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Bargains bloom in the tech sector
Yes, some tech stocks have turned into value plays. Here are a handful of names that the experts think are beaten up -- and ready to be snapped up.
By Michael Brush
When investors in the elite world of private equity pay a fat premium to take out a company in a beaten-up sector, its time to take notice.
Thats exactly what happened in tech this week, when a group of private-equity firms -- including renowned leveraged-buyout specialists Kohlberg Kravis Roberts -- confirmed they would pay $11.3 billion for SunGard Data Systems (SDS, news, msgs).
The buying consortium, which also includes tech-savvy Silver Lake Partners, will pay $36 a share for SunGard, a hefty 44% gain over the $25 SunGard shares traded for last week.
Some value investors saw the deal as further proof of a growing belief: Tech stocks have become, of all things, value stocks.
Silver Lake Partners is a smart investor. And the fact that they would pay up supports our case that there is value in the technology sector, says John Buckingham, a value investor who manages the Al Frank Fund (VALUX).
Bargains, and buyers, aplenty
With the Nasdaq ($COMPX) down more than 7% since January -- and still off 60% from its all-time highs -- many tech stocks looked ripe to bargain hunters even before the SunGard deal. Buckingham, for instance, recently started a newsletter focusing on bargains in the tech sector.
In addition to signaling that this may be the time to seek out cheap stocks in the tech sector, the SunGard takeout offers several clues to why investors may not have to wait long to reap the rewards.
The first is that there's plenty of money on the sidelines waiting to buy.
The SunGard transaction will be the largest leveraged buyout since Kohlberg bought RJR Nabisco in 1989.
More stocks in the news
With the amount of capital sitting in these private-equity shops, I would expect to see more of this, says Ryan Davies, a tech analyst with Cortina Asset Management. Private-equity firms use money from pension funds and other investors to take companies private, overhaul them and then bring them public again -- often in separate pieces.
Corporate cash in pocket
Next, corporate coffers are stuffed with cash. Bear Stearns strategist Francois Trahan estimates that U.S. companies have 69% more cash as a percentage of debt than they should at this point in the recovery, if history is a guide.
Technology companies that sit on piles of cash without knowing how to deploy it in ways that will drive up their share prices are prime takeover targets. These are politely known as mature companies in investment circles. You can expect more and more of these to crop up in the tech sector, says Geoffrey Moore, a consultant at TCG Advisors and author of The Gorilla Game, the 1998 classic on how to find hot tech sector trends.
With no debt, steady recurring revenue backing solid cash flow, and a strong presence in the slow-growth sector of data security, SunGard was a prime example.
Faced with nagging questions from shareholders about plans for all that cash, SunGard opted to reward shareholders by agreeing to a leveraged buyout. In LBOs, buyers fund the transaction with a large chunk of debt that gets transferred to the target, or SunGard in this case. This deal wouldnt have been possible without the kind of financial strength SunGard enjoyed, says Carla Cooper, a Robert W. Baird analyst who covers SunGard.
I think it is part of the maturing of the technology sector, which will start going into buyout mode, says Moore.
Technology companies will be big buyers, as well. Indeed, in recent months weve also seen tech predators snap up software companies Ascential Software (ASCL, news, msgs), Retek (RETK, news, msgs) and Peoplesoft.
A how-to guide for finding tech values
So what tech bargains look like buys now?
Buckingham offers his views in his recently-launched newsletter on tech value plays called the Prudent Speculator TechValue Report. The report should be worth watching, since Buckinghams Prudent Speculator newsletter consistently gets top grades by Hulbert Financial Digest, a service that ranks investment newsletters.
Buckingham says component makers, semiconductor makers and software companies are the sector's cheapest groups. Component makers sell for 0.79 times sales, well below their five-year historic average of 1.2 times sales. Semiconductors go for 3.53 times sales, a 37% discount to their five-year average of 5.57. And at 5.78 times sales, software stocks trade at a 24% discount to their five-year average of 7.63 times sales.
