Beaten down for most of the past decade, science and technology stocks have staged an impressive recovery this year. Fund managers are optimistic that the rally will continue, as corporate fundamentals are positive and many of the past excesses have been purged.

“Investors used to look at technology as a ‘suckers’ sector. People thought, ‘Tech is for chumps’,” says David Eiswert, manager of TD Science & Technology Fund and vice president of Baltimore-based T. Rowe Price & Associates Inc. “As we saw the big pull-back last fall, it was the crescendo for the end of ‘I hate tech’ trade. Tech companies were trading at six or seven times free cash flow. They were not loved.”

Yet, unbeknownst to many investors, argues Eiswert, there’s been a dramatic improvement in tech companies’ fundamentals.

“Tech companies really grew up in the past decade and their boards became much more active in how companies were managed,” he says. “Of all the sectors in the S&P 500 [composite index], there is only one in which the balance sheets have net cash — technology. As you went into the [market] correction last fall, you discovered that tech stocks are actually pretty cheap — and the return on capital dynamics looked really good. That’s why tech has outperformed.”

The other positive factor, adds Eiswert, is that many tech companies have been rushing to replenish inventories. “You had a massive freeze-up in the supply chain [last fall]. It went out of equilibrium,” says Eiswert, noting that many suppliers stopped or drastically curtailed production during last fall’s financial crisis. “But in March, there was a huge snap-back in production. We took advantage of that.”

An investor who blends top-down and bottom-up styles and looks for opportunities around the world, Eiswert admits he began selling defensive firms last winter and buying innovative growth companies that had been dumped by investors: “We are very focused on big changes in technology.”

Currently, 20% of the TD fund’s assets under management is in communications equipment, 22% is in software, 18% is in semiconductors and smaller weightings are in areas such as Internet and media.

One of the larger holdings in the 90-name TD fund is Aixtron AG. Based in Germany, this small-cap firm builds machinery that makes light-emitting diodes that are gaining acceptance in flat-panel televisions. (LEDs generate no heat and consume much less power than conventional light sources.)

“This company has a 70% share of the market to build LEDs,” says Eiswert. “The market is moving from supplying small backlights for handsets to providing the thousands of lights behind a 50-inch LED TV. The supply chain will grow by multiples.”

He adds that manufacturers such as Samsung Electronics Co. Ltd. are switching to LED-based TVs.

Acquired in January at around 4.8 euros a share, the Aixtron stock is now 10.5 euros a share. Eiswert estimates the stock could be worth 12 to 15 euros within two years.

Another favourite is Palm Inc. The maker of communications devices has a “very iconic brand, but it was tarnished and management had missed a bunch of technology transitions,” admits Eiswert.

Things changed in October 2007, when U.S. private-equity firm Elevation Partners took a large position in Palm and installed Jon Rubinstein as chairman and CEO. Formerly the head of engineering at Apple Inc., Rubinstein was instrumental in developing the iPod and iPhone.

“The mobile computing market is a global one, and has room for innovation,” Eiswert says. “We thought [Palm] had the right vision to make this work.”

Although Palm’s stock fell to US$2 a share last fall, Eiswert kept buying. Early this year, with the successful launch of the Pre handset, the share price took off.

It is now US$14.50 a share. Eiswert, who believes the firm is a takeover candidate, says the stock price could rise to US$20-US$25 a share within two years.

The tech sector was ripe for recovery, says Daniel McClure, manager of Investors Global Science & Tech Fund and Toronto-based vice president of I.G. Investment Management Ltd.

“There were huge excesses, as far as supply is concerned, and it took several years to wring them out of the system,” he says. “In addition, valuation multiples needed to come down. And coming into this last recession, you had leadership in the resources space. A lot of money went there.”

@page_break@Looking back over 25 years, McClure notes, technology stocks tend to underperform coming into a recession and then outperform as the economy emerges from a recession. “On a macro level, we went into a severe recession, and it will be a while before it feels like it’s over, as far as Main Street is concerned. But leading indicators have bottomed out, and they are starting to turn around,” says McClure. “It’s positive for the market, and particularly positive for technology as a potential leadership sector.”

Typically, McClure adds, the second half of a year tends to be slightly stronger than the first half because the back-to-school market and holiday season are drivers of revenue. “People are a little jittery now,” says McClure, referring to the traditional weakness experienced in the summer months. “We will trade somewhat sideways, and then seasonal factors will come into play in the second half of the year. We will come out of this recession, at a time when a lot of the fiscal stimulus is starting to hit.”

