5/24/98 NY Times article. BARS and H&Q recommend ASND
Washington Sideshow for Technology
nytimes.com
By LAWRENCE M. FISHER
Last Monday, as the Department of Justice and 20 state Attorneys
General filed their antitrust suits against the Microsoft Corp., a
question circulated among the venture capitalists huddled in partners
meetings on Palo Alto's Sand Hill Road and other nerve centers of
high-technology finance.
Is it safe again to invest in desktop software?
"I had that question posed to me yesterday for the first time in two
years," said Roger B. McNamee, a principal in Integral Capital
Partners, which invests in private and public technology companies. "It
looks like it's almost time to take aim at Microsoft's core business,
whether they're vulnerable or not. There isn't anything happening yet,
but I expect entrepreneurs to focus on this, people who couldn't get
funded before."
In recent years, venture capital has simply not
been available for software start-ups focused
on desktop applications, programming tools
or, in your dreams, operating systems. New
companies dancing at the edge of Microsoft's
vision had to plug along on their founders'
savings or meager income from shareware
licenses -- the $10 or $20 a head sent in on
the honor system by people who copied the
product from friends or downloaded it from a
bulletin board.
The lucky companies, like Vermeer
Technologies Inc., developer of the Front
Page program for creating Web sites, were
acquired by Microsoft on rewarding terms; the unlucky ones died
young.
Venture capitalists have a longer horizon than most mutual fund
managers or retail investors, and they count on making outsize returns
for taking outsize risks on early-stage companies. So theirs are usually
the first heads to pop up from cover when a monster like Microsoft
turns its gaze elsewhere.
But the landmark antitrust suits should prompt all technology investors
to reconsider their strategies and to question the possible consequences
of the suits for their portfolios.
For many investors, U.S. vs. Microsoft leaves the landscape little
altered from before, despite the huge headlines of last week. So far,
1998 has been a turbulent year for technology companies: Many face
significant near-term challenges independent of the suits, which could
take many years to play out. The case is just one more variable to add
to the equation.
Most analysts say the short-term consequences will likely be small, in
terms of both harm to Microsoft's financial results and help to
companies in its line of fire, like Netscape Communications or Novell.
As McNamee put it: "It doesn't make sense to invest in companies
whose success depends on Microsoft's failure." That has not changed,
and it is worth noting that among the 200 securities firms surveyed by
First Call, none lowered its rating of Microsoft last week.
Two added coverage of Netscape, but rated it a hold; just one raised
its rating on Novell, from a buy to a strong buy.
In the longer term, a Microsoft chastened, or at least distracted, by
years of antitrust litigation may be less inclined to "cut off the air supply"
of promising new software companies, as a now-famous internal
company memorandum put it. But analysts say it is too early for most
investors to identify those promising players.
Better to focus for now, they say, on software companies that have
found growth areas outside the giant's core business, like supply chain
management or sales force automation. Or better to look at companies
that are developing ideas for overcoming the limitations of networks and
telecommunications systems, the main choke points in computing today.
Most analysts also say that investors must contend with a number of
broad issues confronting the technology group. Many of the industry's
leading companies have reported disappointing financial results in recent
quarters, including Intel, Compaq Computer and Hewlett-Packard.
Yet in most cases, prices of technology stocks remain high. Shares in
IBM actually rose after it reported a 13 percent decline in earnings. No
one wants to sit out the information age without owning some
technology shares, but choosing stocks is more difficult than ever.
Bruce Lupatkin, director of technology research at Hambrecht & Quist,
said he believed the long-term consequences of the suit would be
positive. "Although it is perhaps initially negative for the market from a
psychological perspective, it is overwhelmingly positive for the industry
going forward," he said.
"If it were to actually check some of the behavior of Microsoft, or
Microsoft's sphere of influence got even marginally narrowed, it creates
opportunities that wouldn't otherwise be there," he said. "It would fuel
investment in a bunch of areas people are afraid of today."
But Lupatkin has a hard time finding technology shares to recommend
right now. "If you look at business fundamentals, and then look at share
prices, there is a bit of a dichotomy," he said. "The market certainly
feels a bit toppy, and everybody seems to be waiting.
"Communications and connectivity companies are doing very well, and
likely to continue," he added, naming Cisco Systems and Ascend
Communications. "The companies to be avoided are the PC-centric
folks."
A delay in the release of Microsoft's Windows 98 would inevitably
delay some personal-computer purchases, but analysts say the PC
makers are already in a slump for more fundamental reasons. One is a
glut of inventory, largely created by Compaq as it moved to emulate
Dell Computer's build-to-order business model. In cleaning out old
product, Compaq packed dealers and distributors with deeply
discounted machines that have yet to sell through to customers.
Another factor is the erosion of the historical link among
microprocessor upgrades, new software releases and PC sales.
Depending on which factor you see as more important, the PC slump
may be half over, or just beginning.
"I think we're largely through it," said John T. Rossi, a managing
director at BancAmerica Robertson Stephens. He said he expects PC
sales to rebound next year with the release of Microsoft's Windows NT
5.0 for corporate networks of computers. "Even though the near-term
view is scary, this new operating system, even slowed down or changed
by the government, will likely lead to a good PC market next year."
