Q: When the Nasdaq bottomed in October 2002,
around 1100, there were lots of technology stocks trading below their cash
positions. Now, that was the time to buy. But that was 800 points ago on
the Nasdaq. I presume you aren't finding bargains of that
variety.
A: That was a unique time, with irrational
valuations. You would buy a stock below cash, and it would go even lower.
One company we own, Keynote Systems, had $9.40 in cash and, at that
point, two consecutive quarters of positive cash flow. And the stock
traded as low as $6.20 a share.
Q: It was priced like it was going out of
business.
A: And it clearly wasn't. People at that time were
living in fear, with no sign of any upturn in technology demand. People
like to go back and look at the price they could have had if they had
bought at the very bottom. But the easy money isn't normally in buying off
the bottom, because you don't know where the bottom is. When we were at
1300 or 1400 on the Nasdaq, we felt we were pretty close to the bottom --
and we went down another 10% from there.
Q: Right, but things aren't as cheap as they
were.
A: But there is still a lot of opportunity. The trends
don't last just for one year. If you go back to pre-9/11 by a number of
days, and you look at the market move, it isn't that powerful.
Fundamentally, though, things have gotten substantially better, both for
the world economy and technology in particular. At that point, pre-9/11,
you had tremendous excesses in the system. We aren't at that stage
anymore.
Q: There has been a lot of discussion about the
strengthening of corporate spending on information-technology. Are you
optimistic?
A: I am. The first quarter is historically slow
-- I think people have forgotten about seasonality. For a few years, we
went through such a downward trend that it didn't matter, and in the late
1990s, we were in such a powerful up-trend that seasonality ceased to
exist. Before all that, in a normal cycle we would have a sluggish first
quarter. Then you would start to see a pickup in the second quarter.
Things would slow in July and August, pick up again in September as people
came back from vacations, and then you would see a further pickup in the
fourth quarter. That was pretty much the pattern we saw last year, but
more muted.
This time, we had a normal seasonal first quarter. We are
seeing evidence of continued, gradual improvement in the second quarter,
which should continue through the second half of this year.
Q: That sounds good. But there are some
worrisome macro issues. The Federal Reserve is going to raise rates pretty
soon, for instance. And China is determined to slow down its economy,
which will curb demand for all kinds of things.
A: True,
interest rates will be going up. And, yes, China is a concern, because if
China rolls over, that will affect the strength of technology orders. But
the overall trend is positive. And, by the way, it isn't just the
enterprise -- the telecom industry has finally showed some signs of a
pickup in spending. The large telephone companies are buying at a slower
pace. But they are spending money again. You are seeing that from the
results at companies like Tellabs. Cisco Systems is starting
to benefit, as well.
Q: As you look at the technology landscape, are
you biased for or against any particular segments?
A: We
look for value-added products, as opposed to commodity-oriented
businesses. That drives us toward software, communications and networking,
as opposed to, say, semiconductor equipment and memories.
Q: In the past, your fund has dabbled in
venture investing.
A: We did a lot of venture deals. In
2000, we actually had six of our companies go public in a very short time.
We have only one venture investment left, a networking-equipment company
called 2Wire.
Q: But you have stopped looking for new venture
deals.
A: When you go back to the early 'Eighties, when I
first started in the business, the fear in the tech sector was that you
were competing against IBM, Digital Equipment or National Semiconductor.
When you think about it, those were companies that you wanted to compete
with. They were slow. They were monolithic. They didn't react to new
market opportunities; they were focused on where they were, not where they
were going. Today you are competing with Cisco, Intel,
Microsoft and the next tier down. They have substantial capital,
and they are looking for new market growth opportunities.
Q: So the competition for little companies is
going to be stiffer.
A: Right. So for venture investors, it
is going to be very tough sledding. There are better returns to be made in
the public market. Where we are doing our real venture investing is in
early-stage public companies that have very strong balance sheets. We can
find small-cap companies with positive cash flow and earnings and half
their valuation in cash, trading at less than two times revenue. That is a
better opportunity than the private market.
Q: On the other hand, you mostly avoid the
really large-cap tech names.
A: We are more likely to buy
small-caps, where our research edge is greater and where we can work
channels and contacts and industry experts to get advantages. But we have
owned Cisco, which I covered as an analyst, and we will probably own it in
the future. It's less likely we would buy Intel or Microsoft, though -- we
don't really have any leading information there, we aren't going to be
ahead of the curve. You have to realize where you have an edge and where
you don't.
