Technology 2013: The Gladiators Have Entered Into The Ring

by: David Urban

The year 2012 will go down as a very auspicious year for the technology sector. It was a stock picker's year as Apple (NASDAQ:AAPL) roared to become the largest company by market capitalization, Microsoft (NASDAQ:MSFT) cagily watched from the sidelines like a cat ready to pounce, and Google's (NASDAQ:GOOG) Android raised the bar for everyone. So what does 2013 hold for the Technology sector and where are the values for investors?

Zynga (NASDAQ:ZNGA) and Facebook (NASDAQ:FB) launched two IPOs, which were widely seen as litmus tests for future social media and technology IPOs. The subsequent failure of those IPOs indicate that the new generation of technology companies is not ready for the prime-time stage. In both cases the valuations were too rich for the market and the private exchanges where the prices happened to be set were done without financial information.

This may be a hidden benefit rather than a failure. The young and successful companies providing significant innovation in the private sector will continue to work without the pressure of the public markets looking over their shoulder for short-term successes or pressing for an IPO.

Companies like Dwolla and Twitter continue to move forward and innovate within their respective spaces providing guideposts for smaller start-ups as they move along their life cycles.

Unfortunately for investors the winners will not be last year's IPOs but innovators in the private space as app developers and start-ups look to fill needs not covered by operating systems. The gaming area will continue to see challenges in terms of monetization although there are smaller companies doing well. The key in gaming and with Zynga is to see more of a social engagement with their userbase to better understand how to monetize the casual player while not alienating the hard-core gamer.

The most interesting developments will come from the big 3 industry titans, Apple, Microsoft and Google. The rise of the smartphone and tablet industries, pioneered by Apple, has met significant competition from Google's Android, which powers Samsung's (OTC:SSNLF) offerings and Microsoft's new Windows operating system.

In a massive sea change of irony, Apple, once looked at as the kitschy software innovator has become the new Evil Empire surpassing Google and Microsoft after some major glitches with its Maps software.

Microsoft, the sleeping giant, has awoken to the threat being posed by iOS and Android in the rapidly growing smartphone and tablet sectors by integrating Windows 8 into tablets and smartphones.

The new advertising campaign surrounding the launch of the Surface has been targeted at a younger audience in an attempt to attract a cool, hip vibe and the holiday campaign against Google entitled Scroogle hits at Google's search function.

These campaigns are the signal of change at the Washington state software giant. The first few years of the tablet and smartphone revolution were spent watching from the sidelines as Apple created two new consumer product categories and Google jumped in as competition with Android. The first few offerings fell flat but now Microsoft has a hardware portfolio to complement Windows 8 in Slate and mobile offerings from Nokia (NYSE:NOK) mirroring the approach used by Apple and to an extent Google.

The biggest question for Microsoft is whether it can stem the bleeding in the Online area, which is an area of significant concern. While the other areas are providing strong profits the Online area bleeds cash.

Google, meanwhile, has pushed the purchase of Motorola Mobility off to the side putting maximum effort behind Samsung's offerings and improvements in Android have made it a worthy competitor to Apple's iOS, although the fragmentation issue remains for app developers.

In the smartphone and tablet wars you need more than just one portion of the equation to be successful. Apple has shown that the vertical integration of software and hardware works and forced Microsoft to respond by linking up with Nokia and creating the Surface. Google purchased Motorola Mobility before shunting it to the side in favor of working closely with Samsung.

It remains to be seen if Google will be able to reignite the fire inside of Motorola Mobility that inspired the innovation in the mobile phone area going back to the tiny Smart-Tec and RAZR phones. The key for Google will be to balance innovation at Motorola Mobility and maintain strong relationships with 3rd-party handset developers like Samsung.

In 2013 this dance of the gladiators will continue as Apple moves forward with new offerings to counter Samsung reigniting the fire that has been lost over the last year. The stumbles will no doubt focus the company back upon the guiding principles of Steve Jobs.

The winners in this three-way dance will be the consumers as innovation increases across the technology sector. None of the three companies can afford to let the others gain a lock on the tablet and smartphone spaces similar to how Microsoft gained a lock on the PC market back in the late 80s and early 90s.

In terms of investment attractiveness for 2013, Apple is the easy choice selling for only 13.3 times twelve month earnings, a discount of almost 20% to the market. A screaming buy when one considers that the S&P 500 has low single-digit growth to negative corporate profit growth for the past two quarters and Apple profit growth remains in the double digits.

Looking at Microsoft it has a complete product catalog to compete with Apple and Google but the key for 2013 will be execution. Just slapping a Windows logo on a tablet will not sell like 10 years ago. Microsoft's valuation is attractive with a dividend yield of just under 3.5% and a PE Ratio of just more than 14 times earnings. If it can succeed in two areas Online and creating a smartphone/tablet hit with the under-30 crowd there is significant upside in the shares.

The rest of the tech area looks like a vast wasteland. Tablets have cut so far into the businesses of Hewlett-Packard (NYSE:HPQ) and Dell (DELL) that one has to wonder about their future survival. There will always be a place for PCs, servers and printing but the technology sector is littered with the shells of companies that neglected to innovate and found themselves left behind.

To summarize, the winner for 2013 will continue to be Apple, which has products that still inspire buyers. Google will do well as it attempts to spread its domination in search and Android's reach in the tablet/smartphone area.

Microsoft is the wildcard. It appears as though it has turned the corner and woken up with its new ad campaigns. The question for next year will be creating a hit product and stemming the bleeding in Online. Should it succeed on both fronts there is significant upside in the shares.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.