The technology sector has come a long way since the heady
market highs of 2000 and yet many investors still treat it with circumspection,
thanks to the bursting of the internet bubble and crazy dot com valuations. We
believe that the sector has evolved and that much of what was promised in 2000
is now becoming reality.
Looking back, the 1980‘s was all about the migration to the
PC, followed by the rise of the Internet in the 1990‘s and culminating in the
NASDAQ bubble of 2000. To illustrate how far the industry has come, I thought
this quote from Computerworld magazine summed it up rather nicely: “If the auto
industry had done what the computer industry has done in the last 30 years, a
Rolls-Royce would cost $2.50 and get 2,000,000 miles to the gallon.”
It is our view that we are at the forefront of the third wave
of a disruptive new cycle - namely that of connected computing. This has been
made possible thanks to three key drivers - cloud computing, broadband
applications and the growing ubiquity and mobility of computing. The glue that
keeps all of this together is the affordability and speed of broadband. To
illustrate this point, NTT Japan has successfully tested fibre optic cable that
pushes 14 trillion bits per second down a single strand of fibre, which in plain
language is equivalent to 2660 CDS or 210 million phone calls every second!
Ironically, it was the cheap capital of 2000 that allowed
broadband to become so pervasive, as companies had so much money thrown at them
that it allowed telecom operators to create broadband virtually for free.
To digress for a moment for those of you who are not tech
savvy, I‘ll explain what cloud computing is all about. It means that instead of
all the computer hardware and software you’re using sitting on your desktop, or
somewhere inside your company’s network, it’s provided for you as a service by
another company and accessed over the Internet, usually in a completely seamless
way. Exactly where the hardware and software is located and how it all works
doesn’t matter to you, the user - it’s just somewhere up in the nebulous “cloud”
that the Internet represents. This is exciting because it allows companies to
make savings and to boost efficiency. It also allows smaller companies to become
more competitive, without being forced to spend a huge amount of capital on IT
infrastructure. Furthermore, it’s changing the way the world works as your
competitors aren’t just in the next town or the next country, they could be
eight time-zones away and you probably have never heard of them.
As the third wave plays out there are going to be winners and
losers in technology, as new entrants take over from the old stalwarts. Driving
the change is the rise of the mobile internet device or smart phone / tablet.
Previously the preserve of early adopters and enterprise, 2010 was the year when
smart phones became mass market products as volumes grew 80% year over year.
Penetration rose from 18% to 27% by the first quarter of 2011. The key winner in
this space has been Apple, now the largest market capitalisation stock in the
world.
This is unleashing wide ranging forces across the capital
equipment, software, hardware, telecoms and consumer electronics sectors. The
potential losers in this revolution are easily identified. They are the
technologies and companies that shaped the PC era over three decades: Intel and
Microsoft, other PC makers as well as hard drive vendors and original design
manufacturers that produce over 80% of PC notebook components.
Take Microsoft, for example. With a price/earnings ratio of
around 10 the software giant is a value play for some hedge fund managers,
including Greenlight Capital‘s David Einhorn. Even Warren Buffet has recently
called Microsoft - cheap. But the likes of Ben Rogoff of Polar Capital believe
that Microsoft and most other stocks in the PC camp will provide disappointing
returns to investors. GLG’S Technology Fund team says, “To discuss one year’s
P/E is flawed. It is not that valuation is unimportant. It is instead important
to look at an addressable market and how it will evolve over four or five years.
Apple and ARM, and others, are slowly destroying the business models of Intel
even though they are still making decent profits.”
However, the GLG team doesn’t expect the losers to blow up as
connected computing continues to evolve and grow. Instead, their sense is that
the stocks of earlier tech eras will behave like IBM, which in the 1990s fell
slowly but relentlessly until the company had lost 80% of its market value. We
are not arguing that Microsoft or Intel will disappear. What we are saying is
that they will be affected for maybe 10 years or more as the market they address
gets smaller and they operate at lower (profit) margins.
Companies which we believe are on the cutting edge of
innovations have to be the likes of Apple. Thanks to the popularity of the
iPhone, Apple has managed to capture over 17% of the global smart phone market
in less than 36 months. Apple’s cash reserves exceed $34 billion, enough to buy
the world’s leading PC vendor, Dell, and still leave change. It also has more
cash on its balance sheet than the entire market capitalisation of Nokia.
Apple’s flagship store in Regent Street is the most profitable for its size in
London, earning twice as much per square foot as Harrods. Apple is not alone in
having lots of cash on its balance sheet and this cash, which is burning a hole
in many legacy companies’ pockets, should be supportive of the small and mid cap
technology shares today.
Developments in the technology space are changing so quickly
that one needs the steady hand of fund managers who really understand the space.
For every 60-fold gainer like Autonomy there are equally spectacular examples of
capital destruction. Nortel Networks, worth $250 billion in 2000, crashed from
$83 per share to under $1 in just two years! It is important to learn from
history and the lessons show that the winners typically win for longer than
people think while the losers always look cheap and present dangerous value
traps.
To end off, it would be remiss of us not to comment on the
rise of Social media aka Facebook, Twitter and the like. Some info:
% With over 500 million users, Facebook is now used by 1 in
every 13 people on earth, with over 250 million of them (over 50%) logging in
every day.
% To reach 50 million users took Radio 38 years, TV 13 years,
Internet 4 years and Facebook 9 months.
% 48% of 18-34 year olds check Facebook when they wake up,
with 28% doing so before even getting out of bed.
% Almost 72% of all US internet users are now on Facebook,
while 70% of the entire user base is located outside of the US.
% Over 700 billion minutes a month are spent on Facebook, 20
million applications are installed per day and over 250 million people interact
with Facebook from outside the official website on a monthly basis, across 2
million websites.
% Over 200 million people access Facebook via their mobile
phones.
% 1 in 8 people married in the US last year met via social
media.
% Social media has now overtaken pornography as the number
one activity on the web.
% 48% of young people said they now get their news through
Facebook.
% 14% of people believe adverts, 78% of people believe peer
reviews.
% If Facebook was a country it would be the world’s fourth
largest.
We are not alone in being nervous of their valuations and to
date none of the funds that we invest in hold these companies, largely due to
the fact that the real winners have not yet listed! When they do list, their
valuations are bound to be on the high side and many will talk about bubble
valuations, but as the following example shows, social media companies march to
a different drum. The traditional methodologies of one year forward P/Es for
companies that show exponential growth are not necessarily appropriate.
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The above data and research was compiled from sources
believed to be reliable. However, neither MBMG International Ltd nor its
officers can accept any liability for any errors or omissions in the above
article nor bear any responsibility for any losses achieved as a result of any
actions taken or not taken as a consequence of reading the above article. For
more information please contact Graham Macdonald on
[email protected]
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