Most of us remember those days when the "Wintel" juggernaut was in full force and Cisco (CSCO) was king of networking with unbridled growth in full view. It was also an incredible era of fast money, misguided euphoria and unrealistic expectations. Microsoft (MSFT), Intel (INTC) & Cisco were the bellweathers for tech investing, and of course, that baton has long since been passed to a new generation of companies perceived as better able to extract value out of the internet and the consumer.
Share prices for Microsoft, Intel & Cisco remain near post bust lows and one would think that they stopped growing as the dominant franchises they once were. Fast forward a decade, and one can see that much growth has taken place, albeit growth of the more prosaic variety - earnings, revenue and accretion of net cash have all grown smartly.
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*Numbers based on approximates or rounded for ease of depiction.
Indeed, while growth has been staggering, valuations have plummeted. To say that sentiment has changed is to put it mildly. To be sure, there have been tectonic shifts in how Wall Street views what they perceive as the “legacy” components to the core businesses of Intel, Microsoft and Cisco. The new technology stars Google (GOOG), Facebook, and Apple (AAPL) have all the sizzle of a high end steak house, but the contrarian in me says there will be challenges ahead for these businesses. There are no sacred cows. And this is just the nature of the tech business. I would much prefer to own shares in the stalwarts of the past with valuations that belie their dominant franchises. Let’s take a moment to analyze the pervasive negative sentiment that is dogging the shares of these companies.
Microsoft. The “legacy” part of the business still runs on 74% of all computers, but the MS OS and Windows Office monopoly are perceived by Wall Street as eroding in importance as much of the world moves towards mobile devices (smart phones and tablets mostly). It is fair to say that Microsoft has missed out on several macro shifts that have mostly been driven by the consumer market place. Microsoft lags in search to Google by a wide margin and the proliferation of mobile devices also caught them off guard. Offerings have been anemic, but there is hope that with a new Mobile OS that is forthcoming by end of year.
Certainly, Microsoft has been able to ratchet key wins in its desire to “own the living room” of the consumer as the Xbox and Xbox live offerings have recently gained significant traction after many years of seemingly fruitless investment on behalf of Microsoft. The recent Skype acquisition, the partnership with Yahoo (YHOO) on search and finally the Mobile OS partnership with Nokia (NOK) are all additional wildcards in the race for growth beyond the reliable Office and PC OS profits that remain the source of most of Microsoft’s profits.
Clearly, there have been missteps by management and Mr. Ballmer, for all his apparent tenacity, has not been the visionary that has brought that bit of magical growth back to Redmond. At a recent share price of $25 and trading at ten times earnings, Microsoft is valued more as would a stodgy industrial conglomerate with few prospects for growth. One would be naïve to count Microsoft out, however. Its quest for growth will probably not be quixotic as they grind out multiple paths in new frontiers of this new era of “cloud” computing.
Their dominant position in extremely profitable core businesses gives them formidable advantages when it comes to having the financial flexibility to go after many of these nascent growth markets. People seem to forget this about technology: fortunes can change quickly and a bullet proof balance sheet and myriad opportunities for growth often do avail themselves for companies that can continue to be resourceful.
Intel. Gordon Moore and Andrew Grove are long gone as architects and operators of the company that so masterfully capitalized on the power of the silicon chip to change the lives of millions. “Intel inside” is still a relevant marketing slogan but talk to any self respecting 20 year old and Intel becomes less ubiquitous in their realm of mobile communications and devices. This is the crux of the problem facing Intel. Many of the fastest categories of growth have moved to wireless devices – an area where Intel is not a market leader. Intel was caught off guard by the quick surge in mobile convergence to the smart phone and must use its manufacturing scale and operational prowess compete on these fronts.
There is no denying that Intel will be part of the conversation as it vies to become a leader on mobile platforms which require showcases a new form of processing power that is both lighter and less energy intensive. A colleague of mine who works at Intel was especially impressed by CEO Paul Ottelini’s recognition of missed opportunities and roadmap for being part of the conversation in mobile devices at the latest corporate event. This is not to say that Intel has had the discipline of say an IBM when it comes to meeting financial benchmarks and meeting earnings per share milestones. However, at $21.00 share and a P/E Ratio of 10 Intel is priced with low expectations in mind.
The 3.2% dividend yield off of a relatively low payout ratio is another reason to take comfort in this issue. Like Microsoft, Intel is a dominant franchise with capability to INVEST and COMPETE in new growth segments. It does not hurt that Intel has a deep management team led by Paul Ottelini that is not scared of making bold changes to capitalize on a future that will be ever more dominated by the proliferation of mobile devices. Intel has the balance sheet and ability to compete and win in these frontiers of growth. The war is only just beginning but Wall Street with its focus on short term trends is creating an opportunity for investors today.
Cisco. By many metrics, Cisco is the most tantalizing prospect of the three former “tech darlings”. It also has the least credibility on Wall Street because of disappointing earnings forecasts and a missed revenue number off its most recent quarter. Cisco continues to plumb new 52 week lows as a result of this and other strategic blunders. Cisco has clearly strayed from its core offerings in the domain where it is still king- corporate networking- where it maintains over 70% market share versus the smaller but more nimble competitors such as Juniper and Riverbed.
Cisco is no longer a growth story and its share price of $15 prices it at an astounding nine times earnings. Cisco is absurdly cheap and with $25B in net cash it is probably a gift at this price. It could go lower still with a further degradation in its core business, but there are several catalysts that would give the stock a quick boost such as an increase in its 1.8% dividend yield or an exit by its beleaguered CEO John Chambers. Even Ralph Nader has recently joined the fray in agitating for change at the top.
Longer term, Cisco will likely claw back and refocus on the networking side of the business. A complicated product refresh cycle is taking place currently and when complete Cisco will continue to compete favorably and is unlikely to lose its dominant position. Cisco is also angling for growth in the server market where it is competing against HP (HPQ), Oracle (ORCL) and IBM as an end to end offering for networking and integrated server technologies.
Recent growth in this domain has been compelling but comes at the expense of riling former technology partners where it will now compete head to head in this very competitive space. Cisco is simply too dominant in a slice of the tech business that is likely to grow by leaps and bounds as ever more applications continue to place huge demands on computer networks. Cisco is at the heart of this transformation and will almost certainly benefit from demand for its one stop shop products and services.
The old titans of tech are out of favor, but not out of growth. A decade ago, many on Wall Street were trumpeting (and profiting from) the prospects of Intel, Microsoft and Cisco in spite of effervescent valuations, but now the complete opposite is true. In my mind, there is no better time to invest each of these three equities and I think much of the risk has been squeezed out. Returns on equity are simply too high, balance sheets too strong and brand recognition and market dominance too powerful to become “has beens” of the tech world.
I vividly remember the same negative sentiments regarding IBM and Apple Computer at their respective nadirs. Take the long view and keep an eye on history before relegating these tech stalwarts of yore to the dustbin. Check back in a few years and it will be interesting to hear Wall Street singing the praises of a more popular iteration of these very same companies. Of course, by the time Wall Street hops on board, share prices will likely be at far different levels.
Disclosure: I am long MSFT, INTC, CSCO.