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Great Expectations
UBS Warburg's Pip Coburn sees a "supernova rally" in tech stocks, but then what?
By ERIC J. SAVITZ
An Interview With Pip Coburn -- Pip Coburn, the global technology strategist at UBS Warburg, has some good news and bad news. The good news is, he thinks tech stocks are setting up for a "supernova rally" which will take the Nasdaq Composite back to 2000 or higher. The bad news is, he expects the rally will eventually burn itself out for lack of fuel.
And when it does, Coburn says, investors will find a distinct lack of new technologies to propel revenue growth. In Coburn's view, that will mean some lean years for technology investors, marked by slow growth and steadily compressing P/E multiples. Coburn provided the details in a thought-provoking Q&A...
Q: And yet, you expect a huge rally.
A: At some point you'll start to get confidence that revenues are going to turn. You'll start hearing that tech is as strong as it ever was. We've had 14 rallies of at least 10% while we were going from 5000 down to 1114. Each time we've been disappointed ultimately. Eventually at some point we are going to get a turn in the revenues of the Global 1000. The economy will turn. At that point, I think the story you are going to hear is the following -- and it is going to be hard to resist for most people. The companies will say, "We are cautiously optimistic on the next 9 to 12 months. We are feeling good with the earnings forecasts that you have for the next six months and this is the most visibility we've had in perhaps three years." Why will the visibility be improved? The companies will say that client revenues are improving, that customers underspent over the last three years and that they're starting to increase spending. Also, companies will want to take advantage of accelerated tax depreciation which ends September 12, 2004.
Q: That all sounds feasible.
A: And the bulls will say they think that new killer apps will emerge, that they always do, and maybe most importantly, that we are still very early on in the roll-out of the Internet. Also, companies have reduced break-even points, cutting head count dramatically, so margins will start taking off. Investors will think we are back in the 1990s. We won't be, but investors will think so...
Q: I presume you are looking for more than a 10% or 15% rally.
A: Today, we're around 1500 or so on the Nasdaq. I think we could see the Nasdaq north of 2000.
Q: What companies will lead the charge?
A: The companies that will do well in the early stages of the rally will be the semis, the semi-equipment guys, contract manufacturers, and some of the tier 2 and tier 3 software players...
Q: So what you are suggesting, is that the fate of the tech sector in the coming months will be tied to the economy, not innovation.
A: Yes. That's very dissatisfying to our clients. They're used to tech being special and different, a combination of tremendous secular drivers, matched with some cyclical components. So now I'm saying tech is anti-secular, an anti-growth area, with cold technology abounding everywhere you look, and that you need cyclical elements to get that top-line growth. And yet, there will be a period that is pretty healthy and feels good, so we'll get to play this for a while. It's tough to call the timing, maybe 12 to 18 months, but it will last a lot longer than people suspect. And prices will move higher than people suspect.
Q: When should investors get positioned for the big rally?
A: I want to have our model portfolio include companies that at the turn are going to be big beneficiaries. I want them as small positions today, but what I don't want is one day to reach the conviction that the time has come, and then try to start researching those stocks.
Q: Because it will be too late.
A: All that stuff, all that work, you've got to do it now. Even if you only have 1% positions in your portfolio. When it hits you that the world is turning, you can change your portfolio rapidly. I suspect there will be a month or two this year when you'll see managers rapidly turning over their portfolios. What they'll want to do first is get cash positions down to zero.
Q: They'll be penalized for not being fully invested.
A: You are going to be crushed, if we are talking about a 50% run. Say you have a 10% cash position. That's 500 basis points that you just lost versus your benchmark.
Q: Being in the wrong stocks will also be a problem.
A: In the rally, the very largest tech stocks in the S&P technology index, Intel, Dell, Microsoft, IBM, Cisco Systems, while they are long-term winners, will lag as a group. These companies are doing well fundamentally already -- you get less room to dream of upside on the top line, margin expansion and multiple expansion...
Q: So if we look five to seven years out, and growth will be modest, and multiples will be lower, what kind of tech stocks will you want to own?
A: It's going to be very difficult for someone to come in and replace Nokia in their space, or replace Cisco in their space, or to invent a better mouse trap to take on Dell. The companies that are the dominant leaders today have their eyes out for every opportunity -- smaller players getting in to that top tier will be a real long shot. I mean, if I can track this stuff for a living, Cisco certainly should be able to track it far, far better than I can.
Q: Are there big names that look vulnerable in the scenario you've laid out?
A:Sun Microsystems, EMC and Hewlett-Packard are obvious candidates. The companies in the middle of the telecom equipment space are candidates. Advanced Micro Devices will continue to struggle. One of the things we're continuing to see is the progression of service and administration into software. Software is getting burned into hardware, and the hardware is commoditizing. In 1990, about half of enterprise tech spending was hardware oriented. Last year it was closer to 30%. That's a long-term trend, it is not turning around and we have some additional forces that are making it even harder to compete as a strict hardware company. We have Linux. We have Dell. And we have Microsoft, Intel and IBM really applying the heat.
Q: Pip, pretend it is May 2008. What will be the five biggest positions in your model tech portfolio?
A: Cisco and Dell will be still pretty interesting, attacking new spots. Intel may finally be really cracking some new markets and taking share from other people.
Q: Microsoft?
A: It will depend a lot on the price at that point and time, but yeah, Microsoft is not going anywhere. And IBM is probably going to grow in terms of importance. Another candidate is Taiwan Semiconductor, if they can manage their financial side and don't get too much competition from the Chinese. (See Follow-Up.)
Barron's: In 2008, we'll check in and see how you did. Many thanks.
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