Q: How concentrated is your
portfolio?
A: Very. We want to be a leading expert on all
our companies. Typically we hold about 20 names on the long side and five
or less on the short side. We figured out early on that if you were trying
to follow 35 companies or more, it was just too many. The academic
research suggests you really don't decrease your risk much with more
companies in the portfolio, but you do cut into average annual returns.
Our strategy is to know the company well. We don't own companies we
haven't visited. We want to know the chief executive. Where we really have
made our money over time has been with quality management teams. When the
company has a strong CEO, he can build a strong team around himself. We
also do a lot of balance-sheet analysis. Bill Hambrecht taught me that the
balance sheet talks to you -- it really does tell you what is going
on.
Q: What's your favorite stock?
A: Right now, it's Marvell Technology. They have an
exceptional management team. It's reasonably valued. And they are six
months away from an explosion in business in several new markets. Marvell
is a fabless provider of chips for communications networking. They also
provide parts for the disk-drive business. Intel has historically
been a large customer. Dell uses them, too, and so does Apple
Computer. In the drive business, they serve Western Digital,
which is a new customer for them, Seagate and others.
Q: The drive business has been
troubled.
A: Their parts are used on small form-factor
drives. Seagate in its last quarterly conference call talked about the
fact that the only areas showing above-expectations growth right now are
notebook drives and small form-factor drives. They also are supplying
parts for 802.11 [wireless networking] products, although they haven't
announced who their consumer-electronics customers are yet. That should
really pick up for them starting in the third quarter of this calendar
year.
Q: What kind of chips might they be supplying
to Dell or to Apple?
A: For Dell, Cisco and Intel, they
supply chips used in local-area-network interface cards. They also have a
networked-switch-component business. For Western Digital and Seagate, they
provide core technology for the interfaces on their drives.
Q: Presumably, you think the stock is
cheap.
A: It is, but let me just mention one other area
where they have been spending heavily, which will become an important
business for them later this year. And that's power management.
Historically, it's been an analog business. But it will be converted to
digital technology. That leads them into new markets, competing with
companies like Linear Technology and Analog Devices. They
have already announced a number of wins in that market.
Q: How fast do you see them
growing?
A: I think they are going to continue to grow at
10%-plus sequentially once we get past the second calendar quarter. That's
above Wall Street expectations -- most of the analysts aren't expecting
growth to be as rapid. But I think you are going to see some really
positive surprises. And frankly, at the current valuation, you don't need
many surprises to drive the stock higher.
Q: What's the valuation for
Marvell?
A: Backing out the cash, the company sells at 22
times next year's earnings, or about 29 times this year. It sells at under
five times this year's net revenue, or about three times expectations for
next year, with very high margins. The stock trades at roughly $39.
Q: What do the earnings look
like?
A: $1.36 for this calendar year, and $1.75 next
year.
Q: How about another pick?
A:
QLogic is a stock we have owned for many years. The company makes
interface cards and related products for the storage-networking market.
They recently missed Street estimates for the first time in about 30
quarters, and it sold off very aggressively. They are going through a
short-term lull in their growth.
Q: The stock has quickly dropped by
half.
A: True. But it's still a very high-gross-margin
business. It is a company that continues to generate positive cash flow.
They sell at a little more than three times net revenue, and only about 14
times this year's earnings. They had an inventory adjustment with two of
their major OEMs [original-equipment manufacturers]. They went through a
product transition, as well, which they have finished. And they have an
acclaimed new switching product that is priced much lower than the
competition and which has gotten very good feedback from the sales
channels. It's being tested by four potential customers, and we won't see
the result until the second half. Overall, as we look forward, the
company's SAN [storage-area network] business is going to be a good one.
They provide the network-interface cards for shortage networks. There's a
lot of proprietary software involved, because unlike the Ethernet world,
where all the cards are relatively interchangeable, for the networking
companies this is a golden secret.
Q: How fast are they growing -- and what kind
of valuation are we seeing with the recent slide in the company's stock
price?
