Where Tech Is Still Connected


Consumers are the key to tech stocks at the moment -- the best choices are companies that cater to that market, according to Thomas W. Smith, Standard & Poor's investment officer and head of S&P's group of technology-stock analysts.

One place to start, Smith says, is companies making semiconductors and semiconductor equipment, the building blocks essential for future growth -- with the exception of suppliers to the still-soft telecom market. Overall, although 2002 will see some degree of recovery, better prospects await in 2003.

Tech names on the S&P buy list now include International Rectifier (IRF), Fairchild Semiconductor (FCS), Microchip Technology (MCHP), Helix Technology (HELX), Siebel Systems (SEBL), Intuit (INTU), Electronic Arts (ERTS), Qualcomm (QCOM), DoubleClick (DCLK), and Flextronics (FLEX).

Smith made these and many other points in a chat presented May 21 by BusinessWeek Online and Standard & Poor's on America Online, in replying to questions from the audience and BW Online's Jack Dierdorff. Following are edited excerpts from this chat. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Tom, after a really good week, the market has had two down days -- and today people blamed tech. How do you read the signals?

A: I think the broader market is soft in the face of several obstacles. One is some questions about how fast the overall economy is going. Second is a question of political instability, especially in the Middle East, and the fresh round of terrorist warnings in the U.S. And third, valuations in many areas of the market remain high by long-term historical measures.

So investors may be waiting to see how low valuations go before they buy aggressively again. On the bright side, a solid fundamental recovery for semiconductors, one of the main building blocks for tech, has been under way for half a year now.

Q: Here's a one-word question -- Cisco (CSCO)?

A: Cisco Systems is presently a 3-STAR (hold) [in S&P's Stock Appreciation Ranking System], as followed by Megan Graham-Hackett. She estimates earnings [per share] in the fiscal year ending in July of 36 cents, improving to 52 cents for fiscal '03. Although Cisco posted earnings with some optimistic points last week, overall we view Cisco as stabilizing its business situation, rather than accelerating in a big way.

Q: Thoughts about Intel (INTC)?

A: Intel is another prominent tech company that we also rank as a 3-STAR (hold). Intel should enjoy seasonally better sales in the second half of the year, as we enter back-to-school and Christmas selling seasons. But for major corporate buying of desktop computers, I think we will see a much stronger season in the second half of 2003. We currently view it as fairly valued.

Q: What companies do you like (if any) in the telecom sector?

A: In telecom equipment, we like Qualcomm (QCOM), a 5-STAR (buy). We expect it to strongly outperform in the next 6 to 12 months, which is the time horizon the S&P STAR system works with.... Our analyst Ari Bensinger expects that a move to next-generation chips that carry higher margins should help improve results. QCOM is well positioned to benefit from the coming transition to broadband wireless networks.

Q: What do you think of SEBL

(Siebel Systems) vs. PSFT

(PeopleSoft)?

A: Our software analyst, Jonathan Rudy, ranks SEBL a 5-STAR (buy). And PSFT is ranked a 3-STAR (hold). One difference between the two is evident in today's news. PSFT is involved in some controversy concerning its auditors. The SEC charged PSFT's former auditor, Ernst & Young, with violating SEC rules by entering into a business deal with PeopleSoft at the same time it was an auditing client of PeopleSoft.

Beyond the controversy, PeopleSoft has solid profitability and a strong balance sheet, which supports the hold ranking. Siebel Systems has been a strong player in e-business applications used in a variety of industries.

Q: Any thoughts on Micron's (MU) ability to complete the acquisition of Hynix?

A: The Micron-Hynix story has been a fascinating soap opera to watch from afar. Micron was in talks for many months to buy Hynix' memory plants, which would have given Micron some additional capacity at a cheap price, compared to building plants. From Hynix' point of view, they have significant debt obligations, and with slow semiconductor markets, they were having trouble growing their way out of the debt situation. In the end, the Hynix board rejected a proposal from Micron, and the talks have stopped for now.

