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Technology’s Slim Pickings

Morningstar’s analysts see plenty of solid companies in the technology sector, but attractive valuations are much rarer.

Philip Guziec, 04/05/2012

The media has been talking all about tech in the past several months, from Apple’s big earnings to Facebook’s IPO and everything in between. I recently sat down with some of Morningstar’s tech analysts to see if there’s still investing opportunities in the area.

Philip Guziec: Since the market bottom in March 2009, we’ve seen the IPO market come back to life—lots of big tech names, some high-profile IPOs. You can’t turn on financial radio without hearing about a big IPO. What can we say about these?

Rick Summer: I think there is a dichotomy among the companies that have come out. Looking at the companies that we covered in 2011, there was only one company that came out that we felt pretty strongly about, that had good competitive advantages, and that was LinkedIn LNKD. And that traded extremely well, above its offering price. But the aftermarket trading for most of these companies has been pretty poor.

We’ve seen a little bit of a recovery here in 2012 for many of those companies, and certainly, the lineup of companies that are in a rush to go public has increased yet again. We’re seeing a big appetite from investors for investing in these. However, given that historical growth rates have been very tremendous, given the large appetite for IPO investment, and lastly, given the very large secondary market that’s taken place, where investors have been able to invest in advance of that IPO market, we’re not seeing a lot of attractive valuations. That being said, all eyes are on Facebook, a company we like that’s supposed to price sometime in the spring. It’s going to be a challenge, probably, to get around valuation once again. But it’s a company that we still think should be on investors’ radar screens just in case things end up trading south after the IPO. Many companies may not be worth participating in on day one or day two, but if they disappoint from an investor perspective and trade down, they could offer better long-term options for investment.

Guziec: You mentioned moaty names, LinkedIn being one of them. Are there any others?

Summer: In the IPO land, LinkedIn is the only one that we’d be excited about. Facebook, when it goes public, will be very interesting. I think that the growth rate for Facebook, while the market opportunity is fantastic, the stock will be decidedly choppy, from our early take on it. What that means is that a company with pretty distinct competitive advantages may end up being in a situation where it trades off, and investors could be able to get a crack at that. Right now, in terms of our coverage universe of companies that have recently gone public, those would be the two that we think could offer investors more of a core holding if the price was right.

Guziec: And other than that, we’d need a pretty deep valuation hit before we’d be interested in any of these other no-moat businesses?

Summer: Yeah, that’s our take on things, and it’s not surprising, when you have a robust IPO market. Sellers sell when prices are high, and that’s what insiders and venture capital firms are going to do.

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