A: Their fiber-channel business -- fiber channel is a
standard way of connecting storage networks -- last quarter grew about 35%
to 40% and their SCSI [small-computer-system interface] business, which is
another standard, on which they built the company, has been in a slow
decline. The switching sector, which is still a small business for them,
should see explosive growth in the second half. Overall, for the next
couple of quarters you should see year-over-year growth of about 10%. And
after that, you should see stronger growth as some of their new businesses
kick in.
Q: So buy on the weakness, you
say.
A: I'm still upbeat on QLogic. Longer term, you are
still looking at 15% to 20% growth for the storage industry -- and I think
they will become a major force in the switching business at the
low-to-middle end of the market. Overall, you can return to 20%-plus
growth. The stock trades around 27. That's about 14 times this year's
expected earnings.
Q: Sounds cheap. Let's have another
name.
A: DSP Group. Their chips are in almost every
cordless phone. The company has been outgrowing the industry for years as
it continues to pick up market share. If you buy a Panasonic cordless
phone, which is the leading provider, with 40% to 50% of the market, the
guts of the product is from DSP Group. They provide the transceiver, the
receiver and the base-station technology, as well as the answering system
and the caller-ID stuff and the core logic that goes into these products.
It's a very good business, with a lot of older phones on the 900-megahertz
standard being replaced by 2.4-gigahertz phones, and a lot of old analog
phones wearing out and being replaced, as well.
Q: Who is the competition?
A:
When they started, it was Texas Instruments and Rockwell. But they
really dominate the market now.
Q: That's good. Except it raises questions
about how fast they can grow if they already control the
market.
A: They are just cracking the European market. They
said on their last conference call to expect a pickup in revenue growth in
the third and fourth calendar quarters as they start to get revenue from
the new European contracts they have signed. Also in the fourth quarter,
you will see them make their foray into cordless video phones.
Q: Is there a wi-fi wireless networking play
for them as well? Or Bluetooth?
A: Bluetooth is a standard
that's been widely adopted by the Japanese manufacturers, more so than by
users. But they do provide core Bluetooth technology, and if it takes off,
that would play well for them. The same goes for voice-over-IP [Internet
protocol] calling. They should do $181 million in revenue this year, and
the earnings estimate for this year is $1.06. They also have $12.67 a
share in cash.
Q: The stock is about $25 -- so half the
valuation is in cash.
A: Right, so if you take out the cash
and the related interest income, the stock is trading at about a 14
price-earnings ratio on this year's forecasted results. I think it's a
20%-plus grower for the next couple of years.
Q: Why hasn't anyone discovered the
stock?
A: In part, I think it reflects the fact that there
aren't many analysts covering the company. It doesn't conveniently fit in
with the guys who cover the cellular market or, for that matter, the
semiconductor market. It might also be related to the fact that while they
are headquartered here, the majority of their research and management
staff is based in Israel.
Q: Doug, onto the next.
A: A
company I like back in the enterprise-software world is Citrix
Systems. They provide software that lets you seamlessly connect to
disparate corporate systems remotely. It's fairly easy to use and to
implement. I think you are going to see a lot of MIS departments going in
their direction. On Wall Street, companies use the software to allow
remote access into corporate-communications systems. It provides the
required security, which financial firms are obviously focused on. It
allows you to dial into the corporate network and access multiple systems
within the company's computing architecture. It lets you operate remotely
as if you were in-house. But the software also lets you do things from
your own desktop in the office to move seamlessly across multiple
networks.
Q: What do the numbers look
like?
A: They have been growing at about 20% year-over-year
-- and you should continue to see fairly consistent growth. The stock is
around $20 and trades for about 22 times expected 2004 earnings. It has
been as high as $23-$24 in recent weeks.
Q: Let's have another.
A: In the
large-cap area, we like Flextronics, the largest player in contract
manufacturing. It has an unrivalled management team, led by CEO Michael
Marks, who's a great salesman.
Q: Has the contract-manufacturing business
recovered from the ugly downturn? After that, many companies in the
industry had huge capacity excesses.
A: Everybody in the
industry had to deal with those issues. When Flextronics came out of the
peak period, in fact, they were doing a tremendous amount of telecom
business -- that was their dominant sector.
Q: And the worst place to be when demand came
unglued.
