TMT: Portfolio Update – Dreams, Comebacks, Skeptics and the Death Watch Redux

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Artur Pylak


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October 30, 2014

TMT: Portfolio Update – Dreams, Comebacks, Skeptics and the Death Watch Redux

Last quarter, we created a framework to assess TMT stocks, juxtaposing near-term cash flow expectations (5-year consensus cash flows) with long term expectations (post 5 year cash flows implied by residual value). Arrayed on these axes, companies fall into 4 distinct quadrants 1) High near-term/High long-term “Dream Stocks”, 2) High/Low “Skepticism Stocks”, 3)Low/High “Comeback Stocks”, and 4) Low/Low “Death Stocks”. We extended this analysis to all US-traded TMT stocks with market cap above $3B, yielding a universe of 180 names, updating it to account for recent changes in valuation. As with the original analysis, the stocks largely fall into intuitively sensible quadrants. We believe the categorization has clear implications for investment – Dream Stocks are easily forgiven for short term transgressions, Skepticism Stocks are chronically “undervalued”, Comeback Stocks must justify their valuations or rerate, and Death Stocks have potential to surprise but could be value traps.

  • TMT valuations reflect expectations driven by themes. Valuation metrics have been poor predictors of TMT performance – expensive stocks often grow into their valuations, while cheap ones often get cheaper or fail. Still, in the context of a thematic investing approach, valuation can shed insight into the sentiment behind individual names. Our model sorts a universe of 180 large cap TMT stocks based on consensus 5-year cash flow projections and the percentage of enterprise value represented by the 5th year terminal value implied by the current share price, metrics intended to represent the short term and long term growth expectations of the market.
  • “Dream Stocks” must keep investors believing. The quadrant characterized by high growth expectations for both the short and long term as “Dream Stocks”. These are the long term leaders in the emerging cloud/mobile era – names like NFLX, FB, CRM, and WDAY reside here. Typically, investments in this category work, as long as that belief of long-term dominance remains intact. Unexpected signs of competitive rivalry or other business model deterioration are treated far more harshly than short term sales or EPS fluctuations. While these stocks are maddening to value investors, they are analogous to DELL, CSCO, MSFT, and INTC during the heyday of the PC era.
  • “Death Watch” stocks must overcome deep investor biases. The “Death Watch” quadrant is the group of stocks with low expectations in both the short and long term. These companies are often value traps with little prospect for reversing decelerating earnings. Today, the “Death Watch” includes PC era leaders like ORCL, NTAP, and CSCO, where we largely concur with the negative implications of their valuations. However, the “Death Watch” also includes stocks, like MSFT, STX, and WDC, where neither short term nor long term expectations reflect the real growth potential. If we are correct, these names could show significant appreciation as results belie the market bias.
  • Investors do not believe that “Skepticism Stocks” can sustain near term momentum. Stocks that sport strong consensus short term FCF growth, but modest terminal values reflect low investor confidence that current success can be sustained. This quadrant contains stalwarts like QCOM, VMW, GLW, and EBAY. In each case, the size of the company, the emergence of disruptive competitors, and the lack of compelling new paradigm growth narratives tempers investor enthusiasm. These stocks may continue to underperform their near term performance unless they can reestablish their growth bona fides with new product initiatives and/or substantial upside revenue surprises. Otherwise, strong results by these companies may go unrewarded, much as MSFT remained “cheap” during its post-Gates decade of slow growth and high cash flows.
  • “Comeback Stocks” often reflect unwarranted investor optimism. The 4th category holds stocks with dismal short term expectations but high implied long-term value. Here we find old-line IT names, like IBM, XRX, ADP and PAYX, where recovery is a substantial stretch. These stocks are amongst the most vulnerable in the TMT universe, as unless near term cash flows can surprise significantly to the upside, it is almost certain that the implicit long term expectations will have to contract. Eventually, we expect most to be excellent candidates for short side investments.
  • Stocks shift quadrants on price moves, revisions and earnings. The implied long term growth changes with stock price, everything else equal, moving names up and down with sharp changes in valuation. Earnings and revisions affect the 5-year expected growth, moving a stock left when revisions are particularly negative relative to reported results and right when the opposite is true. For example, a slew of cyclical stocks moved into the Dream category on anticipatory upward revisions. AAPL lurched leftward past the Deathwatch threshold as revisions did not keep pace with strong earnings, while GOOG dropped toward Skepticism status on multiple contraction after 3Q earnings. These moves are interesting, because they may imply future revisions, highlight investor overreaction or indicate real changes in sentiment. Obviously, stocks that are close to the threshold of either axis are more likely to shift quadrants, and we note that traditional cyclical stocks shift by their nature.
  • Adding AAPL and TMUS to our large cap model portfolio. Performance in the large cap portfolio was flat the past 3 months, with early strength scuttled by the significant earnings season downturn in internet stocks, such as NFLX, AMZN, GOOG, TWTR, and FB, as well as poor results delivered by S and ARMH. We are concerned that AMZN is likely to see further losses and downward revisions in coming quarters, and are replacing it with AAPL, where we expect strong 1H15 results and upward revisions. We will also replace S with TMUS, based on our disappointment in S’s strategy and execution.
  • Adding INVN, ZEN and PFPT to our small cap model portfolio. Our small cap portfolio underperformed its benchmark, with poor performance from XXIA, AMCC, and FUEL partly offset by strong performance by CNVR and OVTI. We are replacing XXIA and AMCC, neither of which appears to be capitalizing on opportunities that we had seen for each, along with FUEL, which has become mired in controversy. We are adding INVN, a leading provider of MEMS sensors for mobile devices, ZEN, a provider of SaaS customer service applications, and PFPT, a SaaS security vendor. All three companies are well positioned for opportunities created by the ongoing paradigm shift to mobile devices and distributed cloud data centers.

