The Buckingham Report

Most of those familiar with our work at The Prudent Speculator are likely aware of our attraction to cash rich and debt-poor technology stocks. Even though many value investors shun technology because, as Warren Buffett has said, they don’t understand it or their algorithms require a company to be profitable before they can make a purchase, we have enjoyed sensational returns on value-priced (at the time of our purchase) tech stocks like Apple Computer, Click Commerce, Cam Commerce, Diodes, InVision Tech and ValueClick.

Each of these was struggling with a bottom line that was trying to get into the black when we bought in, but all of them maintained a balance sheet loaded with cash and little or no debt as well as what we believed to be viable business prospects over the long-term. For those with a short memory, Apple, yes Apple, could be had for a split-adjusted $7 in early-2003 when its debt-free balance sheet had some $6 per share in cash and investments, meaning that investors were valuing the iPod purveyor’s historically innovative business at next to nothing.

Obviously, hindsight is 20-20 and Apple has gone on to post massive gains for us as the stock now trades north of $60, but we believe that downside risk is mitigated by buying into financially strong companies while investor infatuation with all things tech affords tremendous upside appreciation potential. Of course, we know that ‘Cash is King’ names like Aether Systems and Via Net.Works have not panned out, so broad portfolio diversification is paramount to achieving success. But incredibly, it is not always a requirement that a company turn around its business for a stock to post healthy gains.

For example, four years ago we featured a tiny telecom equipment provider named Vyyo, Inc. (VYYO) as a Hotline Special. At the time, VYYO was trading for a split-adjusted $4.44 and we wrote the following in support of our recommendation:

Continuing on the ’Cash is King’ theme, we would buy first-time recommendation Vyyo, a supplier of broadband access systems used by telecommunications service providers to deliver wireless, high-speed data connections to business and residential subscribers. The company's flexible point-to-multipoint systems are based on the Internet Protocol (IP) used for data transport over the wireless services, and by using a modified version of the cable industry's DOCSIS standard, economies of scale from the cable industry are combined with the wireless environment.

A year and a half ago, when broadband stocks were hot, this issue traded above $100. Today, the price is south of $5, even though the company has reported three consecutive quarters of improving results. While we are not saying business is great by any means, the bottom certainly seems to have been reached during the first quarter (ended 3/01) when sales totaled just $700,000 with a pro-forma net loss of $0.25 per share. Fast forward to the recently completed December quarter, which showed sales increasing to $3.3 million and the net loss declining to $0.09. Vyyo's balance sheet at December 31 is in excellent shape, thanks to a secondary offering of 4 million shares priced at $94.68 in September 2000, with a current ratio of better than 8 to 1, no long term debt, and about $6.75 per share in cash and short term investments. The company had about $7.14 per share in cash and short term investments at the end of the third quarter, so the burn rate isn't too bad. We would buy thinly-traded VYYO up to $4.65 as our three-to-five year target price is $9.

Boy, were we ever wrong, as the company in the four years since has produced little in the way of revenue and has reported quarter after quarter of operating losses. In fact, in the disclosure of its latest quarterly results, VYYO managed revenue of just $225 thousand while posting a net loss of $8.9 million. The revenue decline, coupled with the string of losses certainly accelerated the aforementioned burn rate, so much so that there is now only $1.58 per share remaining in cash and short-term investments.

Vyyo must have ended up as a big loser for us then, right? Well, actually no as tech investors often pay little attention to silly things like revenue and profits. Far more important to these folks were comments from Vyyo CEO Davidi Gilo who said, “Throughout 2005 we have concentrated on restructuring the company to focus entirely on the wireless utility, T-1 over HFC (hybrid-fiber coax) and spectrum overlay markets. Our financial results reflect this transition. We believe that we are making significant progress in achieving our objectives in each of these large, strategic opportunities.”

Believe it or not, we were able to sell 50% of our VYYO at $8.80 in early-2005 as momentum investors made a foray into the shares and we let go of the balance of our stake at $6.90 last month. Our average sale price of $7.85 gave us a gain of more than 75% on our initial investment! Take a look at what our resident tech expert Mark Mowrey wrote in support of our decision to cash in the remainder of our VYYO chips:

Shares in broadband systems maker Vyyo have been on a rapid ascent this month, though we're not exactly sure why. The company has released two white papers better explaining the advantages of their two major product lines - broadband wireless SCADA (Supervisory Control And Data Acquisition) systems and a line of capacity expansion products targeted at cable providers (called multisystem operators, or MSOs). We would discount the likely success of the former, given its weak traction to date, the fact that so many other companies have failed at creating a broad market for similar products, and the fact that other technologies will likely offer greater capacity at lower cost-of-equipment than Vyyo's technology going forward.

So Vyyo looks to be depending mostly on its cable-directed capacity expansion products, which allow for more efficient use of a greater amount of radio spectrum using for the most part the already-built infrastructure. These technologies, in theory, would provide cable companies the ability to directly compete with telecom firms in offering triple-play services over fiber, even after the telcos have installed fiber optic links at or near customer premises.

Trouble is, we think, despite the 'obvious' benefits the technologies could provide, they're a tough sell. From what we understand, MSOs are generally wary of committing to one manufacturer, especially one so small as Vyyo. Plus, with the telco roll-out of fiber-to-the-premises (FTTP) networks progressing quite slowly, there's no immediate need to begin a counter-attack. No wonder, then, Vyyo is pitching the technology as a 'first strike'.

