Outsourcing IT and communications remains a fertile investment theme
If you walk down any high street today you will notice a whole host of electronic devices in use. The mum, taking a picture of her baby with a camera phone, the suited office worker prodding away at an iPad, teenagers tuning in to their MP3 music players, or using mobile interfaces to update friends on Facebook or Twitter. We have truly entered the age of the gadget.
As the digital revolution gathers pace a number of key technology trends are emerging of which five in particular offer great opportunity. Using these five top-down drivers we have identified a quintet of companies where the returns for investors could be astronomical.
POWER PLAYS
The clever server computer replication technology of WANdisco (WAND:AIM) is the best way to gain exposure to our first theme being the growth of big data. Meanwhile, mobile network kit supplier Filtronic (FTC) is plugged into the cloud computing and mobility space, our second theme. And the ‘Internet of Things’, whereby gadgets communicate directly with each other, plays well to the strength of wireless microprocessor designer CSR (CSR).
Meanwhile, for our fourth theme, advanced materials, Oxford Instruments (OXIG) fits the bill perfectly with its high-tech equipment sold into nanotechnology and industrial markets across the globe. Finally, light-emitting diode (LED) manufacturer Dialight (DIA) is our chosen route into the energy efficiency trend as the falling price of semiconductors means its products could soon be adopted on a mass scale.
Technology companies and their products have become part of our everyday life and lexicon. There are iPads, iPhones and the BlackBerry, millions of mobile apps (shorthand for applications) for hundreds of types of smartphones, e-coupons, ‘livechat’ on social networks, even the word ‘Google’ has become an unofficial verb to search the internet. Spin through the business pages of most newspapers or news websites and the services and brands of some of the world’s technology titans - Apple (AAPL:NDQ), Google (GOOG:NDQ), Microsoft (MSFT:NDQ), Amazon (AMZN:NDQ) - are as ubiquitous to us Brits as roast beef or the Beeb.
Much of the current investor appetite for technology growth stories stems from the excitement generated by big tech floats in the US over the past few years. These have included Facebook (FB:NDQ) and more recently Twitter, due to start trading on the New York Stock Exchange today (7 Nov). But technology is a wonderful thing in many respects beyond social networking.
Technology has made life easier and given us the highest-ever standards of living. Those of us in the Western world enjoy ourselves with films, television, video games and countless other internet attractions. Technology has also made the world smaller, allowing people without a voice to be heard across the planet providing more information than we ever thought possible, all at the touch of a few buttons.
Last month Google broke through the $1,000 barrier for the first time after reporting forecast-beating third-quarter numbers with net income of $3 billion on close to $14.9 billion of revenues, up 12% against the third quarter of 2012 and 53% ahead of the $9.72 billion posted in the same quarter of 2011. It’s not alone. Here in the UK, microchip design champion ARM (ARM) has put up its own set of record third-quarter figures (22 Oct) and at 986p is 28% ahead in the year to date and just 10% off the £10.96 all-time high struck in May.
DISRUPTIVE TECHNOLOGY
Huge disruptive innovations, that are transforming how we all do business and go about our daily lives, underlie the epic growth rates being recorded by companies like Google and ARM. Ernst & Young global technology transaction advise team leader Joe Stegar, says: ‘The disruptive megatrends of social, mobile, cloud, big data analytics and cross-sector blur have helped fuel a significant rise in global technology M&A activity since 2009.’
Jeremy Gleeson, manager of the AXA Framlington Global Technology Fund, agrees. ‘There are a number of compelling themes producing exciting investment opportunities in the technology sector in the near and longer term.’ He has his own list of personal favourites, such as mobile and cloud computing, social media, super connectivity through the ‘Internet of Things’ and cyber security.
Others share the views of Gleeson and Ernst & Young. Last month Gartner, one of the world’s biggest technology trend researchers, revealed its top predictions for IT organizations and IT users for 2014 and beyond. These combine several disruptive topics ? digital industrial revolution, digital business, smart machines and the Internet of Things ? that are set to have an impact well beyond just the IT world. Daryl Plummer, managing vice president and a senior analyst at Gartner, says: ‘Gartner’s 2013 chief executive officer survey suggests CEOs feel that business uncertainties are declining and yet, CIOs [chief information officers] awake each day into a world of technology uncertainty and change.’
