Regime change in Egypt and anti-austerity rallies in Portugal appear to be nothing more than dust in the wind for the broad-based S&P 500, which is slowly trickling its way back to its all-time record highs. For skeptics like me, that's an opportunity to see whether companies have earned their current valuations.
Keep in mind that some companies deserve their current valuations. For example, Emulex (NYSE:ELX), a connectivity solutions supplier for storage and networking companies, hit a new high on rumors that it could be hiring an investment bank to explore its strategic alternatives. Even if these rumors prove untrue, Emulex could be in line for a big orders boost as service providers like AT&T ramp up their 4G LTE expansion and enterprises build out their data centers.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Sharing is caring, but growth matters too!
There are few industries that boast higher forward valuations than the software-as-a-service, or SaaS, sector. Investors definitely have a reason to be excited about growth in this industry, as it's helping numerous industries reduce costs and improve efficiency, and it could be ripe for further consolidation. But just make sure not to lump SaaS provider IntraLinks (NYSE:IL) in with that group.
The advantage for IntraLinks is that it fits into a very unique niche of SaaS: It handles inter-enterprise communications. Essentially, IntraLinks provides software that allows the collaborative sharing of information between businesses and during mergers and acquisitions. To shareholders' delight, M&A activity has been really strong over the previous year, with the company highlighting a 21.5% increase in M&A software revenue in the first quarter. Yet I'm not convinced this is worth anywhere near the current forward earnings multiple of 48.
First, IntraLinks needs M&A activity to continue to grow if it has any chance of delivering a respectable increase in revenue. If we've learned anything from history, it's that M&A activity has a tendency to ebb and flow with the economy. Although U.S. GDP is on the mend, the prospect of higher interest rates as a direct response to the imminent end of QE3 could halt M&A activity in its tracks.
Another disconcerting aspect about IntraLinks is its overall revenue outlook. Whereas you could easily snag double-digit growth from countless SaaS providers, IntraLinks is only going to deliver roughly 3% sales growth this year and less than 5% next year. It makes little sense to pay an earnings multiple of nearly 50 given such weak growth rates. I'd suggest doing yourself a favor and looking elsewhere in the SaaS industry.
A case of the Tuesdays
Investors are really starting to see the best in deeply discounted home appliance retailer Tuesday Morning (NASDAQ:TUES), which delivered a 2.8% increase in comparable-store sales in the third quarter, but I have other ideas for where its share price may be headed.
I will certainly give the company credit for being in the early stages of executing a turnaround. Traffic and sales ticket values were both higher in the third quarter than they were in the year-ago period, but the housing market and U.S. consumers are still much more fragile than we think they are. In a similar scenario to that of IntraLinks above, I suspect a rise in interest rates could really put a scare in U.S. consumers and cause them to tighten their spending -- especially as it relates to discretionary home purchases.
Tuesday Morning is also a very cyclical company. Over the past year, only the Christmas quarter was profitable, with the company reporting a wider-than-expected loss in the other three quarters. This puts a lot of pressure on management to get the right product on its shelves. One bad fourth quarter can sack Tuesday Morning's prospects for up to a year!
Finally, it's a case of shareholders jumping the gun. Tuesday Morning isn't set to become profitable on an annual basis until next year; and even then is valued at close to 40 times forward earnings and 42 times its free cash flow.
I see plenty of question marks, which, as an investor, would make me want to leave this stock on the sales rack.
Can the excitement lead to profitability?
Sometimes investors have to put aside their feelings about a product or technology being "cool," and just face the facts that a stock has gotten way ahead of its expectations. That's how I currently feel about biopharmaceutical company Alnylam Pharmaceuticals (NASDAQ:ALNY) which is a wholly clinical-stage company developing exciting new RNAi therapeutic products.
From a testing perspective, the initial results have been encouraging. One of its more advanced compounds is ALN-TTR02, which the company reported positive mid-stage data on earlier this week. The study demonstrated a 93% knockdown in TTR rates for the treatment of TTR-mediated amyloidosis. This was consistent with the 94% reduction noted in early-stage trials.
But we have to ask ourselves if two mid-stage trials and three early-stage trials merit a $2.3 billion valuation regardless of how much promise Alnylam's ALN-TTR02 has shown. For me, that answer is "No!" Thus far, peak sales estimates for ALN-TTR02 have ranged from $800 million to $2 billion. However, the drug needs to complete phase 3 trials, go in front of the Food and Drug Administration's panel, get approved the FDA, and be successfully marketed. On top of this, Alnylam will also owe single-digit royalties to Tekmira Pharmaceuticals. We're talking about 1,000 steps to go, and investors are focused on No. 72.
Ultimately, Alnylam is a very intriguing company, but it isn't worth nearly $2.3 billion until we get a good look at those phase 3 results. Even with the approval of ALN -TTR02 there is no guarantee of profitability for Alnylam for quite some time. Even as an optimist, I can't support the company's valuation here.
Sometimes the best short-selling candidates aren't terrible companies, but merely companies that shareholders have gotten a little too excited about. In each case above, the potential for growth, a turnaround, or a blockbuster pipeline candidate exists, but shareholders would be wise to wait for the actual results rather than chasing the share price any higher.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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