My colleagues and I spent a great deal of time on-air Thursday discussing Apple's (NASDAQ:AAPL) acquisition of music streaming and audio equipment company Beats. While I think the deal is a good thing for Apple, read further before buying AAPL shares.
For the past century, we have been burying millions of miles of copper wire to facilitate communication. This not only spawned miraculous changes in the transmission of voice and data, but it created slews of millionaires who recognized the potential and exploited the build-out of the now archaic telecom infrastructure.
Beyond the meteoric rise of the price of copper itself, telecom giants like NTT Group, AT&T (NYSE: T), Deutsche Telekom, Lucent, Verizon (NYSE: VZ) and so many more collected billions in fees for allowing the masses to access their information highways.
In the 1990s, several companies began to lay the new foundations for the coming of the Internet age by installing fiber optic cables between major city hubs to increase speed, efficiency and quality of the signals being transmitted. The build-out has been relatively slow and hit a major speed bump with the recession in 2008-09.
While fiber optics have been used for decades, we are just in the early stages of the next generation of light-speed data popularized by high-frequency trading (HFT) firms and books like "Flash Boys," which begins with a single bundle of fiber being laid between Chicago and New Jersey.
Big data, cloud computing and streaming media are all dependent on high-speed, high-capacity data lines. And the Apple deal simply accelerates an already growing trend -- one where speed, bandwidth and Internet access for all is the end goal.
How to Exploit the Apple, Beats Merger Like the Pros
Sometimes when the headlines are steering retail investors one way, the pros look to find the not-so-obvious impacts of a deal or trend.
On the surface, many investors see Apple paying $3 billion for a company that makes overpriced headphones. In reality, they are gaining talent, ideas and software. Most importantly, Apple is gaining a streaming Internet music service that it can integrate into iTunes (or keep separate) and enter the highly competitive and fast-growing market of streaming music and video -- think Apple's version of Pandora (NYSE: P).
Backing my thesis is the recent FCC proposal on net neutrality -- or the potential end of it. The discussions about paying for bandwidth are likely to end up making the Internet faster and cheaper. The bottom line is that companies like Netflix (NASDAQ: NFLX), Apple, Pandora and Google (NASDAQ: GOOG) need to get your entertainment to you quickly and as cheaply as possible. Google has even started laying its own fiber in an effort to stay one step ahead of the competition.
Selecting the right fiber stock is tough, as there are several players who all stand to benefit from the expansion.
Corning (NYSE: GLW) is a large supplier of both cable and hardware for the industry, and the stock has been an exceptional performer over the past two years. Its Gorilla Glass is used in many smartphones and tablets as well. Finisar (NASDAQ: FNSR) and JDS Uniphase (NASDAQ:JDSU) should also benefit from the fiber revolution, but those stocks have had tremendous runs and are volatile.
The stock I like best is Level 3 Communications (NYSE: LVLT). The company provides myriad services and solutions for networking. It is a key consolidator and force to be reckoned with in network infrastructure with operations in over 500 global markets. It controls over 100,000 route miles of fiber.
Earnings have increased sharply over the past year or so. The company was losing money in Q1 of 2013, but it recently beat Q1 2014 consensus estimates by $0.19, earning $0.47 per share.
Earnings estimates have been moving higher over the past year, and estimates for 2015 are the highest in five years, when shares were hitting their mid-2011 peak.
LVLT is a Zacks #1 Rank (strong buy), and it recently received several upgrades from other analysts. There are currently no sell ratings on the stock. Over the past two months, analysts have also been upping their price targets. The median target is around $50, which is our goal for the stock as well.
I think traders are going to start focusing on fiber and network companies even more in the coming months with the FCC talks and the meteoric rise in bandwidth usage, and that should be a catalyst for higher prices in LVLT.
LVLT Call Option Trade
Today, I am interested in buying LVLT Sept 41 Calls for a limit price of $4.50.
Risk graph courtesy of tradeMONSTER.
While I believe this is going to be more of a short-term trade, I opted for the September expiration because of the market's overbought situation and because this will allow us to hold through the next earnings report if the target has not yet been hit.
This call option has a delta of 67, which means it will move roughly $0.67 for every dollar that LVLT moves, but it costs about one-tenth the price of the stock.
The trade breaks even at $45.50 ($41 strike price plus $4.50 options premium), which is 4% above current prices.
The $50 price target would equate to a least $9 in options premium, or a 100% return.
For our stop-loss, I am willing to let this trade move around quite a bit because it is a higher-risk trade and the markets are shaky. Since we are looking to make 100%, I am willing to risk the entire premium. That said, don't be afraid to close the trade out in September if LVLT is stagnant.
Recommended Trade Setup:
-- Buy LVLT Sept 41 Calls at $4.50 or less
-- Do not use a stop-loss
-- Set price target at $9 for a potential 100% gain in 2-4 months
-- Do not use a stop-loss
-- Set price target at $9 for a potential 100% gain in 2-4 months
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