A surprisingly deep divide has opened between Canadian and U.S. technology stocks. Sector analysts are forecasting very different futures for each group, with the domestic companies’ prospects appearing lackluster compared with their U.S. counterparts.

An Investment Executive analysis of 26 high-tech stocks tells the story. Only four of 18 Canadian tech firms are recommended by a strong majority of analysts, according to Bloomberg LLP. Three of the companies — March Networks Corp. of Ottawa, Q9 Networks Corp. and Workbrain Corp. , both of Toronto — recently completed initial public offerings. Each is growing quickly but none has a market capitalization greater than $317 million. Ottawa-based Cognos Inc. is the only large-cap tech stock in Canada
that has the confidence of the analysts.

The contrast with eight U.S. tech bellwethers couldn’t be sharper. Lucent Technologies Inc. of Murray, N.J., is the only member of the U.S. group not favoured by analysts.

Analysts’ divergent perceptions are all the more surprising when you consider that Canadian tech shares — as reflected in the information technology subindex of the S&P/ TSX composite index — have already dropped almost 9% year-to-date as of Sept. 7. The Nasdaq computer index has lost virtually no ground over the same period.

The relatively weak standing of the Canadian firms has a lot to do with the industry niches they have targeted. Many of the most valuable tech companies — Nortel Networks Corp. of Brampton, Ont., JDS Uniphase Corp. of Ottawa, Celestica Inc. of Toronto and PMC-Sierra Inc. of Burnaby, B.C. — make telecom gear. All are either still undergoing a painful restructuring or recovering from one, just as the industry is ratcheting down growth. Even the wireless infrastructure market, which has been on a tear for the past two years, is pausing for breath.

Canada’s semiconductor companies — ATI Technologies Inc. of Thornhill, Ont., Tundra Semiconductor Corp. of Ottawa and PMC-Sierra — have been hit by a worldwide slump in orders. International Data Corp., a U.S. consulting firm, predicts sales of chips will fall 2% in 2005 following a 26% surge in 2004.

Finally, some of Canada’s more prominent software companies have been struggling of late. Open Text Corp. of Waterloo, Ont., and Hummingbird Ltd. of Toronto each reported year-over-year declines in earnings during their most recent financial quarters, and both have been trimming staff and operations in an effort to recover momentum.

The U.S. bellwethers, in contrast, are moving from strength to strength, with many growing at the expense of rivals.

For instance, CIBC World Markets analyst Steve Kamman recently rated Cisco Systems Inc. of San Jose, Cal., as his top pick. “Cisco is set to deliver faster-than-market growth by taking share from competitors and adjacent markets,” he noted in a Sept. 8 report.
Cisco is the leading manufacturer of routers that form the backbone of the Internet and is positioning itself as a provider of telecom gear.

Despite Cisco’s large size (US$24.8 billion in sales in the fiscal year ended July 30, 2005), Kamman is convinced the company can increase sales by 13.1% a year until 2009, when it would be a leviathan with almost US$40 billion in revenues. Kamman has a 12 month-18 month price target of US$25 a share, up 36% from its Sept. 7 close, based on earnings estimate of US$1.02 a share for fiscal 2006.

Nine of every 10 analysts are recommending clients buy shares in Microsoft Corp. of Redmond, Wash., based on their predictions for continuing growth from a very large base. Yun Kim, an analyst with New York-based A.G. Edwards & Sons Inc., is projecting a 12% rise in revenue this year to US$39.8 billion, followed by another double-digit increase in 2006 to US$44.1 billion. Sales of packaged software products generally are expected to rise only about 7% this year.

Microsoft’s earnings per share aren’t growing at the same pace as its sales, but that’s because it has upped its dividend to 32¢ a share from 24¢. The key to the firm’s performance is its hold over key markets for software applications and computer operating systems, giving it pricing power, as well an automatic stream of revenue, as it introduces new versions of its software.

It’s a similar story at another U.S. giant, Dell Inc. of Round Rock, Texas. A.G. Edwards is projecting a 15.9% rise in sales for the computer maker in the fiscal year ended Jan. 31, 2006, to US$57 billion, vs a 9%-10% jump in revenue for the personal computer industry generally. Dell’s sales are projected to increase a further 13.5% the following year.

@page_break@The U.S. group of eight includes a few industry categories that don’t have serious Canadian competitors. San Jose, Cal.-based eBay Inc. and Google Inc. , of Mountain View, Cal., are the top Internet trading and search-engine companies, respectively. Both firms are experiencing terrific revenue and earnings growth. Jeetil Patel, an analyst for Deutsche Bank Securities Inc. in California, is forecasting earnings growth of 36% this year and 23% next for eBay, while CIBC World Markets analyst Michael Gallant is predicting profit increases of 123% and 41% over the same period for Google.

Whether the growth is strong enough to justify share prices at roughly 50 times forward earnings, especially in the case of eBay, is another question. Gallant is among a minority of analysts who rate eBay a “hold”.

Patriotic Canadian investors have some tech stocks worth considering. Cognos continues to excite analysts with its rock-steady performance and leading position in business intelligence software. California-based Roth Capital Partners LLC recently initiated coverage of Cognos with a 12-month price target of US$42 a share, representing a capital gain of 15% at the time of its report. Roth Capital analyst Nathan Schneiderman is predicting Cognos sales will grow 11% in each of the next two years, or nearly double the rate of growth of its primary market. He expects earnings in 2006 and 2007 fiscal years ending Feb. 28 will improve at an even faster rate.

For contrarian investors, Waterloo, Ont.-based Research in Motion Ltd. could offer some pleasant surprises in coming months. Despite RIM’s supercharged performance of late — sales more than doubled last year to US$1.35 billion and earnings per share quadrupled to US$2.10 — a majority of analysts rate the BlackBerry maker a “hold” or a “sell.” The reason has to do with new competitors, ranging from Microsoft to Good Technology Inc. of Sunnyvale, Cal.

For example, Pablo Perez, an analyst with ThinkEquity Partners LLC in San Franciso, Cal., cites Good Technology’s recent ability to integrate voice mail and corporate e-mail in its technology in his decision to rate RIM a sell.

However, Gus Papageorgiou, an analyst with Scotia Capital Inc. in Toronto, offers a useful reality check in a note he published August 24. RIM, he writes, has spent years developing an unparalleled distribution network for its Blackberry handsets. The firm’s arrangements with 115 carriers around the globe, and its compatibility with a wider variety of e-mail products, give it the ability to reach 87% of e-mail users. Papageorgiou points out that even Microsoft can reach only 46% of the market, while Good Technology is limited to 25%. His conclusion: RIM is on course for a few spectacular years. Scotia is projecting earnings of US$3.65 a share in the fiscal year ending Feb. 28, 2007, up 40% from the current year; sales are also expected to rise 40% in the same
period, reaching US$2.9 billion. IE