Recessions, often seen as an investor’s worse nightmare, should really be viewed as an opportunity. Recessions, as defined by the NBER, require that the nation in question experiences two consecutive quarters of negative GDP growth. It’s no news that America has been in a recession since December 2007, spurred by the rapid deterioration of the capital markets due to the credit crisis. This downturn has left many investors and corporations reeling, preferring to stick to cash instead of investing in retirement funds or operations, respectively.
I believe that such downturns offer opportunities and historically, IT companies flush with cash can expand R&D during these times allowing them to offer better products during a bull cycle. The recession earlier in the decade yielded Google (NASDAQ:GOOG) search, improvements in Intel’s (NASDAQ:INTC) chip sets, and MySpace’s (NASDAQ:NWS) social networks, among many other innovations. The quandary now is what technological innovation will occur during this bear market? Say hello to formal cloud architecture, the engine behind today’s hottest web based applications.
A Historic Glimpse into R&D Spending
In the recent past, it’s easy to notice which companies beefed up on their product research and development during opportune times. Times of opportunity arise whenever the competitive environment is undergoing change, or when macroeconomic conditions become difficult to operate under. Like many things in the world of finance, the time to invest in R&D depends on the situation and the company. I believe that some of the best opportunities for companies (mainly IT and healthcare) lie in present times, where companies, especially smaller ones, are strapped for cash and find it hard to expand operations or even continue operations. This can allow larger corporations to buy them, or perhaps even better, put excess cash to use and develop products that beat the competition.
Looking at the last recession after the collapse of the dot-com bubble, market leaders Intel and Nokia (NYSE:NOK) increased their R&D as did Adobe (NASDAQ:ADBE) and Altera (NASDAQ:ALTR). Looking at the numbers: in 2002, Intel and Adobe hiked up such spending by 6% and 9.8% respectively, in the following years after the recession, both companies observed solid price appreciation beginning in 2003. Although many could attribute this to the performance of the broader market, both companies outperformed the S&P 500 (NYSEARCA:SPY). This is an example of two companies whose management took advantage of a bear market and invested in the future value of their respective companies.
Do not think that this approach is not being taken in the credit crunch. Although the appropriate SEC filings have not come out, several large names with solid cash reserves are advancing their product offerings. Such companies include Intel, IBM (NYSE:IBM), Microsoft (NASDAQ:MSFT), Sybase (SY), and Oracle (NYSE:ORCL) just to name a few. Whether it be in the form of acquisitions or in house activities, these companies are working to break into the next shift in computing, web based applications. Already prevalent, there is still much to develop in this new market, cloud computing.
A Look at Web-Based Applications
Web-based applications are widely used, from the age old Hotmail system to the powerful GoogleDocs suite of productivity tools. Web-based applications are growing in popularity because of their ease-of-use, compatibility to legacy software, and, most importantly, their accessibility. The beauty of a tool like GoogleDocs or any other web based application is the ability to pull it up on any computer. Sure, you might need passwords or maybe a security token, but with those in hand you can access your data anywhere in the world! As companies mature their offerings, applications such as these can become a common place that can be accessed anywhere.
Imagine a world in the future where one could walk up to a small terminal and plug in their Blackberry device and use it to navigate to a web browser. Using the web browser, not only could they check their corporate email, but also finish up that LBO model and run the sensitivity analysis the boss man requested the night before you left on your family vacation. This is a world that could soon be real, as the likes of Sybase transition their offerings to tailor to the mobile world, where information is needed on the go. Now this accessibility advantage is not new to corporations, the true advantage of this breed of software is the underlying architecture and the efficiencies it provides.
The Underlying Architecture
Behind the world’s best web-based applications exists some of the best infrastructure, running the applications that we pull up on command at all hours of the day. This equipment, composed of switches, routers, bridges, servers, and cooling units, is extremely costly, and requires rigorous maintenance routines to keep it working well. The advent of virtualization software, from the likes of VMWare (NYSE:VMW) as well as Oracle, Microsoft, and SAP (NYSE:SAP) have helped corporations squeeze more productivity from their existing hardware. The current economic slowdown has companies rushing to virtualize their systems so they can maximize their resources while providing better end products for customers. Essentially, web applications are running on a cloud that deliver virtualized services, services that are becoming extremely cost effective to offer.
Sybase, which is breaking into the mobile world, would essentially share resources efficiently over its warehouse of servers that would act as one computing unit to deliver applications. This revolution will help deter inefficient resource usage. Very often, large server farms are not being used to their optimal capacity. This sharing of resources will help ensure that all systems are used, thus preventing waste in the back office. Migration to this architecture will eventually lead to the demise of computer terminals as we know it with the emergence of more mobile solutions that can tap into the computing power of the cloud.
It is important to find entities that are offering such software and services, capitalizing off both public and private corporations who are seeking increased productivity in an environment filled with cost cuts. Once conditions are favorable, companies whose offerings are widely used will be able to sell mobile solutions as well as tailored solutions to their clients who can gain an edge and outdo their competitors. Such offerings require intense R&D spending right now, the process of developing software and improved hardware is capital intensive and could take several years to perfect. Looking at the current spectrum, I feel that IBM, MSFT, GOOG, and ORCL are great plays, although a great niche player is Sybase. Computing seems to be shifting once again to offer investors an opportunity for large gains in the intermediate future.
- Santosh Sankar
Disclosure: The mutual fund the author is associated with is long IBM, INTC, MSFT, and GOOG. The author’s family is long IBM and MSFT.