Dreams, Skepticism, Comebacks and The Death Watch

Winning in technology is about innovation, and winning in tech investing is about imagination – where are we going and who will benefit from the journey? Investors’ dreams are embedded in tech stock prices, and as long as those dreams are alive, valuation can be meaningless. Over the past several years, tech CEOs, often founders like Jeff Bezos, Larry Page or Mark Zuckerberg, have used those dreams to fund bold investments toward future domination while sacrificing immediate profits, a trade off that investors have, thus far, been willing to stomach. Dreams can be nightmares as well. Once written off by investors, companies perceived as future losers have a very hard time changing the accepted narrative. We have modeled these phenomena by separating out the short term performance and long term potential elements implicit in the share prices of 180 TMT stocks with market caps >$3B, plotting the 5 year CAGR of consensus free cash flow estimates against the percentage of enterprise value (EV) represented by the implicit 5th year terminal value left after subtracting the NPV of those explicitly forecasted cash flows.

The companies fall into four fairly distinct quadrants. In the upper right, characterized by strong forecast growth and a substantial terminal value, are the “Dream Stocks”. Most of the companies that you would expect to be here, are here – NFLX, AMZN, FB, CRM and others. Dream Stock valuations are resilient as long as the narrative of future domination remains viable. The lower left corner is the “Death Watch” list, companies where investors expect neither near term cash flow growth nor long term success. A number of old-paradigm IT companies live here – CA, ORCL, CSCO, etc. Death Watch stocks can escape by proving the near term consensus trajectory wrong, something we believe MSFT is in the process of doing. Escape is more difficult for “Skepticism Stocks”, such as VMW, QCOM, and GLW, which investors expect to deliver strong near term results, with no faith that they can sustain them. Even if names in this category beat expectations now, they must also change the narrative for the future. Conversely, the “Comeback Kids” in the north-west are getting the benefit of the doubt. Bad performance today, by stocks like IBM, HPQ, TXN and ADP, is somewhat overlooked against perhaps overly sunny expectations of future value. While valuations here may be somewhat resilient, we view the risks as overwhelmingly to the downside.

Stocks do shift quadrants, moving up and down with changes to market cap and left and right depending on the balance of reported cash flows and analyst revisions. For example, AAPL’s strong results raised the base for 5-year growth but estimates did not rise proportionately. With AAPL’s estimated 5-yr growth rate only just above the threshold, the stock shifted from Skepticism to Death Watch. We believe that AAPL will likely continue on a strong growth trajectory over the next couple of quarters and that upward revisions will follow. As such, we are adding it to our large cap model portfolio, replacing AMZN, which we fear could face downward revisions after its gloomy 4Q guidance. We are also swapping out S, a Comeback Kid that continues to disappoint on strategy and execution, for TMUS, a Dream Stock competitor.

We are also adjusting our small cap model portfolio, although small cap names are not yet included in the valuation model. We are removing XXIA, AMCC, and FUEL, all of which had poor performance over the past 3 months without signs of pending recovery. In their place, we are adding leading mobile device sensor vendor INVN, SaaS customer service application provider ZEN, and SaaS security solution company PFPT.

