Last Friday’s BusinessWeek features technology as the core of its “double-issue”, proudly proclaiming that tech isn’t dead and that the best is still to come. While I have no doubt that many future productivity enhancements have yet to be implemented, and that technology still has the capacity to alter the world, I do believe that it currently presents a very weak investment premise over the short- and medium-term.
For starters, it’s important to look past the hype. BusinessWeek’s fluff pieces on how the pace of technological change hasn’t slowed (i.e. Computer-chip performance keeps doubling every 18 months, and disk-drive capacity and Internet-connection speeds are improving even faster.) are in some senses true and others not. Take the Internet-connection speeds referenced here. According to one research report, traffic is indeed doubling approximately every 12 months. Yet compare that to an article in Wired News, which says a study found that Broadband adoption was only running at about 50% per year, which is far from any sort of doubling. And more telling, the pool of users interested in pursuing broadband access is shrinking. This hardly strikes as a long-term growth opportunity. In fact, in this space, as an investment premise, only Verizon makes much sense. As BusinessWeek wrote in its cover story two weeks ago, Verizon is pumping billions in to capital expenditures to reinvent its businesses around a fiber optic network and 3G and beyond wireless service. And as BusinessWeek itself writes,
How can Verizon pay for all this? Its business is one of the great cash machines of Corporate America. The largest local-phone operator and the largest wireless company, Verizon generates about $22 billion a year in cash from operations. That’s 50% more than SBC, twice as much as BellSouth (BLS ) and nearly three times as much as AT&T (T ). More than any company in the industry, Verizon can make enormous bets and pay for them out of its own pocket. Seidenberg expects to cover the fiber-optic initiative without raising the capital budget above the current level, while he continues to reduce the company’s debt. “Funding is not an issue,” he says.
And it’s pretty clear that while funding may not be an issue for Verizon, it is for everyone else. So, you could invest in any of the other telecoms, but in a few years they won’t be able to match Verizon anyway. And given how much money Verizon is investing in itself, the barriers to entry will be extremely high. So, what’s the grand investment premise out of the “rapid-fire broadband adoption” that may not really exist anyway, as the Wired News article points out? Verizon. Welcome to the great tech revival.
For that matter, regarding tech investments, take a look at Cisco. As Briefing.com points out in a recent stock brief, Cisco has relied on increasing margins as its growth stock, since revenue growth stalled out. With the most recent quarterly report, margins actually declined slightly for the first time. Their take on Cisco’s fair value given its current trailing EPS and expected growth rate: $12.50 a share. Cisco’s current stock price: $17.59 (based on the 4 PM close). A good investment? Maybe as a short.
But BusinessWeek proudly proclaims examples such as Microsoft’s move in to gaming with the XBox console. Except that on the whole, margins on the hardware business are lower than those for software, and particularly with regards to the commodity hardware that makes up an XBox console. As long as Microsoft is intent on becoming a purveyor of hardware, its margins will decline. And if growth in the software business that has been their mainstay were truly growing, why would theymove in to a lower margin business?
Then there’s the PeopleSoft-Oracle debacle. The entire reason that Oracle wants to purchase PeopleSoft is to purchase PeopleSoft’s enterprise suite customers. This is driven by the clear recognition that Oracle’s database products are becoming a software commodity, relatively easily replaced by a future database software that provides a better cost/benefit ratio. In order to maintain their revenue streams, they need to move up the ladder in to Enterprise Applications, and since their own suite of applications has achieved little in the way of market-share, they’re pursuing PeopleSoft, who has been more successful. Yet another sign that, as an investment premise, tech is weak.
While I have no issue with the idea that BusinessWeek is out looking for the cutting edge, the idea that tech as we know it will return as a whole to even double-digit growth in the near term strikes me as unlikely. While I do believe there are exceptions, and that perhaps one day a wonderful new idea will capture people’s imaginations again, there’s certainly nothing immediate on the horizon. And rehashing glory statements from the Nasdaq glory days and spinning the idea of tech giants moving in to new areas of business (usually less profitable and because their old ones aren’t growing) as signs of encouragement strike me as the heart of folly. Sure, some companies may be making profits, but that doesn’t justify them as an investment premise.