I think Micron is better off without the Hynix plants because they would have required significant investments in a foreign country and would have been a complicated network of factories to manage. As it stands now, Micron is still a very large player and the low-cost producer in DRAM. I presently rank Micron a 3-STAR (hold), partly because DRAM prices have fallen in recent weeks.

Q: Would it be best to buy the QQQ

[Nasdaq] index for a long-term hold instead of trying to pick each stock?

A: We presently have a market-weight recommendation for the tech sector. However, within tech we see clear weakness in telecom equipment and chipmakers that serve that area. And at the other end of the spectrum, we see a good fundamental recovery under way for semiconductors and semiconductor equipment, which are often early movers in a new tech cycle.

In the middle we see software, computer hardware, and networking equipment. In those middle groups, we are finding some companies we like as buys that are oriented toward consumer markets, where the demand has held up more strongly than for corporate buying of tech equipment. In conclusion, I think it would be better to try to pick your way into some of the individual stocks, rather than invest in the broad group.

Q: What are your thoughts on AMD

(Advanced Micro Devices) and SUNW

(Sun Microsystems)?

A: AMD is a 3-STAR (hold). It's an interesting company in that it has a new product family, the Hammer family of chips, scheduled to debut this autumn, which should coincide with the period of seasonal strength for personal computers. If AMD can execute well in the ramping up of production of the new line, it should have some good innings ahead.

AMD also trades just above its book value, which indicates a low valuation compared to many other chipmakers. AMD's perennial problem is that it's always getting pushed around by Intel in the PC-processor market. Recently, AMD has been able to maintain about a 20% market share. And that, in my view, is a pretty good performance.

Sun Microsystems is one of our favorite networking-equipment makers. However, business remains soft for now. We presently rank the company a 4-STAR (accumulate). Our analyst Megan Graham-Hackett estimates an 8-cent loss in fiscal '02 (June), improving to a 19-cent EPS in fiscal '03. So recovery is under way, although the timing is a bit uncertain.

Q: What about these two giants -- EMC

(EMC) and TXN

(Texas Instruments)? Is TXN a buy here?

A: EMC is a solid player in the storage-hardware market. For now, it's a 3-STAR (hold)...the timing of the recovery is still a little hazy. On TXN, it's a 4-STAR (accumulate). It's a strong competitor in analog and DSP chips used in communications and a wide variety of other applications. It's already in recovery from the difficult downturn suffered by most chip companies in 2001.

Q: What are the S&P 5-STARS (strong buy) in tech currently?

A: Starting with semiconductors, which is an area that we are positive on as a subsector, our names are International Rectifier (IRF), Fairchild Semiconductor (FCS), Microchip Technology (MCHP), and Linear Technology (LLTC). The theme for these chipmakers is broad end markets.

In semiconductor equipment, we like Brooks-PRI Automation (BRKS), Helix Technology (HELX), and Kulicke & Soffa (KLIC). In software, again we like Siebel Systems (SEBL), Tripos (TRPS), Symantec (SYMC), and one more, Barra (BARZ).

Consumer-oriented software makers are Intuit (INTU) and Electronic Arts (ERTS). We mentioned Qualcomm (QCOM), and the last entry is DoubleClick (DCLK). And Flextronics (FLEX) is the low-cost producer in the contract-manufacturing area, and we think it will do well whenever the recovery really gets here.

Q: I'm hearing more speculation that a recovery in tech is being pushed back into 2003. Your thoughts?

A: Yes, I think the recovery has been pushed back in some areas, especially telecom equipment. But to some extent, certain areas of software that depend on decisions by businesses to increase their capital expenditures are also pushing out their recovery a bit. On the other hand, software companies whose business depends on consumer buying decisions are holding up better.

For semiconductors, we see a firmer recovery for chipmakers exposed to the auto, industrial, and consumer-electronics areas. Semiconductor makers exposed solely to wireline-communications markets are facing a lagging recovery. For computers and networking, we see some recovery in '02, but things should be more decisively improving in 2003.


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