MORE detail on G-S's call today:
With the weak IT spending environment soon to be entering its third year, our decision to wait out the slowdown for a number of our quality companies under the presumption that they would rebound faster than others has long since ceased to be realistic. Recent notes from our Economics Group as well as our own Technology Strategy Navigators and IT Surveys continue to point to the same disturbing conclusion: namely, that there is little change in the IT spending environment and little reason, other than the potential of some modest seasonality, to think that there will be much change in early 2003. As a result, we are making several changes:
1. We are revisiting some ratings and bringing them more in line with what we have been saying about the broader technology picture and with our current thinking. Specifically, we are reducing our ratings from RL to MO on EMC and Sun Microsystems.
2. We are lowering 2003 revenues on most of our companies and earnings on a few. We already lowered our estimates on both Emulex and NetApp to reflect our expectations for longer than expected weakness in the IT spending environment following their respective conference calls during the past week. We have not made any incremental downward revisions to our QLogic numbers as we think that the changes we made following the June quarter conference call already capture our growth expectations for the storage subsystems companies in 2003.
Our new CY2003 revenue and EPS estimates are included in the table below.
.................Revenue...................EPS.........Date
.......Old......New....1stCall...Old.....New..1stCall..Chngd
HP....$76.7B...$74.2B...$76.3B...$1.36...$1.30...$1.33..8/15
IBM...$84.4B...$83.8B...$85.2B...$4.50...$4.50...$4.56..8/15
SUN...$15.0B...$14.5B...$14.9B...$0.23...$0.21...$0.20..8/15
BRCD..$ 885M...$841M......NA.....$0.64...$0.59.....NA...8/15
ELX...$411M....$355M....$352M....$0.80...$0.75...$0.85..8/08
EMC...$6.8B....$6.5B....$6.8B....$0.17...$0.17...$0.17..8/15
NTAP..$1.2B....$1.0B....$1.1B....$0.40...$0.35...$0.35..8/14
QLGC..$511M....$515M....$503M....$1.25...$1.25...$1.21..7/19
STK...$2.2B....$2.1B....$2.1B....$1.00...$0.90...$0.93..8/15
3. We are lowering our longer-term three-year revenue growth targets on Brocade, EMC, Emulex, HP, IBM, NetApp, Qlogic, StorageTek, and Sun to more closely align our stated views about intermediate-term IT spending with our specific company targets.
............2003 Revenue Growth..........3-YR Revenue Growth
..............Old........New................Old......New
HP...........7.0%.......4.5%................10%......6%
IBM..........5.5........4.8.................13.......7
SUN..........15.9.......12.4................15.......12
BRCD.........40.0.......33.5................30.......28
ELX..........27.0.......23.8................30.......23
EMC..........19.5.......15.5................20.......16
NTAP.........31.7.......22.2................25.......23
QLGC.........27.0.......25.5................25.......24
STK..........7.9........2.9.................8........4
Wgt'd Avg Of Co's 6.0 7.5
IT Spending Growth 5.0 7.4
*THE WEAK OUTLOOK WE HAVE MAINTAINED FOR IT CAPITAL SPENDING SINCE THE START OF 2001 HAS RECENTLY BEEN JOINED BY A DETERIORATING MACROECONOMIC VIEW:
--Economic Outlook:
Key economic data such as the ISM survey (formerly NAPM), consumer confidence, and durable goods orders have all shown recent signs of weakness. Meanwhile, the labor market continues to languish with no meaningful signs of improvement in sight. As a result, our Economics Research Group has recently lowered its already below-consensus GDP forecast for CY Q4 2002 from 2.5% to 2%, and for CY Q1 2003 from 2.75% to 2%. Our economists have had only modest expectations for the bulk of the year, and at this point are still not forecasting a double-dip, but nevertheless the majority of risks remain to the downside.
--IT Spending Outlook:
a) As we have noted in our recent Tech Strategy publications, with the overwhelming majority of 2003 IT budgets to be set in the fall, the still weak economic environment is likely to cause initial budgets to be set very conservatively. At this point, we see 5-7% growth in 2003 IT spending as a best-case, with our own expectation that overall budgets will increase closer to 3-5% after starting out the year essentially flat.
b) End demand remains lackluster in tech's most important end markets of financials, communications, and manufacturing, in total representing over 50% of normalized end demand. The Federal sector remains the only relative bright spot but at only 10% of total demand, is insufficient to drive aggregate growth on its own. The fact that virtually all of our companies are citing their Federal business as a current area of strength raises some flags, particularly given the normal seasonality associated with this business.
c) Our most recent IT Spending Survey indicates that 34% of CIOs do not expect a return to 'normal' spending until after 2003, up from only 26% only two months ago. We expect this trend to continue.
