The New Convergence
MY 13 FAVORITE STOCKS FOR THE NEXT 13 YEARS
by Rich 'thedocman' Johnson
The following 13 stocks (in no particular order) are my personal "convergence"
favorites for the long-term investor. I don't pretend that all possible convergent
technologies are represented by these selections. They aren't. They're simply
13 of the best technology/Internet/communications companies that I think best
define the new convergence.
Full disclosure: I am long on ALL of these stocks in my personal
portfolio except Sun Microsystems (SUNW). I have not traded any of
these stocks within two weeks of the publication of this article. I will not
trade any of these stocks within three trading days following
publication of this article.
Broadcom (BRCM). Broadband is the Holy Grail of the digital revolution. With
demand for fast Internet access increasing exponentially (Web traffic is said to
double every 100 days), the ability to smoothly and seamlessly deliver up
massive amounts of digital fare (let's call them digibits for digital data bits) to
home and business consumers is central to the convergence theme. There are
a plethora of competing technologies vying to be the "caterer" of choice for this
last mile of the digital delivery system (cable, xDLS over existing wireline,
direct satellite broadcast, digital wireless).
Broadcom (which reported a 360% increase in Net income in its latest quarter
and which also declared a 2:1 stock split) supplies specialty
broadband-enabling chipsets to all of the providers of these competing
technologies. The company is, therefore, in the enviable position of being
totally indifferent as to which technology emerges as the favorite in the
broadband delivery war. But that's not Broadcom's only competitive advantage.
Its "system on a chip" technology integrates the functions of multiple
semiconductors into a single chip, drastically reducing the number of chips
required to build, for example, a cable modem. Fewer chips mean lower
production costs and smaller, more flexible products. As demand for Internet
access escalates and these products achieve commodity status, the low-cost
producer will gain significant competitive advantage. Broadcom stands to gain
from these trends in proportion to the increase in digibit traffic.
Cisco Systems (CSCO). This 10-year-old maker of specialized computers and
software that direct digital packet flow over networks (routers) and other
networking products and services is the granddaddy of my portfolio. I've held it
continuously since 1991, and it represented, until last month, my biggest
holding. Recently, Time Magazine (Do You Know Cisco? January 17, 2000)
described it as the "baby in the crèche of the Internet revolution." Cisco is
centrally positioned to continue its dominance of the explosively growing, $21
billion market it invented. But Cisco is not stopping there.
"Help—the paranoids are after me!" should be Cisco Systems CEO John
Chambers' personal motto. To keep the company one step ahead of
irrelevance, Chambers is positioning Cisco to compete with entrenched titans
Nortel (NT) and Lucent (LU) in the lucrative communications equipment
market. Cisco's huge $7 billion purchase of startup Cerent Corp. and its optical
switching technology clearly indicates the central role optical technology plays
in Cisco's New World communications plans. Now trading at about 100 times
forward EPS and with revenue and earnings expected to continue to grow in
excess of 30% annually, Cisco is a core holding. (Cisco's ninth stock split is
scheduled for March 22, 2000.)
CMGI (CMGI). CMGI is a special case of a convergent entity. The term
commonly applied to CMGI and its ilk is "Internet incubator." But applied to
CMGI, the term rings almost nostalgic. CMGI's metamorphosis—from a
grooming service for startup companies into an "economic network"—has been
so rapid that Peter D. Henig of Red Herring coined the phrase "EcoNets" to
reflect its new status (And Now EcoNets, February 2000). CMGI is king of the
EcoNets.
At its inception, CMGI was a de facto mutual fund of startup Internet ventures.
CMGI provided funding, management support and business development
services leading to the inevitable IPO of the closely supported company. This
business model has changed dramatically. Instead of just nurturing companies
for future spin-off, CMGI is now building a vast network of interrelated (some
would say incestuous) startups that gain distinct competitive advantage
through the synergies and scale opportunities they provide one another.
Witness the recent transactions between CMGI, Engage Technologies,
Adsmart and Flycast.
