Monday, March 10, 2014

Tech Cliffs

Over on Twitter, Joe Magyer asks a great question:

I have an answer here. I do not think its about being cool. I think its firstly about admitting one's limitations which I find refreshing. This is unique to value investors. Whereas lots of investors try to predict the future of solar or nanotech or biotech, value investors are ok with saying "I don't know." To Joe Magyer's point we should not revel in ignorance, but as investor its certainly good to know your limitations.

Next, I think when many value people say "I don't know tech" what I think they really mean is - I cannot predict who will win. They feel comfortable that P&G and Pepsi will still be selling Tide and Frito's but who will win the Cloud? Hard to say ten years out.

Consider the Dividend Compass Cup (a hypothetical competition for ranking dividends), the two finalists were Microsoft and Baxter. Cash cows today with shades of gray on the horizon.

I think you can look at a lot of tech like pharma. And its no coincidence they trade for similar valuations. You look at GSK, Baxter and the like and you compare them to Microsoft, Cisco, and the like and what do you see? Low valuations, great margins, nice dividends. Why is that?

I think in both cases you have a "cliff" problem. With big pharma, the patent cliff is a very well known problem, when generics come in, sales and margins get hit. What about tech? With tech there is not a FDA imposed cliff, but there are cliffs for sure - competition.

Look at Cisco. They have problems with growth in emerging markets in general and in China specifically. They have the threat of very smart competitors like Juniper. They have the threat of shrinking IT shops (i.e the Cloud). They have the threat companies like Google and Facebook building their own gear from scratch. That is a lot of threats! The certainty of an FDA cliff which you can at least plan for, looks enviable by comparison.

So I don't think its so much of case of willful ignorance as much as it is recognizing that its a hard space for anyone to predict. Having said that Buffett bought into IBM. Makes sense, its as much an Accenture-services type play as a tech company these days. Buffett commented that once he saw how entrenched IBM was at BNSF that was a factor. And Don Yacktman's been buying up Microsoft, Oracle and Cisco (though he says he likes the other Sysco better). So it looks like for the opportunity and the right price exceptions are being made by value investors.

But I think Yacktman is right to prefer the other Sysco. There is value in big tech today but it makes sense to remember that tech cliffs are out there. When was the last time you used a Wang computer? How are DEC sales these days?  To stay ahead leaders are forced into all manner of deals, look at WhatsApp, look at Google and Waze. Some will work out, but its hard to know at the time. And forget about speculative deals, just look at Blackberry's run from ubiquity to irrelevance.

Tech is a business where you are riding the bear, you cannot tell it where to go, all you can do is hold on. Tech is a massively important industry for society but for investors it deserves a discount to account for the inability to predict too far out where cliffs are and which ones to worry about.

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