Though pockets of weakness have emerged, we expect well-positioned tech and telecom firms will continue to prosper.
--Semiconductor firms continue to see demand weaken, but we believe the current downturn in the industry--the most cyclical area within tech and communications--is isolated to a few areas and largely the result of specific one-off events.
--The M&A environment has heated up again as cash-rich firms, especially in the software industry, look to further augment their capabilities.
--We continue to favor larger firms that have the resources to easily weather any bumps in the global economic environment while also taking advantage of opportunities as they arise.
The persistent stream of revenue and profit warnings from the semiconductor industry has been the strongest theme of the past several weeks. Giants Intel INTC and Texas Instruments TXN have both sharply lowered their outlooks for demand recently. While end-market demand has certainly weakened in certain areas, including several industrial segments, we believe the current chip downturn is more of a reflection on the deeply cyclical nature of the industry. In some cases, customers have drawn down inventories on fears that the current turbulence in the financial markets will hamper sales. In addition, a handful of one-time events have hurt demand. The flooding in Thailand, for example, has hampered hard disk drive production, disrupting the PC supply chain. The current weakness has pushed several semiconductor stocks well below our fair value estimates. We'd focus on well positioned firms such as Analog DevicesADI.
Demand for tech hardware remains decent, especially among consumers. Smartphones and tablets have been the primary driver of demand, with Apple AAPL arguably the biggest beneficiary. We believe the next several months will prove critical as other firms attempt to build credibility in these markets. Given that these products are likely to build increasingly large customer switching costs over time, grabbing share today is critical. We think it will be tough for anyone to reach the type of scale Apple has achieved, especially in tablets, and the firm's shares remain among our best ideas.
The telecom industry also provides an example of the strong getting stronger, often at the expense of the weak. Several cable companies, including Comcast CMCSA, recently inked a deal to sell wireless spectrum to Verizon Wireless. The firms have also agreed to resell each other's services, a move that pairs companies that have historically been mortal enemies. These agreements have removed a major pillar of support for Sprint S and its partner Clearwire CLWR.
We continue to see better value among the smaller U.S. telecom players, but the gap in uncertainty between these firms and giants like Comcast, Verizon VZ, and AT&T T has widened. For exposure to large, stable telecom firms, we prefer companies outside the U.S. at current valuations, including France Telecom FTE.
The enterprise software giants have finally entered the cloud race. SAP's SAP proposed $3.4 billion acquisition of SuccessFactors SFSF marks an acceleration of the firm's cloud computing efforts. Although the deal is strategically interesting for the companies involved, the announcement came on the heels of Oracle's ORCL announced intention to acquire software-as-a-service (SaaS) customer service specialist RightNow Technologies RNOW and was quickly followed by IBM's IBM decision to acquire DemandTec DMAN, a SaaS vendor that helps retailers set prices. We have long held that large-enterprise software vendors would have to embrace growing customer interest in public cloud computing, and this wave of acquisitions suggests that the enterprise software giants are now backing prior lip service to cloud services with actual financial commitment.