3SOF

Nice upgrade today:

QuoteTuesday , May 16, 2006 08:24 ET

Issuer: Komag Inc (NasdaqNM: KOMG)

Analyst Firm:  Brean Murray

Ratings Action: INITIATE

Current Rating: Accumulate

Target Price: $54.00

Analyst Comments: The firm expects KOMG's dramatic turnaround to continue and for the company to post higher revenues & earnings in 2007.

As time pass and the demand for Hard disks continues to increase I would expect to see more upgrades from the Analysts. KOMG has already told that their capaicity utilization is 100% in Q2. Q3 and Q4 will be even stronger. The analysts now start looking into 2007 and I think they will like what they see.

What a miserable day for the market and 3SOF!

Nasdaq is down for the fifth consecutive day. The good news is that KOMG is up for the fourth consecutive day 



This is an extremely strong performance in a market that is undergoing a correction.

It would be easy to say that this is due to the strong fundamentals and low valuation of the company but I think there is more into it than that. As discussed earlier KOMG has a huge short position initiated when the whole market was very bearish on the HDD industry. The people that are short KOMG has already lost a lot of money on their position and I believe they are using this opportunity to close some of there positions.

Let me use this opportunity to discuss the market in general. I guess that the question that is on everybody minds is should I sell or buy 

During a correction like the one we are going through now you should in my opinion go cash with at least 50% of the money you have invested in the market and wait for the market to turn.

There are several reasons for this. The most important is to preserve wealth but also look at this as an opportunity to buy value stocks close to the bottom when the market eventually will turn.

All bear markets bounce so use this as an opportunity to reduce your exposure to the market if you haven't done it already. This is a difficult as I am sure that every stock you are holding is a winner but try to ask the following questions:

• Would I buy this stock today?
• Is this stock's price backed up with solid earnings or other strong fundamentals?
• Would I feel comfortable holding this stock a year from now.

If the answer is no to any of these questions and if you are over exposed to the market I would use a bounce to sell some of these stocks. What I wouldn't recommend is to go out and panic sell all your stocks. I am confident that most of the damage has been done but the US market will most likely remain weak in the months to come and you need to adjust your investment strategy accordingly.

I am personally very concerned about the US economy. Try to look at it like this. If US was a company would you buy the stock?  Unfortunately you can't buy or short United States of America. But you can vote on the health of the US economy by buying and selling US dollar. The vote right now is that US is weak!

Now this is not only bad news. All companies reporting in US dollars but has another functional currency should be doing great. These are companies like CHID, AOB, TBYH and XING. The value of their assets and profits increase automatically. Then add that these companies are working in an economy that is booming and they seem attractive. That is why I am very bullish on Chinese stocks.

You could also consider gold as a hedge against the US economy. I like gold stocks here. A nice play could be NXG (this is both a gold and copper play).

Finally if you are comfortable with your exposure to the market you might consider some short term trading here. We will most likely see a lot of volatility and there will be money to be made on fundamentally strong stocks that are falling in sympathy with the market. But again make sure to buy stocks which you would be comfortable holding for a longer term!

Remember that in a market like this there is money to be made even on the long side you just have to be cautious 

Andrew Neff from Bear Sterns recently met with Komag's management and it seems he left the meeting excited about the prospects for KOMG:

QuoteKomag, Inc. (KOMG-$42.58) - Outperform

Meeting With Management: Adding Capacity At A Measured Pace; Well Positioned for Perpendicular, Notebook

Encouraging Meeting With Management. Following our meeting with CEO TH Tan and CFO Kathy Bayless, we came away reassured about favorable demand trends, KOMG's focus on minimizing the impact of the STX/MXO merger, while continuing to broaden the appeal of aluminum-based discs in wider markets (i.e., notebooks, perpendicular). The company did not provide any new financial outlook.