It Just Doesn’t Matter, It Just Doesn’t Matter

In a previous lifetime, we had access to a top notch quantitative analysis team with comprehensive back tested model. While the predictive performance of this model against most sectors of the economy was excellent, it was consistently poor for tech stocks, despite many attempts to adjust it. Very few metrics, whether value-oriented or momentum-oriented, showed significant correlation to future performance, and those factors that did have correlation, had low levels of explanatory power and tended to change from period to period. Valuation tools were particularly frustrating – if anything, tech stocks worked slightly counter to classic mean reversion, expensive stocks had a slight tendency to get more expensive and cheap stocks would get cheaper, but without enough predictive significance to drive a quantitative investment strategy. Momentum was dangerous – it would work until it didn’t, with frequent, dramatic inflection points that the model couldn’t predict. This experience, spread over more than a decade, has given us strong conviction in the primacy of thematic investing in TMT.

History supports a thematic approach. During the PC era, top performers Dell, Intel, Microsoft, Cisco, and Oracle were perpetually expensive, growing into their valuations and then some. Of course, the late ‘90’s saw hype around these and other, less established, tech stocks push to unsustainable heights. However, pure valuation-based and momentum-based analyses were useless in identifying the collapse of the bubble. The few that were able to anticipate the inflection point did so with thematic tools – telecommunication carriers had insufficient capital to continue financing their investment in network build-outs, triggering a domino effect of canceled orders, catastrophic quarterly disappointments, and share price collapse across the TMT landscape. In the aftermath of the 2001 recession, only investors with a firm vision of the coming future were prescient enough to buy Apple, Google, Amazon, or, all of which have been expensive against consensus expectations all of the way up.

At this point, thematic investing behavior has been almost innate, although the reactions to 3Q14 earnings showed more than a little push back. Amazon CEO Jeff Bezos has taken the luxury of investing his company’s potential profits back into the business to expand rapidly, enter new markets and develop new products without feeling pressure to deliver short term EPS. Facebook and Google operate with similar halos. Market sentiment may push back on this behavior here and there, as it did in response to 3Q14 earnings, but, historically, these companies don’t have to throw more than a small bone to get investors back on their side. As long as the dream of future domination remains alive in the minds of investors, perceived future winners have a long leash. Meanwhile, companies that are perceived as losing relevance in the future are given no benefit of the doubt. For these players, even strong financial results are nitpicked for signs of potential future weakness. The CEOs of companies like Microsoft, Qualcomm, and Apple must feel some frustration over their second class treatment by the market.

The Dream is Still Alive

We have created a framework for sorting stocks based on the short term and long term expectations of the market (Exhibit 1-2). For each of a universe 180 large cap TMT stocks, we calculated the 5-year CAGR of free cash flows expected by consensus estimates – where 5 year consensus forecasts were not available, we estimated the missing years based on the trajectory of the data at hand. We then calculated the 5th year terminal value that was implied by the current share price by subtracting the net present value of those forecasted cash flows from enterprise value (essentially, market cap + current liabilities – cash & investments), discounting cash holdings to reflect future tax liabilities and capital inefficiency. The remainder, expressed in present day dollars, and taken as a percentage of the enterprise value, represents the portion of the current valuation related to long-term franchise value. We then plotted the companies on axes representing the near-term FCF CAGR and the terminal value percentage of total EV. The size of the bubble is the current percentage cash flow margins. The collected plot is not particularly linear, with the various companies spreading out from a mean of roughly 12% 5-year FCF CAGR and 68% of value represented in the fifth year terminal value. When we introduced this framework in July, the mean was 11% and 65% respectively, and we’ve kept these levels as cutoffs for each category to remain consistent in tracking movement between quadrants.

Exh 1: SSR’s TMT Quadrant Valuation Framework

Exh 2: SSR Quadrant Framework – Universe of 180 TMT companies

We then examined the companies inhabiting each of the four quadrants of the graph. The upper right hand section – companies carrying expectations of better than 11% annual cash flow growth and with implicit terminal values that were more than 65% of their EV – contains the “Dream Stocks” (Exhibit 34). These 69 companies are richly valued, even in comparison to their strong projected near term growth. Amongst the group are such luminaries as Amazon, Facebook, and, alongside well regarded cloud/internet names like LinkedIn, WorkDay, and TripAdviser, and fast growing up-and-comers like Twitter, Splunk and Tableau. Interestingly, a large group of traditional cyclical names, led by LAM Research, Micron and Amphenol, reside in the quadrant, indicative of an expected beneficial skew in the supply/demand equation for their products. We also note a collection of, what we believe are, sub-scale cloud infrastructure players, such as Equinix, Rackspace and Akamai. Their high terminal values may be reflective of an unjustified belief in the enduring value of their substantial fixed assets, which are not reflected in EV. We are skeptical that those assets likely retain business value in a future IT world that we expect to be dominated by a small handful of massive public cloud operators, and see the stocks as particularly vulnerable to rerating as sentiment around their long term positioning adjusts to reality.

