Last week’s price action suggests that most of the activity in the tech sector is currently focused on mid-cap stocks, as our Next Wave portfolio gained more than twice what the NASDAQ Composite index was able to deliver. And while our Investments Portfolio of large-cap stocks did okay – up 1.67% compared to +2.23% for the index – our Next Wave Portfolio increased 5.51% in value during the same time!

And that result includes a 10.75% drop in the price of Zynga, which was added to the portfolio last June by me at a price of $3.00 and has struggled to break above it ever since. Rob DeFrancesco has done such a wonderful job of selecting stocks for this portfolio that I’ve asked him to replace it with one he likes better, so be on the lookout for another great recommendation from him very soon.

We also take a quick look at two of our original recommendations for our Investments Portfolio – Micron and Oracle – which have struggled recently but we still think they can get back in the groove in the months ahead for the reasons outlined in Linda McDonough’s article. The fickle nature of the tech sector tends to result in certain groups of stocks going in and out of favor, and right now it appears mid-cap stocks are the flavor of the month.

Next Wave Portfolio Update—Closing Out Zynga Position

By Rob DeFrancesco

Zynga (ZNGA) shares last week dropped 17.9% in one session following the announcement that Don Mattrick would step down as CEO less than two years after his appointment. Mattrick, an expensive hire from Microsoft’s Xbox gaming division, was brought on to try to steer Zynga in the right direction in terms of developing new mobile games and fixing the execution issues that arose under former CEO (and cofounder) Mark Pincus.

Unfortunately, Mattrick wasn’t very successful during his short time at company, with Needham & Co. pointing out that the expected turnaround is far from complete: Zynga does not even have a single title ranked among the top 15 grossing game apps on iOS or Android.

With Mattrick out, Pincus is returning to run the show, something that is causing much consternation among investors. Many of Zynga’s past problems (including poor game quality, a fumbling of mobile initiatives, lack of innovation and an overall disruptive culture at the company) were blamed on Pincus.

While Zynga has a couple of promising new games in beta testing, I believe the disruption caused by Pincus’ return to the CEO spot will weigh on Zynga shares over at least the next few quarters, so I am removing the stock from the Next Wave Portfolio.

Shares of Silicon Motion Technology (SIMO) last week jumped 9.9% in one session after the mobile storage/communications chipmaker issued a positive first quarter pre-announcement. On Friday, the stock hit a new 52-week high at $32.50.

Preliminary results for the March quarter show revenue is expected to come in roughly flat sequentially (at the high end of the original guidance range of a sequential decline of 5% to zero growth), which equates to a top line of $80.5 million, above the consensus estimate of $78.4 million. New Q1 gross margin guidance of 51% to 52% is at the high end of the original range of 50% to 52%. Full results will be released after the close on April 27.

Following the positive news, Topeka Capital raised its Silicon Motion Technology price target to $39 from $32, saying the company continues to benefit from secular mix momentum, driven by growth of embedded controllers and solid state drives. The firm believes demand in China for low-cost smartphones has recovered and that Silicon Motion’s embedded controllers are tracking to expectations, implying a stabilization in inventory conditions.

Gigamon (GIMO) on Friday received an upgrade to ‘Outperform’ from analysts at William Blair based on the company’s growing security momentum and new product cycle. Those were two key reasons why I added Gigamon to the Next Wave Portfolio last month. Following the upgrade, the stock on Friday closed with a gain of 6.7%; earlier in the session it hit a new 52-week high at $23.45.

The firm believes Gigamon’s growing linkage to security projects will drive longer-term top-line growth, while improved sales execution is expected to lead to more consistent financial performance. William Blair says upbeat discussions with industry and reseller contacts give it increasing conviction that the recent rebound in Gigamon’s business will be sustainable, with Q1 results likely to meet or beat moderate Wall Street expectations (the consensus numbers: EPS of four cents on revenue of $42.1 million). The firm also sees potential upside to 2015 estimates.

William Blair points out that as security becomes a bigger priority for virtually all organizations, there is growing need for pervasive network traffic visibility across both physical and virtual environments, which Gigamon’s solution fabric provides. With the security tie-in, Gigamon’s products are increasingly driving strategic value for customers, elevating their importance to the must-have level.

The company’s solution set enables efficient visibility across the production network for security tools, especially in complex networks that have multiple individual security tools that need separate data feeds. William Blair says this is where Gigamon shines, as the company’s technology can parse and manipulate data so that only the appropriate information is sent to the right tools at the right time, saving both time and money.