It is the CIOs who typically control IT departments, and adds Plummer: ‘The savvy CIO will get his or her CEO to recognise the change being brought about by disruptive shifts is coming at an accelerated pace and at a global level of impact.’
MOBILE DEVICES KEY
Most of us already realise that mobile technology is changing the way we work, socialise and learn new things. The internet, social networking, geo-location - all of these things are altering how we interact with the world around us. Owning one of today’s half-decent smartphones is pretty much the equivalent of having an electronic Swiss Army knife at your disposal, bringing access to communication, education and entertainment all through a single device.
Juniper Research released new estimates last month (29 Oct) indicating that the number of smartphone shipments exceeded a quarterly record of 250 million in the third three months of this year. That puts year-on-year growth at nearly 50% on the equivalent figures for the July to September quarter in 2012.
AXA’s Gleeson believes many ‘growth technology stocks are ripe for picking,’ and we agree. Serious investors ignore at their peril the core technology trends that are now emerging.
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Theme one: Big data
CRUNCHING BIGGER NUMBERS
Big data is basically information that exceeds the processing capacity of conventional database systems, as it is too numerous and moves too fast. The mountain of data we are collectively spewing out these days is staggering, and it’s getting exponentially bigger by the day. Gartner estimates the total amount of unstructured data (photos, videos, Tweets, documents etc?) alone will increase to 650% of its current size by 2017, having grown nine-fold in the five years to 2011 to nearly two zettabytes. Last year’s figure was over 2.5 zettabytes with researchers expecting eight zettabytes by 2015. Looked at another way, the amount of data generated in a year during the 1990s we are today churning out in 60 seconds. The novelty lies in the fact that with ever-larger data volumes and new data sources, we can obtain more statistically accurate results and, hopefully, make more accurate predictions about the future. Shopping is seen as an obvious early opportunity to spin-out big data tools and analytics, in both the off and online worlds. Emerging eCommerce (internet) and mCommerce (mobile) giants such as Amazon have been applying simple examples for several years, such as books and music recommendations based on individual shoppers’ purchases, and those of similar customers.
How to play the theme
WANdisco (WAND:AIM) £11.60
Its patent-protected IP allows big data generators and analytics companies ‘always-on’ data feeds across the globe via clever server computer replication technology. Based on open-source technology, it uses a ‘freemium’ model, the firm provides free access to clients and up-sells various in-house built enterprise extras, including newly launched tools for the Hadoop 2.0 platform, the engine that powers Facebook, Amazon, Google, and almost every major source of big data. With more than five million users worldwide across 2,000 international companies, WANdisco’s claim of an internal pay-back inside of a year and return-on-investment of 150% for its users is compelling. While the £272 million cap company is not currently expected to make a profits breakthrough until 2015 at the earliest, these estimates are based solely on existing products, suggesting the possibility of cashflow neutrality late next year, or early 2015. CEO David Richards sees WANdisco developing into a $1 billion revenue business in time, ambitious given last year’s $7.9 million of bookings. That will double in 2013, reckons Panmure Gordon analysts, hitting over $24 million in 2014. Panmure has a DCF-based valuation of £14.47.
Theme two: Cloud computing and mobility
IT ON THE GO
The emergence of cloud computing is threatening to, and in many cases already has, transformed the way consumers and businesses use their IT infrastructure. In the past, the big software suppliers have tended to employ IT services specialists for hands-on implementation and installation of solution suites, using many as product resellers too. But cloud computing and the outsourced hosting capabilities it brings is changing this dynamic by allowing simple and centralised application installations which can be accessed by all workers using a standard web browser from anywhere, at any time. This also means businesses can be charged according to use, via monthly fees, providing better value and easing the strain on cashflow as the cost is shifted from an upfront capital expenditure (licences) to part of normal running costs just like any utility bill or salaries. ‘With the advent of cloud, we believe that this traditional partnership model will experience severe strain,’ argues Canaccord. ‘The balance of power will depend on the competitiveness of software products and the strength of IT services vendors’ customer relationships.’ What this means in simple terms is that software suppliers with their own in-house developed suites are likely to increasingly control the customer relationship themselves, so long as the products are top quality.
