Our Outlook for Technology & Telecom Stocks
Current prices offer very little margin of safety in the tech sector.
Quarter-End Insights
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One of the big technology trends we're watching is the development of the smartphone market. There are few larger opportunities in technology than the global handset market, and we expect the smartphone segment to eventually be dominated by two or three software platforms. We believe Apple's (AAPL) iPhone platform has likely reached escape velocity and will be one of the software platforms that dominate the smartphone market.
The iPhone platform continued to gain momentum as Apple shipped 7.4 million iPhone units in its fiscal fourth quarter of 2009 (calendar Q3). While there may be long-term challenges, such as wireless carrier pushback, we believe investors underestimate the importance of early and sustained momentum in the race to build a dominant software platform. We believe the iPhone will continue to exceed expectations for some time to come. Some stats: Apple has shipped a cumulative 33.7 million iPhones and 17 million iPod Touches to date. Apple's App Store contains over 85,000 applications and users have downloaded over 2 billion apps in the past year. There are over 125,000 developers in Apple's iPhone Developer Program.
The iPhone OS ecosystem is, by far, the most developed in the mobile space, and its lead continues to widen. The stars are aligned for the iPhone OS platform to reach the critical mass that pulls users and developers into a virtuous cycle that is nearly unstoppable.
- Apple's soup-to-nuts model of hardware and software and applications allows for complete control of the user experience. Contrast with the Android and Window Mobile model where the user experience can be compromised in any step of the supply chain. Google (GOOG) has apparently seen the light on the soup-to-nuts model and has risked alienating its Android partners by introducing its own Google Nexus One phone.
- Apple iPhone developers are making money selling in the App Store, thus encouraging the creation of more apps. Windows became the dominant desktop OS because the developer ecosystem made multiples more money than Microsoft did with Windows.
- The iPhone is not the platform, it is the iPhone OS, which runs on the iPod Touch and the rumored upcoming Apple tablet device. A family of devices sharing the same common iPhone OS increases the user base, making the platform more attractive to more developers.
- Apple's competitors appear to be in complete disarray. Although RIM's (RIMM) Blackberry will likely remain entrenched in the enterprise market, the company made the inexplicable decision to leave out Wi-Fi connectivity in its consumer-oriented Storm. The recent bugs with the Palm Pre App Catalog are almost comical (paid apps being downloaded for free, Palm limiting the number of apps users can install, etc.). The Android ecosystem has thus far failed to develop a single compelling device that captures the public's attention like the iPhone. Nokia's (NOK) Symbian platform is sliding into complete irrelevance. Microsoft's (MSFT) mismanagement of its mobile efforts reached an embarrassing crescendo with the loss of Sidekick user data. By the time these competitors get it right, if they ever do, it may well be too late.
To elaborate on point four, the Sidekick fiasco has likely killed Microsoft's mobile platform efforts. Microsoft acquired Danger, the maker of the Sidekick, for $500 million in early 2008 to gain a foothold in the mobile consumer market. The acquisition has since been crushed under the weight of poor management. Along with the interminable delays in the development of Windows Mobile 7 and the intermittent development of its "Pink" phone, the Sidekick disaster illustrates that Microsoft's mobile effort is in shambles. Microsoft has now relegated itself to be a nonparticipant in the mobile platform race, and this will eventually have negative effects on its core Windows franchise.
Valuations by Industry
The massive rally since March moderated slightly this quarter, but without a material pullback, most of the technology and telecom sector remains fairly valued.
| Technology Industry Valuations | |||||
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| Star Rating | Price/Fair Value* | P/FV Three Months Prior | Change (%) | Uncertainty Percentile** | |
 | |||||
| Application Software | 2.78 | 1.04 | 1.00 | 4.0 | 25.0 |
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| Communication Equipment | 3.00 | 0.85 | 1.02 | -16.7 | 69.3 |
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| Computer Hardware | 2.92 | 1.02 | 1.14 | -10.6 | 12.5 |
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| Electronics & Computer Distribution | 3.08 | 0.97 | 1.09 | -11.1 | 71.6 |
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| Semiconductors | 2.97 | 0.98 | 0.98 | 0.0 | 42.0 |
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| Data as of 12-14-09. *Market-Weighted Harmonic Mean **Ranks the industry's fair value uncertainty (most uncertain =100) based on the aggregate market-weighted uncertainty ratings of each industry's underlying stocks. |
The large changes in the price/fair value stem from the market-weighted nature of the metric. For example, computer hardware saw a 10.6% drop in its price/fair value, but this is not because the industry was suddenly priced more attractively. The change was caused by the increase of our Hewlett-Packard (HPQ) fair value from $41 to $55 per share. As HP sports a $123 billion market cap, it has a substantial weighting in the price/fair value calculation.
Our general valuation outlook is unchanged from last quarter. A substantial and lasting economic rebound appears to be have been priced in by Mr. Market, and if such a scenario fails to materialize, the recent rally could easily reverse. As evidenced by the price/fair value ratios, current prices offer very little margin of safety. Of course, we could easily have another liquidity-driven asset bubble courtesy of the Federal Reserve. In that case, fundamental analysis will have little bearing on stock prices until such time as the bubble bursts.
Our Top Tech Picks
The market rally has made compelling technology buys fairly scarce. Here are our favorite ideas at this time.
| Top Tech Sector Picks | |||||
| | | | | |
| Star Rating | Fair Value Estimate ($) | Economic Moat | Fair Value Uncertainty | Consider | |
| |||||
| First Solar |  | 261.00 | None | High | 130.50 |
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| Applied Materials |  | 22.00 | Wide | Medium | 15.40 |
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| France Telecom | | 37.00 | Narrow | Medium | 25.90 |
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| Rogers Communications | | 37.00 | Narrow | Medium | 25.90 |
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| ATMI | | 27.00 | Narrow | Medium | 18.90 |
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| Data as of 12-23-2009. |
First Solar (FSLR)
First Solar possesses unique short-term advantages over its peers, and we believe it will remain at the forefront of the solar industry for years to come.
Applied Materials (AMAT)
This firm is the behemoth of the semiconductor equipment industry, with unmatched scale and a broad product portfolio. It has steadily been establishing its solar equipment business in an effort to drive growth. However, severe cyclical slowdowns in the chip and solar equipment markets have been hampering it.
France Telecom (FTE)
Despite seeing a bit more weakness in the first half of 2009 than we had expected, we continue to like France Telecom. We expect the firm to continue to enlarge its wireless business, and we like its emerging-markets portfolio, which we expect to be the focus of future acquisitions.
Rogers Communications (RCI)
Rogers has established a diversified product offering that is growing in multiple ways.
ATMI
ATMI is a top supplier of materials used during chip fabrication. The firm will benefit from continued advances in semiconductor technologies, but it is presently mired in a severe cyclical downturn in business conditions.
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