Tech: a second-half story

December 25, 2000: 7:00 a.m. ET

Earnings weakness, volatility likely to persist through first half of 2001
By Staff Writer Richard Richtmyer

NEW YORK (CNNfn) - The technology bubble burst in 2000, and the aftershocks from that implosion are widely expected to extend throughout the first half of 2001.

A slew of fourth-quarter earnings warnings that recently rolled in from big-name tech companies such as Intel (INTC: Research, Estimates), Compaq (CPQ: Research, Estimates) and Microsoft (MSFT: Research, Estimates) underscored the impact of the slowing U.S. economy on the PC industry.

Meanwhile, recent warnings from companies such as Internet advertising firm DoubleClick (DCLK: Research, Estimates), as well as the steady flow of news about the demise of one dot.com after another, effectively ended the debate about whether Wall Street had been overly optimistic about the promise of the Internet and the dawning of a "New Economy" where the old rules just don't apply.

So is the worst over in the tech sector? Well, not quite. Most market observers are expecting things to get worse before they get better.

Revenue, earnings growth slowing
Wall Street analysts have substantially lowered their expectations for tech companies' profits in the coming months, according to First Call Corp., a research firm that tracks corporate earnings projections and trends.

For the first quarter of 2001, analysts on average expect profits in the technology sector to rise 8.4 percent. That's a drastic decrease from expectations only several months ago of first-quarter earnings growth closer to 28.2 percent.



	Start to think about the second half to load back up on technology stocks.



	Chuck Hill First Call

Meanwhile, analysts reduced their second-quarter tech-earnings growth forecasts to 4.3 percent, from the 10.9 percent growth rate they previously anticipated, according to First Call's survey. For all of 2001, they expect profit growth in the neighborhood of 13.5 percent, compared with a previous projection of 23.8 percent.

"The story on slowing earnings growth and revenue growth is not over," said First Call research director Chuck Hill.

"You're just now getting the fourth-quarter story," he said. "Wait until you get the first-quarter and the second-quarter stories for next year, and then start to think about the second half to load back up on technology stocks."

Steve Milunovich, technology strategist at Merrill Lynch, agreed. In a recent report, Milunovich noted that growth in the technology sector likely will moderate in the first half of 2001. The market currently is in the "second quarter of what is typically a six-quarter profit moderation," he said.

Among other segments, he said PC unit growth could slow to 15 percent and communications equipment "may remain under a cloud" until it becomes clearer when telecom companies will begin spending again.

"We expect the first half of 2001 could be difficult with fundamentals and stock prices improving in the second half," Milunovich said. "The question now is: 'Hard landing versus soft landing?'"

So should you avoid tech altogether?
With lingering questions about the economy and continuing signs of slowing in the PC segment, most market watchers agree that the list of opportunities in the tech sector is narrowing. But that doesn't mean they recommend avoiding tech altogether.

Instead, they are advising investors to keep their eyes on those companies offering products and services that will enable other tech firms to operate their businesses more efficiently.

"If you feel like you want to shift money around but keep it in the tech sector, you might shift it to the electronics manufacturing service companies like Solectron and Flextronics," said Ulric Weil, technology analyst at Friedman Billings Ramsey & Co.

Electronics manufacturing services, or EMS, companies build products such as wireless phones and PCs, and provide aftermarket services as well as supply-chain management for big-name tech companies such as Compaq and Motorola.

By farming out their manufacturing to contract manufacturers, technology firms save money, reduce the time to get new products to market and benefit from the EMS companies' economies of scale. While there already has been a trend toward outsourcing, Weil said that might accelerate in a slowing economy.

"Everybody is trying to save money, and they can do that by outsourcing their assembly, repair and service business to these outsourcers, who are much more efficient than they are," he said.



	These companies are like mutual funds of their customers and generally don't have huge customer concentration issues.



	Jim Savage Thomas Weisel Partners

Jim Savage, who tracks the contract manufacturing industry for Thomas Weisel Partners, noted that while these firms are not immune to an economic slowdown, a weakening economy does indeed prompt more outsourcing. He also noted EMS companies are somewhat insulated from earnings risks because they typically have a broad base of customers producing a wide range of products.

"These companies are like mutual funds of their customers and generally don't have huge customer concentration issues," Savage said. "If one customer, or even one segment, does poorly, they can overcome that with strength in another."

The top five EMS companies are: Solectron (SLR: Research, Estimates), Flextronics (FLEX: Research, Estimates), Celestica (CLS: Research, Estimates), SCI Systems (SCI: Research, Estimates), and Sanmina (SANM: Research, Estimates).

Companies that provide supply-chain management, customer relationship and e-commerce software also represent some of the better opportunities in technology in the coming months, according to Bill Gramas, a software analyst at Gruntal & Co.

"Because they enhance productivity and efficiency, supply-chain products would be embraced even more in an economic slowdown," Gramas said.

By 2004, Gramas said the market for supply-chain management solutions and services is expected to be roughly $20.3 billion. He recommends I2 Technologies (ITWO: Research, Estimates) in that segment.

Other software stocks Gramas expects will perform strongly in the coming months are Siebel Systems (SEBL: Research, Estimates) in the customer-relationship and marketing segment, and Ariba (ARBA: Research, Estimates) in the e-commerce area.

* Disclaimer