Under the radar ‘old tech’ offering multiple ways of winning

Technology is undoubtedly today’s most discussed investment sector, with the high-profile FAANGs front and centre of most conversations. While the FAANG stocks, as well as the theme of disruption, continues to attract most of the investor attention, it is important to recognise the opportunities within the diverse tech sector run far deeper.

In fact, the fervour to be on the right side of the change during this disruption age has distorted the valuations of many stocks within the tech space – with valuations of the perceived winners driven to excessive levels, at the expense of many fundamentally sound businesses.

We have witnessed numerous examples of this in recent times and have taken the opportunity to buy into many high-quality businesses trading cheaply relative to any reasonable assessment of medium term prospects.

At Antipodes Partners, our investment approach looks to take advantage of the market’s tendency for irrational extrapolation around change. At the core of our philosophy, we seek in our long investments both attractively priced businesses offering a margin of safety, as well as investment resilience characterised by multiple ways of winning.

Below are three attractive, largely under the radar, tech stocks we believe offer investors multiple ways of winning:

Qualcomm
Qualcomm invented many of the technologies at the heart of the communications revolution over the past 25 years. It operates as two businesses – licensing and technologies. Licensing generates revenue by charging device manufacturers for the use of Qualcomm’s intellectual property. This is typically a stable, high-margin business.

However, Qualcomm and Apple’s relationship soured in 2017, to the point where Apple began to withhold licensing payments. Apple’s decision caused a steep decline in revenues in Qualcomm licensing, as well as higher legal costs to protect its IP position. While we do not have specific insights into how a court might ultimately adjudicate, we would be surprised if any court could determine Apple should somehow be treated differently from others in the industry. A commercial agreement is likely to be reached, which would restart Apple’s payments and provide a one-time payment for withheld royalties.

Qualcomm’s technologies business supplies chips to power mobile devices. This business has the leading market position in a highly consolidated industry with extremely high and growing entry barriers. Intel has just been scrapped as a modem supplier from the 2020 iPhone and the other two leading players, Mediatek and Samsung, are still behind on performance innovation, as evidenced by the fact Samsung still uses Qualcomm’s products in the high-performance Galaxy range of smartphones. Qualcomm has been historically undermanaged, with margins significantly below what we believe achievable given Qualcomm’s scale. Semiconductor peers with similar dominance routinely generate operating margins above 20%, versus Qualcomm’s more recent levels in the mid-teens. Further evidence of Qualcomm’s portfolio and industry position were provided last year, when rival semiconductor company Broadcom unsuccessfully bid for the company.

We see multiple ways to win over the next three years – including the settlement of outstanding disputes with Apple and the initial ramp of 5G technologies, where Qualcomm should naturally lead, as well as a much sharper focus on margins and return on capital driven by the scare Broadcom provided. Qualcomm’s natural cash generation affords the company a near 5% dividend yield, a rarity for tech companies, while we ultimately believe the uncertainties weighing on the shares will be resolved by early 2019. At this point the market is likely to embrace Qualcomm’s true earnings power, with its share price potential above $90 a share.

Netapp
NetApp, one of the two dominant providers of enterprise storage systems over the past two decades, is a good example of sentiment temporarily trumping reality. The rise of Amazon’s public cloud services, part of which comprised cheap commodity storage, began to eat into the market for dedicated storage vendors such as NetApp.

While this market shift was indeed real, the market by early 2016 had become convinced traditional storage was dead and NetApp’s shares traded at just 4x free cash flow. Fast forward two years and NetApp’s business has evolved substantially. With the accelerated introduction of a new operating system that integrates well with hyperscalers Amazon Webservices, Microsoft Azure and Google Cloud, the company has leveraged this to become the fastest growing company in the ‘all flash’ storage segment, with hard disks giving way to solid state flash memory for many high end corporate and web-scale environments.

Cisco
Until recently, Cisco’s shares traded at less than half the valuation of comparable companies. The growth of web-scale vendors has placed different demands on networking providers – with the growing client preference for customised, rather than out of the box, solutions. It is entirely within Cisco’s capabilities to address this need, as few are better resourced or know more about networking than Cisco.

Cisco’s business model is also evolving as it layers deeper software capabilities into its solutions, providing a pathway to deliver its technology stack via subscription, rather than product sales. While this has created a short-term headwind to reported growth, it will significantly grow customer lifetime value as subscriptions are adopted. For now, Cisco’s valuation offers a significant margin of safety and recent tax reform has provided a further boost.

Jacob Mitchell, portfolio manager and CIO of Antipodes Partners

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