|Barron's Technology Trader | SATURDAY, MAY 26, 2012|
Tech Spending Pie Is Being Sliced Into Too Many Pieces
By TIERNAN RAY
Proliferation of new products puts pressure on sellers of traditional gear.
Don't feel bad for tech: Although the Nasdaq Composite Index has fallen 9% since it hit a 52-week high of 3134.17 on March 27, it is nevertheless still up 9% for the year, trouncing the nearly 5% gain in the S&P 500.
The rise has been broad-based, too, covering companies ranging from chip maker Cirrus Logic (CRUS), the top gainer this year, with a 73.2% price appreciation, to Apple (AAPL), up 39%.
For the most part, the best performers were companies with very respectable double-digit rates of revenue growth, and a pretty decent outlook for this year and beyond, even if it is a bit lower.
That's the good news. The bad news: Tech's recent slide has coincided with an increasingly glum outlook for technology spending. Two weeks ago, Cisco Systems' CEO, John Chambers, remarked that his customers were showing greater reluctance to spend, prompted by growing worries about the economic crisis in Europe. His warning has led the Street to conclude that tech won't really take off until the fall and winter.
THAT'S WHEN MICROSOFT (MSFT) will start selling its Windows 8 operating system, which might goose corporate spending. In the meantime, stock brokers are suggesting ways to play the "dead money" that technology stocks may represent over the summer.
For example, Michael Purves, a strategist with Weeden & Co., Thursday told clients to sell out-of-the-money options with July expiration dates on Cisco shares that they own, in the belief that the stock won't move enough, either up or down, from its recent price of $16.33 to hit the options' striking price. The seller, however, will get some income from the premium the buyer pays for the options, be they puts or calls. (Cisco shares, down 1.5% in the past 10 years, versus the S&P 500's 22% rise, haven't budged in a long time.)
But the truth about where tech spending is headed is probably a little more complicated—and sobering—than saying that things will be better come the fall.
Research firm IDC says that global tech spending will rise 5.9%, versus last year's 6.4%. Gartner sees it climbing 5.2%, down from 6.8% last year. (Research firms' assessments of past spending can differ, just as their predictions of future spending can.)
Gartner also says, mind you, that the rising greenback will make that spending growth feel like just 2.5% for U.S. companies in actual dollar terms. But the basic premise is that information-technology outlays, as they usually do, will rise at about two times the U.S. GDP growth rate, which the Federal Reserve is pegging at about 2.4% to 2.9% for 2012.
I have a theory that tech faces not just a potential slowdown in economic activity, but also a shifting of priorities. That's a story with long-term implications. Companies have finite budgets, and there are so many things to spend money on that big tech outfits, such as Cisco and Hewlett-Packard (HPQ), are challenged to squeeze the same increases in revenue out of their traditional customer base.
Hundreds of new products are now competing for every dollar that formerly was spent on traditional IT goods—routers and switches, or laptops and servers. For example, F5 Networks (FFIV) competes with Cisco in selling products to make computers communicate faster. Its sales, totaling perhaps $1.4 billion this year, will be just a speck, compared with Cisco's projected $46 billion. But F5 will see 22% year-over-year growth if it hits that number, while Cisco may see just a 7% gain.
Dell's (DELL) fiscal Q1 report last week, which missed estimates, further confirmed that expanding a big tech company's sales is getting harder and harder, regardless of how talented management and the sales force are.
Everywhere you look, there seem to be examples of a hundred million dollars here, a billion there, of new stuff vying for money that used to pay for the old stuff. The number of dollars in information-technology budgets probably is increasing, but not as fast as the number of items that the dough can be spent on.
In short, instead of buying new computers and networks, corporations are fine-tuning their existing ones to make them smarter. And they're fine-tuning them with products from the little guys.
Will companies such as F5 get their due? So far, they haven't. Shares of the company are up just 3% this year, and competitor Riverbed Technology (RVBD) is down 30%, despite a projected 14% revenue growth rate. These companies are so small that they can miss the "whisper number" for a quarter's results and see their stock swoon.
Hence, technology companies, large and small, are caught in the same predicament: a fragmentation of IT spending into bits that leaves everyone fighting for a crumb.
With the exception of Apple, which has found a way to sell a $199 phone to everyone and, soon, his brother, wife and cousin, it is becoming more difficult to reach a critical mass selling tech products or services.
WHICH BRINGS US TO THE DILEMMA of Hewlett-Packard, which is trying to shed what it deems uncritical mass.
The company last week said that it will get rid of 27,000 or so workers over the next three years—about 8% of its total headcount. This restructuring is meant to save as much as $3.5 billion annually by the end of 2014.
Wall Street loves a restructuring, and HP shares closed the week up 4.2%, at $22.33. But I don't think that the announced plan will improve HP's long-term prospects. The company lacks a raison d'être at the moment, and its $123 billion or so in annual revenue is also prey to the same splintering of tech spending.
But the reduction in staffing will help the balance sheet. The $10 billion spent by Hewlett-Packard last year on software maker Autonomy, which is looking like more of a mistake by the minute, to judge from the fiscal Q2 results, has left HP with about $17.5 billion in long-term net debt.
That's roughly equal to the company's projected cash flow, as measured by earnings before interest, taxes, depreciation and amortization this year.
The question for the rest of tech is whether those 27,000 people will start enough new ventures to support the aggregate demand for tech products. Or whether they'll start ventures that come up with more new products that divvy up the revenue pie further.
Time will tell, but I'm not optimistic.