Sean Udall is the author of the TechStrat Report, a tech focused newsletter. The following is a free sample. Take a free trial!
There are many potential catalysts in the tech space for 2012. Most are similar to what drove the microtrends for 2011. The key difference, though, lies in the potential clearing of very substantial headwinds. First, any firm resolution to the nagging EU concerns should quell valuation compression in tech -- and in US stocks broadly. Also, the major headwinds from the Japan tsunami and subsequent nuclear scare and Thai flooding are abating and may become tailwinds in 2012.
As I see it, the key drivers carrying over from last year are persistent M&A bidding, and the advent of "ultrabook" production, which should spur the themes I'm calling "devices today, bandwidth tomorrow," and "AAAOC," meaning Affordable, Anywhere, Always-on Computing. There's also a very strong trend of bandwidth growth from an array of sources. Smartphones, tablets, ultrabooks, the coming Windows 8 and continued gains from Google's Chrome OS should all facilitate the consumption of data, voice, video and real-time bandwidth intensive applications. As Part 1 in my forthcoming series of articles highlighting various aspects of the tech investment landscape, this piece highlights a few of my favorite growth names among the key players in large and larger mid-cap technology. Forthcoming articles will focus on the small cap space, in which I feel there's a tremendous valuation disparity, my key tech themes for 2012, and a special situations report. Some of this which will key on M&A, which has always been a value-oriented focus of mine.
Note: Aside from Google, the names below are in no particular order.
10 Favorites Among Key Tech Players
I try not to have a favorite, but I usually do. This name replaced Apple
(AAPL) as my favorite large cap tech for most of 2010. I expected a big move, but the EU provided a serious headwind and Google did well to hold serve for the year. At this point, I think the stock has two years of gains embedded in the shares. (For myriad fundamental supports for my thesis, please see 10 Reasons Google Goes to $3,000
In short, the underlying drivers continue to be growth in online advertising (in election year), e-commerce, mobile commerce, huge Android gains, Chrome OS, and social networking adoption. I think Google is severely undervalued and will really move after it breaks the all time highs in the $750s. As previously stated, I think this level ($735-750) will act much like the $160-170 area did for Apple's shares.
I have stuck with a good portion of my Qualcomm since aggressively adding during the lows of 2010 (in the low-mid $30s). Qualcomm is much like Google in that the company has performed and grown nicely, while the stock was flat. This served to reduce the valuation by more than 25%. With a forward P/E of 13, closer to 10 adjusted for net cash, this stock could trade closer to my target range of $75-90 within a year or less and still be reasonably priced versus its strong growth rate. In addition to the 3/4G cash cows, I'm seeing other catalysts. Mirasol display is likely still a couple years out, but Windows 8 is coming. I think few investors realize the potential for Qualcomm to see additional growth from this platform. For its part, Qualcomm has invested heavily to support coming products set to run on the platform. This, in addition to strong work throughout the Android platform, should have Qualcomm designs winning no matter which smartphone platform gains or losses in 2012.
It keeps doing a lot of the right things and maintains a very strong cash position as well as solid (if not a bit inconsistent) cash flow production. But the main point here is this: Zynga's
(ZNGA) market cap = $6.6 billion; Electronic Arts' market cap = $6.7 billion. Enough said. I'll take EA all day long, and I believe we'll see a substantial move in the shares during 2012.
I have been working on this article for a few days and I wish Akamai Technologies was still selling at $27 (as it was a few days ago) versus the current $31 and change. However, I think Akamai benefits from two of my working themes. Bandwidth growth and M&A. Starting with M&A, this has been one of the most rumored names in Techland for years. However, the data center and content delivery space has been consolidating. Verizon
(VZ) has been active (buying Terramark). Level Three Communications
(LVLT) and Global Crossing have merged. Akamai itself has been active in grabbing some of the best new technology entrants. The one company that needs to buy and just got snubbed is AT&T
Personally, I think this would be an excellent name for an Amazon
(MSFT) or even IBM
(IBM) to acquire. Now it may be more a matter of when, not if, before Akamai sees some major premium coming its way. The bandwidth growth call is easier. Akamai is a key facilitator in this space and nobody would argue that they don't perform the task superbly. The rub is that the industry experiences periods of price compression and then stability, and those crosscurrents are transposed against earnings expectations. The mere fact that the last few quarters was a compression period against tough comps for Akamai should provide potential for better results going forward.
I'm highlighting Skyworks as a favorite into 2012 as it has once again become an incredibly cheap name in its universe (trading at less 8x forward 2012 EPS, well below expected market growth). There are a slew of catalysts, which is potentially the rub for this stock. With fairly aggressive M&A activity in 2011, Skyworks has a lot of moving parts.
Among the several catalysts I'm seeing are: 1) the new iPad and iPhone 5 (they likely hold or possibly increase current content in these products), 2) potential for share gains in the Samsung smartphone food chain, 3) ramp up of low-cost 3G Android solutions in China -- think Huawei, and ZTE Corp
(ZTCOF.PK), and 4) and I like the greater exposure to power management silicon with the buy of AATI Advanced Analogic.
