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Opportunities in the global tech sector

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Jul 4 – 10, 2016.
Published on The Edge Markets on Jul 14, 2016

In the past two years, the global technology sector has enjoyed a bull run almost similar to the dotcom boom of 15 years ago. This year, tech stocks have taken a hit and investors are starting to worry the sector could be seeing its next bust cycle.

However, the prevailing view is that a tech bust is not going to happen anytime soon. In fact, many fund managers believe the sector will continue to provide exciting opportunities.

Devan Linus Rajadurai, founder and chief investment officer of Malayan Traders Capital, for one, does not see a bubble forming in the US tech sector. He believes it is a good time for investors to buy “legacy and established” tech companies such as Apple and Microsoft. Legacy companies, he says, are those whose products and services are already a part of people’s lives, such as Apple’s iPhone, Google’s search engine and Intel’s chips.

Malayan Traders Capital’s Absolute Return Fund has about RM100 million under management, 41% of which is invested in global tech companies. As at May 12, the fund — which is domiciled in the Cayman Islands — had generated a return of 44.4% since its inception in June 2012.

Indeed, in the last two years, companies such as Apple and Microsoft had seen their stock prices increase by more than 60% while new tech firms such as Netflix and LinkedIn were trading at PERs of more than 100 times.

However, things changed early this year. Netflix’s shares plunged 23% in January while LinkedIn’s shares fell almost 50% on Feb 4 alone.

In April, Apple and Microsoft saw their share prices drop 17% and 10% respectively after posting disappointing quarterly results. Alphabet, the parent company of Google, also saw its share price decline as earnings came in below market expectations.

“There has been a huge overvaluation of social media or ‘web-based’ companies such as LinkedIn and Netflix. LinkedIn was loss-making and the shares were trading at a high price before they crashed. The company was acquired by Microsoft on June 13,” says Devan.

“Investors of unlisted companies such as Uber and Evernote are largely private venture capital firms. And if you look at the total assets of these firms, the number is small relative to the whole asset management industry. So, if these few companies go bust, it will not affect the global market.”

Netflix was trading at a PER of 316.07 times on the Nasdaq as at June 24, according to Bloomberg data. LinkedIn was trading at a PER of 1,189.5 times last year and its estimated PER for this year is 906.29 times. The average PER of the Nasdaq Composite Index was 29.53 times as at June 26.

Grant Bowers, vice-president and portfolio manager of the Franklin US Opportunities Fund, a feeder fund launched in Malaysia, does not expect a bubble to form in the US tech sector either. “We don’t see a bubble forming. We hold a long-term and positive outlook for the sector,” he says.

The Franklin US Opportunities Fund feeds into a target fund of the same name. According to the feeder fund’s fact sheet as at April 30, four of its top 10 holdings were tech stocks — Alphabet, Facebook, Amazon and Apple.

Positive Long-term Outlook

Bowers says now is a good time to invest in US tech companies with high quality growth, superior profitability and meaningful competitive advantages, with the right valuation. The growth in the tech sector is expected to be driven by companies’ continued investment in technological improvements to remain competitive.

“Despite this year’s pullback, we still have a positive long-term outlook for tech companies as the growth outlook remains strong, with a tremendous amount of changes likely to take place in the next few years. The tech sector has always experienced bouts of volatility. But historically, these events have been excellent buying opportunities for investors,” he says.

“The outlook remains because companies’ spending [on technology] remains strong as many have realised that investment in technological improvements are required to remain competitive in the global marketplace. New software, factory automation and data analytics can all improve productivity and lower production cost for companies, thus keeping them ahead of their competitions.”

The Franklin US Opportunities Fund has generated a return of 26.24% since its launch in May 2013. However, it had posted a return of -7.33% in the 12 months ended April 30. Alphabet and Facebook were its top two holdings at 4.53% and 4.28% respectively.

“Alphabet is the world’s leading search engine and the largest beneficiary of the ongoing shift from traditional to digital advertising. Facebook is the world’s largest social media company with more than 1.6 billion monthly users worldwide. The Facebook network is scalable and growing rapidly. It will continue to monetise its large user base in the years ahead,” says Bowers.

Devan says the plunge in share prices has presented investors with a good opportunity to buy into tech companies such as Apple and Microsoft. These companies have strong balance sheets and cash flow and will continue to generate profits by selling smartphones in emerging markets such as China, India and Indonesia, he adds.

Meanwhile, an analyst with a local fund management firm who covers technology stocks says he does not see much upside for the global tech sector going forward. That is because companies are already cutting their supply of smartphones as demand has reached a peak this year.

“The tech sector has had a bull run in the past two years and there is an oversupply situation in terms of hardware, especially smartphones. The market is saturated and the big boys are cutting down on their supply,” he explains.

But Devan does not think so. He believes that despite the saturated smartphone market, sales could expand further on the back of untapped demand from emerging markets such as China, India and Indonesia.