Investments Portfolio Update – Micron and Oracle

By Linda McDonough

Micron (MU) was added to the investment portfolio last December. On April 1^st the manufacturer of memory chips reported second quarter earnings and revenue that were slightly better than analysts’ forecast but lowered expectations for the current quarter.  

Although the stock is down 20% since our initiation, it has remained above our $26 stop price. Cyclical woes of higher inventory and weak Asian demand have slayed many semiconductor stocks this year.  Although Micron is not immune to these issues, the stock is priced to reflect lower earnings and should enjoy more success over the next year due to a revolutionary production technique being developed with Intel.

The semiconductor group has been swamped with bad news for the past 6 months. Just last October the group was hit when the CEO of semiconductor make Microchip Technology (MCHP) ominously warned that the industry was on the brink of a correction.  Microchip’s weak quarter was blamed on soft Chinese demand and a surplus of inventory held by customers. On March 26th, Micron competitor Sandisk (SNDK) slashed revenue guidance for the current quarter. Their rationale was eerily similar to Microchip’s and to that offered by Intel two weeks earlier: weak PC sales worldwide had left customers with too much semiconductor inventory on hand.

Although Micron’s July 2013 acquisition of Elpida Memory helped the company diversify into chips utilized in servers, the company is still quite dependent on the PC market. DRAM chips (dynamic random-access memory) still represent 65% of its revenue. On its second quarter call, Micron’s CEO Mark Durcan echoed Intel’s comments. He warned that tepid PC sales and high inventory levels would render new orders anemic for the next quarter of two.

However, a revolutionary manufacturing technique being developed with Intel would allow the company to introduce faster, cheaper chips within a year. In addition, he remarked that Micron would not sell product into the channel at discounted levels and would instead hold onto inventory to reap better pricing after customers had cleared their shelves.

Micron is down 20% year to date, far worse than the Philadelphia Semiconductor Index (SOX), which is up 3% due to the success of a few companies selling chips used by Apple. Yet the stock is still cheaper than many rivals.  Micron carries a 7.5 P/E on 2016 earnings versus the 13 P/E assigned to Intel and Sandisk.  The stock is priced to reward investors who are patient enough to wait out the industry’s inventory adjustment.  Revenue, earnings and cash flow should reignite towards the end of the calendar year.

Stay tuned to see what Intel has to say about the current state of the PC market when it reports earnings on Tuesday, April 14th.

Oracle is currently rated a HOLD due to its lukewarm 3.2 STR (Smart Tech Rating). Although the stock provides some yield (1.4%), the company has not been able to accelerate cash flow growth. Recent results were dampened by a stronger dollar and the law of large numbers.  

Oracle’s notoriously competitive CEO, Larry Ellison, is enjoying the race to become the largest merchant of software as a service (Saas) and platform as a service (Paas). On its third quarter earnings call mid-March he noted, “Salesforce.com has announced that it also expects to add about $1 billion of new SaaS and PaaS business this year. So it’s going to be a close race who sells more in the cloud this year, us or them. Stay tuned.”

Based on his sailing record and unyielding spirit, we suspect Mr. Ellison will be breathing down the neck of Marc Benioff, Salesforce.com’s CEO. However, this success may pressure near term results. Winning Saas and Paas deals will mean convincing customers that they would rather pay a monthly fee to Oracle rather than licensing the software outright as they had done in the past.  It should be no surprise that companies from Microsoft to Adobe are attempting to shift to this model.  A subscription model delivers a very predictable and much more profitable revenue stream to a company.  However as Oracle transitions customers over, they will be receiving a smaller up-front payment.  For example, instead of a customer paying $1,000 for an up-front software licensing deal, they will now be paying a much smaller monthly fee.  Obviously this is more beneficial to Oracle over the long run but can pressure the growth of near term earnings.

While much of the focus on Oracle is on this subscription revenue, it still represents only 5% of total revenue.  The valuation gap between Oracle and Salesforce.com will narrow only when Saas and Paas revenues garner a significant slice of Oracle’s total revenue.  We are keeping our Hold rating on Oracle until either its price drops below our $42 buy limit or the fundamentals improve enough to bolster our STR (Smart Tech Rating).

NASDAQ Composite Index:                                                                       

Thursday, April 10 = 4,995.98                                                    

Trailing 12 months = + 21.0%                                        

Trailing 7 Days = + 2.2%                                       

Trailing 4 Weeks = – 0.6%