A Rare Buying Opportunity in the Tech Sector

We had some big action last week in the tech sector: bad results from Google (GOOG) and Microsoft (MSFT) proposing an acquisition for Yahoo (YHOO).

I do repent for not picking on the relentless rumors on a YHOO M&A upside. In fact, Pete Najarian or Guy Adami (don't remember who from Fast Money, CNBC) re-iterated this prior to Yahoo earnings day. The market reacted negatively to MSFT and pummeled it over 6% on Feb 1. YHOO is not cheap at a multiple of 40+ even at the pre-acquisition price, but the potential strength within the company is not small either. 500 million unique users - just imagine what wonders it could do to ad and content revenue if channeled the right way.

Also, look at it this way: In absolute terms, MSFT's offer is approx USD 16 bn over YHOO's market value of USD 25 bn prior to the acquisition. As compared to this, MSFT's market value has dropped over USD 26 bn compared to pre-offer levels (which was already low at a multiple of 19-20). Also, the market is completely discounting the benefits that could accrue from a massive web audience that a MSN + Yahoo combination would have.

A good way to play - MSFT March 27.5 options at 3 looks cheap. MSFT has to correct on the upside after probably a few more days of market jitter. Also, if anti-trust factors or competitor offers come in the way of the offer, MSFT would bounce back anyway! I don't see too much of a downside from this level.

In Google's case, the market overreacted to a perceived threat from the MSFT-YHOO announcement. GOOG simply has too massive a search market % (57%+) and near-dominance in online ad revenues (over 75% market share) to get seriously impacted by an MSFT-YHOO combination. With its aggressive diversification (including the latest bid on wireless spectrum) and ubiquitous brand name, its difficult to pull them down any time soon.

GOOG looks very attractive at 38.8- again March options look good. I dont see too much of a downside here too - GOOG closed at 495.43 Monday as compared to its highs of over 700 as late as last December.

I also like Apple (AAPL) at the low 130s - at a multiple of below 30. Financials got a deserved pull back Monday - wait for a while more, and you might again have good buying opportunities at Citigroup (C), Wachovia (WB) etc.

Disclosure: Long MSFT, GOOG, AAPL, C.

Comments

[James Cullen:]

If another offer was to be made for YHOO, it could just as easily make MSFT go down because they'll likely raise their bid.

2008 Feb 06 08:47 AM

[techy:]

what if the whole market is headed south, due to loss of risk appetite?

do you still think, multiples>25 will be sustainable?

what if the recession story is true, do you still think google and apple revenues will grow?

this is a bullish article which is not taking into account the macroeconomic and market conditions.

2008 Feb 06 11:33 AM

[Tom B:]

MSFT is going down because they might be shelling out lots of money, if the Yahoo deal goes through. This usually happens in M&A; I wouldn't read much into it.

2008 Feb 06 01:24 PM

[reagan:]

What is happening to Apple today???????

2008 Feb 06 01:42 PM

[Tom B:]

"What is happening to Apple today???????"

Looks to me like Tech is down, in general.

2008 Feb 06 02:55 PM

[Promod Radh...:]

techy:
I agree with you on the nature of this article! I hold on to the view despite the CSCO earnings report!

Let's take a look at these stocks individually:

1) MSFT has been sustaining a revenue and EPS growth of over 24% over multiple quarters. Assuming a PEG of 1 on forward earnings, you are looking at a EPS growth of 18 to price the stock at 31+. I do not think the slow down/recession is going to be as bad that MSFT gets hit worser than that!

2) AAPL - Phenomenal EPS growth over the past quarters due to block buster cutting edge products and high margins. Revenue growth of 28%. At 120-125, the stock is priced at a PE of ~28. If you really hold a negative view on the economy, i would agree this one holds some medium-term risk. However, i dont see much of a risk on a 12-18 month horizon.

3)GOOG - EPS growth of over 50%+ consitently over past quarters. At a PE of 38 at 495 levels, this one's holding the least amount of risk among the 3 - again by a classic PEG=1 thumbrule. I do not believe a revenue stream of online advertising would be as affected by a slow down as compared to TV or other media advertising.


Finally, the calls you take on these stocks - short term or long term depends on your risk appetite and view on the economy. Short or medium term, the judgements are debatable, especially on AAPL. Long term (12-18 months) risk is very low on these stocks at current levels.

2008 Feb 06 07:02 PM

[Promod Radh...:]

CSCO earnings report today is going to add to this short term pain. I dont think the entire sector's going for a prolonged slump though. Especially MSFT, GOOG - there's enough inherent strength in their business models to make them attractive at current levels even in a slow market. Downside risks in AAPL might be higher in the short-to-medium term though.

2008 Feb 06 07:05 PM

[reagan:]

No, duh, Thomas Barta but Apple got crushed.When is this crap going to end?

2008 Feb 06 07:45 PM

[prospector:]

Goog, Aapl, MSFT are all tech. Tech stocks are seasonal commodities. August to January they're prices are up. February to July, they're down. I just wish I had known this before I bought MSFT at $36 bleeding dollars. "wimper.... wimper..... sob....sob..." I feel like a kicked puppy for getting in at the peak.

Whether or not we have a recession doesn't make a difference to tech other than the fact that a recession will make tech stocks go down MORE than it normally would anyway.

If you want to salvage the tech stocks you own, there will likely be a small stock rally following the Goldman Conference in Las Vegas 2/21/08.

2008 Feb 08 08:59 AM