By Bolko Hohaus, manager of the Lombard Odier Invest Infology Fund For the third year in a row, ...
By Bolko Hohaus, manager of the Lombard Odier Invest Infology Fund
For the third year in a row, the major technology indices are set to end the year in the red. Investors hoping 2002 would see a significant improvement after two years of poor performance are likely to be disappointed.
In August, the Nasdaq 100 was close to 50% down on the year. Since then, the indices have recovered but remain volatile and the clouds over the technology sector still loom.
Despite valuations coming down tremendously, the telecom equipment sector is likely to remain in trouble for some years to come. Telecom operators, as their customers only recently started to acknowledge, massively overpaid for 3G licences. They have started to write down these investments but, to date, this has really only happened outside their own home market, as in the case for Sonera and Telefonica in Germany. Other announcements from the telecom industry will follow but this can take some time to filter through.
The wireline sector suffers from even more overcapacity and is a shrinking business. As a result, even before starting to increase their investments significantly, telecom operators will first reduce their debt levels, potentially increase dividends and wait for major investments until they are more comfortable with their debt situation.
This process is likely to take years instead of months and will mean a painful adjustment to the equipment industry capacity. Consolidation in the telecom equipment sector over the next year may be the way forward.
On a more positive note, areas such as wireless local area networking, digital cameras and camera phones will continue to show healthy growth rates even in a slow economic recovery.
Businesses will increasingly look to automate their internal and external processes for efficiency. Software companies, providing the right tools for increasing efficiency, will also continue to blossom.
There is another important message coming from analysis of the technology sector. Instead of looking for the next killer application or the next Cisco, investors will have to spend more time analysing the business models and balance sheets of technology companies. This makes it a perfect stockpicker's market going forward.
Technology companies with weak balance sheets and unstable cashflows will have trouble accessing the equity or corporate bond markets given investors' appetite for low risk.
Many technology companies may even disappear in the coming 12 to 24 months, with a weaker than expected economic recovery driving consolidation and leading to business failure for firms with insufficient resources.
In the short-term, the risk is that earnings estimates for many technology companies for 2002 and 2003 are still too high. Analysts are predicting a huge increase in IT spending and therefore an increase in profits for technology companies in the fourth quarter this year, which is unrealistic given the current macroeconomic outlook.
However, even with more short-term trouble on the horizon, the long-term prospects for the technology industry are strong, with new products likely to create excitement once again.
Growth opportunities still present.
Techs should profit from cyclical recovery.
Focus on telecom cashflow a good sign.
Earnings estimates still too high for 2002/2003.
Telecom troubles likely to last for some time.
Many tech companies will disappear.
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