CMGI-owned Engage Technologies (ENGA), which is owned by CMGI,
recently announced the purchase of two other CMGI-owned advertising
companies, Adsmart and Flycast. Post-merger, Engage will not only maintain
its advantageous competitive position vis-à-vis the remaining companies under
the CMGI umbrella, but enhanced, it also emerges a much more formidable
rival to Doubleclick (DCLK, a major Internet advertising force.
By leveraging internal relationships this way, the value of CMGI's companies
has increased to more than $11 billion from just $1.3 billion a year ago.
Analysts expect CMGI's share price to reach $500 within two years from a
current $120. Numbers like those will be the norm as CMGI evolves into the
economic model that promises to command the Internet of the future.
Corning (GLW). Founded in 1851, Corning is one of the oldest Internet
companies around! While Corning doesn't possess the cachet of other
convergent technology upstarts, its transformation from a stodgy houseware
products company to the leading supplier of optical fiber used in fiber optic
cable is nothing short of remarkable.
Optical fiber plays a crucial role in the rollout of the Internet and in advanced,
high-speed telecommunications. With 40% of the fiber optics market, Corning
is the curl of this wave. Since 1995, this fast-growing, high-margin segment of
Corning's business has increased from 22% to 53% of its revenue as demand
swelled to 60 million kilometers. The market is expected to grow to 100 million
kilometers a year by 2002.
Corning's premier fiber product, Large Effective Area Fiber (LEAF), introduced
in 1998, is a breakthrough in fiber optic technology. By effectively increasing
the cross-sectional area of optical fiber, LEAF increases effective bandwidth
without increasing the number of fibers needed to transmit photon traffic. LEAF
also increases the distance the photons can travel before boosting is required.
This product is an industry favorite as witnessed by the 100% year-over-year
increases in LEAF sales. In February, Corning unveiled a $750 million
expansion to increase fiber-making capacity by 50%. Additionally, the
company recently announced a 10-fold expansion in manufacturing capacity
for optical filters and photonic devices, driven by swelling demand for dense
wavelength division multiplexing (DWDM) components. Corning is clearly on
top of the developing trends in telecommunications and will profit accordingly.
EMC Corp. (EMC). With the Internet and e-commerce boom comes a
concomitant increase in demand for storage, retrieval, protection, sharing and
analysis of mission-critical data. EMC is the major player in the high end of
the intelligent enterprise storage market. Through its acquisition of Data
General, it is contesting the lower- to mid-level market as well.
Business-to-business transactions will come to dominate e-commerce and
EMC already commands more than 50% of the Fortune 500 company storage
market. Profits are improving continuously as sales of higher-margin software,
services and high-end storage products make up an increasingly higher
proportion of overall sales.
In reporting EMC's latest stellar financial results (at $0.34 a share, third quarter
earnings exceeded analysts' expectations by $0.03), CEO Mike Ruettgers
proclaimed, "We have created a market with no visible limits and set the
standard for the future." That pretty much describes why this is a stock all
long-term investors should have in their convergent-technology portfolio.
Exodus Communications (EXDS). Exodus provides soup-to-nuts service for
mission-critical Internet operations. It's becoming the service provider of choice
for companies completely outsourcing their Internet operations&151;from
planning site design to managing traffic growth. Through an expanding array of
international "Internet Data Centers," Exodus plays transparent host to its
customers' Web sites. In so doing, Exodus offers a myriad of add-on services.
Data centers provide a secure, physical facility (with "redundant subsystems")
for the customer's own servers.
But Exodus does more than just host customer-designed Web sites. It also
provides Web oversight services that assure peak performance as traffic to
customers' Web sites increase. Routine back-up services are available to help
assure data integrity. Customers can opt for data caching to improve
performance at high-traffic Web sites. Custom security services and
consultation top off the suite of available options. This innovative company is at
the forefront of service companies responding to needs generated by the
erupting Internet. It is one of the best examples of a convergent technology.