Adding Capacity In A Measured Pace. Highlighting the importance of capacity utilization on its margins, KOMG noted that it is adding capacity at a measured pace and is tracking competitors actions. To that end, KOMG noted that the minimum volume requirements from its volume purchase agreements from HDD vendors (STX, MXO, WDC, Hitachi) equates to full capacity planned for KOMG. Moreover, despite recent concerns about capacity addition at KOMG's competitors (e.g., Showa-Denko), KOMG highlighted that this incremental capacity is for glass media (i.e., more expensive than aluminum) and sees the overall aluminum-based media capacity being increased at a measured rate.

Inventory Build Due To Raw Material Tightness. Addressing the concerns about recent inventory build, KOMG noted that raw materials were the primary cause of the increase (finished goods actually declined in 1Q) and the build was necessary to address the tight availability of raw materials.

Maintaining Estimates. We are maintaining our post-option EPS for 2006 of $4.85 and for 2007 EPS of $5.30. For 2Q06, we maintaining our $1.17 in EPS on revs of $229mm (up 10% seq).

Maintaining Price Target Of $65. As for valuation, we are maintaining our CY06 target of $65 by applying a 12.3x P/E multiple on our post-option 2007 EPS (i.e., 12x on pre-option EPS). We continue to monitor industry capacity coming online and STX/MXO internalizing media production, but we believe KOMG can navigate through these risks and growth opportunities remain (mobile, PMR, higher volumes at WDC).

Encouraging Meeting With Management. Following our meeting with CEO TH Tan and CFO Kathy Bayless, we came away reassured about recent demand trends and KOMG's focus on minimizing the impact of the STX/MXO merger, while -- at the same time -- continuing to broaden the appeal of aluminum-based discs in wider markets (i.e., notebooks, perpendicular magnetic recording [PMR]). The company did not provide any new financial outlook. We highlight some of the key takeaways below:

• Adding Capacity In A Measured Pace. Highlighting the importance of capacity utilization on its margins, KOMG noted that it is adding capacity at a measured pace and is actively tracking competitors actions. To that end, KOMG noted that the minimum volume requirements from its volume purchase agreements from HDD vendors (STX, MXO, WDC, Hitachi) equates to full capacity planned for KOMG. Moreover, despite recent concerns about capacity addition at KOMG's competitors (e.g., Showa-Denko), KOMG highlighted that this incremental capacity is for glass media (i.e., more expensive than aluminum) and sees the overall aluminum-
based media capacity being increased at a measured rate.

• Expanding Into New Markets: Notebooks, PMR. Highlighting the price advantage of aluminum-based disk over glass-based disk (has about $0.50-$1.25 cost advantage), KOMG noted its efforts to drive incremental growth by expanding the use of aluminum in 2.5-inch drives, which has historically used glass media only. In addition, the company noted that it working to rollout media for PMR drives with minimal additional capital expenditures (i.e., 75%-80% of current equipment can produce PMR disks).

• Inventory Build Due To Raw Material Tightness. Addressing the concerns about recent inventory build, KOMG noted that raw materials were the primary cause of the increase (finished goods actually declined in 1Q) and the build was necessary to address the tight availability of raw materials.

Maintaining 2006 and 2007 Estimates. We are maintaining our pro forma post-options EPS estimate for 2006 of $4.85 (which includes the impact of stock-based compensation expense of $3.2 million) on revenues of $962 million, up 40% year/year. We are assuming finished disk units of 148 million, up 39% year/year, with ASP of $5.75, gross margin of 28.0%, and tax rate of 2.9%. For 2007, we are maintaining our post-options EPS of $5.30 (including the impact of stock-based compensation expense of $0.13) on revenues of $1.10 billion, up 15% year/year. We are assuming finished disk units of 169 million, up 14% year/year, with ASP assumption of $5.77, gross margin of 27.7%, and tax rate of 4.0% (no change)

• Maintaining 2Q06 (June) estimates. For 2Q06, we are at post-options EPS estimate of $1.17 (vs. $0.86 a year ago) on revenues of $229 million (up 32% year/year and 10% sequentially). Komag is forecasting revenues to grow 5%-10% sequentially from the March quarter's $209 million (or about $219-$229 million) and achieve a net margin about 17%, implying an EPS range of about $1.14-$1.19 (including options expense).

