5th September 2013
After a weak year, technology valuations have hit their lowest point ever relative to the wider S&P 500 index. This is largely down to the weakness of yesterday’s technology giants, companies such as Microsoft, Cisco, EMC and IBM. This week Microsoft announced that it planned to deploy some of its significant cash pile on a €5.4bn deal to buy Nokia’s mobile phone business. Could this move into the mobile herald the dawn of a new, better, era for the embattled behemoths? If so, does it make the technology sector a buy? Investment journalist Cherry Reynard weighs up the issues.
Microsoft’s purchase of Nokia is due to be completed in early 2014, when 32,000 Nokia employees will move across. The deal gives Microsoft the means to compete against Samsung and Apple in the Smartphone business. Microsoft’s management described the move as “a bold step into the future” and “win-win” for employees, shareholders and customers as reported on the BBC.
Others have not been so generous in their assessment. Victor Basta at technology M&A consultancy Magister Advisors described it as a ‘clean up’ deal at the end of an era: “The burning question, of course, is whether Nokia’s gradual erosion – in market share, value and perception – can be reversed. Microsoft must be betting that with more control they will be able to reengineer the business and gain market share. There is a huge array of challenges in the way though. There is fierce competition in the market and the competitor set in mobility has changed as fundamentally as the PC market changed when Microsoft entered it in the early 80s. The risk for Microsoft is that this deal is a me-too strategy on the heels of Google’s deal with Motorola and a fundamental recognition that Apple’s content and hardware ecosystem is the only model that can work. In fact Microsoft is attempting to ‘recreate Apple’ by combining its software and hardware under one roof.”
Gavin Clarke on the Register repeated the phrase ‘the sound of two garbage trucks colliding’. This was originally coined by Sun Microsystems’ co-founder and chief executive Scott McNealy to describe the merger of rivals Hewlett-Packard and Compaq: “McNealy used it to describe the unseemly act of two elderly corporate tech giants with outdated practices and ageing products attempting a merger,” he said.
Whether the deal is a solution depends on how Microsoft’s problem is defined. The manager of the RCM Technology Trust, Walter Price, says: “Our portfolio has very little exposure to hardware or conventional enterprise software, even though on conventional metrics many of these companies look cheap. There is a reason why companies such as EMC and Microsoft are cheap: they have very low growth rates. They may have lots of cash, but they are businesses in transition and need to spend that cash wisely to ensure that they have a future.”
He says that the transition to cloud computing is contracting Microsoft’s customer base. Cloud computing allows companies to opt out of the infrastructure business and buy solutions instead. Microsoft needs to make the transition to the post-cloud computing era. If it does so, it will be a recovery story. If it doesn’t, Price believes that it may move into structural decline. He points out that it has executed well on parts of its business, such as entertainment, but believes the next few years will be ‘make or break’ for company as it transitions to the cloud.
It is fair to say that this deal does not address that structural issue to any great extent, and uses up valuable cash that could have been used to address the problem. To this extent, the naysayers may be right about the Nokia deal. Apple is already struggling to keep pace with Samsung, and there is also competition from Chinese mobile manufacturers – Price describes the market as ‘a lot of units and no profits’. On that assessment, this is not a deal guaranteed to deliver.
This suggests that valuations in mainstream technology companies are deceptive. These companies may be on low valuations, but there is not necessarily value there until they can prove they are capable of making the transition to the post-cloud era. However, it does not mean that there are not exciting things going on elsewhere in the technology markets or indeed, that the sector has little to offer. For example, Price has identified companies round the world that are winners from the mobile internet – from Google, Amazon and Facebook to Pandora for music, Trip Adviser for travel, and Yelp for restaurant reviews and local shopping. This is replicated globally in groups such as C-trip in China. He believes many of these companies have the capacity for 50%+ growth rates over the near term.
David Hambidge, head of multi-asset investing at Premier Asset Management, says that he is retaining holdings in technology across his growth portfolios in spite of the difficulties for some of the technology giants. He adds: “We are aware that there is a generation of retail investors that will never buy technology again, but technology funds have been pretty good to us. We tend to use technology as a proxy for the US market because we don’t like many actively managed US funds.”
The deal is unlikely to be the game-changer Microsoft needs and therefore it may not reverse its low valuation, or those of its peers. There is plenty of excitement to be found in the technology sector, and plenty of stocks with exciting growth. But that excitement and growth just isn’t to be found in the lumbering technology giants of yesterday.