JDS Uniphase (JDSU). This is my top stock pick for the long-term investor. In
June 1999, JDS Uniphase was formed by the merger of ostensible competitors
Uniphase and JDS Fitel, two giants of the optical component space. As
mergers go, this was a masterstroke. Each company brought to the table
different but complementary product suites that, together, allow JDSU to offer
a full line of optical products. More importantly, before their merger the two
companies sold their products to virtually the same customer base. So,
post-merger, JDSU can sell an extensive optics product line to the same
customers with little overlap or sales cannibalization. The result is that better
margins accrue to JDSU even as sales costs are reduced.
Fiber optic networking and optical communications are expanding in lockstep
with the expanding demand for bandwidth because fiber optics is the only
technology currently able to scale to meet the increased digibit demand. To
meet this unprecedented growth and further solidify its rising dominance in the
space, JDSU is in the process of acquiring competitors Optical Coatings
Laboratory (OCLI) and E-Tek Dynamics (ETEK). These acquisitions will
significantly bolster JDSU's production capacity in the all-important dense
wavelength division multiplexing (DWDM) market.
Before these acquisitions, JDSU had predicted annual growth in revenues
would approach 80% and an EPS growth rate in excess of 90%. JDSU's stock
price has exploded 900% in the last year and, including the split scheduled for
March 1, the stock will have split 2:1 three times in the past eight months. As
the major, non-captive producer of fiber optic systems, JDSU is on the cusp of
explosive growth and profitability.
(Editor's note: Enter Indi's JDSU Open contest now—win $2,000!)
Nokia (NOK). Wireless—the wave of the future. I don't think a whole lot needs
to be said of Nokia's position in this space. As the world's number one maker
of analog and digital cell phones, Nokia drives the development of the market.
According to Opstock Securities (Helsinki) analyst Mikael Schroeder, "Nokia
is the industry's shaper…[Nokia] has reached the stage where it can dictate
future development&151;others just follow behind.' Nokia's newest offerings
address the fast-growing wireless Internet access market with Internet-centric
phones based on wireless application protocol (WAP) technology. Nokia's
future is tied to the future growth of wireless usage and, particularly, to the
growth of the mobile-phone-connected Internet. Both are booming industries
whose growth is expected to accelerate dramatically over the next decade. In
January, Nokia's record first-quarter profits (+52%) were accompanied by the
announcement of a 4:1 stock split.
PMC Sierra (PMCS). PMC Sierra, which announced a 2:1 stock split effective
in February, makes specialty chipsets that, in a sense, complement
Broadcom's last-mile semiconductor offerings. PMC Sierra has carved out a
very lucrative niche serving the high-speed data transmission and networking
markets. The company designs, markets and supports state-of-the-art
semiconductors for ATM, Ethernet, SONET, SDH, T1/E1/J1, T3/E3/J2 and IP
applications in the communications, networking and Internet accessing
markets. PMC Sierra has the reputation of being an extremely nimble and
responsive company whose rapid response times enable its customers (such
as industry giants Alcatel, Nortel, Cisco, Lucent and Ericsson) to respond
rapidly to the fast-changing communications equipment market (particularly in
regard to providing Internet backbone access). Expect this company to excel
in the fast-growing, rapidly changing digibit marketplace.
Qualcomm (QCOM). The Wireless Microsoft. As Microsoft now dominates
operating systems, so QCOM should dominate wireless Internet transmission.
To understand QCOM's potential, you need to understand three facts:
First, code division multiple access (CDMA). Without getting into the
specifics, suffice it to say that CDMA is, arguably, the most efficient
technology for wireless broadband transmissions. It's therefore the odds-on
favorite to become the worldwide standard for third generation (3G) wireless
devices and services.
Second, Qualcomm owns CDMA. QCOM already has more than 300 United
States patents on this world-class technology and has hundreds more issued
or pending worldwide. Through licenses and royalties from a growing stable of
major communications equipment manufacturers (more than 75 at last count),
Qualcomm benefits every time a CDMA-enabled phone or application-specific
integrated circuit (ASIC) is sold.
