Bear Market Rally Ahead; Why Gilat Fell Too Far

Nov.19.08 | About: Gilat Satellite (GILT)

With another trading week now upon us, I decided to read what two experts, whose opinions I value very highly, have been saying about the current crisis - economist John Mauldin and Citigroup chief US equities strategist Tobias Levkovich. These are two experts with both legs firmly on the ground, who do not indulge in the firebrand rhetoric usually heard from people such as the famous Jim Rogers.

Rogers has made himself scarce of late, probably because his situation is pretty grim. He is short on the dollar, long on oil (a target price of $200 a barrel), and all the other commodities now tanking, and long on the Chinese stock exchange, which collapsed more than 60% last year.

Mauldin was one of the first people to spot the seeds of the current financial disaster, because he accurately predicted the devastating and long-term significance of the sub-prime crisis, which first surfaced in the summer of 2007 and was considered at the time a localized and short-term market failure in a specific bond market niche, something that would soon pass. He, on the other hand, spelled out exactly what this plethora of sophisticated CDOs and other assorted instruments represented, describing the actions of the people who created them as "taking nuclear waste and turning it into gold" with the help of the credit rating agencies.

Now that the pollution caused by this waste has spread far and wide, taking the world into the throes of a severe recession, Mauldin sees a rally in the equities market, but still chooses his words cautiously, defining it as the rally of a bear market, given that the recession is not about to end in the near future. As he sees it, all the big money withdrawn from hedge funds over the last few weeks will return via a rotating door to the big institutional investors, since as everyone knows, it's not orphans and widows who have been investing in hedge funds but the wealthy.

This money is currently making a stopover in ten-year US Treasury bonds with a yield of 3.75%, a return that is unacceptable to investors like these. Mauldin expects that from mid-January, this money will be channeled back into the stock market as a classic long investment in long-term value equities and not, as was the case in the past, in hedge funds that specialize in short-long speculative positions.

Mauldin expects a major rally throughout the first quarter, but no more than that, since the recession is set to continue, and once these funds are invested, he does not see any more money driving the rally after that until the expected move out of recession towards the end of next year. He also believes there is a chance that this rally could begin as early as the end of this year, due to the closure of short positions that have yielded enormous profit over the year.

Levkovich was another person who saw the approaching recession well ahead of time, which was why he came out last summer with the advice to investors to pull out of energy, industrial, and raw materials stocks while prices were still high. Like Mauldin, he, too, is cautiously optimistic. As he sees it, the worst of the bad news as far as the credit squeeze and official data is concerned is now behind us, and the situation will only improve with time. He believes that, based on the forecasts that things will start to improve in the second half of 2009, the equities market is not far from the floor.

Accordingly, Levkovich advises investors to buy shares in sectors which he believes are already close to the bottom end of their business cycle, and to steer clear of others that still haven't reached theirs, owing to the continuing recession. Among Levkovich's recommended choices are the financial, chip, and retail chain sectors, which were the first to nosedive, and according to his review from the beginning of the year, the sectors to avoid are energy, capital equipment, and raw materials, which are only just feeling the recession now. He warns that while the low earnings multiples on these sectors may be tempting, they are historic and signal, in his view, an imminent swing to heavy losses.

Gilat Satellite - Waiting for salvation

Among the companies traded at depressingly low earnings multiples that represent either a call for investment or a trap of the kind Levkovich refers to, are a number of Israeli technology companies which collapsed during the crisis of the past few months. Satellite terminal marker Gilat Satellite Networks (NASDAQ:GILT) is the one which, I feel, stands out from the rest, because you find yourself pondering how a company, which not so long ago was on the verge of being sold at $11.40 a share, after a due diligence review lasting an entire year, is now languishing at $2.50.

I'm unaware of any colossal collapse in its business, as might be implied from the current share price, and what's more, it is in a niche covering infrastructure for satellite communications, telephony and the Internet, primarily in the third world, an area that is hardly likely to implode in one recession or another. The current share price, it should be noted, reflects a market cap of just $100 million for Gilat, against a book value of $237 million as of the third quarter, most of it in cash and real estate assets.

As of its most recent report, Gilat was profitable and its annual rate of sales stood at $280 million. To add to this, it has a fair chance of collecting a $47 million penalty charge from the consortium that backed out of the agreement to acquire it, nearly half the company's current market cap. However, it is clear that this will entail a long legal process, which could end earlier if a settlement is reached, and that settlement is unlikely to amount to a mere pittance.

Gilat will unveil its results next Monday and assuming that, save for the setback of the aborted acquisition, the ground under it actually remained intact in the third quarter, there is no reason for there not to be a steep northward correction in the share price. The company is expected to report earnings per share of $0.08 and sales of $68 million. I will not be surprised if these targets are not achieved in full, given that management has been preoccupied with the handling of the aftershock caused by the collapse of the acquisition, rather than driving forward its business.

In addition, during this quarter management spent quite a bit of time and resources finding a solution to a major project in Columbia. The project was halted by the government there a year ago on the grounds that the company had failed to meet certain terms of service that had been written into the original contract six years earlier. Gilat replaced almost its entire management team in the region at the beginning of the year, and in the company's last conference call - in August - company chairman and CEO Amiram Levinberg said he expected that a solution would be in place by the end of September, but so far no announcement has been made about this.

The share reached its current price in three stages. First to take aim were the short sellers, who learned of the cancellation of the acquisition before it became common knowledge, and hammered it with short sales, reaching a high of 640,000 shares on the eve of the cancellation, of which just 10% now remains. This was followed after the announcement by the mass stampede for the door by all those US institutionals which bought millions of shares driven by an almost total belief that at $11.40 a share they had a bargain. The third and final stage, which dragged the share price down to its current level, was the collapse of the market itself, and the dearth of buyers for the shares the Americans were offloading.

Disclosure: None

Published originally by Globes [online], Israel business news - www.globes.co.il

© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.