Portal: A Bad Apple?

04/28/2006 12:00 am EST


Mark Mowrey

Senior Analyst, Al Frank Asset Management

Mark Mowrey is part the exceptional research team at the Al Frank funds. His focus is on finding stocks with both growth and value with the technology space. Here's a sample, as he reviews a growth stock, where recent bad news that may have created a value.

"Without telling why, Apple Computer dropped the next-generation chips from PortalPlayer (PLAY NASDAQ), which are due out in the second half of this year, from its mid- to high-end flash-based portable music players, specifically the iPod nano. The stock fell 42% on news of this product transition setback.

"This is an incredible setback, indeed. But not yet a company killer, so we're highlighting the stock as a Hotline Special. Officially, PortalPlayer develops semiconductor, firmware, and software platforms for portable multimedia products such as personal media players and secondary display enabled notebook computers.

"PLAY makes the second of two companies competing for Apple's iPod business that have performed, well, less than gratifyingly after our initial recommendation. The other is SigmaTel (SGTL NASDAQ), shares which suffered greatly when Apple cut their chips from the parts list of the iPod nano in favor of PLAY's back in 2005, and which fell sharply after our initial recommendation on weak guidance.

"Now, there's a high likelihood that Portal's business will come back to SigmaTel. After all, it is the king of flash-based portable music player controllers. Fine justice that would be. Portal stole nano-related sales from SigmaTel, which at the time was Apple's sole controller supplier for its then only flash-based iPod, the Shuffle. Of course, neither may get the business.

"Were Apple to begin focusing more heavily on video in its flash-based players, Texas Instruments could get the work. The company has developed a chipset named DaVinci that can serve as the brains of portable video players. Another option for Apple, this one more probable than Texas Instruments, is Broadcom. That company was included in the first iPod video as the driver for video output. PortalPlayer maintained its role as the core processor for the device.

"Broadcom has since developed a competing system-on-a-chip (SoC) that could replace both its existing video driver and PLAY's processor. Samsung could also get the work, considering the fact that Apple get much of its NAND flash memory chips supply from the Korean electronics giant, and that Samsung could integrate memory and controller functions perhaps more easily than the others.

"Of course, we don't really even know why Apple cut Portal's next generation chip. Portal doesn't know why, either. Or at least they aren't saying why. Could be Apple has different plans for the iPod nano. Or Portal's technology might not have stacked up well against the competition in terms of availability, performance, price, or all three.

"We're hoping, certainly, that Apple will choose SigmaTel. SigmaTel recently added FM radio tuner functionality to its chips, an option Apple now offers iPod users via a fumbly $50 adapter. The incorporation of a radio tuner into the nano would make for a nice feature progression without significant added cost, helping Apple to justify static pricing while not cutting too hard into margins. For those interested in SGTL, we continue to recommend its purchase up to $9.90.

"Given the dramatic potential detriment to Portal's income statementthe company believes it generated more than 90% of revenue from Apple in 2005 we cut a major chunk out of PLAY's target prices. And we caution that a hit to Portal's hard drive iPod business would be a more significant issue, potentially leaving revenue at 10% of its current level.

"CEO Gary Johnson stressed that the company is still shipping product for video iPods, and that they would vigorously compete for that business. A loss there is not altogether unlikely, though, with Broadcom and Texas Instruments both keen on grabbing those chip sales away. Were such a situation to arise, the stock would take another grand hit.

"However, Portal isn't without any other cards to play. In fact, its best hand may yet be shown. The company's 'Preface' chips, which will take advantage of the 'Sideshow' application to be included in Microsoft's next-generation Vista operating system, could mark a major departure from PLAY's heavy reliance on Apple for revenue. In fact, on a unit basis, chip shipments could well exceed those for the portable music player segment.

"Preface's potential is part of the reason we remain buyers of the stock today. The other? Cash and near-cash on the balance sheet now comprise 61% of the stock price, at $7.54 per share, with the remainder trading at just three times trailing earnings. At that level, earnings could take a gigantic hit before the stock became overly expensive. A fabulous firm, Portal could adjust operations before earnings turned negative. Keeping a long-term view alive, we remain buyers up to $16.09."

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