Third, the wireless market is growing enormously. By 2008, wireless is
expected to surpass traditional wireline in all types of digibit
transmissions—Internet, data, video, voice, audio. A push into China was given
a boost in February when Qualcomm announced a much-anticipated licensing
agreement with China United Telecommunications. By 2010, it's estimated
that CDMA will be used in 85% of all mobile phones. As wireless
communication mushrooms, so do Qualcomm's prospects.
By divesting two businesses that were drains on earnings (Ericsson bought
the wireless infrastructure business; Kyocera, the mobile handset business),
Qualcomm has shown it can position itself to capitalize on the demand for this
convergent technology. I'll be buying on any price weakness.
Sun Microsystems (SUNW). Servers, specialized computer systems
designed specifically for building huge networks, are the core Internet
architecture. And the premier builder of servers is Sun Microsystems. As the
Internet infrastructure is extended, Sun remains one of the main beneficiaries,
providing networking, storage and high-margin software services.
Sun's high-end servers and storage devices already make up the backbone of
many telecommunications networks, ISPs, and large corporate networks.
Even so, S&P revenue growth expectations were recently revised upwards
(from 20% to 25% for fiscal 2000) due primarily to the increasing demands of
Internet growth. Topping off its remarkable Internet strategy is Java, the
object-oriented programming language Sun developed to run on any computing
platform. The advantages to developers writing software for use over the
Internet are obvious. Finally, in (Johnny-come-lately) recognition of the
popularity of Microsoft's Windows NT, Sun has created software and hardware
products to ensure interoperability between NT and Sun's own SPARC/Solaris
systems, a new market opportunity that Sun values at $30 billion.
Texas Instruments (TXN). Digital signal processing (DSP) and the
deployment of 3G wireless communications go hand-in-hand. As the leading
manufacturer of DSP chips (with a 47% share of a market that's growing 30%
a year), Texas Instruments is at the forefront of the coming build-out in
next-generation wireless communications, DSP broadband modems and
networking equipment. TI expects the DSP market to triple in the next five
years with the driving force being all of the bandwidth hogs I've discussed here.
As TI increasingly focuses on its core DSP operations (TI's low margin DRAM
business was divested in 1998) earnings have increased dramatically. Expect
more of the same as bandwidth demand strengthens.
Verisign (VRSN). Verisign is rapidly becoming one of the prime enablers of
growth in commerce over the Internet. President Ronald Reagan's famous
maxim regarding diplomatic relations with the former Soviet Union, "Trust but
Verify," could easily be Verisign's company motto. The company provides trust
services to authenticate transactions, verify identifications and secure
payments over the Internet. Fear of fraud is frequently cited as the greatest
impediment to using the Internet as the conduit for financial transactions.
VRSN helps alleviate those fears by providing the necessary security for all
breeds of e-commerce (business-to-business, consumer-to-business,
citizen-to-government, client-to-service provider). As Internet commercial traffic
erupts, so does the need for VRSN's services.
VRSN's business model was strongly validated last year when California
decided to allow certain official state government transactions to be conducted
over the Internet using VRSN's authentication services. As confidence builds in
VRSN's ability to provide total Internet security, the opportunities are
boundless. In January, Verisign announced a whole new suite of services
designed specifically for the global wireless communications market. As a
major player in a major convergent technology, Verisign is a must-own position
for the long-term investor.
THEDOCMAN'S DISCLAIMER: I am not a registered investment adviser or a broker/dealer. I am
providing information to you solely for informational purposes and such information is not to be
construed as an offer to sell or the solicitation of an offer to buy. The opinions included in my
musings are based on my own feelings about a particular stock. My opinions are based on
sources believed to be reliable and written in good faith, but no representation or warranty,
expressed or implied, is made as to their accuracy, completeness or correctness. Readers are
urged to consult with their own independent financial advisors with respect to any investment.
All information contained in my scribblings should be independently verified with the companies
mentioned before any investment decision is made, whether buying or selling. I may or may not
have positions in the stocks that I discuss. I receive no compensation of any kind from any
companies that I express opinions about.
Copyright © 2000 Individual Investor Group. All rights reserved.
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