TMT in 3Q11: Temporary Flight to Value But New Paradigm Growth Apparent


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TMT in 3Q11: Temporary Flight to Value But New Paradigm Growth Apparent

3Q11 was a wild ride for TMT investors that ultimately rewarded a focus on enterprise IT, with particularly strong performance from low-multiple, old paradigm leaders that are unlikely to thrive in the longer term.  In contrast, telecommunications/cable carriers, semiconductor companies and high-multiple cloud-related names fared relatively poorly.  Given our focus on the change leaders in a sector in the midst of a tectonic plate shift, our model portfolios showed modest underperformance vs. the S&P benchmarks.  Over longer time frames, the stocks in our portfolios have largely outperformed.

Despite the flight to value observed over the better part of the past 3 months, we see significant evidence that our overarching long term theses – i.e. mobile platforms to replace PCs, wireless broadband to squeeze fixed networks, Internet delivered video to eclipse channelized TV, IT hardware to face commoditization, and consolidation of internet value to a handful of “meta-aggregators” – are proceeding apace.  Sales growth by companies driving change remains exceptional, although earnings and cash flows for many have been inconsistent due to substantial investments against future opportunities.

However, our attention to companies pursuing LED lighting opportunities appears to have been premature.  Demand for general lighting applications has not yet accelerated, as the cost gap vs. alternative solution has been slower to close than expected and government sponsorship of a transition to the technology has not coalesced.  While we remain optimistic that the long term opportunity is compelling, we are less enthusiastic in the immediate term.  Our large cap and small cap portfolios have suffered for a considerable overweight against this theme.  As such, we are removing Veeco, AXT Inc, and Cree, and replacing them with companies aligned with our larger TMT change thesis.

We will also remove ROVI from the large cap portfolio, which delivered disappointing sales and offered sobering guidance going forward as the decline of its legacy analog copy protection and DVD burning software will overhang the growth in its promising technology for interactive program guides and licensing for video programming meta-data over the next few quarters.  In the small cap portfolio, we are removing PegaSystems (PEGA) and Ceragon networks (CRNT), both of which sharply reduced guidance after delivering weak 3Q results.  Portfolio constituent Global Traffic Network was acquired by privately held GTCR Gridlock Holdings.

In our large cap portfolio, we are adding Amazon, which traded off nearly 13% over the past 3 months despite delivering 43% top line growth, as a bump in  its investments in infrastructure, talent and proliferating its Kindle Fire platform cowed investors.  We see these investments is amply justified by the substantial opportunities in front of Amazon, and see the pull back as an attractive entry point in a company we expect to be a dominant force in the TMT landscape of the future.  We are also adding Nvidia, which will see products based on its innovative Tegra3 mobile processor platform hit the market by year end.  A design breakthrough that employs a fifth processor core with a restricted power draw dramatically reduces the overall power needs of systems based on the chip.

In the small cap portfolio, we are adding (ACOM), K-12 (LRN), InterClick (ICLK), Ubiquity Networks (UBNT), and Glu Mobile (GLUU).  ACOM, which appeared in our portfolio previously, has re-established its strong growth and profitability yet trades at 8% free cash flow yield.  LRN, an on-line curriculum provider, is growing better than 40% YoY with tail winds as its product offers school districts substantial long term savings vs. the status quo.  ICLK is a fast growing, small on-line advertising specialist in a market where those skills are increasingly valuable.  UBNT is a recent IPO that specializes in high performance radios and antennas for wireless broadband and backhaul.  Its most recent report showed sales more than doubling YoY.  Finally, GLUU is a mobile gaming specialist developing apps for major video game franchises like Guitar Hero and Call of Duty, as well as its own titles.  While not yet profitable, it is well positioned with capabilities that could make them an attractive target.

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