Information Technology Finance 724/824 SIM Class Summer 2009

1. Information TechnologyFinance 724/824SIM ClassSummer 2009 Russell Kolmin Zachary McAllister Paul Melko Mahavir Sanghavi Daniel Schuerman

2. Agenda Agenda • Sector Overview • Business Analysis • Economic Analysis • Financial Evaluation • Valuation • Recommendation

3. SIM Portfolio Composition SIM Portfolio Composition

4. SIM Weightings Relative S&P 500 SIM Weighting Relative S&P

5. Sector Overview

6. Sector Overview

7. Sector Overview

8. Business Analysis-Info Technology Largest sector with a focus primarily on computer hardware and software. Sector growth depends primarily on technological advancement and innovation. Unpredictable: what is hot now may be obsolete in 6 months Dependence on cutting edge technology leads to enormous R&D costs. These R&D costs are the largest barrier to entry

9. Business Analysis (cont.) Cyclical Sector with large impact on S&P500 Tends to follow market cycles, can be highly volatile A leading indicator during recovery, growth periods Largely impacted by Corporate and Consumer Spending Current Corporate/Consumer spending is down, however with ongoing technological advancements, corporations will be upgrading IT as recovery begins Primary indicator is Personal Computer demand PC Demand tends to create “pin-action” on all other IT components (i.e. Software, Peripherals, Storage, Services) New Trend – Cell phones becoming handheld PCs Leads to need for PC style software, hardware, storage, etc.

10. Business Analysis (cont.) Information Technology Life Cycle – primarily impacted by the life cycle of PCs PCs’ typical life-span = 3-5 yrs (physically longer, however obsolete) Demand – largely affected by developed countries, growth potential in under-developed 60% of all PCs owned by 15% of the world-wide population1 LOTS of untapped demand Increasing handheld device demand/infrastructure Tel-com sector expanding infrastructure and increased cell phone capabilities desired 1: www.garnter.com (June 23, 2008)

11. Business Analysis (cont.) Growth Opportunities US Healthcare reform(Electronic Patient records) Windows 7(How will it be received?) Office 2010 Increased Corporate Spending/ Consumer Saving Rate (following recovery, where will money be spent?) Stimulus Package(how will broadband infrastructure expansion impact demand?) Asia Growth/Savings Rates(exploding demand?) Growth Risks Regulations (China, Iran, North Korea, etc) Double-dip recession or unstable recovery

12. Business Cycle Analysis Investopedia.com

13. Business Analysis Summary • IT Growth Opportunities outweigh risks • However double-dip still possible • Demand is Strong Long Term • IT becoming a business staple with massive growth potential innovation • Short-term…what happens with Windows7 and Corporate Spending? • It appears IT spending is going to increase

14. Economic Analysis • Key facts about Info Tech sector • Over 75% of sales outside the U.S. for almost all major companies. • Leading Indicators • Global Semiconductor Bookings • Corporate IT Spending Index • Change in Real Consumption (U.S.) • Consumer Confidence Index is a good gut check. • Data on leading indicators was available only up to June 09, which limited the predictive power of the analysis in the short term.

15. Economic Analysis -2.1 Is the rest of the World GDP lagging US GDP?

16. Economic Analysis 323.4

17. Economic Analysis

18. Economic Analysis -73.7

19. Economic Analysis 49.3

20. Economic Analysis Summary • Leading Indicators show that the sector may be overvalued based on the comparative analysis. • If the assumption that ROW is going into a recession holds true then IT sector will be hurt. • In the short term, • With a slowly recovering global economy, this sector may be a drag with no significant upside. • With the possibility of a double dip recession in the U.S. and slowing global economy, the sector has a significant downside. • In the long run, • The sector is more attractive at a reasonable valuation.

21. Financial Analysis IT Sector Index over the past five years

22. Index price relative to S&P 500 • The IT Index has been lagging relative to the S&P 500 the past couple years – recovering from tech bubble • However this has changed so far this year, with the Index well outpacing the S&P 500 – will it continue? High: 12.3 Low: -19.4 Current: 12.3

23. EPS Analysis • Year to year EPS increased until 2009 • This latest year is the first one that saw a decrease in EPS for the last five year. High: 20.46 Low: 10.24 Median:16.41 Current: 17.71

24. Net Profit Relative to S&P 500 • Profit has consistently been higher than the S&P 500 average • Over the past couple of years this difference has jumped even higher

25. IT Sector Return on Equity • Has risen rather consistently over the past 5 year, with only a slight decrease this year High: 22.5% Low: 16.7% Median: 19.5% Current: 21.7%

26. ROE Relative to S&P 500 • The IT sector ROE has been relatively close to S&P 500 average, however this has changed since 2007

27. Financial Evaluation Summary • Even though the IT sector has gone down in EPS, ROE and Net Profit Margins, it has still out performed the S&P 500 in these areas • This outperformance is probably why the IT sector has gone up in price more than any other sector in the S&P 500 this year • Have prices caught up with this performance, or will they continue to outpace the S&P 500?

28. Relative Price/Earnings High 1.4 Low .98 Median 1.3 Current 1.1

29. Relative Price/Book High 1.7 Low 1.2 Median 1.4 Current 1.7

30. Relative Price/Sales High 2.1 Low 1.5 Median 1.7 Current 2.1

31. Relative Price/Cash Flows High 1.6 Low 1.1 Median 1.4 Current 1.3

32. Sector Valuation Summary

33. Valuation Summary • On an absolute basis, the sector is inexpensive. • Relative to the S&P500, the sector is a little expensive. • The direction of the market will determine the sector’s future.

34. Recommendation • Currently over-weighted in the SIM (1.76%) • Almost same as Industrials • Best performing sector in the S&P for the year • Will performance continue? • Yes, world-wide growth will drive IT growth • Yes, recovery will drive IT spending • Yes, long-term growth of IT seems inevitable • Yes, IT is becoming a business staple • Yes, near-term IT spending is trending up • No, economic analysis reveals that the sector may be overvalued. • No, short-term run is ending based on P/S (which is above its median) • Recommend weighting stands where it is.

35. Appendix

36. EPS Growth Relative to S&P 500 • IT Sector can have widely fluctuating EPS growth relative to the S&P 500

37. Net Profit Margin in IT Sector • Saw large increase in 2007, however fell back down in 2008 and into 2009 High: 12.2% Low: 11.0% Median: 11.3% Current: 11.3%

38. Holdings Valuation Analysis

39. Holdings Valuation Analysis

40. Economic Analysis

41. Economic Analysis

42. Economic Analysis

43. Economic Analysis -1.8

44. Absolute Forward Price/Earnings High 23.9 Low 12.1 Median 20.3 Current 18.0

45. Absolute Price/Book High 4.8 Low 2.3 Median 3.9 Current 3.6

46. Absolute Price/Sales High 3.0 Low 1.3 Median 2.5 Current 2.0

47. Absolute Price/Cash Flow High 17.7 Low 8.0 Median 14.5 Current 11.7