The technology sector has come a long way in the 10 years since the bursting of the dotcom bubble, writes RCM's Walter Price
The debt overhang in the developed world may be stifling global economic growth, but the technology sector offers attractive opportunities with solutions to many of the major current challenges.
There is a multitude of companies with strong balance sheets across the sector, while consolidation in the industry has reduced competition, boosting the position of industry leaders.
In the 2000 tech bubble, some stocks were selling at 200 to 400 times earnings, whereas looking at valuations now, many tech companies are on less than 25 times earnings. They have a lot more cash, and even the Chinese companies are now starting to build up cash, providing a useful buffer during difficult times.
Also, strong secular trends in the sector will see firm future growth despite recent volatility – with a bottom-line focus on profits and cashflows.
The value chain
Chinese technology companies are at the forefront of this shift, as China has developed from a low-cost producer of goods and services, moving up the value chain with companies that have a long runway of growth ahead of them.
With technology-intensive products, China has the advantageous combination of low-cost manufacturing, good sources of raw materials and access to financing. Together, these make it a very effective player.
In particular, this can be seen in new ‘clean’ tech industries such as solar power, where the industry has shifted from a European-centric industry to a Chinese-centric industry in the last three years.
Solar panels currently provide less than 1% of total incremental power in the world, but this is set to rise to somewhere between 5% and 15%. We think China will be the major manufacturer of those products, which are starting to take off in the US utility market where solar energy is now considered competitively priced.
Batteries included
Similarly, if we look at electric cars then China is likely to be a leading exporter. Batteries need to be low cost to be effective, and China has the experience of building batteries for cell phones and conventional cars, and has developed the technology. China could become one of the leading exporters of low-cost batteries for electric cars.
Aside from exports and demand from emerging markets, another important dynamic development generally for the growth of the technology sector is internet TV.
On-demand programming allows users to watch programmes they want, when they want. Interactive programming allows users to search for content by various criteria, watch other programmes simultaneously with picture-in-picture functionality or text with keyboards that are now provided with many new TVs. Future developments are likely to include TVs that connect directly to internet; at the moment the internet is accessed through Blu-ray players, Xboxes and PS3s.
Integration
Internet TV will become increasingly integrated into people’s lives. For example, Netflix has over 12,000 titles for streaming available to about 12 million subscribers and the proportion of subscribers watching live streamed videos has gone from 28% to 48% in the past year.
In addition, corporate spending is returning to the sector. Many companies have technology infrastructure so old this spending is essential – creaking PCs, servers and routers need to be replaced, and this can be done at a cheaper cost with new innovations. Major transformations in technology include ‘cloud computing’ – enabling businesses to streamline operations by shifting from local networks to global internet-based networks.
Under-investment
Corporate cost-cutting in recent times has seen a prolonged period of under-investment in technology, and companies will find it hard to delay spending on replacing their IT systems for much longer. As a result, technology companies that focus on efficiency gains for business customers – such as through cloud computing and virtualisation software – are poised for growth.
There are four companies promoting cloud computing: Microsoft, Amazon, Google and Salesforce.com. Of these we believe the latter three are going to see their growth rates remain high because they are the chief players in this trend.
The big technology companies are certainly adding a lot of cash and rather than building up new divisions from scratch, they are often buying established players. Cisco has already made major company acquisitions to supplement its portfolio, while Oracle has been a large buyer of technology software companies, becoming in the process the largest corporate software company. The top 10 technology companies have about $170bn of cash right now, putting them in a strong position to make further acquisitions.
Some might shy away from tech stocks because they fear a double-dip recession, but many of the tech large caps can boast stable, cash-rich balance sheets, and the prospect of double-digit earnings growth.
Walter Price is manager of the RCM Technology Trust