Valuation: 2006 Year-end Price Target Of $65. As for valuation, our 2006 price target is $65. We arrive at our price target by applying a 12.3x P/E multiple on our post-option 2007 EPS. While concerns remain regarding industry capacity coming online as well as the potential negative impact from Seagate/Maxtor internalizing more of its media production in 2007, we believe Komag can navigate through these risks and growth opportunities remain (mobile, perpendicular recording, more volumes at Western Digital).

Bear Sterns meeting with management supports the assumptions for our valuation when KOMG was picked to 3SOV so we will continue to hold the stock. 3SOF didn't have the best timing for this pick but I have a feeling that most members who subsequently bought the stock is sitting on a small profit by now 

It will be exciting to see if KOMG can continue its impressive run over the last 6 trading days. We had a BO under increasing volume on Friday but we might see some resistance from MA(50).

It seems like everything is lined up to a perfect storm today. First we had very bullish comments from Bear Sterns then yesterday we got coverage in the Wall Street Journal:

QuoteComputers & Office Equipment
Top Analyst: Mark S. Miller, Hoefer & Arnett
Notable Pick: Komag
By SUZANNE SATALINE
May 22, 2006

To pick the best computer hardware stocks last year, it helped to look inside the guts of some consumer electronics.

As shoppers scooped up personal digital recorders, TiVos and iPods, some analysts anticipated the growth market in disk drives that are used in products other than desktops and laptops. This year's Best on the Street analysts saw that potential and scored with companies in the storage and drive business.

Mark S. Miller, who worked last year at Hoefer & Arnett Inc. in San Francisco, rose to the top with Komag Inc., a leading producer of thin-film disks, the high-capacity storage medium for disk-drive makers. He has rated the stock a "buy" since May 2003, and investors who followed his call for all of last year would have reaped an 85% return.

The 54-year-old analyst, who moved to Brean Murray, Carret & Co. in March of this year, picked stocks sparingly last year. His only other "buy" rating in this sector was on a former employer, Seagate Technology, the world's largest disk-drive supplier. His recommendation in April yielded a 17% return through the end of the year.

A former optical-design engineer at the National Aeronautics and Space Administration, Mr. Miller also worked for 17 years in the disk-drive industry before becoming an analyst. He watched as Komag emerged from bankruptcy in 2002 and thought that, given the rapid growth in technology for consumer electronics, the company's stock would be an excellent buy.

"I come from a marketing perspective rather than an actuarial one," Mr. Miller says. "I tend to look...at the quality of the product in my analysis."

Mr. Miller says he expects consumer applications for disk drives to grow to 35% of the overall market by 2009, from 10% now. High-tech companies, he figures, will have to upgrade disk storage for the booming market in high-definition TVs. He's also watching the cellphone business as companies begin experimenting with disk drives that will help users shoot and send video clips.

A top pick for this year is Veeco Instruments Inc., a maker of microscopes and instruments for nanotechnology and a supplier of thin-film heads, which read disks. The stock is in the electronic and electrical equipment sector for this survey.

No. 2 in the computer and office equipment group, Kevin M. Hunt of Thomas Weisel Partners in Boston, put Komag (2) on his "buy" list in October 2003 and kept it there through all of last year. But his best pick was Rackable Systems (2) Inc., a maker of servers and storage products. His "buy" rating in July generated a 133% return through the end of the year.

Meanwhile, however, he missed out on a 123% return with a "hold" rating on Apple Computer (5) Inc. all year.

Mr. Hunt, 38 years old, was a mechanical-engineering major for two years at Duke University before he decided "I liked financial stuff better than thermodynamics" and transferred to economics. He says he accrued most of his hardware knowledge by researching private-equity deals in his early days at Thomas Weisel.