“Dream Stocks” get the benefit of the doubt, and can weather near term setbacks as long as the market remains convinced of the long-run narrative of domination. For these stocks, sales growth is far more important than margins to investors and sloppy quarters are quickly forgiven in the face of new product introductions and confident forward statements. Most of them will probably grow into their valuations – at least eventually.

Exh 3: SSR’s TMT Valuation Framework CHART – “The Dream Stocks”

Exh 4: SSR’s TMT Valuation Framework TABLE – “The Dream Stocks”

Exh 4: SSR’s TMT Valuation Framework TABLE – “The Dream Stocks” CONT

Death Watch

Opposite the dream stocks, in the lower left hand corner of the graph, is the “Death Watch” quadrant (Exhibit 56). Here, stocks are expected to underperform on 5 year cash flow growth and carry a vote of “no confidence” in the form of a smaller than average implicit terminal value. At the center of the 23 names in the group is a gaggle of former enterprise IT darlings – Microsoft, Oracle, Cisco, HP, Checkpoing, Brocade, Computer Associates and NetApp. Clustered near the upper thresholds are Electronic Arts, AOL, F5 Networks, and Informatica. To the left, with poor expected near term cash flows but nearly average implicit terminal values, are former high fliers Symantec, Citrix First Solar and SanDisk, stocks badly in need of an upside surprise.

We were shocked to see that Apple now falls within the Death Watch category, owing to very strong 3QCY14 results that were not matched by similarly dramatic upward revisions. Essentially, the base year for computing Apple’s 5-year projected cash flow growth has risen, but the projection for 5th year cash flow has not. This took the projected cash flow CAGR from a comfortable 15.4% down to a well below average 8.6%. Previously, Apple had been squarely in the skepticism quadrant, with its low terminal value owing to perceptions that the addressable market for Apple’s most important product category – the iPhone – is approaching saturation while its second most important product category – the iPad – has begun declining in sales as much lower priced competitors take control of the tablet market. Without real evidence that the Apple Watch or ApplePay could buttress the slowing growth of the iPhone and replace the declining sales of iPads, long term top line growth estimates have become an article of faith. We believe that Apple is very likely to deliver results over the next 2-3 quarters that will be well above consensus, either exacerbating this situation or prompting significant upward revisions and share price appreciation. Even if there is no multiple expansion, the earnings and cash flow growth should be more than ample to prompt upside share price performance.

Stocks in this group have the advantage of low expectations, and to the extent that they can deliver near term surprises against consensus, excellent performance is possible without fundamental changes in investors’ long term perceptions of their positioning. We also note that investor perceptions may be wrong. We are enthusiastic about Microsoft’s long term potential as a provider of enterprise cloud hosting and SaaS applications, and see the market skepticism, borne of more than a decade of strategic meandering, as a substantial opportunity. We have included Microsoft as a constituent of our large cap model portfolio for the past 2 ½ years; we also have included Seagate, which we believe can prosper with future investment in cloud storage; and we are adding Apple.

Exh 5: SSR’s TMT Valuation Framework CHART – “Death Watch”

Exh 6: SSR’s TMT Valuation Framework TABLE – “Death Watch”

Skepticism Bordering on Cynicism

Stocks with expectations for strong near term growth but low implicit terminal values are in a difficult position. These “Skepticism Stocks” may deliver upside sales growth, fat margins and EPS beats, but until investors stop expecting the sky to fall at some point down the line, results will be raked over for signs of encroaching weakness and any negative news flow will be amplified, even as positive news flow is ignored. Sitting in this category are 30 companies, most of them former market darlings that have had a bit of a fall from grace (Exhibits 78). To the far right of the quadrant, with expected cash flow growth more than double the universe average but carrying paltry implicit terminal values, are companies like Qualcomm, Corning, Garmin, RedHat and Juniper. Each was viewed as an early winner from the emerging mobile era – Qualcomm raked in the royalties and dominated smartphone chipsets, Corning made all of the glass going into those smartphones, Garmin was the early leader in GPS, RedHat was the open source OS leader, and Juniper was a duopolist selling the most critical plumbing for Internet data carriers. Alas, investors no longer believe that any of that is going to last.

