Cool Gadgets Could Save Tech Sector
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.
For those who are pretty excited about all the new tech gadgets transforming our world (and making it unsafe to walk down the sidewalk due to the danger of being upended by someone watching “American Idol” on their cell phone), attending the Cowen and Company 34th Annual Technology Conference was a bit of a downer. Somehow, the hundreds of analysts and portfolio managers crowding into the Helmsley Palace just didn’t seem to be having that much fun.
Admittedly, tech stocks have been tumbling since January, which can ruin anyone’s spirits.As it turns out, there are a great number of anxieties plaguing the tech area that, according to Arnie Berman, are not yet resolved. Mr. Berman, Cowen’s new tech strategist, says he thinks that while the group has not hit bottom, the industry will snap out of its malaise over the next few months and head significantly higher. The reason, essentially, is all that cool new stuff.
The Morgan Stanley tech index shows the group is down 1.9% since the beginning of the year. More telling is that the shares have dropped almost 8% since the peak reached in early January. Mr. Berman, who came to Cowen from SoundView Technology Group, cites a number of reasons for the miserable performance.
First, almost every major new product development has been plagued by delays or disappointments. These include a delay in Microsoft’s much-anticipated Vista operating system, which, according to Mr. Berman, has cast an enormous pall over sales of PCs. There have also been delays in the introduction of new gaming consoles. Meanwhile, sales of notebook PCs and capital spending for broadband projects have been disappointing.
The only sector doing better than expected has been wireless handsets. Here too, Mr. Berman cautions, decelerating year-over-year gains could temper stock price performance in coming months.
Such problems have not ended. Anticipation of the Vista launch will likely mean that buyers will postpone PC purchases. Although cumulative PC sales during the 2006-07 period may well end up on target, this year’s performance will likely continue to be subpar. Specifically, Mr. Berman says he doubts there will be many Windows PCs under Christmas trees in 2006 with Vista set to come out in January.
The Vista delay is likely to reverberate throughout the components sector as well. Mr.Berman is not positive on Broadcom, Marvell, and Texas Instruments, considering those stocks expensive in the current environment. Other names he is cautious on include AMD, Dell, and Hewlett-Packard, all of which he projects being hurt by weakening PC sales.
Although most corporations are generating excess cash, Mr. Berman is also cautious on corporate technology spending. In his view, corporations will commit, finally, to boosting tech spending only when they feel their competitive position will be significantly weakened by not doing so.
He cites the communications service providers as the only industry ramping up spending.This is also the area where most new technology development is likely to occur. Developments like IPTV (Internet protocol TV, for those in the dark) will require companies like AT&T and Verizon to make massive tech investments.
This leads to another question plaguing the industry: Will Microsoft, which recently stunned analysts by announcing a massive capital spending program, be the only tech company forced to raise spending?
Mr. Berman thinks the answer is yes. Many tech companies will have to increase capital spending, which could put pressure on margins because recent gains in profitability have stemmed at least in part from declining depreciation charges. Mr. Berman points out that tech company margins have gone from an unsustainably low level in 2002 to a level today that may prove unsustainably high. More worrisome is that analysts are projecting even better profitability in 2007.
Meanwhile, the options backdating scandal has certainly taken a toll on the tech stocks. The sector has long relied on stock options to reward management; a number of companies may well be charged with backdating options grants.
Finally, the sector may be suffering a seasonal drought.Typically, tech stocks do not perform well in the second year of a presidential cycle. It seems that buying the group in October has, usually, turned out well.
So what’s the bull case for the sector? It goes back to all the fun gadgets that make teenagers especially giddy. Mr. Berman points to two important developments that have been underplayed in the press. The first is Disney’s announcement that it will be making considerable TV programming available on the Web. The second is that this month the FCC will conduct its most important auctions of wireless spectrum since the mid 1990s. The last big auctions in 1995-96 ushered in a jump in telecom spending; the same is likely this time around.
In Mr. Berman’s view, “all roads lead to communications.”The sector is least vulnerable to problems near term, and it is most attractively positioned in terms of new product introductions.
There are also changes taking place in how tech companies provide software to corporate users.Mr.Berman describes the history of the industry as having followed four “architectural” waves: mainframes, mini computers, PCs, and client/servers. The next wave he describes as the “ubiquitous computing” wave.
He equates 2006 with 1991, as a return of investment in the product cycle. For the corporate sector, this includes the Vista introduction from Microsoft and on-demand software provided by the likes of Salesforce.com (CRM), Concur Technologies (CNQR), and Rightnow Technologies (RNOW).
Looking at current valuations, Mr. Berman’s three best choices in the sector are companies that should benefit from the broader trends in place and that are currently out of favor. KLATencor (KLAC), which has been hit by the options backdating scandal, provides software systems to semiconductor makers. A spending revival in the sector should boost the company’s profits. Juniper Networks (JNPR), also a victim of the options uproar, will benefit from an upturn in broadband investment and Sun Microsystems (SUNW) will participate in the trend toward outsourcing of software solutions.All three stocks have excellent long-term prospects in Mr. Berman’s view, and are currently out of favor.
See? Not that much fun.