by Tony D’Altorio, Investment U Research
November 5, 2009
While economists and commentators debate the issue, many investors have already placed large bets on a V-shaped recovery for the tech sector.
They have some good reason to think so too, since the tech-heavy Nasdaq composite has risen 70% from its March lows. The problem is, they’re expecting “business as usual” in the industry… meaning they think spending will pick up the way it did in the 1990s.
Kris Gopalakrishman, CEO of Indian tech giant, Infosys (Nasdaq: INFY) sees it differently, though. He warns that capital spending was artificially high in the 1990s: “You had multiple bubbles going around, plus leverage – it was an unusual environment.”
Meanwhile, his competitors have joined him in calling for caution concerning how fast and far tech demand picks up. Although some tech insiders have expressed optimism about 2010, most don’t expect it to differ that much from 2009.
Craig Mundie, chief research and strategy officer at Microsoft (Nasdaq: MSFT), sums up the situation well: “The run-up in stocks seems to have outdistanced the run-up in practical terms of the underlying strength of the businesses.”
He goes on to say: “We don’t think it’s like other recessions. It’s essentially more like a global reset, from which there is going to be slower growth.”
So how can investors play the situation?
Profits Play Hide and Seek With the Technology Sector
If you want to play the tech sector recovery, it’s worth keeping several proven facts in mind…
- Costs – not revenues – remain the overriding short-term focus. Since tech executives expect little or no real growth anytime soon, they’ll have to generate profits elsewhere, most likely by reigning in expenses.
In turn, this will lead to a continuation of certain trends that we saw before the downturn, such as…
- A further shift of production to the emerging world, where it costs less to make the same products.
- Increased consolidation in the form of mergers and acquisitions.
- Branching out into new, related markets.
For proof of that, look no further than Cisco Systems (Nasdaq: CSCO), the leading supplier of networking equipment and network management. The firm recently spent $3 billion to acquire Tandberg, a global supplier of video communications equipment.
But tech companies have also begun to invest much more heavily in IT services instead of dealing only in equipment. For instance, in 2008, Hewlett-Packard (NYSE: HPQ) snapped up EDS, while Dell (Nasdaq: DELL) acquired Perot Systems.
One compelling reason for this strategy is that services represent a steadier source of income, thanks in part to the longer-term nature of the contracts involved. Plus, services have the added bonus of typically coming out of a company’s operating budget instead of its capital budget, making the area less vulnerable to swings in capital spending.
Technology companies have a final card up their sleeves, but they may have waited too long to play it…
Take a Byte Out of Emerging Markets
With emerging markets notching up impressive and consistent economic growth, they have an increasing need for a more solid, reliable infrastructure. This includes banking systems, new telecommunications networks and “smart” power grids capable of distributing electricity more efficiently.
And there’s plenty of room for growth, too. While emerging markets account for a mere 21% of global IT spending right now, that will grow to over 50% by 2013, according to technology research company IDC.
So where does this put the West?
Western-based tech companies recognize the buying power countries such as China, India and Brazil hold, but while some of them have the brains and brawn to make it big in emerging markets, they need to move quickly.
That’s because a growing number of local suppliers have sprung up over the past several years. These firms already have a better understanding of their consumers’ needs and present serious competition to anybody trying to move in on their consumers.
All told, big-name technology companies have to adjust if they want to thrive in this new business climate… and investors need to do the same. That means focusing on companies that have large exposure to the emerging economies.
But for now, most technology stocks have run too far, too fast. Investors should approach these stocks with caution.