The analyst points out that sales of hardware such as personal computers have also dropped in recent years. “The demand in the hardware space has slowed and I do not see many catalysts in the short term. Virtual reality and electric vehicles can be the new catalysts for the industry, but over the long term.”

However, Devan says the overall tech sector, which includes software products and web-based services, is actually seeing growth. “If you look at the revenue generated by major tech companies around the world, it is growing.”

Cloud computing the next growth catalyst

One of the things that will boost the earnings of technology companies, says Devan, is the rising demand for cloud computing technology, which allows users to store and access data on the internet.

“Cloud businesses, which provide data storage services and online server capacity, are growing at more than 20% per annum. That is one reason Microsoft is still doing well,” he says.

Devan is referring to the Worldwide Semi-annual Public Cloud Services Spending Guide produced by International Data Corp, a US-based market research, analysis and advisory firm that specialises in IT. It projects worldwide spending on public cloud services to grow at a compound annual growth rate of 19.4% over the next four years.

The higher demand for cloud computing solutions can be seen in the profits generated by Microsoft’s cloud products Azure and Office 365. Another indicator of the huge potential of the cloud is the services provided by Amazon Web Services Inc (a subsidiary of, which saw a revenue of US$7.88 billion in 4Q2015, up 69% from the previous corresponding period, based on its recent earnings report.

Apple is one of Devan’s favourite stocks. It was trading at US$96.10 per share, with a PER of 10.74 times, on June 24. The share price had fallen dramatically since the company’s quarterly results were announced on April 26.

Apple’s revenue had fallen for the first time in 13 years as iPhone sales declined for the first time ever. Two days after the results announcement, billionaire investor Carl Icahn sold his stake in the company after expressing his concerns over the attitude of the China government, which could make iPhone sales “very difficult”. Apple shares subsequently dropped 9.12% to US$94.26 per share.

Devan says the stock is looking attractive as Apple is sitting on US$200 billion cash while generating US$40 billion every year. “The company has a market capitalisation of US$500 billion. It has US$200 billion on its books and every year, it makes US$40 billion cash. This shows it is a good investment and that is why Berkshire Hathaway bought into it. It knows the market sometimes does not understand tech stocks.”

He says one of the reasons iPhone sales have been affected is because Chinese consumers are holding back on the purchase of the current model and are waiting for the iPhone 7, which is expected to be launched later this year. “While waiting for that to come out, they are buying the cheaper Huawei or Oppo smartphones. When the iPhone 7 comes out, Apple’s earnings will increase. I am sure that the smartphone will be big in China as the consumers there like highly innovative products.”

The company, meanwhile, has rolled out the cheaper iPhone SE targeted at the emerging markets.

New technology trends gaining traction

Richard Clode, fund manager of the Henderson Global Technology Fund, says while he likes established companies such as Apple and Alphabet, he plans to use the returns generated from some of these companies to invest in those that are riding new technology trends. The trends include the contactless payment card, keyless entry system for cars and electron-beam inspection for semiconductors.

The Henderson Global Technology Fund is the target fund of TA Global Technology Fund, which was launched in Malaysia by TA Investment Management Bhd in 2011. As at April 30, the feeder fund had

RM68.91 million under management and had generated returns of 3.81% and 56.51% over a one and three-year period respectively.

Clode has invested in Netherlands-based NXP Semiconductors, which is riding the theme of the contactless card and keyless entry. Hermes Microvision Inc, which is based and listed in Taiwan, is another company he is following closely for its development of electron-beam inspection.

“NXP Semiconductors was spun off from Philips Semiconductors and is listed in the US. Recently, it merged with Freescale Semiconductor to become one of the top five non-memory semiconductor companies. NXP is riding on a couple of themes, including the contactless card and keyless entry [system] for cars, which it is very strong at. The keyless system is an especially new area in the automotive industry, which will see automated driving become more common in the future,” says Clode.

“We think the company is very attractive. It is generating a lot of cash flow through share buybacks and we are hope that it will give out dividends for the next year.”

Contactless cards refer to debit or credit cards that allow consumers to make a limited amount of payment (€15 to €30 in Europe) by touching them to a reader without the need for a personal identification number or signature. These cards are gaining traction in the US and Europe as they speed up transactions.

The remote keyless entry system, such as the passive entry system developed by NXP Semiconductors, allows a car to recognise the driver and automatically unlocks the door as he approaches. The system can also lock the car, turn off the lights and enable the alarm when the driver leaves the car. Clode says this technology will be popular in the coming years as electronic and automated driving will one of the key trends in the future.

Clode says Hermes Microvision is another diamond in the rough. “The company is the leader in the electron-beam inspection space, and that is very rare for a tech company in Asia. When we find gems like this, we spend time with them as there is a great opportunity for us to invest.