Still, were even one MSO to choose Vyyo, the stock would go crazy. And that's despite the fact that the shares already discount from 5 to 10 times trailing revenue in future top-line growth. At least one analyst has predicted that Cox Communications might use Vyyo's tech in a New Orleans rebuild. That thinking led to the late November 2005 spike in the shares. The latest run is perhaps a return of that same thinking.

Vyyo also suffers dwindling cash stores - from about $6.75 per share in January 2002 to about $1.58 today - and negative revenue growth - from about $8.2 million per year in 2001 to $2.7 million in the four quarters ending September 2005. In fact, given negative operating cash flow of $27 million over the past twelve months, compared to current cash of $20.5 million (actually likely less, since it's a calendar Q3 2005 figure), something will have to come quick.

Now, even if the company were to score a big win, it would have trouble funding the deployment of gear with current working capital. Some debt or equity offering will likely be required, neither of which would help our cause. Again, though, given the attitude of most tech investors, such trivial matters would presumably be overlooked in favor of momentum. But is that reason enough, given our prudent value stance, to keep holding a name that at the present time seems more than fairly valued?”

Almost defying logic, VYYO didn’t even need to announce a new product or customer win to keep the shares moving as the stock jumped another 15% on Monday in reaction to the following press release:

“The multi-billion dollar revenue potential of business services for the cable industry will be the subject of discussion when experts from Charter Communications, Sanford C. Bernstein and Co., Inc., Sprint Nextel and Vyyo Inc. convene for a CED Magazine Webcast tomorrow.

"T1, Cellular Backhaul and Wireless -- Steering Cable's New Revenue Drivers" will discuss the ability of cable system operators to capitalize on the largely-untapped business services market as a means of maintaining growth in the face of increasing satellite and telco competition.

A successful business services strategy begins with making that entire market sector a priority," said Vyyo. "Our discussion will explore the need to create a separate business services structure within your organization, the economics and payback of T1 over coax delivery, and ways in which operators can leverage their HFC plant to backhaul cellular traffic.”

Imagine that! Simply announcing that you operate in a business with great revenue potential can add more than $15 million to the value of your company overnight! Forget about making money the old fashioned way - by earning it - just issue a press release! Now to be fair, other telecom equipment stocks have rallied in the past week, so we may not be able to attribute all of the market-cap appreciation to the PR department, but it is clear that investors are often willing to bid up tech stocks simply on the fantasy of potential revenue and income, rather than the reality of actually making money.

While we only buy ‘Cash is King’ technology stocks because we believe Plan A - growth in revenue, leading to growth in profits - will work, it is nice to know that Plan B - momentum investors piling in - can be a viable alternative!

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The information contained herein is believed to be reliable. However, such information has not been verified by us and we do not make any representations as to its accuracy or completeness.

Past Performance is no guarantee of future results.

Neither the information contained in the Buckingham Report, nor any opinion expressed, shall be construed to be or constitute an offer to sell or a solicitation of an offer to buy any securities.

Opinions expressed are those of John Buckingham, which are subject to change without notice and are not intended to be a forecast of future events, a guarantee of future results, nor investment advice. Performance results of such recommendations are subject to risks and uncertainties including (i) national and international economic conditions and fluctuations, (ii) economic conditions of particular industry and service sectors, (iii) the ability of the management of the company whose security is recommended to perform and achieve expected results of operations.

Al Frank Asset Management, Inc. (AFAMI) is adviser to its own proprietary mutual funds and is the manager of individual client investment accounts. As adviser to its own proprietary mutual funds and manager of individual client accounts, AFAMI may purchase, sell or hold positions in the securities referenced in the Buckingham Report. Also, AFAMI employees may hold, purchase or sell securities mentioned in the Buckingham Report subject to AFAMI’s Insider Trading policies.

Previous, successful recommendations may not be indicative of the results for all past recommendations. Certain previous recommendations have not resulted in profit, and in fact have resulted in losses. Of the 1,278 stocks recommended in The Prudent Speculator since 3/10/77 through 1/31/06, 71.36% were sold or otherwise closed out at a profit or are presently in a profit position if not closed out. The average holding period for each of our recommendations has been 6.65 years and they have shown an average annualized rate of return of +21.13%, not including dividend reinvestment, advisory and trading costs or leverage. A complete list of all past recommendations is posted on our website at www.prudentspeculator.com. Each investment decision you make should be determined with reference to the specific information available for such investment, and not based upon the success of past recommendations.

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About Al Frank Asset Management

Al Frank Asset Management, Inc. (AFAMI) is an Investment Adviser, registered with the Securities & Exchange Commission, is editor of The Prudent Speculator (TPS) newsletter, editor and publisher of The Prudent Speculator TechValue Report (TVR) newsletter, and is the Investment Adviser to two value oriented no-load proprietary mutual funds.

Al Frank Asset Management, Inc. is committed to assisting our customers build wealth. We are a leading resource for value-based investor information in the financial community, where we combine our simple, proven philosophy of buying under valued securities for their long-term appreciation with our experience, hard work, and intensive research to give you actionable investment information that can be used on a daily basis.

For information on separate account management, please call us toll free at (888) 994-6827. Or, visit us at www.alfrank.com.