News Analysis date published New: 
Friday, August 31, 2012 - 09:30
New Date created: 
Friday, August 31, 2012 - 09:52
New Date last updated: 
Friday, August 31, 2012 - 09:30

Buy or Sell? Friday's Winners: SAIC, SPLK, OVTI

Friday, August 31, 2012 - 9:30am

Among the biggest winners in Friday's early trading are SAIC Inc. (Nasdaq: SAIC), Splunk (Nasdaq: SPLK) and Omnivision (Nasdaq: OVTI).

Breaking up is easy to do
For the past few decades a number of academic studies found that building a far-flung empire of companies is a bad idea as far as investors are concerned. The unwieldy nature of such massive enterprises makes it hard to peg a value for the entire firm, leading to a "conglomerate discount."

So whenever investors see a company take steps to break itself into pieces -- or "deconglomerate" -- they cheer loudly. In just the past 18 months firms such as Marathon Oil (NYSE: MRO), Sara Lee (NYSE: SLE) and Tyco International (NYSE: TYC) have all racked up quick gains when they announced plans to break into two parts.

The latest example: Information technology and defense contractor SAIC Inc., which is rallying nearly 8% this morning after announcing plans Thursday to spilt itself in two.

SAIC's decision is for an unusual reason: The company found that certain divisions were being hampered from pursuing government bids because of a conflict of interest. In effect, the government was displeased that SAIC's technology consultants were recommending the use of the firm's technical services division.

Yet caution is warranted, especially after today's gain. That's because SAIC has been a huge beneficiary of the government's decision to outsource many security and intelligence functions over the past decade. Sales shot up from $5 billion in fiscal (January) 2004 to more than $10 billion by fiscal 2009. The fact that sales rose to just $10.6 billion by fiscal 2012 highlights the limits of government's outsourcing efforts. And there's a good chance that outsourced contracts will be brought back in house to save money, which means that companies like SAIC may actually see revenue declines in the belt-tightening years ahead.

A solid sophomore report from Splunk
When a company goes public, the stage is often set for a solid initial quarterly report. The company is well aware that many investors are paying close attention, so all efforts are made to pump up the quarter. Yet many of these companies often stumble in the subsequent quarter as all the tricks to juice a quarter have been exhausted.

So it's quite impressive that analytics software firm Splunk delivered an impressive sophomore quarterly report on Thursday evening, giving the stock a double-digit gain in today's trading. Fiscal second-quarter sales of $44.5 million were more than 10% ahead of consensus expectations as more clients sign up for the company's "Big Data" software. That phrase has created a lot of buzz in tech circles this year as companies seek to more effectively harness and analyze all of the reams of data their servers are producing. Splunk was widely touted as one of the leading Big Data players when it was private, and still has that reputation now that it is public.

Trouble is, with buzz comes nosebleed valuations. Splunk is on track to generate around $185 million in sales this year, yet its $3.5 billion valuation should give you pause. That kind of price/sales multiple is hard to maintain as a company grows ever larger. Shares now trade for twice as high as the April 2012 offering price, and if you missed this meteoric rise, you may as well wait to see if Splunk stumbles in the next quarter or two, which would allow you to own this intriguing company at perhaps a far lower price.

Another Apple play falls near the tree
Unless your name is Samsung, it can be so nice to get a phone call from Apple (Nasdaq: AAPL). Once the company decides to use your company's technology, you can count on solid demand for your products -- and strong appreciation from investors. Omnivision, which provides the chips used in Apple's phone-based cameras, is just such an example. The company's sales have risen from $507 million in fiscal April (2009) to around $900 million by fiscal 2012, thanks to big orders from Apple.

Omnivision's just-announced fiscal first-quarter sales of $258 million were nicely ahead of the $243 million consensus forecast. More impressively, projections of sales in excess of $350 million in the current quarter are far above the consensus $270 million forecast. That's an early glimpse that Apple expects to sell a lot of new iPhones in coming weeks and months. Look for analysts to sharply boost their forecasts as fresh reports roll in, and look for shares to extend today's gains as investors take note of a still-reasonable valuation in the context of surging sales and profits.

Action to Take --> Although Omnivision will never garner a high multiple, shares have ample room to run further. As a point of reference, audio chip maker Cirrus Logic (Nasdaq: CRUS) is also a provider to Apple and trades at around 13.5 times forward earnings. If analysts adjust their fiscal 2013 earnings-per-share forecasts for Omnivision up to around $1.50, then shares could move up into the lower $20s.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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