When we bought Novell (NOVL-Nasdaq) in late 2002 at $2.90 (U.S.), the company was covered by one lonely analyst. That's unusual for a member of the Standard & Poor's 500-stock index with revenue of more than $1-billion.
While analysts rarely issue a "sell" rating to "insult" a stock, if they really don't like a company, they will often not bother to rate it at all. This is especially the case if the firm, like Novell, has plenty of internal capital resources, and is therefore a poor prospect for the broker's investment-banking arm.
For contrarians, a lack of analyst coverage can be a positive signal. In terms of sentiment, there really isn't any place to go except up. The cold shoulder from Wall Street can also be helpful to management that is overhauling the guts of a corporation. Rather than worrying about the baying of the hounds every quarter because the company "missed" expectations by a penny, they can concentrate on long-term strategy and investments that might not show results for several quarters. Or years.
Of course, without analysts to tell the tale, a firm making good progress on the operational front is unlikely to receive fair value from the market. Indeed, this is frequently the case with well-run small-capitalization companies that don't use debt to maintain growth. But for an enterprise of Novell's size, it's simply a matter of changing the "background story," so an analyst has something to sell.
Novell was toxic as long as the main theme was a company reliant on a legacy software product in an area where Microsoft was eating its lunch. But once Novell hitched itself firmly to the Linux bandwagon, and showed it was willing to spend part of its cash horde to gain dominance over the burgeoning operating system, the wind shifted.
Roth Capital began covering the stock in July, 2003. With Novell's stock at $3.70, the California-based investment banker initiated coverage with a "strong buy" recommendation. That was timely, as the stock started to move smartly on news of the acquisition of Linux vender Ximian, and then really spurted ahead with a $50-million investment by International Business Machines Corp. By the time Merrill Lynch initiated coverage in December with a "buy" rating, Novell was already over $9. Seven more brokers have piled on so far this year. History shows that coverage begets more coverage.
Our initial sell target for Novell was $12.44, which it hit on Jan. 29. But we at Contra the Heard didn't sell. In a departure from our disciplined methodology of taking the profit on at least half our position when a holding meets expectations, we reset our target to $18.24. The stock closed Friday at $8.98.
In our view, Linux has a bright long-term future and Novell is currently the world's leading distributor of the operating system. Traditional heavyweights such as IBM and Hewlett-Packard have realized that Linux may be the one chink in the armour of archrival Microsoft. Though Novell's management has a spotty record, it is nonetheless an organization that is well known to the Fortune 500. That makes it a more likely champion than a pure Linux play such as Red Hat.
One thing is for sure: However the battle unfolds, Novell once again has an audience of analysts to cheer it on.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter. This column first appeared on GlobeinvestorGOLD.com.