Much can happen in thirteen years. Just ask a thirteen year old today.
Or ask a Vintage Ferrari collector about the prices back in 2000. Or look at EMC, Cisco Systems and Ebay and have followed their share prices. Ever wondered which were some of the most valuable companies back in 1999? Chances are it was a technology company. But the party did not last long. Earnings for these companies eventually slowed down and the Nasdaq composite corrected from 5000 reached in 1999 to 3400 today. The Nasdaq is still 32% below its all time high. Today the technology sector is more attractively valued. There might be expensive companies like Amazon and LinkedIn still around but both of them are growing their cash flow nicely and have strong revenue growth. Broadly speaking there is value within the technology sector. But investors, which were once in love with technology companies back in 2000, are not giving the sector much attention today.
To illustrate our point lets take a closer look at a former technology star EMC Corporation.
EMC did one thing well: Store data for its clients around the world. Fuelled by the growth of the Internet and data in general, EMC was growing its revenues and earnings at 30% in the late 1990s. The company was praised by analysts as being one of the ‘four horsemen’ of the Internet. But beginning in 2000/2001 companies had become more careful with their technology spending and EMC suffered dramatically. Revenues went from $8.8bn in 2000 and dropped to $5.4bn in 2002. With such a drop in revenues EMC posted a loss for the full year in 2002. EMC, which had been valued as high as $200bn was worth only $10bn by 2003. Eventually earnings slowly recovered for the technology giant as technology spending slowly returned. Furthermore in 2003 the company bought a little known company called VMware for $650m. That proved to be a very smart buy. Today VMware is worth $23bn, trades as a public company and EMC still owns over 30% of the company.
To understand just how things have changed from 2000, we have to look at valuations. EMC in 2000 traded for over 25x revenues and was worth north of $200bn. Today EMC has a market value of $50bn, in 2013 (closing year March) booked revenues of $22bn and net profits of $2.8bn. Operating cash flow for 2013 was $6.2bn. To put this in perspective EMC today trades for under 8x operating cash flow, and has price /earnings ratio of 12x forward earnings. EMC trades for a little more than 2x its latest 12months sales. As an added bonus shareholders of EMC get to carry an option on fast growing VMware which carries newer technology. So why are shares of EMC not being valued more highly by investors today?
The answer of course lies in the growth prospects going forward.
Back in 2000 EMC had operating margins of 30% and was growing revenues at 30% a year. Today EMC has operating margins of 11% and is growing earnings at 10%. So EMC’s growth has slowed down to a sustainable level. What makes EMC interesting though is that the company believes strongly in its future. It increased its share buyback to $6bn and started rewarding investors with a quarterly dividend of $0.10 which equates to a yield of nearly 1.7%.
Looking at EMC is good way to see what has changed during the past 13 years in regards to technology companies.
In 1999 investors could not bid EMC high enough. Today the company remains largely overlooked and trades for a little more than 2x sales and 8x operating cash flow. Clearly investors who bought EMC in 1999 at $80-$100 are not faring well today. But will investors do well in buying shares today at $23? The answer is not as straightforward as one might think. The growth in revenues and earnings at this once formidable data storage company has slowed and there is little reason with the economic uncertainty that growth rates will improve going forward.
There is also some concern that EMC has not kept up with technology changes, cloud computing has taking much growth away from EMC and companies like Salesforce Software, Amazon are better positioned there. Think of how many technology companies no longer exist today (or are largely irrelevant) but once dominated their industry. Digital Equipment Corporation, Compaq Computer, Nokia, NCR the list goes on and on. EMC could be another such example. But EMC has a strong balance sheet and therefore has time on its side. It also owns a large stake in a company that is still growing strongly (VMware). Also EMC believes in its own future by buying $6bn of shares back- that is always reassuring for investors to see.
Lastly I believe in following the ‘smart money’. Paul Singer who runs one of the most successful hedge funds Elliott Management, with $22bn in assets just bought a 4% stake in Network Appliance or Netapp, which is a main competitor to EMC. Why is Paul worth paying attention to? Well he only lost money in two years since founding Elliott in 1977. That is a track record worth noting.
