Growing technology sector has potential

Typically, spending on technology increases in good economic times. Says J.P. Scandalios, research analyst and portfolio manager with Franklin Advisors Inc. in San Mateo, Calif.: “There’s a long-term correlation between overall corporate profitability and spending on technology globally.”

Thus, he suggests, the short-term uncertainty in the IT sector stems from a “less than robust global economic backdrop.” Nevertheless, Scandalios is bullish on technology in the long term, which he believes will benefit from ongoing innovation and increasing demand globally.

Chris McHaney, vice president and portfolio manager with BMO Asset Management Inc. in Toronto is also “positive as a whole” on the technology sector, which he says “is in good shape [and] a good long-term buy-and-hold.”

Sam Mitter, vice president and head of technology investments with Meadowbank Asset Management Inc. in Toronto, is even more optimistic: “Based on the recent earnings strength from the tech sector, the resurgence in U.S. payroll numbers and more positive global economic data, tech could be an interesting place to park funds, given its global exposure and especially if the U.S. Federal Reserve Board starts to consider tapering [its bond- buying program] next year.”

In a July 2013 report entitled A mixed outlook for the global tech market in 2013 and 2014, Cambridge, Mass.-based Forrester Research Inc. suggests that purchases of tech-related goods and services will grow, remain depressed or decline over the next two years, depending on the geographical location of the buyers.

The Forrester report forecasts that in the U.S., technology buying will improve in 2013 and 2014; in Europe, growth in spending will be depressed in 2013 and rise marginally next year; Canada, Japan, Australia and India should experience modest increases in both years; and growth rates should be in the high single digits in China, Latin America, Africa and the Middle East.

A 2013 outlook report from the Downers Grove, Ill.-based Computing Technology Industry Association (CompTIA) projects the technology sector’s growth rate at 3%, with upside potential of 5.2%. This report states: “The two steps forward, one step backward pattern experienced for much of the past two years has conditioned many businesses to expect a dose of bad news with any good news.”

To invest in technology, you must look at the sector from a global perspective, says Mitter, who notes that in Canada, “technology comprises only 3%” of the Toronto Stock Exchange by weight. In fact, there’s only one Canadian company of global scale: Montreal-based CGI Group Inc.

That said, Mitter contends: “Canada is a fertile ground for a large number of innovative startups, supported by government initiatives and talent spinoffs from the likes of BlackBerry Ltd.”

When looking at technology, your clients must be aware that the sector is in the midst of “disruptive change,” Mitter says, “as new business models and technologies emerge, challenging the status quo of traditional technologies.”

For example, he says, the dramatic increase of smart mobility has led to the accelerated growth of transformational technologies such as cloud computing; software as a service (SaaS); big data analytics, which transform source data into valuable business intelligence; and the “Internet of things,” which adds wireless connectivity and cloud services to everyday devices.

Although traditional large hardware and/or software providers, such as Redmond, Wash.-based Microsoft Corp., Cupertino, Calif.-based Apple Inc., San Jose, Calif.-based Cisco Systems Inc. and Redwood City, Calif.-based Oracle Corp., continue to be well positioned in their respective spaces, they now have to contend with the emergence of what Mitter calls “game changers.”

Microsoft, for example, says Scandalios, “cannot stick with its legacy business model” and is now offering cloud services.

On the other hand, McHaney cautions: “Apple’s recent move to provide [productivity] software for free to its users” can lead to further changes in Microsoft’s business model, as [the latter firm] traditionally has “relied on software” for its revenue.

Also, Scandalios says, firms such as Seattle-based Amazon.com Inc. and Mountain View, Calif.-based Google Inc. are facing off with traditional providers by developing and marketing their own cloud-computing technologies.

As the tech sector goes through what the CompTIA report calls “a constant state of creative destruction,” the question that arises, says McHaney, is whether “companies are nimble enough to make changes.” In order to survive, some technology firms have been building their in-house resources to compete, he adds, but many others have been “buying rather than building.”

Thus, merger and acquisition (M&A) activity has continued apace in recent years. Scandalios says this is a “secular theme resulting from dynamic change, great business models and low interest rates.”

M&A activity has been based on two themes: consolidation and convergence aimed primarily at increasing scale of operation, eliminating competition, reducing cost or acquiring innovation; and business line or portfolio extension, aimed mainly at increasing services or capabilities and enhancing revenue.

For example, Apple acquired Melbourne, Fla.-based fingerprint sensor technology firm AuthenTec Inc. last year in a move to embed this security feature in devices such as the iPhone 5s, introduced this past September. As well, Google acquired cellphone pioneer Motorola Mobility LLC of Schaumburg, Ill., while Cisco and Oracle bought cloud-computing capabilities by acquiring San Francisco-based Meraki Inc. and RightNow Technologies Inc. of Bozeman, Mont., respectively.

As new technologies become ubiquitous, products such as tablets and smartphones have become staples, contends McHaney, who sees this trend as an important shift.

Subsectors in which he sees potential include: hardware, the “backbone of the Internet”; servers that meet the need for “more data being stored”; and microchips, which are essential to the development of the so-called “Internet of things” that connects a wide range of wireless, mobile and radio protocols.

Scandalios favours subsectors such as: SaaS, which is growing in penetration; wireless infrastructure, which is experiencing improved spending due to global expansion and the adoption of the long-term evolution (a.k.a. LTE) standard for wireless communication; the Internet of things; big data analytics; and cloud computing.

In particular, he likes cloud-computing firms such as Salesforce.com Inc. of San Francisco, Pleasanton, Calif.-based Workday Inc. and NetSuite Inc. of San Mateo; as well as SaaS providers such as ServiceNow Inc. of La Jolla, Calif. In the wireless infrastructure space, he favours SBA Communications Corp. of Boca Raton, Fla.

Although innovative technologies are gaining ground, many losers also are being exposed. Some of the companies “facing headwinds,” Scandalios advises, include those involved in the production of switching and routing equipment and hard-disk drives.

And although sales of desktop computers have fallen substantially, Scandalios adds, the laptop computer, as we know it, is likely to morph into different formats with convertible and detachable features.

© 2013 Investment Executive. All rights reserved.