Poorer but wiser. That’s how technology investors – those who didn’t realize they were backing near-crazy growth expectations and failed to bail out – would probably describe the lessons learned after the disaster-strewn meltdown of 2000. Even experienced fund managers caught the technology contagion; a few of them had the front to hang onto earlier cash bonuses, to the anger of many private investors who had no such safety net.
And yet, four years on, the tremor of bulls’ feet has begun to pulse – lightly so far – through the earth again. Stocks from a wide range of IT companies, including Nvidia Corp and Cisco Systems, have risen appreciably in the last quarter, some spectacularly so: Apple Computer is up more than 60 percent since the end of September, while software player AMD has soared 63 percent.
The big tech turnaround
What’s going on? Certainly, 2004 was not a specially joyful year for most capital markets, so why has tech suddenly begun to sizzle and spit? And what have fund managers – not to mention IROs – learned from the hard, bitter lessons of Spring 2000?
Ian Heslop, fund manager of Old Mutual’s Global Technology Fund, says the industry has experienced a thorough shakedown, and tech earnings and revenue growth are more realistic than the dizzying levels reached four years ago. ‘The consensus in our office is that numbers are much more real and [companies] know they won’t get credit for giving over-aggressive growth figures,’ Heslop states. ‘Earnings guides do tend to be highly achievable, if not on the loose side.’
But even if earnings look a tad loose, markets expert Justin Urquhart Stewart of Seven Investment Management is wary about any new tech bull run. This year’s fashion items, he cautions, can turn into next season’s tank tops. ‘I was rather worried when I read the same tech boom headlines,’ he says. ‘It looks dangerously like another fashion fad. I don’t think there is really an appetite for it. Some parts of the industry have been undervalued, and there has been some rebalancing going on with increases in corporate expenditure, though some will always take it too far.’
Happily for investors, the Sarbanes-Oxley rash of upgraded securities regulations should mean tech companies now operate on a much tighter leash. But Heslop says not all Sox changes have been positive. ‘One problem now, which you didn’t have four years ago, is Regulation FD,’ he points out. ‘I’m not necessarily looking for information that’s particularly proprietary, but it does seem as if companies are hiding behind Reg FD, giving less information than they were. Reg FD was supposed to make things more equal, not less. More people also see their job first as how to stay within the law, rather than disseminating information to investors. For example, you might want to find out whether a quote is back-end loaded, or tracking in a less linear fashion than normal. Information tends to be forward-looking or retrospective, but many companies are simply not prepared to talk about what’s happening now.’
IR lacking
So what would investors prefer? An information surplus in a climate of investor near-hysteria, or a thinner flow of information digested by a more rational, discerning market? Hugh Grieves, London co-manager of Société Générale’s Technology Fund, thinks the quieter tech waters have done much to steady investor focus. But some things don’t change – such as poor IR presentations. ‘Tech companies tend to go to extremes,’ Grieves notes. ‘They either assume you have a PhD in computer engineering or assume you know hardly anything and give you a presentation of such blandness that the experience is meaningless. Sometimes the same sort of IR presentation is given to all, with absolutely no attempt to tailor to specialty knowledge.’
For Grieves, the perfect presentation would be a decent description of the market in which a company operates, what drives its growth and how it slots into its own market. ‘Microsoft does a very good job of explaining; SAP does a reasonable job,’ he points out. ‘But some companies still give you no validation on anything that’s said, like the market catchphrase ‘best-of-breed technology’. Then they might talk about partnerships in place, or synergies. But if you don’t understand these claims, you need to see examples. What investors have learned is not to believe everything they hear.’
This skepticism can often be directed more at IROs than at CFOs, says Nick Evans, fund manager of Framlington’s NetNet and Nasdaq tech funds. ‘In many cases, IROs don’t seem to be much better informed than investors,’ says Evans. ‘Good IR teams have close ties with management. They could even save management time on the road seeing investors by simply being a lot better prepared. Technology demand trends and product lifecycles can change a lot faster than other sectors, so there’s a need for IR to be more informed than in other sectors.’
Evans, who took over the Framlington NetNet fund mid-way through 2001, well over a year after the tech bust, focuses squarely on earnings growth and cash flow. Over the last two years performance is up – due in part, Evans says, to a more disciplined approach to valuations. ‘We’re growth-orientated but only when growth is combined with reasonable valuations,’ he explains. ‘However, we don’t expect a bullish environment for tech spending. With decelerating GDP growth, tech spending is likely to decelerate with it, but it will still grow. So we’re looking at technology companies that increase productivity, like offshore outsourcing, business intelligence, integration, IP networking and security. We also look for other themes like broadband adoption, and digital conversion of voice, video and data, where there’s more potential for double-digit growth.’
That growth is badly needed. For the five years from the beginning of November 1999 to November 2004, the Framlington NetNet fund plummeted 66 per cent in value. Admittedly the fund heaved itself up by 41 percent during the last two years of this period, but for those who piled into the fund in late 1999, their losses remain wretched and painful.