Exh 7: SSR’s TMT Valuation Framework CHART – “Skepticism Stocks”

Most of the rest of the companies are clustered between 12 and 20% expected annual cash flow growth, including a roster of fallen investor favorites –VMWare, EBay, Expedia, Nvidia, EMC, Accenture and Priceline – and a few cyclicals –Analog Devices, Xylinx and Altera. All of these stocks have something to prove to investors, and may not be accorded multiples commensurate with their current results without offering serious evidence that the future will be very different than what investors fear.

Exh 8: SSR’s TMT Valuation Framework TABLE – “Skepticism Stocks”

The Comeback Kids

Then there are the stocks where the consensus expects weak near term results, but where the implicit terminal value is nonetheless high (Exhibits 910). These 59 “Comeback Stocks” are widely spread across the quadrant, with old-line technology firms – Intel, IBM, Xerox, Texas Instrument, Automatic Data Processing, Paychex, TE Connectivity and Motorola Solutions – well represented along with most US telecommunications carriers – AT&T, Verizon, Sprint, Frontier, Level 3, Century Link and EchoStar – and payments players – Visa, MasterCard, FIS, and FiServ. Investors may believe they see something in the future of these companies that justifies raising them above the “Death Watch”. There are also a few companies that are still investing toward their future – GoPro, Nuance, and Windstream. The other names in the group are fairly idiosyncratic, here largely because investors are willing to forgive their near-term stumbling.

There is real risk in the Comeback Stocks. In particular, we see nothing in the activities, assets or character of the old-line technology names to lead us to believe that they will mount the recovery implicit in their relatively rich terminal values. Given the valuation, the risks are often asymmetrically negative. This is the place to go hunting shorts. Still, sometimes, the story is good enough to buy – we include FIS in our model portfolio based on faith in the future of mobile payments.

Exh 9: SSR’s TMT Valuation Framework CHART – “Comeback Kids”

Exh 10: SSR’s TMT Valuation Framework TABLE – “Comeback Kids”

Exh 10: SSR’s TMT Valuation Framework TABLE – “Comeback Kids” (CONT.)

Exh 11: Quadrant Framework Movement Since July 2014 Update

Quadrant Mobility

Stocks can and do move within our model. Of the 77 stocks that we categorized 3 months ago, 23 shifted to a new quadrant, 8 moving up to be Dream Stocks, 4 falling to the Death Watch, 6 moving to Skepticism Stocks (2 falling from Dream status, 4 rising from the Death Watch), and 5 becoming Comeback Kids (1 dropping from Dream, 2 rising from Death, and 2 jumping diagonally from Skepticism). Obviously these moves are more likely with names that are already near the 11% 5-year cash flow estimate or 65% terminal value as a percentage of EV thresholds. We also note that cyclical stocks, where valuations can be meaningfully detached from near term projections, are very volatile within this framework and skip merrily from quadrant to quadrant. Of the 23 shifting stocks, 8 were either semiconductor capital equipment or commodity semiconductor vendors that have historically exhibited classically cyclical behavior (Exhibit 11).

The most surprising mover in the TMT universe was Apple, which dropped from the Skepticism quadrant down to the Death Watch. The mechanics are interesting. After its big 3Q14, the 1st year base for Apple’s 5-year cash flow growth projections shifted upward without corresponding revisions to analyst forecasts. As a result Apple’s forecast growth slipped from 15.6% to 8.6%, below the 11% threshold that separates Skepticism Stocks from the Death Watch. We believe that Apple is likely to continue on its strong cash flow growth trajectory for at least two more quarters, likely prompting further upward revisions from analysts. This could be impetus for a further leg of appreciation for the stock, even if skepticism keeps investors from expanding its multiple.

