We advocate an aggressive stance in TMT, with a focus on stocks positioned to take advantage of major paradigm shifts driven by innovations in smartphones, IP video, 4G, LED lighting, telepresence and cloud computing. We note that Apple, Cisco and particularly, Google have positioned themselves advantageously across multiple opportunities, with Nokia, Qualcomm, Broadcomm, ARM, Ericsson, Netflix, NewsCorp, Cree, Veeco, Polycom, Salesforce.com, and Amazon also well stationed. We also favor emerging companies with proprietary advantage in key new technologies, as well as new business models that are levering technology to attack traditional markets. We are skeptical as to the potential for companies in sub-sectors without IPR-based competitive barriers – e.g. telecom, cable, television networks, manufacturing, distribution and many semiconductor categories – to sustain above average returns.
TMT currently trades at a modest premium to its 5 year average vs. the S&P500. On the whole TMT has performed only slightly better than the market over the past 12 months, but this is misleading, as the very poor relative performance of cable, telcos and to a lesser extent, semiconductors pulled down the average. TMT sector analysts are expecting 23% EPS growth for 2010, well ahead of full market expectations, but, in our opinion, achievable, given potential for margin expansion on cost reductions and revenue growth. On a subsector basis, semiconductors and hardware may have the most difficult time meeting expectations while software, tech services, mobile devices, and internet stocks face a lower bar.
New disruptive technologies are moving from conception to commercialization, assisted by the improvements in semiconductor speed, size and power draw predicted by Moore’s Law. History suggests that the adoption of new technical paradigms can occur swiftly and comprehensively, catalyzing enormous growth for companies that can catch the wave. We believe that future users will access most applications and content via wireless internet connections with powerful search/navigation tools and that the opportunity to profit from content aggregation and regulated oligopolies will be severely compromised. We also anticipate dramatic reductions in the cost of LED lighting that presage the end of the 135 year run for the incandescent light bulb. We expect enterprise technology use to become even more web-centric, as telepresence displaces business travel and cloud computing breaks reliance on in-house data centers.
The trajectory of technological change is governed by formal and informal standards processes, subject to industry politics, government regulation and policy, and customer adoption which may favor some market participants to the detriment of others. Size and incumbency can help, but more often hinder companies seeking to gain advantage. Many of the best TMT investments in history were the direct result of winning this crucial game, often against well established competitors. The benefits of standards are typically robust and long-lasting, at risk only to new disruptive innovation and thus, new standards obviating them.
The concentration of value along TMT value chains is also changing. Manufacturing and distribution have largely ceased to be a competitive factor, while increased competition has and will continue to pressure margins for network operators of all ilks. The weakening of “gate keepers” should allow owners of unique proprietary intellectual property and content to reap even greater benefit in the future.