How to play the theme
Filtronic (FTC) 65.5p
Increased mobility means faster and more reliable mobile communications, and this is where the microwave technology designer and manufacturer is a winner. In the relentless march of long-term evolution (LTE) of telecommunications networks Filtronic argues convincingly that 4G network development leaves mobile network operators (MNOs) two viable solutions. Either they should increase spectrum by adding bandwidth, or increase backhaul, the parts that connect the network backbone and end users, both of which would require upgraded or new base stations where Filtronic is a key supplier of technology. Investors will be reassured by news that network upgrade activity continues to rapidly build, particularly in the US, but also by hints that European MNOs are beginning to scale investment, boding well for second-half volume sales. This underscores current pre-tax profit estimates of £4.3 million this year building to £6.8 million in the 12 months to May 2015, putting the shares on a PE multiple of 17.4 falling to 13, based on Panmure Gordon’s 3.73p and 5p respective EPS forecasts.
Theme three: The Internet of Things
EVERYTHING CONNECTED
Gadgets are increasingly talking to each other meaning that technology is moving beyond computers and phones. The Internet of Things promises to revolutionise home entertainment (set-top boxes, hi-fi equipment), medical applications (heart defibrillators, and monitoring devices, for example) security and surveillance, and home energy, where connected meters and thermostats are starting to gain real traction. As Canaccord analysts point out: ‘In the home, TVs, set-top boxes, radios, cameras and other consumer electronics are being connected and, in the car, location and connectivity technologies are combining to provide automotive infotainment systems.’ The idea that you might set the washing machine going from work, or record your favourite TV drama while on the bus or train home is possible today, but this is just scratching the surface of what the future holds. American venture capitalist Mary Meeker used her annual Internet Trends Report to flag ‘wearables, drivables, flyables and scannables’ as emerging technology device trends. It doesn’t take much imagination to match iWatches and Google Glasses (wearables), connected (perhaps even self-driving) cars (drivables), mini-drones (flyables) and even QR codes (scannables) as some of the devices she is referring to. Google looks set to launch its glasses next year.
How to play the theme
CSR (CSR) 553.0p
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Theme four: Advanced materials
VERY SMALL STUFF
Boffins are learning more about the very atomic make-up of stuff every day. By investigating the nanotech world leading scientific and engineering organisations are developing exciting technologies to manipulate materials in ways we could never have imagined even 10 years ago. Breakthroughs in solar energy, telecommunications and healthcare have all been made possible by nanotech science and our increasing ability to play around with atoms, the building blocks of everything. One of the more exciting applications being studied now is carbon-based graphene, ultra-thin slices of graphite. This material really is amazing stuff. It is a super-strong, light and almost see-through and promises to break new ground in heat and electricity transfer, and could even one day provide the cabling to carry an elevator into space. Advanced materials could ultimately see futuristic talk of harnessing nanobots (microscopic robots), replenishing dwindling food supplies, instant water purification, advances in healthcare, and a multitude of other applications become reality.
How to play the theme
Oxford Instruments (OXIG) £13.05
The company designs and supplies some of the very high-technology tools and systems that scientists and researchers need to develop advanced applications. Its business model sees high-tech equipment sold into nanotechnology and industrial markets across the globe, and increasingly to Far East markets keen to expand their technological and scientific research base. This provides a vast and growing installed base from which after-sales parts and service revenues stem, generating highly visible and rising revenues. The company prides itself on turning smart science and innovation into commercially successful products, raising the barriers to entry for new competitors. Research spending cuts in Europe and the US have temporarily slammed the brakes on yet Oxford insists it remains on target to match its ’14 Cubed’ objectives (14% average revenue growth and return on sales, by 2014) (see The Big Debate, pages 36-37). Analysts at Numis point out: ‘Demand for Oxford’s products is being driven by the shift to smaller applications and the ability to analyse and manipulate matter at the atomic level.’ That means increasing nanotechnology research paid for with bigger and bigger budgets, in time. Numis estimates funding levels will increase between 10% and 20% a year going forward, underpinning EPS estimates it has for Oxford of 75.6p next year to March 2015, and 84.2p the year after. That implies a PE of 17.3 falling to 15.
Theme five: Energy efficiency
BRIGHT IDEAS
How to play the theme
Dialight (DIA) £11.01
