April 25, 2004
Can the Technology Industry Grow Bigger, Not Just Older?
By STEVE LOHR
ORT through the daily celebrations, wailing, teeth-gnashing and brow-furrowed ruminations that accompanied the avalanche of quarterly earnings reports over the last couple of weeks, and one theme seems pretty clear: tech is back. Profits for the technology companies in the Standard & Poor's 500-stock index soared 64 percent in the first quarter, compared with 24 percent for the S.& P. 500 over all, Thomson First Call reports.
So is it off to the races again? That is far less clear. In fact, there is a lively debate about what is really happening in the technology business, one that plays out daily in the stock market. And the signals are often confusing.
Ten days ago, for example, I.B.M. said it was finding steady improvement in demand from corporate customers. Big Blue even noted an "inflection point" in the pickup of hardware sales. But right after that announcement, its stock - and technology shares as a whole - started falling. Then, on Thursday, Microsoft reported that it was noting increasing corporate demand, and the opposite happened: its stock, and technology shares in general, got a nice little bounce.
The daily referendum of buying and selling on Wall Street points to the basic questions: Is the technology business still a growth sector? Is technology special?
To many investors, the answers seem to be yes and yes. The stocks of the 100 largest tech companies trade at about 30 times projected earnings for the next 12 months - or about 50 percent higher than the price-to-earnings ratio of the S.& P. 500. True, technology shares look nothing like they did in the zany days of the bubble, when prices soared to nearly 70 times earnings. But they are still way, way up there: the long-term historical average multiple for technology stock prices is in the range of 15 to 25.
Not surprisingly, value investors view today's technology stock prices as a sign of collective delusion. "To me, it's astounding," said Richard Bernstein, chief quantitative strategist for Merrill Lynch. "There is this perception that there is something unique about the tech sector."
Add in the cost of expensing the stock options that are so popular among Silicon Valley companies and the price of technology stocks is even higher, about 46 times earnings, according to a study by Merrill Lynch. "You can see why people are trying to ignore it," said Steven Milunovich, a technology analyst.
Institutional investors who are optimists about the technology sector tend to regard it as a cyclical industry on steroids. In good times, they say, tech stocks will do better than the market as a whole and in down cycles they will do worse. These days, they see themselves as riding an upswing that could still run a year or longer, with ups and downs along the way. "Tech stocks have further to go, but mainly because the stock market has further to go," said James W. Paulsen, chief investment strategist at Wells Capital Management.
Mr. Paulsen and other tech enthusiasts point to strong corporate profits, businesses finally loosening their purse strings, and the fact that spending on computer hardware and software is about half of all business investment. Strong economic growth, he says, would lead companies to invest more - and that means more spending on technology.
An accounting echo from the boom years of 1999 and 2000 could add fuel to the cyclical upswing. Hardware and software are capital expenditures that companies typically depreciate as an expense over three to five years. In the technology slump, companies stopped buying, and now the depreciation expenses from earlier spending are way down, as the equipment is at least three years old.
The effect is to give companies more money to spend in their technology budgets, a trend that may continue for up to two years, said Ken Davis, a principal at McKinsey & Company. At I.B.M., John R. Joyce, the chief financial officer, said the depreciation impact on technology spending was evident in the first quarter and should continue.
But what about the long term? Some analysts expect a slowdown. The industry, they say, is likely to grow at about 1.5 times the rate of economic growth, down from the historical average of 2.5, predicted John Gantz, director of research for IDC, a technology research firm. The reason, he said, is simple: a maturing, trillion-dollar industry can grow only so fast.
Even so, veteran investors say, there will be plenty of dynamism, turmoil and growth opportunities in some technology markets. But it is an environment that will favor stock pickers over those who are trying to ride the sector in general. "Growth was synonymous with tech investing in the 1990's," said David Readerman, a senior analyst at Marsico Capital Management. "That relationship has been broken."
Which markets will prosper? Mr. Readerman, who began his career in 1983 as a personal computer software analyst, just returned from a trip to South Korea, where he studied the frontiers of wireless and broadband technology in a market far more advanced than the United States. Throughout Asia, as well as Europe, the market for high-end mobile phones with cameras, color screens and other features is booming.
Such surging sales, Mr. Readerman noted, helped Motorola triple its quarterly profits, while Nokia reported disappointing results because it could not keep up with the demand for high-end phones. And he pointed to Qualcomm, the creator of one of the main digital cellphone technologies, which reported last week that its quarterly profits jumped more than fourfold. Qualcomm's technology, known as CDMA, is used in cellphones to send and receive music, video and data services. "When you look beyond a PC-centric view of technology, there are some very interesting opportunities," Mr. Readerman said.
Other fundamental shifts are taking place. "There is potentially a huge transition from technology being sold as a product to technology being sold as a service," said Roger B. McNamee, general partner of Integral Capital Partners.
After all, he noted, the popular Web sites for shopping and search are services. The stellar quarterly earnings of Amazon.com, Yahoo and eBay show that the march of the Internet is continuing, despite the dot-com collapse. And the imminent initial public offering of Google is the most eagerly awaited I.P.O. since Netscape sold shares in 1995, touching off the Internet boom. The other notable Silicon Valley offering expected this year, Salesforce.com, also fits the technology-as-service theme. It markets sales-force automation as a utilitylike service over the Internet, instead of a software product.
THERE is also a basic overhaul of computing under way in corporate data centers, according to Mark Stahlman, an analyst at Caris & Company. The trend involves building more powerful, efficient and secure data centers by lashing together swarms of computers using low-cost microprocessors and clever software that can divvy up work across hundreds or thousands of machines. That vision of virtual computing, Mr. Stahlman said, is being pursued by big companies like I.B.M., Hewlett-Packard and Sun Microsystems and little-known start-ups like Azul Systems, Vieo and Cassatt.
"It represents a huge shift that will play out over the next 5 to 10 years," Mr. Stahlman said. "Things are up for grabs in that market, and there is plenty of opportunity."
In other words, technology is still special - sometimes. |