A question of trust
Many fund managers who were also badly burnt are now – one hopes – more skeptical. Grieves says much skepticism is really just common sense, like having more cash on the balance sheet rather than too little. Overall tech transparency has improved in most places, he adds, though Asia can still give him pause: ‘Asians typically are still poor on IR, and still very good at disappearing when business is bad. Typically, Chinese and Korean companies make very bald growth statements, and they all say exactly the same kind of thing – too much competitive posturing.’
The trust element is also echoed by Evans. ‘If a company wants a successful relationship with investors, it’s about making realistic promises, and showing you can deliver on those promises,’ he says. ‘It doesn’t matter if it’s from an IR guy or senior management, though hopefully the IR person is part of senior management.’
Some savvy investors have certainly used the poor market sentiment to bolster their positions, aware that the last corporate IT buying spree was a while back, and some replacement buying is inevitable. Much of the really opportunistic buying, though, is likely to have taken place in late 2002 when the technology-laden Nasdaq hit rock bottom. Tech stocks generally are more highly geared, so any change in market sentiment will give an extra kick to any sector comeback.
However, investors should also be aware that the recent tech uptick could well have been supported by a strong seasonal following wind, says Robert Harley, a research fund analyst at independent broker Bestinvest. And upward gusts in winter aren’t unusual. ‘Historically, tech companies have their best quarterly reports in the last quarter of the year, and their weakest often in the second or third quarters,’ Harley explains. ‘This could be down to future capital expenditure and what is planned for the following year. But I don’t think in the broader sense [tech] is a high conviction sell yet.’
Harley says it is also useful to screw down tight on what technology actually means. ‘Do you include Amazon, Yahoo! and Google?’ he asks. ‘These are good users of technology, certainly. But this area can get very blurred.’ He says Bestinvest is now interested in a Legg Mason growth fund, run by Robert Hagstrom, which has a lot of good consumer discretionary players and big users of technology, though most aren’t tech operators per se.
Meanwhile, the likes of Heslop are putting cash behind companies that have taken a knife to costs, and cut deep, such as Lucent and Nortel. ‘[Both] have gone from 100,000 employees to 25,000 and gearing in revenue improvements should be a real improvement,’ Heslop says. ‘Margin structures on a lot of tech hardware and software are relatively high, and that can add a lot to profitability, especially if people pay money for the most recent upgrades, and can see reason to do it.’
Heslop also points out that tech companies are now more keen to look at the efficiencies of their whole business model, rather than simply looking to the next six-month payback period on the back of a new software update.
The future is bright
Some US government tinkering – now that election uncertainty has been removed – around the edges of corporate tax laws could help lift prospects, with more share buybacks looking likely. Higher energy prices, too, are concentrating minds on high-tech energy products. Spending on defense and surveillance, both heavy users of technology, is also on the increase.
The possibility of higher IT spending is backed by new data from IT research specialists Forrester Research. Forrester surveyed almost 1,400 tech decision-makers from the US and Europe and found US companies plan to more than double their 2004 IT spending, from 1.7 percent to 3.9 percent. Major software application buys are indicated, as well as a bigger security spend, the survey claims. Meanwhile, Sarbanes-Oxley and other regulatory requirements could also push spending on storage and content management equipment.
According to Forrester, ‘Demand for storage looks particularly strong, with 43 percent of North American enterprises expecting to increase spending on storage hardware and software – a big change from last year.’ Forrester also predicts much of the upturn will come from the retail, media and entertainment industries, and that Europe, not the US, will lead R&D emerging technology investment, with Europe spending almost 50 percent more in this area.
So is the tech upturn for real? Lipper research analyst Jeff Tjornehoj says it’s still a strong case of ‘buyer beware’. ‘I think someone will pull away the punch bowl,’ he warns. ‘This latest surge has really been only in the last quarter of 2004. I think there could be some profit taking to come, with slackening volumes – and more volatility.’
Heslop agrees: ‘Look at the whole Blackberry phenomenon. People are getting more mobile, handsets are more intelligent. Any high-level employee can be in touch with work 24 hours a day, so there’s a lot of interest in the sector. But it is starting to feel like 2000 again, and valuations are getting far beyond growth rates. Amazon is a great stock, but we don’t hold it. It’s a bookseller on twice the P/E of Barnes & Noble – how far can Amazon really grow to justify that price?’
There’s also the question of maturity. Many companies that drove the tech boom in the late 1990s – Cisco, Intel, Amazon – are now mature companies that carry much less of a ‘wow’ factor. Consolidation, then, is very much the theme.
As IR magazine went to press, Bill Gates opened the massive Consumer Electronics Show in Las Vegas, where 50,000 new products were unveiled to tech fans. In his introductory speech, Gates told the audience great strides had been made in the key IT worry areas of compatibility and ease of transfer – issues that deeply affect corporate IT budgets. Consumer and entertainment technology buying also appears strong, with high-definition TV and digital broadband and music technologies – not to mention an explosion of gaming products, many designed to be played online – tempting consumers to open their wallets, Gates predicts.
Tech investors, then, could certainly be rewarded. But Harley says the tech sector has rewarded – and ravaged – investors before. ‘The thing about tech is that it’s a broad sector,’ he cautions. ‘You have to look at all the components. And, yes, it does have a habit of surprising on the upside – but breaking backs on the down.’
