. OSG has a more diverse fleet, and never got quite the sexy attention given to FRO or some of the others. They time charter more of their boats, which makes things a bit more stable and means they're not as subject to vacillating spot rates -- either high or low. OSG would make me sleep better at night than FRO.

OMM is a smaller company that focuses on smaller ships -- Suezmax and Aframax tankers, I believe. I actually like this company more than either FRO or OSG at this point because the management never placed outsize bets during the wild bull market in 2004 ... and because they're in a little bit different business. OMM charters both product tankers (carrying refined products like heating oil or jet fuel or gasoline) and smaller crude oil tankers. It was their practice to have about half their fleet on multi-year time charter and half on the spot market to try to get the best of both worlds, which made a lot of sense. Whereas FRO always seemed to be aggressively trying to free up cash to dividend out to it's majority stockholder (and the rest of us, of course), OMM always seemed to me to be building a sustainable business with lower debt and a longer range vision than OSG or FRO, though all companies in this sector are pretty heavily leveraged.

And TRMD was my favorite for a while -- six months after selling it it sat on my wish list. This Danish company is very thinly traded here in the US and still very much uncovered, but it's not nearly as cheap as it used to be, either. Today I still like Torm's exposure to a very diverse set of shipping businesses, from a few bulkers to product tankers, including edible oils and other non-petroleum products.

I reconsider buying into this business every now and then, but the real time to buy is when everyone thinks things have bottomed out and the banks are going to start repossessing the ships. It might be that the tanker industry is more corporate and better financed now, and won't see those wild swings as marginally financed families tried to build their fleets -- if so, the downside will be a bit more limited than it used to be in this sector. I think I'd be more interested in product tankers in the near term, since I think the real worldwide shortages are going to be in refined products, not crude oil for the foreseeable future ... but that's just me. If I were to buy one of these today it would probably be OMI, but I'm not in the market at the moment.

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