FRIENDS IN LOW PLACES
by Edward Moy
10|05|2001 07:00 AM
'Tech opportunity' is no longer an oxymoron, and mutual funds offer a relatively low-risk way to play.
Often the best opportunities in investments are the ones least in favor. Right now, tech stocks head up that list. (Who'da thunk it?) For many people it seems just as crazy to consider tech investments now as it once seemed idiotic to exclude them back in 1999 and early 2000. But investors who are inclined to tiptoe back into the tech sector might do so through closed-end mutual funds. We asked Mike Prentis, who runs the 3i Group European Technology Fund, to walk us through the still precarious technology sector. His U.K. investment trust, which holds about $130 million of various tech stocks, currently sells at about a 20% discount to the fund's net asset value.
Prentis, who focuses on small- and mid-cap issues, was happy to discuss trends in the Euro-tech sector, provided readers clearly understand that he and his firm are under regulatory restrictions that prohibit them from marketing their fund to nonqualified, non-U.K. residents. By agreeing to speak to Grant's Investor, Prentis has no intention of violating those restrictions.
As for what is going on in the technology sector, he minced no words in reminding would-be investors of the "huge uncertainty" that persists despite the massive hit technology stocks have taken over the past 12 months. "I think it is difficult to be very confident about any particular trends at the moment," he said. However, he did suggest a few areas that offer "fairly low-risk growth."
Pointing to "outsourcing-type companies in Europe [as] good places to look," Prentis mentioned names ranging from Xansa (Bloomberg: XAN LN), which is the old FI group, to ITNet (ITN LN), to a French company, Atos Origin (SAX FP)*. These firms "provide all sorts of outsourcing solutions to companies [and] to governments," he noted, "with long-contracted revenues stretching out five to seven years hence. I rather like that, with this kind of customer base, they look to sell other products [in addition to their contracted services]. For instance, at IT Net [which operates in the U.K.], about half of its revenue is in the local government space." At Atos Origin, on the other hand, "half of its business is effectively outsourcing functions for all sorts of companies," Prentis said. "They process millions of credit card transactions, for instance, for some of the big credit card providers under contract."
Prentis explained that the outsourcing companies "virtually take over the running of large parts of their [clients'] IT departments. They take the employees under their payroll and basically run the whole IT function using their own computers. They don't have to manage the whole of the IT function; they also can manage certain processes [and] they are providing certain functions on an ASP [Application Service Provider] basis for some of the [local authority clients]. They've actually provided SAP [software] on an ASP basis." That the contracts typically stretch for at least five years "gives you quite a bit of comfort," Prentis added.
Speaking specifically of IT Net, he called it "pretty sensibly valued at a mid- to high-teens P/E, and it's growing its earnings per share probably at about that level per annum. So, at the moment, it's quite comforting given the current market."
What else on the Continent is Prentis excited about?
R&D outsourcing plays, for one thing, especially companies like France's Altran (ALT FP) to which other large French companies -- engineering concerns, aerospace, banks -- outsource much of their R&D function. "It's quite a big company," Prentis said, with a market cap of over four billion euros. "It's a lot larger than ITNet. It has a major market position. It's been growing its revenues and earnings by at least 30% per annum for many years now. People want to work for it, and it's very confident about demand levels in most parts of its business. In fact, despite all the gloom and doom around, it just isn't seeing any signs of a slowdown. It isn't seeing any signs of deferment of orders, [so] it's unusual in that sense."
A Cambridge-based company called TTPCom (TTC LN) is another lower-risk beneficiary of outsourcing that merited a mention from Prentis. It operates in the mobile communications market. TTPCom "develops its own intellectual property and licenses it out to tier-one players around the world," Prentis said, typically for an up-front license fee and a share of future royalties. "For instance, four or five months ago, it . . . licensed some of its mobile platform to Intel. But it has also done a lot of work in the Far East and [recently] it announced two licenses with unnamed Japanese companies." Prentis judges TTPCom "fairly safe," because he does not believe it will be exposed to cutbacks in clients' R&D spending. The 3i Group, he said, is well acquainted with the company's management team.
