Thursday, November 14, 2013

Buying Tech Stocks

I wrote last week about the difficulties of developing a winning investment strategy in technology stocks.  More examples can be found in recent news reports.

The pace of change in tech is, of course, astonishing.  Here for example is an excerpt from an article in this morning's New York Times about the incredible processing power that is now offering on a subscription basis through something they call "Amazon Web Services" (I added the emphasis):

...On Tuesday, a company appearing at the Amazon conference said it had run in 18 hours a project on Amazon’s cloud of computer servers that would have taken 264 years on a single server

The project, related to finding better materials for solar panels, cost $33,000, compared with an estimated $68 million to build and run a similar computer just a few years ago. Akin more to conventional supercomputing than {IBM's} Watson’s question-and-answer cognitive computing, the project was the first of several announced at the Amazon conference. 

“It’s now $90 an hour to rent 10,000 computers,” the equivalent of a giant machine that would cost $4.4 million, said Jason Stowe, the chief executive of Cycle Computing, the company that did the Amazon supercomputing exercise, and whose clients include The Hartford, Novartis, and Johnson & Johnson. “Soon smart people will be renting a conference room to do some supercomputing.” 

Little wonder, then, that the most valuable companies in the technology area that have little or no profitability, murky revenue outlooks, yet are offering users capabilities that few thought available just a few years ago (e.g. Twitter).

Still, it is almost mind-boggling to see the young entrepreneurs who started the instant message service Snapchat turn down $3 billion from Facebook.

While Snapchat is hugely popular among millenniums,  the company has no revenue or profits.  Moreover, it is not clear how they will be able to monetize its current popularity:

What business makes no money, has yet to pass its third anniversary and just turned down an offer worth billions of dollars? Snapchat, a social media service run by a pair of 20-somethings who until last month worked out of a beachfront bungalow in Venice, Calif...

The service, started in 2011 by Evan Spiegel, 23, and Bobby Murphy, 25, two former Stanford fraternity brothers, lets users send photo and video messages that disappear after they are viewed. Snapchat quickly gained a reputation as an easy way to send sexually suggestive photos, but it also picked up steam as a fun and easy way to trade photo messages. 

The company has in recent months become one of the most sought-after businesses in the tech industry, getting attention from top Silicon Valley companies and venture capital firms, as well as international technology companies. 

Interestingly, Fortune magazine's technology columnist Dan Primack thinks that Snapchat was right to turn down a multi-billion dollar payday:

Facebook's original offer was said to be for between $1 billion and $2 billion, but today the WSJ is reporting that Zuckerberg later raised the stakes to $3 billion. And was still rebuffed!

At first blush, it seems ridiculous. A pre-revenue company founded less than three years ago turns down a deal that would value it at 3X what either Instagram or Tumblr got...

...Snapchat and its investors seem to believe that this company is the next generation of social networking -- not an add-on to the dominant incumbent. Snapchat is about immediate/disposable communication, not permanent record-keeping...

In other words, Snapchat is providing its users exactly what existing services like Facebook and Twitter and Tumble are not. Not surprisingly, some people close to the company say that Snapchat's depth of engagement is off the charts. Sure the core technology itself is fairly simple. So is Twitter's (TWTR) -- a company that also wasn't monetizing 2.5 years into its existence.

Meanwhile, back in "old" tcch, companies like IBM, Oracle and Microsoft are trading at multi-decade lows.  Here's JP Morgan strategist Thomas Lee as quoted on CNBC:

{Lee} sees opportunities in low PE, mega-cap tech names like Microsoft, IBM, Cisco Systems, Oracle, EMC, even Hewlett-Packard—saying more than half the group are "under 12 [times earnings]." 

"It reminds of the pharma trade a few years ago. People looked at these low multiples, these cliffs, and thought it wasn't worth buying. And then they were great stocks," he said.

In other words, the current winners in the tech space seem to be inversely correlated with profitability.