Christian Schwab, 36, of Craig-Hallum Capital Group LLC in Minneapolis, the third-ranked analyst, also scored with Komag (3). A "buy" rating through most of July yielded a 70% return. He got even better returns with his calls on Maxtor Corp., a storage-products maker. A "buy" rating through late July and again beginning in late November generated a return of 76%, compared with the stock's 31% return for the full year.

Mr. Schwab says he remains positive on the computer industry in 2006, as it further consolidates with Seagate's pending acquisition of Maxtor, announced in December.

And today Komag and Seagate Reaffirm Strategic Relationship:

QuoteKomag is a key strategic media supplier to both Seagate and Maxtor," said Bill Watkins, Seagate's President and CEO. "We continue to have an excellent relationship with Komag and now that the acquisition of Maxtor has been completed, we look forward to a continuing relationship with Komag under the terms of the strategic supply agreements that are in place between both Seagate and Maxtor with Komag

Mix this with a very bullish chart and a huge short position that are deeply under water and you have an explosive cocktail 

Good job, Good eye, excellent pick!

Michael , I salut You!

Hi Voova,

It seems we were a bit early to the party 

The technical picture today is not pretty. Instead of showing a nice strong white candle, which I at least expected at the opening, we printed a bearish engulfing.

For short-term traders this would be a sales signal but we are prepared for a small set back on this trade. This was from the outset a pick based on the fundamentals and all news around Komag the last week have done nothing than confirmed the assumptions we made when KOMG was picked for 3SOF. Long-term KOMG is poised to go much higher. The concern about the supply/demand situation in 2007 will evaporate. The hard disk sector and therefore Komag is going to benefit from the strong demand for storage in years to come.

Michael

You remember nasdaq at 5000 points ?

Now it's only 2000. KOMG is only 43...   

Sure I remember when Nasdaq was at 5000. I also remember when it was at 1300 in the end of 2003. Those who bought KOMG then are sitting on a 4000% profit 

KOMG has had one of the most sustained up trends for the last 3 years that I am aware of and I am pretty sure that it will continue in the years to come. Even after a 4000% rise the PE is still around 10 so there is room for this incredible run to continue!

The trend is your friend and here you have the ultimate trend:

Volume on KOMG increased twofold in last 10 days!

Interesting, may be buyout comes due to industry consolidation ( seagate/maxtor ) ?

fyi:
KOMG: Short Interest UP 20.3% to 7.5M in May 2006
Wednesday, May 24, 2006 16:19 ET

According to new short interest data from NASDAQ, short interest for Komag Inc (NasdaqNM: KOMG) INCREASED 20.3% to 7,518,501 shares for the month ended mid-May, 2006.

SYMBOL         APRIL                 MAY          CHANGE       %CHANGE        DAYS/COVER
--------   -------------   -------------   -------------  ------------  ----------
KOMG           6,248,816       7,518,501      +1,269,685       +20.32%           6

Based on KOMG's 20-day average daily share volume of 1,495,055, it would require approximately 6 day(s) of buying to cover this short interest.

& lots of insider selling:
http://www.secform4.com/insider/showhistory.php?cik=komg

Hi la-onda

I understand that high S interest isn't good from on side and good from other side(short squeeze).

But the question is why big funds or"big boys" shorted it (amounts like those - from big players, imho)?  For manipulation or another reason?I don't understand exactly how it works? 

I can only say that at november 15 last year S interest was higher and KOMG was only climbing 

Best,
Vova

Hi Oliver and Vovaa

As Vovaa hinted to it is always very important to put short and insider activity into context. What is the volume and what is their track record

Lets start with the short activity:



Most of the existing short position was established between middle July and November last year. In the same period the sentiment concerning the Hard Disk Drives industry changed from Extremely Bearish to very Bullish. Basically the short case fell apart for each upgrade the analyst issued and for every earnings report that HDD companies released. They therefore started covering between November and March. However at the end of November they had in their wisdom shorted approximately 30% of the total float and every attempt to cover basically was met with a sharp increase in the stock price. In the middle of March they probably realized that they had dogged themselves into a hole they couldn't get out off with out a little help. But help was on the way! A very little known research house, American Technology Research issued a sell recommendation with a target of 29 and the shorts promptly followed up shorting additional stocks.