Anything appealing besides outsourcing plays? we wondered.
Yes. Prentis's firm is "heavily overweight in parts of the semiconductor industry," he said, calling it a cyclical play. "We feel at some point the cycle is bound to turn upwards," and many companies have plunged to a point at which valuations are "very attractive," he said.
"A reasonable example," Prentis went on, "would be BE Semiconductor (BESI NA) in the Netherlands. [It] is a very small company [whose] share price has fallen a long way. It's a leading player [that] provides equipment to help package semiconductors. It's got a very strong balance sheet [and] a huge amount of cash on its balance sheet . . . about 3.5 euros of cash per share, and the share price is about six euros." As one of the first companies to go into a downturn, BESI, Prentis thinks, will probably be one of the early beneficiaries of a rise in capital equipment spending. With more than half its market cap in cash on its balance sheet, good market position and a history of being very profitable, Prentis believes BESI's share price could "perform very strongly on the first signs of an upturn in activity."
Prentis acknowledges that the terrorist attacks in the U.S. are likely to delay a recovery. Nevertheless, he believes that certain semiconductor stocks offer lower risk than some software and service companies because the valuations are comparable to the cyclical lows in 1998. Among other holdings he mentioned are "small- [and] mid-caps such as SOITEC (SOIT FP) [and] Elmos (ELG LN), but also Suess Micro (SMH GR)."
Having heard what he likes, we asked Prentis about any areas of concern.
"At the moment, we are cautious about many software companies," he allowed, and expects them to struggle to hit third-quarter numbers. "I think that the September quarter-end will show that a lot happened. Most of the licenses [signed] were put on hold after September 11 -- we are on a bit of a hiatus there. With software companies, the licenses tend to be signed in the last two weeks of the quarter, and the last two weeks of the September quarter were particularly difficult, because very few companies wanted to sanction spending large sums of money on software licenses when the world economy looked far more uncertain than it did in August."
But although he advises caution in the software area near term, he expects it to come back quickly. "History shows that companies tend to spend a lot of money on software," he said, "and a lot of software does actually enable companies to make significant savings quickly. The return-on-investment argument is strong for many parts of the software industry. Those that have a product which is demonstrably capable of saving labor costs are likely to continue to do well. Demand is going to pick up again. But in the very short term, it's high risk."
A particular zone of concern is communications software, although Prentis noted that, in the area of mediation software, "companies such as Comptel (CTL1V FH) and Intec (9738 JP) are continuing to sign new software licenses, albeit at a slower rate than previously hoped. Delays in 2.5-generation [activity] are not helping," he said.
Prentis's firm is also wary about many of the IT consultants. "Labor utilization rates have been falling [and] we've seen job losses growing. Companies will look to cut back their spending on outside consultants in more difficult times," he said. "We haven't seen it to a huge degree yet in Europe, but there are early signs of that trend."
Surveying the investment climate right now, Prentis discerns a mood of "general caution. I would suspect that institutions have probably increased their cash positions slightly, and that most are probably sitting on their hands waiting to see what happens next, which is how we would probably describe ourselves -- wary." Wary, perhaps, but not out of the game.
©MM, MMI Grant's Investor, Inc.
www.grantsinvestor.com
[XASAF] XANSA PLC FOREIGN
[ITWNF] ITNET PLC FOREIGN
* no OTC foreign symbol
[ALTKY] ALTRAN TECH SA ADR ADR
[ALTKF] ALTRAN TECHNOLOGIES FOREIGN
[TTPNF] TTP COMMUNICAT PLC FOREIGN
[BESI] Nasdaq
[BESIF] BE SEMICONDUCTOR IND FOREIGN
[BESUF] BE SEMICONDUCTOR IND FOREIGN
[SOTTF] SOITEC FINANCE SA FOREIGN
[EMOMF] ELMOS SEMICONDUCTOR FOREIGN
[SESMF] SUESS MICROTEC AG FOREIGN
[COPTF] COMPTEL FOREIGN
[ICCNF] INTEC COMMUNICATIONS FOREIGN
[IECCF] INTEC INC FOREIGN |