While I viewed Qualcomm as the best comm-semi investment among the large caps for much of 2010 and this year, the large price declines in Broadcom Corporation has led me to switch Broadcom back to the top allocation slot. For its part, Broadcom has a much stronger (15% versus 4% industry growth) and more diverse revenue base, and I think the networking and storage segments have become underappreciated. I also think Broadcom has conducted the most aggressive and best M&A strategy in the group (though Qualcomm's buy of Atheros was brilliant). Specifically, Broadcom's purchase of NetLogic Microsystems (NETL) will pay huge dividends and strengthen the company's leadership position in high-end networking and add leading wireless backhaul. Broadcom has also greatly improved its cash flow generation since early 2008 -- enough so that it is essentially paying for NetLogic with cash generated since 2008. With NetLogic being accretive and the shares trading for less than 9x forward earnings net of cash, this stock is very cheap versus normalized growth. Bottom line, I think people focus far too much on Broadcom's handset strategy (which is great) and nearly completely ignore the other key growth drivers: networking, storage, wireless backhaul, wired/wireless mobility. And in most if not all of these areas, Broadcom is the global leader in key technologies as well as the strongest R&D development.
Corning's current share price of $13 (roughly) is, in a word, idiotic. Sometimes the market is just wrong, and it's wrong with Corning selling this cheaply. I think the name could fetch $20 and still be a great value. However, at this point I love the fact that nary a soul has a price target much north of the high teens. The one-two punch of the Japan quake and Thai flooding took a big toll on Corning, but these effects are largely short-term in nature and mitigating. I think people might be quite surprised to see the starting price levels for future pound-the-table buy recommendations a year or two from now. I won't even mention the valuation multiples post net cash, because it hasn't mattered this year. Or that I expect to see normalization in glass shipments, a huge share buyback program, a pretty good dividend, and solid cash generation again. Well, I guess I just did. At some point those fundementals will matter again and if any "gorilla growth" comes to the fore the shares should see valuation expansion versus years of contraction.
EMC Corporation (EMC)
EMC doesn't look as cheap as many other techs on the surface, with a current P/E around 20 and the forward around 13. However, it owns 80% of VMWare (VMW), which would represent about 30B of EMC's $45B Mcap. On top of that, EMC has net cash over 6 billion. Add that to the value of VMWare, and you are getting EMC's $20 billion of revenue for less $9 billion. That PSR ratio of .45 is one heck of a good deal for a company with flat sales, but EMC is kicking out 18% annual sales growth. Said another way, the P/E for EMC net of VMWare and cash would be less than 5 (the forward PE quite a bit lower still).
Looking at all this, EMC's valuation goes from somewhat cheap to absurdly so.
Additionally, VMWare has dropped 15% (roughly) in the last month. Even so, it's entirely possible that its stock could decline further if were to succumb to the plague of growth stock valuation compression. That said, I don't view VMWare in the light of a Netflix (NFLX) or a Salesforce.com (CRM), as it has already shown an ability to grow faster than it's stock price. This has served to reduce the valuation levels materially over the last two to three years.
Lam Research Corporation (LRCX)
In my view, the deal to acquire Novellus Systems (NVLS) strengthens an already fine set of assets for Lam. The deal was ultra-friendly, which secured a favorable merger price. Basically, the folks at Novellus feel fine transferring their ownership of Novellus shares to Lam Research Corporation shares. In addition to the Novellus deal, part of my thesis for Lam includes optimistic expectations for this tech sub-sector. Broadly, the semi-cap equipment space is widely expected to experience another tough year in 2012 -- this has been written about ad nauseum, so muted earnings expectations have been built in to stock prices. Even so, cash flow has stayed strong in this group as some necessary consolidation has already occurred. On the other hand, what if the consensus here turns out to be too conservative? I think that could be the case, especially since Lam's area of strength is the gear used in various areas of memory fabrication.
During much of 2011 I favored Cisco (CSCO) and was cautious on Juniper, especially anywhere above $35. While the market loves to anoint a current winner at all times between Cisco and Juniper, there are periods when both companies can do well and the shares perform in tandem.
I think 2012 could be one of those periods. Both have strong if not very strong product cycles forthcoming. The biggest question will be when risk-on returns. And Juniper needs more risk-on to catch a bid than Cisco does. The other variable to consider here is the timing of Juniper's strong product cycles and when they will kick in. If this occurs during a return of risk-on, the upside here could be spectacular.
Regarding product cycle specifics, we should start seeing the data storage segment gain steam soon, within the next couple of business quarters. My guess is that core router sales will start improving in Q2 and accelerate into the second half of 2012. And a potential positive here is that the "death" of the T-Mobile deal may boost Juniper's sales at the margin. At this point, AT&T is starting to see a more rapid share erosion to Verizon's superior 4G services. Moreover, I think AT&T is reaching a critical point where they will need to start aggressively ramping up the upgrade to the more robust LTE version of 4G. If they don't, they risk a big run on share to Verizon.
And what about Apple? Stay tuned for my thoughts in a separate piece.
Positions in GOOG, AAPL, QCOM, AKAM, LVLT, SWKS, BRCM, GLW, EMC, JNPR, and CSCO.
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