Tech, Part 2:
Software
Microsoft's World
You may not like its tactics, but from an investor's view, there's a lot to like about
Microsoft. For one thing, the company will be a direct beneficiary of any pickup
in PC sales, thanks to Windows and Office. More intriguing for the long haul is
Redmond's increasingly aggressive bid for a greater slice of the corporate market,
where it has not traditionally been a big player. Microsoft continues to push its
.Net strategy for simplifying the links between software programs, which should
give it an increased presence in corporate IT departments. Meanwhile, starting at
the low-end of the market, Microsoft has begun sneaking into enterprise
applications, territory historically controlled by SAP, Siebel Systems and Oracle.
While Microsoft has gotten more press for its efforts at "controlling the living
room" via its Xbox game player, the bigger opportunity lies in gaining an increased
share of corporate spending.
Microsoft has a few other things going for it, including roughly $10 a share in
cash and investments -- some investors argue that it's time for the company to
start paying a dividend -- strong management, and a stock off nearly two-thirds
from its peak.
Bill Whyman, an analyst with the Washington-based Precursor Group, thinks
Microsoft's .Net Web services strategy could eventually become a big factor. "If
Microsoft is stuck on the PC, then growth will mature," he says. "If .Net
succeeds, the company will be let loose in the enterprise, and the established
incumbents should be saying, 'Uh-oh.' If Microsoft can get off the PC, it opens up
a $90 billion enterprise-software opportunity, of which it now has a very small
share."
Not the least, the stock seems reasonably priced. "The last time the stock was at
anywhere near these valuations, it looked like most of its legal problems were in
front of it," Berman says. "It now looks like the problems are mostly behind it."
We agree. Buy it.
While you're at it, buy some Oracle. In recent years, the database giant has
suffered not only from the IT spending slowdown, but also from concerns about
lack of management depth and market share losses in it applications business.
All of that has hammered Oracle's stock: The shares are down about 35% this
year, and more than 75% since the Nasdaq peak in early 2000. Even so, the stock
is not statistically cheap, at about 23 times expected earnings for the May 2003
fiscal year, and about five times next year's revenues.
Still, we think Oracle is likely to expand its applications business as corporate
customers become increasingly interested in choosing fewer and larger vendors,
which favors application "suites" over "best of breed" choices from smaller
software companies. The company is likely to continue to dominate the database
software market. And Oracle has smartly expanded its services business, eating
up business that might otherwise go to consulting groups like Accenture. Oracle
will survive and thrive.
For similar reasons, we like SAP, which dominates the market for enterprise
resource planning software. Surveys of IT managers consistently show
widespread plans to spend on the category. SAP has a huge installed base of large
customers who continue to pay SAP for service and support. Revenue and
earnings should show double-digit growth in 2003 and beyond; the stock trades
for 22 times 2003 earnings, a comparable valuation to Oracle. And like Oracle, the
company is likely to benefit as IT departments prune the number of companies
from which they buy services. Though we caution that any delay in the IT
spending recovery will cause trouble, we're cautiously bullish.
Services
Seeking Help
To calm your frayed nerves, imagine you are a technology investor sitting under a
palm tree on a sugar-sand Caribbean beach, watching dolphins frolic in the lazy,
deep blue waves. In one hand you hold a rummy island beverage; in the other, two
years of brokerage statements. They show you own only one stock. You read
them, lean back and smile.
That's because the one stock is credit-card processor First Data, the only one of
the 20 largest tech stocks to actually gain ground since the March 2000 bubble;
First Data's shares are up more than 60% since that time. Look at the stock chart,
and you might think it was upside down.
While First Data isn't everyone's idea of a tech stock -- it doesn't make chips or
hardware or routers -- the company is a major consumer of computing resources.
First Data, which also operates the Western Union electronic-money-transfer
business, has continued to grind out steady revenue and profit growth, a fact that
the market has richly rewarded. It's hard to find fault with its business -- or the
stock. The shares trade at 20 times expected 2002 earnings, or less than 18 times
2003 estimates; top-line growth is holding steady at about 10%. First Data has
been a good place to seek shelter from the storm. If we were anticipating a
V-shaped tech recovery, we might urge leaving First Data for purer tech plays.
But for now, it seems a sensible hedge against broader exposure to corporate IT
spending.