Like Eiswert, McClure points out that tech companies have had much better balance sheets than firms in most other sectors. “Twenty per cent of their market cap is in cash,” says McClure, noting also that past excesses concerning option grants have been corrected. “These companies have learned from the last time around in 2000-2002: you have pristine balance sheets at a time when you’re in a growth sector.”

On a micro level, McClure argues, the tech sector will benefit from a cyclical rebound in the personal computer market as companies upgrade their systems and continued growth in so-called “smartphones,” demand for alternative energy and trends in the Internet and gaming. That’s how McClure has positioned the Investors fund, which has 10%-20% of AUM in each of five key areas: computer equipment, communications equipment, alternative energy, gaming and the Internet.

Running a concentrated fund with 37 names (the top 15 account for 70% of AUM), McClure has large holdings in a mix of large-caps, mid-caps and small-caps. “I look for names where there is a unique play,” he says, “and the equity, and its growth, is underappreciated.”

One favourite small-cap is Absolute Software Corp. The Vancouver-based firm provides so-called “endpoint security” for corporate and government clients through a software-based system.

“Its product, Computrace, allows you to recover lost or stolen PCs,” says McClure, noting that Absolute Software has partnerships with many large PC makers and boasts around six million subscribers. “People are getting more concerned about security. Here’s a great Canadian company that’s developed a unique solution.”

Acquired in mid-2007, Absolute Software’s stock price is $5.80 a share. “It has a lot of great long-term growth prospects,” says McClure. Although he has no stated target, he adds, “We would not be in it for only 10%-20% upside.”

In the smartphone area, McClure favours Qualcomm Inc. The U.S.-based semiconductor maker earns royalties on patents on chips used in handsets, and had US$11 billion in revenue in 2008. The stock price peaked in August 2008 at US$56.80 a share, tumbled to US$28 last November, and is now US$47.30.

“[Qualcomm] will continue to grow, because it gets paid from handset sales and smartphones. Smartphones will attract a growing portion of the wireless market,” says McClure. “The underlying secular trend is quite strong.”

He has no stated target, but notes that the consensus view for the stock price is US$52-US$55 a share within 12 months.



Like his peers, François Campeau, manager of CI Global Science & Tech Corporate Class, is also bullish and argues that the tech sector recovers early in the economic cycle.

“The best sector in the S&P 500 this year is the semiconductor sector,” says Campeau, a principal with New York-based Trilogy Advisors LLC, noting that the S&P 500 tech sector is up by 18% year-to-date (in US$). “It’s telling us the economy is getting better.”

And valuations are attractive. “We’re able to find stocks with a free cash flow yield of 10%,” Campeau says, referring to one recent acquisition, IT consulting firm Accenture Ltd. “Microsoft’s price/earnings multiple is 13. It’s not hard to find tech stocks at a discount to the broader market.”

Most important, Campeau believes that the recession was largely attributable to a process of de-stocking, in which companies halted purchases outright or curtailed them drastically. “Many companies focused on cash and cut back on orders,” he says. “Now, we’re seeing the opposite. We’re in the process of restocking. Many companies will benefit strongly.”

Campeau expects the economic recovery will be V-shaped, mainly because the decline was so severe. “It will be strong on the upswing, because of restocking and the massive fiscal stimulus,” he says, noting that bellwether companies such as Intel Corp. have produced second-quarter earnings that surprised on the upside.

From a sector standpoint, Campeau is favouring the software industry and Internet companies: “They are share-gainers. Even in the recession, they are growing. Most of these [Internet] companies benefit from the network effect.”

One top holding in the 40-name CI fund is priceline.com Inc. The online travel firm is gaining market share and is growing at the expense of travel agents. It also has a strong balance sheet and no debt.

“It’s a structural story. And it’s even stronger in Europe, where priceline.com derives about 65% of its revenue,” says Campeau, adding that growth is also strong in the U.S., where revenue is growing at around 30% a year. “The European hotel market is very fragmented. Hotels in Europe need priceline.com more than they do in the U.S. It’s a very strong company, a share-gainer and well positioned.”

Acquired last February, the stock is now US$122.95 a share. Campeau has no stated target, although he sees more than 20% upside in the next 12 months.

Another favourite is Concur Technologies Inc. The Redmond, Wash.-based software developer offers an online travel-expense reporting system that generates recurring revenue for the firm.

“When you book your flight, everything goes on the Internet. You don’t have to spend hours producing these reports. It saves so much time for everybody,” says Campeau, noting that Concur has aligned itself with American Express Inc., which is reselling Concur’s system. “The AmEx connection will be a strong growth driver for Concur.”

Acquired in March at around US$20 a share, the stock is now trading at US$33.90. “Penetration is still very low. The market cap could double over the next three or four years,” Campeau says. “For me, it’s a long-term holding.”

IE