Fleckenstein on IT spending:
The tech-spending rebound isn't coming
When the biggest tech of all reports the same thing its brethren do -- no uptick in IT -- it's only a matter of time before their investors start to believe them.
This week, we'll take a look at the ramifications of Microsoft's Oct. 23 earnings announcement. (Contrarian Chronicles is put to bed on Thursday morning, so I was unable to devote time to this in my column last week.)
Let's just get this out upfront: Microsoft is arguably the biggest success story ever in technology. It is an extraordinarily well-managed company, with a balance sheet like the Rock of Gibraltar. That said, in the investing business, what matters is the price you pay for the business you want to invest in. For most companies in America today, the price is too high.
Of course, many of them are not managed all that well, and a lot are run by charlatans and cheerleaders. Microsoft, on the other hand, is run by brilliant (though very tough) people, who, I think, are pretty straight-shooters.
But even companies as fine as Microsoft have problems when they get too big or end markets change. Microsoft managed to gain a monopoly, something that's very, very rare in technology. That monopoly, however, cannot alter a simple fact: The rate of growth has slowed quite a bit in the end market. The latter is mature and saturated, in essence a replacement market. And that poses a problem for a company trading at 29 times trailing earnings.
A high stock price, coupled with little growth, is a problem seen in many companies outside of technology. But most tech companies face an additional problem, and that is the obsolescence issue. This is why I believe tech stocks should never command high P/Es except maybe in their very early days. Then, they need to be bought with the assumption of being sold down the road, because very few technology companies are long-term winners.
Gateway: from high flier to five-spot
We could contrast Microsoft with a related company that recently reported, computer maker Gateway. This one-time high flier, which traded upward of $80 in the mania, today fetches just under $5. In the mania, I received lots of catcalls for suggesting that it was crazy to pay a big multiple for PC stocks because they didn't do any R&D to speak of. Folks took great umbrage at my likening the PC business to the TV business. Now, Gateway itself is crowing about its TV business.
In any case, Gateway announced that it lost 43 cents a share, but excluding all the things that it gets to exclude in today's alphabet soup of one-time charges, it only lost 20 cents a share. If you do the math, however, it turns out that Gateway is losing 7 cents for every dollar of revenues. Stated another way, Gateway is basically selling dollar bills for 93 cents. Since most tech stocks lie somewhere between Gateway and Microsoft, folks can use their own judgment to determine whether a company is more like Microsoft -- in the better-managed and barrier-to-entry department -- or more like Gateway -- in the poorly managed and no-barrier-to-entry department -- and on its way to oblivion.
Meanwhile, what Microsoft had to say in its earnings results was very important for the here and now, as well as for allowing me to create the little vignette I just outlined. Significantly, the company announced that its deferred revenues were about $500 million less than expected. In other words, Microsoft misread corporate America's interest in software and software licenses to the tune of some $500 million. To quote its CFO, John Connors, from the conference call on the topic of the deferred-revenue shortfall: "We were probably a little bit optimistic about what the quarter was going to look like. IT spending has been slower to recover (than the company expected)."
So, the corporate IT business was weaker than Microsoft had expected. This did not affect the company in the recent quarter, but it will have an impact down the road. That means there will be less deferred revenue running through its financial statements. Microsoft also allowed that this will occur again next quarter, though it did not expect the drop to be as large. But it expects this trend to be over in the second calendar quarter of 2004. At least, it hopes that will be the case.
No, there hasn’t been an IT uptick
Microsoft's news should put to rest the notion that has been floated all year about a second-half recovery for tech spending. (What strength has been seen comes via the consumer, and we know why the consumer was strong last quarter -- tax cuts and refinancing.) Microsoft has not seen an IT recovery. IBM has not seen it. Hewlett-Packard has not seen it. Just last Wednesday, Dell’s CFO told a dead-fish-house conference that he had yet to see signs of a tech pickup in medium to large businesses. Further, I have been hearing that Cisco Systems' quarter is not going so well, which is hardly surprising, given what Nortel Networks and Lucent Technologies (just to pick two Cisco customers) had to say. (And it's not only technology that isn't seeing a rebound, as 3M told us several days ago.)
So here it is, early November, and there still have been no signs of a second-half rebound in IT.
Despite Thursday's announcement that GDP grew 7.2% in the quarter, given what corporate America has been saying, you have to wonder where that 7.2% came from, or how big that number needs to be to generate IT spending and jobs.
Of course, understanding that there would be no rebound has not been a profitable idea, as believing in a rebound has carried the day. However, that will change when folks do come to understand that the rebound is not coming (especially with the stock prices of most companies where they are). The question is, when will folks realize this, and/or when will they care? Will that be next week or a couple months from now? I do not know the answer to that question.
Connecting the dots: Watch out for dislocation
When you put a summation sign under all this, what you can see is that stocks, and technology stocks, specifically, have had a tremendous run on the idea that things were about to get better, and they have not. Should things continue to not get better, which is my expectation, one of these days there is going to be a massive dislocation. Folks ignore this at their peril. |