You might argue that we should cut-and-paste our review of IBM and slot it up in
the hardware section. But Big Blue has made a determined move away from
hardware and into services. The most obvious demonstration of that: the recent
agreement to acquire PwC Consulting, which contrasts with a previous decision
to exit disk-drive manufacturing.
"It is gradually becoming a healthier company, in the sense of pruning businesses
that are absolute drags, and taking costs out, and trying to be more transparent in
the information it give out," says Goldman's Conigliaro. "It's also trading at the
low end of its historical valuation relative to the S&P 500."
IBM, like Oracle, Microsoft and SAP, should benefit as companies concentrate
their technology spending with a smaller number of vendors. Though there no
doubt will be some integration problems with the PwC deal, IBM proved a shrewd
buyer-it is paying 0.7 times sales, comfortably below the multiples for comparable
public companies. With IBM trading at about 14.5 times expected 2003 earnings,
the shares are reasonably priced. The stock is a Buy.
Cheaper than IBM is Electronic Data Systems. EDS shares have been pummeled
in recent weeks; it has been an IT services provider to WorldCom. Worries about
the deal have left the stock trading at just 10 times expected 2003 earnings of
$3.43 a share. In a recent research report, Merrill Lynch analyst Stephen
McClellan brands the stock "a rare value for patient investors," even after sharply
marking down the company for the WorldCom exposure. We see no reason to
expect any slowdown in corporate outsourcing of data centers and other business
processes -- though McClellan says EDS shares could be stuck in neutral until it
wins some more "megacontracts." That said, EDS looks like one of the better
bargains among large-cap tech stocks.
Telecom
Cut The Cord
Let's be blunt. We're worried about the cellular business. The issue is relatively
simple. The market for cellular voice traffic is maturing. The cellphone companies
think they can stimulate replacement demand with color screens, built-in cameras
and other new features. And yet most people use cellphones to make voice calls.
We fear current estimates for handset sales for both this year and next year are
too high -- and if that's true, the stocks could see another down leg.
Merrill's Milunovich says the cell- phone makers are suffering from a condition
Harvard tech guru Clay Christensen calls "overshoot," meaning current technology
is already more than good enough for most users. In markets where that happens,
Milunovich says, profits shift from systems companies, such as Nokia and
Motorola, to component companies, such as Qualcomm and Texas Instruments.
Montgomery's Rezaee says he'd be a buyer of Qualcomm shares "once the dust
settles." The company's CDMA technology has a strong foothold in Korea, Latin
America and in the U.S., where Sprint and Verizon have standardized around it.
Unlike Motorola or Nokia, Qualcomm does not make phones. Rather, it collects
licensing fees from systems using CDMA technology, and it sells chips for
CDMA-based phones. With the stock trading for about 23 times expected earnings
for the September 2003 fiscal year, though, it seems fully valued.
Of the large handset companies, Motorola is having a better time of it for the
moment than Nokia. While Motorola has been showing some results from a long
restructuring process, its Finnish rival has lost some market share. Motorola is
"doing things it should have done years ago," as Rezaee puts it, although it remains
to be seen if the company can produce reliable revenue growth.
Nokia dominated the phone business in the late 1990s, thanks in part to ineffective
competition from Ericsson and Motorola. But competition has heated up. Though
not in our top 20, the company gaining the most ground in the wireless phone
market at the moment is Samsung. Meanwhile, the sector as a whole could see
more disappointments, as the industry's struggling carriers attempt to lure
investors to use additional services made possible with so-called 2.5G and 3G
services.
Neither handset maker looks expensive at the moment -- Nokia trades for 14 times
expected 2003 earnings, versus 24 times for Motorola, though Motorola looks
cheaper on a revenue basis, at 0.9 times expected 2003 results, about half that of
Nokia. And yet we think estimates, and stock prices, face one more down leg. For
now, we would not be buyers of any companies in the handset business.
The bottom line: There are tech-stock bargains to be had, but investors should
tread cautiously; some of the bear's wounds will prove fatal. The PC, cellphone,
semiconductor, chip-equipment and enterprise-software businesses will continue
to struggle. And yet it turns out the tech sector is not as dead as you thought.
These difficult days will allow a handful of well-positioned companies to extend
their lead. So cheer up. Go buy yourself a cellphone, a PC or a DVD player. And
start writing that tech-stock wish list. |