We also note the sharp downward movements in a list of digital economy companies within the Dream Stock category. Amazon, Facebook, Netflix, Twitter and Google all took substantial hits to market cap with their 3Q earnings reports, although all of them posted attractive cash flow results and, for the most part, did not see significant downward revisions to 5-year expectations. The sharp reaction to the nitty-gritty details of these results and guidance may indicate a sentiment shift, one that could affect all of these stocks. Of these, Google is the closest to the threshold, just 190bp of terminal value away from being a Skepticism Stock. We are not yet inclined to believe that this sentiment change is permanent, and expect that near term growth will be more than sufficient to dispel concerns for most of this group. Still, we are somewhat concerned that the news flow for Amazon will remain negative for longer, as the skepticism on this stock is in response to a perception that the company’s investments are no longer reasonable. Eventually, a sagging share price will force change, if only to assure employee retention, but the change could take several quarters to materialize.

The Large Cap Model Portfolio

Our large cap model portfolio performed roughly in-line with its benchmark metric, rising a scant 30bp against a 20bp appreciation in the tech components of the S&P 500. Still, the flat result is disappointing given the hit taken over the past two weeks in stocks like NFLX, GOOG, AMZN, TWTR and FB. Overall, our best performers were DATA and WDAY, which bounced back nicely from the sentiment that swamped the SaaS application sector in July. Surprisingly TWTR was also a good performer, despite the painful sell-off catalyzed by the 3Q report. We remain comfortable with TWTR’s underlying position and long term value (Exhibit 12).

The weak performers were S, AMZN, NFLX and ARM. We are not concerned for either NFLX or ARM, but have decided to remove S and AMZN. While we still believe that S faces significant long term opportunity, we are not convinced that the company has either the strategy or ability to execute necessary to exploit that opportunity. We will replace it with TMUS, which despite having less attractive spectrum assets than S, has articulated a bold strategy and executed it. We believe that it will benefit not just from the deterioration of VZ and T’s structural oligopoly, but also from the poor execution by S. As for AMZN, we remain convinced that the company is positioned to be one of the biggest long term winners from the sea change paradigm shift that is affecting the entire TMT landscape, with an addressable market that runs into tens of trillions of dollars. Still, CEO Jeff Bezos’s apathy for shareholders has taxed investors’ willingness to continue to fund his aggressive investment in future businesses. Meanwhile, aggressive price competition for AWS means that this rapidly growing business will be a continued drain on resources. The sharp reaction to the past two quarters and the company’s tepid forward guidance suggests real risk, even after the recent sell off. We will get off of the train until this dynamic stabilizes.

To replace AMZN, we are adding another iconic digital company, AAPL. We have been often characterized as congenitally bearish on the company, but we see a window to generate considerable upside in the stock. The iPhone 6 and 6 Plus, driven by considerable pent up demand for a larger screen model, is shortening user upgrade cycle and driving a reacceleration in growth. While we fear that this may be borrowing demand from future periods, opening the potential for disappointment at this time next year, we believe the immediate risk reward is greatly in the investor’s favor. We expect that we will see $120 by the time of the next portfolio update (Exhibit 13).

Exh 12: SSR Large Cap TMT Model Portfolio – Before Reconstitution

Exh 13: SSR Large Cap TMT Model Portfolio – Reconstituted

The Small Cap Model Portfolio.

The small cap portfolio performed poorly in the quarter, falling 440bp while the technology components of the S&P600 rose 2.2%. The big culprits were AMCC (-41.7%), FUEL (-33.0%) and WWWW (-27.7%), while positive results were delivered by CNVR (+46.3%), OVTI (+18.9%), and RKUS (+11.5) We are replacing AMCC and FUEL – AMCC has failed to make progress against the goal of an ARM-based server chip solution, while FUEL is mired in controversy amidst a securities fraud class action lawsuit. We are also replacing XXIA, which has been a portfolio laggard for the past three quarters (Exhibit 14).

In their place, we are adding sensor component vendor INVS, SaaS customer service application company ZEN, and SaaS security solution provider PFPT (Exhibit 15). INVS supplies MEMS-based accelerometer/gyroscope parts for mobile devices, and recently displaced Bosch in providing the main orientation and movement sensor for Apple’s new iPhone. While the company sank on an earnings miss earlier this week, the longer term prospects for the INVN are great and current levels present a buying opportunity. We expect the market for sensors to grow at nearly 11% going forward, as detailed in our recent research piece ( ZEN is a leader in providing customer service platforms from the cloud. It is projected to grow revenues at better than 40% and is an intriguing candidate for acquisition. PFPT is also an acquisition candidate. It is the only major SaaS-based security solution and has been growing at better than 45% through a combination of organic expansion and acquisitions.

Exh 14: SSR Small Cap TMT Model Portfolio – Before Reconstitution

Exh 15: SSR Small Cap TMT Model Portfolio – Reconstituted

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