*OUR NEW RATINGS ON EMC AND SUNW ARE MEANT TO REFLECT THE WEAK REALITY OF THE NEXT FEW QUARTERS, VALUATION ISSUES, & LOWER GROWTH. We can see the 'law of small numbers' leading to meaningful percentage increases in each of these stocks should a tech rally actually develop in C4Q, which we still think is probably more likely than not. At the same time, we expect early 2003 IT budgets to be patterned after current spending, making upside even from current low numbers less likely. Our specific thoughts on each of these names are as follows:
--EMC: SOLID STORAGE FRANCHISE IN THE MIDST OF NUMEROUS SECULAR CHANGES. EMC is in the midst of working through massive efforts to re-align itself strategically and operationally, with these changes complicated by the current weak spending environment. Still, it has made significant progress in streamlining its operations and broadening its distribution, by adding Dell, Avnet, Arrow, and other resellers targeting the SMB segment. EMC will turn over its entire product line in the second half of 2002 and early 2003, highlighted by major releases on the software front that are part of the company's shift to open software that will, in turn, drive top-line growth and gross margin improvement longer-term. Whereas longer term we would expect EMC to regain a good part of its former stature, the stock's current prospects likely remain tied to the outlook for overall tech, and EMC's multiple of 42x our 2003 EPS estimate remains too high to be compelling in the near term.
--SUNW: IMPRESSIVE FUTURE VISION WILL FACE SUBSTANTIAL HURDLES BEFORE PLAYING OUT. Sun's competitive challenges are probably greater than ever. Nearer term, we are concerned about the relative absence of operating leverage in Sun's model in the face of minimal headcount cuts. We are also aware of a higher level of unease among some Sun employees who may not be as willing to wait for results unless there are clear signs of building success. Even while Sun's standing in the enterprise is not in danger, it has lost some time in its competitive battle against Microsoft and IBM. At the same time, Sun's vision, almost always complex and playing against the mainstream in the industry, is also compelling. As always, Sun is marching down a course in which its own technological innovations become the enabler of its ultimate success. Although we have seen too many Sun successes to argue with its chances, most of what Sun is counting on will take time to germinate. Although Sun's valuation is no longer the issue that it was, we see no meaningful fundamental catalyst to drive the stock near term.
*WE ARE MAINTAINING OUR RL RATING ON IBM AND BROCADE AS THEY ARE BEST POSITIONED TO WEATHER THE LONGER-THAN-EXPECTED ECONOMIC DOWNTURN. --While clearly not immune to the sluggish macro environment, we continue to believe that IBM is a stronger company today than in years past. Even in today's difficult environment, IBM's revenue growth should gradually accelerate and its operating leverage noticeably improve after shedding some slower growth and unprofitable business segments and revamping its product lines. With a relative multiple of 0.9X, at the lower-end of its typical range of 0.8-1.1X, investors are likely to view IBM as representing a good value even in the midst of the current sluggish environment as it has built an impressive track record of delivering predictable and consistent results. Our 12-month price target for IBM is $90, assuming a relative market multiple of 1X. Our target is subject to the risk of an even slower rebound in IT spending --Brocade remains the other favorite. Despite some competitive issues on the horizon, Brocade is arguably the best demand-driven story in tech. At $16.25 the stock is trading at roughly 28X our new CY 2003 estimate with a PEG of 0.9X (using our new 28% long-term growth rate). Our 12-month price target for BRCD is $21 based on BRCD trading up to a 25% premium to the group given its higher growth rate and better visibility. This price target is also subject to the risk of an even slower rebound in IT spending.
*AT THIS POINT, MOST ENTERPRISE SYSTEMS AND STORAGE VALUATIONS ARE WITHIN PRE-BUBBLE RANGES. With any recovery in IT spending pushed out to the back half of 2003 at the earliest, and any further revisions to estimates still weighted to the downside, we think enterprise systems and storage names are likely to remain within their current trading ranges for the intermediate term. That said, some seasonality, albeit tempered versus historical patterns, could help lift the stocks heading into CY'Q4.
.........P/E......Pre-bubble P/E.....P/S....Pre-bubble P/S
........CY03.....HI.....LO....AVG....CY03...HI....LO....AVG
SYSTEMS
HPQ.....11.3x....21.8...12.3...15.8...0.6...2.1...0.7...1.1
IBM.....16.6.....47.2...7.8....16.3...1.5...1.4...0.4...0.8
SUNW....21.1.....20.6...9.3....14.2...1.0...1.8...0.3...0.9
STORAGE
BRCD....25.5x....44.9x..14.8x..26.7x..4.4x..9.7x..4.1x..6.3x
EMC.....42.3.....35.6...10.3...19.4...2.4...5.0...0.7...2.3
ELX.....20.9.....33.7...11.4...22.2...3.7...3.0...0.3...1.3
NTAP....25.7.....87.2...28.9...47.7...3.0...9.3...2.9...4.8
QLGC....27.0.....26.9....7.8...18.1...6.3...3.8...0.4...1.4
STK.....13.6.....62.0....9.1...17.0...0.6...2.1...0.5...1.2 |