A: Nonetheless, they were the first contract
manufacturer to show a business rebound, despite being in the most
difficult position due to the huge reliance on the telecom-equipment
business. They were able to pick up a lot of other business during the
downturn and take market share from the competition. In the fourth
quarter, for the first time in a while, contract manufacturers were
telling customers they were running out of capacity. In the most recent
quarter, they boosted revenue year-over-year by over 20%. But they are
less focused on revenue growth than they have been historically, and more
focused on adding to gross margins. So they are becoming a larger player
in the ODM business.
Q: ODM being original design manufacturer, in
which contract manufacturers also do the requisite design work.
Presumably, adding design work enhances margins. So what does the
valuation look like?
A: They are selling at about 23 times
this year's earnings expectations of about 71 cents a share. That number
is probably too low. The company has a market cap of about $9 billion,
which is about 0.5 times revenue. The stock is at about 16. I think you
could see it 30-plus a year from now.
Q: Flextronics has become a big player in
cellphone making. Do you see them as a play on continued growth in that
business?
A: I look at them as a play on the general pickup
in tech. But I also see a company increasing gross margins. As that
happens, you will start to see a different market-cap-to-revenue equation
for this company.
Let me just mention one more larger company --
Polycom, which is a leading provider of voice and video-conference
phones. We were a venture investor in the company. They are benefiting
from the spread of voice-over-IP. They make equipment both for
circuit-switched and IP calls.
Q: And the stock is cheap, I'd
assume.
A: It is. The company should earn at least 67 cents
this year. It has a market cap of about $1.9 billion. With the stock
around 19, that's about 29 times earnings. But they have nearly $600
million in cash and investments -- back that out and the multiple is about
20.
Q: On to the small-caps.
A: I
own a number of stocks with a similar profile -- smaller companies with
high cash positions. One example of that would be PCTel. PCTel's
core business today is focused on the wireless-communication business.
They provide 802.11-related [wireless networking] software called Segue
that almost all the major carriers are standardizing on as a way to
connect to a wireless network. Segue helps you find a network, and helps a
carrier manage the network with their client interface. It is becoming a
standard. They also have wireless security-software products, and antenna
products. They want to be a complete supplier of wireless products. They
have about half their valuation in cash -- a market cap of about $228
million and cash of about $107 million. Revenue this year will in the
mid-$50 million range. But they should be able to expand their base
business by more than 50%, and I would expect them to make small accretive
acquisitions.
Q: Very nice. How about another
one?
A: An incredibly inexpensive stock with an easy story
to tell is Keynote Systems, which I mentioned earlier. They have had about
nine straight quarters of positive cash flow. Their cash and real-estate
holdings are worth about $9 a share, or about 75% of the $12 stock price.
It's a service-oriented company that does Website-performance analysis. On
a net market-cap-to-revenue basis, it trades at about a multiple of two
times. You won't see explosive growth, but they are producing positive
surprises, with profit in the last quarter of six cents a share rather
than the three cents the Street had expected. For the year, they should
earn about 20 cents.
Q: Last chance for a long pick.
A: One company we like with the potential for explosive
growth is Ceva, which is hardly a household name.
Q: What do they do?
A: This
company provides core digital-signal processing technology to companies
like Samsung for wireless handsets and consumer applications. They are an
alternative to Texas Instruments, which is the market leader. This could
be a very large company in a year or two if they continue to execute on
their strategy. It is a little bit more expensive than some of the other
stocks I mentioned, priced at 2.5 times net sales.
Q: They make software, not
chips.
A: They are providing key core software development
for DSPs [digital signal processors]. The engineers inside these companies
are developing these custom parts. They are small. They'll do about $40
million in revenues this year. It could easily reach $100 million or more
in a couple of years. The company has a market cap of about $155 million,
with about $60 million in cash.
Q: You run a hedge fund, Doug, so we have to
ask you about short ideas.
A: Our best shorts over the
years have been frauds -- and we have found it is much more difficult
today, with the SEC and the New York state attorney general being so
aggressive, to find accounting frauds.
Q: What about overpriced stocks?
A: One short we have done as a pair trade is
PMC-Sierra, against our long with Marvell. We think Marvell has a
stronger opportunity in every way, with better management, faster growth
and greater opportunities. Marvell also trades at a lower multiple of
revenue. PMC is at 44 times net earnings, compared with 29 times for
Marvell.
Q: Doug, thanks for all the great
ideas.
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