So how is this working for them?



The chart above shows the shorting acitivity and I have highlighted certain days were I believe most of the shorting was done. As can be seen I believe most shares was sold short at a price between 25 and 35. Let's say the average is 30. In the middle of March the shorts had managed to cover 4 million shares at a significant loss. My feeling based on the chart is that most of the covering happened at prices around 37-50 lets say in average 42. If correct they had lost 48 million USD on the shares they managed to cover. They still held 5.8 million shares short, which they had an unrealized loss of 116 million USD on.

Recent activity

Here is what I think happened at the end of March. A couple of the big hedge funds set down together and discussed the problem they had with Komag. Basically they had lost 150 million USD and they couldn't get out of their position without increasing this loss even further. They decided to buy a research house to issue a negative biased report in the hope that the rest of the analysts would follow up. As their break-even point for covering without a loss was 30 they asked for a target price of 29. When the report was issued they followed up with shorting the stock on the same day to create momentum.

The strategy partly succeeded they managed to get the stock price down with a few points and some of the analysts promptly changed their recommendation. Unfortunately other analyst took the time to do their own analysis and reiterated their buy recommendations. So by the end of the day the stock went back to where it was before the short attack.

I was thinking about writing this when American Technology Research issued their sell recommendation and suspicious target but I know that some people don't believe in these kind of conspiracy theories so I refrained. For those who are in doubt that this is happening there are actually a few recent court cases where hedge funds are accused of paying for negative biased coverage, which you might want to read!

So how is the short community's track record on KOMG?

I guess miserable is the best word to describe it. There are two things I am absolutely sure about. They wish they had never shorted the stock in the first place and they would love to close their position at this level if they could!

KOMG is a very healthy company with a strong cash flow and it is difficult if not impossible for them to drive the price down so they can cover. This is probably best illustrated with the latest attempts. They are actually already sitting on a loss on those shares they shorted in April. Their situation today is probably worse than it was in March because they have now set a deadline, which is 2007. I strongly believe that KOMG will continue their profitable growth in 2007 and when this happens the shorts are dead meat.

To sum it up as Vovaa said short activity can sometimes be a blessing in disguise and in the case of KOMG I think that the huge short position is a real asset. They will have to continue to cover sooner or later and if they are smart they will start cover before the end of this year.

Concerning Insider selling, which often is used by the short community to argue that the stock is overvalued, it is again important to put it into perspective. The graph below shows the insider sells during the last year.



As you can see there is no increase in insider selling. In fact insiders have been selling shares at this level since the stock was below 10. Their track record is as bad as the short community's. So why are they selling shares?

The answer is very simple. Their share options are part of their salary. They sell shares to pay for their mortgage, a new car etc. They have been doing this constantly for the last many years and historically there have been absolutely no connection between the development in the share price and the insider sales.

If your ability to pay your invoices depends on the performance of the stock you might work a bit harder to make sure the company is succeeding. So again no help for the short community here even though they will continue to bring it up every time an insider sell some of his shares!

Michael

Thank You for deep analysis and explanation . I'm realy enjoyed 

Some interesting stuff

http://www.digitaltvdesignline.com/news/174402937;jsessionid=JQGIGOJKHJ31AQSNDBECKICCJUMEKJVN

http://www.storagesearch.com/semico-art1.html

Very positive article about future growth of HDD.. and "PERPENDICULAR recording" !!!

http://money.cnn.com/2006/05/03/technology/hard_drives/index.htm

We have some more..

http://www.infoworld.com/article/06/01/13/73896_HNfujitsuharddisk_1.html