Technology: Data Security and Privacy Remain on the Forefront

• Overall, we view the tech sector as modestly overvalued at a market cap weighted price/fair value of 1.02.
• Enterprise cloud computing remains the most important story in tech.
• Data security and privacy remain at the forefront of technology.
• We still see a hot M&A sector, particularly in semis and software.

Overall, we view the Tech sector as slightly overvalued today at a market cap weighted price/fair value of 1.02 as of May 31, versus 1.05 as of the end of February and 1.08 at the end of November. The Nasdaq index has risen about 4% from mid-March to mid-June and is up about 11% year to date in 2018 as of mid-June.

In our view, the single most important trend in technology remains the ongoing shift toward cloud computing, which we think is having ramifications on dozens of stocks across our coverage. We continue to see several undervalued names with healthy cloud computing exposure, such as

Perhaps the most newsworthy items in technology over the past few months have been Facebook's privacy, data security, and regulatory struggles. Cambridge Analytica gained access to data on a reported 87 million

Another ongoing trend within technology remains M&A. In the second quarter, two notable deal announcements were Adobe's bid to enter into commerce by acquiring Magento and Microsoft's $7.5 billion valuation of developer community Github. We anticipate more and more software deals in the years ahead, as leading vendors like Adobe, Microsoft, Salesforce, Oracle,

We have not seen a sizable merger in the semiconductor space in the past couple of months, but this sector remains a hot one. Recent deals include

Top Picks

Synaptics

SYNA

Star Rating: 4 Stars

Economic Moat: None

Fair Value Uncertainty: Very High

Consider Buying: $32.00

Synaptics is a leading-edge smartphone component provider whose touch, display, and fingerprint solutions are ubiquitous across premium mobile devices, including the Apple iPhone and Samsung Galaxy. We expect greater adoption of organic light emitting diode displays, integration of touch and display, and fingerprint sensors to drive average revenue growth in the midsingle digits for Synaptics. Despite its current technology lead, major customers such as Apple and

Criteo

CRTO

Star Rating: 4 Stars

Economic Moat: None

Fair Value Uncertainty: Very High

Consider Buying: $18.50

Criteo, one of the leading ad-tech companies in the growing digital ad market, is currently trading well below our fair value estimate, creating an attractive buying opportunity, in our view. While significant changes in the retail industry, possible increasing competition from the two dominating firms in digital advertising, and various data tracking changes brought about by companies such as Apple have increased risks faced by Criteo, we believe they are more than priced in to the stock. In our view, given the disruption in the overall retail environment, the firm is taking the right steps in investing in new product development to attract more retail ad and marketing dollars. Criteo is now further integrating its Criteo engine with its clients’ CRM systems to gather more consumer purchasing behavior data. Such data can be utilized for more timely and higher yielding online retargeting and multi-channel marketing campaigns. We also think Criteo is well aware of possible threats from its friends/enemies Google and Facebook, which is why it continues to invest in new offerings and in expanding its services into new geographic regions. Also, we have taken such competition from the two behemoths into account as we continue to give Criteo a negative moat trend rating.

Microsoft

MSFT

Star Rating: 4 Stars

Economic Moat: Wide

Fair Value Uncertainty: Medium

Consider Buying: $85.40

We view Microsoft as one of two top-flight public cloud infrastructure- and platform-as-a-service vendors in the world alongside Amazon, and we think it is poised to amass greater market share. We think the market opportunity for IaaS and PaaS numbers in the hundreds of billions, as large public cloud vendors will consolidate IT spending that was once allocated to disparate vendors around a small handful of strategic providers. We view Microsoft as one of those strategic providers, and we believe its Azure offering will grow at a 31% compound annual growth rate over the next 10 years, eventually contributing north of 35% of total revenue by the end of our explicit forecast period compared with an estimated 9% in fiscal 2018. We also view the opportunity around Office 365 as one of the most important long-term growth stories for the firm. Office 365 is now larger than the legacy Office business, and we expect Microsoft to enjoy the natural uplift in lifetime customer value that comes with a migration to a high-retention subscription model. We think the firm provides a better value to consumers across applications and storage, reflected in the firm’s 30-million-plus consumer subscribers. Microsoft remains one of the highest-quality operators in enterprise software today, and we believe the business is starting to pick up steam as it works through declines in its legacy businesses. Finally, shareholders can also reap the benefits of a robust capital return program that has returned more than $70 billion to shareholders in the past three years by way of dividends and share repurchases.

Quarter-End Insights

Communication Services: Undervalued With a Case of Merger Fever U.S. telecom consolidation is in the works with a T-Mobile-Sprint merger.

Basic Materials: Overpriced, With Significant Downside Ahead for Commodities Few basic materials stocks currently offer risk-adjusted return potential amid our negative outlook for commodity prices.

Financial Services: A Positive Outlook for U.S. Banks, More Consolidation to Come for Asset Managers While tightening of financial regulations is uneven across the globe, rising deposit costs are nearly universal.