Rossi said shares of the major PC companies and the component
manufacturers had been beaten up enough to warrant buying them at
current prices.
"Buy a list of leadership companies, like Seagate, Quantum, Intel,
Micron," he said. "They actually stand out in an overvalued market. It's
almost a value approach to technology issues."
He cautions against stocks with high valuations in areas like enterprise
software, which face more downside risk.
But others see a more structural problem for the PC industry. It used to
be that Intel would make faster microprocessors, Microsoft would
enlarge its operating system, and customers would buy new PCs to run
new applications that took advantage of the changes.
But in an interconnected world, in which the speed limit is imposed not
by the computer but by the home user's pokey modem or the corporate
customer's creaky network, a 300-megahertz Pentium is not likely to
offer significant performance gains over a 166-megahertz chip. Intel has
had to respond by dropping processor prices far more rapidly than in
the past, and PC manufacturers have followed suit, to entice upgraders.
Investors seeking the next big growth opportunity may do best to focus
on companies attacking this communications bottleneck, like purveyors
of cable modems for home users or high-speed network switches for
corporate environments, said Thomas Thornhill, director of technology
research for Nationsbanc Montgomery Securities.
"Look at the entire infrastructure and identify the companies working to
remove the constraints on performance," he said.
Among those companies, he likes Cisco, Lucent, Ciena, Tellabs,
Ascend and 3Com. The sector "is very fragmented, and there are a
wide range of alternatives," he said.
For more conservative investors, the regional Bell companies are a
good play, Thornhill said, as they move from offering dial-tone to data
services, Internet connections and video. "You take the lid off their
revenue growth," he said.
But bandwidth plays are long-term investments. In the short term, many
analysts fear that the technology market is headed for its habitual
summer swoon, prompted by long European vacations and
exacerbated this year by the Asian economic crisis.
"We're not going to have a great summer, for sure," said Michael
Murphy, editor of the California Technology Stock Letter. "You still
have the aftereffects of the inventory glut. Europe is doing O.K., but
instead of getting better, it seems to be flattening. Japan isn't getting
better at all."
Murphy is worried that the broad market remains overvalued and
vulnerable to an Alan Greenspan-prompted crash. Murphy has
protected the accounts he manages with index puts -- options that pay
off if the associated stock indexes fall -- while remaining invested in
technology stocks.
Murphy picks those stocks by identifying companies whose share
prices are low relative to a combination of earnings and
research-and-development funds, a figure he calls growth flow.
Companies he finds attractive on that measure include Adobe Systems,
which he believes has benefited as Microsoft has been busy attacking
Netscape on the Internet instead of taking on desktop publishing, where
Adobe is dominant despite a weak first quarter.
"Adobe's not the biggest danger to them," he said.
He also likes Applied Materials, the big semiconductor equipment
manufacturer; Cypress Semiconductor, and LSI Logic.
The growth flow approach, as explained by Murphy in his recent book,
"Every Investor's Guide to High-Tech Stocks and Mutual Funds"
(Broadway Books), is a variation on value investing. It is less
concerned with identifying the next Microsoft than with buying quality
companies that are currently undervalued by Wall Street.
The strategy seems to work for Murphy; the average annual return of
the newsletter's picks for over a decade is 45.7 percent.
Competing for technology investors' attention is "The Gorilla Game"
(Harper Business), by Geoffrey A. Moore, Paul Johnson and Tom
Kippola, whose thesis is that new technology markets naturally anoint
leaders, or "gorillas," which define standards, grow very rapidly and
dominate the market for decades as a result.
Microsoft is the quintessential gorilla in software, but so is Intel in
microprocessors, Cisco in networking equipment, Oracle in relational
data base software. The book says investors can gain by buying and
holding gorilla stocks, regardless of their apparent value.
"Technology-driven markets self-generate monopolies," said Moore,
who is chairman of the Chasm Group, a Silicon Valley marketing
consulting firm. "That phenomenon isn't going to change, regardless of
what the government does."
Microsoft is not worth any less, and Netscape is not worth any more,
as a result of the lawsuits filed last week, he said.
Moore divides investing opportunities between platform companies, like
Microsoft, Intel and Cisco, and applications companies, like Oracle,
SAP AG and Peoplesoft. Though applications do not create as
powerful a monopoly position, the leader in any category still enjoys
outsized growth.
Though Moore is not an investment adviser, he currently favors
companies in supply chain management software, like Manugistics and
I2 Technologies, and companies in sales force automation, like Siebel
Systems, Vantive and Clarify. Several of these concerns are his
consulting clients.
"Find a category that is going into hypergrowth," Moore advised.
"Rather than guess who is going to be the winner, buy every legitimate
candidate and hold them until the market identifies the winner. When
you see it has clearly won, sell the other shares and put the money into
the gorilla, and hold it until the category is eliminated."
"The irony," he said, "is that at no point in that time will the gorilla look
undervalued."
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