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Technology Sector. Internet, Software, and Hardware. Deborah Koch, CFA Senior Equity Analyst. S&P IT Sector vs. S&P 500 Performance – 1 yr. Source: FactSet. S&P IT Sector vs. S&P 500 Performance – 5 yr. Source: FactSet. Technology. Sector Overview: Overweight.

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Technology Sector

Internet, Software, and Hardware

Deborah Koch, CFA

Senior Equity Analyst


Sector Overview: Overweight

  • We are positive on the technology sector, and we expect spending on technology products and services to improve in C2010 as the global economy improves

  • We expect enterprise I.T. spending to be better the 2H2009, as budgets were set later than normal. We also expect consumer tech spending to be decent for the holidays, given solid back to school results

  • In C2010, we expect enterprise I.T. spending to increase in the low-mid single digits, with hardware spending recovering sooner than software and services

  • While consumer spending may remain constrained depending on the pace of an employment recovery, technology continues to gain share of wallet, driven by digitization

  • Tech company balance sheets remain strong, with high levels of cash and little debt; M&A activity has picked up recently; valuations are reasonable; and currency should begin to help reported growth rates in CQ42009


Secular Drivers for Tech:

  • Industries facing massive business transformations, global competition and increased compliance and regulation are using technology to generate new revenue streams and to gain competitive advantages vs. their peers

  • Enterprises are reducing the number of tech vendors they deal with, which is driving consolidation of smaller providers and helping the large cap tech companies gain share of corporate budgets

  • Tech companies have a relatively high international exposure, and should continue to benefit from the long term secular growth trends of globalization and infrastructure build out in developing countries

  • New technologies like software as a service; virtualization; mobile applications; and Web 2.0 technologies such as social networking will be implemented by enterprises to improve productivity and reduce costs

  • Digital technologies, mobile applications and digital content will continue to drive consumer technology spending


Risks to Monitor:

  • With technology stocks outperforming YTD, expectations are rising, and evidence of a recovery in growth will be necessary to sustain valuations and estimates at some point

  • Most companies have completed their cost cutting programs, and further margin expansion will require a return to revenue growth

  • Technology price deflation seems to be accelerating, and could reduce revenue growth and put pressure on margins for many tech companies

  • High balances of overseas cash may result in higher levels of debt on tech company balance sheets in the future, since overseas cash cannot be used for share repurchases, dividends or domestic acquisitions without incurring a tax penalty

Ntm margins and valuation
NTM Margins and Valuation

*Uses NTMFactSet consensus estimates for our companies

Ntm revenue growth and valuation
NTM Revenue Growth and Valuation

*Uses NTMFactSet consensus estimates for our companies


Coverage (Deb Koch):

1 – Sector Outperform

  • Activision (ATVI)

  • Apple (AAPL)

  • Adobe (ADBE)

  • (AMZN)

  • BMC Software (BMC)

  • Cognizant Technology Solutions (CTSH)

  • Google (GOOG)

  • McAfee (MFE)

  • Oracle (ORCL)

2 – Sector Perform

  • Accenture (ACN)

  • Autodesk (ADSK)

  • Cisco (CSCO)

  • Citrix (CTXS)

  • eBay (EBAY)

  • Electronic Arts (ERTS)

  • Intuit (INTU)

  • Juniper (JNPR)

  • Microsoft (MSFT)

  • SAIC (SAI)

  • SAP AG (SAP)

  • Symantec (SYMC)

  • Yahoo (YHOO)


Apple (AAPL, 1/A): Continued Share Gains Expected Due To Superior Technology Platform

  • AAPL has perfected the user experience in all of its devices, with tight integration between hardware, software, internet based services and third party content

  • We expect new devices at new price points, new carrier relationships and new geographies to expand AAPL’s addressable market

  • Mac sales continue to benefit from iPhone and iPod success

  • Based on the iPhone’s current deferred revenue model, estimates seem conservative and valuation is reasonable; we expect an accounting rule change could result in upward estimate revisions

Technology (AMZN, 1/B): eCommerce Share Gainer

  • eCommerce share gains should continue driven by category and geographic expansion, and by increasing penetration of Prime membership, third party sales and digital media

  • Margins should expand gradually over time driven by a slow mix shift toward third party, private label and digital media

  • While the Kindle has been a success, we expect AMZN to sell digital media – including ebooks, movies and music – on any open device over time, which we view as a long term positive

  • AMZN is one of the best cash flow stories that we follow, given its negative cash cycle and low capex requirements; the stock is currently selling at less than 20X our 2010E FCF/share of $5.00


McAfee (MFE, 1/C): Security Share Gainer

  • MFE has been gaining share in enterprise security as customers have moved from point products to integrated suites with higher price points, and has differentiated itself with a common management platform

  • MFE was early to focus on the PC OEM and ISP channels in the consumer market, which has allowed them to gain share

  • Revenue is mostly recurring, and margins should continue to expand as management integrates past acquisitions and improves internal efficiencies

  • New management has more consistently executed on strategy, resolved accounting issues, added to the product portfolio with key technology acquisitions and improved credibility with investors


Coverage (Bill Hurley, so far):

  • Qualcomm, QCOM (1/B):

    • The company gets revenue from licensing intellectual property and is the market leader for baseband communications chips

    • QCOM is uniquely positioned to benefit from global 3G wireless build-out and the shift to smartphones

  • Altera, ALTR (1/B):

    • ALTR is a leading provider of programmable logic devices (PLDs), benefiting from global communications infrastructure growth and PLD market share capture from other types of chips

    • New products and an effective market duopoly point to sustained, high margins

  • Texas Instruments, TXN (2/B):

    • TXN is transforming itself from being primarily a wireless company into an analog and embedded processing chip company

    • Margin expansion and refocused growth offset by lost operating profit from exiting wireless baseband

Thank you.

Deborah Koch, CFA

Senior Equity Analyst