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By Greg Carlson | 05-11-2011 04:59 PM

Artisan's Cepukenas: A Lot to Like in the Tech Sector

Valuations are still very reasonable and understandable in the tech sector, says Artisan's Craigh Cepukenas.

Greg Carlson: I know that with the Small Cap Fund as well as the Mid-Cap and Large-Cap Growth funds, you are finding opportunities within technology?

Craigh Cepukenas: We are finding a lot of opportunity there, and we have for several years. I mean, if you go all the way back to the tech bubble, when the tech bubble burst, a lot of interesting franchises were left behind, both on a valuation basis and just because a lot of investors were burned on the other side of that tech bubble bursting. But really, when we're looking for franchises, we're focused around the idea of the sustainability of a profit cycle, and so we find a lot of disruptive business models, a lot of innovation.

If you think of, for example, virtualization, big data, all the changes around the network, the service providers trying to do things like voice, video, data, do it wirelessly, do it securely, do it faster, there's just a number of themes that we think are still in the very early stages. So we've had a number of interesting companies.

If I focus on maybe the top 20, Informatica: it's a software provider of ETL technology, and so they do things, they call it ETL, Extract-Transform-Load, but they clean up databases. For aggregating data at an ever-increasing rate and your ability to sift through that data is really important, so you have start with the clean dataset before you can develop a business around it--so it is a very successful company. It's been a core holding for a number of years, in our top 10. So it's one example of a lot of innovation we're finding in technology.

The other thing we like about technology is we still think the valuations are very reasonable and understandable. We have to pay a little bit more of a P/E, but we're getting growth rates that are much, much faster than the average company. So we continue to be excited. They're across all three portfolios.

Carlson: And how is the financial strength of these companies. It's vastly improved from, say, the tech bubble 10 years ago, correct?

Cepukenas: Very, very good point. I mean these companies have cash positions that they've never enjoyed before. I think the top three or four software companies have something like $100 billion--less today because Microsoft bought Skype. So they're spending something like $8 billion, but these balance sheets are loaded. We have experienced some M&A, where we've had some of our companies taken out strategically, and we think that's the theme that we will continue to play.

Many tech companies underinvested through the downturn, and as things get better, they have a choice: Try to spend in R&D to catch up, or many times just go out and buy something with the excess cash flow that they're generating, and so we've had a couple of pretty high-profile takeouts this year. Qualcomm bought Atheros to start out the year. Recently eBay bought GSI, [Applied Materials] just bought Varian Semiconductor, so we have had three tech takeouts, which we think actually underscores the work we're doing around these franchises--all bought strategically for product cycles they have.

Carlson: Before we wrap up, is there another area within the Small Cap Fund, another industry or sector that you would highlight?

Cepukenas: I think one of the things that we have done a good job on over the last 18 months is repopulating the garden positions in health care. Health care was somewhat out of favor in 2010 as we were trying to figure out what regulation would look like. We call this theme "Do More with Less." So, we have all kinds of sub-themes around health-care IT spending, things that will actually reduce the costs of our health-care system.

So, we have a number of companies--one I might highlight is, I think, in the top 10 of Small Cap Growth, Cepheid, a molecular diagnostic company. They have an instrument called GeneXpert, which is groundbreaking. It essentially moves health care closer to where the problems are. You can think of it as a razor/razor blade model, where you put a small sample in of DNA and get a very accurate and fast answer out of the other end. So, it has all kinds of uses, helping you figure out exactly what kind of strain of a flu somebody has, tuberculosis. They have a whole menu of tests you can run very rapidly, which allows you to better treat the patient, because you know exactly what they have, and do it quickly, so that somebody just doesn't walk out the door and infect the community.

So, it's an example of a fast-growing company that is helping reduce the overall costs of our health-care system over time. So we have lots and lots companies that play in that theme, and it's an area that we've actually generated a fair amount of alpha in over the past year and a half.

Carlson: So, I assume then within health care, you are not necessarily finding much within say biotech? Because that's sort of the traditional small-cap growth hunting ground in the sector, right?

Cepukenas: It's difficult for us to find biotech companies that have accelerating profit cycles before they have profits. We have done, I think, a better job identifying some of those that are near profitability. So, we do have some things that play around the biotech theme, which we think is absolutely a growth sub-sector of health care. So, we have found some things. Cepheid is actually considered a biotech stock, even though it doesn't look like the traditional pre-profit biotech stock that many people think of when they think of biotech.

Carlson: Okay. So, thanks very much for your time, Craigh.

Cepukenas: Thank you.

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