There are some companies out there that have been historically viewed as growth stocks and now represent real value, agrees Mark Morris, a tech specialist at NWQ Investment Management Company, another value shop.
Heres a closer look at some companies in these areas.
Software: Not boring just yet
Whod have thought that one of the four horsemen of the tech sector, Microsoft (MSFT, news, msgs), would ever turn up in value portfolios? But thats exactly what you find these days.
Shares of Microsoft (the publisher of this Web site) gapped down in November when the company announced it would use part of its huge cash hoard to pay a dividend. Its drifted lower ever since -- perhaps as growth investors concluded Microsoft turned into a boring dividend paying company.
But it is too soon to count Microsoft out as a growth company, and down at these levels it looks cheap, says Morris, whose NWQ Investment Management Company owns shares of the company.
Microsoft has a very sustainable franchise in its core operating system software business, says Morris. He expects earnings and cash-flow growth to come in part from consumer-electronics products like the Xbox game machine.
In software, Morris also likes Computer Associates (CA, news, msgs), a systems-management software company that trades for a price-to-sales ratio of 4.6 -- or well below the five-year group average of 7.63. Computer Associates has a solid sales presence among the Fortune 1000. Morris says that should help the company boost sales and hit its target of increasing cash flow by 10% a year in the next few years. Based on those plans alone, the company should be worth $50 per share right now. It recently traded for $27.
In software, Buckingham puts American Software (AMSWA, news, msgs), which produces supply-chain management software, near the top of his list. American Software has a price-to-sales ratio of just 2.5, and it has $2.40 per share in cash. American Software also pays a 4.5% dividend. The stock recently traded for $6.
Hardware and components: Reshaping HP
Laid low by concerns about how it might make its printer, personal computer and corporate information technology divisions synch up for better growth, Hewlett-Packard (HPQ, news, msgs) trades for just 0 .7 times sales, compared to a range of about 0.5 to 1.1 times sales in the past five years. What might move it to the upper end of that range?
For starters, the appointment of a reputable chief executive to replace outgoing chief Carly Fiorina and news of a share buyback, says Steve Neimeth, a value portfolio manager at SunAmerica Value (SSVAX, news, msgs). He thinks both could happen in the second quarter. The company has about $4 per share on hand to help support a buyback program.
Value investor Marty Whitman of Third Avenue Value (TAVFX, news, msgs) has significant positions in just three tech names. But hes only been buying shares in one at recent levels: AVX Corp. (AVX, news, msgs). Whitman likes the companys leadership in the business of selling components that store, filter or regulate electric energy. The company also has a cushion of $3 per share in cash and a price-to-sales ratio of 1.65. AVX recently traded for around $12. In components, Buckingham likes Applied Films (AFCO, news, msgs), a $22 stock with $12 per share in cash and a price-to-sales ratio of 1.6.
Chip stocks: Hitting the cycle's bottom
Semiconductor stocks are notoriously cyclical. But long term, the sector keeps growing because we use more and more chips in everything from cars to coffee makers, says Buckingham. The time to buy them is now, when they are out of favor and cheap, because we are near the bottom of the cycle. Applied Materials (AMAT, news, msgs) is the blue-chip name in semiconductor equipment, says Whitman, who owns it. The stock is also cheap, with a price-to-sales ratio of just 3.3. Historically, it has traded for 2.5 to 10 times sales, says Neimeth, who also owns the stock. The company has more than $4 per share in cash.
Cheap chip stocks in Buckinghams newsletter include: Cohu (COHU, news, msgs), Veeco Instruments (VECO, news, msgs) and Novellus Systems (NVLS, news, msgs).
If you buy any of these tech names as value plays, remember to hold for the long term. They are not trades. The key to success with tech investing, and all investing for that matter, is to remain patient, says Buckingham. I cant tell you how many times we have been rewarded in year two, three or 10 for holding an undervalued stock even when things looked very dicey.
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