Thursday, June 6, 2013

Why Carlyle Avoids Tech and Telecom Investments

Yesterday I wrote about my lunch with Bill Conway, CEO of the Carlyle Group.

In the course of our meeting, Conway mentioned that while Carlyle had widespread expertise in a variety of investment alternatives, there were two sectors that they avoided:  technology and telecommunications.

The latter was interesting - prior to Carlyle, Conway had been chief financial officer at MCI from 1984-87, which at the time was a rapidly growing telecom business.  However, Conway felt that the telecom business was too much of a commodity business - and was too capital intensive - to offer significant long-term investment opportunities.

The deliberate avoidance of technology companies was striking as well. However, the more I thought about it after the meeting, I can see why.

Although we all would like to discover the next Apple, the odds are significantly stacked against it.  The lifespan of a typical technology company tends to be fairly brief. For example, only 17% of the tech companies started at the height of the tech bubble in 2000 were still in existence by 2009, according the Bureau of Labor Statistics.

Like most private equity companies, Carlyle makes its investments based on what they believe are reasonable expectations for future business growth.  In technology, however, the incredibly rapid pace of change makes this almost impossible.

I was reminded of this even more yesterday, when I had the chance to listen to Brent Thill, technology software analyst at UBS.

Brent is one of the better analysts the space, in my opinion, but boy this is a tough sector to get right!

For example, the news has recently been full of the huge threats to cyber-security.  The U.S. and China are engaged in a very loud and public argument about hacking, with both governments on both sides accusing the other of not only stealing trade secrets via the internet but also harming the data flow on the web.

So, you would think that any company involved in internet security would be rocketing higher.  However, that has not been the case.  Here's the YTD (through June 3) returns of the internet security software companies that Brent follows relative to S&P 500:

Check Point                            + 5%
Fortinet                                   -12%
Palo Alto Networks                -14%
Sourcefire                              +15%
Symantec                                +19%

S&P 500                                 +15%

In other words, in what should have been the hottest part of the software sector - security - only one stock was ahead of the market, and two others were losers.

The problem, according to Brent, is that software purchases and installation tend to take time, so any new orders will not show up in financial results for several quarters.

The other problem is that some of the large tech companies - most notably IBM and Oracle - are aggressively offering holistic solutions to companies which large data needs.  These companies will not only offer security, but will also include numerous other data management solutions that could make the life of a company's CIO more comfortable.