Fund Manager Landis Favors
Small- and Micro-Cap Techs
The market is celebrating a one-year rally in tech stocks, but Kevin Landis isn't ready to put a lampshade on his head.
Mr. Landis is the chief investment officer at Firsthand Capital Management, a Silicon Valley-based tech-investing boutique. He's also the lead
manager of the firm's five technology-focused mutual funds. The $624 million Firsthand Technology Value Fund, the firm's oldest and
largest offering, is up 137% over the past 12 months, compared with 86% for its average peer according to Chicago investment researcher
Morningstar Inc.
That said, the fund and its shareholders are still smarting form the bone-jarring bear market. Despite its heady recent gains, the fund
averages a 32% annual loss over the past three years, compared to a 28% annual tumble for its average peer.
Mr. Landis believes the tech-led stock rally over the past year was justified by an economic recovery and rising corporate tech spending. But
he fears many investors may have piled into shares of massive, well-known tech firms like Microsoft Corp. The problem, he believes, is that
these behemoths may be more "comfortable" than profitable as investments in coming years.
Doesn't history tell us now is a good time to sell tech stocks, rather than buy them? Why is he buying micro-cap tech stocks and what does
he make of the recent fund-trading scandal1? We got some answers.
1. What's driving this rally?
The short answer is that the economy got better, and investors' psychology has also improved.
There have been a couple of different factors driving tech stocks up. One is a major shift in sentiment. A year ago the technology sector
was deep in oversold territory. People were deathly afraid of owning tech [stocks]. You had both investor morale and tech-business
fundamentals really bottoming out. Part of all these gains were just unwinding that, but that's really only what got the rally started.
What has kept it going is steadily improving fundamentals [for tech companies]. During the downturn we got a lesson in how discretionary
[corporate] tech spending can be. In a recession you might be able to cut your headcount or use of electricity a bit. But you can much more
easily cut back on your servers in a lot of cases.
Tech spending was the first thing companies cut, we discovered. But it was also the first thing they added back in recent months. As a
result, fundamentals at many tech companies are getting better.
2. Doesn't past experience tell us now is probably a good time to be taking profits in tech stocks, not buying them?
Maybe. But not simply because the stocks have just made a big move up. Whether that argument holds up or not will be determined by what
the tech stocks you own are worth, relative to what they're going to be able to earn. Today, I would distinguish between stocks that are
continuing to grow and those that have perhaps moved up just because they're well-known companies and [investors are buying them
because] sentiment has turned positive.
We're avoiding the big-cap, high-comfort tech stocks today. These are household names people are comfortable owning, but that aren't
growing much or showing much fundamental improvements. If you look at that big companies at the top of the Nasdaq composite and you
see Microsoft Corp., Dell Inc., Cisco Systems Inc. and Intel Corp. If people are owning those stocks today expecting them to grow at
30% to 40% annually, they'll be disappointed. For these companies, the "too-far, too-fast" argument will probably hold true.
For some things could be even worse. I think Sun Microsystems, for example, will become the poster child for Darwinism in technology.
The [server and software maker's] fundamentals haven't gotten better, so the argument for the stock isn't getting better either.
3. It looks like you've raised your fund's exposure to small- and micro-cap tech stocks. What did you buy there?
Last year, a lot of micro-cap stocks started trading close to the value of the cash on their books. A lot of people looked at them as risky, but
they were actually pretty close to [value investing pioneer] Ben Graham's model for a bargain. [Mr. Graham believed stocks were
undervalued when they traded near the value of the company's cash and saleable assets.]
When people talk about technology, they always focus on big companies and the biggest product or trend lately,
ignoring smaller companies with newer products and ideas. If you and I talked about tech in the mid-1980s, we
would've mostly talked about PCs, for example. And if we talked about tech in 1998, we would've mostly talked
only about the Internet.
One way to see tech after this downturn is to just say it's over and that these stocks and companies won't come
back. Another way is to look at all the smaller companies with new products and maybe new markets for
technology. You don't know what will work, but there are a lot of neat ideas, so you spread your bets.
One example of a small-cap stock we found is Roxio, Inc. It's a digital media software company that mostly made
programs for CD and DVD recording and photo editing. We got interested last year when the company had a
market cap of about $60 million with about $40 million in cash. [The stock was a 2.8% position in the Firsthand
Technology Innovators Fund on July 31.]
They were rolling out an update of their flagship software product and ended up also buying PressPlay and the
assets of Napster. Now they're getting ready to relaunch Napster as a paid music-sharing service, tying in their software for burning DVDs
and CDs. We feel like that's an intriguing idea and pretty safe purchase.
4. It also seems like you've built up positions in defense stocks over the past year. What do you see there?
I don't see a big difference between say commercial technology and defense technology. But Wall Street and folks like Standard & Poor's
categorize defense stocks as being different from tech stocks. I think that's a market inefficiency and I'm trying to exploit it because there's
growth in defense technology.
We have plenty of bombs and we can deliver then anywhere. I think what we learned [during the recent armed conflict in] Afghanistan,
though, is that we need more and better surveillance technology to figure out where those bombs should go.
So, among big-caps we're invested in Raytheon Co. In small-caps involved in defense technology that we're invested in are Aeroflex, Inc.,
Flir Systems, Inc. and Herley Industries, Inc.
5. The Internet's three big survivors -- eBay, Yahoo, and Amazon.com -- have seen their share prices rocket up this year. But aren't they too expensive to
own?
I'd add a fourth one there that doesn't get the credit it's due: InterActiveCorp, [headed by Barry Diller, a diversified collection of
e-commerce and media companies including Ticketmaster, Expedia and Match.com] I like their business model because you have to be a
real business to make it on to that team.
With all of these Net companies, people are giving them credit for being the last ones standing and for maintaining a fair amount of growth.
If you look at eBay's quarterly revenue growth for example, not just the quarterly growth of its stock price, you see a relentless ramp-up in
their revenues right through a nasty recession.
That gets you a steep valuation and these companies' rich valuations make them a good place for debate. We own these stocks in our
E-Commerce Fund, but I just can't justify putting them in our Technology Value Fund. That said, eBay is in our Technology Leaders
Fund because I think that's where it belongs.
6. What's your biggest worry today?
It's that people will look at big-cap tech stocks and expect a lot of growth. In looking at tech today, I say it's like walking around in a forest
after a fire. A lot of the trees are dead, but you see a few big trees that survived and a lot of new growth.
For the survivors, like Microsoft, Intel and Dell, there are advantages to surviving. They're big players with lots of market share. They came
out of the fire still pretty healthy. But they won't grow taller very quickly.
7. Alliance Capital recently suspended2 the manager of its technology fund and a sales executive for allowing a large investor to make rapid trades in the
firm's technology mutual fund in return for a large investment in a hedge fund the manager also ran. As someone who manages both technology mutual
funds and a tech hedge fund, have you looked closely at your own compliance policies?
We have, and it made me want to hug my compliance officer.
From what I understand of the Alliance example, the hedge fund investment was simply a way for this investor to pay these folks for doing
something they should've known was wrong.
We do make every effort to curb timers and when it comes to favoring a hedge fund investor over a mutual fund investor, that's just a
non-starter. You can't exactly put out a press release talking about how clean you are, but we're happy with the compliance procedures we
have in place. |