“Historically, electron-beam inspection was used for R&D purposes, not mass production. What the company is trying to do now is get it to mass production. The defects in semiconductors are getting harder to detect optically, so electron-beam inspection could have huge potential in the future. That is what we are investing in — the long term.”

Tencent Holdings Ltd, which launched WeChat and Weibo, is another company Clode likes. It is one of the largest internet companies in Asia and only a quarter of its revenue is derived from advertising, compared with Facebook’s 90%. There is still room for Tencent to grow its advertising revenue, he says.

Visual Reality is another company that could take off in the future “if it is done well”, says Devan. “I can’t predict its earnings [once it takes off]. But it could be really big. It will take over the entertainment space — people will use it to watch movies and surf the web.

“It is like the tablet. Microsoft came out with its tablet and failed. But when Steve Jobs created the iPad, it worked. It is the same with virtual reality. If these guys [Oculus Rift, HTC and Sony] find the right formula to do it correctly, they could move into the TV space. But if they do it wrong, then it could be like Microsoft’s tablet. However, to invest in them right now would be a complete gamble.”

Malaysian players to benefit from global trends

On the local technology scene, Devan Linus Rajadurai, founder and chief investment officer of Malayan Traders Capital, says the companies here are mostly original equipment manufacturers that provide semiconductor parts for the big boys.

“Most of the so-called tech companies in Malaysia or Southeast Asia are manufacturers. If you want to get the whole value chain, you can only get it in the US or China. The opportunities for retail investors, however, are in the global tech companies listed in the US as China remains a protected market,” he says.

Richard Clode, fund manager of the Henderson Global Technology Fund, concurs with Devan, saying that tech companies in Asia are very focused on manufacturing electronic hardware. The key drivers of their earnings are usually the smartphone sales of the big boys such as Apple and Samsung.

“I think this is very much the case for Asian technology. There are generally personal computers and smartphone related. PCs are having a terrible time and the smartphone market is saturating — there is more competition and companies’ pricing power is under pressure. This is why we underweight Asian tech,” says Clode.

Meanwhile, a technology analyst with Hong Leong Investment Bank says although the global smartphone market has saturated, it is still growing. This provides a solid foundation for local tech companies to expand their business further.

Data provided by Gartner Inc, a US research and advisory firm that provides IT-related insights, shows that worldwide combined shipments for devices, including personal computers, tablets and mobile phones, are expected to reach 2.4 billion units this year. Global smartphone sales alone are estimated to reach 1.5 billion units, or 7% growth from last year.

Growing global trends such as automated driving will benefit local companies such as Malaysian Pacific Industries Bhd (MPI) and Unisem (M) Bhd, which manufacture microchips.

“I like MPI. More than 20% of its business is in the automotive sector, providing semiconductors and microchips for new technology such as keyless entry. I expect its next financial results to be strong,” says the analyst.

Kong Heng Siong, RHB Investment Bank’s equity analyst who covers the tech and gaming sectors, says local tech companies are currently not involved in global trends such as cloud services and contactless cards. However, the “smart car” trend could be more relevant to the local players.

“The smart car is about providing convenience to passengers. One of the examples is the tyre pressure monitoring system available in some luxury cars. We also expect to see greater adoption of sensors in the automotive industry [which will benefit these players],” he says.

The electronic tyre pressure monitoring system is designed to monitor the air pressure inside pneumatic tyres on various types of vehicles. It is aimed at helping car users better maintain their tyres to avoid accidents on the road.

Kong says RHB Investment is largely neutral on local tech companies over the near to medium term as Brexit could give rise to concerns about a potential slowdown in the overall semiconductor demand, which largely depends on the global economic outlook. “However, we expect all semiconductor players, such as MPI, Unisem, Globetronics and Inari Amertron, to benefit from these trends once they take off globally.”

Technology funds available to local investors

The TA Global Technology Fund is the only unit trust fund for local retail investors that invests in the global tech sector. The feeder fund feeds a minimum of 95% of its net asset value into the Henderson Global Technology Fund.

The minimum initial investment amount for the TA Global Technology Fund is RM1,000. There is a 5.5% sales charge and an annual management fee of 1.8%.

Local investors can also invest in global tech stocks through Malayan Traders Capital’s Absolute Return Fund. The fund has about RM100 million under management, 41% of which is invested in global tech companies.

However, the fund is only available to qualified investors with a minimum investment amount of RM500,000. The fund charges a 1% management fee and 20% performance fee on the profit above the high watermark of its net asset value. There is no sales charge.

Qualified investors can also look at the Franklin US Opportunity Fund, a wholesale feeder fund that has 37% equity exposure to IT companies in the US. The fund has generated a cumulative return of 29.64% since its inception on May 23, 2013. There is a minimum initial investment amount of RM10,000, a 5% sales charge and an annual management fee of 1.75%.

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